0 © 2013 PFM Asset Management LLC Fixed Income Security Types Marco Island May 5, 2014 Presented...

1© 2013 PFM Asset Management LLC

Fixed Income Security TypesMarco Island

May 5, 2014

Presented by:Michael R. Varano, Managing Director and Senior Portfolio

[email protected]

PFM Asset Management LLC300 South Orange Avenue, Suite 1170

Orlando, FL 32801

2014 Spring Education Forum

Florida Tax Collectors Association

mailto:[email protected]


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


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


• 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


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)


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


• 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



• 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



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


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


• 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


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.


Issuer: Commercial Banks, Savings & Loans


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.


Corporate Notes

Issuer: Publicly owned corporations


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


• 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



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.


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”


• 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


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


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”


Historic Federal Funds Target Rate


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


LIBOR


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

0 © 2013 PFM Asset Management LLC Fixed Income Security Types Marco Island May 5, 2014 Presented...

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