Words of Wall Street. The Language of Fixed Income Investing. 52 nd Annual Conference

Transcription

1 Contact Greg Warner Director & Senior Portfolio Manager 300 West Sixth Street, Suite 1940 Austin TX Words of Wall Street The Language of Fixed Income Investing 52 nd Annual Conference July 25, 2017

2 Agency Security A debt security issued either by a Federal or Federallysponsored agency Federal agencies are backed by the full faith and credit of the US Government (ex. GNMA) Federally sponsored agencies are backed by the credit of the agencies themselves with an implied guarantee of the US Government (ex. FHLB, FFCB) Agencies currently in conservatorship, owned and operated by the U.S. government include Fannie Mae and Freddie Mac. Types of agencies include discount notes, bullets, callables and step-ups. 1

3 Basel and Basel III Basel refers to the Basel Committee on Banking Supervision - The Committee consists of senior representatives of bank supervisory authorities and central banks from Argentina, Australia, Belgium, Brazil, Canada, China, France, Germany, Hong Kong, India, Indonesia, Italy, Japan, Korea, Luxembourg, Mexico, the Netherlands, Russia, Saudi Arabia, Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, the United Kingdom and the United States. It usually meets at the Bank for International Settlements (BIS) in Basel, Switzerland, where its permanent Secretariat is located. Basel III refers to rules adopted by the committee that apply to banks and their liquidity management practices (see next slide). 2

4 Liquidity Coverage Ratio (LCR) The primary rule adopted by Basel III. This standard aims to ensure that a bank has an adequate stock of unencumbered HQLA to meet its liquidity needs for a 30 calendar day liquidity stress scenario. HQLA = High Quality Liquid Assets Cash or assets that they can be easily and immediately converted into cash at little or no loss of value. Stress scenario assumes run-off of deposits, loss of wholesale funding capacity, loss of other short-term financing, contractual outflows due to downgrades, unscheduled draws on loans and liquidity facilities, etc. 3

5 Basis Point A unit of measurement used in the valuation of fixed income securities, equal to 1/100 th of 1% Often abbreviated as BPS or bps 100 bps = 1 percentage point, 1.00% 50 bps = ½ percentage point, 0.50% 10 bps = 1/10 th percentage point, 0.10% 1 bps = 1/100 th percentage point, 0.01% 4

6 Bear market/bull market In a bear market, security prices are falling. In a bull market, security prices are rising. This simple terminology holds true for both stocks and bonds. Note: Remember that for bonds there is an inverse relationship between price and yield. When bond prices are falling (bear market), yields are rising and vice versa. 5

7 Bid (vs. Offer) A bid is the price a broker will show an investor when the investor wishes to sell a security. An offer is the price a broker will show an investor who seeks to buy a security (also called the ask price). When buying a security, investors want the lowest price (highest yield). When selling a security, an investor will always seek the highest bid price. For discounted instruments (T-bills, agency discount notes, CP), sellers will accept the lowest discount rate (low rate=high price). When buying securities we often refer to obtaining three competitive bids, actually we are getting comp offers. 6

8 Bloomberg A dedicated electronic trading platform that allows subscribers to analyze, trade and monitor the universe of tradable securities in real time. The system also allows for communication between users, and provides news and market quotes across a secure network. 7

9 Broker (vs Dealer) Broker A person or firm acting as an agent for buyers and sellers and charging a commission for services rendered. Brokers (agents) act as intermediaries between buyers and sellers. Dealer A person or firm acting as principal in buying and selling securities. Dealers (principals) trade for their own account and (in theory) put their own money at risk. Term is frequently combined as broker-dealer because most act in both capacities. 8

10 Bullet A security that is repaid in a lump sum at the end of its term Bullets are not callable. Bullets do not amortize or make periodic principal payments. The term usually refers to an agency bond. 9

11 Callable Bond A callable bond is a security with an embedded option that gives the issuer (agency) the right to repay the investment early and return the full principal amount to the investor prior to final maturity. The issuer will likely exercise this option if rates fall to a level where new debt can be issued at a lower rate. The callable investor receives a higher yield, but is subject to reinvestment risk at lower rates. Caveat: Roll-down 10

12 Call Structures American - Call option may be exercised at any time after the initial call date. Also known as continuous calls. European Call option may be exercised only on a single, predetermined date. Also known as a one-time call (1X). Bermudan Call option may be exercised only on interest payment dates, usually semi-annually, sometimes quarterly. Discrete Call option may be exercised only on specific dates, usually this would be quarterly or monthly. 11

13 Cash Settlement Cash settlement occurs when a security is purchased and subsequently delivered on the same day. Regular or Reg settlement occurs the following business day for treasuries, agencies and commercial paper. Skip day settlement occurs one day after regular. A broker will ask the investor whether they would like cash or regular settlement. T+3, T+5 12

14 Cheap / Rich Cheap bonds that trade at lower prices (higher yields) and/or those with wider (larger) spreads: That 2-year bullet is cheap to the curve. Rich - bonds that trade at higher prices (lower yields) and/or those with tighter (smaller) spreads: That new issue 3-year callable is too rich. 13

