CH 7 Flashcards
level of default risk in Treasury securities?
none; but that doesn’t mean investors can’t lose money. gov securities trade in the 2nd market (OTC) and are subj to interest rate risk just like other debt sec
T bills
Rather than making regular cash int paym, bills/ST obligations are issued at a discount from par.
T bills are considered mm instruments.
the 13-week T-bill is commonly used in quant analysis as the risk-free investment.
T notes
2, 3, 5, 7, 10 yrs
pays interest every 6 months; sold at auction every 4 weeks
T bonds
LT securities (10-13 yrs in original maturity) that pays interest every 6 months.
historically, the 30-yr bonds are callable at par, give yrs before maturity date.
STRIPs
Treasury Dept entered the 0 cpn bond market by designating certain Treasury issues as suitable for stripping into interest and principal components.
These sec, named separate trading of registered interest and principal of sec, became known as STRIPS. Altho the sec underlying T STRIPS are the US gov’s direct obligation, major banks and dealers perform the actual separation and trading.
0 coupon bonds have minimal reinvestm risk .
***STRIPS vs TREASURY RECEIPTS
STRIPS: backed in full by US gov. Receipts are not.
Treasury receipts are created by BDs and sold under names like Certificates of Accrual on T Sec (CATS) and Treasury Income Growth Receipts (TIGRS).
Both are quoted in YTM and have not been issued since the late 1980s.
Treasury receipts
brokerage firms can create a type of 0 coupon bond known as Treasury receiptts from US T-notes and bonds. BDs buy Treasury sec, place them in trust at a bank, and sell separate receipts against the principal and cpn payment.
Unlike T sec, T receipts are NOT backed by full faith and credit of US gov. Each T receipt is priced at a discount form the payment amount, like a 0 coupon bond.
TIPS
Treasury Inflation-Protected Sec help protect investors against purchasing power (inflation) risk. These bonds are issued with a FIXED interest rate, but the principal amt is adjusted semiannually by an amt equal to the change in CPI.
This interest payment the investor receives every 6 months is equal to the fixed interest rate times the newly adjusted principal.
During times of inflation, int payments increase, while times of deflation, interest payments fall. These notes are sold at lower interest rates than conventional fixed-rate T notes bc of their adjustable nature.
TIPS are exempt from…
state and local income taxes on the interest income is generated. (Like any other Treasury sec)
they ARE subject to federal taxation though!
however, in any yr when the principal is adjusted for inflation, that increase is considered reportable income for that yr even tho the increase will not be received until the note matures.
*** Max T-bill maturities are subject to change, but are never longer than…
never longer than 52 weeks
52-week bills are auctioned every 4 weeks, and the others, such as the 4-week and 26-week bills, weekly.
T Note Maturities and Denomin
issued in denomin of $100 tot $5M
T notes mature at parr, or they can be refunded. If a T-note is refunded, the gov offers the investor a new sec with a new interest rate and maturity date as an alternative to a cash payment for the maturing note.
Pricing for T Notes
T notes are issued, quoted, and traded as % of part in 1/32.
Maturities and Denomin of T Bond
issue in denomin of $100 to $5M and mature at least 10 yrs from the date of issue.
Agency Issues
Congress authorizes the fed gov t issue debt sec to these agencies:
- farm credit admin
- GNA or Ginnie Mae
other agency-like organizations operated by private corps include the following
- Feddie Mac
- Fannie Mae
- Sallie Mae
GNMA
gov-owned corp that support he Dept of Housing and Urban development
Ginnie Mae
does NOT originate mortgage loans, nor does it purchase, sell, or issue securities. Instead, private lending institutions approved by GNMA originate eligible loans and pool them into securities, known as pass-thru certificates, and sell the GNMA MBS to investors.
GNMA guarantees…
timely paym of interest and payment. GNMAs are backed directly by the gov, so risk of default = 0. GNMAs offer slightly higher interest rates than comparable Treasury securities.
price, yields, and maturities fluctuate in line w general interest-rate trends. If int rates fall, homeowners tend to pay off their mortgages early, which has the effect of acc the certificates’ maturities.
Int rates rising though can cause certificates to mature more slowly
in addition tot interest rate risk, there are 2 other types of risks associated with MBS:
- prepaym risk - risk that underlying mortgagees will be paid off earlier than anticipated; will occur if int rates fall, causing homeowners to refinance their mortgagees at lower rates.
- extended maturity risk - underlying mortgages will remain outstanding longer than anticipated.
- occur if int rates rise, the virtually eliminating any refinancing, also known as extension risk.
***GNMA FEATURES
back by full by the US gov
- $1000 min
- monthly int and principal paym
- taxed at all levels
- pass-through certificates
which is most susceptible to reinvestment risk?
MBS
When interest fall, mortgage holders typically refinance at a lower rate. This meant that they pay off their mortgages early, which causes a prepayment of principal to holders of MBS.
The early principal payments cannot be reinvested at a comparable return
Farm Credit System (FCS)
national network of lending institutions that provides agricultural financing and credit.
System is privately owned, gov-sponsored enterprise that raises loanable funds through the sale of Farm Credit securities to investors.
They’re NOT obligations nor are they guaranteed, by the US gov or any fed agency.
Backed by Banks of the FCS
These funds are made available to farmers through a nationwide network of 4 banks and 68 Farm Credit lending institutions. The FCA (Fed Credit Admin), a gov agency, oversees the system. Included in the system are the Federal Land Banks, Fed Intermediate Credit Banks, and Banks for Cooperatives.
federal FCS issues…
discount notes, floating rate bonds, and fixed rate bonds.
The proceeds from the sale of securities are used to provide farmers with real estate loans, rule home mortgage loans, and crop insurance.
Freddie Mac
Federal Home Loan Mortgage Corp (FHLMC) is a public co.
It was created to promote the development of a nationwide secondary market in mortgages by buying resi mortgages from fin institutions and packaging them into MBS for sale to investors.
FHLMC sells 2 types of securities: mortgage participation certificates (PCs) and guaranteed mortgage certificates (GMCs).
Mortgage participation certificates (PCs)
make principal and interest payments once a month
