U.S. Government Debt
A customer with $25,000 to invest could buy: A. 1 mortgage backed pass through certificate at par B. 2 mortgage backed pass through certificates at par C. 10 mortgage backed pass through certificates at par D. 50 mortgage backed pass through certificates at par
A. 1 mortgage backed pass through certificate at par Mortgage backed pass through certificates are sold in minimum denominations of $25,000 (instead of the typical $1,000 for other bonds and $100 for Treasury issues). They have a much higher minimum to discourage small investors (who tend to be less sophisticated) from buying them - because they have difficult to quantify risks of shortening or lengthening maturities, due to interest rates falling or rising, respectively. A customer with $25,000 to invest could buy 1 of these certificates at par.
Treasury Notes are issued by the U.S. Government in which form? A. Book Entry B. Bearer C. Registered to Principal Only D. Registered to Principal and Interest
A. Book Entry All U.S. Government securities are issued in book entry form only.
Which Treasury security is NOT sold on a regular auction schedule? A. CMBs B. Treasury Bills C. STRIPS D. TIPS
A. CMBs CMBs are Cash Management Bills. They are sold at auction by the Treasury on an "as needed" basis to meet unexpected cash shortfalls, so they are not part of the regular auction cycle. They are the shortest-term U.S. government security, often with maturities as short as 5 days. They are sold in $100 minimums at a discount to par value, just like Treasury Bills.
Which of the following is the most likely purchaser of STRIPS? A. Pension fund B. Money market fund C. Individual seeking current income D. Individual wishing to avoid purchasing power risk
A. Pension fund Pension funds and retirement accounts are the large purchasers of STRIPS. These zero-coupon bonds are purchased at a deep discount and are held to maturity to fund future retirement liabilities. There is little credit risk, because the U.S. Treasury is a top credit. There is no current income because they don't pay until maturity. They have a huge amount of purchasing power risk as a long-term zero coupon obligation, but this is not an issue of they are held to maturity.
All of the following are true statements regarding Treasury Bills EXCEPT: A. T-Bills are issued in bearer form in the United States B. T-Bills are registered in the owner's name in book entry form C. T-Bills are issued at a discount D. T-Bills are non-callable
A. T-Bills are issued in bearer form in the United States T-Bills are registered in the owner's name in book entry form; no bearer securities can currently be issued in the U.S. to individual residents. T-Bills are original issue discount obligations and are not callable, since they are short term obligations.
Which of the following is a zero coupon original issue discount obligation? A. Treasury STRIPS B. Treasury Notes C. Treasury Bonds D. Treasury TIPS
A. Treasury STRIPS Treasury Bills and STRIPS are zero coupon original issue discount obligations that do not have a stated interest rate. Treasury Notes and Bonds are issued at par with a stated interest. rate. TIPS pay a floating rate of interest based on the inflation rate.
Treasury notes: A. are issued in minimum $100 denominations B. are issued at a discount C. have maturities between 10 and 20 years at issuance D. mature at par plus accrued interest
A. are issued in minimum $100 denominations Treasury notes are issued at par in minimum denominations of $100 each, and pay interest semi-annually. At maturity, the bondholder receives par. Maturities at issuance range between 2 and 10 years.
A high income client who lives in California would be more likely to be a Treasury security as an investment because the interest income is: A. exempt from California state income tax B. exempt from federal income tax C. exempt from both California state income tax and federal income tax D. subject to both California state income tax and federal income tax
A. exempt from California state income tax The interest income received from U.S. Government obligations is subject to federal income tax, but is exempt from state and local income taxes (one level of government cannot tax the other's obligations). Thus, Treasury securities are a more attractive investment for customers looking for a very safe investment who reside in high income tax states (like New York and California). They are a less attractive investment for customers who live in states that have no income tax (like Florida and Texas).
Payments to holders of Ginnie Mae pass-through certificates are made: A. monthly and represent a payment of both interest and principal B. monthly and represent a payment of only interest C. semi-annually and represent a payment of both interest and principal D. semi-annually and represent a payment of only interest
A. monthly and represent a payment of both interest and principal All pass-through certificates pass on the monthly mortgage payments received from the pooled mortgages to the certificate holders. Thus, payments are received monthly. These represent a payment of both interest and principal on the underlying mortgages.
