Chapter 4 Section 2: U.S. Government Debt and Agency Debt

What is the largest and most active trading market in the world?

The market for U.S. Government Debt

What does the U.S issue debt for?

To finance the running of the government

What does negotiable government debt take the form of?

Long-term bonds, intermediate term notes, and short-term notes known as Treasury bills

What are U.S. government bonds and market participants exempt from?

regulation under the Securities Act of 1933 and the Securities Exchange Act of 1934

Because of U.S. governmental bonds exemption, what does this mean for the Securities and Exchange Commission?

They do not oversee the issuance of them

Who does have an oversight role in the regulation of banks?

The Federal Reserve

What types of savings bonds are issued by the U.S. Government?

Series EE and Series HH bonds

Are savings bonds negotiable or non-negotiable?

Non-negotiable

What type of taxes is the interest on savings bonds exempt from?

State and local taxes

When are federal taxes due on Series EE bonds?

Until they are redeemed

Are savings bonds (EE Bonds) part of the U.S Governmental debt market?

No

Who can buy and redeem Savings bonds? (EE Bonds)

Only the government

What form are short-term treasury bills, intermediate-term notes, and long-term bonds issued?

Book-entry form

Debt issued by the U.S. government and its agencies are usually considered what?

Risk free

What are government and agency securities still subjected to?

Interest rate and purchasing power risk

Treasury bonds are long-term securities issued with maturities of how long?

30 years

What are the minimum denominations treasury bonds are issued with?

$100 for caproate and municipal bonds

What does the acronym STRIPS stand for?

Separate Trading of Registered Interest and Principal Securities

What types of strips does the U.S. Treasury issue?

Interest-only (IO) strips and principal-only (PO) strips

What financial instruments did STRIPS largely replace?

Treasury Receipts

Who decided to issue STRIPS directly on selected U.S. Government debt issues?

The U.S. Treasury

Who were STRIPS introduced for?

investors who wish to avoid reinvestment risk

What is another name for STRIPS

Treasury receipts

STRIPS were designed for pension fund managers who want what?

A safe, long-term investment and to not worry about reinvesting semi-annual interest payments that could be subject to reinvestment risk if market interest rates fall

Treasury Inflation-Protected Securities (TIPS)

designed for investors who want to avoid purchasing power power risk

What type of interest rate do TIPS have?

Fixed over life

How is the principal amount determined?

Adjusted every 6 months by an amount equal to the change in the Consumer Price Index (CPI)

How is the return at maturity measured on TIPS

Whichever is higher, the principal or the inflated adjusted principal

How is TIPS interest rate payment in comparison to other treasury issues with the same maturity?

Th e rates are lower

What are Treasury Notes (T-Notes)?

Intermediate-term securities issued by the U.S. Treasury.

What is the maturity range for Treasury Notes (T-Notes)?

2 to 10 years at time of issuance.

What is the minimum denomination for T-Notes?

$100 par value.

How often do T-Notes pay interest?

Semiannually.

How are T-Notes quoted?

As a percentage of par value in 32nds.

Are T-Notes callable?

No, they are noncallable.

What are Treasury Bills (T-Bills)?

Short-term securities issued by the government.

What are the maturities for Treasury Bills (T-Bills)?

1, 2, 3, 6, and 12 months (or 4 weeks, 8 weeks, 13 weeks, 26 weeks, and 52 weeks).

How are T-Bills issued in relation to par value?

They are issued at a discount from par ($100 minimum) and mature at par.

What is the interest income earned from T-Bills?

The discount earned is the interest income.

How are T-Bills quoted?

They are quoted on a discount yield basis.

Series EE Bonds

Savings products issued by the U.S. government with a minimum purchase amount of $25

Are Series EE bonds traded?

No, only redeemable with the treasury

Are government-sponsored enterprises (GSEs) such as Fannie Mae and Fannie Mac directly backed by the full faith and credit of the U.S. Treasury?

No

Since GSEs are not fully backed, what does this result in?

Higher yields

The Federal Farm Credit System

Offers farmers low rate financing. Issues discount notes, intermediate term bonds and long term bonds.

Mortgage-backed securities (MBSs) agencies

FHLB, Fannie Mae, Ginnie Mae, FHLMC/Freddie Mac

What is the minimum denomination for MBSs?

