Accreted Value The current value of your zero coupon municipal bond, taking into account interest that has been accumulating and automatically reinvested in the bond.
Accrued Interest Interest deemed to be earned on a security but not yet paid to the investor.
Active Tranche A CMO tranche that is currently paying principal payments to investors.
Advance refunding A financing structure under which new bonds are issued to repay an outstanding bond issue prior to its first call date. Generally, the proceeds of the new issue are invested in government securities, which are placed in escrow. The interest and principal repayments on these securities are then used to repay the old issue, usually on the first call date.
Amortization Liquidation of a debt through installment payments.
Ask Price (or Offer price) The price at which a seller offers to sell a security.
Average Life On a mortgage security, the average length of time that each principal dollar is expected to be outstanding, based on certain assumptions about prepayment speeds.
Basis Point One one-hundredth (.01) of a percentage point. For example, eight percent would be equal to 800 basis points. Yield differences are often quoted in basis points (bps).
Bearer Security A security that is not registered in the name of an owner. As a result, it is presumed to be owned by the bearer or the person who holds it. Bearer securities are freely and easily negotiable, since ownership can be quickly transferred from seller to buyer.
Beneficial Owner One who benefits from owning a security, even if the security’s title of ownership is in the name of a broker or bank.
Bid Price The price at which a buyer offers to purchase a security.
Bond An interest-bearing promise to pay a specified sum of money — the principal amount — due on a specific date.
Bond Equivalent Yield An adjustment to a CMO yield which reflects its greater present value, created because CMOs pay monthly or quarterly interest, unlike most types of bonds, which pay interest semiannually.
Bond Fund An investment vehicle, which invests in a portfolio of bonds that is professionally managed. Types of bond funds include open-ended mutual funds, closed-end mutual funds, and exchange traded funds.
Bond Insurers (and Reinsurers) Specialized insurance firms serving the fixed-income market that guarantee the timely payment of principal and interest on bonds they insure in exchange for a fee. A partial list of bond insurers includes American Municipal Bond Assurance Corp. (AMBAC), ACA Financial Guaranty, Asset Guaranty Insurance Co., Financial Guaranty Insurance Co. (FGIC), Financial Security Assurance (FSA), Municipal Bond Insurance Association (MBIA) and Radian Reinsurance Inc.
Book-Entry A method of recording and transferring ownership of securities electronically, eliminating the need for physical certificates.
Bullet Bond/ Bullet Maturity A bond that pays regular interest, but that does not repay principal until maturity.
Call A one-way option of the issuer (not the investor) that allows the issuer to retire bonds by paying investors a stated price, usually a premium above the par value. Many high-yield bonds allow issuers to call bonds after the first five years.
Callable Bonds Bonds which are redeemable by the issuer prior to the maturity date at a specified price at or above par.
Call Premium A dollar amount, usually stated as a percent of the principal amount called, paid by the issuer as a "penalty" for the exercise of a call provision.
Call Risk For a CMO, the risk that declining interest rates may accelerate mortgage loan prepayment speeds, causing an investor’s principal to be returned sooner than expected. As a consequence, investors may have to reinvest their principal at a lower rate of interest.
Cap The top interest rate that can be paid on a floating-rate security.
Closed-End Investment Company An investment company created with a fixed number of shares, which are then traded as listed securities on a stock exchange. After the initial offering, existing shares can only be bought from existing shareholders.
Closed-end Mutual Fund A fund created with a fixed number of shares which are traded as listed securities on a stock exchange.
CMO (Collateralized Mortgage Obligation). A bond, backed by a pool of mortgage pass-through securities or mortgage loans, which generally supports several classes of obligations (see REMIC)
CMT (Constant Maturity Treasury) A series of indexes of various maturities (one, three, five, seven, or ten years) published by the Federal Reserve Board and based on the average yield of a range of Treasury securities adjusted to a constant maturity corresponding to that of the index.
COFI (Cost of Funds Index) A bank index reflecting the weighted average interest rate paid by savings institutions on their sources of funds. There are national and regional COFI indexes.
Collar Upper and lower limits (cap and floor, respectively) on the interest rate of a floating-rate security.
