Fixed Income Report

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Fixed Income Report

Because the population is aging, investors want more opportunities for investment with income. And there are plenty more than most financial advisors realize. This is especially true of insurance agents that started their careers with large insurance companies who had them purposely get a series 6 license (which limited their possibilities of what they could do and made them more captive). Its now time to get the series 7 because then you can offer individual fixed income securities. Individual securities offer so much more to investors than funds (in most cases): 1. The security of a fixed maturity date when the principal is return 2. The security of a fixed interest rate (no fund offers this) 3. A known credit quality (i.e. rating) 4. No annual management fees 5. Tax control Just as with stocks, wealthy investors buy individual bonds, not funds, for the above advantages.

High Yield FDIC Insured CDs

You can attract seniors by offering CDs that pay a lot more than the local bank. On such option is callable CDs: 1. These are long term CDs. Buy them and forget them. You can get your interest semiannually, but the CD has a 15-year term. So, this CD may outlive the senior. However, smart investors, want money to outlive them (the consequences of you outliving your money, lets not even discuss). At your death, your heirs have the option of putting (placing for redemption) the CD at face value, even if the term has not expired. These CDs have a call feature, which means the bank can decide to pay off the principal early and thus are named callable CDs. Therefore, if interest rates fall, the bank will probably pay off the CD because the bank can go sell a new CD for less. If interest rates rise, they will not call the CD. Therefore, the banks are willing to pay 1 to 1.5 more interest on callable CDs because the banks gets great flexibility. The CD may have a step rate feature. If the bank does not call the CD after the first year, the interest rate may be stepped down for the remaining term (you will know this before you invest). There are also CDs that step up. For 2014 All Rights Reserved Brokerville www.brokerville.com 888-893-2990

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example, interest for the first 5 year changes each year as follows 3%, 3.5%, 4%, 4.5%, 5%. But the bank will have the option to call the CD, say after the 2nd year. So if rates have fallen or remained steady, they may just pay off your clients and not have to keep increasing the rate. The investor has the option to sell the CD at any time in the secondary market, however, an early sale could get less than the amount paid and there is no assurance of a buyer for the CD. Large institutions like LaSalle maintain a secondary market for CD trading.

So who are these CDs for? For people who want to put their money in the safest place (FDIC insured), who want a very high rate and who do not need access to the funds. These investors will have other funds set aside for liquidity needs and will have adequate medical and long term care insurance so that these funds can be left to earn a very high rate. Another type of CD pays interest based on the increase in the S&P 500 index. For example, its a 5-ear CD and pays interest equal to the increase in the S&P 500 index during the period. If the index is negative, the CD pays no interest. Even though CDs are not securities, you need a broker dealer and series 6 to transact them. LaSalle bank (www.lasallebdsd.com) has an excellent on line inventory and you can but any CDs they offer through your broker dealer.

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Federally Backed Mortgage Notes

Conservative investors desiring income can do better than many other alternatives by investing in federally guaranteed and federally backed mortgage notes. The notes are issued by the Government National Mortgage Association (Ginnie Mae), the Federal Home Loan Association (Freddie Mac) and the Federal National Mortgage Association (Fannie Mae) and often provide yields 1% to 1.5% better than Treasury notes. For investors willing to make the required tradeoff, the extra income can be welcome. Mortgage notes have an implied AAA rating. Therefore, the credit markets do not consider them to have more credit risk than treasury securities. But while treasury securities have a fixed maturity date, mortgage notes do not. And you get a higher yield for accepting that variability. When you invest in mortgage notes, you are lending your money to a group of people to buy homes (with the federal agency or federally sponsored corporation guaranteeing your money). If the borrowers move and payoff their mortgage or refinance, you get paid back. This could happen at any time. You could get payments or principal at any time. For many seniors, this is not a big negative because the return of their principal is of utmost importance, which is assured if you hold the notes to maturity (various maturity options are readily available). Note that with mortgage securities, the yield and average life consider prepayment assumptions that may or may not be met. Changes in payments may significantly affect yield and average life. Both treasury securities and mortgage notes have a fixed percentage yield and treasury securities have a fixed maturity. Often, large securities firms will buy these notes and break them apart into different slices called tranches. These are called Collateralized Mortgage Obligations (CMOS) because the actual security is not the one issued by say Ginnie Mae, but the security is backed by or collateralized by the Ginnie Mae. Why do they do this? Because by breaking the security into pieces, they can offer more options to various groups of investors. For example, the Ginnie Mae security represents a pool of 10,000 mortgages with a 30 year maturity at an average of 6%. Those mortgages will be paid off at different times as people move. Also, as interest rates change, many people may pay off mortgages to refinance. Some investors might be willing to wait as long as 30 years (they get interest each month) in return for a higher rate. So maybe that investor gets 7%, because he is willing to wait. Another investor wants to make sure they get all of their money back in 5 years and they buy the tranches with that feature but they get only 5% interest. They get less because they get more assurance. 2014 All Rights Reserved Brokerville www.brokerville.com 888-893-2990

