Unit 7: U.S. Treasury and Government Agency Securities

A customer with an income objective who resides in a state with a high personal income tax might find it best to purchase A. Bonds issued by the U.S. Virgin Islands. B. Mortgage-backed securities issued by the Government National Mortgage Association (GNMA). C. U.S. Treasury STRIPS. D. Corporate bonds with an investment-grade rating.

A. Bonds issued by the U.S. Virgin Islands. Bond issued by U. S. Territories, such as the Virgin Islands, are triple tax-exempt. That is, investors do not have to pay federal, state, or local income taxes on the interest. GNMA and corporate debt securities are taxable on all levels. Although the Treasury STRIP is exempt from state income tax, as a zero coupon bond, it provides no income.

Which of the following statements regarding U.S. government agency obligations are true? I. They are direct obligations of the U.S. government. II. They generally have higher yields than direct U.S. obligations. III. The Federal National Mortgage Association (FNMA) is a publicly traded corporation. IV. Securities issued by the Government National Mortgage Association (GNMA) trade on the NYSE floor. A. II and III B. I and II C. II and IV D. I and III

A. II and III U.S. government agency debt is an obligation of the issuing agency. This obligation causes agency debt to trade at slightly higher yields that reflect this greater risk. FNMA securities and GNMA pass-through certificates trade over the counter. GNMA is the only agency whose securities are direct U.S. government obligations.

Your customer wishes to lock in a long-term yield with minimal risk and is not interested in regular income. Which of the following securities should you recommend? A. Treasury STRIPS B. Treasury bond C. Treasury bill D. Corporate A-rated zero-coupon bond

A. Treasury STRIPS The Treasury STRIPS is long-term, no-interim income security and has a locked-in yield because it is purchased at a discount from par. The Treasury bill is short term, the Treasury bond provides semiannual interest, and the corporate zero is riskier than the STRIPS.

For an investor who needs regular income, a GNMA pass-through certificate would be attractive because A. the investor would receive a monthly check. B. the income is not taxable on the state or local level. C. each check is for the same amount. D. the security has the direct backing of the U.S. government.

A. the investor would receive a monthly check. GMNAs pass through the mortgage payments collected on the pool. Because home mortgages are paid monthly, distributions are made to investors monthly. The fact that GNMAs have the ultimate in security—government backing—does not represent a unique benefit for receiving regular income. Treasury bonds or notes have that backing but only pay interest semiannually. The income from a GNMA is taxable at all levels. Because the mortgage payments, which contain principal as well as interest, include mortgage prepayments, the monthly checks will vary.

Interest income from all of the following are exempt from state and local taxation except A. Treasury bills. B. FNMA mortgage-backed issues. C. Treasury bonds. D. Series EE savings bonds.

B. FNMA mortgage-backed issues. As a general rule, the interest income from U.S. government and agency securities is subject to federal taxation only; it is generally exempt from state and local taxation. However, the interest income from mortgage-backed securities is fully taxable.

U.S. government securities that let investors hold and trade the individual interest and principal components of eligible Treasury notes and bonds as separate securities are I. clipped bonds. II. stripped bonds. III. subject to annual taxation on the per-year accreted amount. IV. subject to taxation at maturity. A. I and IV B. II and III C. I and III D. II and IV

B. II and III U.S. government securities where the interest payments have been stripped from the principal and trade as separate securities are referred to as Treasury STRIPS. These are zero-coupon bonds issued by the U.S. government and are subject to annual taxation on the per-year accreted amount.

Which of the following statements regarding the Government National Mortgage Association (GNMA) is true? A. GNMA originates loans to home buyers and sells the mortgage-backed securities to private lending institutions. B. GNMA approves residential mortgages for home buyers. C. Private lending institutions approved by GNMA originate eligible loans and sell the mortgage-backed securities to investors. D. Lending institutions apply to GNMA for funds to lend to residential home buyers.

C. Private lending institutions approved by GNMA originate eligible loans and sell the mortgage-backed securities to investors. GNMA is a government-owned corporation that approves private lending institutions, such as banks and mortgage companies, to originate eligible loans, pool them into securities, and sell the GNMA mortgage-backed securities to investors. GNMA does not originate loans, and it does not issue or sell securities.

Treasury STRIPS and Treasury receipts are quoted based on A. 0.125 (⅛ of a point in dollars). B. 0.03125 (1/32 of a point in dollars). C. yield to maturity. D. amortization of premiums.

C. yield to maturity. Noninterest-bearing securities, like zeroes, are quoted based on their yield to maturity. They are sold at a discount and mature at par.

Which of the following statements regarding the Federal Farm Credit System securities are not true? A. Interest is tax exempt at the state and local levels. B. They issue short-term notes and long-term bonds. C. The proceeds are used to make loans to farmers. D. They are direct obligations of the U.S. government.

D. They are direct obligations of the U.S. government. With the exception of Ginnie Mae, all agency securities are indirect obligations of the U.S. government.