$25,000

Once enough mortgages have been purchased, what are they placed inot?

A "pool"

How are MBSs divided once placed into the pool?

Into $25,000 mortgage-backed pass-through certificates and sells them to investors

Who are the monthly mortgage payments passed to?

The certificate holder

How often are payments made to certificate holders?

Monthly, not semiannually.

What does each payment to certificate holders include?

A portion of both principal and interest (since they are mortgage payments)

Why are the certificates considered self-liquidating?

Because the mortgages are paid off over time, and those payments reduce the principal until it is fully repaid.

What is prepayment risk?

Refers to the risk that mortgage prepayments will occur, affecting the expected cash flows from mortgage-backed securities.

How does the length of a certificate depend on underlying mortgages?

The length of the certificate depends on the underlying mortgages in the pool.

Why is the actual life of a mortgage-backed certificate shorter than its stated length?

The actual life of the certificate is shorter because mortgage prepayments occur when homes are sold or mortgages are refinanced.

What happens to prepayments in mortgage-backed securities?

Prepayments are passed through to the certificate holder.

Why is the real maturity of a mortgage-backed certificate unknown?

Because of prepayment risk, the real maturity is unknown.

When does prepayment risk increase?

When interest rates fall since homeowners are more likely to refinance in a low-interest-rate environment

What type of entity is Freddie Mac?

Government-sponsored enterprise.

What backing does Freddie Mac have?

Implied guarantee from the federal government.

What is Freddie Mac's function?

Issues MBSs (mortgage-backed securities) and collateralized mortgage obligations (CMOs).

What is the purpose of Freddie Mac?

Bring more funds into the housing sector to encourage home ownership.

What type of entity is Fannie Mae?

Government-sponsored enterprise.

What backing does Fannie Mae have?

Implied guarantee from the federal government.

What is Fannie Mae's function?

Issues MBSs and CMOs.

What is the purpose of Fannie Mae?

Bring more funds into the housing sector to encourage home ownership.

What type of entity is Ginnie Mae?

Government agency.

What backing does Ginnie Mae have?

Fully backed by the federal government.

What is Ginnie Mae's function?

Does not issue but guarantees MBSs and CMOs.

What is the purpose of Ginnie Mae?

Bring more funds into the housing sector to encourage home ownership.

Where does trading of government securities take place?

Solely in the over-the-counter markets

Who participates in OTC markets?

large commercial banks, foreign banks, U.S. government securities dealers, and full-service brokerage firms

Who is the largest participants in the OTC market?

U.S government securities dealers

Primary dealers

hooked up to the Federal Reserve wire system and deal directly with the Fed

Secondary dealers

all other firms trading U.S government securities

Open market operations

the purchase and sale of U.S. government bonds by the Fed

How does the Fed trade?

by maintaining its own trading account that buys and sells large quantities of government securities in the market to manage interest

What does the Fed do when it wishes to loosen credit?

Buying Treasury securities from the primary dealers

Dovish stance

When the Fed buys securities from primary dealers, these dealers give cash to secondary dealers (banks). Banks then have more cash to lend and market interest rates are lowered

What results from dovish stance?

Spurs economic growth

What does the Fed do when it wishes to tighten credit?

Sells Treasury securities from the primary dealers

Hawkish stance

When the Fed sells securities from primary dealers, these dealers take cash from secondary dealers (banks). Banks then have less cash to lend and market interest rates are rose

What results from hawkish stance?

Economic growth slows

When and how often are agency securities sold?

Sold by competitive bid at weekly yield auctions

What does 'Fed funds' refer to?

Federal Funds

What are Fed funds?

Overnight loans of reserves from one Federal Reserve member bank to another.

At what rate are loans of Fed funds made?

Federal Funds rate.

Fedwire Funds Service

The wire system that clears trades of U.S. government and agency securities

Is interest received from U.S. government securities federally taxed?

Yes

Is interest received from U.S. government securities state and local income taxed?

No

Is interest received from municipal securities state and local income taxed?

Yes

Is interest received from municipal securities federally taxed?

No

Tax status of mortgage-backed pass-through obligations and corporate bonds

Taxable both federally and state level