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Res 94-175 RESOLUTION NO. 94-175 A RESOLUTION OF THE CITY COUNCIL OF THE CITY OF FEDERAL WAY, WASHINGTON, ADOPTING AN INVESTMENT POLICY TO GOVERN THE INVESTMENT OF PUBLIC FUNDS IN A MANNER WHICH WILL PROVIDE THE HIGHEST INVESTMENT RETURN WITH THE MAXIMUM SECURITY WHILE MEETING THE DAILY CASH FLOW DEMANDS OF THE CITY. WHEREAS, the City of Federal Way's 1994 Adopted Budget constituted administration of funds equalling $33,422,275.00, including operating and capital components; and WHEREAS, the city council of the city of Federal Way has previously adopted financial policies to govern the administration of the budget; and WHEREAS, the City Council seeks at all times to maintain the highest fiscal integrity with respect to its administration of public funds; and WHEREAS, the budget of the City also includes a certain percentage of idle funds which are intended to be invested in order to balance the city's cash requirements for ongoing operations with the opportunity for the highest, prudent investment potentials to insure a reasonable return on idle funds with the highest investment return with maximum security; NOW, THEREFORE, THE CITY COUNCIL OF THE CITY OF FEDERAL WAY, WASHINGTON, DOES HEREBY RESOLVE AS FOLLOWS: section 1. policv Adopted. The city Council of the City of Federal Way hereby adopts the Investment Policy attached hereto as Exhibit A and incorporated herewith by this reference as the Investment Policy for the city of Federal Way. RES # 94-175 , Page 1 COpy section 2. Ratification. Any act consistent with the authority and prior to the effective date of this resolution is hereby ratified and affirmed. section 3. Severabilitv. If any section, sentence, clause or phrase of this resolution should be held to be invalid or unconstitutional by a court of competent jurisdiction, such invalidity or unconstitutionality shall not affect the validity or constitutionality of any other section, sentence, clause or phrase of this resolution. section 4. Effective Date. This resolution shall be effective immediately upon passage by the Federal Way city council. RESOLVED BY THE CITY COUNCIL OF THE CITY OF FEDERAL WAY, WASHINGTON, this ~ day of May , 1994. CITY OF FEDERAL WAY ATTEST: ~¿¿~ MAYO, Y E. GATES A. LAKE FILED WITH THE CITY CLERK: 5/10/94 PASSED BY THE CITY COUNCIL: 5/17/94 RESOLUTION NO. 94-175 RES\INVEST .POL RES # 94-175 , Page 2 1.0 Policy City Council Approval: May 17,1994 CITY OF FEDERAL WAY INVESTMENT POLICY It is the policy of the City of Federal Way to invest public funds in a manner which will provide the highest investment return with the maximum security while meeting the daily cash flow demands of the entity and conforming to all state and local statutes governing the investment of public funds as well as this Investment Policy. 2.0 Scone This Investment Policy applies to all financial assets of the City of Federal Way. These funds are accounted for in the City's Comprehensive Annual Financial Report and include: 2.1 Funds 2.1.1 2.1.2 2.1.3 2.1.4 2.1.5 2.1.6 2.1.7 2.1.8 3.0 Prudence General Fund Special Revenue Funds Capital Projects Funds Debt Service Fund Enterprise Funds Internal Service Funds Trust and Agency Funds (with the exception of the Federal Way Retirement System Fund) Any new fund created by the City Council, unless specifically exempted by the City Council Investments shall be made with judgment and care - under circumstances then prevailing - which persons of prudence, discretion and intelligence exercise in the management of their own affairs, not for speculation, but for investment, considering the probable safety of their capital as well as the probable income to be derived. 3.1 The standard of prudence to be used by investment officials shall be the "prudent person" standard and shall be applied in the context of managing an overall portfolio. Investment officials acting in accordance with written procedures and the Investment Policy and exercising due diligence shall be relieved of personal responsibility for an individual security's credit risk or market price changes, provided deviations from expectations are reported in a timely fashion and appropriate action is taken to control adverse developments. 4.0 Objective The primary objectives, in priority order, of the City of Federal Way's investment portfolio shall be: EXHIBIT ('/I If Page 2 4.1 Safety Safety of principal is the foremost objective of the investment program. Investments of the City shall be undertaken in a manner that seeks to ensure the preservation of capital in the overall portfolio. 4.1.1 The City shall ensure the safety of its invested idle funds by limiting credit and interest rate risks. Credit risk is the risk of loss due to the failure of the security issuer or backer. Interest rate risk is the risk that the market value of portfolio securities will fall due to an increase in general interest rates. a. Credit risk will be mitigated by: 1. Limiting investments to the safest types of securities; 2. Prequalifying the financial institutions with which it will do business; 3. Diversifying the investment portfolio so that the failure of anyone issuer or backer will not place an undue financial burden on the City; 4. Monitoring all of the City's investments on a daily basis to anticipate and respond appropriately to a significant reduction of creditworthiness of any of the depositories. b. Interest rate risk will be mitigated by: 1. Structuring the City's portfolio so that securities mature to meet the City's cash requirements for ongoing operations, thereby avoiding the need to sell securities on the open market prior to maturity to meet those specific needs; 2. Investing primarily in shorter-term securities, unless it is anticipated that longer- term securities can be held to maturity without jeopardizing liquidity requirements; 3. Occasionally restructuring the portfolio to minimize the loss of market value and/or maximize cash flows. c. The physical security or safekeeping of the City's investments is also an important element of safety. Safekeeping requirements are defined in Section II of this Policy. 4.2 Liquidity The City's investment portfolio must be structured in a manner which will provide that securities mature at the same time as cash is needed to meet anticipated demands (static liquidity). Additionally, since all possible cash demands cannot be anticipated, the portfolio should consist largely of securities with active secondary or resale markets (dynamic liquidity). Page 3 4.3 Yield Yield on the City's investment portfolio is of secondary importance compared to the safety and liquidity objectives described above. Investments are limited to relatively low-risk securities in anticipation of earning a fair return relative to the risk being assumed. While it may occasionally be necessary or strategically prudent for the City to sell a security prior to maturity to either meet unanticipated cash needs or to restructure the portfolio, this Policy specifically prohibits trading securities for the sole purpose of speculating or taking an unhedged position on the future direction of interest rates. Specifically, "when, as, and if issued" trading and open-ended portfolio restructuring transactions are prohibited. 