THE BEECHMONT CREST ONLINE GUIDE TO STOCKS AND INVESTING
Overview of Capital Market Instruments
- Fixed debt obligations
- Capital market instruments are traded in the secondary market. This means that they can be bought and sold after they are issued by the institution of origin (a government or corporate entity).
U.S. Treasury Securities
- Fixed income securities. May take the form of bills, notes, or bonds, depending on the time to maturity.
- A bill matures in one year or less.
- A note matures in 1~10 years.
- A bond matures in 10 years or more after its issue date
- U.S. Treasury securities are safe because the chance of default is very small
U.S. Government Agency Securities
- Issued by government agencies other than the Treasury.
- Example: The Federal National Mortgage Association (FNMA or Fannie Mae) sells bonds and uses the profits to purchase mortgages.
- Other government agencies that issue bonds include: the Federal Housing Administration (FHA), the Government National Mortgage Association (GNMA or Ginnie Mae), and Federal Land Banks (FLBs).
- Securities issued by government agencies are considered to be extremely safe for the same reason that U.S. Treasury Securities are safe: there is little risk of default.
Municipal Bonds
- Issued by local governments. May take the form of general obligation bonds (GOs) or revenue bonds.
- General obligation bonds are funded by the municipality’s total taxing capabilities. A revenue bond is tied to the taxes generated from a specific project---whether a stadium, a sewage treatment plant, or a power plant.
- The interest earned from a municipal bond is exempt from state and federal taxes. (Exemption from state taxes requires that the investor be a resident of the state where the bond was issued.)
Corporate Bonds
- Fixed income securities issued by private-sector corporations, railroads, or public utility corporations to raise money for ongoing operating expenses or special projects
- All corporate bonds must include an indenture (a contract that lists the payment schedule, details about the bond, and the obligations of the issuing institution).
- Corporate bonds have call provisions. Call provisions allow the issuing institution to call its bonds before they mature. When this occurs, bondholders are obligated to submit their bonds. The issuing institution will then pay back the principal of the bond with an additional call provision premium.
- A sinking fund provision entitles the issuing institution to redeem a certain portion of the bond prior to its maturity. (Sinking fund provisions allow institutions to shield themselves from possible liquidity problems in the future.)