Glossary of Industry Terms & Supporting Information

ICON Securities Lending (T – Z)

Time Value of Money: The time value of money is the value of money figuring in a given amount of interest earned over a given amount of time.

For example, 100 dollars of today’s money invested for one year and earning 5 percent interest will be worth 105 dollars after one year. Therefore, 100 dollars paid now or 105 dollars paid exactly one year from now both have the same value to the recipient assuming 5 percent interest; using time value of money terminology, 100 dollars invested for one year at 5 percent interest has a future value of 105 dollars. This notion dates at least to Martín de Azpilcueta (1491-1586) of the School of Salamanca.

The method also allows the valuation of a likely stream of income in the future, in such a way that the annual incomes are discounted and then added together, thus providing a lump-sum “present value” of the entire income stream.

All of the standard calculations for time value of money derive from the most basic algebraic expression for the present value of a future sum, “discounted” to the present by an amount equal to the time value of money. For example, a sum of FV to be received in one year is discounted (at the rate of interest r) to give a sum of PV at present: PV = FV ? r·PV = FV/(1+r).

Some standard calculations based on the time value of money are:

Present Value The current worth of a future sum of money or stream of cash flows given a specified rate of return. Future cash flows are discounted at the discount rate, and the higher the discount rate, the lower the present value of the future cash flows. Determining the appropriate discount rate is the key to properly valuing future cash flows, whether they be earnings or obligations.

Present Value of an Annuity An annuity is a series of equal payments or receipts that occur at evenly spaced intervals. Leases and rental payments are examples. The payments or receipts occur at the end of each period for an ordinary annuity while they occur at the beginning of each period for an annuity due.

Present Value of a Perpetuity is an infinite and constant stream of identical cash flows.

Future Value is the value of an asset or cash at a specified date in the future that is equivalent in value to a specified sum today.

Future Value of an Annuity (FVA) is the future value of a stream of payments (annuity), assuming the payments are invested at a given rate of interest.

Tombstone advertisement: Tombstone are ads that are most often used in the financial industry, where a particular transaction (e.g. an offering or placement of stock of a company) is formally announced, in a form that discloses the participants in a specified order according to their role in underwriting or brokering the transaction (See bulge bracket.) In the United States, securities regulations require that most such advertising be in tombstone form. This is in order to prevent the advertisement from being perceived as a promotion of the particular stock issue involved.

A Tombstone Ad is simply an announcement (not an offer) of a new security for sale. This advertisement is the only one allowed during the “cooling-off period.”

Total return: The total return on a portfolio of investments takes into account not only the capital appreciation on the portfolio, but also the income received on the portfolio. The income typically consists of interest, dividends, and securities lending fees. This contrasts with the price return, which takes into account only the capital gain on an investment.
Trade date: Trade Date is a securities industry term describing the trading day a trade (bonds, equities, foreign exchange, commodities etc) was conducted. Trade Date does not necessarily equal the actual calendar date because in many cases (differing from market to market and asset to asset and exchange or OTC) a trade done very early or very late falls on the previous or following trade date.

This occurs because in the international market a trade conducted in (e.g.) Japanese equities at 3pm in London needs to effectively be considered as the following day for Japanese stock exchange reporting requirements.

Trade finance: Trade finance is related to international trade. While a seller (the exporter) can require the purchaser (an importer) to prepay for goods shipped, the purchaser (importer) may wish to reduce risk by requiring the seller to document that the goods have been shipped. Banks may assist by providing various forms of support. For example, the importer’s bank may provide a letter of credit to the exporter (or the exporter’s bank) providing for payment upon presentation of certain documents, such as a bill of lading. The exporter’s bank may make a loan (by advancing funds) to the exporter on the basis of the export contract.

Other forms of trade finance can include export credit insurance, export factoring, forfaiting and others. In many countries, trade finance is often supported by quasi-government entities known as export credit agencies that work with commercial banks and other financial institutions.

In short, trade finance means money lent to exporters or importers.
Trader: In finance, a trader is someone who buys and sells financial instruments such as stocks, bonds and derivatives. A broker who simply fills buy or sell orders is not a trader, as they are merely executing instructions given to them.

Traders are either professionals working in a financial institution or a corporation, or individual investors, or day traders. They buy and sell financial instruments traded in the stock markets, derivatives markets and commodity markets, comprising the stock exchanges, derivatives exchanges and the commodities exchanges. Several categories and designations for diverse kinds of traders are found in finance, these may include:

• stock trader
• day trader
• pattern day trader
• swing trader
• floor trader
• rogue trader

Tranche: In structured finance, a tranche (often misspelled as traunch or traunche) is one of a number of related securities offered as part of the same transaction. The word tranche is French for slice, section, series, or portion. In the financial sense of the word, each bond is a different slice of the deal’s risk. Transaction documentation (see indenture) usually defines the tranches as different “classes” of notes, each identified by letter (e.g. the Class A, Class B, Class C securities). The term “tranche” is used in fields of finance other than structured finance (such as in straight lending, where “multi-tranche loans” are commonplace), but the term’s use in structured finance may be singled out as particularly important. Use of “tranche” as a verb is limited almost exclusively to this field.

How tranching works

All the tranches together make up what is referred to as the deal’s capital structure or liability structure. They are generally paid sequentially from the most senior to most subordinate (and generally unsecured), although certain tranches with the same security may be paid pari passu. The more senior rated tranches generally have higher ratings than the lower rated tranches. For example, senior tranches may be rated AAA, AA or A, while a junior, unsecured tranche may be rated BB. However, ratings can fluctuate after the debt is issued and even senior tranches could be rated below investment grade (less than BBB). The deal’s indenture (its governing legal document) usually details the payment of the tranches in a section often referred to as the waterfall (because the moneys flow down).

Tranches with a first lien on the assets of the asset pool are referred to as “senior tranches” and are generally safer investments. Typical investors of these types of securities tend to be conduits, insurance companies, pension funds and other risk averse investors.

Tranches with either a second lien or no lien are often referred to as “junior notes”. These are more risky investments because they are not secured by specific assets. The natural buyers of these securities tend to be hedge funds and other investors seeking higher risk/return profiles.

