| Rate Move | Bond Price | Why |
|---|---|---|
| Rates rise | Price falls | New bonds pay more; old bonds less attractive |
| Rates fall | Price rises | Old bonds pay more than new; more valuable |
Duration: Higher duration = greater price sensitivity. Longer maturity + lower coupon = higher duration.
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2. Yield Hierarchy for Premium vs. Discount Bonds
| Bond Type | Price vs. Par | Yield Order (High to Low) |
|---|---|---|
| Discount bond | Price < Par | YTM > Current Yield > Coupon |
|---|
| Par bond | Price = Par | YTM = Current Yield = Coupon |
|---|
| Premium bond | Price > Par | Coupon > Current Yield > YTM |
|---|
Memory trick: For discounts, all yields stack UP above coupon. For premiums, all yields fall DOWN below coupon.
Current Yield formula: Annual interest ($) / Market price
TEY formula: Muni yield / (1 - marginal tax rate)
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3. Corporate Bond Liquidation Priority (Highest to Lowest)
Secured creditors (mortgage bonds, equipment trust certificates)
General/unsecured creditors (debentures, trade payables)
Subordinated debenture holders
Preferred stockholders
Common stockholders — always lastExam trap: "Debentures" = unsecured. "Subordinated debentures" = below regular debentures. Common stock = last always.
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4. Municipal Bond Tax Treatment
| Tax Type | Treatment |
|---|---|
| Federal income tax | ALWAYS exempt (all munis) |
| State/local tax | Exempt ONLY in the state that issued the bond |
| Federal estate tax | NOT exempt — munis are in taxable estate |
| AMT | Certain private activity bonds ARE a preference item |
Tax-Equivalent Yield (TEY):
TEY = Muni yield / (1 - tax bracket)
Example: 4% muni, 35% bracket — 4% / 0.65 = 6.15% TEY
Higher bracket = higher TEY = munis more attractive
GO bonds: Backed by taxing power; require voter approval; safer; lower yield
Revenue bonds: Backed by project revenues only; no voter approval; higher yield
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5. T-Bill Discount Formula
T-Bills trade at a discount to $10,000 face value. The return is the discount itself.
Dollar return = Face value - Purchase price
Bank Discount Yield = (Discount / Face value) x (360 / Days to maturity)
Example: Buy at $9,750, mature at $10,000, 182-day T-Bill
- Discount yield = ($250 / $10,000) x (360 / 182) = 2.5% x 1.978 = 4.95%
Note: Discount yield uses 360-day year and face value as denominator — understates true return vs. 365-day actual yield.
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6. GNMA vs. FNMA vs. FHLMC
| Feature | GNMA (Ginnie Mae) | FNMA (Fannie Mae) | FHLMC (Freddie Mac) |
|---|---|---|---|
| Type | Government agency | GSE (private) | GSE (private) |
| U.S. gov guarantee | YES — explicit, direct | NO — implied only | NO — implied only |
| Mortgage type | FHA/VA (gov-insured) | Conventional | Conventional |
| Securities issued | MBS pass-throughs | MBS / notes | Participation certificates |
| Credit quality | Equal to Treasuries | Below Treasuries | Below Treasuries |
The single most-tested fact: Only GNMA carries the full faith and credit of the U.S. government.
Prepayment risk: When rates fall, homeowners refinance — investors get principal back early — forced to reinvest at lower rates.
Extension risk: When rates rise, prepayments slow — bond duration extends — price drops more than expected.
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7. Money Market Instruments Quick Reference
| Instrument | Issuer | Maturity | Secured? | Min Size | Notes |
|---|---|---|---|---|---|
| T-Bills | U.S. Treasury | 4-52 weeks | U.S. gov | $100 | Risk-free benchmark |
| Commercial Paper | Corporations | 1-270 days | Unsecured | $100,000 | Avoids SEC reg under 270 days |
| Banker's Acceptance | Bank (on behalf of importer) | 30-180 days | Bank guarantee | Varies | Used in international trade |
| Repo | Dealer (borrower) | Overnight-30 days | Treasuries/gov securities | Varies | Dealer borrows via securities sale |
| Negotiable CD | Commercial bank | 2 weeks-1 year | Bank obligation | $100,000 | FDIC covers only first $250k |
| Federal Funds | Banks (to banks) | Overnight | Unsecured | $1M+ | Rate set by FOMC target |
| Eurodollars | Foreign banks | Short-term | Unregulated | $1M+ | USD held outside U.S.; no FDIC |
SOFR (Secured Overnight Financing Rate): Transaction-based benchmark replacing LIBOR. Based on overnight Treasury repo trades. Published by NY Fed.
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8. TIPS and STRIPS Quick Rules
TIPS:
- Principal adjusts with CPI (up with inflation, down with deflation)
- Coupon % is fixed; dollar coupon rises/falls with adjusted principal
- At maturity: receives greater of adjusted principal or original par
- Phantom income: annual inflation adjustment is taxable even without cash — best in tax-deferred accounts
STRIPS:
- Created by separating Treasury coupon payments from principal
- Each payment becomes a separate zero-coupon bond
- Sold at deep discount; redeems at face value
- Phantom income: annual accretion is taxable — best in IRAs/401(k)s
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9. Corporate Bond Feature Summary
| Feature | Callable Bond | Convertible Bond | Secured Bond |
|---|---|---|---|
| Who benefits | Issuer (can refinance) | Investor (equity upside) | Investor (collateral) |
| Coupon vs. plain bond | Higher yield (call risk) | Lower yield (conversion value) | Lower yield (safer) |
| Key risk | Reinvestment risk (investor) | Dilution risk (existing shareholders) | Collateral value risk |
| Key formula | YTC = yield if called early | Parity price = Bond price / Conversion ratio | N/A |