5,0 Dele!!ation of Authority Authority to manage the City's investment program is derived from RCW 35A.40.050 and Sections 7-1 and 7-2 of the Federal Way City Code. Management responsibility for the investment program is hereby delegated to the City Manager and his or her designee, who shall establish written procedures for the operation of the investment program consistent with this Policy. Such procedures shall include explicit delegation of authority to persons responsible for investment transactions. No person may engage in an investment transaction except as provided under the terms of this Policy and the procedures established by the Director of Management Services. The Director of Management Services shall be responsible for all transactions undertaken and shall establish a system of controls to regulate the activities of subordinate officials. 6.0 Investment Committee There is hereby created an Investment Committee, consisting of the City Manager, Management Services Director, designated investment official, and one other City employee appointed by the City Manager. Members of the Investment Committee shall meet at least quarterly to determine general strategies and monitor results. The Investment Committee shall include in its deliberations such topics as: economic outlook, portfolio diversification and maturity structure, potential risks to the City's funds, authorized depositories, brokers and dealers, and the target rate of return on the investment portfolio. The Investment Committee members must disclose any personal financial interest in instruments or brokers utilized by the City. Written investment procedures must be approved by the Investment Committee. The Investment Committee shall provide for immediate release of meeting minutes, which shall be disseminated by the City Manager to the full City Council. Any two members of the Committee may request a meeting, and three members shall constitute a quorum. The Committee shall establish its own rules of procedure. The Committee's authority shall not apply to investment of the Federal Way Retirement System. The Committee shall perform such other duties as may be assigned to it by this Policy or by motion of the City Council. 7.0 Ethics and Conflict of Interest Officers and employees involved in the investment process shall refrain from personal business activity that could conflict with proper execution of the investment program, or which could impair their ability to make impartial investment decisions. Employees and investment officials shall disclose to the City Manager any material financial interests in financial institutions that conduct business within this jurisdiction, and they shall further disclose any large personal financial/investment positions that could Page 4 be related to the performance of the City's portfolio. Employees and officers shall subordinate their personal investment transactions to those of the City, particularly with regard to the timing of purchases and sales. 8,0 Authorized Financial Dealers and Institutions Banks and savings and loan associations seeking to establish eligibility for the City's competitive certificate of deposit purchase programs shall submit information as required by the Investment Committee. The Investment Committee shall regularly report to the City Council its list of eligible banks and savings and loan associations. In addition, a list will be maintained of approved security broker/dealers selected by creditworthiness, who maintain an office in the state of Washington. Securities dealers not affiliated with a bank shall be required to be classified as reporting dealers affiliated with the New York Federal Reserve Bank, as primary dealers. Regional dealers may qualify if, in the determination of the Investment Committee, SEC Rule 15C3-1 (uniform net capital rule) has been satisfied. No public deposit shall be made except in a qualified public depository as established by state law. 8.1 Required Documentation All financial institutions and broker/dealers who desire to become qualified bidders for investment transactions must supply the Investment Committee with certain documents, including but not limited to: audited financial statements, proof of National Association of Securities Dealers certification, trading resolution, proof of state registration, certification of having read the City's Investment Policy (see Section 8.3 below), and depository contracts. Each bank, savings and loan, and broker/dealer, otherwise qualified under the provisions of this Policy, who wishes to do business with the City shall submit a copy of its latest financial statement to the City, including a balance sheet and profit and loss statement. Banks shall also provide their most recent Consolidated Report of Condition ("call report") at the request of the City. If the security dealer is a private partnership registered with the SEC, the following shall be required in lieu of a profit and loss statement: 1) disclosure of its excess net capital in the notes to the statement of financial condition, and 2) a separate letter from its CPA firm attesting to the fact that Rule 15C3-1 has been complied with and the dealer's internal systems and controls have no material inadequacies. 8.2 Rating Service/Creditworthiness Criteria The City shall use a commercial rating service (Thomson Bankwatch or equivalent) to most efficiently assess creditworthiness and qualification for the City's list of authorized depositories and securities brokers/dealers affiliated with a bank or savings and loan. If a rating is not available for a particular institution, the Investment Committee may authorize a staff-generated financial statement analysis or other reliable rating service analysis. Depositories and broker/dealers affiliated with a bank shall be rated "B/C" or better. Commercial paper shall be rated AllPl in accordance with state law. Page 5 8.4 8.3 Required Certification Statement Before accepting funds or engaging in investment transactions with the City, the supervising officer at each depository and recognized security broker/dealer shall submit a certification. The document will certify that the officer has reviewed the Investment Policy and agrees to disclose potential conflicts or risks to public funds that might arise out of business between the firm/depository and the City. All financial institutions shall agree to undertake reasonable efforts to preclude imprudent transactions involving the City's funds. The supervising officer shall agree to exercise due diligence in monitoring the activities of other officers and subordinate staff members engaged in transactions with the City. Employees of any firm of financial institution offering securities or investments to the City shall be trained in the precautions appropriate to public-sector investments and shall be required to familiarize themselves with the City's investment objectives, policies, and constraints. Required Master Repurchase Agreement Each bank, savings and loan, and security broker/dealer, otherwise qualified under the provisions of this Policy, who wishes to enter into repurchase agreements with the City shall be required to execute, in advance, the City's Master Repurchase Agreement. 