15 Commercial Paper (CP) An unsecured short-term promissory note issued by a corporation or local government, with maturities ranging from one to 270 days CP with a minimum rating of A-1/P-1/F1 (S&P/Moody s/fitch) is typically required for public entities. Many money market funds and local government investment pools invest heavily in CP. 3(a) versus 4(2) / 144a 14

16 Deflation / Disinflation Deflation A drop in general price levels, the opposite of inflation. Disinflation The slowing down of price increases, i.e. a slowing in the rate of inflation. BUT prices are still rising, they are just rising at a slowing rate. 15

17 Delivery vs Payment (DVP) A type of transaction in which the purchaser pays for securities at the time they re delivered into their safekeeping account - not before! Required by many states laws and standard industry practice. Occasionally, securities may be delivered free. Electronic systems such as the Fed Wire System and DTC (Depository Trust Company) allow for this type of settlement. 16

18 Discount Note ( Disco ) An agency note with a zero coupon that trades at a discount to face value (par) and matures at par. The difference between the discounted cost and par represents the interest earnings. Sometimes called zeros because of the 0% coupon. Similar to a Treasury-bill. Maturities range from one day to one year. Examples of issuers: FNMA, FHLMC, FHLB, FFCB. 17

19 Diversification Dividing investable funds among a variety of different security types offering independent returns, and maturing at different times throughout the year(s) Diversification spreads investor risk and smooths earnings. A well-diversified portfolio should perform relatively well regardless of the direction interest rates move. 18

20 Duration A measure of the sensitivity of a bond s price (or value) to a change in interest rates. Expressed in years If interest rates change by 1%, a bond with a duration of 1 year will experience a 1% change in price. A bond with a duration of 3 years will experience a 3% change in value for the same 1% change in interest rates. The longer the duration, the more sensitive the value of the bond is to interest rates. The same concept applies to a portfolio of securities. 19

21 Federal Reserve System ( the Fed ) The Central Bank of the U.S. which is responsible for supervising and regulating member banks, providing banking services, providing information and setting monetary policy through the FOMC. There are 12 Regional Fed offices or districts throughout the U.S., including New York, Chicago, Atlanta, Dallas, Boston, San Francisco, Philadelphia, Cleveland, Kansas City, St. Louis Richmond, and Minneapolis. 20

22 Federal Open Market Committee ( FOMC ) A group of Federal Reserve officials that meet eight times per year to set U.S. monetary policy (raise and lower interest rates). 12 members--the seven members of the Board of Governors of the Federal Reserve System; the president of the Federal Reserve Bank of New York; and four of the remaining eleven Reserve Bank presidents, who serve one-year terms on a rotating basis Its dual mandate is to seek maximum employment and a stable rate of inflation. An unofficial third mandate is to maintain a strong and stable financial system. 21

23 Fed Funds Rate Technically, this is the overnight rate at which Fed member banks trade excess reserves amongst themselves. The Federal Reserve raises and lowers interest rates by manipulating the fed funds rate. This is done by buying and selling securities in the open market. The fed funds rate influences all other short term rates, especially overnight repurchase agreements. The current fed funds target is 1.00% to 1.25%. 22

24 Long (vs Short) Long Position of an investor who buys a security before selling, expecting a price increase in the interim. Also the position of an investor who simply owns a security. If you own a bond, you are said to be long. Short Position of an investor who sells a security before he buys it, expecting the price to decrease in the interim. If you sell something you don t own, you are said to be short. 23

25 Mark-to-Market The process by which a security book value is adjusted to reflect its current market value This mark-to-market concept is the basis for GASB 31 24

26 Money Market Mutual Fund A pool of money representing deposits from a large number of participants invested solely in money market instruments (short-term debt securities such as T-bills, discount notes, commercial paper and repos). A variable rate of interest is paid and funds typically may be withdrawn at any time. Government vs Prime fund Similar to investment pools; Daily rates vary depending on the type of fund and the management fees charged. 25

27 Constant Dollar vs Floating Net Asset Value (NAV) A constant dollar fund is a conservative type of fund whose stated objective is to maintain a $1 share value. Often referred to as a dollar in-dollar out fund, the principal value is subject to minimal risk. The principal value of a Floating NAV fund will fluctuate, although they may stay close to $1.00 SEC money market reforms implemented last year require that so called prime money market funds must use a floating NAV. Government funds and retail class funds were exempted and may continue to target a stable $1 NAV. 26

28 Primary Dealer A group of large government securities dealers who can buy and sell directly with the Federal Reserve Bank of New York. Primary dealers must make a market in U.S. Government securities, participate in Treasury auctions, provide the Fed with market information and analysis, and work with the Fed in the implementation of monetary policy. There are currently 23 primary dealers, including Merrill Lynch, Goldman Sachs, Citigroup, J.P. Morgan, and Wells Fargo. 27

