Compare Debt Securities - Series 7
- What is the primary difference between a Treasury note and a Treasury bond?
- Original maturity: note – years; bond years. Treasury notes and bonds differ mainly in issuance maturity, with notes shorter to distinguish intermediate from long-term debt.
- What is a collateralized mortgage obligation (CMO)?
- MBS structured into tranches with different cash-flow priorities. CMOs allocate prepayment risks unevenly across tranches, offering investors choices in maturity and risk profiles.
- What is the key difference in backing between GNMA MBS and FNMA/FHLMC MBS?
- GNMA has U.S. government guarantee; FNMA/FHLMC do not. GNMA's full faith and credit guarantee ensures timely payments, reducing credit risk compared to GSEs' corporate status.
- What is the defining feature of a zero-coupon bond regarding interest payments?
- No periodic interest; issued at a discount and accretes. Zeros provide return through accretion to par value at maturity, appealing to investors seeking no reinvestment risk.
- What is the key tax feature of interest on U.S. Treasury securities for state and local taxes?
- Exempt from state and local income tax. Federal law exempts Treasury interest from state and local taxation to encourage investment in government debt.
- What is the conversion ratio on a convertible bond?
- Number of shares received per bond upon conversion. The ratio determines equity value received, set to make conversion attractive when stock price exceeds parity.
- What is a STRIPS in the U.S. Treasury market?
- Treasury principal or interest coupon stripped into a zero. STRIPS create zero-coupon securities by separating coupons and principal, allowing investors to buy discounted components.
- What is a corporate mortgage bond?
- Secured bond backed by a lien on specific real property. Mortgage bonds provide security through pledged real estate, giving holders a claim on assets in case of default.
- What is an agency security issued by a government-sponsored enterprise (GSE)?
- Debt of a federally chartered entity, not a U.S. Treasury. GSEs like Fannie Mae issue agency debt to support housing, carrying implicit government support but not full backing.
- Which has higher credit risk: U.S. Treasury bonds or corporate bonds of the same maturity?
- Corporate bonds. Corporate bonds carry issuer default risk, unlike Treasuries backed by the U.S. government's full faith and credit.
- Which U.S. Treasury security has the shortest original maturity (up to 1 year)?
- Treasury bill (T-bill). T-bills are issued with maturities of 4, 8, 13, 17, 26, or 52 weeks, making them the shortest-term Treasury securities.
- What is extension risk in mortgage-backed securities?
- Rates rise, prepayments slow, and average life extends. Higher rates reduce refinancings, prolonging mortgage durations and exposing investors to longer interest rate risk.
- What does it mean that U.S. Treasury securities are backed by the "full faith and credit" of the U.S.?
- They are direct obligations of the U.S. government. This backing ensures the highest credit quality as the U.S. government pledges its taxing power and resources to repay.
- What is a municipal bond's key federal tax feature for most investors?
- Interest is generally exempt from federal income tax. This exemption lowers effective yields, making munis attractive to high-tax-bracket investors seeking tax-advantaged income.
- In a corporate liquidation, which is paid first: secured bondholders or subordinated debenture holders?
- Secured bondholders. Secured bondholders have priority claims on specific collateral, ahead of unsecured or subordinated creditors in liquidation.
- What is prepayment risk in mortgage-backed securities?
- Borrowers repay early, changing timing and yield of cash flows. Prepayments from refinancings or sales accelerate principal return, altering expected yields and cash flow timing.
- What is a callable bond?
- Bond the issuer may redeem before maturity at stated terms. Call provisions allow issuers to refinance at lower rates, benefiting them when interest rates decline.
- What is a corporate debenture?
- Unsecured corporate bond backed by the issuer's credit. Debentures rely solely on the issuer's general creditworthiness without collateral, ranking below secured debt in bankruptcy.
- Which agency/GSE MBS typically carries the least credit risk: Ginnie Mae, Fannie Mae, or Freddie Mac?
- Ginnie Mae (GNMA). GNMA securities are explicitly guaranteed by the U.S. government, unlike the implicit backing of Fannie and Freddie.
- Which security has inflation-adjusted principal and pays interest on the adjusted principal?
- TIPS (Treasury Inflation-Protected Securities). TIPS protect against inflation by adjusting principal based on CPI, with interest paid semiannually on the adjusted amount.
- What is a convertible bond?
- Bond exchangeable into a stated number of common shares. Convertibles offer equity upside potential while providing fixed-income downside protection until conversion.
- What is a putable bond?
- Bond the holder may force the issuer to redeem early. Put options protect holders by allowing sale back to issuer at par, useful if rates rise or credit deteriorates.
- What is a pass-through mortgage-backed security (MBS)?
- Security that passes mortgage principal and interest to holders. Pass-throughs distribute pro-rata shares of mortgage pool cash flows, providing monthly income from underlying loans.
- What is the investor's primary risk with a callable bond when rates fall?
- Reinvestment risk due to early redemption. Falling rates prompt issuers to call bonds, forcing investors to reinvest proceeds at lower prevailing yields.
- When interest rates fall, what typically happens to MBS prepayments and average life?
- Prepayments rise; average life shortens. Lower rates encourage mortgage refinancings, increasing prepayments and shortening the security's effective duration.