• These are Certificates of Deposit issued by a financial institution.
• They are considered securities by the Firm and in most state jurisdictions because they are traded in the secondary securities market.
• They typically will carry FDIC insurance.
• Maturities will vary.
• Two types of CDs
- Generic—Certificate of Deposit has a fixed interest rate for a specific period of time. No special provisions.
- Step—Certificate of Deposit issued with multiple levels of yield. Some are “Step Up” where the rate will gradually increase on a predetermined schedule. Others are “Step Down” where the certificate could pay a high up-front rate and then decline in subsequent years.
• Some certificates have a provision where upon the death of the owner, the certificate can be “put” to the issuing bank at par value. Not all brokered CDs carry this provision so make sure you know all the facts pertaining to the certificate you are recommending - especially with elderly customers.
• Many Brokered Certificates are callable.
Tax Considerations
• Interest on the Certificate is taxable in the current year. A capital gain or loss can be incurred if sold prior to maturity.
Market Values
• There is a general relationship between market values and interest rates. If interest rates increase, values go down. If interest rates decrease, values go up.
• Investor should understand that if they sell the CD prior to maturity, the value could be higher or lower than what they originally paid.
Collateralized Mortgage Obligations (CMOs)
General Investment Features
• Mortgage backed bonds that separate mortgage pools into different maturity classes, called tranches.
• Maturities can range from a few months to 20 years.
• Issued by Federal Home Loan Mortgage Corporation (Freddie Mac) and private issuers.
• Usually backed by agency and AAA rated.
• Monthly return of principal and interest.
Tax Considerations
• Interest is taxable in the year it is earned.
Market Values
• In return for a lower yield, CMOs provide investors with increased security about the life of their investment compared to purchasing a whole mortgage backed security.
• Market values are largely based on which “tranche” of CMO is being quoted.
• However, if interest rates drop sharply, causing a flood of refinancings, prepayment rates will soar and CMOs can be repaid before their expected maturity.
Zero Coupon Bonds
General Investment Features
• Bonds are a loan from the investor to the entity.
• Bonds have a fixed maturity date.
• The bonds are purchased at a discount and mature at their face value.
• They do not make regular interest payments.
• The government, corporations, or municipalities can issue zeros.
• Maturities can range from 1 to 30 years.
Tax Considerations
• With the exception of municipal zero coupon bonds, these bonds are taxed on an accretion basis.
• For instance:
- A zero coupon bond is purchased at $500 and will mature in 10 years at a face value of $1,000.
- The investor will pay taxes on $50 of income each year on this bond.
(Face Value – Purchase Price, divided by # of years to maturity = Annual Taxable Income. $1,000 - $500 = $500. $500/10 years = $50 taxable income annually.) Investor must understand taxes (if taxable) are due annually although interest not yet received. These may be referred to as “Phantom Taxes”.
Market Values
• Because zero-coupon securities bear no interest, they are the most volatile of all fixed income securities. Zeros fall more dramatically than bonds paying out interest when interest rates rise – when interest rates fall, however, their value should rise more rapidly than bonds.
Registered Representative of, and securities, advisory services and insurance products through INVEST Financial Corporation (INVEST), member FINRA /SIPC, a registered investment advisor and affiliated insurance agencies. INVEST is not affiliated with Mayo-Vera Financial Advising.
This website may contain concepts that have legal, accounting and tax implications. It is not intended to provide legal, accounting, or tax advice. You may wish to consult an attorney, tax advisor, or accountant regarding your specific situation. No representations are made as to the accuracy of the information contained herein or any information contained in any link provided herein.
