Using the Fundamentals
Linda T. Patterson
Patterson & Associates
linda@patterson.net
The Investment Decision

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Where do I need money?
What can I buy?
Am I diversified?
A: cash flow
A: authorized securities
A: policy
Where is the market?
Where are the rates going?
What has the best yield?
A: relative value
Relative Value Analysis is = Comparative Shopping
Yield is our common denominator to compare alternatives
Strategies

Dependent first off on your cash flow

Dependent on your risk tolerance

Dependent on your policy limits

Dependent on your economic view

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Will rates go up?
When will it go up?
How far will it go?
What part of the curve will go up?
A Major Change Factor
•
•
What is driving the rates and markets currently?
What factors will change outlooks?
1.00
Jun-14
Mar-14
Oct-13
0.50
Jul-13
Jun-12
#REF!
0.00
3mo
6mo
1yr
2yr
3yr
Public entities operate primarily in this area of the curve.
At Today’s Rates
What do You Do?

$15mm are in Texpool
You need $500,000 a month

You have a safekeeping account at bank

You have little time

Strategy Exercise

Portfolio
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Bond Funds



Low $30mm
High $60mm
100% liquid now
Need $2mm/month
25% of ptf.
Expected life 1yr.
Debt svc


Feb & Aug
$8mm/$4mm
50
40
millions

60
30
20
10
0
Cash Flow – Multiyear View
Today’s Questions/Considerations

Questions:

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When do I first need money?
How should I use my Sept. allotment?
How will I use the tax money?
Can I invest the bond money better?
What is with this core?
Rates:



o/n
0.10%
6 mo 0.30%
12 mo 0.45%
3 mo 0.11%
9 mo 0.30%
18 mo 1.00%
A Strategy Forms…

Bond funds (approx. $7.2mm)
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Debt Svc

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Leave $3.6 liquid
Invest $1.8 to 6 mos. and $1.8 to 9 mos.
Invest $4mm to Feb (rest to come from taxes)
Invest $4mm to Aug to fulfill Aug payment
Operating Funds


Leave $24mm liquid to fund Sept. through Dec
$3mm remaining invested out to April (8 mos.)
Plan Execution

Target the beginning of each month
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Without a s/k account
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At maturity leave funds liquid for expenses
CDs from TX banks
CDARS
Money market accounts
With a s/k account
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CDs from TX banks
Municipal debt in the 6 mo to 18 month area
Treasuries or agencies
Evaluating the Choices

Sector analysis
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Spread analysis

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assuming that similar sectors are similar
which issuers are available, wanted
which maturity range is best
which bond is best in that maturity
Yield curve analysis


where are rates now
where are rates going
Spread Analysis

Spread means difference
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Difference in rate between securities or market sectors
8

Spreads are dynamic
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Anticipated spreads on credit
Current spreads
Historical spreads
Treas
7
Agy
CP
6
3mo
6mo
1yr
2yr

Doing a spread analysis means comparing rates

You must check the rates at that maturity in various sectors
Sector Analysis

Market sectors are the different types of securities

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Sectors vary by risk and structure
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Treasuries, agencies, CP, CD, pools
agencies and new agency issues
commercial paper
taxable municipals
Evaluating sectors requires information on that sector

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credit decisions and risks
historical spread analysis
Yield Curve Analysis

Yield curves depict the market conditions

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Shows the markets expectations and demands
Tells a story
Illustrates the best value
Read in light of current conditions
Picking the best place on the curve


Your portion of the curve is restricted by policy
Your portion is restricted by risk tolerance and cash flow
Yield Curve
6
5/26/06
5
4
01/01/08
3
10/15/08
2
10/15/09
1
0
o/n
3 mo
6 mo
T-Bills
1 yr
2 yr
3 yr
T-Notes
5 yr
10 yr
30 yr
T-Bond
Yield Curve Nuances
7.00
Cheap
Steepness
6.00
Flat
Value
5.00
Rich
Pick-up
4.00
3.00
3 Mo
6 Mo
1 Yr
2 Yr
5 Yr
10 Yr
30 Yr
Relative Value by Yield
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A core investment out 1.5 years…
T-Note
FNMA
FHLMC
FHLB Call
CD
0.28
0.35
0.33
0.40
0.95
%
%
%
%
%
What are your considerations ?
How far do you feel safe going?
Which do you do today?

Debt Service Strategizing

It is June 15th

Your Aug debt service payment is fully funded

The Feb payment is $3,000,000

What are your options? Your plans?
Debt Service 2/15/14

Pool will probably yield average 0.04% to 0.06%

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Money market account at 0.35%
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Proceeds $ 5,250 for six months
CD for 6 months should be 0.30%

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Proceeds $ 750 for six months
Proceeds $ 4,500 for six months
Agency discount note at 0.15%

Proceeds $ 2,250 for six months
Strategies must change – so adjust

Jan 2001 – Jan 2002
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June 2004 – June 2005

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Overnight rates move from 6.50% to 1.00%
Need to lock-in rates as long as reasonable
Going long was primary strategy
Overnight rates move from 1.00% to 3.00%
Need to move up with the rates
Staying short was primary strategy
Sept 2008 – Sept 2009
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Overnight rates move from 2.0% to 0%
Need to lock in rates and look for alternatives
Going long was primary strategy
Disciplined Investing
Even Infrequent Investors Need It

Horizon investing

Chose the time period

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Month or quarter periods
Stay to your horizon

Consistently cover next disbursement
Create liquidity buffer as you go

Create a ladder to pay upcoming liabilities

Investments

Investments are not just longer term

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Investments are not locked in

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Basically all investments can be sold
Investments are designed to pay your bills

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Every dollar every day is an investment
Cash flow planning tells us where
market swings become irrelevant once investment is made
Investments in place on a ladder creates earnings
Passive Management
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Passivity
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No unnecessary action: liquid reliance
Defensible and easy
Will mirror the lowest rates available
Passive Conservative
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Based on facts: cash flow needs/core
Conservative with liquid buffers
Targets month-by-month needs
Usually stays within one year horizon
Occasionally given to fits of agony
Increases portfolio yields
The Pie and the Portfolio
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Liquid Sector
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Provides liquidity
Alternatives
 Bank demand deposits
 Local government pools
 Money market mutual funds
 Overnight repurchase agreements
Today’s strategy
Short-Term
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Match upcoming known expenditures
Alternatives – in different scenarios

Securities (discount notes, CDs, some liquidity options)
The Pie and the Portfolio

Long-Term
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Ultimately matching known expenditures
 becomes the short-term
Usually 6 to 12 months
Alternatives directed by market yields
Today’s strategy
Core

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Reserves, no planned shorter term use
Focus on rate movements and yield
May call for different securities
Today’s strategy
Two Views to the Structure
$9.0
$8.0
$7.0
Core
10%
$6.0
$5.0
$4.0
$3.0
$2.0
$1.0
$0.0
Long
20%
Liquid
20%
Short
50%
Debt Service Cash Flow
Liquidity

Liquidity funds must provide
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Funds availability
Reasonable return
Ease of use
Reporting
Used for long term liquidity in rising rate environment
Used for short-term liquidity facilitating choice of securities
Bank Liquidity Choices

A range of choices
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non-interest bearing checking
interest bearing checking
money market accounts
sweeps
Dependent on risk/access
Sweeps as an Investment
Account A
Excess amounts sweep each
day not entire amount.
Daily Sweep
Account B
Account C
to MMMF
Make sure your policy
includes MMMF as
authorized investment
Liquidity Choices
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Local Pools
“Money Market Mutual Funds” (MMMF)
Repurchase Agreements (larger entities)
Bank Options
 checking accounts,
 interest bearing accounts,
 money market accounts,
 Sweeps to money market funds
Risk and return variations on each choice
Liquidity Choices

Where would you put $2mm?

