Government Bonds and Agency Issues

Question 1

Series EE Bond

Answer 1

AKA: Savings Bond
Purchased directly from the U.S. Government at a discount from face value (50%)

+ Pays no semiannual interest and can be redeemed at maturity for face value
+Interest is earned via bonds appreciation towards face value
+ Interest is taxable, the option to pay annually, at maturity or rolling it into HH bond and continue deferring taxes

Question 2

Series HH Bond

Answer 2

Can not be purchased only traded in for matured EE bonds.

+ Pays semiannual interest that can be redeemed at any time for face value
+ Available in denominations of 500 - 10k

Question 3

Treasury Bills

Answer 3

U.S. Government short term debt obligation (4-52 weeks) that are auctioned off weekly and sold at a discount from par value. Treasury awards the highest bidders and works its way down until all bills have been sold.

+ Pays no semiannual interest, interest is earned via the appreciation to face value.
+ Because bills are sold at a discount, a higher dollar means a lower rate for purchasers.

Question 4

Noncompetitive Tenders (T-Bills)

Answer 4

Noncompetitive bids are filled before any competitive tenders. Noncompetitive tenders must agree to the average yield. All bids are filled by the treasury and settled in FED funds.

+ Max amount for Competitive tenders is 500k
+ Treasury Bills denominations are 100 - 1 million

Question 5

Treasury Notes

Answer 5

U.S. Government mid-term debt obligations (1-10 years) that are auctioned off every 4 weeks.

+ Pays semiannual interest
+ Denominations of 100 - 1 million
+ Refundable by the government if so, the government will offer a new note with a new rate and new maturity, though investors may choose to pick the principal payment instead.

Question 6

Treasury Bonds

Answer 6

U.S. Government Long term debt obligations (10-30 years)

+ Pays semiannual interest
+ Denominations of 100 - 1 million
+ Treasury may call in bonds at par, they must give 4 months notice before calling the bonds.

Question 7

Treasury Strips

Answer 7

Zero-coupon bonds backed by U.S. Government Securities. Can be used to create current income by buying the semiannual coupon payments due over the term of the Treasury securities.

+ Investor can buy principal payments of 1000
+ Can be used to have a certain amount in a future date ( like a child going off to college)

Question 8

Treasury Receipts

Answer 8

Similar to Treasury Strips except that broker-dealers and banks create them, they’ll purchase large amounts of Treasury securities, place them in a trust and sell off the interest and principal payments to different investors.

Question 9

Treasury Inflation-Protected Securities (TIPS)

Answer 9

Provides protection from inflation

TIPS are sold at a fixed rate with their principal adjusts semiannually to reflect changes in the Consumer Price Index (CPI).

During inflation principal amount and investors interest payments increase, and opposite effect during deflation.

TakeNote: Because the principal amount of TIPS is adjusted to account for inflation the real return of inflation-adjusted return will always equal the coupon rate.

Question 10

Agency Issues

Answer 10

Federal Government authorizes certain agencies to issue debt securities, which are known as Agency Issues.

Revenues generated from taxes, fees, and interest income back these agency issues

Investors are offered rates that fall between rates of similar terms of Treasury and corporate securities.

Question 11

Investors, who purchase Agency Issues in the secondary market?

Answer 11

Are given prices based on a percentage of par just like corporate issues.

Question 12

Ginnie Mae

Answer 12

Government-owned corporation and the only agency whose securities are backed by the full faith and credit of the U.S. Government.

Question 13

Purpose of Ginnie Mae

Answer 13

To provide liquidity to the mortgage markets by buying pools of mortgages that have been insured by insured by the FHA and VA.

Question 14

Investors of Ginnie Mae

Answer 14

These pools of mortgages are sold to private investors in the form of pass-through certificates.

Investors of Pass-Through Certificates receive monthly interest and principal payments.

Question 15

Risk of owning Ginnie Mae

Answer 15

Early Refinancing. Because as interest rates fall, people will refinance and investors won’t receive higher interest rates as they had hoped.

Question 16

The yield on Ginnie Mae

Answer 16

Are based on a 12-year prepayment assumption because most mortgages are repaid early.

Question 17

Fannie Mae

Answer 17

Federal National Mortgage Association (FNM)

It’s a public for-profit company, where stocks are traded publicly and in the business to provide mortgage capital.

Fannie Mae buys mortgages and packages them to create MBS.

Question 18

Fannie Mae considered credit security because..

Answer 18

It has a credit facility with the government and recevies tax considerations.

Question 19

Fannie Mae MBS issued in the denomination and interest payments

Answer 19

Denominations of 100 - 1 million and pay interest semiannually

Question 20

Fannie Mae issued minimum debentures of

Answer 20

Denominations of 10k that mature in 3 to 25 years.

Question 21

Freddie Mac

Answer 21

Federal Home Loan Mortgage Corporation(FHLMC)

Is a publicly-traded company and makes a profit through loans, by purchasing residential mortgages from lenders and groups them into pools then sells off the interest.

Question 22

Federal Farm Credit System

Answer 22

Is a group of private lenders that offer different types of financing to farmers.

The FFCS sells off the farm securities to obtain funds to provide farmers, which are not backed by the U.S. Government.

Securities pay interest every 6 months and only available in book-entry form

Question 23

FFCS different types of lenders

Answer 23

• Federal Land Bank: Provides mortgages money
• Bank of the Cooperatives: Provides money for feed and grain
• Federal Intermediate Credit Bank: Provides money for tractors and equipment

Question 24

Collateralized Mortgage Obligations

Answer 24

Are Mortgage Backed Securities structured like pass-through certificates with different maturity schedules (tranches). CMO’s are collateralized by pools of mortgage consisting of 1 - 4 homes.

• Issued by Fannie, Fred, and private companies
• AAA-rated
• Risk is early refinancing
• Taxable at all levels

Question 25

CMO’s investments

Answer 25

CMO’s pay interest and principal monthly, however, the principal pays one tranche until the final tranche is paid off AKA: Z tranche (most volatile).

Question 26

CMO and Interest Rates

Answer 26

CMO’s are interest-bearing investments - affected by a change in interest rates.

• Rates fall = more refinancing = investors paid off quicker
• Rates rise = refinancing slow down = investors paid off slower
• Rate of principal payments vary

Question 27

CMO Secondary Market

Answer 27

Most CMO’s have an active secondary market and considered liquid.

Complex CMO’s may not have an active secondary market and be illiquid.

Question 28

Types of CMO’s

Answer 28

• PO: Principal Only
• Interest Only
• Planned Amortization Class
• Targeted Amortization Class

Question 29

Principal Only CMO’s

Answer 29

Only receive principal payments from the underlying mortgage - receives from both scheduled principal payments and prepayments. And because they do not receive interest payments they sold at a discount, the appreciation to its face value is the investor’s return.

PO’s are sensitive to a change in interest rate so as rates fall the value of the CMO rises and prepayments accelerate and vice versa.