“Market information also suggests that the more junior tranches of structured products are often bought by specialist credit investors, while the senior tranches appear to be more attractive for a broader, less specialized investor community”. Here is a simplified example to demonstrate the principle:

Example

• A bank transfers risk in its loan portfolio by entering into a default swap with a “ring-fenced” SPV (“Special Purpose Vehicle”)
• The SPV buys gilts (UK government bonds)
• The SPV sells 4 tranches of credit linked notes with a waterfall structure whereby:
  • Tranche A absorbs the first 25% of losses on the portfolio
  • Tranche B absorbs the next 25% of losses
  • Tranche C the next 25%
  • Tranche D the final 25%
• Tranches B, C and D are sold to outside investors
• Tranche A is bought by the bank itself

Benefits

Tranching offers the following benefits:

• Tranches allow for the “ability to create one or more classes of securities whose rating is higher than the average rating of the underlying collateral asset pool or to generate rated securities from a pool of unrated assets”.  ”This is accomplished through the use of credit support specified within the transaction structure to create securities with different risk-return profiles. The equity/first-loss tranche absorbs initial losses, followed by the mezzanine tranches which absorb some additional losses, again followed by more senior tranches. Thus, due to the credit support resulting from tranching, the most senior claims are expected to be insulated – except in particularly adverse circumstances – from default risk of the underlying asset pool through the absorption of losses by the more junior claims.”
• Tranching can be very helpful in many different circumstances. For those investors that have to invest in highly rated securities, they are able to gain “exposure to asset classes, such as leveraged loans, whose performance across the business cycle may differ from that of other eligible assets.” So essentially it allows investors to further diversify their portfolio.

Risks

Tranching poses the following risks:

• Tranching can add complexity to deals. Beyond the challenges posed by estimation of the asset pool’s loss distribution, tranching requires detailed, deal-specific documentation to ensure that the desired characteristics, such as the seniority ordering the various tranches, will be delivered under all plausible scenarios. In addition, complexity may be further increased by the need to account for the involvement of asset managers and other third parties, whose own incentives to act in the interest of some investor classes at the expense of others may need to be balanced.
• With increased complexity, less sophisticated investors have a harder time understanding them and thus are less able to make informed investment decisions. One must be very careful investing in structured products. As shown above, tranches from the same offering have different risk, reward, and/or maturity characteristics.
• Modeling the performance of tranched transactions based on historical performance may have led to the over-rating (by ratings agencies) and underestimation of risks (by end investors) of asset-backed securities with high-yield debt as their underlying assets. These factors have come to light in the subprime mortgage crisis.

Trustee: Trustee is a legal term for a holder of property on behalf of a beneficiary. A trust can be set up either to benefit particular persons, or for any charitable purposes (but not generally for non-charitable purposes): typical examples are a will trust for the testator‘s children and family, a pension trust (to confer benefits on employees and their families), and a charitable trust. In all cases, the trustee may be a person or company, whether or not they are a prospective beneficiary.

General duties of trustees

Trustees have certain duties (some of which are fiduciary). These include the duty to carry out the express terms of the trust instrument, the duty to defend the trust, the duty to prudently invest trust assets, the duty of impartiality among the beneficiaries, the duty to account for their actions and to keep them informed about the trust, the duty of loyalty, the duty not to delegate, the duty not to profit, the duty not to be in a conflict of interest position and the duty to administer the trust in the best interest of the beneficiaries. These duties may be expanded or narrowed by the terms of the instrument creating the trust, but in most instances cannot be eliminated completely. Corporate trustees, typically trust departments at large banks, often have very narrow duties, limited to those explicitly defined in the trust indenture.

A trustee carries the fiduciary responsibility and liability to use the trust assets according to the provisions of the trust instrument (and often regardless of their own or the beneficiaries’ wishes). The trustee may find himself liable to claimants, prospective beneficiaries, or third parties. In the event that a trustee incurs a liability (for example, in litigation, or for taxes, or under the terms of a lease) in excess of the trust property they hold, they may find themselves personally liable for the excess.

Trustees are generally held to a “prudent person” standard in regard to meeting their fiduciary responsibilities, though investment, legal, and other professionals can be held to a higher standard commensurate with their higher expertise. Trustees can be paid for their time and trouble in performing their duties only if the trust specifically provides for payment. It is common for lawyers to draft will trusts so as to permit such payment, and to take office accordingly: this may be an unnecessary expense for small estates.

Other uses

The term trustee is also applied to someone held to a fiduciary duty similar in some respects to that of a trustee proper. For example, the directors of a bank may be trustees for the depositors, directors of a corporation are trustees for the stockholders and a guardian is trustee of his ward’s property. Many corporations call their governing board a board of trustees, though in those cases they act as a board of directors.

In the case of UK charities, a trustee is an unpaid volunteer who undertakes fiduciary responsibilities on behalf of the charity, subject to the provisions of Charity Law, a branch of trust law, and the Charities Act 1993. For charity trustees, the Charity Commission of England and Wales, Office of the Scottish Charity Regulator of Scotland and Voluntary Activity Unit of Northern Ireland often has concurrent jurisdiction with the Courts. Many UK charities are also limited liability companies registered with Companies House, in this case the trustees are also Directors of the company and their liability is limited. This is the preferred model if the charity owns property or employs people.

City Government

(USA) Depending on the state, a Trustee is a member of the Village Board of Trustees which is a village’s elected legislative body as outlined by local or state law. It can be composed of the Mayor and a set number of Trustees and usually manages village property, finances, safety, health, comfort, and general welfare and leadership of the town (acting as a Board of Police or Fire Commissioners or a Moderate Income Housing Board for example). Village Board of Trustees is comparable to but distinguished from City Council or Town Council.
In states like Missouri, small villages have a Trustee instead of a Mayor who is elected to manage village business in a similar function.

Prison trustee

Trustee, more frequently spelled trusty, is a term used for a prison inmate who has special work-related privileges, usually as a result of good behavior.

Bankuptcy Trustee

In the United States, when a consumer or business files for bankruptcy all property of the filer becomes property of a newly created entity, the “bankruptcy estate.” (See 11 U.S.C. § 541.) For all bankruptcies (consumer or business) filed under Chapter 7 or Chapter 13 of Title 11 of the United States Code (the Bankruptcy Code), a trustee (the “trustee in bankruptcy” or TIB) is appointed by the United States Trustee, an officer of the Department of Justice that is charged with ensuring the integrity of the bankruptcy system and with representatives in each court, to manage the property of the bankruptcy estate, including bringing actions to avoid pre-bankruptcy transfers of property. In bankruptcies filed under Chapter 11 or 12, the debtor continues to manage the property of the bankruptcy estate, as “debtor in possession,” subject to replacement for cause with a trustee.