Alternatives:

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O/N Repo Rate
MMMF or $1 Pool Rate
Bank checking
Bank money market account
Bank sweep to MMMF
The 14 extra bps buys you $2,800 a year.
0.04
0.04
0.01
0.18
0.00
Commingled Investments
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Local Government Pools
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Money Market Mutual Funds
Mutual Funds
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All offer:
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Economy of scale
Diversification
Some extension with liquidity
Reporting
Pools and Funds Provide
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It’s all about disclosure
Information statements
 Prospectus
 Full Information
Confirmations
 Transaction History
Reports
 Monthly History
All requirements built on SEC requirements for MMMF
What do these
figures tell you?
Know how to read
the facts about
your pool(s).
Pools and Funds
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Pools
Based on ILCA
Require resolution by
Board
Rated
Unregulated
All types
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Money Market Funds
SEC registered
No resolution required
SEC oversight and
regulation
Strict restrictions
based on liquidity
only
Pools vs Funds
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You are not “insured” in either

Pools
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require a resolution and certification
Are not a security – they are a cooperative
Funds
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Need to be in your policy
Do not require resolution or certification
They are a registered security
Fund/Pool Types

Constant dollar funds/pools
Strive to maintain $1 asset (share) value
Money market equivalent – known as 2a-7 funds

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
Net asset value funds/pools
Share value fluctuates on market price
Mutual fund equivalents – potential loss of principal

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Constant
NAV
1
2
3
4
5
6
7
8
9
10
11
12
Pools – Know what they are..
Read the information statement

Most pools are constant dollar
 Texpool I and II
 Logic
 Class
 TASB – Liquidity
 TexStar

Some pools are mutual funds

Some are a hybrid


It’s your job to know
Have accounts at more than one pool
Types of MMMF
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MMMF are regulated securities

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maximum maturity 13 months
Maximum WAM of 60 days
Types of MMMF

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Treasury
 US Treasury Obligations & repo with treasuries
Government
 US treasuries and agencies & repo backed by treasuries and agencies
Enhanced Government
 Same as Government but including CP
Prime
 treasuries, agencies, CP, BA, or corporate to 5%, repo
New SEC Rules for MMMF
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New regulations are directed towards safety, liquidity and stability
Minimum 10% in securities convertible to cash in 1 day
Minimum 30% in securities convertible to cash in 1 week

Maximum WAM shortened to 60 days
Maximum WAL of 120 days
 weighted average life to reduce use of variables

Monthly reporting to SEC on shadow prices

Create procedures for stress tests

New Rules for MMMF

Repo collateralized with US Obligations or cash only

Ability to process at price not $1

Maximum 3% in second tier securities (higher risk securities)
 from 5%
Maximum of 5% in illiquid securities

Know Your Investor requirements added

Ability to suspend redemptions to prepare for liquidation

Proposed Money Market Rules

SEC is out for comment now

Sec wants to turn PRIME money funds into mutual funds

Not strive to maintain $1
Fluctuate with market values (price)
Can reflect principal loss

Are they for you? What does your policy say?

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Money market mutual funds, excluding prime funds.
Money market funds which strive to maintain a $1 NAV.
MMMF Considerations

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This is a registered security
 add as authorized investment to your policy as direct or sweep
 Safety is that you own and not have pledged securities
Get and read the prospectus
 Check historical rates
 Check the expense fee
 Choose the type that fits you risk tolerance
It may add value to go directly to fund
 Usually will under-perform pools because of expenses/subsidy
Know the procedures
The Ubiquitous Repo

Repurchase Agreements
Simultaneous “Buy-Sell” Transactions

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Allows full liquidity at market rates
Uses DVP and independent custody
Margins (102%) monitored constantly
Various types include overnight, open & term
“Flex” is designed for capital projects

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Established for the entire expenditure period
Rate is fixed and normally above issue rate
Flexibility on draws with xx/month
Interest on semi-annual basis
BUY
SELL
Tri-Party Repo Transactions
Public Entity
Agreement to buy-sell
with $$$
Primary dealer
with securities
Instructions
$
Third Party NYC Bank
Cash
$$
Account
Securities
Account
Securities
Safeguards for True Repos

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Primary dealers only
 Banks are allowed under law but not competitive
Written Master Repurchase Agreement
 The Bond Market Association Master Repo Agreement
Independent Safekeeping
 Money center bank usually
DVP at all times!
Mark-to-market daily
Collateral Margins (102%)
Designated Collateral
Danger: Repo Bank Sweeps

FDIC has no set procedure for liquidation

Losses have occurred

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Ownership is not clear
Securities are segregated in bank’s name
Securities remain in bank’s safekeeping account
Rates are slightly higher for a reason
Spread Money Market Accounts
Through a BANK
Through a BROKER
Beyond Liquidity: Securities

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Securities
Provide stability in rate
changes
May add yield
May not be liquid
Needed by all but smallest
entities

Liquidity Options

Float, and lag, rates both up and
down
Always provide short rate
Assure liquidity

Needed by all entities


Investments Choices
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US Treasuries
US Agencies/
Commercial Paper
 corporations, ABS
Bankers Acceptances
Certificates of Deposit
Brokered CD Securities

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Repurchase Agreements
Money Market Mutual Funds
Mutual Funds
GICs
Investment Pools
State of Israel bonds
Municipal Obligations
[Letters of Credit]
Best Choices for
Infrequent Investors


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US Treasuries
 Treasury Bills and Notes
 Primarily discount securities
US Agencies/Instrumentalities
 FHLB, FNMA, FHLMC, FFCB
 Primarily discount structure
Certificates of Deposit

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
FDIC and collateralized Depository
FDIC Brokered (with controls)
Money Market Mutual Funds
Local Government Investment Pools
Other alternatives for today’s special situation
The Name is BOND…

Securities:
 Yield enhancement
possibilities
 Liquidity restrictions
 Must reflect cash flow
 Never invest beyond needs
 Provide for diversification
 Understand the accounting
 Minimize risk by limiting
choices
DEPOSITORY
Certificates of Deposit

Depository agreements
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
Bank relationship
Any bank now allowed but primarily Texas
Requires paperwork to create a deposit
 Patriot (Terrorist) Act provisions
Funds are left in the bank as a deposit
All MUST BE Insured by FDIC or collateralized


