Term
The federal government now issues bills, notes
Note that the U.S. government does not issue 9-month T-bills. |
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Definition
| bonds, and TIPS (the newest of the securities). A fifth security, STRIPS, is thought to be issued by the federal government, but it is not. A broker/dealer using Treasury notes or bonds issues it. |
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Term
| TREASURY BILLS (T-BILLS) have maturities of no more than one year |
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Definition
currently sold as 4-, 13-, 26-week, and 52-week maturity instruments.
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These are also known as 1-month, 3-month 6-month, and 1-year Treasury bills |
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Term
Treasury bills are sold:
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By the Department of the Treasury at the direction of the FEDERAL OPEN MARKET COMMITTEE (FOMC) |
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Definition
At weekly auctions on Mondays and Tuesdays and paid for on the following Thursday
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On a discounted purchase price, which translates into a “yield” to the investor; bills are not quoted in dollars, but on an annualized discounted yield to maturity basis, commonly called BASIS |
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Term
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Definition
| Noncompetitive buyers receive their Treasury bills at the highest yield, the same as the competitive bidders. |
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Term
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Definition
| Securities sold with a maturity from 1-10 years |
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Term
| Treasury bonds or T-bonds: |
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Definition
Are sold with a maturity of 30 years
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May be CALLABLE, but they must have a call date in addition to the maturity date. Not all bonds are callable. |
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Term
| Treasury Inflation-Protected Securities (TIPS) were first introduced by the U.S. Treasury in 1997 as a variable rate government security. |
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Definition
| The principal amount of the TIPS is adjusted for inflation and/or deflation, but never below the par amount. |
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Term
| The value of the principal at maturity is the amount that will be paid, even if it is more than the original amount paid. |
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Definition
| The semiannual interest payments are based on the inflation-adjusted principal at the time the interest is paid, and when the interest rate is applied to the adjusted principal value, the amount of the payment increases. |
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Term
| TREASURY STRIPS or ZERO-COUPON securities are |
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Definition
| actually issued by broker/dealers and backed by U.S. government securities. TREASURY STRIPS are also known as TREASURY RECEIPTS. |
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Term
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Definition
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Term
| STRIPS is an abbreviation for |
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Definition
| Separate Trading of Registered Interest and Principal of Securities. These are notes or bonds, issued by broker/dealers and some banks who have had the interest component separated from the principal component of the investment. |
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Term
| The principal of the note or bond is then resold as a ZERO-COUPON debt security |
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Definition
| and does not make any periodic interest payments. |
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Term
| The interest that has been stripped off is also resold |
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Definition
| as a zero-coupon security with maturities on each of the interest payment dates. |
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Term
| Treasury bills — known as T-bills, have maturities |
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Definition
| 1 month, 3 months, 6 months, and 1 year. These securities are actually issued as 4- week, 13-week, 26-week, and 52-week maturities |
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Term
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Definition
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Term
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Definition
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Term
| backed by the “full faith and credit” of the U.S. government. |
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Definition
| When the federal government issues Treasury bills, notes, or bonds, it guarantees the principal and interest of these securities. |
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Term
| Guaranteed debt means that the securities (bonds) |
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Definition
| are guaranteed by the full faith and credit of the U.S. government. |
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Term
| Government National Mortgage Association (GNMA), also known as GINNIE MAE |
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Definition
| GNMA issues PASS-THROUGH CERTIFICATES (types of bonds) that represent a pool of mortgages, including mortgages from the Department of Veterans Affairs and from the Federal Housing Authority. |
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Term
| GNMA is an agency under the jurisdiction of the U.S. government. |
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Definition
| The GNMA bond is issued at a yield that is 50 basis-points less than the pooled mortgages as a guaranty and service fee. Remember that basis equals yield to maturity. |
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Term
| GNMA issues PASS-THROUGH CERTIFICATES |
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Definition
They are issued in $25,000 minimum quantities.
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Investors receive monthly payments of interest and principal based on their ownership of the securities. Therefore, they are commonly known as MONTHLY PASS-THROUGHS. |
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Term
| When investors buy these securities in the secondary market, they do not have to pay the full $25,000 principal. |
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Definition
| Instead, they pay a percentage of the $25,000 face value, depending on how much has been paid in prepayments and in the monthly payments |
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Term
The federal government does not guarantee the debt of the following home loan issuers:
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Federal L Housing Administration (FHA)
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Federal Home Loan Banks (FHLB) −
Federal National Mortgage Association (FNMA)
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FNMA issues bonds to finance the Department of Veterans Affairs, FHA, and conventional mortgage loans.