Chapter 7 trustees in bankruptcy are chosen by the United States Trustee from a panel, and are known as panel trustees. Every judicial district has a permanent Chapter 13 trustee, known as a “standing trustee.”

Underwriting: Underwriting refers to the process that a large financial service provider (bank, insurer, investment house) uses to assess the eligibility of a customer to receive their products (equity capital, insurance, mortgage or credit).

The name derives from the Lloyd’s of London insurance market. Financial bankers, who would accept some of the risk on a given venture (historically a sea voyage with associated risks of shipwreck) in exchange for a premium, would literally write their names under the risk information that was written on a Lloyd’s slip created for this purpose.

Risk, exclusivity, and reward

Once the underwriting agreement is struck, the underwriter bears the risk of being able to sell the underlying securities, and the cost of holding them on its books until such time in the future that they may be favorably sold.

If the instrument is desirable, the underwriter and the securities issuer may choose to enter into an exclusivity agreement. In exchange for a higher price paid upfront to the issuer, or other favorable terms, the issuer may agree to make the underwriter the exclusive agent for the initial sale of the securities instrument. That is, even though third-party buyers might approach the issuer directly to buy, the issuer agrees to sell exclusively through the underwriter.

In summary, the securities issuer gets cash up front, access to the contacts and sales channels of the underwriter, and is insulated from the market risk of being unable to sell the securities at a good price. The underwriter gets a nice profit from the markup, plus possibly an exclusive sales agreement.

Also, if the securities are priced significantly below market price (as is often the custom), the underwriter also carries favor with powerful end customers by granting them an immediate profit (see flipping), perhaps in a quid pro quo. This practice, which is typically justified as the reward for the underwriter for taking on the market risk, is occasionally criticized as unethical, such as the allegations that Frank Quattrone acted improperly in doling out hot IPO stock during the dot com bubble.

Securities underwriting

Securities underwriting is the way business customers are assessed by investment houses for access to either equity or debt capital.

This is a way of placing a newly issued security, such as stocks or bonds, with investors. A syndicate of banks (the lead-managers) underwrite the transaction, which means they have taken on the risk of distributing the securities. Should they not be able to find enough investors, they will have to hold some securities themselves. Underwriters make their income from the price difference (the “underwriting spread“) between the price they pay the issuer and what they collect from investors or from broker-dealers who buy portions of the offering. When a dealer bank purchases Treasury securities in a quarterly Treasury bond auction, it acts as underwriter and distributor. Treasury securities purchased by a primary dealer are held in a dealer bank’s trading account assets portfolio, and they are often resold to other banks and to private investors.

Bank underwriting

In investment banking, underwriting is defined as the transaction between the issuer of the instruments of debt or equity and the firm which has agreed to liquidate the instruments immediately upon their issuance. In investment banking underwriting, the government or private entity which issues the debt or equity instruments has an immediate need for cash (specie), and has no interest in waiting to locate buyers for the instruments at an indeterminate or specified date. The issuer also usually has no detailed knowledge of the individuals who are capable or interested in the present or future purchase of the instruments, and (most importantly) what the highest and most fair price for the securities may be so.

In banking, underwriting is the detailed credit analysis preceding the granting of a loan, based on credit information furnished by the borrower, such as employment history, salary and financial statements; publicly available information, such as the borrower’s credit history, which is detailed in a credit report; and the lender’s evaluation of the borrower’s credit needs and ability to pay. Underwriting can also refer to the purchase of corporate bonds, commercial paper, government securities, municipal general-obligation bonds by a commercial bank or dealer bank for its own account or for resale to investors. Bank underwriting of corporate securities is carried out through separate holding-company affiliates, called securities affiliates or Section 20 affiliates.

Insurance underwriting

Underwriting may also refer to insurance; insurance underwriters evaluate the risk and exposures of potential clients. They decide how much coverage the client should receive, how much they should pay for it, or whether even to accept the risk and insure them. Underwriting involves measuring risk exposure and determining the premium that needs to be charged to insure that risk. The function of the underwriter is to acquire—or to “write”—business that will make the insurance company money, and to protect the company’s book of business from risks that they feel will make a loss. In simple terms, it is the process of issuing insurance policies.

Each insurance company has its own set of underwriting guidelines to help the underwriter determine whether or not the company should accept the risk. The information used to evaluate the risk of an applicant for insurance will depend on the type of coverage involved. For example, in underwriting automobile coverage, an individual’s driving record is critical. As part of the underwriting process for life or health insurance, medical underwriting may be used to examine the applicant’s health status (other factors may be considered as well, such as age & occupation). The factors that insurers use to classify risks should be objective, clearly related to the likely cost of providing coverage, practical to administer, consistent with applicable law, and designed to protect the long-term viability of the insurance program.

The underwriters may either decline the risk or may provide a quotation in which the premiums have been loaded or in which various exclusions have been stipulated, which restrict the circumstances under which a claim would be paid. Depending on the type of insurance product (line of business), insurance companies use automated underwriting systems to encode these rules, and reduce the amount of manual work in processing quotations and policy issuance. This is especially the case for certain simpler life or personal lines (auto, homeowners) insurance.

Underwriting in the EU

Following Council Directive 2004/113/EC on gender equality in access to services, insurance underwriting in the EU has been slightly modified, specifically in respect to motor/auto insurance. This directive does not allow policies to be underwritten on the basis of gender or without current and thorough research qualifying the difference in prices available to men or women.

Underwriter can analyze the risk by inspecting the place and quote the premium

Other forms of underwriting

Real estate underwriting

In evaluation of a real estate loan, in addition to assessing the borrower, the property itself is scrutinized. Underwriters use the debt service coverage ratio to figure out whether the property is capable of redeeming its own value or not.

Forensic underwriting

Forensic underwriting is the “after-the-fact” process used by lenders to determine what went wrong with a mortgage.  Forensic underwriting refers to a borrower’s ability to work out a modification scenario with their current lien holder, not to qualify them for a new loan or a refinance. This is typically done by an underwriter staffed with a team of people who are experienced in every aspect of the real estate field.

Unsecured debt: In finance, unsecured debt refers to any type of debt or general obligation that is not collateralized by a lien on specific assets of the borrower in the case of a bankruptcy or liquidation.