Collateral Securities or property pledged by a borrower to secure payment of a loan. If the borrower fails to repay the loan, the lender may take ownership of the collateral. Collateral for CMOs consists primarily of mortgage passthrough securities or mortgage loans, but may also encompass letters of credit, insurance policies, or other credit enhancements.
Companion Tranche: A CMO tranche that absorbs a higher level of the impact of collateral prepayment variability in order to stabilize the principal payment schedule for a PAC or TAC tranche in the same offering.
Compound Interest Interest that is calculated on the initial principal and previously paid interest.
Compound Accreted Value The value of a zero coupon bond at any given time, based on the principal, with interest compounded at a stated rate of return over time.
Confirmation A document used by securities dealers and banks to state in writing the terms and execution of a verbal arrangement to buy or sell a security.
Conventional mortgage loan: A mortgage loan that is based solely on real estate as security, is not insured or guaranteed by a government agency, and is eligible for purchase or insurance by Fannie Mae or Freddie Mac.
Convertible Bond A corporate bond that can be exchanged, at the option of the holder, for a specific number of shares of the company’s stock. Because a convertible bond is a bond with a stock option built into it, it will usually offer a lower than prevailing rate of return.
Coupon This part of a bearer bond denotes the amount of interest due, and on what date and where payment will be made. Bearer coupons are presented to the issuer's designated paying agent for collection. With registered bonds, physical coupons don't exist (see Registered Bond). The payment is mailed directly to the registered holder. Note that while bearer bonds are no longer issued in the United States and, hence, physical coupons are increasingly scarce, dealers and investors often still refer to the stated interest rate on a registered or book-entry bond as the "coupon."
Coupon Payment The actual dollar amount of interest paid to an investor. The amount is calculated by multiplying the interest rate of the bond by its face value.
Coupon Rate The interest rate on a bond, expressed as a percentage of the bond’s face value. Typically, it is expressed on a semi-annual basis.
CPR (Constant Prepayment Rate) The percentage of outstanding mortgage loan principal that prepays in one year, based on an annualized Single Monthly Mortality (SMM), which reflects the outstanding mortgage loan principal that prepays in one month.
Credit Rating A formal evaluation of a company’s financial health and ability to repay debt obligations, conducted by a rating agency such as Standard & Poor’s, Moody’s and Fitch Ratings. The agency’s evaluation is summarized in a rating, such as BB.
Credit Rating Agency A company that analyzes the credit worthiness of a company or security, and indicates that credit quality by means of a grade, or credit rating.
Current Refunding A financing structure under which old bonds are called or mature within 90 days of the issuance of new refunding bonds.
Current Face The current remaining monthly principal on a mortgage security. Current face is computed by multiplying the original face value of the security by the current principal balance factor.
Current Yield (CY) A calculation of the annual interest payment from a bond divided by the current market price of the bond.
CUSIP The Committee on Uniform Security Identification Procedures, established under the auspices of the American Bankers Association to develop a uniform method of identifying securities. CUSIP numbers are unique nine-digit numbers assigned to each series of securities.
Dated Date (or Issue Date) The date of a bond issue from which the first owner of a bond is entitled to receive interest.
Default Failure to pay principal or interest when due. Defaults can also occur for failure to meet nonpayment obligations, such as reporting requirements, or when a material problem occurs for the issuer, such as bankruptcy.
Debenture Unsecured debt obligation, issued against the general credit of a corporation, rather than against a specific asset.
Discount The amount by which the purchase price of a security is less than the principal amount, or par value.
Discount Note Short-term obligations issued at discount from face value, with maturities ranging from overnight to 360 days. They have no periodic interest payments; the investor receives the note's face value at maturity.
Discount Rate The rate the Federal Reserve charges on loans to member banks.
Double Exemption. Bonds that are exempt from both state and federal income taxes.
Double and triple tax-exemption Securities that are exempt from state and local as well as federal income taxes are said to have double or triple tax-exemption.
Duration The weighted maturity of a fixed-income investment's cash flows, used in the estimation of the price sensitivity of fixed-income securities for a given change in interest rates.