9.0 Authorized and Suitable Investments The City is empowered by statute to invest in the types of securities listed in Exhibit A. The following table summarizes categories of investments authorized under this Policy, in general order of safety and liquidity: 9.1 9.2 9.3 9.4 9.5 9.6 9.7 9.8 9.9 State Investment Pool Repurchase Agreements U.S. Treasury Obligations U.S. Government Agencies U.S. Government-Sponsored Corporations/Instrumentalities Bankers' Acceptances: Secondary Market Domestic and Foreign Commercial Paper: Secondary Market Insured Certificates of Deposit: Banks and Savings & Loans Uninsured/Collateralized Certificates of Deposit: Banks and Savings & Loans With respect to Sections 9.4 and 9.5 above, conventional Agency and Instrumentality securities include those provided below. Not all government agency and instrumentality securities are widely traded. Page 6 Some lack broad and deep markets, and others are inappropriate for cash management purposes by virtue of their price volalility or technical characteristics. Therefore, the City shall maintain a preference for the government agency issues listed below (see Exhibit B for details): Discount securities Farm Credit Consolidated System-wide discount notes Federal Home Loan Banks discount notes Federal Home Loan Mortgage Corporation (Freddie Mac) discount notes Variable-rate securities Student Loan Marketing Association (Sallie Mae) CoUDon securities Federal National Mortgage Association (Fannie Mae) Federal Farm Credit Bank Federal Home Loan Bank Federal Land Bank 10.0 Competitive Selection of Investment Instruments Before the City invests any surplus funds, a competitive "bid" process shall be conducted. If a specific maturity date is required, either for cash flow purposes or for conformance to maturity guidelines, bids will be requested for instruments which meet the maturity requirement. If no specific maturity is required, a market trend (yield curve) analysis will be conducted to determine which maturities would be most advantageous. 11.0 Collateralization Collateralization shall be required on two types of investments: certificates of deposit and repurchase agreements. In order to anticipate market changes and provide a level of security for all funds, the collateralization level will be at least 100% of market value of principal and accrued interest. 11.1 Certificates of Deposit For certificates of deposit, any amount exceeding FDIC or FSLIC coverage shall be collateralized by eligible securities which are prescribed, designated and segregated in accordance with state law (RCW 39.58.050). 11.2 Repurchase Agreements A repurchase agreement is a transaction in which a counterparty agrees to transfer to the City securities in exchange for funds, with a simultaneous agreement by the City to resell the securities to the counterparty at a date certain. In such cases the transferred securities shall be U.S. Treasury or Government Agency issues whose market value at the time of transfer is equal to at least 100% of the repurchase agreement's face value. For other than overnight investments, the securities transferred shall be marked to market and maintained at an amount Page 7 equal to at least 100% of the repurchase agreement's face value. The market value of the transferred securities may be required to exceed the repurchase agreement's face value by an amount which is expected to protect against a sudden decrease in the market value of the transferred securities. The types of securities to be accepted as transferred securities in repurchase agreements in which the City is the buyer shall be limited to the types of eligible U.S. Treasury or Government Agency issues listed in Sections 9.3 and 9.4 above. The City shall maintain a preference for shorter-term maturities. If it is determined that the transferred securities have variable degrees of market risk due to the type of instruments involved and/or their terms to maturity, the City may require the counterparty to transfer additional securities. The number of transferred securities for each repurchase agreement shall ordinarily be limited to three or less. The City may authorize the counterparty to transfer more than three. Substitutions of transferred securities shall be limited to U.S. Treasury Bills and may not be made without prior approval by the City. Substitutions are to be confirmed in accordance with Section 11.0. 11.3 Other Investments Any other investments shall be collateralized by the actual security held in safekeeping by the City's safekeeping agent. 12.0 SafekeeDinl! and Custodv All security transactions, including collateral for repurchase agreements, entered into by the City shall be conducted on a delivery-versus-payment (DVP) basis. To protect against potential fraud and embezzlement, the assets of the City shall be secured through third-party safekeeping and custody procedures. Securities will be held by a third party custodian with which the City has executed a safekeeping agreement. The delivery of these securities will be evidenced by safekeeping receipts. Verification of transferred securities will be part of the City's annual financial audit by the State Auditor's Office. 13.0 Diversification It is the policy of the City to diversify its investment portfolio. Assets held in the common cash fund shall be diversified to avoid incurring unreasonable risk of loss resulting from overconcentration of assets in a specific maturity, a specific issuer, or a specific class of securities. Diversification strategies shall be determined and reviewed periodically by the Investment Committee. As a general rule, which may be amended by the Investment Committee as economic cycles change, the following diversification limitations may be imposed on the portfolio: 13.1 Maturity No more than 20% of the portfolio may be invested beyond 12 months, and average maturity of the portfolio may not exceed two years. Page 8 13.2 Default Risk No more than 5% of the portfolio may be invested in the securities of a single issuer, except for the U.S. Treasury, to which no limits apply, and commercial paper, which is limited to 3% of the portfolio in accordance with state law. No more than 30% of the portfolio may be invested in bankers' acceptances and certificates of deposit. 13.3 Liquidity Risk At least 10% of the portfolio may be invested in overnight instruments or in marketable instruments which can be sold to raise cash in one day's notice. 14.0 Internal Controls The City's internal controls shall be designed to prevent losses of public funds arising from fraud, employee error, misrepresentation by third parties, or unanticipated changes in financial markets. Controls which the City deems important include, but are not limited to: Control of collusion Separation of functions Separation of transaction authority from accounting and recordkeeping Custodial safekeeping Avoidance of bearer-form securities Specific limitations regarding securities losses and remedial action Clear delegation of authority to subordinate staff members Written confirmation of telephone transactions Supervisory authority of employee actions Minimize the number of authorized investment officials Documentation of transactions and strategies The City will undergo an annual independent review by the State Auditor's Office which will verify compliance with policies and procedures. 15.0 Performance Standards The investment portfolio will be designed to obtain a market average rate of return during budgetary and economic cycles, taking into account the City's investment risk constraints and cash flow needs. 15.1 Market Yield (Benchmark) The City's investment strategy is primarily passive. Given this strategy, the basis used by the City to determine whether market yields are being achieved shall be the range between the six- month U.S. Treasury Bill and the State Investment Pool. Page 9 16.0 Reportim! The Director of Management Services is charged with the responsibility of including a report on investment activity and returns in the City's monthly financial report. Reports may include, but are not limited to: market conditions, performance, breakdowns by security type and maturity, and number of trades. 