Accounting for Investments. Linda Patterson Patterson & Associates, Austin

Transcription

1 Accounting for Investments Linda Patterson Patterson & Associates, Austin

2 What and Why I Need to Know about Investment Accounting The book value of my portfolio What is my investment worth throughout its life The market value of my portfolio What could I sell it for if I need to How these values are changing Illustrates volatility Volatility = risk How that affects my strategy

3 Key Security Accounting Concepts It is all about timely information How the security is bought Par Premium Discount How it changes value over time Accretion Amortization How securities earn

4 Two Types of Securities Money market = created with maturities 1 year or less Here you earn solely from accretion of principal US Government > T Bills US Agencies > Discount Notes Local Government > BANs, TRANs Corporations > Commercial Paper Fixed income = created with maturities 1 year or more Here you can earn from principal and interest US Government > Treasury Notes/Bond US Agencies > Agency Notes Local Government > Long term Bonds Corporations > Corporate Notes

5 How Do We Earn? Earnings come from only two sources: Principal The value of the principal increases Interest A note s coupon accrues then pays on a set schedule Interest accrues then pays on a fund/pool usually monthly A CD usually accrues then pays at maturity

6 Yield Yield is a calculation based on price and coupon Coupons on debt securities will not change (they are fixed ) Market price will change daily your holding price will not If your book value is > market value you have a? Yield allows us to compare any security to another This is the common denominator Your yield remains the same for you as long as you own it Your holding yield

7 Bought above par moves to par Premium Amount above par is amortized expensed 100 (par) Expense (Amortization) Income (Accretion) Discount Bought below par moves to par Amount below par is accreted earns Issuance Maturity

8 Prices and Yields Move Inversely % $ A 5% coupon at par (100) Coupon = 5% Yield = 5%

9 Prices and Yields If Rates Go UP % $ A 5% coupon is not worth as much if rates go up so price goes down Coupon = 5 % Yield = 6 %

10 Prices and Yields If Rates Go DOWN $ % A 5% coupon is worth more if rates go down so price goes up Coupon = 5 % Yield = 4 %

11 Unrealized and Realized A gain or loss is not realized until it is taken Difference between book and market over time shows volatility What is the risk of taking out a big gain? big loss? What is a fair value gain/loss then?

12 Accounting Three-Step Entry made when security is bought Capturing detail and position value Entries made monthly Capturing interest accruals Capturing cash flows from coupons Capturing changes in the principal owned (book value) Entry made at maturity Capturing last interest payment Capturing the repayment of your principal

13 Security Bought at PAR The CD is bought at par (100) Principal will equal par and will not change Interest will be accruing each day (paid monthly or at maturity) You recognize the interest earned each month Check the bank s day count! The principal + interest each month reflects your total book value as it increases Each month you recognize earnings Mo 1 Mo 2 Mo 3 Mo 4

14 Debit Credit Purchase Investment (Book Value) 1,000, Cash 1,000, Month-end Month #1 Interest Receivable 10, Interest Earnings 10, Month-end Month #2 Interest Receivable 10, Interest Earnings 10, Maturity Investment (Book Value) 1,000, Interest Receivable 20, Interest Earnings 10, Cash 1,030, A 3 month CD accruing interest each month and paying all interest at maturity.

15 Discount Structured Securities ( Discos ) Securities with original maturities < one year not sold at discount If it was sold at a discount what else would it have???? All short securities year is 360 days Treasury Bills Agency discount notes Commercial paper Bankers acceptances Quoted at a discount Often arithmetically close to yield Ask to be quoted yield for comparison purposes Larger the discount = lower the price Know the convention but buy on yield Ask the broker to quote the yield for comparisons T Bill A 1.95 discount price discount price is a short hand for actual $$ T Bill B 1.65 discount price

16 Discount Structured Securities Always bought at a price less than 100 Always accrete on a straight line 100 Earn daily and only through accretion Buying a $100,000 T-Bill Price = $ 98,000 You own it 200 days until maturity Discount / # of days 2,000/200 days= $ 10 / day You Earn 97 Purchase Maturity You buy it at $ 98,000 it matures at $ 100,000

17 Daily Accretion You purchased a T Bill 8/6/xx about 0.11% yield Par $ 1,000, Principal $ 997, (this is the book value only on day 1) Discount $ 2, Days to Maturity 356 Daily Accretion $ 6.47 (2, * 356/365) Earnings only from accretion

