Chapter 12 Part 6 Flashcards
STRIPS are always sold
at a discount. The difference between the investor’s purchase price and the bond’s face value is interest
The federal government sells Treasuries to the public through
auctions conducted by the federal Reserve System.
All Treasuries are sold in
book-entry form. The investor never receives the actual paper security. Instead, the Federal Reserve enters the names of the owners in its records.
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
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
Interest on Treasury notes and bonds accrues on the basis of a
365-day year (in a leap year, 366 days) and the actual days elapsed
The interest earned on Treasuries is subject to
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
Taxpayers must report the interest from T-notes and T-bonds on their tax returns for the
same year in which the interest is received.
The interest earned from T-hills must be reported the
same year in which the T-bill matures.
Treasury STrIPS are taxed the same way as
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
Nonmarketable U.S. government securities are commonly called
savings bonds. They are primarily purchased by small investors.
Series EE Bonds are
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
Investors can purchase EE Savings Bonds through
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
Series I Bonds
“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”
The interest on all types of U.S. Savings Bonds is exempt from
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
Mortgage-Backed Agency Securities are backed by
groups (pools) of home mortgages
The three agencies that issue mortgage-backed securities are the
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
A mortgage is a
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
The Government National Mortgage Association, usually referred to as Ginnie Mae, is
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
The Federal National Mortgage Association, often referred to as Fannie Mae, was
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
Fannie Mae sells mortgage-backed securities with the underlying mortgages being
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