As you see, by breaking the Ginnie Mae into pieces, more types of investors can be served.

Closed End Income Funds

You have probably purchased open-end income funds. These funds typically invest in some type of bonds such as municipal, government or corporate bonds. The price you pay for your shares is exactly equal to the value of your share of the bonds in the portfolio. And on any day, you can redeem your shares by selling them back to the fund. What if you could buy into the same type of portfolio at a discount? You receive the same interest, but pay less to get it. This translates into a higher yield on your money. This is a frequent possibility with closed end income funds whose shares sell at a discount to the value of the bonds in the portfolio. When you sell your shares, you do not sell them back to the fund, but rather, sell to another investor just like when you sell shares of stock. These funds can be an excellent source of superior income. Ask a couple questions to make sure you are not taking extra risk: What percentage of bonds in the portfolio are premium bonds? If that number is significant, say more than 20%, this could lead to erosion in the bond portfolio value as these bonds mature at par. Does the fund use leveragedoes it borrow to buy bonds? While this strategy can lead to a significant increase in the interest you earn, leverage cuts both ways and can cut into the yield if short-term rates rise quickly. You can find a comprehensive list of closed end income funds in Barrons, issued every Saturday (see next page). And as you see from the next page, each fund trades at a premium or discount to the value of the bonds in the fund. By buying at a discount, you can obtain some very attractive yields.

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Premium or Discount

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Structured notes
We have omitted a discussion of vanilla bonds (e.g. corporate, municipal, etc) as you probably know about and understand that alternative. The purpose of this report is to explain investments that pay more than market rates. It is essential that you fully understand these instruments before investing, as there is always a trade off of these four items:

Length of term Volatility Rate Credit risk (easily reduced or eliminated by investing on high grade or guaranteed instruments).

Lets take the example of a note backed by GNMA, a federal agency. GNMA loans money so that people can purchase homes. If you invest in these notes, your payments are guaranteed. To have these notes be more suitable for various investors, a financial institution might split the note into two portionsthe principal repayment portion and the interest portion. You are able to buy one portion or the other. Each portion is priced based on assumptions about interest rates and the rate of mortgage prepayments. Lets say you buy the portion where you receive the principal. As you know, as people make their mortgage payments, part of each payment is principal which you receive, as the investor. When interest rates fall, people tend to refinance and you will get your principal payments faster than expected. This increases your yield (the faster you receive a stream of payments, the higher your yield). The opposite can also happen. Interest rates rise, and the length of your investment (the time it takes to receive your principal) stretches out. This reduces your yield as money received in the future has a lower present value today. These changes in yield cause the market value of these securities to change dramatically. Changes in market value are only important if you need to sell into the market. Your funds are backed by a government agency and you will eventually get all of the principal payments, but the yield, market value and length of your investment can vary greatly. These types of securities are great for people who love to guess about the future because they can put their money where their mouth is. Another example is Libor Range notes. Libor is the London Interbank Offered Rate something like an international discount rate. Libor range notes work as follows. The investor gets 6% interest as long as Libor remains between 3% and 4%. If the Libor rates moves outside of this range, the investors earn nothing for the remainder of the term.