In the event of the bankruptcy of the borrower, the unsecured creditors will have a general claim on the assets of the borrower after the specific pledged assets have been assigned to the secured creditors, although the unsecured creditors will usually realize a smaller proportion of their claims than the secured creditors.

In some legal systems, unsecured creditors who are also indebted to the insolvent debtor are able (and in some jurisdictions, required) to set-off the debts, which actually puts the unsecured creditor with a matured liability to the debtor in a pre-preferential position.
Uptick: A higher price than the previous trade.
Uptick rule: The uptick rule generally prohibits short selling of securities except on an uptick. The rule was defined by U.S. Securities and Exchange Commission (SEC) which summarized it: “Rule 10a-1(a)(1) provided that, subject to certain exceptions, a listed security may be sold short (A) at a price above the price at which the immediately preceding sale was effected (plus tick), or (B) at the last sale price if it is higher than the last different price (zero-plus tick). Short sales were not permitted on minus ticks or zero-minus ticks, subject to narrow exceptions.”

The rule went into effect in 1938 and was removed when Rule 201 Regulation SHO became effective in 2007. In 2009, the reintroduction of the uptick rule was widely debated, and proposals for a form of its reintroduction by the SEC went into a public comment period on 2009-04-08.

U.S. Dollar: The United States dollar (sign: $; code: USD) is the unit of currency of the United States. The U.S. dollar is normally abbreviated as the dollar sign, $, or asUSD or US$ to distinguish it from other dollar-denominated currencies and from others that use the $ symbol. It is divided into 100 cents (200 half-cents prior to 1857).

The U.S. dollar is the currency most used in international transactions.^[1] Several countries use it as their official currency, and in many others it is the de facto currency.

T he U.S. dollar bill uses the decimal system, consisting of 100 equal cents (symbol ¢). In another division, there are 1,000 mills or ten dimes to a dollar, or 4 quarters to a dollar. However, only cents are in everyday use as divisions of the dollar; “dime” is used solely as the name of the coin with the value of 10¢, while “eagle” and “mill” are largely unknown to the general public, though mills are sometimes used in matters of tax levies and gasoline prices. When currently issued in circulating form, denominations equal to or less than a dollar are emitted as U.S. coins while denominations equal to or greater than a dollar are emitted asFederal Reserve notes (with the exception of gold, silver and platinum coins valued up to $100 as legal tender, but worth far more as bullion). Both one-dollar coins and notes are produced today, although the note form is significantly more common. In the past, “paper money” was occasionally issued in denominations less than a dollar (fractional currency) and gold coins were issued for circulation up to the value of $20 (known as the “double eagle,” discontinued in the 1930s). The term eagle was used in the Coinage Act of 1792 for the denomination of ten dollars, and subsequently was used in naming gold coins. In 1854, James Guthrie, then Secretary of the Treasury, proposed creating $100, $50 and $25 gold coins, which were referred to as a “Union,” “Half Union,” and “Quarter Union,”^[3] thus implying a denomination of 1 Union = $100.

Today, USD notes are made from cotton fiber paper, unlike most common paper, which is made of wood fiber.

U.S. coins are produced by the United States Mint. U.S. dollar banknotes are printed by the Bureau of Engraving and Printing, and, since 1914, have been issued by the Federal Reserve. The “large-sized notes” issued before 1928 measured 7.42 inches (188 mm) by 3.125 inches (79.4 mm); small-sized notes, introduced that year, measure 6.14 inches (156 mm) by 2.61 inches (66 mm) by 0.0043 inches (0.11 mm).

U.S.Treasury security: A United States Treasury security is a government debt issued by the United States Department of the Treasury through the Bureau of the Public Debt. Treasury securities are the debt financing instruments of the United States Federal government, and they are often referred to simply as Treasuries. There are four types of marketable treasury securities: Treasury bills, Treasury notes, Treasury bonds, and Treasury Inflation Protected Securities (TIPS).

There are several types of non-marketable treasury securities including State and Local Government Series (SLGS), Government Account Series debt issued to government-managed trust funds, and savings bonds. All of the marketable Treasury securities are very liquid and are heavily traded on the secondary market. The non-marketable securities (such as savings bonds) are issued to subscribers and cannot be transferred through market sales.

History

The U.S. government knew that the costs of World War I would be great, and the question of how to pay for the war was matter of intense debate. The resulting decision was to pay for the war with a balance between higher taxes (see the War Tax Act) and government debt. Traditionally, the government borrowed from other countries, but there were no other countries from which to borrow in 1917: U.S. citizens would have to fully finance the war through both higher taxes and purchases of war bonds.

The Treasury raised funding throughout the war by floating $21.5 billion in ‘Liberty bonds.’ These bonds were sold at subscription where officials created a coupon price and then sold it at Par value. At this price, subscriptions could be filled in as little as one day, but usually remained open for several weeks, depending on demand for the bond.

After the war, the Liberty Bonds were reaching maturity, but the Treasury was unable to pay each down fully with only limited budget surpluses. The resolution to this problem was to refinance the debt with variable short and medium-term maturities. Again the Treasury issued debt through a fixed-price subscription, where both the coupon and the price of the debt were dictated by the treasury.

The problems with debt issuance became apparent in the late-1920′s. The system suffered from chronic oversubscription, where interest rates were so attractive that there were more purchasers of debt than supplied by the government. This indicated that the government was paying too much for debt. As government debt was undervalued, debt purchasers could buy from the government and immediately sell to another market participant at a higher price.

In 1929, the U.S. Treasury shifted from the fixed-price subscription system to a system of auctioning where ‘Treasury Bills’ would be sold to the highest bidder. Securities were then issued on a pro rata system where securities would be allocated to the highest bidder until their demand was full. If more treasuries were supplied by the government, they would then be allocated to the next highest bidder. This system allowed the market to set the price rather than the government. On December 10, 1929, the Treasury issued its first auction. The result was the issuing of $224 million three-month bills. The highest bid was at 99.310 with the lowest bid accepted at 99.152.

Foreign countries later started to buy U.S. debt as an investment of their surplus U.S. Dollars. Nowadays, China is the primary holder of U.S. bonds. China owns so many U.S. bonds, there is fear that if they stop buying them, the U.S. economy would collapse. The bonds issue further links the U.S. and China economies so tightly that both fear the consequences of a potential slow down in China’s purchase of those bonds. In her visit to China, U.S. State Secretary Hillary Clinton called on authorities in Beijing to continue buying U.S. Treasuries, saying it would help jumpstart the flagging U.S. economy and stimulate imports of Chinese goods.

