Government and Government Agency Issues

Question 1

Treasury Note

Answer 1

U.S. government’s intermediate-term security and range in term from 1 year up to 10 years. Treasury notes pay semiannual interest and are auctioned off by the Treasury every four weeks. Treasury notes are issued in denominations ranging from $100 up to $1,000,000 and may be refunded by the government. If a Treasury note is refunded, the government will offer the investor a new Treasury note with a new interest rate and maturity. The investor may always elect to receive their principal payment instead of accepting the new note.

Question 2

Treasury Bond

Answer 2

U.S. government’s long-term bonds. Maturities on Treasury bonds range from 10 years up to 30 years. Treasury bonds, pay semiannual interest and are issued in denominations ranging from $100 up to $1,000,000. Some Treasury bonds may be called in at par by the treasury. If the Treasury Department calls in a bond issue, they must give holders four months’ notice.

Question 3

Treasury Receipts

Answer 3

Similar to STRIPs, except that broker dealers and banks create them. Broker dealers and banks will purchase large amounts of Treasury securities, place them in a trust, and sell off the interest and principal payments to different investors.

Question 4

Treasury STRIPS

Answer 4

Stands for separate trading of registered interest and principal securities. The Treasury securities are separated into two parts: a principal payment and semiannual interest payments. A Treasury STRIP is a zero-coupon bond that is backed by U.S. government securities. An investor seeking some current income may wish to purchase the semiannual coupon payments due over the term of the Treasury securities. A STRIP may be purchased by an investor who needs to have a certain amount available on a known date in the future.

Question 5

Treasury Inflation Protected Securities (TIPS)

Answer 5

Are sold with a fixed interest rate and their principal is adjusted semiannually to reflect changes in the consumer price index. During times of inflation, the principal amount of the TIP will be increased and the investor’s interest payments will rise, while during times of falling prices, the principal amount of the bond will be adjusted down and the investor will receive a lower interest payment.

Question 6

Collateralized Mortgage Obligation (CMO)

Answer 6

A mortgage-backed security issued by private finance companies, as well as by FHLMC and FNMA. The securities are structured much like a pass-through certificate and their term is set into different maturity schedules, known as tranches. Pools of mortgages on one family to four-family homes collateralize CMOs. They are given a AAA rating. The only real risk that the owner of a CMO faces is the risk of early refinance. CMOs pay interest and principal monthly. However, they pay the principal to only one tranche at a time in $1,000 payments. The CMO pays off each tranche until the final tranche, known as a Z tranche, is paid off.

Question 7

Government National Mortgage Association (GNMA)

Answer 7

Ginnie Mae - a wholly owned government corporation and is the only agency whose securities are backed by the U.S. government. The purpose of Ginnie Mae is to provide liquidity to the mortgage markets. Buys up pools of mortgages that have been insured by the Federal Housing Administration (FHA) and the Department of Veteran Affairs (VA). The ownership in these pools is then sold off to private investors in the form of pass-through certificates. These certificates generally have the same risks as a traditional CMO.

Question 8

Federal National Mortgage Association (FNMA)

Answer 8

Fannie Mae - a public for-profit corporation. However, placed in receivership by U.S. government. Has a credit facility with the government and receives certain favorable tax considerations. Purchases mortgages and then packages them to create mortgage-backed securities.

Question 9

Federal Home Loan Mortgage Corporation (FHLMC)

Answer 9

Freddie Mac - a publicly traded company in business aimed at making a profit. However, placed in receivership by U.S. government. Purchases residential mortgages from lenders and packages them into pools and sells off interest in those pools to investors.

Question 10

Types of CMOs

Answer 10

Principal only (PO), Interest only (IO), Planned amortization class (PAC), Targeted amortization class (TAC).