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Above $250,000 requires agreement and collateral
Texas collateral rules protect you under PFCA
Different collateral types are legal
Controlled by PFIA and depository law (Local Gov’t Code Ch.105)
PFIA Language re CD
2256.010


(a) Texas CD or CU Share Certificate
 Insured by FDIC or Nat’l CU Share Insurance
 Collateralized per PFCA including authorized mortgage backed
securities in PFIA
 Secured in any manner allowed by law
(b) Brokered CD
 Invest through Texas bank or Texas broker (on broker list)
 Fully insured by US or its instrumentality
 Includes CDARS spread program
 Limited to $250,000 per bank
 Broker can custody ---conflict with DVP
CD Confusion
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Depository CD
Relationship with bank
Paperwork involved
Can exceed $250,000
Collateralize > $250,000
Only TEXAS
Not on broker list

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MERGER PROTECTION

Brokered CD
A registered security
Straight buy/sell
Can not exceed $250,000
No collateral allowed
Any state
Can be spread (CDARS)
On broker list
NO MERGER
PROTECTION
Brokered CDs

Differentiate “Brokered” CD as securities in policy



(Added 2011)
“Brokered certificate of deposit securities”
Often sold by brokers or banks
Legal in Texas -------but only if FDIC insured
A Pool ?? Or??
What does your policy say??
These are brokered CDs bought by a pool, not in City’s name and not in their policy.
Policy Language Authorizing
Depository CDs


Fully insured or collateralized depository certificates of
deposit of banks doing business in Texas, with a
maximum maturity of ----- years guaranteed or insured
by the Federal Deposit Insurance Corporation, or its
successor, or collateralized in accordance with this
Policy.
Collateralized CD will be created under a written
collateral agreement.
Policy Language Authorizing
Brokered CDs


FDIC insured brokered certificate of deposit securities
from banks in any US state,
 delivered versus payment to the City’s safekeeping
depository,
 not to exceed one year to maturity.
Before purchase the Investment Office must verify that
the bank is FDIC insured on www.fdic.gov
Controls on Brokered CD

The investment officer must monitor



On no less than a weekly basis
Status and ownership of the issuing bank
based on FDIC information
If the bank has merged or been acquired
where other deposits exist

Investment Officer shall immediately liquidate
any brokered CD which places the city above
the FDIC insurance coverage
CD Accrual and Payments

You purchase a CD:






Par
Principal
Interest rate
Days-to-Maturity
$ 500,000.00
$ 500,000.00
1.50 %
180
Total Earnings =
Earning each day =
$
$




($500,000 x 1.50%) / 360 x 180
3,750.00
20.83 per day
Earnings are from accrued interest only
Earnings belong on your monthly/quarterly reports
Payments will differ (monthly, quarterly, at maturity) Check it!
Buying an FDIC CD

FDIC coverage is permanent at $ 250,000

Decide on your needed maturity date



Phone several banks in Texas for the rate competition
 Ask for the maturity ranges (3 mo, 6 mo, 1 year) and compare
 Get all in APY (annual percentage yield)
 Clarify dates, agreement and certification requirements
Do not use a broker to place a depository CD
Chose the best rate and notify the banks
 Get instructions to send money
 Send money on settlement date
Buying A Collateralized CD

Decide on your needed maturity

You will need a collateral agreement



Phone several banks for the rates


Agree on terms and collateral needs
Clarify certification
Get all in APY (annual percentage yield)
Chose the best rate and notify the banks


Get instructions to send money
Send money on settlement date
Buying a CDARS CD




Check for CDARS banks in Texas (CDARS.com)
 Currently up to $50 million at $10mm per week
Maturities set at 3,6, and 12 months normally
 They all settle on Thursdays
Phone or email several banks for the rates
 Get all in APY (annual percentage yield)
 Certification only from entrance bank
Chose the best rate and notify the banks
 Get instructions to send money and agreement for CDARS
 Standard CDARS Deposit Placement Agreement
 Send money on settlement date
Certificate of Deposit
Account Registry Service
CDARS Banks in Texas
Other CD Options

Virtual Banks doing business in Texas


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


State Farm Insurance
Ally Bank
USAA
Others?
Stay under FDIC insurance levels
Must make investment directly
Check the Rates

Current rates survey:

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
Ally MMA
Ally 1-year CD
State Farm MMA
State Farm 1 –year CD
State Farm 9 month CD
BBVA 1-year
0.84%
0.85%
0.65%
0.36%
0.95%
0.50%
Possible for 4a-4b corporations?
Rates change normally on Tuesdays – all banks
Reduce Your Collateral Cost

Collateral is expensive for banks – and you!

Additional FDIC assessments increase costs




On time and demand deposits
10% to 15% possible
Certificate of Deposit Account Registry Service
(CDARS) could reduce collateral on time deposits
Manage your collateral and balances

Monitor the alternative rates – stay on top of them
CDARS: An Edge for Small Banks



No fee to customers
CD rates are negotiated as normal
Banks must be members
 Promontory Inter-financial Network (700 banks)

Initial test transactions are used
City receives consolidated report

Reciprocal or non-reciprocal

Sample CDARS CD

Account ID
Product Name
Interest Rate
Account Balances
Effective Date
Maturity Date
YTD Interest accrued
Average Annual & Earned:

CD Issued by Bank X


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
Balances and interest paid/accrued
$ …………….
Balances and interest paid/accrued
$ …………….
CD Issued by Bank Y

1000088888
52 week CD
2.350 %
$ 195,000
01/15/04
01/14/05
$ 2,291.25
2.377 %
Security Basics

Buying Securities




At a discount
At par
At a premium
Reporting Securities



Amortized value
Book value
Market value
The Money Markets





Loose collection of markets
Creativity and innovation
Structural variety requires knowledge
(embedded options, calls, strips, bullets, etc.)
Book entry requires documentation
DVP settlement is critical
Two Types of Securities





You earn only from principal or interest
Money market = created only 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 only 1 year or more
Her you can earn from principal and interest
 US Government
> Treasury Notes/Bond
 US Agencies
> Agency Notes
 Local Government
> Long-term Bonds
 Corporations
> Corporate Notes
A Word on Security Earning

Earning come from only:

Principal


The value of the principal increases
Interest


A coupon accrued then pays on a schedule
Rate accrues then pays on a fund/pool
Bought above par – moves to par
Amount above par is amortized – “expensed”
Premium
Expense
100
(par)
Income
Discount
Bought below par – moves to par
Amount below par is accreted – “earns”
Issuance
Maturity
A Word on Security Price



PAR means $100 or $1=$1
 Buying at par means you pay the face value
DISCOUNT means below PAR
 Buying a discount means you pay less than face
PREMIUM means above PAR
 Buying at premium means you pay more than face
Discount Structures


All securities with original maturities < 1 year
 Treasury bills
 Agency discount notes
 Commercial paper
Quoted at a discount
 Often close to yield
 Ask to be quoted yield for comparison purposes
Discount Securities
Accrete (Gain) Value Over Life


Always bought at a price less than
100
Earn daily and only through
accretion
100
What
You
Earn
99.5
99

Buying a $100,000 T-Note
 Price = $ 98,000
 You own it 200 days until
maturity
 Discount/# of days
 2,000/200 days= $ 10 / day
98.5
98
97.5
97
Purchase
You buy it at $ 98,000
it matures at $ 100,000
Maturity
Buying at a “Discount”

Discount notes
 All securities under one
year at issue or auction
 T-Bills, CP, Discount notes
101
100
99
97

Notes at a discount



Securities bought below face
Book value increases daily in
a straight line
Earnings are difference
discount to Par (face)
E
98
96
A
Accretion
R
N
95
94
93
92
Purchase
Maturity
Daily Accretion

You purchased a T-Bill 8/6/12 about 0.11% yield:




Par
$1,000,000.00
Principal
$ 997,695.69 (book value day 1)
Discount
$
2,304.40
Days-to-Maturity
356
Ouch !