17.0 Investment Policv Adootion The City's Investment Policy shall be adopted by resolution of the City Council. The Policy shall be reviewed annually by the Investment Committee to ensure its consistency with respect to the overall objectives of safety, liquidity and yield, and its relevance to current laws and financial trends. Proposed amendments to the Policy shall be prepared by the Director of Management Services on behalf of the Investment Committee, and after review and approval by the City Manager, shall be forwarded to the City Council for consideration and approval. Attachments: Exhibits A, Band C Page 1 EXIDBIT A INVESTMENTS AUTHORIZED UNDER STATE LAW Security * Certificates, notes, bonds, or other obligations of the United States Obligations of U.S. agencies or of any corporation wholly owned by the government of the United States * * Federal Home Loan Bank notes and bonds Federal Land Bank bonds * Federal National Mortgage Association notes, debentures, and guaranteed certificates of participation Obligations of any other government-sponsored corporation whose obligations are or may become eligible as collateral for advances to member banks as determined by the board of governors of the federal reserve system * * Bankers' acceptances purchased on the secondary market Commercial paper purchased on the secondary market * * State, county, municipal, or school district bonds or warrants of taxing districts of the state. Such bonds and warrants shall only be those found to be within the limit of indebtedness prescribed by law for the taxing district issuing them and to be general obligations. Motor vehicle fund warrants, when authorized by agreement between State Treasurer and the Department of Transportation, requiring repayment of invested funds from any moneys in the motor vehicle fund available for State highway construction. * * Washington State Treasurer's Investment Pool Any investments authorized by law for the Treasurer of the State of Washington or any local government of the State of Washington other than a metropolitan municipal corporation, but such investments shall not include certificates of deposit of banks or bank branches not located in the State of Washington. * * Bonds of the State of Washington and any local government in the State of Washington which bonds have, at the time of investment, one of the three highest credit ratings of a nationally recognized rating agency. General obligation bonds of a state other than the State of Washington and general obligation bonds of a local government of a state other than the State of Washington, which bonds have, at the time of investment, one of the three highest credit ratings of a nationally recognized rating agency. * RCW 43.84.080; 36.29.020 43.84.080; 36.29.020 43.84.080; 36.29.020 43.84.080; 36.29.020 43.84.080; 36.29.020 43.84.080; 36.29.020 43.84.080; 36.29.020 43.84.080 43.84.080 43.84.080 43.250.040 39.59.020 39.59.020 39.59.020 Page 2 Security Bonds or warrants of this State * General obligation or utility revenue bonds or warrants of any city or town in this State A city's or town's own bonds or warrants of a local improvement district which are within the protection of the local improvement guaranty fund law * * Interim financing warrants of a local improvement district which is within the protection of the local improvement guaranty fund law A city's or town's own local improvement installment notes which are within the protection of the local improvement guaranty fund law * * Bonds or other obligations issued by a metropolitan municipal corporation pursuant to Chapter 35.58 RCW Bonds or other obligations issued by a housing authority pursuant to the housing authorities law of this State or issued by any public housing authority or agency in the United States * Outstanding warrants of the county tax refund fund in the same county as the government making the investment Subject to compliance with RCW 39.56.030, registered warrants of a local government in the same county as the government making the investment * * Subject to the arbitrage provisions of Section 148 of the Federal Internal Revenue Code, or similar provisions concerning the investment of state and local money and funds, the following mutual funds and money market funds: .. Shares of mutual funds with portfolios consisting of only United States government bonds or bonds issued by federal agencies with average maturities of less than four years, or bonds described in RCW 39.59.020 (I) or (2), except that bonds otherwise described in RCW 39.59.020 (I) or (2) shall have one of the four highest credit ratings of a nationally recognized rating agency; Shares of money market funds with portfolios consisting or only bonds of states and local governments, or other issuers authorized by law for investments by local governments, which bonds have at the time of investment one of the two highest credit ratings of a nationally recognized rating agency; Shares of money market funds with portfolios consisting of securities otherwise authorized by law for investment by local governments .. .. RCW 35.39.030 35.39.030 35.39.030 35.39.034 35.45.150 35.58.510 35.82.220 36.33.070 39.59.010 39.59.030 Page 3 Security * Notes or bonds secured by mortgage which the Federal Housing Administration has insured or has made a commitment to insure in obligations or national mortgage associations Debentures issued by the Federal Housing Administration Bonds of the Home Owner's Loan Corporation * * * Notes, bonds or debentures of savings and loan associations, banks, mutual savings banks, savings and loan service corporations operating with approval of the federal home loan bank, and corporate mortgage companies that are rated not less than" A ", or are insured or guaranteed and backed as required Farm ownership and soil and water conservation loans fully guaranteed as to principal and interest under the Bankhead-Jones Farm-Tenant Act; and the Washington land bank (provided that the funds to be invested are not under constitutional prohibition) * * Washington State Housing Finance Commission bonds Port district revenue bonds and notes issued under the authority of Chapter 54.34. RCW * * Local utility district bonds issued by a public utility district RCW 39.60.010 39.60.010 39.60.010 39.60.050 43.33A.080 43.180.190 53.34.150 54.16.070 Page 1 EXIllBIT B PREFERRED/MOST COMMONLY USED GOVERNMENT AGENCY ISSUES Discount Note Issuers Fann Credit System Much of the instrumentality debt has been issued by financial institutions providing a variety of credit services to the American agricultural community. The cooperative Farm Credit System provides credit and financial services to a variety of producers, homeowners and farm-related businesses. To accomplish these purposes, Congress has created the Federal Land Banks and Federal Loan Associations, the Federal Intermediate Credit (PIC) Banks and the Banks for Co-operatives. The 37 Farm Credit Banks maintain a fiscal agency in New York City, through which public offerings of their securities are administered. A nationwide syndicate of about 170 dealers manages these securities in the United States and abroad. Fann Credü ConsolidiUed System-wide discount notes The 37 Farm Credit Banks collectively issue consolidated system-wide discount notes. These are the joint and severable obligations of the banks, with maturities ranging between five and 270 days. Discount notes are