Debt Securities and Money Market Instruments
Beyond traditional corporate bonds, you need to know several other debt instruments that appear on the Series 7 exam. These range from ultra-short-term money market instruments to specialized securities with unique characteristics.
Corporate Commercial Paper
Commercial paper is a short-term unsecured promissory note issued by corporations for working capital needs.
| Feature | Detail |
|---|---|
| Issuer | Corporations with high credit ratings (investment grade) |
| Maturity | 1-270 days (most commonly 30-90 days) |
| Pricing | Sold at a discount to face value |
| Collateral | None (unsecured) |
| Registration | Exempt from SEC registration if maturity is 270 days or less |
| Use of proceeds | Short-term working capital (payroll, inventory financing) |
- The 270-day maximum maturity allows the issuer to avoid SEC registration under Section 3(a)(3) of the Securities Act
- The discount from face value represents the investor's interest
- In practice, most commercial paper has a maturity of 30-45 days
Think of it this way: A company needs cash for next month's payroll. Instead of taking out a bank loan, it sells IOUs at a slight discount. Investors buy the IOUs and collect face value when they mature; the discount is their return.
Exam Tip: Gotchas
- Commercial paper maximum maturity is 270 days (not 90 days or 1 year). The 270-day limit is what keeps it exempt from SEC registration.
- Commercial paper is unsecured. Only investment-grade companies can issue it because there is no collateral backing it.
Brokered Certificates of Deposit (CDs)
Brokered CDs are bank-issued CDs sold through broker-dealers, giving them unique characteristics:
- FDIC insured up to $250,000 per depositor, per bank
- Can be traded in the secondary market (unlike traditional bank CDs)
- May be callable by the issuing bank
- Subject to interest rate risk if sold before maturity (price fluctuates with rates)
Exam Tip: Gotchas
- FDIC insurance only protects against the bank's default. If you sell a brokered CD before maturity in the secondary market, you can still lose money due to interest rate changes.
- Brokered CDs are not the same as traditional bank CDs. They trade in secondary markets and their prices fluctuate with interest rates.
Eurodollar Bonds
Eurodollar bonds are U.S. dollar-denominated bonds issued outside the United States.
| Feature | Eurodollar Bond | Domestic Corporate Bond |
|---|---|---|
| Denomination | U.S. dollars | U.S. dollars |
| Issued where | Outside the U.S. | Inside the U.S. |
| SEC registration | Not registered | Registered |
| Form | Typically bearer | Book-entry |
| Interest payments | Annually | Semiannually |
| Regulation | Less regulated | Subject to U.S. regulation |
Exam Tip: Gotchas
- "Eurodollar" has nothing to do with the euro currency. "Euro" here means "outside the country of the currency." A Eurodollar bond is denominated in U.S. dollars but issued outside the U.S.
- Eurodollar bonds pay interest annually, not semiannually like domestic corporate bonds.
Variable-Rate Preferreds
While technically preferred stock, variable-rate preferreds are grouped with debt-like instruments because of their fixed-income characteristics:
- Dividend rate adjusts periodically based on a benchmark rate
- Less interest rate risk than fixed-rate preferreds because the dividend adjusts with market rates
- Behave more like floating-rate debt than traditional equity
Exam Tip: Gotchas
- Variable-rate preferreds have less interest rate risk than fixed-rate preferreds. Because the dividend adjusts with market rates, their price stays more stable when rates change.