Chapter 08: U.S. Treasury and Government Agency Debt

Question 1

__________ are considered non-negotiable because they cannot be sold in the secondary market.

Answer 1

Savings bonds are considered non-negotiable because they cannot be sold in the secondary market.

Instead, they may be redeemed only by the U.S. government.

Question 2

Marketable securities are _____ because investors are able to sell their securities to other investors after they’re issued.

Answer 2

Marketable securities are negotiable because investors are able to sell their securities to other investors after they’re issued.

Question 3

True or False. Treasuries may be freely transferred after they’re issued.

Answer 3

True

Question 4

The U.S. government issues securities to finance their operations. The securities may be divided into two major groups.

___________ which includes savings bonds and ____________ which includes treasuries

Answer 4

The U.S. government issues securities to finance their operations. The securities may be divided into two major groups.

non-marketable (non-negotiable), which includes savings bonds and marketable (negotiable), which includes treasuries

Question 5

Negotiable instruments include the following:

Answer 5

• Treasury bills
• Treasury notes
• Treasury bonds
• Treasury Seperate Trading of Registered Interest and Principal Securities (T-STRIPS)
• Treasury Inflation-Protected Securities (TIPS)
• Treasury Cash Management Bills (CMBs)

Question 6

Both notes and bonds are currently issued in _______ form which means that an investor never receives the actual paper security.

Answer 6

Both notes and bonds are currently issued in Book-entry form which means that an investor never receives the actual paper security.

Question 7

___________ suggests that a security is being held in the name of a broker-dealer at a depositary, such as the Depository Trust & Clearing Corporation (DTCC)

Answer 7

street-name holding suggests that a security is being held in the name of a broker-dealer at a depositary, such as the Depository Trust & Clearing Corporation (DTCC)

Question 8

True or Flase. Government securities are quoted in increments of 1/32 nds of a point, while most other bonds are quoted in increments of 1/8ths of a point.

Ex: a u.s. government bond quoted at 97.08, actually means 97 8/32.

Or 97.25% of par, of $972.50

Answer 8

True

Question 9

The symbol ___ is an indicator of a Treasury note.

Answer 9

n

For example: Feb 20n refers to a Treasury note that matures in February of 2020

Question 10

The interest rate on ____ is fixed; however, the principal amount on which that interest is paid may vary based on the change in the Consumer Price Index (CPI)

Answer 10

TIPS

Question 11

________ are referred to as discount securities or non-interest-bearing securities

Answer 11

T-bills are referred to as discount securities or non-interest-bearing securities

Question 12

______ are quoted on a discounted yield basis

Answer 12

T-bills are quoted on a discounted yield basis

Maturities of one month (4 weeks), three months (13 weeks), six months (26 weeks), and one year (52 weeks)

Question 13

Allows investors to compare the yields available on T-bills with the yields available on notes, bonds, and other interest-bearing securities

Answer 13

The bond equivalent yield

• the interest being earned is on the amount invested, not on the face amount.

Question 14

___________ are backed by Treasury securitied that are owned by the issuing broker-dealer, they’re not directly backed by the U.S. Treasury.

Answer 14

Treasury Receipts are backed by Treasury securitied that are owned by the issuing broker-dealer, they’re not directly backed by the U.S. Treasury.

Question 15

__________ are backed by the full faith and credit of the US Treasury and are quoted on a yield basis, not as a percentage of their par value.

Answer 15

STRIPS are backed by the full faith and credit of the US Treasury and are quoted on a yield basis, not as a percentage of their par value.

Question 16

Since both _______ and ________ trade at a discount and are non-interest-bearing, they trade without accrued interest

Answer 16

Since both treasury bills and treasury strips trade at a discount and are non-interest-bearing, they trade without accrued interest

Question 17

Weekly auctions are currently conducted for the 3 & 6 month T-bills every Monday and for the 4 week T-bills every Tuesday.

The auctions for 12 month T-bills are held on a monthly basis.

Answer 17

NOTE

Question 18

When Treasury auctions are held, securities firms compete with each other by submitting their bids to buy Treasuries through an automated system.

these bids are called competitive tenders since they specify the price and/or yield at which the firm is willing to buy the Treasuries. If an individual wants to purchase Treasuries, she usually submits a non-competitive tender. Non-competitive bids are filled first; however, the bidders must agree to accept the yield and price as determined by the auction

Answer 18

Non-competitive bidders agree to pay the lowest price of the accepted competitive tenders. Although all non-competitive tenders are accepted (awarded) first, the yield that the investors will receive is determined after the competitive tenders are accepted. Therefore, all purchasers of Treasury securities through this auction process will pay the same price. This single price auction process is referred to as a Dutch auction.

Question 19

_______________________ are publicly chartered, but privately owned organizations. Congress allowed for their creation to provide low-cost loans for certain segments of the population. The enterprise issues securities through a selling group of dealers with the offering’s proceeds provided to a bank (or other lender). The bank then lends the money to an individual who is seeking financing (e.g., students, homeowners, or farmers).

• have implicit guarantee from the U.S. Government
• considered to have minimal default risk

Answer 19

Government-sponsored enterprises (GSEs) are publicly chartered, but privately owned organizations. Congress allowed for their creation to provide low-cost loans for certain segments of the population. The enterprise issues securities through a selling group of dealers with the offering’s proceeds provided to a bank (or other lender). The bank then lends the money to an individual who is seeking financing (e.g., students, homeowners, or farmers).

Question 20

__________ are debt instruments that are secured by pools of home mortgages. The agencies that issue these securities include the _____________, ________________, ________________.

