Fixed Income Securities

Fixed income securities are those, which promise either a fixed stream of income or a stream of income that is determined according to a specified formula. Debt or bond is most popular fixed income securities. Fixed income securities include saving deposit (commercial Banks, credit union), money market instruments. Like certificate of Deposit, commercial paper Banker’s acceptance and so on.

A) Saving Deposits:

Saving deposits in general refers to the personal savings account at a bank or saving & loan company or credit union. Such an account provides substantial safely of principal & interest, high liquidity and a relatively low return.

B) Commercial Bank

Commercial banks are the main institutions where people maintain saving deposits in different form & different conditions. There are 3 most popular saving deposits in real practice.

a. Demand deposit

b. Time deposits

c. Certificate of deposit (CDs)

Ø Demand Deposit

Many people maintain a checking account at a commercial bank. Formallu these accounts are termed demand deposits, because money can be withdrawn on demand by the depositors.

An alternative to a checking account is a standard saving accounts. In this a/c request for withdrawals are almost honored immediately. Almost any amount may be invested in a saving account.

Ø Time Deposit

The standard saving account is time deposits where deposits are made for some fix periods. These deposits can’t be withdrawn before the maturity period.

Ø Certificate of deposits (CDs)

Some types of deposits may be made in almost any amount when other may be made only in units of say $ 1000 each. The later may be represented by certificates of deposit (CDs), which clearly qualify to be called securities large-denomination CDs (generally $100000) or more & known as “Jumbas”) may be negotiable; that is original depositors may sell the certificate to someone else before maturity.

v Other types of personal saving accounts

In US, ano of institutions similar to commercial banks are authorized to accept federally insured deposits and to use the proceeds to make consumer loans. These institutions include Saving & Loan companies; mutual saving banks & credit unions. They act similar to commercial banks & venders the service to customers.

v Money Market Instruments

The money market usually applied to the buying & selling of debt instruments maturing in one year or less. These instruments sometimes are called cash equivalents or just cash for short. Money market instruments include short-term marketable, liquid, low-risk debt securities. Short-term here refers for one year & less.

Some money market instruments are negotiable and are traded on active market & other are not. Investors buy money market securities at discount from their face values and get benefits from the pri9ce appreciation that typically occurs at maturity date of the securities. The maturity date of the securities. The most common money market securities are described below.

a) Commercial Paper

Large well-known companies often issue their own short-term unsecured debt notes rather than borrow directly from banks. These notes are called commercial paper. Commercial paper maturities ranges up to 270 days & longer maturities would require registration only those companies with high reputation as well as government sponsored financial & non financial companies issue commercial paper.

b) Certificate of deposit (see above)

c) Bankers’ Acceptance

A bankers’ acceptance is a time draft drawn on a bank by an exporter or an importer to pay for merchandise. If the bank honors the draft, it will stamp “Accepted “ on its face and endorse the instrument. By doing so the issuing bank has unconditionally guarantee to pay the face value of the acceptance at maturity shielding exporters and investors in international markets from default risk. Acceptances Cary maturities ranging from 30 days to 270 days (90days market common) and are considered prime-quality money market instruments. They are actively traded among financial institutions, industrial corporations & security dealers as a high quality investment & source of ready cash.

d) Eurodollars

Eurodollars are the deposits of U.S dollars in banks located outside the United States or in US-based banking facilities free of U.S deposit regulation. The banks record the deposits on their books (a/c) in U.S dollars, not in their home currency. Most Eurodollars deposits are for large sums and most are time deposits of less than six months maturity. Eurodollars deposits are non-negotiable, meaning that they can not be traded.

e) Repurchase agreement

Dealers in government securities use repurchase agreements, also called “repos” or “RPs” as a form of short-term, usually overnight, and borrowing. The dealer sells government securities to an investor on an overnight basis, with an agreement to buy back those securities the next day at a slightly higher price. The increase in the price is the overnight

interest. The dealer thus takes out a one-day loan from the investor and the securities serve as collateral. Repos are considered very safe in terms of credit risk because the loans are backed by the government securities.

f) Government securities

Government of the country collects revenue mainly from tax, service charges & fees. Such revenues are used for social & development purpose. The revenues collected so far do not cover all the expenses. Therefore difference (deficit) so creates has to be financed primarily by issuing debt securities. The proceeds of these debts are used for development purpose as well as to repay the old debt. The government may issue long, medium or short term debt according to the requirement. Some common securities are;

T-bills, T-notes, T-Bonds, Saving bonds, Development bonds.

g) Treasury Bills

T-bills are the most marketable of all money market instruments. T-bills represent the simplest form of borrowing. The government raises money by selling bills to public. Investors buy the bills at a discount from the stated maturity value. At the bill’s maturity, the holder receives from the government a payment equal to the face value of the bill. The difference between the purchase price and ultimate maturity value constitutes the investor’s earnings.