Which statement is TRUE about the Federal National Mortgage Association (FNMA)? A. FNMA is a publicly traded corporation that issues pass through certificates guaranteed by the U.S. Government B. FNMA is a publicly traded corporation that issues pass through certificates which are not guaranteed by the U.S. Government C. FNMA is owned by the U.S. Government and issues pass through certificates that are U.S. Government guaranteed D. FNMA is owned by the U.S. Government and issues pass through certificates that are not guaranteed by the U.S. Government
B. FNMA is a publicly traded corporation that issues pass through certificates which are not guaranteed by the U.S. Government Fannie Mae performs the same functions as Ginnie Mar except that its pass through certificates are not guaranteed by the U.S. Government; and it has been "sold off" as a public company. Its stock was listed for trading on the NYSE, but Fannie went "bust" in 2008 after purchasing too many "sub prime" mortgages and was placed into government conservatorship. Its shares were delisted from the NYSE and now trade OTC in the Pink OTC Markets.
Which investment does NOT have purchasing power risk? A. STRIPS B. TIPS C. Treasury Bonds D. Treasury Receipts
B. TIPS Purchasing power risk is the risk that inflation will cause interest rates to increase; and therefore, bond prices will fall. "TIPS" are Treasury Inflation Protection Securities - the principal amount of these securities is adjusted upwards with the rate of inflation. Even though the interest rates is fixed, the holder receives a higher total payment, due to the increased principal amount. When the bond matures, the holder receives the higher principal amount. Thus, there is no purchasing power risk with these securities. STRIPS are zero-coupon Treasury obligations - these have the highest level of purchasing power risk. If there is inflation, market interest rates are forced upwards, and zero-coupon bonds such as STRIPS fall dramatically in price (Treasury Receipts are broker-created zero-coupon bonds). Longer term T-Bonds are also susceptible to purchasing power risk, though not as badly as long-term zero-coupon bonds. The bonds that have the lowest purchasing power risk are short term money market instruments and TIPS.
Which statement is TRUE regarding Treasury Inflation Protection securities in periods of deflation? A. The amount of each interest payment will stay the same and the principal amount received at maturity is unchanged at par B. The amount of each interest payment will decline and the principal amount received at maturity is unchanged at par C. The amount of each interest payment will stay the same and the principal amount received at maturity will decline D. The amount of each interest payment will decline and the principal amount received at maturity will decline
B. The amount of each interest payment will decline and the principal amount received at maturity is unchanged at par Treasury "TIPS" are Treasury Inflation Protection Securities - the principal amount of these securities is adjusted upwards with the rate of inflation. Even though the interest rate is fixed, the holder receives a higher interest payment, due to the increased principal amount. When the bond matures, the holder receives the higher principal amount. In periods of deflation, the principal amount is adjusted downwards. Even though the interest rate is fixed, the holder receives a lower interest payment, due to the decreased principal amount. In the situation where the principal amount has been adjusted below par due to deflation, when the bond matures, the holder receives par - not the decreased principal amount - a real benefit if an investor is concerned about deflation.
Which statement is TRUE when comparing Treasury Notes to Treasury STRIPS? A. Treasury Notes pay interest annually B. Treasury STRIPS pay interest at maturity C. Treasury STRIPS pay interest semi-annually D. Treasury Notes pay interest at maturity
B. Treasury STRIPS pay interest at maturity Treasury Notes are government obligations maturing between 1 year and 10 years which pay interest semi-annually. Treasury STRIPS are notes or bonds "stripped" of coupons, meaning all that is left is the principal repayment portion of the note or bond (sometimes called the "corpus" or body). STRIPS are zero coupon original issue discount obligations that do not have a stated interest rate. The accretion of the discount over the bond's life represents the interest earned.
