US Gov Debt and Agency Debt Flashcards
US Gov Debt
Issued by the US treasury and a variety of gov agencies. Unlike corps who can issue equity securities, the US treasury and gov agencies only issue debt securities (Treasuries and Agencies)
Types of US Gov Treasuries
Short term bills (T-bills), intermediate term notes, long term bond
Gov Savings bonds
EE bonds. They are not part of the securities market. They are non-negotiable and cannot be traded. They are bought from the gov and can only be redeemed with the gov
Regulation of US gov bonds
They are not regulated by SEC. The federal reserve does have oversight role in regulation of banks
Treasury bond variations
STRIPS - stripped of interest payments, making them zero-coupon investments.
TIPS - fixed interest rate, principal is adjusted every 6 months by amount equal to change in Consumer Price Index (CPI)
Features of STRIPS
These were introduced for investors who wish to avoid reinvestment risk. They are treasury bonds that are stripped down into multiple individual bonds from the expected cash flow of a bond (based on normal interest payment amounts plus the final principal payment). There are no interest payments on the individual strips themselves i.e. they are zero interest bonds. The STRIPS are traded at discount.
They were designed for pension fund managers who want:
* A safe long tem investment
* No worry about reinvesting semiannual interest payments that could be subject to reinvestment risk, if market interest rates fall.
Because they are long term zero coupon bonds, price swings are very volatile as interest rates move. This security is highly susceptible to interest rate risk. But purchasers are not worried about this since STRIPS are usually held to maturity. They are not subject to reinvestment risk as there is no coupon paid.
Features of TIPS
Designed for investors who want to avoid purchasing power risk.
Fixed interest rate over the life of the bond.
Principal amount is adjusted every 6 months by an amount equal to the change in the Consumer Price Index (CPI).
Pay a fixed interest amount semiannually.
The interest payment will increase if the principal amount is adjusted upwards due to inflation and will decrease if the principal amount is decreased due to deflation.
The bondholder will also receive a higher return at maturity if the principal amount is adjusted upwards due to inflation. This protects from purchasing power risk.
The bondholder will still receive par at maturity if the principal amount is decreased due to deflation.
TIPS have a lower interest rate than other treasury issues with a similar maturity, due to the inflation protection feature. They are only available for long-term treasury issues
US Gov Agencies and sponsored agencies
Gov Agency - Ginnie Mae (doesnt issue MBSs but guarantees them)
Gov Backed Agencies - Federal Home Loan Banks, Fannie Mae, Freddie Mac (all do Mortgage Backed Securities)
Federal Farm Credit - assoicated with farm loans - think its gov backed agency
Sallie Mae - Securities based on student loads - used to be gov agency but seems to be private company now
Mortgage Backed Securities
Federal Home Loan Banks, Fannie Mae, Ginnie Mae, Freddie Mac
They purchase mortgages from banks. They obtain fudns to buy mortgages by selling bonds.
Sold in min denom of $25,000
Payments are made monthly to bondholders, consisting of a portion of the principal and interest
Mortgage prepayments can occur which may cause them to complete early (prepayment risk). This risk increases when interest rates are low as homeowners are likely to refinance to a lower interest mortgage
Trading Gov and Agency debt
Take place in over the counter market and not on an exchange. The participants include large commercial banks, foreign banks, US gov securities dealers and full service brokerage firms, as well as the Federal Reserve (the Fed) itself.
The largest participant in the market are the primary US gov securities dealers. Primary dealers are hooked up to the Federal Reserve wire system and deal directly with the Fed.
All other firms trading US gov securities are termed secondary dealers. They buy and sell Treasuries in the market through primary dealers and can also bid at the weekly auction. Most smaller banks and brokerage firms are secondary dealers
Federal Reserve Trading Treasuries
Open market operations involve the Fed engaging in the trading of US treasuries. The Fed maintains its own trading account that buys and sells large quantities of gov securities to manage interest rates.
To loosen credit the Fed buys Treasury securities from the primary dealers who in turn provide cash to other dealers (mainly banks) which results in lower interest rates as there is more cash available (dovish stance by Fed to spur econimic growth)
To tighten credit the Fed sells Treasuries to primary dealers which removes cash from the banking system thus resulting in higher interest rates (hawkish stance by Fed to slow economic growth)
Market for Agency trading
Dominated by primary dealers. Agency securities are issued differently to treasuries. Each agency has assembled a selling group of firms who sell the agency’s issues. Most agency securities are quoted on a yield spread basis against equivalent maturing Treasuries