Embedded Option A provision within a bond giving either the issuer or the bondholder an option to take some action against the other party. The most common embedded option is a Call Option, giving the issuer the right to call, or retire, the debt before the scheduled maturity date.
Exchange-traded fund A fund that tracks an index, a commodity or a basket of assets. It is passively- managed like an index fund, but traded like a stock on an exchange, experiencing price changes throughout the day as they are bought and sold. Bond ETFs like bond mutual funds, hold a portfolio of bonds and can differ widely in their investment strategies.
Extension Risk The risk that rising interest rates will slow the anticipated rate at which mortgages or other loans in a pool will be repaid, causing investors to find that their principal is committed for a longer period than expected. As a result, they may miss the opportunity to earn a higher rate of interest on their money.
Extraordinary Redemption This redemption is different from optional redemption or mandatory redemption in that it occurs under an unusual circumstance such as destruction of the facility financed.
Face (or Par Value or Principal Value) The principal amount of a security that appears on the face of the instrument.
Factor A decimal value reflecting the proportion of the outstanding principal balance of a mortgage security, which changes over time, in relation to its original principal value.
Federal Funds Rate The interest rate charged by banks on loans to other banks. The Federal Reserve's ability to add or withdraw reserves from the banking system gives it close control over this rate. Changes in the federal funds rate are sometimes studied by economists and investors for clues to Federal Reserve intentions.
Fixed Rate bond A long-term bond with a set interest rate to maturity.
Floating-Rate Bond Bond for which the interest rate is adjusted periodically according to a predetermined formula, usually linked to an index.
Floating-Rate CMO A CMO tranche which pays an adjustable rate of interest tied to a representative interest rate index such as the London Interbank Offered Rate (LIBOR), the Constant Maturity Treasury (CMT), or the Cost of Funds Index (COFI).
Floor The lower limit for the interest rate on a floating-rate bond.
Future Value The value of an asset at a specified date in the future, calculated using a specified rate of return.
General Obligation Bond A municipal bond secured by the pledge of the issuer's full faith, credit and taxing power.
Hedge An investment made with the intention of minimizing the impact of adverse movements in interest rates or securities prices.
High-Yield Bond A bond issued by a lower-rated corporation, sovereign country or other entity rated BA, BB or below, and offering a higher yield than more creditworthy securities; sometimes known as a Junk Bond.
Inverse Floater A CMO tranche that pays an adjustable rate of interest that moves in the opposite direction from movements in a representative interest rate index such as the London Interbank Offered Rate (LIBOR), the Constant Maturity Treasury (CMT), or the Cost of Funds Index (COFI).
Investment-Grade (High grade bond) Bonds considered suitable for preservation of invested capital by the rating agencies and rated BAA, BBB or above.
IO (interest-only) Security A security or tranche that pays only interest and not principal. IO securities are priced at a deep discount to the “notional” amount of principal used to calculate the amount of interest due.
Issue Date See Dated date.
Issuer An entity which issues and is obligated to pay principal and interest on a debt security.
Interest Compensation paid or to be paid for the use of money. Interest is generally expressed as a percentage rate.
Jump Z-Tranche A Z-tranche that may start receiving principal payments before prior tranches are retired if market forces create a “triggering” event, such as a drop in Treasury yields to a defined level, or a prepayment experience that differs from assumptions by a specific margin. “Sticky” jump Z-tranches maintain their changed payment priority until they are retired. “Non-sticky” jump Z-tranches maintain their priority only temporarily for as long as the triggering event is present. Although jump Z-tranches are no longer issued, some still trade in the secondary market.
Junk Bond A debt obligation with a rating of BA, BB or lower, generally paying interest above the return on more highly rated bonds; sometimes known as a High-Yield Bond
Legal Opinion A letter from a law firm concerning the validity of a municipal bond with respect to statutory authority, constitutionality, procedural conformity and usually the exemption of interest from federal income taxes. The legal opinion is usually rendered by a law firm recognized as specializing in public borrowings, often referred to as “bond counsel.”
Leverage The use of borrowed money to increase investing power.