The Government National Mortgage Association A. buys conventional mortgages from financial institutions for repackaging as pass through certificates B. buys FHA and VA guaranteed mortgages from financial institutions for repackaging as pass through certificates C. gives its implied backing to the payment of interest and principal on mortgages purchased form financial institutions D. issues mortgages directly on U.S. Government subsidized housing
B. buys FHA and VA guaranteed mortgages from financial institutions for repackaging as pass through certificates Ginnie Mae buys FHA and VA guaranteed mortgages from banks and assembles them into pools. GNMA then sells undivided interests in these pools as pass-through certificates. The monthly mortgage payments are passed through to the certificate holders. GNMA guarantees the payment of interest and principal on the underlying mortgages and has the direct backing of the U.S. Government. The agencies that have an implied U.S. Government backing are Fannie Mae and Freddie Mac.
The nominal interest rate on a TIPS is: A. the same as the rate on an equivalent maturity Treasury Bond B. less than the rate on an equivalent maturity Treasury Bond C. more than the rate on an equivalent maturity Treasury Bond D. unrelated to the rate on an equivalent maturity Treasury Bond
B. less than the rate on an equivalent maturity Treasury Bond The interest rate placed on a TIPS (Treasury Inflation Protection Security) is less than the rate on an equivalent maturity Treasury Bond. For example, a 30 year Treasury Bond might have a coupon rate of 4%; but a 30 year TIPS has a coupon rate of 2.75%. The "difference" between the two is the current market expectation for the inflation rate (1.25% in this example). The reason why the TIPS sells at a a lower coupon rate is that, every year, the principal amount is adjusted upwards by that year's inflation rate. So there are really 2 components of return on a TIPS - the lower coupon rate plus the principal adjustment equal to that year's inflation rate.
A security which gives the holder an undivided interest in a pool of mortgages is known as a: A. unit investment trust B. pass through certificate C. first mortgage bond D. face amount certificate
B. pass through certificate The question defines a pass through certificate - an undivided interest in a pool of mortgages, where the mortgage payments are passed through to the certificate holders
A security which gives the holder an undivided interest in a pool of mortgages is known as a(n): A. equity real estate investment trust B. pass through certificate C. first mortgage bond D. mortgage real estate investment trust
B. pass through certificate The question defines a pass through certificate - an undivided interest in a pool of mortgages, where the mortgage payments are passed through to the certificate holders. Real Estate Investment Trusts (REITs) are investment companies similar to closed end funds. In such an investment, one owns a trust unit; however the unit does not represent a undivided ownership interest in the underlying real estate or mortgages. Mortgage bonds are issued by corporations pledging real estate as collateral.
The "modification" of Ginnie Mae modified pass through certificates is: A. the pooling of mortgages of similar maturities to back the security B. the guarantee of the U.S. Government C. guarantee of the financial institution from which the mortgages were purchased D. the setting of a fixed interest rate for the pool of mortgages backing the security
B. the guarantee of the U.S. Government Ginnie Mae Pass through certificates are termed "modified" because they are backed by the U.S. Government as well as the agency. Fannie Mae and Freddie Mac offer pass through certificates that are not modified because there is no government guarantee.
The minimum denomination on a mortgage backed pass through certificate is: A. $1,000 B. $10,000 C. $25,000 D. $100,000
C. $25,000 Mortgage backed pass through certificates are sold in minimum denominations of $25,000 (instead of the typical $1,000 for other bonds and $100 for Treasury issues). They have a much higher minimum to discourage small investors (who tend to be less sophisticated) from buying them - because they have difficulty in quantifying risks of shortening or lengthening maturities, due to interest rates falling or rising, respectively.
Which investment gives the greatest protection against purchasing power risk? A. 10 year Double Barreled Bonds B. 10 year Guaranteed Bonds C. 10 year TIPS D. 10 year STRIPS
C. 10 year TIPS The best answer is C. Purchasing power risk is the risk that inflation will cause interest rates to increase; and therefore, bond prices will fall. Since all of the choices have the same maturity, this is not a factor. "TIPS" are Treasury Inflation Protection Securities - the principal amount of these securities is adjusted upwards with the rate of inflation. Even though the interest rate is fixed, the holder receives a higher total payment, due to the increased principal amount. When the bond matures, the holder receives the higher principal amount. Thus, there is no purchasing power risk with these securities. STRIPS are zero-coupon Treasury obligations - these have the highest level of purchasing power risk.