also used to complement borrowing from commercial banks to meet routine cash management requirements. Also, they provide for interim financing between bond sales. The notes generally are issued through subscription sales and have a wide institutional following. Cash managers sometimes buy the "discos" with specific maturity dates to match payroll or other planned disbursements. The Federal Farm Credit Banks Funding Corporation also issue consolidated bonds with six-month and nine-month maturities offered monthly. Intermittently throughout the year, bonds are issued with longer maturities in denominations of $1,000 or more. Federal Home Loan Banks The Home Loan Bank system was organized under the Federal Home Loan Bank Act, beginning in 1932. Twelve district banks operate a credit reserve system under the supervision of a federal board. Membership in the credit system consists of savings and loan associations, cooperative banks, insurance companies and savings banks. The banks issue consolidated bonds and discount notes as joint and severable obligations of the Home Loan Bank System. Although the banks operate under federal charter with government supervision, the securities are not guaranteed by the U.S. government. However, the banks are required to maintain secured advances, guaranteed mortgages, U.S. government securities or cash in an amount at least equal to the amount of the consolidated bonds and discount notes outstanding. Therefore, the reserves pledged against this outstanding debt are considerable. Consolidated notes are issued with original maturities of one year or less, and are available in denominations of $100,000, $150,000, and $1 million. Maturities range between 30 and 360 days, at the discretion of the buyer. Consolidated bonds are issued only in book entry form for a minimum of $10,000 with multiples of $5,000 thereafter. Income is exempt from state and local taxes, which slightly diminishes yields. Page 2 Federal Home Loan Morlgage Corporation (Freddie Mac) Also known as Freddie Mac, the Federal Home Loan Mortgage Corporation (FHLMC) was established in 1970 to help maintain the availability of mortgage credit for residential housing. To accomplish this goal, the FHLMC purchases a large volume of conventional residential mortgages and participations in mortgages from members of the Home Loan Bank system. The FHLMC finances these operations by marketing guaranteed mortgage certificates and mortgage participation certificates (PCs). Freddie Mac offers discount notes and bonds under its own name, in contrast to an older practice of obtaining credit from the Home Loan Bank System. These securities do not carry U.S. government guarantees. Variable Note Issuers Student Loan Marketing Association (Sallie Mae) In 1972, Congress amended the Higher Education Act of 1965 and established a private, not-for-profit corporation called the Student Loan Marketing Association (SLMA). Sallie Mae, as the corporation is also known, provides for financing the federal Guaranteed Student Loan Program. Through Sallie Mae financing operations, student loans are guaranteed, encouraging lending by various financial institutions. To serve lenders' liquidity needs, the SLMA warehouses advances through a revolving line-of-credit arrangement, until loan cash flow begins. These advances in turn are insured by the U.S. Commissioner of Education. Sallie Mae regularly enters the credit markets with short-term and non-guaranteed discount notes with maturities under one year, accompanied by an extensive program of floating-rate notes with various maturities. The rate is adjusted periodically at a premium above the 91.;jay T-biIl rate. These securities can offer useful hedges against future periods of rapid interest rate increases. Counon Securities Issuers Federal National Morlgage Association (Fannie Mae) The Federal National Mortgage Association (FNMA or Fannie Mae) was the first modern federally chartered corporation owned entirely by stockholders. The agency was chartered in 1938, and its operations were partitioned into two corporations in 1968. Its sister organization, the Government National Mortgage Association, represents a spin-off of former FNMA operations. FNMA purchases of conventional mortgages are financed by the sale of corporate obligations (debentures and short~term notes) to private investors. The debentures are issued in book entry form only in denominations starting at $10,000, with $5,000 increments thereafter. Secondary market operations are financed in part through issuance of short-term notes that resemble commercial paper. The maturities on these notes range up to 360 days, with rates occasionally brought in line with rates available in the money market for Treasury bills, commercial paper and similar discount instruments. A minimum order for these notes is $50,000. The notes are issued through dealers. FNMA securities enjoy a strong secondary market in the short-term sector, with yield premiums of one- fourth percent (over T-bills) now common in the six-month to one-year maturity range. FNMA debt interest is not exempt from state and local taxation, enhancing yield potential for public investors. Page 3 Federal Farm Credit Bank See discussion under discount notes. Federal Home Loan Banks (FHLB) See discussion under discount notes. Federal Land Banks Organized in 1917 pursuant to the Federal Loan Act, the Federal Land Banks make loans secured by first mortgages on rural real estate for various agricultural purposes. Each borrower is required to purchase stock in the association in an amount equal to 5 percent of the loan. This stock then is pledged with the association as collateral security for loan repayment. About $25 billion is bonds issued by the Federal Land Banks are outstanding; they are no longer issued. Page I accretion (of a disco un/) accrued in/erest active add-on raJe agencies amomze arbitrage asked back discoun/ raJe back up bankers' acceptance (BA) EXHIBIT C GWSSARY In portfolio accounting, a straight-line accumulation of capital gains on discount bonds in anticipation of receipt of par at maturity. Interest due from issue or from the last coupon date to the present on an interest-bearing security. The buyer of the security pays the quoted dollar price plus accrued interest. A market in which there is much trading. A specific rate of interest to be paid. Stands in contrast to the rate on a discount security, such as a Treasury bill, that pays no interest. Federal agency securities. In portfolio accounting, periodic charges made against interest income on premium bonds in anticipation of receipt of the call price at call or of par value at maturity. Strictly defined, buying something where it is cheap and selling it where it is dear; for example, a bank buys 3-month CD money in the U.S. market and sells 3-month money at a higher rate in the Eurodollar market. In the money market, often refers: (1) to a situation in which a trader buys one security and sells a similar security in the expectation that the spread in yields between the two instruments will narrow or widen his profit, (2) to a swap between two similar issues based on an anticipated change in yield spreads, and (3) to situations in which a higher return (or lower cost) can be achieved in the money market for one currency by utilizing another currency and swapping it on a fully- hedged basis through the foreign-exchange market. The price at which securities are offered. Yield basis on which short-term, non-interest-bearing money market securities