As the economic recession continues, more doubts arise over the real value of U.S. treasury securities. Though carefully worded, Chinese premier Wen Jia Bao’s warning about possible devaluation of Chinese held U.S. bonds was taken very seriously by Washington:

“Of course we are concerned about the safety of our assets. To be honest, I’m a little bit worried,” Wen said at a news conference Friday after the closing of China’s annual legislative session. “I would like to call on the United States to honor its words, stay a credible nation and ensure the safety of Chinese assets.”

However, it is important to note that such comments, while critical, were very likely indicative of Chinese “gesturing” ahead of the April 1st G-20 Economic Summit. As of April 2009, the U.S. dollar had rallied YTD against all other major world currencies. Further, as of April 2009, China remained the number one holder of U.S. debt.

On March 18, 2009, the Federal Reserve used quantitative easing “to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months.”

Marketable Securities

Directly issued by the United States Government

Treasury bill

Treasury bills (or T-bills) mature in one year or less. Like zero-coupon bonds, they do not pay interest prior to maturity; instead they are sold at a discount of the par value to create a positive yield to maturity. Many regard Treasury bills as the least risky investment available to U.S. investors^{[citation needed]}.

Regular weekly T-bills are commonly issued with maturity dates of 28 days (or 4 weeks, about a month), 91 days (or 13 weeks, about 3 months), 182 days (or 26 weeks, about 6 months), and 364 days (or 52 weeks, about 1 year). Treasury bills are sold by single price auctions held weekly. Offering amounts for 13-week and 26-week bills are announced each Thursday for auction, usually at 1:00 pm, on the following Monday and settlement, or issuance, on Thursday. Offering amounts for 4-week bills are announced on Monday for auction the next day, Tuesday, usually at 1:00 pm, and issuance on Thursday. Offering amounts for 52-week bills are announced every fourth Thursday for auction the next Tuesday, usually at 1:00 pm, and issuance on Thursday. Purchase orders at TreasuryDirect must be entered before 11:30 on the Monday of the auction. The minimum purchase – effective April 7, 2008 – is $100. (This amount formerly had been $1,000.) Mature T-bills are also redeemed on each Thursday. Banks and financial institutions, especially primary dealers, are the largest purchasers of T-bills.

Like other securities, individual issues of T-bills are identified with a unique CUSIP number. The 13-week bill issued three months after a 26-week bill is considered a re-opening of the 26-week bill and is given the same CUSIP number. The 4-week bill issued two months after that and maturing on the same day is also considered a re-opening of the 26-week bill and shares the same CUSIP number. For example, the 26-week bill issued on March 22, 2007, and maturing on September 20, 2007, has the same CUSIP number (912795A27) as the 13-week bill issued on June 21, 2007, and maturing on September 20, 2007, and as the 4-week bill issued on August 23, 2007 that matures on September 20, 2007.

During periods when Treasury cash balances are particularly low, the Treasury may sell cash management bills (or CMBs). These are sold at a discount and by auction just like weekly Treasury bills. They differ in that they are irregular in amount, term (often less than 21 days), and day of the week for auction, issuance, and maturity. When CMBs mature on the same day as a regular weekly bill, usually Thursday, they are said to be on-cycle. The CMB is considered another reopening of the bill and has the same CUSIP. When CMBs mature on any other day, they are off-cycle and have a different CUSIP number.

Treasury bills are quoted for purchase and sale in the secondary market on an annualized discount percentage, or basis.

With the advent of TreasuryDirect, individuals can now purchase T-Bills online and have funds withdrawn from and deposited directly to their personal bank account and earn higher interest rates on their savings.

Treasury note

This is the modern usage of “Treasury Note” in the U.S., for the earlier meaning see Treasury Notes (19th Century).

Treasury notes (or T-Notes) mature in two to ten years. They have a coupon payment every six months, and are commonly issued with maturities dates of 2, 3, 5, 7 or 10 years, for denominations from $100 to $1,000,000.

T-Notes and T-Bonds are quoted on the secondary market at percentage of par in thirty-seconds of a point. Thus, for example, a quote of 95:07 on a note indicates that it is trading at a discount: $952.19 (i.e. 95 7/32%) for a $1,000 bond. (Several different notations may be used for bond price quotes. The example of 95 and 7/32 points may be written as 95:07, or 95-07, or 95’07, or decimalized as 95.21875.) Other notation includes a +, which indicates 1/64 points and a third digit may be specified to represent 1/256 points. Examples include 95:07+ which equates to (95 + 7/32 + 1/64) and 95:073 which equates to (95 + 7/32 + 3/256). Notation such as 95:073+ is unusual and not typically used.

The 10-year Treasury note has become the security most frequently quoted when discussing the performance of the U.S. government-bond market and is used to convey the market’s take on longer-term macroeconomic expectations.

Treasury bond

“U.S. Bonds” redirects here. You may be looking for the singer Gary U.S. Bonds.

Treasury bonds (T-Bonds, or the long bond) have the longest maturity, from twenty years to thirty years. They have a coupon payment every six months like T-Notes, and are commonly issued with maturity of thirty years. The secondary market is highly liquid, so the yield on the most recent T-Bond offering was commonly used as a proxy for long-term interest rates in general.  This role has largely been taken over by the 10-year note, as the size and frequency of long-term bond issues declined significantly in the 1990s and early 2000s.

The U.S. Federal government stopped issuing the well-known 30-year Treasury bonds (often called long-bonds) for a four and a half year period starting October 31, 2001 and concluding February 2006.  As the U.S. government used its budget surpluses to pay down the Federal debt in the late 1990s, the 10-year Treasury note began to replace the 30-year Treasury bond as the general, most-followed metric of the U.S. bond market. However, due to demand from pension funds and large, long-term institutional investors, along with a need to diversify the Treasury’s liabilities – and also because the flatter yield curve meant that the opportunity cost of selling long-dated debt had dropped – the 30-year Treasury bond was re-introduced in February 2006 and is now issued quarterly.^[6] This brought the U.S. in line with Japan and European governments issuing longer-dated maturities amid growing global demand from pension funds.