Daily Accretion $

6.47 (2,304.40/356)
Earnings only from accretion
Discount vs. Price




Discount securities are often quoted as a discount
 Shorthand mechanism for price
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
T-Bill B
1.95 discount
1.65 discount
99.5016667 price
99.5783333 price
Discount Securities



Agency discount notes always sold below par
Quoted at a discount not a price
Only two key elements to know
Discount Listing

Maturity
Dec 16 ‘xx
Mat
165
Bid
0.68
Asked
0.66
Chg
-0.03
Ask Yld
0.75
Security “Notes”

Any security is longer than one year when issued or
auctioned is a note



Notes move to maturity over time
An old 30 year could now be a 1 year note
All notes have a coupon which is ‘fixed’ at issuance *

*With a few exceptions

The rate is based on the then current rates

The coupon earns = accrues interest

The principal can earn or can be an expense
Notes Bought at a Premium

Buying above par ($1=$1)
102
e
x
p
e
n
s
e
101.5

Daily amortization
is an expense
101
100.5

Premium of $20,000
for 180 days
= $111.11/day
Amortization
100
99.5
99
Purchase
Maturity
Discount or Premium?

T-Note



5% Note - yield of 3.22%
A premium or discount ?
T-Note


5% Note - yield of 6.75%
A premium or discount ?
US Treasury Obligations

Various types





Explicit guarantee


T-Bills, T-Notes, TIPS, Strips
Securities are auctioned regularly
If you buy at auction then get auction yield
Securities then move to the secondary market
Based on taxing ability of the US
The ‘certainty’ security

Strict guidelines control the auctions and forms
Treasury Bills

Markets hate uncertainty so it loves its certainty and stability

Auctions are scheduled with $$ announced

Maturities of 1 year or less
No coupon
Trade at discount to par
3- & 6-month auctioned every Monday*
4-week auctioned every Tuesday*
Settlement & maturities on Thursdays*

Cash Management Bills – one month





*Unless a holiday, then next business day
Buying A Treasury Bill

$100,000 T-Bill maturing 5/27/XX
Settling 6/5/xx at 1.11 Discount

The discount price translates into a discount from par


Par
Price
Principal
Discount

Yield



$ 100,000.00
94.83322
$ 94,833.22
$
5,166.78
1.38 %
Notes

Notes are created starting at 2 years

Notes carry a coupon





The coupon is normally ‘fixed’
A few securities coupons change on schedules
A coupon accrues for the owner as long as owned
When you buy a note you also buy the accrued interest
Notes can be bought at/above/below par
US Treasury Notes







The NO-SURPRISES security
Semi-annual fixed coupons fixed at time of issuance
(auction)
Mature on the 15th or last day of month
“Currents” (on-the-runs)= most recently auctioned
Interest is actual days/actual days of year basis
Price quoted as % of par (99,100,101)
Usually quoted as YTM
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
Buying a Treasury Note





Semi-annual coupons
Sold at par, discount or premium
Price is percent of face
Quoted in 32nds
Still only two things to attend to: maturity and yield
T-Note Listing
Rate
1 3/4
Maturity
Aug xx
Bid
97:26
Asked
97:28
Chg
-3
Ask Yld
1.41
Strips

Only Treasury strips are authorized by PFIA

All coupons have been stripped away




Only the principal is purchased
No payment until maturity
Straight line accretion
Creates a long-term discount note


Good for targeting specific dates in future
Usually start at 5-10 year maturities
Other Treasury Structures



Callables
 Treasury has a right to call them
Strips (US Government securities)

Separate Trading of Registered Interest& Principal

zero coupon, wireable, like a long T-Bill
TIPS (a NEGATIVE yield TIPS in 10/10!!)
 inflation adjusted
Treasury Direct
www.treasurydirect.gov



Changed in November 2012
No longer available to governmental
entities – except Federal agencies
Available for ‘corporate entities’ only

Unsure as yet whether this applies to EDC
Where to find the Treasuries:
On the Yield Curve
7
A ‘normal’ yield curve
6
5
3 mo
6 mo
T-Bills
1 yr
2 yr
5 yr
T-Notes
10 yr
30 yr
T-Bond
Treasury Rates Abound
Prices and Yields
Move Inversely
$
%
A 5% coupon at par (100)
Coupon = 5%
Yield = 5%
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 %
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 %
US Agencies

Short term agencies




Called ‘discount notes’
Some are regularly ‘issued’ and some as needed
Non-standard dates created to fill investor needs
Longer term agencies



Called ‘debentures’ or agencies
Some are set maturities – many are not
Different structures created to fit investor or market
US Agencies
The investor’s advantage in lower credit

Treasuries give markets standardization

Agencies offer more to get your business

Advantages




All ‘good day’ maturities
Flexible maturity date choices
Flexible structures
More yield to take ‘risk’ of lower credit
Federal Agencies





Agencies most often in the marketplace
FHLB
 Federal Home Loan Bank
FHLMC in “conservatorship”
 “Freddie Mac” Home Loan Mortgage Corp
FFCB
 “Farm Credit” Farm Credit Bank
FNMA in “conservatorship”
 “Fannie Mae” National Mortgage Assoc.
Government Agencies


Non-standard, semi-annual coupons
Varying middle dates
Agency Listing
Rate
0.75
Maturity
Bid
Asked
Yield
4-xx
92:20
92:24
1.88
Callable Securities



Issuers

Agencies, corporations, public entities
Callable is two securities
1.
Issuer sells fixed income security to investor

Value = present value of stream of cash flows
2.
Investor sells option to call to issuer

Value = probability of being exercised based upon current
yield curve, a rate of volatility, and time to exercise date
Lock-out period

Call protection; initial period during which issuer can’t call bonds
Callable Structures

Various structures – 3/1; 5/2; 10/3 “2YNC6 Berm”
 European – one-time call
 Bermuda – “Discrete call”, callable only on interest payment
dates
 American – “Continuous call”, callable anytime with specified #
of days notice

Step-up callables
 Fixed coupon to next call date
 At call date, bonds either called or coupon “steps
up”/increases to structured higher coupon
 Can have multi-step ups
 Not the same as floating rate notes
Valuation of Callable Securities

Priced at spread to Treasuries

Yield to Worst (YTW)


Which is lesser: Yield to Maturity or Yield to Call
Option Adjusted Spread (OAS)