are quoted. A rate quoted on a discount basis understates bond equivalent yield. That must be calculated when comparing return against coupon securities. (1) When yields rise and prices fall, the market is said to back up. (2) When an investor swaps out of one security and into another of shorter current maturity (e.g. out of a 2-year note into an l8-month note), s/he is said to back up. ' A draft or bill of exchange accepted by a bank or trust company. The accepting institution guarantees payment of the bill. Page 2 basis (I) Number of days in the coupon period. (2) In commodities jargon, basis the spread between a futures price and some other price. A money market participant would talk about spread rather than basis. basis poinJ 1/100th of 1%. basis price Price expressed in terms of yield to maturity or annual rate of return. bear market A declining market or a period of pessimism when declines in the market are anticipated. bearer security A security the owner of which is not registered on the books of the issuer. A bearer security is payable to the holder. bid The price offered for securities. block A large amount of securities, normally much more than what constitutes a round lot in the market in question. book-enJry securities The Treasury and federal agencies are moving to a book-entry system in which securities are not represented by engraved pieces of paper but are maintained in computerized records at the Fed in the names of member banks, which, in turn, keep records of the securities they own as well as those they are holding for customers. In the case of other securities for which there is a book-entry sýstem, engraved securities do exist somewhere in quite a few cases. These securities do not move from holder to holder but are usually kept in a central clearinghouse or by another agent. book value The value at which a debt security is shown on the holder's balance sheet. Book value is often acquisition cost +/- amortization or accretion, which may differ markedly from market value. It can be further defined as "tax book", "accreted book", or "amortized book" value. bp Market abbreviation for basis points. Thus, 1 bp means 1 basis point, 10 bp means 10 basis points. broker A broker brings buyers and sellers together for a commission paid by the initiator of the transaction or by both sides; slhe does not position. In the money market, brokers are active in markets in which banks buy and sell money and in interdealer markets. bull market A period of optimism when increases in market prices are anticipated. bullet (loan or security) All principal is due at maturity. buy-back Another term for a repurchase agreement. Page 3 callable bond cash management bill cash market cash price cash settlement cerlificate of deposit clear collateral commercial paper Comprehensive Annual confirmation coupon credit enhancement A bond that the issuer has the right to redeem prior to maturity by paying some specified call price. Very-short-maturity bills that the Treasury occasionally sells because its cash balances are down and it needs money for a few days. Traditionally, this term has been used to denote the market in which commodities were traded, for immediate delivery, against cash. Since the inception of futures markets for T bills and other debt securities, a distinction has been made between the cash markets in which these securities trade for immediate delivery and the futures markets in which they trade for future delivery. Price quotation in the cash market. In the money market, a transaction is said to be made for cash settlement if the securities purchased are delivered against payment in Fed funds on the same day the trade is made. A time deposit with a specific maturity evidenced by a certificate. Large-denomination CDs are typically negotiable. A trade carried out by the seller delivering securities and the buyer delivering funds in proper form. A trade that does not clear is said to fail. Securities, evidence of deposit or other property which a borrower pledges to secure repayment of a loan. Also refers to securities pledged by a bank to secure deposits of public monies. An unsecured promissory note with a fixed maturity of no more than 270 days. Commercial paper is normally sold at a discount from face value. The official annual financial report for the City of Federal Way. Financial Report (CAFR)It includes five combined statements and basic financial statements for each individual fund and account group prepared in conformity with GAAP. It also includes supporting schedules necessary to demonstrate compliance with finance-related legal and contractual provisions, extensive introductory material, and a detailed Statistical Section. A memorandum to the other side of a trade describing all relevant data. (I) The annual rate of interest on the bond's face value that a bond's issuer promises to pay the bondholder. (2) A certificate attached to a bond evidencing interest due on a payment date. The backing of paper with collateral, a bank LOC, or some other device Page 4 credit risk currenJ coupon currenJ issue currenJ maiurity currenJ yield dealer debenJure debt securities default delivery versus paymenJ discounJ rate discounJ securities discounJ window to achieve a higher rating for the paper. The risk that an issuer of debt securities or a borrower may default on his obligations, or that payment may not be made on sale of a negotiable instrument. (See overnight delivery risk.) A bond selling at or close to par; that is, a bond with a coupon close to the yield currently offered on new bonds of similar maturity and credit risk. In Treasury bills and notes, the most recently auctioned issue. Trading is more active in current issues than in off-the-run issues. Current time to maturity on an outstanding note, bond, or other money market instrument; for example, a 5-year note one year after issue has a current maturity of four years. Coupon payments on a security as a percentage of the security's market price. In many instances the price should be gross of accrued interest, particularly on instruments where no coupon is left to be paid until maturity. A dealer, as opposed to a broker, acts as a principal in all transactions, buying and selling for herlhis own account. A bond secured only by the general credit of the issuer. IOUs created through loan-type transactions - commercial paper, bank CDs, bills, bonds, and other instruments. Failure to make timely payment of interest or principal on a debt security or to otherwise comply with the provisions of a bond indenture. There are two methods of delivery of securities: delivery verses payment and delivery versus receipt (also called free). Delivery versus payment is delivery of securities with an exchange of money for securities. Delivery versus receipt is delivery of securities with an exchange of a signed receipt for the securities. The rate of interest charged by the Fed to member banks that borrow at the discount window. The discount rate is an add-<m rate. Non-interest-bearing money market instruments that are issued at a discount and redeemed at maturity for full face value; for example, U.S. Treasury bills. Facility provided by the Fed enabling member banks to borrow reserves against collateral in the form of governments or other acceptable paper. Page 5 diversification dollar price of a bond equivalent bond yield fail federal credii agencies Federal Deposit Insurance Corporation (FDIC) Federal funds Federal funds rate Federal Home Loan Banks (FHLB) Federal Open Market