TIPS

Treasury Inflation-Protected Securities (or TIPS) are the inflation-indexed bonds issued by the U.S. Treasury. The principal is adjusted to the Consumer Price Index, the commonly used measure of inflation. The coupon rate is constant, but generates a different amount of interest when multiplied by the inflation-adjusted principal, thus protecting the holder against inflation. TIPS are currently offered in 5-year, 10-year and 20-year maturities. Thirty-year TIPS are no longer offered.^[7]

Created by the Financial Industry

STRIPS

Separate Trading of Registered Interest and Principal Securities (or STRIPS) are T-Notes, T-Bonds and TIPS whose interest and principal portions of the security have been separated, or “stripped”; these may then be sold separately (in units of $1000 face value) in the secondary market. The name derives from the days before computerization, when paper bonds were physically traded; traders would literally tear the interest coupons off of paper securities for separate resale.

The government does not directly issue STRIPS; they are formed by investment banks or brokerage firms, but the government does register STRIPS in its book-entry system. They cannot be bought through TreasuryDirect, but only through a broker.

STRIPS are used by the Treasury and split into individual principal and interest payments, which get resold in the form of zero-coupon bonds. Because they then pay no interest, there isn’t any interest to re-invest, and so there is no reinvestment risk with STRIPS.

Nonmarketable Securities

Zero-Percent Certificate of Indebtedness

The “Certificate of Indebtedness” is a Treasury security that does not earn any interest and has no fixed maturity. It can only be held in a TreasuryDirect account and bought or sold directly through the Treasury. It is intended to be used as a source of funds for traditional Treasury security purchases. Purchases and redemptions can be made at any time.

Government Account Series

Government Account Series Treasuries are the principal form of intragovernmental debt holdings. Surpluses from the Social Security Trust Fund are invested in these type of securities^.

U.S. Savings Bonds

Savings bonds were created to finance World War I, and were originally called Liberty Bonds. In 2002, the Treasury Department started to gut the savings bond program by lowering interest and closing its marketing offices, although the program was very well known previously.

Series EE

Series EE bonds are issued at 50% of their face value and reach final maturity 30 years from issuance. Interest is added to the bond monthly and paid when the holder cashes the bond. They are designed to reach face value in approximately 17 years, although an investor can hold them for up to 30 years and continue to accrue interest. For bonds issued before May 2005 the rate of interest is recomputed every six months at 90% of the average five-year Treasury yield for the preceding six months. Bonds issued in May 2005 or later pay a fixed interest rate for the life of the bond, although the Treasury does guarantee that the bond will reach face value after 20 years. In the space of a decade, interest dropped from well over 5% to 0.7% for new bonds in 2009.

Interest is taxable at the federal level only. Investors can elect to defer taxation until the bond ceases to pay interest (30 years after issuance) or until it is redeemed.

Series EE bonds are designed for individual investors, sold at a discount, and redeemed at an amount that includes the interest income. Hence, while interest is calculated monthly, the interest on a Series EE bond is not paid until redemption.

Series HH

Series HH bonds are sold at a discount and mature at face value. Unlike T-Bonds (Treasury Bonds) and agency issues, Series HH bonds are nonmarketable. They also pay interest semi-annually, as do most bonds.

Issuance of Series HH bonds stopped as of August 31, 2004, but there are still many yet that have not matured.

Series I

Series I bonds are issued at face value and have a variable yield based on inflation. The interest rate consists of two components: the first is a fixed rate which will remain constant over the life of the bond and the second is a variable rate reset every six months from the time the bond is purchased based on the current inflation rate. New rates go into effect on May 1 and November 1 of every year.  The fixed rate is determined by the Treasury Department; the variable component is based on the Consumer Price Index from a six month period ending one month prior to the reset time. Like EE bonds, I bonds are issued to individuals with a limit of $5,000 per person (by Social Security number) per year.  A person may purchase the limit of both paper and electronic bonds for a total of $10,000 per year. Redeeming the bonds before five years will incur a penalty of three months of interest.  The Treasury Department announced in early November 2008 the return of a fixed rate component, which the Treasury removed in July. For newly purchased securities, the Series I will pay 0.7% fixed annual rate, in addition to the inflation adjustment. Combining the fixed rate and the inflation adjustment as of November 2008, new I-bonds will earn interest at a 5.64% annual percentage rate.
Venture capital: Venture capital (also known as VC or Venture) is a type of private equity capital typically provided for early-stage, high-potential, growth companies in the interest of generating a return through an eventual realization event such as an IPO or trade sale of the company. Venture capital investments are generally made as cash in exchange for shares in the invested company. It is typical for venture capital investors to identify and back companies in high technology industries such as biotechnology and ICT (information and communication technology).

Venture capital typically comes from institutional investors and high net worth individuals and is pooled together by dedicated investment firms.

Venture capital firms typically comprise small teams with technology backgrounds (scientists, researchers) or those with business training or deep industry experience. VC has a reputation of being a particularly impenetrable career path, employing only those who bring expert value.

A core skill within VC is the ability to identify novel technologies that have the potential to generate high commercial returns at an early stage. By definition, VCs also take a role in managing entrepreneurial companies at an early stage, thus adding skills as well as capital (thereby differentiating VC from buy out private equity which typically invest in companies with proven revenue), and thereby potentially realizing much higher rates of returns.

A venture capitalist (also known as a VC) is a person or investment firm that makes venture investments, and these venture capitalists are expected to bring managerial and technical expertise as well as capital to their investments. A venture capital fund refers to a pooled investment vehicle (often an LP or LLC) that primarily invests the financial capital of third-party investors in enterprises that are too risky for the standard capital markets or bank loans.

Venture capital is also associated with job creation, the knowledge economy and used as a proxy measure of innovation within an economic sector or geography.

Venture capital is most attractive for new companies with limited operating history that are too small to raise capital in the public markets and have not reached the point where they are able to secure a bank loan or complete a debt offering. In exchange for the high risk that venture capitalists assume by investing in smaller and less mature companies, venture capitalists usually get significant control over company decisions, in addition to a significant portion of the company’s ownership (and consequently value).

Young companies wishing to raise venture capital require a combination of extremely rare yet sought after qualities, such as innovative technology, potential for rapid growth, a well-developed business model, and an impressive management team. VCs typically reject 98% of opportunities presented to them, reflecting the rarity of this combination.