Creates synthetic “bullet”
Compare spread from OAS analysis to historical spread for noncallable securities from same market sector
Structured or
Floating-Rate Notes

“Floaters” reset rates periodically

Index

Spreads

Reset Periods

Day Count Periods

Payment Periods

Maturity

Valuation difficulties (accounting variations)
Agencies Come in 2 Varieties

Agencies issue debentures to get funds to buy mortgages

Agency Notes




debentures of the agency
backed by the credit of the agency
Issued like regular discount notes and notes
Mortgage Backed Agencies


Created by pools of and backed by home mortgages
affected by interest rates and mortgage pay-downs
Some More Securities

Additional types of securities


They are legal if in your policy


Not used by most public entities
You might want specificity in definitions
Chose your policy securities carefully
Bond Mutual Funds




Structure is key – not liquid securities
 Moves on market prices – not a straight accrual
 Must have a maximum WAM of 2 years
 Not permitted for bond funds because of risk
 Not much reason to use – especially now
 Potential of principal loss in rising rates
Check the fee
 Use no-load funds
 total expense ratio
Know the earnings history
Read the prospectus
 Size
 Goals and policy restraints
Bond Funds

Must be treasury and agency


Bond Proceeds are prohibited by law!! Too much risk of principal loss.
Maximum WAM of 2 years


Short term bond mutual funds



What would that make the maximum maturity??
Only safe when rates are falling
Rising rates may limit your liquidity or lose principal
Look for Morningstar Four Stars ****




Watch for rates to turn
Watch and check for liquidity terms
Reporting will be different
Restrict the amount used – primarily for reserves
Corporate Bonds



Only for Higher Education and ISD
>50,000
Credit required AA- but higher may be
safer
Monitoring required
Mortgage Backed Securities




Built from pools of home mortgages
 “Pass-through” securities
 Passes through P&I from homeowner
Stated maturity and expected maturity
Performance of pool
 dependent on mortgage payments
 Dependent upon interest rates
Subjective pricing
Basic Mortgage Backed Security
(‘MBS’)
Homeowner gets
Company sells
Agency pools
Mortgage
the mortgage
like mortgages
As
homeowner
pays P&I
monthly
Payments flow
through agency
to investor
It all hinges on the homeowner.
investor
Derivative Mortgage Backed

Created for investors clamoring for yield

Pool of mortgages is divided



Collateralized Mortgage Obligations (CMO)
Each piece (tranche) is structured differently
CMO differ in risk

TAC, PAC, Jump-Z, Inverses
CMO

Collateralized mortgage obligations

Noble laureates puzzle over some of this math

Pools of mortgages split into pieces

Each piece is structured differently


Some carry more risk (and therefore yield)
Certain CMO are unauthorized in TX
Municipal Obligations

Current value over other securities

Taxable and non-taxable issuers


In any US state
Rated A or above (you may want higher!)

Various structures

Credit and liquidity issues

Arbitrage safe haven
Commercial Paper

Unsecured promissory note of a corporation




Credit Considerations



Corporation is borrowing short term funds
Using the low rates of the short term market
Often used by municipalities then rolled to longer term debt
Dual rating is better market-wise
Law allows single rating with LOC
Cautions:





Stay to known names
Consider the situation (like European bank debt!)
Stay short and high quality
Available out 270 days
Stay within 90 days – set your policy as such
Sample CP Policy Language


Commercial paper rated A1/P1 or
equivalent by two nationally recognized
rating agencies with a maturity not longer
than 90 days.
Could stipulate domestic CP only
Asset Backed Commercial Paper

Know what backed the securities

Based on underlying securities or assets


Originally backed by receivables


Not based on credit of the company
Short-term debt used to finance long term risk
High concentrations threaten funds/pools

Florida, Montana, Washington State
Bankers Acceptances

Bankers Acceptances







International trade primarily
Defined as 270 maximum
Restrict to 90-120 days in policy
Illiquid
Measure spread vs CP
Credit issues
Foreign versus domestic?
Israeli Bonds

Issued, assumed or guaranteed






by the State of Israel
Assumed backing by US
Currently 1.20% on 2-year
Denominated in US dollars
Longer term
Illiquid
Limited-Use Securities


GIC
 Guaranteed Investment Contracts
 Basically insurance contracts
Specialized funds [IRS Code Sec 501(f)]



Institutions of Higher Education
Municipal utilities
 Distributing electricity or natural gas
 Hedging contracts
 Decommissioning Trust Fund
Mineral Rights Funds
 Alternate uses for mineral right (gas) funds
 Barnett Shale impetus
Securities Lending


Authorized after 9/1/03
Reverse repo without buy/sell

Banks and some primaries

50% of income to entity (10-15 bps)

Collateralized

Treasuries (primarily) and agencies only
Larger portfolio use
primarily:
must have
securities to lend
Requires a strategy
Securities Lending





Must be at least 100% collateralized with
 treasuries, agencies and munis
 letters of credit from bank rated not less than A
 commercial paper, mutual funds, or pools
Must allow for termination at any time
Collateral must be
 pledged to public entity and held in its name
 deposited at time of the loan
Loan must be with primary or bank in Texas
Contract may not be for term longer than 1 year

Can extend
Special Use PFIA Securities

Guaranteed Investment Contracts (GICs)



Nuclear De-commissioning funds


Primarily housing authorities
Detailed restrictions on use & collateral
Long life requires differentiation
Higher Education variations


Corporate notes, equities, stock mutual funds
NOT for school districts
Securities in General

Current Issues
Round lot purchases may be better prices
Odd lot purchases to buy and hold

Watch for credit warnings and esoteric structures

When it sounds too good to be true…..


BUT… When in Doubt - Don’t!
Strategy Exercises

Three case studies

See handouts
Portfolio Reporting




To show risk
 Volatility risk (change in market value)
To provide accounting/archiving
 Detail for holdings and summary for information
To illustrate compliance
 Compliance with policy parameters (SLDY)
To judge performance
 Yield
 Benchmark comparison
Accounting and Reporting Concepts



Two types of securities
 Discount securities
 Fixed income securities (with a coupon)
Two values
 Market value = price of you sell it – changes daily
 Book value = your value net of amortization – changes daily
Three computations
 Interest accrual (coupons)
 Accretion (earnings)
 Amortization (expense)
What Did I Earn?



Earnings = accrual plus (net amortization +
accrued)
Amortization from notes bought above par
decreases earnings
Accretion from notes bought below par increases
earnings
ISD Earnings per Student


ISDs are being held to earning the equivalent of
the 3-month Treasury Bill
What does this mean?




