Comprehensive GSE, Bond Types, Yield Curves, and Mortgage-Backed Securities

What is a GSE?

A privately owned firm created by Congress to support credit markets.
“Financing entities created by Congress to fund loans to certain groups of borrowers such as homeowners and farmers”

Are GSE bonds explicitly guaranteed like Treasury debt?

No. GSE debt carries some credit risk and lacks the same explicit guarantee.

Why can GSEs generally borrow at relatively low yields?

Strong credit quality plus perceived government support lowers required yields.

What is a GSE yield spread over Treasuries?

GSE yield minus the yield on the comparable Treasury benchmark.

What does 1 basis point equal?

0.01 percentage point; 100 bp = 1.00%.

What does a +35 bp Treasury spread mean?

The security yields 0.35 percentage points more than its Treasury benchmark.

What does a negative GSE-Treasury spread mean?

The observed GSE yield is below the Treasury benchmark at that maturity.

What is a bullet bond?

A noncallable bond whose principal is repaid at final maturity.

What is a callable bond?

A bond the issuer may redeem early according to specified call terms.

Who owns the embedded call option in a callable bond?

The issuer.

Why do callable bonds generally offer extra yield?

Investors bear call/reinvestment risk and effectively sell the issuer a call.

What is a Bermudan-style call?

A call exercisable on multiple specified dates.

What is a European-style call?

A call exercisable on one specified date.

What is an American-style call?

A call exercisable throughout a specified period.

What is a step-up bond?

A bond whose coupon rises according to a predetermined schedule.

How can step-up bonds and callability interact?

The coupon can rise over time while the issuer retains specified call rights.

Coupon < YTM implies what price relationship?

Price < par: the bond trades at a discount.

Coupon > YTM implies what price relationship?

Price > par: the bond trades at a premium.

Coupon = YTM implies what price relationship?

Price is approximately equal to par.

Why can a low-coupon bond still have a high YTM?

A discount price creates capital appreciation toward par in addition to coupons.

What does a bond price of 86.37 mean?

About $86.37 paid per $100 of face value.

What does a bond price of 107 mean?

About $107 paid per $100 face value; it trades at a premium.

What is the difference between coupon rate and YTM?

Coupon determines stated interest; YTM reflects total return if held to maturity.

What does S/A mean on a bond description?

Semiannual coupon payments.

What does unsecured mean for a bond?

It is not backed by specifically pledged collateral.

What does tenor mean on a yield curve?

The time to maturity of the securities represented on the curve.

What does a yield curve's y-axis normally show?

Yield.

What does a yield curve's x-axis normally show?

Maturity or tenor.

Why compare Fannie/Freddie yields with Treasuries?

Treasuries provide a benchmark for low-credit-risk U.S. dollar debt.

What was the key lesson of the Fannie/Treasury Bloomberg curve?

GSE-Treasury spreads vary by maturity and can even be negative at some points.

What was the key lesson of the Freddie/Treasury Bloomberg curve?

Freddie yields were above Treasuries, producing positive spreads.

What was notable about the 0.875% Fannie 2030 bond?

Low coupon, price near 86, and yield near 4.75%: a discount bond.

What was notable about the 6.25% Freddie 2032 bond?

Coupon exceeded YTM, so its price was above par: a premium bond.

What was notable about the Fannie 1.9% 2036 bond?

It traded at a discount and had specified quarterly call opportunities.

What made the Fannie 1.9% bond's call Bermudan-style?

The issuer could call it on multiple discrete specified dates.

What was the Fannie step-up bond's coupon progression?

2.50% → 3.00% → 4.25%.

What two features did the Fannie step-up example combine?

A predetermined step-up coupon schedule and issuer callability.

What is current yield?

Annual coupon payment divided by the bond's current market price.

Does current yield include gain or loss toward par?

No. YTM incorporates that effect; current yield does not.

Why do bond prices fall when market yields rise?

Existing fixed cash flows must become cheaper to offer the higher required return.

Why do bond prices rise when market yields fall?

Existing fixed coupons become more attractive relative to new market rates.

What is reinvestment risk from a call?

Principal may be returned when rates are lower, forcing reinvestment at lower yields.

What is Fannie Mae?

A housing-finance GSE formally known as the Federal National Mortgage Association.

What is Freddie Mac?

A housing-finance GSE formally known as the Federal Home Loan Mortgage Corporation.

What happened to Fannie and Freddie in September 2008?

They were placed into FHFA conservatorship during the financial crisis.

What is conservatorship in the Fannie/Freddie context?

FHFA controls and manages the enterprises while they remain in conservatorship.

Why can GSE debt and GSE preferred stock have very different risk?

Debt has higher payment priority; preferred is subordinate and can have dividends suspended.

What is programmatic GSE debt issuance?

Regular benchmark/reference bond and note programs used to issue debt systematically.

What is reverse-inquiry issuance?

Debt structured in response to specific investor demand, such as some MTNs.

What is an MTN?

A medium-term note, often issued flexibly in response to investor demand.

What day-count convention do many GSE securities use?

30/360.

In what denominations are many GSE securities issued?

$1,000 increments.

Where do many GSE securities clear and settle?

Through the Federal Reserve Book-Entry System.

What is the main idea behind a bond's credit rating?

It reflects an agency's assessment of the issuer's credit/default risk.

Why should lower-credit-quality debt generally offer higher yields?

Investors demand compensation for bearing greater credit risk.

What is a yield spread?

The difference between yields on two securities or benchmark curves.

How do you convert 0.20% to basis points?

20 basis points.

How do you convert 50 basis points to percentage points?