Calculation the Yields on Bills

Bill yields are determined by the bank discount method, which ignores the compounding of interest rates & uses a 360-day year for simplicity. The bank discount rate (DR) on bills is given by the following formula:

DR =

Where,

Maturity period = no. of days to maturity

Because the rate of return on T-bills is figured in different way than the rate of return on most other debt instrument the investor must convert bill yield to an investment yield (coupon-equivalent yield) to make realistic comparison with other securities. The formula for investment yield/rate (IR) is

IR =

Treasury Notes & Bond

The government borrows funds in large part by selling Treasury notes & Treasury bonds. T-notes maturities range up to 10 yrs. whereas bonds are issued with maturities ranging from 10 to 30 years. Both are issued in denominations of $ 1000 or more both make semi-annual interest pmt called coupon pmt.

• Saving bond: main motive to induce for saving pay at last target: Student

• Zero coupon bond: issue at discount ( no coupon)

• Development bond: issue to raise fund for development project.

State & Local government securities

The most popular state & local gov’t securities is municipal bond. They are similar to T-bond & corporate bond except that there interest income exempt from state & local taxation in the issuing state. It means that dividend/interest income is tax exempted income where as capital gain is taxable income. When the bonds mature or if they are sold for more than the investor’s purchase price. There are basically two types) of municipal bonds. These are general obligation bond by the “full faith & credit” (i.e. the taxing power of the issuer and revenue bonds which are issued to finance particular projects & are backed either by the revenues from that project or by the particular municipal agency operating the project.

Behavior of Stock Market Price

Security price fluctuates around their intrinsic value. Any information that affect the intrinsic value has an

Effect on the stock market price movements. More efficient the market, more quickly it adjust the price of security to the new information. E.F. Famma opined that financial information arrived randomly and if the market response to the information is efficient, then the price should fluctuate randomly. Famma suggested three levels of market efficiencies.

I ) Weakly efficient market hypothesis

It states that security prices reflect all historic information. It follows that historic price and volume data of securities contains no information which can be used to earn larger return over what could be earn on passive buy and hold. Strategy by trading on short term price movement. In other words technical analysis is worthless.

Weakly efficient market hypothesis suggest for the following tools to evaluate the market behavior & have decision:

A ) c % Filter rule ( E.F Famma & M.E. Blume)

If the price of a security rises at least c %, buy and hold the securities until its price drops at least c % from a subsequent high. Then liquidate the long position and assume a short position on the same stock until the price rises c %.

B) Sweeney’s c % Filter rule:

If the price of the security rises at least c % buy and hold security until its price drops at c % from a subsequent high. Then liquidate the long position and invest the proceeds in the risk free short-term bond until the price reaches its next through and then rises c %.

C) Run test:

Run test is simply group of positive or negative price trend which provide insight for overall trend of particular security within some specified time so that one can either purchase the stock and sale or short sell. It is computed to test whether the security prices fluctuate randomly or they follow some trend, which sometimes is not detected by filter rules. There are 3 types of run.

i. Positive run: Total positive price changes in the subsequent time

ii. Negative run: Total negative price changes in the subsequent time

iii. Zero run: Total indifferent between the price of two type of time.

Note:

Difference between Famma & Blume and Sweeny

Famma & Blume assumes that decreasing trend of price can have best opportunity for short selling but at the some time sweeny think that it is quite riskier than that of investing in risk free bond. So sweeny emphasis to invest the proceed of sale on risk-free short-term bond rather than risky bond.

II ) Sem-Strong Efficient Market Hypothesis

It assumes that security price reflects all public information. It follows that only those investors who have access to valuable insight information could earn a return larger that what could be earn by using a passive buy and hold strategy by trading on short-term price movement.

II ) Strongly Efficient Market Hypothesis

It states that security prices reflect all the information. It follows that no investor can earn a return larger than what could be earn passive buy and hold strategy by trading on short term price movement.