Most years this will allow for pool use
With low rates add in ECR earning and bank earnings
FY 2011-2012 3-month yielded 0.054%
Pools yielded 0.09%
A.
Bank IBA
0.05%
20,000,000
0.05%
$
833.
$
833.
B.
Pool #1
0.15%
10,000,000
$
1,250.
Pool #2
0.22%
10,000,000
$
1,666.
$
2,916.
0.185%
C.
Pool #1
0.15%
3,000,000
$
375.
Pool #2
0.22%
10,000,000
$
1,666.
ECR
0.40%
7,000,000
$
2,333.
$
4,374.
0.273%
Earnings go to Income not Interest Received. Recognize it!
Accounting for the Portfolio

Buying securities





at par
at a discount
at a premium
Accounting for securities



At par = $1 for $1 face (price of 100)
Below par = below $1 or 100
Above par = above $1 or 100
All affect the principal only
The book value at maturity must equal face value (100)
Straight line amortization/accretion
Earnings from securities are from:


Earning from the changes in principal (premium/discount)
Earning from interest accrued in a coupon (accrued interest)
Book Value

Changes daily

Bought at par
100
Purchase
Point

Bought at discount

Bought at a premium
Purchase
Point
100
Book value moves from start
to 100 regardless of price.
Market Value Changes Daily

Market value is quoted as principal only

Market value equals:




Current price x face value
101.22 x $100,000 = $101,220
98.3 x $100,000 = $ 98,300
Certificates of Deposit



always priced at 100
Market will always equal face amount
100 x $100,000 = $100,000
Pricing





Require an independent source
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
Small issue pricing
 comparables
Earnings

Earnings = amortization + accrued

Note – bought at a premium
1.
2.

Monthly amortization = daily amort. * # days plus
Coupon earnings = coupon rate * face/12
Note – bought at a discount
1.
2.
Monthly accretion = daily accretion * # days plus
Coupon earnings = coupon rate * face/12
What did I earn?
Income equals:
Total Accrued + Net Amortization

Investment Earnings



recognizes coupon flow (accrued)
recognizes original price of security (principal)
Accrual basis

does not include cash coupons
Coupons on a T-Note
$1,000
$800
$600
$400
$200
$0
Jan



Feb
Mar
Apr
May
June
July
Aug
Sept
Oct
Nov
Dec
Coupons on May 15th – when is the next coupon?
How much did we earn in May?
If it matures next August how much will we earn in that
month?
Reporting Issues

Accuracy
Timeliness
Compliance
Risk Identification
Pricing
Value Representation
Formats

Information






A Cardinal Reporting Rule

Weighting the Information

Recognizes the impact of





Dollar value
Maturity
Yield
$ 10,000 CD
$ 500,000 CD
100 days
10 days
=
12 day WAM
Weighted Average Maturity



This measure is useful in determining the degree of
market or interest rate risk.
The longer the WAM, the more exposure to the market
and more potential for capital gains and loses. More risk.
Portfolio managers typically shorten or lengthen average
maturities depending on their interest rate outlook.
 If rates are expected to drop we ------- ?
 If rates are expected to rise we -------- ?
Calculating Weighted Average Maturity
Multiply book value by days remaining to maturity
Divide Sum by total book value of portfolio
Current
Value
Book
Remaining Days
Maturity
to
Book x Days
6,568,777
14
91,962,878
3,211,222
48
154,138,656
5,999,158
300
1,799,747,400
1,425,177
540
769,595,580
1,920,575
270
518,555,250
19,124,909
3,333,999,764/19,124,909
Equals WAM =
3,333,999,764
174.3 days
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.
Calculating Weighted Average Yield
Multiply book value by purchase yield
Divide Sum by total book value of portfolio
Book Value
Purchase Yield
Book x Yield
6,568,777
2.25
147,797
3,211,222
2.10
67,435
5,999,158
1.99
119,383
1,425,177
2.75
39,192
1,920,575
3.20
61,458
19,124,909
435,265 / 19,124,909
Equals WAY =
435,265
2.27 %
To Commingle or Not to …..
Interest Distribution







How to effectively distribute interest to various funds
Replaces separate portfolios
May help your overall yield
Distributed on a pro rata basis by percent of fund
Accuracy
Ease
Timeliness
Distributing Interest

Total interest to be distributed = $10,000
Fund/
Project
Avg*
Bal
% of
Total
Interest
Received
Fund
Fund
Fund
Fund
$ 150,000
$ 40,000
$ 101,500
$
5,000
50.49 %
13.40 %
34.43 %
1.68 %
$ 5,049.00
$ 1,340.00
$ 3,443.00
$
168.00
A
B
C
D
$ 296,500
$10,000.00
*Use either month-end balance or average balance
Specific Report Requirements

Compliance statement and signature


Detail Information




“Report was prepared in compliance with the Act and our policy”
Each investment position (including bank accounts) with
maturity date
Book and market values of each position at end of period
Portfolio/fund investment belongs to
Summary Information



Beginning and ending market value of portfolio
Earnings for the period
Market sector summaries
Report Mirror Policy Parameters

Key report parameters reflect your policy






Maximum maturity limitations
Maximum average maturity limitations
Diversification goals and limits
Performance benchmarks
Philosophy (Strategy) on the portfolio
Volatility (change in market value)


not required by PFIA as of 2011
Reports should reflect risk tolerances
Looking in Reports for Risk

Liquidity risk

Extension risk

Volatility risk

Credit risk

Diversification
Detail Description Elements

Description of the holding






Type (T-Bill, T-Note, FNMA, CD Bank XX, etc.)
Par (face amount)
Coupon rate
Purchase yield
Purchase date )settlement not trade date)
Maturity Date (and call date if applicable)

Book value – amortized value of the security
Market value – price it could be sold for today

Earnings for the period


Accrued + Net Accretion/Amortization
Inventory Report
Sample Inventory Report
As of xx-xx-xx
Purchase
Date
Beginning
Book
Beginning
Market
Ending
Book
Ending
Market
Mo.
Earnings
Security
Coupon
Maturity
Yield
T-Bill
T-Bill
T-Bill
T-Note
0%
0%
0%
5%
1-16-xx
2-22-xx
5-15-xx
8-15-xx
4.22%
4.35%
4.52%
4.75%
101,486
251,488
190,025
354,898
102,100
252,980
194,020
355,390
102,570
251,999
192,005
354,300
102,100
253,005
192,401
366,980
1,084
511
1,980
860
FNDN
FHLB
0%
5%
3-7-xx
6-4-xx
4.41%
5.25%
107,642
104,567
107,666
104,750
107,999
104,850
107,000
106,010
357
1,766
BankOne
BankTwo
4%
3%
3-5-xx
1-8-xx
4.00%
3.00%
98,000
95,454
98,000
95,454
98,327
95,691
98,327
95,691
327
237
Pool #1
0%
xx-xx-xx
4.37%
120,123
102,123
120,999
120,999
876
1,412,483 1,428,740
1,442,513
7,998
Treasuries
4-5-xx
5-10-xx
2-4-xx
7-9-xx
Agencies
11-20-xx
7-3-xx
CDs
3-5-xx
7-8-xx
Pools
xx-xx-xx
TOTALS
1,423,683
Diversification by Sector

By Market Sector

Shows diversification

Illustrates Risks
70
60
50
40
30
Treas
Agency
CD
Pool
20
10
0



Too short
Too long
Barbelled
Diversification by Maturity
35
30
25
20
15
10
5
0

By maturity breakdown
Shows coverage of liabilities

Funds concentration on near-by liabilities


Plus use of longer opportunities
O/n
0-3 mo
3-6 mo
6-9 mo
9-12 mo
Pool/Fund Reporting