LIBOR (London Interbank Offered Rate). The rate banks charge each other for short-term eurodollar loans. LIBOR is frequently used as the base for resetting rates on floating-rate securities.
Limited Tax Bond A bond secured by a pledge of a tax or category of taxes limited as to rate or amount.
Liquidity (or Marketability). A measure of the relative ease and speed with which a security can be purchased or sold in the Secondary Market at a price that is reasonably related to its actual market value.
Lockout The period of time before a CMO investor will begin receiving principal payments.
Maturity The date upon which a loan becomes due and the borrower must repay the lender principal and any final interest. Most bonds have a fixed maturity date (although many may be “called” prior to maturity).
Moral Obligation Bond A revenue bond which, in addition to its primary source of security, possesses a structure whereby an issuer pledges to make up shortfalls in a debt service reserve fund, subject to legislative appropriation. While the issuer does not have a legal obligation to make such a payment, the failure of the issuer to honor the moral pledge would have negative consequences for its creditworthiness.
Mortgage A legal instrument that creates a lien upon real estate securing the payment of a specific debt.
Mortgage Pass-Through A security representing a direct interest in a pool of mortgage loans. The pass-through issuer or servicer collects payments on the loans in the pool and "passes through" the principal and interest to the security holders on a pro rata basis.
Mutual Fund Also known as an open-end investment company, to differentiate it from a closed-end investment company. Mutual funds invest pooled cash of many investors to meet the fund's stated investment objective. Mutual funds stand ready to sell and redeem their shares at any time at the fund's current net asset value: total fund assets divided by shares outstanding.
Negative Convexity A characteristic of CMOs and other callable or prepayable securities that causes investors to have their principal returned sooner than expected in a declining interest rate environment, and later than expected in a rising interest rate environment.
Non-Callable Bond A bond that cannot be called for redemption by the issuer before its specified maturity date.
Notes Short-term bonds to pay specified amounts of money, secured by specified sources of future revenues, such as taxes, federal and state aid payments and bond proceeds.
Offer The price at which a seller will sell a security.
Offering document (Official statement or Prospectus) The disclosure document prepared by the issuer that gives in detail security and financial information about the issuer and the bonds or notes.
Offering Price The price at which members of an underwriting syndicate for a new issue will offer securities to investors.
Official Statement The disclosure document prepared by the issuer that gives in detail security and financial information about the issuer and the bonds or notes.
Open-End Mutual Fund See Mutual fund.
Optional Redemption A right of the issuer, at its option, to retire all or part of an issue prior to the stated maturity during a specified period of years, often at a premium.
Original Face The face value or original principal amount of a security on its issue date.
Original Issue Discount A bond, issued at a dollar price less than par which qualifies for special treatment under federal tax law. Under that law, the difference between the issue price and par is treated as tax-exempt income rather than a capital gain, if the bonds are held to maturity.
PAC (Planned Amortization Class) Tranche A CMO tranche that uses a mechanism similar to a sinking fund to determine a fixed principal payment schedule that will apply over a range of prepayment assumptions. The effect of the prepayment variability that is removed from a PAC bond is transferred to a companion tranche.
Par Value The principal amount of a bond or note due at maturity.
Paying Agent Place where principal and interest are payable — usually a designated bank or the office of the treasurer of the issuer.
Payment Date The date that principal and interest payments are paid to the record owner of a security.
P&I (Principal and Interest) The term used to refer to regularly scheduled payments or prepayments of principal and of interest on mortgage securities.
Plain-Vanilla CMO See Sequential-pay CMO.
PO (Principal-Only) Security A tranche or security that pays investors principal only and not interest. PO securities are priced at a deep discount from their face value.
Pool A collection of mortgage loans assembled by an originator or master servicer as the basis for a security. In the case of Ginnie Mae, Fannie Mae, or Freddie Mac mortgage pass-through securities, pools are identified by a number assigned by the issuing agency.
Premium The amount by which the price of a security exceeds its principal amount.
Prepayment The unscheduled partial or complete payment of the principal amount outstanding on a mortgage or other debt before it is due.