Which statement is FALSE about CMBs? A. CMBs are used to smooth out cash flow B. CMBs are sold at a discount to par C. CMBs are sold at a regular weekly auction D. CMBs are direct obligations of the U.S. government
C. CMBs are sold at a regular weekly auction CMBs are Cash Management Bills. They are sold at auction by the Treasury on an "as needed" basis to meet unexpected cash shortfalls, so they are not part of the regular auction cycle. They are the shortest-term U.S. government security, often with maturities as short as 5 days. They are sold in $100 minimums at a discount to par value, just like Treasury Bills.
Which statement is FALSE about CMBs? A. CMBs are used to smooth out cash flow B. CMBs are sold at a discount to par C. CMBs are sold at a slightly lower yield than T-Bills D. CMBs are direct obligations of the U.S. government
C. CMBs are sold at a slightly lower yield than T-Bills CMBs are Cash Management Bills. They are sold at auction by the Treasury on an "as needed" basis to meet unexpected cash shortfalls, so they are not part of the regular auction cycle. They are the shortest-term U.S. government security, often with maturities as short as 5 days. They are sold in $100 minimums at a discount to par value, just like Treasury Bills.
Which of the following is a TRUE statement regarding Fannie Mae? A. Fannie Mae has only issued negotiable debt securities B. Fannie Mae has only issued negotiable equity securities C. Fannie Mae has issued negotiable debt and equity securities D. Fannie Mar has not issued negotiable securities
C. Fannie Mae has issued negotiable debt and equity securities Fannie Mae is a privatized agency that is publicly traded. Its stock was listed for trading on the NYSE, but Fannie went "bust" in 2008 after purchasing too many "sub prime" mortgages and was placed into government conservatorship. Its shares were delisted from the NYSE and now trade OTC in the Pink OTC Markets. Any security that trades is negotiable, so this term applies to Fannie Mae stock. The debt securities (mortgage backed pass through certificates) that are issued by Fannie Mae also trade over-the-counter. Remember that the debt market is an OTC market.
A customer wishes to buy a security that provides monthly payments for his retirement. Which of the following is suitable? A. Treasury Bonds B. Income Bonds C. GNMA Pass Through Certificates D. Treasury Notes
C. GNMA Pass Through Certificates Ginnie Mae Pass Through Certificates "pass through" monthly mortgage payments to the certificate holders. Each payment is a combination of interest and principal from the underlying mortgage pool. Treasury Bonds and Notes pay interest semi-annually. Income bonds pay interest only if the corporate issuer as sufficient earnings.
Which statement is TRUE about the Government National Mortgage Association (GNMA)? A. GNMA is a publicly traded corporation that issues pass through certificated which are guaranteed by the U.S. government B. GNMA is a publicly traded corporation that issues pass through certificates which are not guaranteed by the U.S. government C. GNMA is owned by the U.S. Government and issues pass through certificated which are guaranteed by the U.S. Government D. GNMA is owned by the U.S. Government and issues pass through certificated which are not guaranteed by the U.S. Government
C. GNMA is owned by the U.S. Government and issues pass through certificated which are guaranteed by the U.S. Government GNMA performs the same function as Fannie Mae except that its pass through certificates are guaranteed by the U.S. Government; and it remains an agency of the government. It has not been "sold off" as a private company, like Fannie Mae, which, since it is bankrupt and is in government conservatorship, now trades OTC. For as long as the government continues to guarantee Ginnie Mae securities, it cannot be a publicly traded company.
Which statement is FALSE regarding Treasury Inflation Protection securities? A. In periods of inflation, the coupon rate remains unchanged B. In periods of inflation, the amount of each interest payment will increase C. In periods of inflation, the principal amount received at maturity will be par D. In periods of inflation, the principal amount received at maturity is more than par
C. In periods of inflation, the principal amount received at maturity will be par Treasury "TIPS" are Treasury Inflation Protection Securities - the principal amount of these securities is adjusted upwards with the rate of inflation. Even though the interest rate is fixed, the holder receives a higher interest payment, due to the increased principal amount. When the bond matures, the holder receives the higher principal amount.