Pools and Funds price and value


Constant dollar (money market equivalents)



designed to show risk to investor
Price is always $1
Days-to-maturity is always 1 day
Mutual fund equivalents


Price is the net asset value or share price that day
Days to maturity is the WAM of the underlying portfolio
Benchmarks

Purpose


Risk or performance?
Selection with yield versus rate of return

Comparability
Sector recognition
Comparable treasury versus index

Always compare same periods


Benchmarks

Measure Risk and Performance

Sample Benchmarks





Comparable Treasury Yields
 3-Mo, 6-Mo, 1 Yr
Fed Funds
Pools or S&P’s LGIP Index
GFOA “Public Investor” Benchmarks
Government Bond Indexes
Summaries Tell the Story










Beginning Book Value
Beginning Market Value
Beginning WAM
10,100,000
10,400,000
240 days
Ending Book Value
Ending Market Value
Change in market value
Earnings for Period
Ending WAM
10,150,000
10,500,000
100,000
4,160
280 days
Period Average Yield
Period Average Benchmark Yield
2.40 %
2.10 %
If you are more than 0.75% from your benchmark you should know why!
Annual GASB Reporting

GASB focus is on risk

Displays fiduciary responsibility and public trust

Annual risk disclosure




Collateral risk
Safekeeping risk
Volatility risk
Credit risk
Government Accounting Standards Board
GASB 31

Fair Market Evaluation
 Designed to show change in market value
 Annual reporting only
 Entry is made and reversed
 Too much volatility equals volatility risk


Discloses risk created by change of market price
Only used for securities > one year only
GASB 40

Disclosure is aimed at:


Credit risk including credit quality from rating
agencies
Interest rate risk


Interest rate sensitivity


disclosure including WAMs and specific derivatives
Primarily on structured notes
Foreign exchange (currency) risk
Texas PFIA Makes GASB 40
Reporting Easy



All areas are covered by policy and approved by governing body
Reporting Credit Exposures:
 All Agencies are AAA
 Credit ratings critical on CP, BA, Corporates
 Procedure to monitor credit in policies
Reporting Interest Rate Exposures:
 % Callables or other structured notes


Requires listing of callable and structured notes only
Reporting Interest Rate Exposures:
 Maximum Maturity
 Weighted Average Maturity
 Benchmarks
So what do I do – about reporting

Recognize amortized book value

Recognize accretion and amortization

Get independent pricing source

Report monthly if possible – quarterly required



Holdings report for detail
Management reports/information for summary view
Use benchmarks
Settlement

Require delivery versus payment (DVP)



Send every broker your delivery instructions



It is the law
No broker safekeeping
Get the instructions from your bank
Instructions are your ABA number and account
Document by trade ticket and confirmation


Clearing confirmation shows security arrived
Safekeeping receipt shows bank is holding the security
ABA 11-12345611
for account of ------ District
?
Purchases and Sales

Settlement

Cash (same day)
Regular (next day)

Bid (sale) vs. Offer (buy)

Independent safekeeping

Delivery and Settlement Language



Federal Reserve’s FedWire
DTC (Depository Trust Corporation)
PTC (Participatory Trust)

Delivery versus Payment
Free Delivery

DK (“Don’t know” the trade)

How Do I Buy a Security?

Security Transactions

Banks


Broker/Dealers


Can sell depository CD or be a broker
Can sell securities of different types
Advice and Management




Investment Advisers
Find, competitively bid and purchase for you
Can not sell anything
Act as your investment officer
Access to the Market




Brokers/dealers access the markets
Market distribution process
A broker puts buyer and seller together
A dealer sells securities from an inventory
US
Treasury
US Agencies
-Primary dealer structure
--Selling groups
-- banks and investment bankers
Corporate
entities
Bankers

Bankers selling a traditional depository CD

Banks acting as a broker

If your bank holds your securities they can not be your broker


Banks are not advisers


Does not perfect DVP
Still need multiple brokers for competition
New factors for depository CD:


Terrorism Act documentation
Collateralized versus FDIC funds
Bank CD Trade Settlement

Getting yields from multiple banks

Check for details

Day count, coupon pay dates, good maturity

Get Policy Certification

If not FDIC, need Depository Collateral Agreement

Terrorism documentation takes time
Broker or Dealer

Broker
 No inventory
 Transaction based
 FINRA Regulation
 Capitalization
 Retail -Institutional


Dealer
 Maintains inventory
 FINRA Regulation
Primary Dealer
 Reports to NY Fed
 Capital monitored
 Open market trading
for NY Fed
 Liquidity provider
 FINRA
Primary Dealer List
www.ny.frb.org
Broker/Dealer vs. Adviser

Broker/Dealers sell a security

Advisers

SEC registered as advisers




Must have a CRD #
Can not charge on a transaction/security
Portfolio perspective
Only an adviser can do competitives for you
Advisers

SEC registered under 1940 Act

A ‘money manager’ who advises and can not sell a
security

Discretionary vs non-discretionary management


public is always non-discretionary because of cash flows
A ‘broker’ can not be an adviser

A broker can not do your competitive bidding
Where is Your Protection




What danger do you really have?????
Peer Experience and References
Credit Lines
Capital Adequacy



A standard not a guarantee
Government Security Dealer Act 1986 (structure)
Government Securities Act 1993 (standards)

SIPC INSURANCE ONLY APPLIES FOR BROKER HELD
SECURITIES – DO NOT ASK FOR OR DEMAND SIPC

FINRA (Financial Institutions Regulatory Authority)

Self regulatory body
FINRA
finra.org
Selecting a Broker

Determined by portfolio needs
Local versus non-local
Primary versus secondary
Banks
How many brokers?
What due diligence?

NEVER use broker safekeeping







Your policy and the law say DVP settlement
move securities to your depository bank
Certification in Texas 2256.005(k)

This is not a guarantee – it affords little or no protection

Policy must be given to any person offering to engage in an
investment transaction


“execute a written instrument in a form acceptable to the investing
entity…and the business organization substantially to the effect
that”



Brokers and bankers (including pools and advisers)
Firm has received and reviewed the policy
Firm has established controls to sell only approved securities
Nothing relieves the entity from responsibility for monitoring for
policy compliance
Some brokers view of certification…
POLICY CERTIFICATION FORM
as required by Texas Government Code 2256.005(k)








________________ (the “Entity”)
________________ (the “Firm”)
I AM A BROKER.
I HAVE PERUSED THE POLICY.
I WILL TRY KINDA, SORTA, MAYBE, PERHAPS ATTEMPT TO NOT SELL YOU
ANY OF THE FUNKY, *&$^%% SECURITIES MY DESK OFFERS.
Firm:
_______________________________________
Signature
_______________________________________


Annual Broker/Dealer List

PFIA requires an annual adoption of list



List is for broker/dealers only



Investment committees can adopt list
Any firm on list must have provided certification
Banks may change as CD rates are found
Pools are already authorized by Board action
May list banks and pools for information
Documents for Your Broker