Committee (FOMC) Federal Reserve System float Dividing investment funds among a variety of securities offering independent returns. Percentage of face value at which a bond is quoted. Annual yield on a short-term, non-interest-bearing security calculated so as to be comparable to yields quoted on coupon securities. A trade is said to fail if on the settlement date either the seller fails to deliver securities in proper form or the buyer fails to deliver funds in proper form. Agencies of the federal government set up to supply credit to various classes of institutions and individuals; for example, S & Ls, small business firms, students, farmers, farm cooperatives, and exporters. A federal institution that insures bank deposits, currently up to $100,000 per deposit. (I) Non-interest-bearing deposits held by member banks at the Federal Reserve. (2) Used to denote "immediately available" funds in the clearing sense. The rate of interest at which Fed funds are traded. This rate is currently pegged by the Federal Reserve through open market operations. The institutions that regulate and lend to savings and loan associations. The Federal Home Loan Banks playa role analogous to that played by the Federal Reserve Banks vis-a-vis member commercial banks. Consists of seven members of the Federal Reserve Board and five of the twelve Federal Reserve Bank Presidents. The President of the New York Federal Reserve Bank is a permanent member while the other Presidents serve on a rotating basis. The Committee periodically meets to set Federal Reserve guidelines regarding the sales and purchases of Government Securities in the open market as a means of influencing the volume of bank credit and money. The central bank of the United States created by Congress and consisting of a seven member Board of Governors in Washington, D.C., 12 Regional Banks and about 5,700 commercial banks that are members of the system. The difference betWeen the credits given by the Fed to banks' reserve accounts on checks being cleared through the Fed and the debits made to banks' reserve accounts on the same checks. Float is always positive, because in the clearing of a check, the credit sometimes precedes the debit. Float adds to the money supply. Page 6 general obligation bonds Glass-Steagall Act good funds governments haircut Iwndle liquidity liquidity diversification liquidity risk long bonds margin market value marketability master repurchase agreement Municipal securities secured by the issuer's pledge of its full faith, credit and taxing power. A 1933 act in which Congress forbade commercial banks to own, underwrite, or deal in corporate stock and corporate bonds. A market expression for immediately available money, that is, Fed funds. Negotiable U.S. Treasury securities. Margin in a repo transaction; that is, the difference between the actual market value measured at the bid side of the market and the value used in a repo agreement. The whole-dollar price of a bid or offer is referred to as the handle. For example, if a security is quoted 101-10 bid and 101-11 offered, 101 is the handle. Traders are assumed to know the handle, so a trader would quote that market to another by saying she was at 10-11. (The 10 and 11 refer to 32nds.) A liquid asset is one that can be converted easily and rapidly into cash without a substantial loss of value. In the money market, as security is said to be liquid if the spread between bid and asked prices is narrow and reasonable size can be done at those quotes. Investing in a variety of maturities to reduce the price risk to which holding long bonds exposes the investor. In banking, risk that monies needed to fund assets may not be available in sufficient quantities at some future date. Implies an imbalance in committed maturities of assets and liabilities. Bonds with a long current maturity. In a repo or reverse repurchase transaction, the amount by which the market value of the securities collateralizing the transaction exceeds the amount lent. The price at which a security could presumably be purchased or sold. A negotiable security is said to have good marketability if there is an active secondary market in which it can easily be resold. A written contract covering all future transactions between the parties to repurchase-reverse repurchase agreements that establishes each party's rights in the transactions. A master agreement will often specify, among other things, the right of the buyer-lender to liquidate the underlying securities in the event of default by the seller-borrower. Page 7 money market money market (center) bank money supply definmons mortgage bond negotiable certificates of deposit note odd lot open market operations opportunity cost original maturity paper The market in which short-term debt instruments (bills, commercial paper, bankers' acceptances, etc.) are issued and traded. A bank that is one the nation's largest and consequently play an active and important role in every sector of the money market. M-l: Currency in the hands of the public, travelers checks of nonbank issuers, net demand deposits plus other checkable deposits including NOW accounts. Excludes deposits due to domestic banks, the U.S. government, and foreign banks and official institutions. M-2: M-l plus money market deposit accounts plus overnight repos and money market funds and savings and small (less than $100,000) time deposits held at all depository institutions plus overnight repos at banks plus overnight Euros held by nonbank U.S. depositors in the Caribbean branches of U.S. banks plus balances at money funds (excluding institutions-only funds). M-3: M-2 plus large (over $100,000) time deposits at all depository institutions, term repos at banks and S&Ls plus balances at institutions- only money funds. L: M-3 plus other liquid assets such as term Eurodollars held by nonbank U.S. residents, bankers' acceptances, commercial paper, Treasury bills and other liquid governments, and U.S. savings bonds. Bond secured by a lien on property, equipment, or other real assets. A large-denomination (generally $1 million) CD that can be sold but cannot be cashed in before maturity. Coupon issues with a relatively short original maturity are often called notes. Treasury notes are coupon securities that have an original maturity of up to 10 years. Less than a round lot. Purchases and sales of government and certain other securities in the open market by the New York Federal Reserve Bank as directed by the FOMC in order to influence the volume of money and credit in the economy. Purchases inject reserves into the bank system and stimulate growth of money and credit; sales have the opposite effect. Open market operations are the Federal Reserve's most important and most flexible monetary tool. The cost of pursuing one course of action measured in terms of foregone return offered by the most attractive alternative. Maturity at issue. For example, a 5-year note has an original maturity at issue of five years; one year later, it has a current maturity of four years. Money market instruments, commercial paper, and other. Page 8 paper gain (loss) par Unrealized capital gain (loss) on securities held in portfolio, based on a comparison of current market price and original cost. (I) Price of 100%. (2) The principal amount at which the issuer of a debt security contracts to redeem that security at maturity, face value. par bond A bond selling at par. pass-through A mortgage-backed security on which payment of interest and principal on the underlying mortgages