History

Main article: History of private equity and venture capital

With few exceptions, private equity in the first half of the 20th century was the domain of wealthy individuals and families. The Vanderbilts, Whitneys, Rockefellers and Warburgs were notable investors in private companies in the first half of the century. In 1938, Laurance S. Rockefeller helped finance the creation of both Eastern Air Lines and Douglas Aircraft and the Rockefeller family had vast holdings in a variety of companies. Eric M. Warburg founded E.M. Warburg & Co. in 1938, which would ultimately become Warburg Pincus, with investments in both leveraged buyouts and venture capital.

Origins of modern private equity

Before World War II, venture capital investments (originally known as “development capital”) were primarily the domain of wealthy individuals and families. It was not until after World War II that what is considered today to be true private equity investments began to emerge marked by the founding of the first two venture capital firms in 1946: American Research and Development Corporation. (ARDC) and J.H. Whitney & Company.

ARDC was founded by Georges Doriot, the “father of venture capitalism” (former dean of Harvard Business School), with Ralph Flanders and Karl Compton (former president of MIT), to encourage private sector investments in businesses run by soldiers who were returning from World War II. ARDC’s significance was primarily that it was the first institutional private equity investment firm that raised capital from sources other than wealthy families although it had several notable investment successes as well. ARDC is credited with the first major venture capital success story when its 1957 investment of $70,000 in Digital Equipment Corporation (DEC) would be valued at over $355 million after the company’s initial public offering in 1968 (representing a return of over 1200 times on its investment and an annualized rate of return of 101%). Former employees of ARDC went on and established several prominent venture capital firms including Greylock Partners (founded in 1965 by Charlie Waite and Bill Elfers) and Morgan, Holland Ventures, the predecessor of Flagship Ventures (founded in 1982 by James Morgan). ARDC continued investing until 1971 with the retirement of Doriot. In 1972, Doriot merged ARDC with Textron after having invested in over 150 companies.

J.H. Whitney & Company was founded by John Hay Whitney and his partner Benno Schmidt. Whitney had been investing since the 1930s, founding Pioneer Pictures in 1933 and acquiring a 15% interest in Technicolor Corporation with his cousin Cornelius Vanderbilt Whitney. By far Whitney’s most famous investment was in Florida Foods Corporation. The company developed an innovative method for delivering nutrition to American soldiers, which later came to be known as Minute Maid orange juice and was sold to The Coca-Cola Company in 1960. J.H. Whitney & Company continues to make investments in leveraged buyout transactions and raised $750 million for its sixth institutional private equity fund in 2005.
Warrant: In finance, a warrant is a security that entitles the holder to buy stock of the company that issued it at a specified price, which is usually higher than the stock price at time of issue.

Warrants are frequently attached to bonds or preferred stock as a sweetener, allowing the issuer to pay lower interest rates or dividends. They can be used to enhance the yield of the bond, and make them more attractive to potential buyers. Warrants can also be used in private equity deals. Frequently, these warrants are detachable, and can be sold independently of the bond or stock.

Warrants are actively traded in some financial markets such as Deutsche Börse and Hong Kong.  In Hong Kong Stock Exchange, warrants accounted for 11.7% of the turnover in the first quarter of 2009, just second to the callable bull/bear contracts.

Working capital: Working capital, also known as net working capital or NWC, is a financial metric which represents operating liquidity available to a business. Along with fixed assets such as plant and equipment, working capital is considered a part of operating capital. It is calculated as current assets minus current liabilities. If current assets are less than current liabilities, an entity has a working capital deficiency, also called a working capital deficit.

Working Capital = Current Assets ? Current Liabilities

A company can be endowed with assets and profitability but short of liquidity if its assets cannot readily be converted into cash. Positive working capital is required to ensure that a firm is able to continue its operations and that it has sufficient funds to satisfy both maturing short-term debt and upcoming operational expenses. The management of working capital involves managing inventories, accounts receivable and payable and cash.

Calculation

Current assets and current liabilities include three accounts which are of special importance. These accounts represent the areas of the business where managers have the most direct impact:

• accounts receivable (current asset)
• inventory (current assets), and
• accounts payable (current liability)

The current portion of debt (payable within 12 months) is critical, because it represents a short-term claim to current assets and is often secured by long term assets. Common types of short-term debt are bank loans and lines of credit.

An increase in working capital indicates that the business has either increased current assets (that is received cash, or other current assets) or has decreased current liabilities, for example has paid off some short-term creditors.

Implications on M&A: The common commercial definition of working capital for the purpose of a working capital adjustment in an M&A transaction (ie for a working capital adjustment mechanism in a sale and purchase agreement) is equal to:

Current Assets – Current Liabilities excluding deferred tax assets/liabilities, excess cash, surplus assets and/or deposit balances.

Cash balance items often attract a one-for-one purchase price adjustment.

Working capital management

Decisions relating to working capital and short term financing are referred to as working capital management. These involve managing the relationship between a firm’s short-term assets and its short-term liabilities. The goal of working capital management is to ensure that the firm is able to continue its operations and that it has sufficient cash flow to satisfy both maturing short-term debt and upcoming operational expenses.

Decision criteria

By definition, working capital management entails short term decisions – generally, relating to the next one year period – which are “reversible”. These decisions are therefore not taken on the same basis as Capital Investment Decisions (NPV or related, as above) rather they will be based on cash flows and / or profitability.

• One measure of cash flow is provided by the cash conversion cycle – the net number of days from the outlay of cash for raw material to receiving payment from the customer. As a management tool, this metric makes explicit the inter-relatedness of decisions relating to inventories, accounts receivable and payable, and cash. Because this number effectively corresponds to the time that the firm’s cash is tied up in operations and unavailable for other activities, management generally aims at a low net count.
• In this context, the most useful measure of profitability is Return on capital (ROC). The result is shown as a percentage, determined by dividing relevant income for the 12 months by capital employed; Return on equity (ROE) shows this result for the firm’s shareholders. Firm value is enhanced when, and if, the return on capital, which results from working capital management, exceeds the cost of capital, which results from capital investment decisions as above. ROC measures are therefore useful as a management tool, in that they link short-term policy with long-term decision making. See Economic value added(EVA).

Management of working capital

Guided by the above criteria, management will use a combination of policies and techniques for the management of working capital. These policies aim at managing the current assets (generally cash and cash equivalents, inventories and debtors) and the short term financing, such that cash flows and returns are acceptable.