How is the interest income received from U.S. Government obligations taxed? A. Subject to both federal and state income tax B. Exempt from both federal and state income tax C. Subject to federal income tax and exempt from state income tax D. Exempt from federal income tax and subject to state income tax
C. Subject to federal income tax and exempt from state income tax Thee interest income received from U.S. Government obligations is subject to federal income tax, but is exempt from state and local income taxes (one level of government cannot tax the other's obligations)
All of the following are true statements about Treasury Bills EXCEPT: A. T-Bills are traded at a discount from par B. T-Bills are the most actively traded money market instrument C. T-Bills have a maximum maturity of 9 months D. T-Bills can be purchased directly at weekly auction
C. T-Bills have a maximum maturity of 9 months T-Bills have a maximum maturity of 12 months, not 9 months. They are sold at a discount from par; are the most widely traded money market instrument since the bulk of the government's financing is through T-Bills; and can be purchased directly at auction by anyone who tenders a non-competitive bid.
Which of the following is a FALSE statement regarding Treasury Bills? A. The maturity is 52 weeks or less B. Treasury Bills trade at a discount to par C. Treasury Bills are callable at any time at par D. Payment is backed by the full faith and credit of the U.S. Government
C. Treasury Bills are callable at any time at par Treasury Bills are original issue discount obligations of the U.S. Government which mature in 52 weeks or less. They are not callable (as a rule, short term obligations are never callable - why would the issuer bother calling in obligations that will mature in the near future?)
The nominal interest rate on a TIPS approximates the: A. discount rate B. federal funds rate C. real interest rate D. expected interest rate
C. real interest rate
Which investment gives the LEAST protection against purchasing power risk? A. 6 month Treasury Bill B. 10 year Treasury Note C. 10 year Treasury "TIPS" D. 10 year Treasury "STRIPS"
D. 10 year Treasury "STRIPS" Purchasing power risk is the risk of inflation - that the prices of goods and services rises faster than real economic growth. When there is significant inflation, interest rates rise. And this causes bond prices to fall. Treasury "TIPS" are Treasury Inflation Protection Securities - the principal amount of these securities is adjusted upwards with the rate of inflation. Even though the interest rate is fixed, the holder receives a higher interest payment, due to the increased principal amount. When the bond matures, the holder receives the higher principal amount. Thus, there is no purchasing power risk with these securities. Treasury STRIPS are zero-coupon Treasury obligations - these have the highest level of purchasing power risk. If there is significant inflation and interest rates rise, these securities do not provide semi-annual interest payments that can be reinvested at higher and higher rates. Rather, all the value is in the single final payment. And if this is discounted to today's value at increasing interest rates, its present value falls - rapidly. In contrast, 6 month Treasury bills have a low level of purchasing power risk. Since they will mature at par in the near future, their value cannot fall very far below this if interest rates rise.
Which statement is TRUE about CMBs? A. CMBs are sold at par at a regular weekly auction B. CMBs are sold at a discount at a regular weekly auction C. CMBs are sold at par on an "as needed" basis D. CMBs are sold at a discount on an "as needed" basis
D. CMBs are sold at a discount on an "as needed" basis CMBs are Cash Management Bills. They are sold at auction by the Treasury on an "as needed" basis to meet unexpected cash shortfalls, so they are not part of the regular auction cycle. They are the shortest-term U.S. government security, often with maturities as short as 5 days. They are sold in $100 minimums at a discount to par value, just like Treasury Bills.
Which statement about the Government National Mortgage Association Pass-Through Certificates is FALSE? A. GNMA is empowered to borrow from the Treasury to pay interest and principal if necessary B. Interest payments are taxable at the Federal, State and Local levels C. The credit rating is considered the highest of any agency security D. Certificates are issued in minimum units of $10,000
D. Certificates are issued in minimum units of $10,000 Ginnie Mae is backed by the guarantee of the U.S. Government, making it the highest credit rated agency security. The other agencies are only implicitly backed. Interest received by the holder of a mortgage backed pass through security is fully taxable by federal, state, and local governments. Certificates are issued in minimum $25,000 denominations. For most investors this is too much money to invest, so they buy shares of a Ginnie Mae mutual fund instead.