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Federal Home Loan Mortgage Corporation (FHLMC), or Freddie Mac |
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Definition
The federal government does not guarantee the debt of the following farm loan issuers:
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Federal Land Banks (issue farm loans)
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Bank for Cooperatives (issues loans to farmers’ co-ops)
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Federal Intermediate Credit Banks (issue short-term farm loans)
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Farm Credit System (formerly known as the Federal Farm Credit Consolidated System-Wide Bank) |
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Term
| The Farm Credit System issues mortgage securities, |
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Definition
| discount notes, and bonds for farm loans that are an obligation of all member banks in the Farm Credit System, but are ultimately backed by the mortgages on the farms and ranches. |
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Term
| Student Loan Marketing Association (SLMA), or Sallie Mae, |
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Definition
generates debt securities used to fund the SLMA loans to students for higher education.
Remember for the exam:
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The government doesn’t cover your Fanny!
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If the issuer’s name starts with an “f” (e.g., federal), the debt issues are not guaranteed by the U.S. government. |
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Term
| The government’s long-term marketable and non-marketable debt is subject to |
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Definition
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Term
| The QUOTES ON BONDS AND NOTES are expressed as a percentage of par: |
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Definition
All government-issued bonds and notes trade in 1/32 of a point; T-bills trade in basis points.
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A bond that is quoted at 96.12–96.20 would have a bid price of 96 12/32 and an offer price of 96 20/32. |
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Term
| This means the bid is offered at 96 12/32% of par, and the offer is listed as 96 20/32% of par. |
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Definition
Translated into dollars and cents, the bid is at 96.375% of par and the offer is at 96.625% of par.
Translated into the actual price of the bond, this would be a $963.75 bid, $966.25 offered, since the bonds are $1,000 bonds, not $100 bonds. The decimal must be moved one place to the right. |
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Term
| When buying government securities, the bonds, notes, and bills must be paid for |
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Definition
| the next business day, called the settlement date. |
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Term
| exempt from state and local taxes. |
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Definition
| Interest from the securities issued by the government is subject to federal tax but is |
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Term
| The interest on Government National Mortgage Association (GNMA or Ginnie Mae) |
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Definition
| is subject to both federal and state taxes. |
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Term
| Bonds issued by territories and protectorates are referred to as TRIPLE EXEMPT |
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Definition
| their interest is exempt from federal, state, and local taxes. |
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Term
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Definition
| taxes the interest on the bond.” |
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Term
Debt securities issued by the following are also exempt from state and local taxes:
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Farm Credit System, including:
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The FICB
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The Land Bank
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The Bank for Co-ops |
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Definition
| Debt securities issued by the Federal Home Loan Bank are also exempt from state and local taxes. |
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Term
| The interest on U.S. government bonds and notes is calculated on the number of days elapsed and a 365-day year when determining the amount of days of accrued interest. The test requires you to calculate the days of accrued interest. |
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Definition
Gov't:
Use the following shortcut to calculate the number of days of accrued interest. First, begin with the formula:
SETTLEMENT DATE
- LAST INTEREST DATE
= NUMBER OF MONTHS AND DAYS OF ACCRUED INTEREST |
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Term
| FEDERAL FUNDS are monies on deposit at the Federal Reserve Bank.These funds are deposited by: |
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Definition
| Individuals purchasing U.S. government securities at the auction as noncompetitive purchasers |
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Term
| FEDERAL FUNDS are monies on deposit at the Federal Reserve Bank.These funds are deposited by: |
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Definition
Banks, broker/dealers, and others who are purchasing U.S. government securities at the auction as primary dealers
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Broker/dealers when clearing trades in U.S. governments securities
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Banks with funds in excess of the reserve requirement as mandated by the Federal Reserve System for member banks |
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Term
| Overnight federal funds are very short-term, very safe, |
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Definition
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Term
| The federal funds rate is considered the most volatile interest rate |
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Definition
| is the rate a bank charges for use of its excess federal funds. |
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Term
| Other money market instruments that are not government-issued include: |
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Definition
Commercial paper
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Banker’s acceptances
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Project notes |
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Term
| finance loans for margin purchases by their customers. |
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Definition
| BROKER LOANS are also known as CALL LOANS, because brokerage firms use them |
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Term
| COLLATERALIZED MORTGAGE OBLIGATIONS (CMOs) are the latest of the high-grade debt securities issued in the debt market by broker/dealers. |
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Definition
| All CMOs, including GNMA, FNMA, Freddie Mac are composed of 15-, 20-, 25-, and 30-year home loans. |
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Term
| CMOs are issued in TRANCHES. |
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Definition
| The tranches are issued in increments of $1,000, compared with GNMA and FNMA securities, which are issued in increments of $25,000. |
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Term
| The PREPAYMENT SPEED ASSUMPTIONS (PSA) is a benchmark of assumed principal payment speeds as determined |
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Definition
| by past prepayments for home loans. |
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Term
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Definition
| tranches pay interest on either a monthly, quarterly, or semiannual basis. |
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Term
| As interest rates in the outside market fall, the prepayments on CMOs and their companion tranches increase. |
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Definition
| As interest rates rise, prepayments decrease or are nonexistent. |
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Term
Risk in CMOs
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Since CMOs are backed by a pool of mortgages, the risk of unpaid repayment should be lessened. |
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Definition
If backed by government agency issues (GNMA), this backing may be indicated.