Answer 20

mortgage-backed securities are debt instruments that are secured by pools of home mortgages. The agencies that issue these securities include the Government National Mortgage Association (GNMA or Ginnie Mae), the Federal National Mortgage Association (FNMA or Fannie Mae), and the Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac).

Question 21

are created when financial institutions, such as banks or mortgage lenders, pool together individual residential mortgages into a single investment vehicle. These mortgages share similar characteristics, like interest rate, maturity, and credit quality.

• “pass through” the principal and interest payments from the underlying mortgage pool directly to investors
  -issuer of the ______ collects these payments from borrowers, takes a servicing fee, and distributes the remaining funds to investors every month
• Since homeowners can pay off their mortgages early, investors face prepayment risk.
• investors may sell them to other investors in the secondary market

Answer 21

mortgage-backed pass-through certificates

Question 22

_____ will purchase residential mortgages from savings institutions to provide liquidity.

• raises money by issuing mortgage-backed securities, pass-through certificates, and guaranteed mortgage-backed certificates.
• not backed by the U.S. gov, instead, they’re backed by other agencies and the mortgages that are purchased

Answer 22

The Federal Home Loan Mortgage Corporation (FHLMC), commonly known as Freddie Mac.

Question 23

guarantees MBS that are backed by mortgages insured or guaranteed by federal agencies, such as the Federal Housing Administration (FHA), Department of Veterans Affairs (VA), United States Department of Agriculture (USDA), and Office of Public and Indian Housing (PIH). These loans often cater to borrowers who may not qualify for conventional mortgages.

• is a fully-owned government corporation, and its guarantees are explicitly backed by the full faith and credit of the U.S. government.
• This means that _____ MBSs carry minimal credit risk, making them attractive to investors.
• any interest earned is subject to federal, state, and local taxes

Answer 23

The Government National Mortgage Association (GNMA), commonly known as Ginnie Mae

Question 24

_________ refers to the possibility that the issuer or borrowers will repay the principal of a bond or loan before its maturity date. This can result in investors receiving their principal investment back sooner than expected, which can affect their overall return on investment.

• is typically higher when interest rates are falling, as borrowers tend to refinance or pay off their existing loans to take advantage of lower rates.

Answer 24

Prepayment risk

Question 25

__________, are created by pooling mortgage-backed securities or mortgage loans and dividing the cash flows into several tranches with varying risk profiles, maturities, and yields. This process, known as tranching, allows investors to choose tranches that match their risk tolerance and investment goals.

• are designed to address the prepayment risk associated with mortgage-backed securities by allocating cash flows to different tranches according to a predetermined priority schedule, known as the “waterfall.” As a result, some tranches may have less prepayment risk, while others may have more, allowing investors to select tranches based on their risk appetite.
• also carry risks, including credit risk (the risk of default by borrowers), interest rate risk, and liquidity risk, which can impact their market value and returns.
• May be classified as a derivate

Answer 25

Collateralized Mortgage Obligations (CMOs)

Question 26

True or False. CMOs are subject to registration under the Securities Act of 1933 and the Trust Indenture Act of 1939. Ongoing filings may be required under the Securities Act of 1934.

Interest payments are generally paid monthly and are
subject to federal, state, and local taxes.

However, the principal payments are considered a return of capital and are not taxable.

Answer 26

True

Question 27

__________ compares CMOs to other types of fixed-income securities and essentially provides an average maturity for each tranche

Answer 27

The average life method

Question 28

If a CMO is assigned a PSA number that is:

• Equal to 100 PSA: assumption is the prepayment speed with remain stable
• Greater than 100 PSA: assumption is the prepayment speed will be faster than normal
• Less than 100 PSA: assumption is that the prepayment speed will be slower than normal

Answer 28

Note

Question 29

Tranches are prioritized: The tranches in a plain vanilla CMO are ranked in a hierarchy, typically denoted by letters (e.g., Tranche A, Tranche B, Tranche C, etc.). Tranche A is the highest priority tranche, followed by Tranche B, and so on.

Sequential distribution of principal payments: Principal payments from the underlying mortgage loans are allocated to the tranches in a sequential order. Tranche A receives all principal payments until it is fully paid off. Once Tranche A is paid off, Tranche B begins receiving principal payments, and so on, until all tranches are paid off.

Interest payments: All tranches receive interest payments on their outstanding principal balance. These payments are typically made on a monthly or quarterly basis.

Answer 29

Note

Question 30

• These tranches have a coupon rate that adjusts based on a reference rate (e.g., LIBOR) and a multiplier greater than one.
  -They benefit from rising interest rates since their coupon rate increases more rapidly than the reference rate.
• are suitable for investors who anticipate interest rates will rise and want to benefit from higher yields in such a scenario.

Answer 30

Super-Floater Tranches

Question 31

-These tranches have a coupon rate that moves inversely to a reference rate, such as LIBOR, with the coupon rate decreasing as the reference rate increases, and vice versa.
- benefit from falling interest rates, as their coupon rate increases when the reference rate declines.
- are suitable for investors who anticipate interest rates will fall and want to benefit from higher yields in such a scenario.

Answer 31

Inverse Floater Tranches

Question 32

is a structured financial product that pools various debt instruments, such as corporate bonds, mortgage-backed securities, or loans, and repackages them into tranches with varying risk profiles and returns.

• expected returns are based on the credit quality of the underlying assets that are contained in the pool
• Are subject to filing and registration requirements of the Securities Act of 1933, Securities Exchange Act of 1934, and Trust Indenture Act of 1939.
• Any interest received on these securities is fully taxable.

Answer 32

Collateralized Debt Obligations (CDOs)