Post on 25-Dec-2015
1© 2013 PFM Asset Management LLC
Fixed Income Security TypesMarco Island
May 5, 2014
Presented by:Michael R. Varano, Managing Director and Senior Portfolio
Managervaranom@pfm.com
PFM Asset Management LLC300 South Orange Avenue, Suite 1170
Orlando, FL 32801
2014 Spring Education Forum
Florida Tax Collectors Association
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Types of Fixed Income Securities
• U.S. Treasury Bills• Federal Agency
Discount Notes• Commercial Paper• Bankers’
Acceptances• Repurchase
Agreements• Certificates of
Deposit• Money Market
Mutual Funds
Money Market Bonds• U.S. Treasury
Notes/Bonds• Federal Agency
Notes/Bonds• Mortgage Backed
Securities• Corporate Notes• Mutual Funds (aka Bond Funds)
Mature in < 1 Year
Mature in > 1 Year
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Credit Ratings
S&P Moody’s Explanation of Rating
AAA Aaa High quality. Smallest degree of investment risk
AA Aa High quality. Differs only slightly from highest-rated issues.
A A Adequate capacity to pay interest and repay principal.
BBB Baa More susceptible to adverse effects of changes in economic conditions.
BB Ba Has speculative elements; future not considered to be well-assured.
B B Generally lack characteristics of desirable investment.
CCC Caa Poor standing. Vulnerability to default.
C C Extremely poor prospects.
D D In default
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• U.S. Treasuries
• SLGS
• Federal Agencies
• Mortgage Backed Securities
Security Types
U.S. Government MunicipalsCorporates
• General Obligation Bonds
• Revenue Bonds
• Commercial Paper
• Bankers’ Acceptances
• Corporate Notes
• Certificates of Deposit
Mutual Funds
Repurchase Agreements
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Issuer: U.S. GovernmentCredit Quality: “Risk Free”Liquidity: High (active market)Custody: Federal Reserve (Book entry)
U.S. Treasury Obligations
Type Term to Maturity Interest Price Quotes Maturity
BILLS 1, 3, 6, 12 months Interest at Maturity Discount (Not equal to yield) Thursdays
NOTES 2-10 years Semi-Annual Coupon Price per $100
15th or last day of monthBONDS 10-30 years Semi-Annual Coupon Price per $100
STRIPS 3 months-30 years Interest at Maturity Discount (Not equal to yield)
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Issuer: Federal agencies Government sponsored enterprises (GSE)
Credit Quality: Most are AA+ (S&P) / Aaa (Moody’s)Most do not carry explicit U.S. Government guarantee (full faith and credit)
Term of Maturity: 1 day to 30 years Liquidity: Generally high, but depends on structureCustody: Federal Reserve (Book entry)Return: Higher than U.S. Treasury obligationsCaution: May have complicated structures
May be callable
Federal Agency/GSE Obligations
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• Fannie Mae (previously, Federal National Mortgage Association)
• Federal Home Loan Banks (FHLB)
• Freddie Mac (previously, Federal Home Loan Mortgage Corporation)
• Federal Farm Credit Banks (FFCB)
• Government National Mortgage Association (GNMA or “Ginnie Mae”)
Most Common GSE Issuers
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Repurchase Agreements
• An agreement in which an investor buys securities from a counterparty who agrees to buy the securities back at a later date at an agreed upon price and rate
• Yield determines the “repurchase price”
Investor Counterparty
Transaction Begins
Transaction Ends
Cash
SecuritiesDelivery vs. Payment
Securities Returned to broker/dealer who “re-purchases” them
Cash + Interest
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Repurchase Agreements
Issuer: Banks and brokerage firms
Credit Quality: Varies
Term of Maturity: 1 day to several years
Liquidity: Generally none prior to maturity
Custody: Book entry (collateral)
Return: Generally higher than Treasuries
Caution: Investors should require a third party custodian
Monitor credit quality of counterparty and collateral value
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Issuer: Domestic and foreign corporations
Credit Quality: Investment grade
Term of Maturity:
1 to 270 days
Liquidity: Moderate to high
Custody: Depository Trust Company (Book Entry)
Return: Moderate to high
Caution: Unsecured promissory noteBankruptcy risk extends for 90 days after maturityMay be asset-backed
Commercial Paper
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• CP issued by a special purpose corporation to finance receivables or purchase assets
• Allows institutions to shift liabilities off of their balance sheets
Asset Backed Commercial Paper
Special Purpose
Corporation (Conduit)
$
$
Investors
$++
$+
Liquidity Provider
Credit Enhancement
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Issuer: Commercial banks
Credit Quality: Based on bank ratingIrrevocable obligation of issuing bank
Term of Maturity: Up to 180 days
Liquidity: Moderate to high
Custody: DTC (Book entry) or Physical
Return: Moderate to high
Caution: Foreign banks may impose additional credit risks
Bankers’ Acceptances
Time drafts used in international trade.