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Remember that the interest and principal are not guaranteed by the U.S. government. If the CMO is backed by a GNMA, the underlying securities, not the payments, are guaranteed by the government.
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If the CMO is not backed by a GNMA, then it is backed by the issuer of the underlying securities. |
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Term
| PLAIN VANILLA CMOs, since they are composed of their |
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Definition
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Term
| Plain Vanilla CMOs are the original CMO securities.These are usually created by broker/dealers |
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Definition
| B/D have purchased a pool of mortgages or a pool of pass-through securities (such as a GNMA) for their account, and then split them up into tranches. |
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Term
| A trustee holds the pool of mortgages or pass-throughs as collateral |
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Definition
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Term
| The creator of the CMO separates the principal and interest |
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Definition
| according to how they will be received and sets them up as tranches. |
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Term
| The shorter tranches are established for the early principal payments, |
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Definition
| the later-maturing mortgages continue until paid. The later-maturing mortgages represent the later interest and principal payments. |
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Term
| Regardless of the amount of principal paid each year, the interest on all tranches will be paid. For this reason, the following is true: |
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Definition
All principal payments are paid sequentially.
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The interest payments are distributed to each tranche according to that tranche’s interest rate.
Early payoffs of the principal are usually applied to the earliest tranche, then sequentially to the later ones. |
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Term
| The drawback of the plain vanilla CMO is that the investor has to be concerned with possible early calls or |
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Definition
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Term
| PAC and TAC tranches have companion securities associated with them. |
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Definition
| The companion securities act as a buffer against excessive prepayments of principal according to the PSA schedule. |
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Term
| When excess principal is paid, the excess goes to the prepayment companion securities of the next earliest maturity years |
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Definition
| than to the main tranche of the PAC or TAC. This makes the tranche (the main tranche) maturity more of a certainty. |
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Term
| The extension-risk companion securities accompany the PAC CMOs only, |
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Definition
| act as a buffer against unexpected lack of principal payments, thus reducing the risk of late payments to the PAC main tranches. |
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Term
| The average life of the extension-risk companion securities varies, |
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Definition
| while the main tranche of the PAC will have greater certainty of cash flow. |
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Term
| The TAC CMO, however, does not have the extension-risk companion securities, |
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Definition
| the main tranche of the TAC has the same uncertainty as the extension-risk companion securities of the PAC CMO. |
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Term
| The prepayment companion securities’ average life is |
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Definition
| shortened when interest rates go down. |
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Term
| The extension-risk companion securities’ average life |
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Definition
| is extended when interest rates go up. |
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Term
| The difference between a PAC tranche and a TAC tranche is: |
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Definition
| A PAC CMO has a main tranche and two companion securities — one for early payments of principal by the borrowers, or prepayments, and one for extension-risk, payments that are late due to mortgage holders who are not refinancing or paying off mortgages as expected. |
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Term
| The difference between a PAC tranche and a TAC tranche is: |
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Definition
| The TAC CMO has a main tranche and only one companion security — the prepayment companion security; therefore, the TAC tranche has a greater chance of being retired late than the PAC. |
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Term
| An investor in either the PAC or the TAC CMO has the choice of investing in the main tranche of the CMO, investing in one of the companion securities, or spreading the investment dollars into a combination of one of the tranches and one or more companion securities. |
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Definition
A person who purchases a PAC tranche has greater certainty of being paid at the end of the tranche period.
A person who purchases a TAC tranche has greater extension risk, but has protection against early calls. |
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Term
| A person who purchases a companion security of either the PAC or the TAC may not be paid on time; |
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Definition
| they may be paid early (prepayment companion) or have the pay-off period extended (extension-risk companion) |
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Term
CMOs are more often quoted in terms of their average life.
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CMO tranches have four main classes: A, B, C, and Z tranches |
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Definition
| The A, B, and C tranches receive interest monthly or semiannually, and the principal when due. |
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Term
Some CMOs have a fifth tranche, the Y tranche.
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The Z (and Y) tranche do not receive anything until the other classes are paid off.
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Many people refer to the Z tranche as the “zero-coupon” tranche, because it is similar in many ways to a zero-coupon bond. |
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Definition
A zero-coupon bond receives nothing until maturity, but a Z tranche does not receive interest or principal until after the A, B, and C tranches are paid their interest and principal.
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The Z tranche is the last tranche to be paid and is very much like a zero-coupon bond. |
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