Prepayment Risk The risk that falling interest rates will lead to heavy prepayments of mortgage or other loans-forcing the investor to reinvest at lower prevailing rates.
Present Value The current value of a future payment or stream of payments, given a specified interest rate; also referred to as a discount rate.
Price The dollar amount to be paid for a security, which may also be stated as a percentage of its face value or par in the case of debt securities.
Primary Market The market for new issues.
Principal The face amount of a bond, exclusive of accrued interest and payable at maturity.
Private Label The term used to describe a mortgage security whose issuer is an entity other than a U.S. government agency or U.S. government-sponsored enterprise. Such issuers may be banks, subsidiaries of investment banks, other financial institutions, or home builders, for example.
Pro Rata Proportional distrution to all holders of the same class, based on ownership.Prospectus See Offering document.
Ratings Designations used by credit rating agencies to give relative indications of credit quality.
Recession A downturn in economic activity on a large scale, such as in the U.S. economy. The Commerce Department defines a recession as two or more quarters of decline in output, as measured by Gross National Product (GNP) or Gross Domestic Product (GDP).
Record Date The date for determining the owner entitled to the next scheduled payment of principal or interest on a mortgage security.
Redemption Premium The amount by which the call price of a security exceeds its principal amount. In the case of zero coupon bonds, the amount by which the call price exceeds the accreted value.
Registered Bond A bond whose owner is registered with the issuer or its agent. Transfer of ownership can only be accomplished when the securities are properly endorsed by the registered owner.
REMIC (Real Estate Mortgage Investment Conduit) A pass-through investment vehicle which issues multiclass mortgage-backed securities that have certain tax and accounting advantages for issuers and investors due to the Tax Reform Act of 1986. Currently, most CMOs are issued in REMIC form and the terms “REMIC” and “CMO” are now used interchangeably.
Revenue Bond A municipal bond payable from income derived from tolls, charges or rents paid by users of the facility constructed with the proceeds of the bond issue.
Reinvestment Risk The risk that interest income or principal repayments will have to be reinvested at lower rates in a declining rate environment.
REMIC (Real Estate Mortgage Investment Conduit) Because of changes in the 1986 Tax Reform Act, most CMOs are now issued in REMIC form to create certain tax advantages for the issuer. The terms REMIC and CMO are now used interchangeably.
Residual A tranche which collects any cash flow from the collateral that remains after obligations to all the other tranches have been met.
Revenue Bond A municipal bond payable from income derived from tolls, charges or rents paid by users of the facility constructed with the proceeds of the bond issue.
Risk The measurable probability that an actual return will be different than expected. There are many types of risk such as market risk, credit risk, interest rate risk, exchange rate risk, liquidity risk, and political risk.
Scenario Analysis An analysis examining the likely performance of an investment under a wide range of possible interest rate environments.
Secondary Market Market for issues previously offered or sold.
Secured Bond A bond that is backed by collateral.
Senior Bond A bond that has a higher priority than another bond’s claim to the same class of assets.
Servicing The collection and pooling of principal, interest, and escrow payments on mortgage loans and mortgage pools; accounting; bookkeeping; insurance; tax records; loan payment follow-up; delinquency loan followup; and loan analysis. The party providing these services receives a fee, the servicing fee, as compensation.
Servicing Fee The amount retained by the mortgage servicer from monthly interest payments made on a mortgage loan.
Settlement Date The date for the delivery of securities and payment of funds.
Sequential-Pay CMO The most basic type of CMO. All tranches receive regular interest payments, but principal payments are directed initially only to the first tranche until it is completely retired. Once the first tranche is retired, the principal payments are applied to the second tranche until it is fully retired, and so on. Also known as a ‘plain vanilla’ or ‘clean’ CMO.
Sinking Fund Money set aside by an issuer of bonds on a regular basis, for the specific purpose of redeeming debt.
Sinker A bond with a sinking fund.
SMM (Single Monthly Mortality) The percentage of outstanding mortgage loan principal that prepays in one month.
Special Tax Bond A bond secured by a special tax, such as a gasoline tax.
