Chapter 12 Part 6

Question 1

STRIPS are always sold

Answer 1

at a discount. The difference between the investor’s purchase price and the bond’s face value is interest

Question 2

The federal government sells Treasuries to the public through

Answer 2

auctions conducted by the federal Reserve System.

Question 3

All Treasuries are sold in

Answer 3

book-entry form. The investor never receives the actual paper security. Instead, the Federal Reserve enters the names of the owners in its records.

Question 4

As we just noted, T-notes and T-bonds pay interest eveiy six months. If a bondholder sells one of these securities between interest payments, she is entitled to the

Answer 4

interest that has accrued up to the point when she sells the bond. The person who buys the bond or note will need to compensate her for this lost interest, just as he would if he bought a corporate bond from her. This additional amount that he needs to pay her is known as accrued interest

Question 5

Interest on Treasury notes and bonds accrues on the basis of a

Answer 5

365-day year (in a leap year, 366 days) and the actual days elapsed

Question 6

The interest earned on Treasuries is subject to

Answer 6

federal income taxes but exempt from state and local income taxes. This can be a big advantage for investors who live in states or cities with high income taxes such as New York and California

Question 7

Taxpayers must report the interest from T-notes and T-bonds on their tax returns for the

Answer 7

same year in which the interest is received.

Question 8

The interest earned from T-hills must be reported the

Answer 8

same year in which the T-bill matures.

Question 9

Treasury STrIPS are taxed the same way as

Answer 9

corporate zero-coupons bonds–investors must accrete the interest every year and pay taxes on it, even though they will not receive anything until the bond matures

Question 10

Nonmarketable U.S. government securities are commonly called

Answer 10

savings bonds. They are primarily purchased by small investors.

Question 11

Series EE Bonds are

Answer 11

30-year investments issued in denominations ranging from $50 to $10,000. Investors purchase them at a 50% discount from face value. Investors who purchased Series EE Bonds between May 1, 1997 until May 1, 2005 receive an interest rate equivalent to 90% of the average yield on five-year Treasury bonds during the last six months. Series EE Bonds issued after May 1, 2005 will have a fixed rate of interest. This rate is reset twice a year

Question 12

Investors can purchase EE Savings Bonds through

Answer 12

various financial institutions. Investors can cash in EE Bonds anytime after 12 months. However, if investors cash in bonds that are less than five years old, a three-month interest penalty will he assessed

Question 13

Series I Bonds

Answer 13

“On September 1, 1998. the government began issuing U.S. Savings Bonds that are indexed for inflation. They are available in seven denominations but are sold at face value. The
government resets the interest rate twice a year depending on the rate of inflation. They have the same restrictions and penalties as EE Bonds. Also, as with EE Bonds, they pay interest for up to 30 years”

Question 14

The interest on all types of U.S. Savings Bonds is exempt from

Answer 14

state and local income laxes but subject to federal laxes. Taxes on the interest on Series EE and I Bonds can be deferred until the bond either matures or is cashed in

Question 15

Mortgage-Backed Agency Securities are backed by

Answer 15

groups (pools) of home mortgages

Question 16

The three agencies that issue mortgage-backed securities are the

Answer 16

Government National Mortgage Association (GNMA), the Federal National Mortgage Association (FNMA), and the Federal Home Loan Mortgage Corporation (FHLMC). Some private institutions also issue mortgage-backed securities

Question 17

A mortgage is a

Answer 17

loan secured by real property such as a house or a condo. Each month, the borrower pays back a portion of the principal (the amount of the loan) plus interest. Thus, each mortgage payment has two components: interest and principal

Question 18

The Government National Mortgage Association, usually referred to as Ginnie Mae, is

Answer 18

a government-owned corporation. Ginnie Mae guarantees securities backed by a pool of mortgages insured by the Federal Housing Administration (FHA) or guaranteed by the Veterans Administration (VA) or the Farmers Home Administration (FMHA). Unlike most agency securities, GNMA securities are direct obligations of the U.S. government

Question 19

The Federal National Mortgage Association, often referred to as Fannie Mae, was

Answer 19

originally incorporated as a government-owned corporation, but is now a private company. (Its stock can be purchased on the New York Stock Exchange.) FNMA buys mortgages from lenders, packages them, and resells the resulting mortgage-backed securities to investors

Question 20

Fannie Mae sells mortgage-backed securities with the underlying mortgages being

Answer 20

Federal Housing Administration, Veterans Administration (VA) and conventional residential mortgages. These securities are not guaranteed by the U.S. government but are backed by Fannie Mae’s ability to borrow from the Treasury