Which statement about Treasury STRIPS is TRUE? A. Treasury STRIPS are suitable investments for individuals seeking current income B. Treasury STRIPS are not suitable investments for retirement accounts C. The holder is subject to default risk D. The holder is not subject to reinvestment risk
D. The holder is not subject to reinvestment risk Treasury STRIPS are government bonds that are "stripped" of coupons. These issues are very safe but do not provide current income. STRIPS are often placed into retirement accounts by conservative investors. This is a zero coupon obligation with a "locked in" rate of return over the life of the bond (thus, it is not subject to reinvestment risk).
Which statement regarding Treasury Bills is FALSE? A. T-Bills are original issue discount obligations B. T-Bills are auctioned off weekly by the Federal Reserve C. When T-Bills mature, the difference between the purchase price and the redemption price is taxable as interest income D. Treasury Bills are an agency security
D. Treasury Bills are an agency security Treasury Bills are original issue discount obligations. They are auctioned off weekly by the Federal Reserve acting as agent for the U.S. Treasury. When the bills mature, the difference between the purchase price and the redemption value at par is taxable as interest income. T-Bills are a direct obligation of the U.S. Government.
Which U.S. Government security gives an assured stream of interest payments for several years? A. Treasury Receipt B. Treasury STRIP C. Treasury Bill D. Treasury Bond
D. Treasury Bond Treasury bonds are issued with 30 year maturity and are non-callable. Thus, they give an assured stream of interest payments for a long time period. Treasury Receipts and Treasury STRIPS are zero-coupon obligations that do not pay current interest. T-Bills have a maximum maturity of 52 weeks, and thus will not provide income over many years.
Treasury notes and bonds are: A. bearer securities B. registered to interest only C. registered to principal only D. fully registered in book entry form
D. fully registered in book entry form Treasury Bills, Notes and Bonds are only available in entry form
Series EE bonds: A. are negotiable B. are issued in minimum denominations of $100 C. pay interest semi-annually D. pay interest at redemption
D. pay interest at redemption Series EE bonds are "savings bonds" issued by the U.S. Government with a minimum purchase amount of $25 (or more). The interest rate is set at the date of issuance. Interest is "earned" monthly and credited to the principal amount every 6 months. The bonds have no stated maturity - the holder can redeem at any time, however interest is only credited to the bonds for 30 years. Savings bonds do not trade - they are issued by the Treasury and are redeemed with the Treasury. No physical certificates are issued - the bonds are issued in electronic form.
A pass through certificate is best described as a: A. corporation or trust through which investors pool their money in order to obtain diversification and professional management B. security which is backed by the full faith, credit, and taxing power of the U.S. Government C. security which is backed by real property and/or a lien on real estate D. security which gives the holder an undivided interest in a pool of mortgages
D. security which gives the holder an undivided interest in a pool of mortgages A pass through certificate is a security which gives the holder an undivided interest in a pool of mortgages. The mortgage payments are "passed through" to the certificate holders.
All of the following are true statements about Treasury STRIPS EXCEPT: A. the investor's interest rate is locked at purchase, eliminating any reinvestment risk B. at maturity, there is no capital gain C. the income is accreted and taxed annually D. these are suitable investments for individuals seeking current income and a high level of safety
D. these are suitable investments for individuals seeking current income and a high level of safety Treasury STRIPS are government bonds that are "stripped" of coupons. They do not provide current income. The discount on the bonds must be accreted annually, with the annual accretion amount being taxable as interest income. As the bond is accreted, its cost basis is adjusted upwards so that at maturity, the bond has an adjusted cost basis of par. Therefore, no taxable capital gain is realized at maturity. This is a zero coupon obligation with a "locked in" rate of return over the life of the bond.