• Cash management. Identify the cash balance which allows for the business to meet day to day expenses, but reduces cash holding costs.
• Inventory management. Identify the level of inventory which allows for uninterrupted production but reduces the investment in raw materials – and minimizes reordering costs – and hence increases cash flow; see Supply chain management; Just In Time (JIT); Economic order quantity (EOQ); Economic production quantity
• Debtors management. Identify the appropriate credit policy, i.e. credit terms which will attract customers, such that any impact on cash flows and the cash conversion cycle will be offset by increased revenue and hence Return on Capital (or vice versa); see Discounts and allowances.
• Short term financing. Identify the appropriate source of financing, given the cash conversion cycle: the inventory is ideally financed by credit granted by the supplier; however, it may be necessary to utilize a bank loan (or overdraft), or to “convert debtors to cash” through “factoring“.

Yield curve spread: Yield curve spread on a simple mortgage-backed security (MBS) is the flat spread over the treasury yield curve required in discounting a pre-determined coupon schedule to arrive at its present market price.

That is, the MBS yield curve spread is based on a comparison of the market price to a model of the bond which includes no variability in interest rate or mortgage repayment rates.

Definition

For mortgage-backed securities, a model of typical repayment rates tends to be given; for example, the PSA formula for a particular Fannie Mae MBS might equate a particular group of mortgages to an 8 year amortizing bond with a 5% mortality per annum. This gives a single series of nominal cash flows (like a riskless bond). If these payments are discounted to net present value with a static treasury yield curve the sum of their values will tend to overestimate the market price of the MBS. The parallel shift, which, if applied to the yield curve makes the NPV of the anticipated receipts equal to the market price is the Yield curve spread.

Zero-coupon bonds: A zero-coupon bond (also called a discount bond or deep discount bond) is a bond bought at a price lower than its face value, with the face value repaid at the time of maturity.  It does not make periodic interest payments, or have so-called “coupons,” hence the term zero-coupon bond. Investors earn return from the compounded interest all paid at maturity plus the difference between the discounted price of the bond and its par (or redemption) value. Examples of zero-coupon bonds include U.S. Treasury bills, U.S. savings bonds, long-term zero-coupon bonds,^[1] and any type of coupon bond that has been stripped of its coupons.

In contrast, an investor who has a regular bond receives income from coupon payments, which are usually made semi-annually. The investor also receives the principal or face value of the investment when the bond matures.

Some zero coupon bonds are inflation indexed, so the amount of money that will be paid to the bond holder is calculated to have a set amount of purchasing power rather than a set amount of money, but the majority of zero coupon bonds pay a set amount of money known as the face value of the bond.

Zero coupon bonds may be long or short term investments. Long-term zero coupon maturity dates typically start at ten to fifteen years. The bonds can be held until maturity or sold on secondary bond markets. Short-term zero coupon bonds generally have maturities of less than one year and are called bills. The U.S. Treasury bill market is the most active and liquid debt market in the world.

Strip bonds

Zero coupon bonds have a duration equal to the bond’s time to maturity, which makes them sensitive to any changes in the interest rates. Investment banks or dealers may separate coupons from the principal of coupon bonds, which is known as the residue, so that different investors may receive the principal and each of the coupon payments. This creates a supply of new zero coupon bonds.

The coupons and residue are sold separately to investors. Each of these investments then pays a single lump sum. This method of creating zero coupon bonds is known as stripping and the contracts are known as strip bonds. “STRIPS” stands for Separate Trading of Registered Interest and Principal Securities.

Dealers normally purchase a block of high-quality and non-callable bonds—often government issues—to create strip bonds. A strip bond has no reinvestment risk because the payment to the investor only occurs at maturity.

The impact of interest rate fluctuations on strip bonds, known as the bond duration, is higher than for a coupon bond. A zero coupon bond always has a duration equal to its maturity; a coupon bond always has a lower duration. Strip bonds are normally available from investment dealers maturing at terms up to 30 years. For some Canadian bonds the maturity may be over 90 years.

In Canada, investors may purchase packages of strip bonds, so that the cash flows are tailored to meet their needs in a single security. These packages may consist of a combination of interest (coupon) and/or principal strips.

In New Zealand, bonds are stripped first into two pieces—the coupons and the principal. The coupons may be traded as a unit or further subdivided into the individual payment dates.

In most countries, strip bonds are primarily administered by a central bank or central securities depository. An alternative form is to use a custodian bank or trust company to hold the underlying security and a transfer agent/registrar to track ownership in the strip bonds and to administer the program. Physically created strip bonds (where the coupons are physically clipped and then traded separately) were created in the early days of stripping in Canada and the U.S., but have virtually disappeared due to the high costs and risks associated with them.

Uses

Pension funds and insurance companies like to own long maturity zero-coupon bonds because of the bonds’ high duration. This high duration means that these bonds’ prices are particularly sensitive to changes in the interest rate, and therefore offset, or immunize the interest rate risk of these firms’ long-term liabilities.

Yield curve traders and academics use zero-coupon bonds to precisely analyze the yield curve. This is because any fixed income security can be broken down into individual cashflows and viewed as an equivalent portfolio of zero-coupon bonds. Analysts can then price fixed income securities by discounting each individual cash flow by the appropriate discount rate implied by zero-coupon bonds.

Taxes

In the United States, the holder may be liable for imputed income (sometimes called phantom income), even though these bonds don’t pay periodic interest.  Because of this, zero coupon bonds subject to U.S. taxation should generally be held in tax-deferred retirement accounts, to avoid paying taxes on future income. Alternatively, when purchasing a zero coupon bond issued by a U.S. state or local government entity, the imputed interest is free of U.S. federal taxes, and in most cases, state and local taxes, too.

Zero coupon bonds were first introduced in 1960s, but they did not become popular until the 1980s. The use of these instruments was aided by an anomaly in the US tax system, which allowed for deduction of the discount on bonds relative to their par value. This rule ignored the compounding of interest, and lead to significant tax-savings when the interest is high or the security has long maturity. Although the tax loopholes were closed quickly, the bonds themselves are desirable because of their simplicity.

In India, the tax on income from deep discount bonds can arise in two ways: interest or capital gains. It is also law that interest has to be shown on accrual basis for deep discount bonds issued after February 2002. This is as per CBDT circular No 2 of 2002 dated 15th February 2002.