Standard Prepayment Model (SIF MA prepayment model) A model based on historical mortgage prepayment rates used to estimate prepayment rates on mortgage securities. SIFMA’s model is based on the Constant Prepayment Rate (CPR), which annualizes the Single Monthly Mortality (SMM), or the amount of outstanding principal that is prepaid in a month. Projected and historical prepayment rates are often expressed as “percentage of PSA” (Prepayment Speed Assumptions). A prepayment rate of 100% PSA implies annualized prepayment rates of 0.2% CPR in the first month, 0.4% CPR in the second month, 0.6% CPR in the third month, and 0.2% increases in every month thereafter until the thirtieth month, when the rate reaches 6%. From the thirtieth month until the mortgage loan reaches maturity, 100% PSA equals 6% CPR.
Subordinated Bond A bond that has a lower priority than another bond’s claim to the same assets.
Superfloater A floating-rate CMO tranche whose rate is based on a formulaic relationship to a representative interest rate index.
Super PO A principal-only security structured as a companion bond.
Support Tranche See Companion tranche.
TAC Tranche Targeted amortization class tranche. A TAC tranche uses a mechanism similar to a sinking fund to determine a fixed principal payment schedule based on an assumed prepayment rate. The effect of prepayment variability that is removed from the TAC tranche is transferred to a companion tranche.
Toggle Tranche See Jump Z-tranche.
Total Return A measure of bond investment return that includes both interest and price change. The total return on investments is generally expressed as an annualized rate, and it assumes reinvestment of all interest back into the investment.
Trade Date The date when the purchase or sale of a bond is transacted.
Tranche A class of bonds in a CMO offering. “Tranche” is the French word for “slice.”
Transfer Agent A party appointed by an issuer to maintain records of securities owners, to cancel and issue certificates, and to address issues arising from lost, destroyed or stolen certificates.
Trustee A bank designated by the issuer as the custodian of funds and official representative of bondholders.
Unit Investment Trust Investment fund created with a fixed portfolio of investments that never changes over the life of the trust. As investments within the trust are paid off, they provide a steady, periodic flow of income to investors.
Unlimited Tax Bond A bond secured by the pledge of taxes that are not limited by rate or amount.
Unsecured Bond A bond that is not secured by collateral.
Variable Rate Bond A long-term bond the interest rate of which is adjusted periodically, typically based upon specific market indicators.
Weighted Average Coupon (WAC) The weighted average interest rate of the underlying mortgage loans or pools that serve as collateral for a security, weighted by the size of the principal loan balances.
Weighted Average Loan Age (WALA) The weighted average number of months since the date of the origination of the mortgages (i.e., the age of the loans) that collateralize a security, weighted by the size of the principal loan balances.
Weighted Average Maturity (WAM) The weighted average number of months to the final payment of each loan backing a mortgage security weighted by the size of the principal loan balances. Also known as weighted average remaining maturity (WARM) and weighted average remaining term (WART).
Window In a CMO security, the period of time between the expected first payment of principal and the expected last payment of principal.
Yield The annual percentage rate of return earned on a security, as computed in accordance with standard industry practices. Yield is a function of a security’s purchase price and interest rate.
Yield Curve A line tracing relative yields on a type of security over a spectrum of maturities ranging from three months to 30 years.
Yield spread The difference in yield between two bonds or bond indices.
Yield To Call A yield on a security calculated by assuming that interest payments will be paid until the call date, when the security will be redeemed at the call price.
Yield To Maturity (YTM) A yield based on the assumption that the security will remain outstanding to maturity. It represents the total of coupon payments until maturity, plus interest on interest, and whatever gain or loss is realized from the security at maturity.
Zero-Coupon Bond A bond on which no periodic interest payments are made. The investor receives one payment-which includes principal and interest-at redemption (call or maturity; see Discount Note).
Z-tranche (Accretion or Accrual Bond) Often the last tranche in a CMO, the Ztranche receives no cash payments for an extended period of time until the previous tranches are retired. While the other tranches are outstanding, the Z-tranche receives credit for periodic interest payments that increase its face value but are not paid out. When the other tranches are retired, the Z-tranche begins to receive cash payments that include both principal and continuing interest.