0.50 percentage points.

If Treasury yields 4.77% and GSE yields 5.12%, what is the spread?

0.35 percentage points, or 35 bp.

What is Fed Funds futures ticker ZQ associated with?

30-Day Federal Funds futures.

How is the implied Fed Funds rate obtained from a futures quote?

100 minus the futures price.

What rate is implied by a Fed Funds futures price of 95.500?

4.50%.

What rate is implied by a Fed Funds futures price of 96.2625?

3.7375%.

For Fed Funds futures, what does a lower futures price imply?

A higher implied average federal funds rate.

For Fed Funds futures, what does a higher futures price imply?

A lower implied average federal funds rate.

Is a Fed Funds futures implied rate guaranteed to occur?

No. It reflects market pricing/expectations, not a guaranteed future policy rate.

What rate does a monthly Fed Funds futures contract broadly imply?

The market-implied average effective federal funds rate for that contract month.

What should you extract first from a Bloomberg bond screen?

Issuer, coupon, maturity, price, yield, ratings, and embedded-option features.

Should every Bloomberg field be memorized for these slides?

Focus on the concepts illustrated unless a specific field was taught separately.

What is a G-spread?

A bond's yield spread over an interpolated government benchmark curve.

What is a Z-spread?

A constant spread added to spot rates so discounted cash flows equal market price.

What is OAS?

Option-adjusted spread: spread after accounting for an embedded option's effect.

Why is OAS relevant for callable bonds?

It separates the embedded option's effect from the underlying spread.

What is duration broadly used to measure?

A bond's sensitivity to changes in interest rates.

What is convexity broadly used to describe?

How a bond's price-yield sensitivity changes as yields change.

What happens to a discount bond's price as maturity approaches, all else equal?

It tends toward par if it remains outstanding and there is no default.

What happens to a premium bond's price as maturity approaches, all else equal?

It tends toward par if it remains outstanding and there is no default.

Why isn't buying a $95 bond that pays $100 at maturity free money?

The discount reflects required return, time value, interest-rate risk, and credit risk.

What does par usually equal in bond quotation terms?

100, representing 100% of face value.

What does a price of 75.21 indicate?

The bond trades at 75.21% of face value, a substantial discount.

What is the core relationship behind GSE/Treasury Bloomberg slides?

GSE yield ≈ Treasury benchmark yield + GSE spread.

Why might observed GSE spreads differ across maturities?

Credit, liquidity, supply/demand, security features, and market technicals vary.

Does a negative observed GSE spread prove GSE debt is safer than Treasuries?

No. Relative market yields can reflect liquidity, supply/demand, and curve construction.

What is the issuer's incentive to call debt when rates fall?

It may refinance expensive debt at lower prevailing rates.

Why is a call unfavorable to investors when rates fall?

An attractive bond may be redeemed and proceeds reinvested at lower rates.

What is the simplest exam definition of a step-up coupon?

A coupon that increases on predetermined dates according to a preset schedule.

What does fixed-rate bond mean?

Its stated coupon rate is fixed rather than resetting with a floating benchmark.

What is the final principal payment on a normal bullet bond?

Face/par value paid at stated maturity.

What distinguishes callable debt from bullet debt?

Callable debt may be redeemed early; bullet debt normally remains until maturity.

Why can two GSE bonds have different yields despite the same issuer?

Maturity, coupon, liquidity, callability, structure, and market conditions can differ.

What is the main Bloomberg skill for the exam?

Recognize the economic concept shown rather than memorize terminal navigation.

What progression do the Bloomberg slides illustrate?

GSE curves → individual bullet bonds → callable bonds → callable step-up bonds.

What are the goals and benefits of Fannie Mae's CRT Program?

• Protect taxpayers through broad, liquid credit-risk markets

• Minimize impact on borrowers, renters, and lenders

• Improve market efficiency through consistent, programmatic issuance

• Create liquidity to strengthen the housing finance system

• Reduce capital previously used to cover transferred risk

Indexed amortization notes -

the basic idea is that you’re paying back both interest and principal. On some schedule, linked to some interest rate index.

Floating rate notes

basically the coupon on the bond changes through time. The step up has a specific change, floating rate securities change more often and is not pre set meaning you don’t know what it’s going to change to. Some reference rate + / - the spread. Interest rates rise? So do your coupon payments. You are protected from interest rate risk. Reset can be daily or once a year. Payments can be quarterly, monthly, annually, semiannually, etc.

 Floating-Rate Note (i.e. Floater) is a debt security that offers interest

payments which reset periodically on predetermined dates based on a reference rate.

 The coupon is calculated in the following manner:

Coupon Rate = Reference Rate + or - Spread

 Spread: the adjustment to the reference rate when calculating the coupon rate. It is set

when a floating rate note is priced and does not change during the lifetime of the note. The

spread to the reference rate is generally expressed in basis points (bps) and can be either

positive or negative.

 Reference Rate: the interest rate or index used in the coupon formula that is combined

with the spread to determine the amount of interest that accrues on the security. The most

common indices used for floaters include the Secured Overnight Financing Rate (SOFR),

Prime rate, Fed Funds Effective rate, and U.S. Treasury Bill rate (T-Bill).

 Reset Periods: The interest rate on a floater can reset as often as daily or as infrequently as

once per year. It is quite common for the interest rate to reset each time an interest payment

is made on the security, and then remain constant until the next coupon payment date.

 Payment Periods: Interest payments for a floater may be made monthly, quarterly,

semiannually or annually.

 Maturity: Floaters can be issued with any maturity, typically ranging between two to five

years.