The series EE bonds are commonly known as savings bonds. They are purchased directly from the U.S. government at a discount from their face value, typically 50%. The Series EE bonds pay no semiannual interest and may be redeemed at maturity for the face value. The investor's interest is earned through the bonds' appreciation toward the face value. The interest earned through this appreciation is taxable by the federal government and the investor may pay taxes on this money each year or may wait until the bond matures. The investor also may elect to roll the matured Series EE bonds into Series HH bonds and continue to defer taxes.
A Series HH bond may only be purchased by trading in matured Series EE bonds. They may not be purchased for cash. Series HH bonds, unlike EEs, pay semiannual interest and are available in denominations of $500 to $10,000 and mature in 10 years. Series HH bonds may be redeemed at their face value at any time.
The most widely held U.S. government securities are Treasury bills, notes, and bonds. These direct obligations of the U.S. government range from one month up to 30 years.
Treasury bills range in maturity from four to 52 weeks and are auctioned off by the Treasury Department through a weekly competitive auction. Large banks and broker dealers, known as primary dealers, submit competitive bids or tenders for the bills being sold. The Treasury awards the bills to the bidders who submitted the highest bid and work their way down to lower bids until all of the bills are sold. Treasury bills pay no semiannual interest and are issued at a discount from par. The bill appreciates up to par at maturity and the appreciation represents the investor's interest. Because bills are priced at a discount from par, a higher dollar price represents a lower interest rate for the purchaser.
All noncompetitive tenders are filled before any competitive tenders are filled. A bidder who submits a noncompetitive tender agrees to accept the average of all the yields accepted by the Treasury and does not try to get the best yield. All competitive tenders are limited to a maximum amount of $500,000. All bids that are accepted and filled by the Treasury are settled in fed funds. Treasury bills range in denominations from $100 up to $1,000,000.
Treasury notes are the U.S. government's intermediate-term security and range in term from one year up to 10 years. Treasury notes pay semiannual interest and are auctioned off by the Treasury every four weeks. Treasury notes are issued in denominations ranging from $100 up to $1,000,000 and may be refunded by the government. If a Treasury note is refunded, the government will offer the investor a new Treasury note with a new interest rate and maturity. The investor may always elect to receive their principal payment instead of accepting the new note.
Treasury bonds are the U.S. government's long-term bonds. Maturities on Treasury bonds range from 10 years up to 30 years. Treasury bonds, like Treasury notes, pay semiannual interest and are issued in denominations ranging from $100 up to $1,000,000. Some Treasury bonds may be called in at par by the treasury. If the Treasury Department calls in a bond issue, they must give holders four months' notice before calling the bonds.
Treasury notes and bonds are quoted as a percentage of par. However, unlike their corporate counterparts, Treasury notes and bonds are quoted as a percentage of par down to 32nds of 1%. For example, a Treasury bond quote of 92.02 translates into:
A quote of 98.04 translates into:
It is important to remember that the number after the decimal points represents 32nds of a percent.
| Treasury Security | Type of Interest | Term | Priced |
| Bill | None | 4, 13, 26, 52 weeks 1, 3, 6, 12 months |
At a discount from par |
| Note | Semiannual | 1–10 years | As a percentage of par to 32nds of 1% |
| Bond | Semiannual | 10–30 years | As a percentage of par to 32nds of 1% |
The minimum denomination for purchasing a Treasury bill, note, or bond from TreasuryDirect.gov is $100. All quotes in the secondary market are based on $1,000 par value.
The term Treasury STRIPs actually stands for separate trading of registered interest and principal securities. The Treasury securities are separated into two parts: a principal payment and semiannual interest payments. A Treasury STRIP is a zero-coupon bond that is backed by U.S. government securities. An investor may purchase the principal payment component of $1,000 due on a future date at a discount. An investor seeking some current income may wish to purchase the semiannual coupon payments due over the term of the Treasury securities.
A STRIP may be purchased by an investor who needs to have a certain amount available on a known date in the future (like the time when a child is going to college). By purchasing the STRIP, the investor will be guaranteed to have $1,000 on that date in the future for each STRIP purchased.
Treasury receipts are similar to Treasury STRIPs, except that broker dealers and banks create them. Broker dealers and banks will purchase large amounts of Treasury securities, place them in a trust, and sell off the interest and principal payments to different investors.
Treasury inflation protected securities, or TIPS, offer the investor protection from inflation. The TIPS are sold with a fixed interest rate and their principal is adjusted semiannually to reflect changes in the consumer price index. During times of inflation, the principal amount of the TIP will be increased and the investor's interest payments will rise, while during times of falling prices, the principal amount of the bond will be adjusted down and the investor will receive a lower interest payment.
The federal government has authorized certain agencies and certain quasi agencies to issue debt securities that are collectively referred to as agency issues. Revenues generated through taxes, fees, and interest income back these agency securities. Investors who purchase agency securities are offered interest rates that generally fall in between the rates offered by similar term Treasury and corporate securities. Investors who purchase agency issues in the secondary market will be quoted prices for the agency issues that are based on a percentage of par just like corporate issue.
The Government National Mortgage Association often referred to as Ginnie Mae is a wholly owned government corporation and is the only agency whose securities are backed by the full faith and credit of the U.S. government. The purpose of Ginnie Mae is to provide liquidity to the mortgage markets. Ginnie Mae buys up pools of mortgages that have been insured by the Federal Housing Administration (FHA) and the Department of Veteran Affairs (VA). The ownership in these pools of mortgages then is sold off to private investors in the form of pass-through certificates. Investors in Ginnie Mae pass-through certificates receive monthly interest and principal payments based on their investment. As people pay down their mortgages, part of each payment is interest and part of each payment is principal and both portions flow through to the investor on a monthly basis. The only real risk in owning a Ginnie Mae is the risk of early refinancing. As the interest rates in the marketplace fall, people are more likely to refinance their homes and, as a result, the investor will not receive the higher interest rates for as long as they had hoped. Ginnie Mae pass-through certificates are issued with a minimum denomination of $1,000 and the interest earned by investors is taxable at all levels: federal, state, and local. Yield quotes on Ginnie Maes are based on a 12-year prepayment assumption because most mortgages are repaid early as a result of refinancing, moving, or a homeowner simply paying off their mortgage.
The Federal National Mortgage Association, also known as Fannie Mae, is a public for-profit corporation. Fannie Mae's stock trades publicly and is in business to realize a profit by providing mortgage capital. It's called an agency security because Fannie Mae has a credit facility with the government and receives certain favorable tax considerations. Fannie Mae purchases mortgages and, in turn, packages them to create mortgage-backed securities. These mortgage-backed notes are issued in denominations from $5,000 to $1,000,000 and pay interest semiannually. Fannie Mae also issues debentures with a minimum denomination of $10,000 that mature in three to 25 years. Interest is paid semiannually and the interest earned by investors from Fannie Mae securities is taxable at all levels: federal, state, and local.
The Federal Home Loan Mortgage Corporation also known as Freddie Mac is a publicly traded company in business to earn a profit on its loans. