Quick Answer
Bond prices and interest rates move in opposite directions; premiums yield less than their coupon, discounts yield more, and at par all four yields match. Treasuries are safest and state-tax-exempt; municipals are federal-tax-exempt; corporates are fully taxable. Lock in par values, maturities, ratings cutoffs, and the money-market 270-day rule.
The whole unit on one sheet: pricing math, bond types, taxation, and the distinctions the exam loves.
Core Bond Types at a Glance
- Treasuries: full faith and credit, virtually zero default risk, the risk-free benchmark. Interest taxed at the federal level only, exempt from state and local.
- Agencies: government-sponsored enterprises (GSEs), mostly housing. Only Ginnie Mae (Government National Mortgage Association) has explicit full-faith-and-credit backing; Fannie Mae and Freddie Mac are implied only.
- Corporates: subject to credit (default) risk, fully taxable at all levels. Priority in liquidation: secured, then debentures (unsecured), then subordinated debentures, then preferred, then common.
- Municipals: interest generally exempt from federal tax. General obligation (GO) bonds ride on taxing power (voter approval, safer, lower yield); revenue bonds ride on project income (no vote, riskier, higher yield).
- Money market: maturities of one year or less; high liquidity, low risk, low return.
The One-Liners That Win Points
- Rates up, prices down; rates down, prices up. A mathematical certainty, not a tendency.
- Premium (above par): market yield below the coupon. Discount (below par): market yield above the coupon.
- Discount: coupon yield < current yield < yield to maturity (YTM) < yield to call (YTC). Premium: reverse. Par: all four equal.
- Longer maturity = more price sensitivity. Lower coupon = more price sensitivity. Zero-coupon = maximum sensitivity at a given maturity.
- T-Bills are zero-coupon but short-term, so low interest rate risk; a 30-year Separate Trading of Registered Interest and Principal of Securities (STRIPS) has high rate risk.
- Callable bonds benefit the issuer (called when rates fall), pay higher yields, and carry reinvestment risk. Convertible bonds benefit the investor, pay lower yields.
- Ginnie Mae is the only agency with explicit government backing.
- GO bonds = competitive bidding; revenue and corporate bonds = negotiated.
Numbers to Lock In
| Item | Value |
|---|---|
| Corporate / government par | $1,000 |
| Municipal par | $5,000 |
| Investment-grade cutoff | BBB- / Baa3 and above |
| Commercial paper / bankers' acceptance max maturity | 270 days |
| Money market maturity | 1 year or less |
| Federal Deposit Insurance Corporation (FDIC) coverage on CDs | $250,000 per depositor, per institution |
| Non-competitive Treasury bid limit | $10 million per auction |
| Conversion ratio | Par value / conversion price |
| Annual interest | Coupon rate x par value |
Memory Aids (verbatim)
- See-Saw: rates on one end, bond prices on the other; the two ends always move in opposite directions.
- Discount Climbs, Premium Dips: for a discount bond each yield measure climbs (Nominal to Current to YTM to YTC); for a premium bond each dips in the same order; par sits flat.
- Fallen Angel: a bond downgraded from BBB-/Baa3 to BB+/Ba1 forces investment-grade-restricted institutions to sell, often causing a sharp price drop.
Top Gotchas
- A quote of 98 means $980, not $98. Quotes are percentages of par; 100 = 100% of par.
- Coupon yield never changes; current yield changes daily with market price.
- Bond ratings measure credit risk only, not interest rate risk. Higher rating = lower yield. Moody's uses numbers; Standard & Poor's (S&P) and Fitch use letters with +/-.
- Treasury interest is exempt from state and local tax, taxable federally, the opposite of municipals.
- Municipal par is $5,000, and the tax exemption covers interest only, not capital gains.
- STRIPS and zero-coupon corporates create phantom income: tax on the annual accretion with no cash until maturity. T-Bills do not.
- TIPS adjust the principal, not the coupon rate. Interest = fixed rate x adjusted principal.
- Debentures are unsecured; subordinated means lower liquidation priority.
- Prepayment risk hits when rates fall (homeowners refinance); extension risk when rates rise. Mortgage-backed securities pay monthly.
- Non-competitive Treasury bidders are guaranteed securities; competitive bidders may be shut out.
- The MSRB writes municipal rules but does not enforce; FINRA enforces on broker-dealers.
One-Breath Recap
Prices and yields see-saw: premiums yield less, discounts yield more, par sits flat with all four yields equal. Treasuries are the safe, state-tax-exempt benchmark; municipals dodge federal tax; corporates are fully taxable and credit-risky. Nail the par values, the BBB-/Baa3 line, the 270-day rule, and who holds the option on callable versus convertible bonds.
Need more than the recap? This is a condensed summary. If it is not enough, read the full Debt Instruments unit for the complete lesson.