29 QE and the Fed s Balance Sheet Quantitative Easing (QE) The process by which a central bank purchases government securities or other assets in an attempt to lower interest rates, expand the money supply, and stimulate economic growth. The Fed s Balance Sheet refers to its assets and liabilities, just like any other entity s balance sheet Through QE, the Fed has accumulated a balance sheet in excess of $4.5 trillion. The asset side includes the securities they purchased while the liability side includes the bank reserves they created to make those purchases. The process of normalization, or shrinking the balance sheet seeks to reverse this. See it here: 28

30 Rally A sharp rise in the general price level of the market, or a particular market or security A rally implies higher prices for securities, and thus lower yields on fixed income securities. Stocks rallied today on better than expected earnings reports. Bonds rallied today after a weak inflation report. 29

31 Repurchase Agreement ( Repo ) A type of agreement in which an investor exchanges cash for securities with a dealer or bank and earns a fixed rate of interest for a specified period. At the end of the period, securities are returned for principal along with accrued interest. Dealers use the cash to finance their inventories Heavily used by pools and money market funds Repo types: overnight, term, open 30

32 Reverse Repurchase Agreement ( Reverse Repo ) The opposite side of a repo transaction. In a reverse, the investor accepts cash from the dealer in exchange for securities, agreeing to return the principal with interest in exchange for the security at a later date. If you have securities and need or want cash, you could enter into a reverse repo. 31

33 SWAP Trading one security for another, OR one payment stream for another (interest rate swap) The best case scenario is to increase overall yield while maintaining similar risk and maturity characteristics in the new security. A typical swap may involve the sale of Treasury securities which become expensive as they near maturity and the purchase of discount notes or CP. 32

34 Spread The additional yield over and above yields on Treasury securities, expressed in basis points, that can be earned by investing in non-treasury securities. For example, if the 2-year Treasury note is yielding 1.40% and a 2-year agency bullet is yielding 1.53%, the spread between the two issues would be 0.13% or 13 basis points. The bid/ask spread is the difference between the current buy and sell price. 33

35 Total Return (or rate of return ) The sum of earned interest, amortization or accretion, plus or minus the change in market value for the period This is an excellent measure for stocks and for mutual funds, but somewhat deceptive for buy-and-hold fixed income portfolios because you may never actually realize the market value gain or loss if you hold to maturity. 34

36 Unchanged Unch d or Unched The 10-year was unched on the day. 35

37 Weighted Average Maturity (WAM) This common term, usually expressed in number of days, represents the average maturity date of a portfolio of fixed income securities, weighted by the dollar value of each security. A longer WAM generally indicates more market risk. 36

38 Yield The return, expressed as a percentage, that a security will earn as a result of both the coupon (interest rate) and any discount or premium paid. A yield will exceed the coupon rate if the security is purchased at a discount...and vice-versa. There are many different types of yield calculations: o BEY Bond Equivalent Yield o MMY Money Market Yield o Many others 37

39 Yield Curve The relationship between yields and maturity dates for a set of similar bonds, usually Treasuries, at a given point in time A standard measure of risk and return A normal yield curve slopes upward Short End generally overnight to 3 years Intermediate 3 to 10 years Long End 10 to 30 years 38

40 Yield Curve (continued) Steep, Flat or Inverted? 39

41 Yield Curve (continued) Steep, Flat or Inverted? 40

42 Yield Curve (continued) Nostalgic Treasury Yield Curve 7.00% 6.50% 6.00% 5.50% 5.00% 4.50% 4.00% 3.50% 3.00% 2.50% 2.00% 1.50% 1.00% 0.50% 0.00% 3 Mo 6 Mo 12 Mo 2 Yr 5 Yr 10 Yr 30 Yr Apr % 1.12% 1.41% 2.09% 3.43% 4.37% 5.16% Dec % 4.51% 4.44% 4.42% 4.36% 4.57% 4.98% Aug % 6.35% 6.16% 6.17% 5.98% 5.70% 5.66% 41

43 Yield Curve (continued) July 2017 vs July 2013 (Taper Tantrum) 42

44 Questions? 43

45 Disclaimer DISCLAIMER: This presentation is prepared for general circulation and for general educational and informational purposes only. The information in this presentation is designed to give general and timely information on the subjects covered. It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person or entity that may receive it. It is not intended to be used as the basis for investment decisions by any individual or entity or as a recommendation for any particular securities, financial instruments or strategies. Any discussion of risks contained herein with respect to any product should not be considered to be a disclosure of all risks or a complete discussion of the risks that are mentioned. All information contained herein is obtained by FSAM from sources believed by it to be accurate and reliable. Information is provided as is without warranty of any kind, and FSAM makes no representation or warranty, express or implied, as to the accuracy, timeliness, completeness, merchantability or fitness for any particular purpose of any such information or analysis. Neither the information contained herein nor any opinion expressed constitutes an offer, or an invitation to make an offer, to buy or sell any securities or other investment or any options, futures or derivatives related to securities or investments. Nothing herein constitutes or should be construed as a legal opinion or advice. Recipients should consult their own attorney, accountant, financial or tax advisor or other consultant with regard to their own situation or that of any entity which they represent or advise. Neither FSAM nor any of its affiliates shall have any liability for any use of the information set out or referred to herein. 44