18 Discount Securities Accounting Buying at a discount security for 1 month (no coupon) Every month you are adjusting your principal (book) value Principal will change and rise to the maturity amount (100) You recognize the principal change as a change in book value Debit Credit Investment Principal 999, Cash 999, Investment principal 999, Accretion / Earnings 1, Cash 1,000,000.00

19 A Discount Security (T-Bill) > 1 month Every month the increase in principal is recognized. Debit Credit At purchase Principal Receivable 460, Cash 460, Each Month Accretion Principal Receivable 10, Earnings 10, At Maturity Cash 500, Principal Receivable 40, Earnings 40, Principal Receivable 500,000.00

20 Security Notes Lots of moving parts: accretion, amortization, accruals Any security is longer than one year when issued or auctioned is a note Notes can be bought at par, a discount or a premium All notes have a coupon which is fixed at issuance * *With a few exceptions The principal may Increase each month if bought at a discount (accretion) Decrease each month if bought at a premium (amortization) Remain at par if bought at par The coupon will accrue each month and pay at each coupon period (6 months)

21 A note will have coupon accrual during its life in Addition to possible accretion and amortization. Note bought at Premium Coupon coupon coupon coupon 100 (par) Note bought at Discount Issuance Maturity

22 Notes Bought at a Premium Buying above par ($1=$1) 102 Daily amortization is an expense The principal is decreasing Book value is decreasing Premium of $20,000 for 180 days = $111.11/day ($20,000 / 180 days) Amortization e x p e n s e 99 Purchase Maturity

23 Buying a T-Note Settlement Date Maturity Date Description xx/xx/xx xx/xx/xx T-Note, 1%, 8/15/xx PAR 5,000, Discount/Premium <4,978.00> Principal 4,995, Accrued Interest 12, Net Settlement 5,007, You are required to buy the coupon interest accrued by the prior owner. On this bond you will accrete the discount and accrue the interest.

24 What about those callables??? Callables have a lock out period then are callable Amortize or accrete to the first call date This represents your first risk date You will then own a par bond If you don t amortize to call and It gets called, you have a? loss gain Purchase Call Maturity

25 Income Accounting Terms Interest Earned = par x interest rate x time (I=PRT) Time (day count method) varies by type of security Accrued Interest = interest earned since last interest payment CDs may be either 360 or 365 days for calculation 0/360 basis (Agency, instrumentality, Municipal Notes) Par x interest rate x # days held in period 360* (*each month is 30 days regardless) Actual/Actual (T Note) Par x interest rate/payments per year x # days held in period # days in current coupon period

26 ACCRUED INTEREST Earnings from Banks and Funds Both these earn for you from interest only You report the beginning principal as beginning book value Add the earnings from the month as interest You report the ending balance with the principal plus interest Money market mutual funds (MMMF) MMMF s under Act must Strive for $1 NAV They accrue daily and pay monthly Bank accounts (including money market accounts) All accounts accrue on balances daily and pay monthly

27 Earnings from Pools (LGIP) Pools come in different types Money market fund equivalents (2a 7) 2a 7 will strive to maintain a $1 NAV (net asset value) Report book balances and accrued earnings for the period Once interest is reinvested your principal has grown New interest is accruing in the new month Mutual Fund Pools Don t strive for $1 Report market value (share price) and use WAM as days to maturity

28 Two Types of Funds For yield For liquidity MMMF Mutual

29 Settlement and Holding Periods Settlement and holding periods Impacts timing of income recognition Trade date is not important unless it is also settlement day Settlement date and maturity dates are key Recognize settlement date as beginning of period Don t count both beginning and ending date Count the last day you know you own it that day Be consistent

30 Pricing Require an independent source Brokers, banks, IDC, Sungard, Thomson Reuters PRICE X FACE = MARKET VALUE Gains and Losses realized and unrealized Structured securities can be tricky Calls, step ups, floaters, indexed, TIPS, pools Mortgage backed securities need more particularly subjective/judgmental pricing Prepayment speed assumptions, PSA rates

31 A Cardinal Reporting Rule: Weighting Weighting the Information All weighting is done on book value Shows level of risk Illustrates strategy Extending or shortening Recognizes the impact of Dollar value Maturity Yield Book Value Days to Net Maturity 1,000, ,000, , ,000, , ,000, , ,000,000 1,000, ,000,000 1,500, ,000,000 1,500, ,000,000, 750, ,500,000 1,000, ,000,000 8,000, days

32 Weighted Average Yield The weighted average yield will accurately describe the performance of a buy and hold portfolio. Weighted yield is a measure against your benchmark. This measure does not consider market value impact. This measure reflects the price at which you bought the securities.