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Issuer: Commercial Banks, Savings & Loans
Credit Quality: Varies
First $250,000 insured by FDIC*
May be secured by pledged collateral
Term of Maturity:
Greater than 7 days
Liquidity: Low to moderate
Custody: DTC (Book entry) or Physical
Return: Moderate (depends on credit quality)
Caution: Non-negotiable CDs have withdrawal penalties
Certificates of Deposit
*Passage of Dodd-Frank Wall Street Reform and Consumer Protection Act permanently raises the current standard maximum deposit insurance amount (SMDIA) to $250,000.
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Corporate Notes
Issuer: Publicly owned corporations
Credit Quality: Varies
Term of Maturity: 1 - 40+ years
Liquidity: Moderate
Custody: DTC (Book Entry)
Return: High, depends on credit and structure
Caution: Unsecured promissory note
Credit analysis required
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• Longer maturities typically generate higher returns over time.• But, longer maturities experience greater volatility.
How Maturity Impacts Long-Term Returns
Source: BofA Merrill Lynch Indices;Cumulative values based on $100 million growing at the rate of return of the index; Investors cannot invest directly in indexes.
Risk/Return of Various Benchmarks
10 Years Ended 3/31/2014
Average Cumulative 10-Year Std. Dev. Quarters With
Annual Value of of Annualized Negative
Merrill Lynch Index Duration Return $100,000,000 Quarterly Returns Returns
3-Month Treasury Bill 0.22 Years 1.65% $117,762,461 0.04% 1 out of 40
1 Year Treasury Index 0.99 Years 2.03% $122,256,503 0.20% 4 out of 40
1-3 Year Treasury Index 1.92 Years 2.48% $127,741,624 0.73% 7 out of 40
1-5 Year Treasury Index 2.72 Years 2.96% $133,875,703 1.57% 12 out of 40
1-10 Year Treasury Index 3.91 Years 3.59% $142,375,180 3.21% 13 out of 40
Money Market Funds and Pools
The History of Money Market Funds
• Money market funds are a type of mutual fund developed in the 1970s as an option for investors to purchase a pool of fixed income securities that generally provided higher returns than interest-bearing bank accounts.
• They have since grown significantly and currently hold more than $2.9 trillion in assets, the majority of which is in institutional funds.
• Under Investment Company Act Rule 2a-7, these funds must limit their portfolio investments to high-quality, short-term debt securities and are mandated to have a weighted average maturity of <60 days.
• Unlike other mutual funds, money market funds seek to maintain a stable share price (typically $1.00) through the use of certain valuation and pricing methods permitted under Rule 2a-7.
• The typical experience for a money market fund investor is that when they invest a dollar, they are able to get back a dollar on demand (plus the yield that was earned during the course of the investment).
• As a result, money market funds have become popular cash management vehicles for retail and institutional investors.
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Examples of Money Market Securities
• U.S. Treasury Bill & Notes
• Federal Agency Discount Notes
• Federal Agency Floating Rate Securities
– Index – Fed Funds, T-Bills, or LIBOR
• Commercial Paper
• Certificates of Deposit
– Negotiable
– Non-Negotiable
• Bankers Acceptances
• Repurchase Agreements
• Municipal Bonds
• Money Market Funds
Other “Money Markets”
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• Local Government Investment Pools (LGIPs)– Money Market Funds setup by public entities with a
common purpose (i.e. States, Local Governments, School Board Associations).
– These funds are typically managed by in state departments or large Asset Management Firms
• Registered Investment Companies (RICs)– Money Market Funds that are registered with the SEC.
• Subject to further regulation– Can be marketed to a larger client base (not state
specific).– Rule 2a-7 of the Investment Company Act of 1940
LGIPs vs. RICs
Market Forces Affecting Funds
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What drives rates for money market securities?
• FOMC - “The Fed”
• LIBOR
• Other supply/demand factors – (i.e. Flight to quality causes
Treasury Bill yields to fall)
Money Market Funds
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Federal Open Market Committee
• Led by chair Janet Yellen
• FOMC meets about every 6 weeks to determine monetary policy.
• Sets Fed Funds Rate- rate at which commercial banks lend to each other on an overnight basis.
• Achieves target through Open Market Operations (the buying and selling of Treasury securities in market- basically controlling supply and demand).
FOMC - “The Fed”
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Historic Federal Funds Target Rate
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What is LIBOR?• “London Interbank Offer Rate”
• Daily reference rate at which banks in this international system could borrow from each other on an unsecured basis.
• Rates published daily in London by the British Bankers Association (through a survey of worlds largest banks)
• The most widely used benchmark rate for short-term fixed income markets and a benchmark for commercial paper and CD’s
LIBOR
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LIBOR
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This material is based on information obtained from sources generally believed to be reliable and available to the public, however PFM Asset Management LLC cannot guarantee its accuracy, completeness or suitability. This material is for general information purposes only and is not intended to provide specific advice or a specific recommendation. All statements as to what will or may happen under certain circumstances are based on assumptions, some but not all of which are noted in the presentation. Assumptions may or may not be proven correct as actual events occur, and results may depend on events outside of your or our control. Changes in assumptions may have a material effect on results. Past performance does not necessarily reflect and is not a guaranty of future results. The information contained in this presentation is not an offer to purchase or sell any securities.
Disclaimer