are passed through to the security holder by an agent. pay-up (I) The loss of cash resulting from a swap into higher-price bonds. (2) The need (or willingness) of a bank or other borrower to pay a higher rate to get funds. plus Dealers in governments normally quote bids and offers in 32nds. To quote a bid or offer in 64ths, they use pluses; for example, a dealer who bids 4+ is bidding the handle plus 4/32 + 1/64, which equals the handle plus 9/64. point (1) 100 bp = 1 %. (2) One percent of the face value of a note or bond. (3) In the foreign-exchange market, the lowest level at which the currency is priced. Example: "One point" is the difference between sterling prices of $1.8080 and $1.8081. porifolio Collection of securities held by an investor. premium (1) The amount by which the price at which an issue is trading exceeds the issue's par value. (2) The amount that must be paid in excess of par to call or refund an issue before maturity. (3) In money market parlance, the fact that a bank's CDs trade at a rate higher than others of its class, or that a bank has had to pay up to acquire funds. premium bond Bond selling above par. present value (of a fuJure payment) The value today of a future payment discounted at an appropriate rate of interest. price risk The risk that a debt security's price may change due to a rise or fall in the going level of interest rates. primary dealer A group of government securities dealers that submit daily reports of market activity and positions and monthly financial statements to the Federal Reserve Bank of New York and are subject to its informal oversight. Primary dealers include Securities and Exchange Commission (SEC) registered securities broker-dealers, banks, and a few unregulated firms. Page 9 prime role The rate at which banks lend to their best (prime) customers. The all-in cost of a bank loan to a prime credit equals the prime rate plus the cost of holding compensating balances. principal (1) The face amount or par value of a debt security. (2) One who acts as a dealer buying and selling for his own account. qualified public deposiJories A financial institution which does not claim exemption from the payment of any sales or ad valorem taxes under the laws of this state, which has segregated for the benefit of a commission eligible collateral having a value of not less than its maximum liability and which has been approved by the Public Deposit Protection Commission to hold public deposits. role of return The yield obtainable on a security based on its purchase price or its current market price. This may be the amortized yield to maturity on a bond or the current income return. ratings An evaluation given by Moody's, Standard & Poor's, Fitch, or other rating services of a security's creditworthiness. relative value The attractiveness - measured in terms of risk, liquidity, and return - of one instrument relative to another, or for a given instrument, of one maturity relative to another. repurchnse agreement Legally, a repurchase agreement is a secured transaction. It differs from other money market instruments because it is not simply the outright purchase of an investment security that will mature on a specific day, like a U.S. Treasury bill or a bank CD. Instead, the repo is a contractual transaction between an investor and an issuing financial institution (bank or securities dealer). The investor exchanges cash for temporary ownership of collateral securities, with an agreement between the parties that on a future date, the financial institution will repurchase the securities. Customarily, the investor receives interest during the term of the repurchase agreement, as agreed at the time of the investment transaction. risk Degree of uncertainty of return on an asset. round lot In the money market, round lot refers to the minimum amount for which dealers' quotes are good. This may range from $100,000 to $5 million, depending on the size and liquidity of the issue traded. safekeep For a fee, banks will safekeep (Le. hold in their vault, clip coupons on, and present for payment at maturity) bonds and money market instruments. savings and loan association Federal- or state-chartered institution that accepts savings deposits and invests the bulk of the funds thus received in mortgages. Page 10 scale secondary 1TIllrket sector SEC Rule 15C3-1 Securities and Exchange Commission (SEC) settlement dale spread technicals thin 1TIllrket tight 1TIllrket trade dale Treasury bill A bank that offers to pay different rates of interest on CDs of varying maturities is said to "post a scale". Commercial paper issuers also post scales. The market in which previously issued securities are traded. Refers to a group of securities that are similar with respect to maturity, type, rating, and/or coupon. See uniform net capital rule. Agency created by Congress to protect investors in securities transactions by administering securities legislation. The date on which a trade is cleared by delivery of securities against funds. The settlement date may be the trade date or a later date. (1) Difference between bid and asked prices on a security. (2) Difference between yields on or prices of two securities of differing sorts or differing maturities. (3) In underwriting, difference between price realized by the issuer and price paid by the investor. (4) Difference between two prices or two rates. What a commodities trader would refer to as the basis. (1) Demand and supply factors influencing the cash market. (2) Value or shape of technical indicators. A market in which trading volume is low and in which consequently bid and asked quotes are wide and the liquidity of the traded instrument is low. A tight market is one is which volume is large, trading is active and highly competitive, and spreads between bid and asked prices are narrow. The date on which a transaction is initiated. The settlement date may be the trade date or a later date. A non-interest-bearing discount security issued by the U.S. Treasury to finance the national debt. Most bills are issued to mature in three months, six months, or one year. Page 11 unifonn net capital rule when-issued trades yield yield curve Securities and Exchange Commission requirement that member firms as well as nonmember broker-dealers in securities maintain a maximum ratio of indebtedness to liquid capital of 15 to I; also called net capital rule and net capital ratio. Indebtedness covers all money owed to a firm, including margin loans and commitments to purchase securities, one reason new public issues are spread among members of underwriting syndicates. Liquid capital includes cash and assets easily converted into cash. Typically there is a lag time between the time a new bond is announced and sold and the time it is actually issued. During this interval, the security trades, wi, "when, as, and if issued." The rate of annual income return on an investment, expressed as a percentage. (1) income yield is obtained by dividing the current dollar income by the current market price for the security. (2) net yield or yield to maturity is the current income yield minus any premium above par or plus any discount from par in purchase price, with the adjustment spread over the period from the date of purchase to the date of maturity of the bond. A graph showing, for securities that all expose the investor to the same credit risk, the relationship at a given point in time between yield and current maturity. Yield curves are typically drawn using yields on governments of various maturities.