Before Selection
 Questionnaire
 Investment Policy
 Certification
After Selection
 CAFR
 Trading Authorization
 Your delivery instructions
 Tax identification number
 No account application (safekeeping agreement)
Broker Dealer Questionnaires

Differentiate between brokers and primary brokers

All brokers:





firm information
contact broker information
delivery instructions
public client references
Non-Primary Brokers:

market sector involvement
Basic Questionnaire Info
Name of Firm:
__________________ CRD #___________________
Address:
___________________________________________________
Primary Representative on account: ___________________________________
Telephone: ________________ Fax: _______________________________
E-Mail:
______________________________________________
Broker CRD# ___________________________
Backup representative or trading assistant: ______________________________
Telephone:
___________________________________________
E-mail:
___________________________________________
Branch Manager:
___________________________________________
Telephone:
______________________________________
Fax:
____________________________________________
E-Mail:
____________________________________________
Questionnaire
Is the firm designated as a Primary Dealer by the Federal Reserve? __________________
Is the firm registered with the tx State Securities Board? __________________________
Is the firm and representative registered with FINRA? ___________________________
How long has the designated representative been an institutional fixed income broker at
this firm? ____________________
In total? _____________________
In what market sectors does the account representative specialize?
Treasuries ? _________
Agencies? _________
MBS?
_________
Delivery instructions: ___________________________________________________
All transactions will be completed delivery versus payment.
Non-Primary Information

FINRA Registration and CRD Report
State Securities Registration
Market Involvement
Public Sector Involvement
References

Audited Financial Statements





provided annually
So what do I do…?

Finding brokers to use


Peer group ideas and references
Use at least 3 – bank/broker


Feel comfortable with the person


Use at least one primary and all institutional brokers
It’s a telephone market – no need to meet
Establishing a relationship


Talk about your policy and limits
Get basic information



Backup person and numbers
Delivery instructions
Send your policy and certifications

Modified certifications
And then what…?

Making an investment

Set your time horizon


Tell the brokers what you need/want


“I need the best rate not past xx/xx/xx in an agency or
treasury”
Wait for them to do the research


Set the maximum maturity date
They will bring back alternatives for you to chose from
Make the decision


Inform them all what you bought (the “cover”)
Feedback is important
And then…….?

You chose on date and yield



Do not go past your due date if it is set
Chose the highest yield (true or gov’t yield)
Settling the security



The broker has your delivery instructions
Tell your bank it is coming (trade ticket)
Broker will send the bond to the bank
Investment Steps

Set your maximum date (your time horizon)

Set your maximum money to invest

Have a general idea of where rates are

Look at value in all markets available
Look at them all !

Check the alternatives authorized for you:

CD
T-Bill
FNMA disco
FNMA note
FHLMC note
SLMA note
TVA note

What are your considerations?






3.01 %
3.85 %
4.01 %
4.00 %
4.07 %
4.09 %
4.12 %
The Buying Decision

Determine the maximum maturity (time horizon)



Offers will differ in maturity and type




Do not go beyond that maturity
Request offers short of or on that date
Are they all authorized?
Do they fit diversification?
Do I know what they are?
Chose the best yield
Your decision will not be simply on
price of one security

TBill
8/8/13
1.75%

TBill
8/8/13
1.79%

TBill
8/8/13
1.80%
Your decision will be

Treasury
FHLB DN
FNMA DN
FNMA DN
FHLB 2%

Which do you chose and why?




11/23/09
11/15/09
11/20/09
11/10/09
11/17/09
4.95
5.15
5.10
5.11
5.15
%
%
%
%
%
Making the Decision




Need:
Choices:
Curve:
$500,000 payroll out ten months
Treasuries, CD, Agency, Pool
Stable and normal upward slope
Yields:
 CD
 T-Bill
 FNMA DN
 Pool
7/25
7/19
7/18
3.80
3.90
4.30
3.75
%
%
%
%
Making the Decision




Need:
Choices:
Curve:
$500,000 payroll out ten months
Treasuries, CD, Agency, Pool
Flat, talk of a Fed increase this month
Yields:
 CD
 T-Bill
 FNMA DN
 Pool
7/25
7/19
7/18
3.80
3.90
4.30
3.75
%
%
%
%
Making the Decision




Need:
Choices:
Curve:
$500,000 payroll out ten months
Treasuries, CD, Agency, Pool
Economy looks bad
Yields:
 CD
 T-Bill
 FNMA DN
 Pool
7/25
7/19
7/18
3.80
3.90
4.30
3.75
%
%
%
%
Relative Value by Yield










Investment out about six months… no specific liability
T-Bill
T-Note
FNMA
FHLMC
GE CP
FFCB
CD
5.22
5.28
5.50
5.52
5.55
5.40
3.50
Which one do you NOT use?
What are your considerations?
%
%
%
%
%
%
%
Relative Value by Yield

Longer term investment out 1.5 years…core investment

T-Note
FNMA
FHLMC
FFCB
WB
CD

What are your considerations ?





1.10 %
1.20 %
1.20 %
1.30 %
1.50 %
1.75 %
Relative Value Choices

In Six Months
T-Bill
FNMA DN
FHLMC DN
GM CP
T-Note
CD
Pool
0.16 %
0.17 %
0.18 %
0.20 %
0.15 %
0.40 %
0.20 %

In One Year
T-Bill
FHLB
T-Note
FFCB DN
FHLMC
CD
0.19 %
0.22 %
0.20 %
0.19 %
0.21 %
0.85 %
Real Value
Which one would you choose?
Rate
5 3/4
10 3/4
Maturity
May 11
May 11
Bid
Asked
97:16
97:18
111:14 111:16
Chg
-4
-0
Ask Yld
6.61
6.61
Buy the discount







5 3/4 Apr 11
Price
97/16
Yield
6.61 %
PAR 1,000,000
Prin
975,625
Acc
19,271
Net
994,896

10 3/4 Apr 11

Price
111/14
Yield
6.61 %
PAR 1,000,000
Prin
1,116,875
Acc
31,600

Net




1,148,145
Active Strategies
Expand on the Same Basics


Advantages

Improved yields

Utilize market opportunities
Techniques





yield curve analysis (rate anticipation)
riding the curve
spread and sector analysis
market timing
swaps
Larger Entities








Some “core” cash
Fund types provide additional opportunity
Annual review required
Rewards and responsibilities
One or more constant dollar pools
Bank sweep accounts
Flex for large bond funds
Ladder of securities matching liabilities
Steps in Developing
a Market View
1. Perspective on world and geo-political situation
2. View of business environment
3. Market and economic conditions
 Yield curve movement
 Relative value
4. Your unique situation
So what do I do – about all this

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Do your cash flow
Write your policy
Choose at least two brokers and qualify them
Create a short term ladder
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Create a longer term ladder
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Out to 4-6 months
if rates are favorable to go further
If not move extra funds to the “high” point in rates
Do competitive bidding
Do delivery versus payment
Get started!
Be careful – Get started –
Good luck!
Linda T. Patterson
Patterson & Associates
Austin, TX
linda@patterson.net