33 Calculating Weighted Average Yield Weighted yield allows comparison to benchmark Book Value Yield Calculation 1,000, , , , , , , , , ,000 1,500, ,350,000 1,500, , , ,500 1,000, ,000 8,000, % 4,442,500

34 Interest Distribution Effectively distributing earnings to various funds Replaces separate portfolios May add to your overall yield by better utilization Distributed on a pro rata basis by percent of fund Just like a pool or fund distributes to you Accuracy Ease Timeliness

35 Distributing Interest Total Earnings =$10,000 Balance Percent of Balance Distribution of Earnings 150, % , % , % , % 1, , % , % , % , % , % 4, ,843, % 10,000.00

36 Reporting the Results The solid accounting should result in informative reports Show the detailed accounting but focus on information Detail information Archival, full details on each position Bank positions and compensating balances Summary information Book and market values to measure value and volatility Risk parameters: weighted maturities and weighted yield

37 Holding Report Sorted by Sector Purchase Date Security Coupon Maturity Date Yield Begin. Book Ending Book Begin. Market Ending Market Earnings Treasuries xx/xx/xx T Bill 0.00 % xx/xx/xx 0.40 % ,000 95, xx/xx/xx T Note 1.00 % xx/xx/xx 0.95 % 1,001,500 1,001,450 1,001,750 1,000, Agencies xx/xx/xx FNMA 0.95 % xx/xx/xx 1.01 % 999, ,999, CDs xx/xx/xx Pools Pecos Federal 1.10 % xx/xx/xx 1.10 % 248, , , , xx/xx/xx Texpool 0.50 % xx/xx/xx 0.50 % 1,450,200 1,450,250 1,450,200 1, Bank xx/xx/xx Int. Bear % xx/xx/xx 0.01 % 2,333,100 2,333,101 2,333,100 2,333,101 1 xx/xx/xx MMA 0.50 % xx/xx/xx 0.50 % 2,500,000 3,500,700 2,500,000 3,500, Summary 8,531,810 7,533,501 8,533, ,050 1,461

38 S Report Shows Detail, Activity and Compliance

39 Link the detail report to a summary report and use graphics to illustrate allocations.

40 Diversification by Sector Shows diversification Treas Agency CD Pool Policy limits if applicable Illustrates Risks Too short Too long Barbelled

41 Diversification by Maturity O/n 0-3 mo 3-6 mo 6-9 mo 9-12 mo 5 0 Maturity breakdown shows strategy and reflects cash flow Shape shows how various time horizon periods are being funded Shows coverage of liabilities Funds concentration on near by liabilities Plus use of longer opportunities

42 Pool/Fund Reporting Price and value designed to show risk to investor Constant dollar (money market equivalents) Price is always $1 so book and market are always $1 Days to maturity is always 1 day because guaranteeing next day liquidity Mutual fund equivalents (fluctuating net asset value) pools and funds Price is the net asset value or share price that day Days to maturity is the WAM of the underlying portfolio

43 Benchmarks Purpose Risk and performance For public entities basically risk Select yield versus rate of return Comparability Sector recognition Comparable Treasury Bill versus your yield Always compare same periods Match your benchmark choice to your policy WAM limit

44 A Note about GASB Annual Statement Use Statement 31 Only for investments bought with maturities >1 yr only Statement 40 Recognition of risks required Statement 72 Fair value measurement if you chose to use fair value Statement 79 External pools and participants value representations

45 The Fair Value vs Market Value Debate PFIA requires reporting on an amortized and market value GASB 31, 72 and 79 has brought in Fair Value Definition Does not apply to securities under one year when purchased For External Pools (LGIP) If pools are 2a 7 ($1 NAV) and fit other requirements use amortized value for value calculations For your use Report for 31 and 40 but only for financial statements use

46 For Your Accounting Notebook Assets Cash Investments Par Unamortized Premium Unamortized Discounts Interest Receivable (Accrued) Fund Balance Income Accounts Interest Earned Accretion of Discounts Amortization of Premiums Gain on Sales Loss on Sales xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx xxx

47 Questions? Thank you and good luck!