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As I said above, these types of securities are great for people who love to guess about the future because they can put their money where their mouth is. Next time you have a prospect that is convinced of their own opinion, you can probably find a structured note to offer them that will allow them to bet on their opinion.

Preferred Shares
Preferred shares are issued by corporations as a way to raise money, just like selling stock. Preferred shares however, have a preferred status because their dividend is always paid before the common stockholders can be paid a dividend. Additionally, preferred shares pay a much higher rate of income than common shares. Therefore, preferred shares are suitable for retirees because they pay higher income and offer greater safety than common stock. For example, the average common stock on the New York Stock Exchange pays a dividend of 2%. However, many preferred shares pay a fixed dividend of 6% and more. These are fixed rates that you enjoy for as long as you hold the preferred shares. Because investors hold these shares for income, they are traded less, are less volatile than common shares, and are designed for a more conservative income oriented investor. You can sell your shares at any time, just like any share of stock. The sales price may be more or less than you paid. Alternatively, many investors hold their preferred shares indefinitely until called (redeemed) by the company. Almost all preferred shares have a provision allowing the company to call in their preferred shares at a set time at a set future date. This list is not kept current (its from 2000), but you can see some familiar names in the left column and some very attractive fixed rates in the yield column.
S&P Description Rating Symbol Div Rate Next Payment Price Current Yield to Call Date Yield Call Call Price

A+ A+ A AAAA BBB+ BBB+ BBB BBB BBB

ABN AMRO Cap Fund II 7.125% Farmers Group 8.25% Chase Preferred 8.10% Allstate Fin 7.100% QUIPs Duke Capital Fin II 7.375% QUIPs Travelers P&C 8.08% American General 8.45% Capital Re LLC 7.65% MIPs Public Storage 8.875% Sierra Pacific Power 8.60% Lincoln National 8.35% Avalon Bay

ABNprB FIGprB CMBpr ALLprA DUKprU TAPprA AGCprM KREprL PSAprG SRPprT LNCprY AVBprF

0.4453 09/30/2001 24.78 7.19% 7.48% 03/31/2004 25 0.5156 07/02/2001 25.6 0.5062 09/30/2001 25 8.06% 8.02% 12/31/2025 25 8.10% 8.09% 09/17/2001 25

0.4968 09/30/2001 25.16 7.90% 6.40% 11/24/2001 25 0.4609 09/30/2001 25 0.505 0.54 7.37% 7.37% 09/30/2003 25 any any any 25 25 25

09/30/2001 25.22 8.01% ** 07/02/2001 25.3 8.54% **

0.4781 08/01/2001 21.75 8.79% **

0.5546 09/07/2001 24.89 8.91% ** any 25 0.5375 07/02/2001 24.48 8.78% 28.54% 07/29/2001 25 0.5218 07/02/2001 25.51 8.18% ** 0.5625 08/01/2001 25.12 8.96% ** 8/20/'2001 25 any 25

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Communities 9% BBB First Industrial Realty FRprA 0.5937 9.5% BBB AT&T Capital Corp NCD 0.5156 8.25% BBB Nexen 9.75% NXYpr 0.6093 BBB NVP Capital I 8.20% NVPpr 0.5125 BBB- Placer Dome 8.625% PDGprA 0.539 BBB- Gables Residential GBPprA 0.5187 Trust 8.3% BBB- BRE Properties 8.5% BREprA 0.5312 BBB- Newscorp 8.625% NOPprA 0.539 **purchase not recommended above $25 per share

09/30/2001 25.02 9.49% ** 09/30/2001 25.5 09/15/2001 09/30/2001 09/28/2001 08/29/2001 25.46 22.74 22.8 23.57

any

25

8.09% 7.33% 11/15/2003 25 9.57% 9.01% 9.46% 8.80% 8.87% 10/30/2003 21.10% 04/01/2002 28.54% 12/17/2001 14.03% 07/24/2002 25 25 25 25

09/30/2001 25.25 8.42% 8.07% 01/28/2004 25 09/30/2001 24.37 8.85% ** any 25

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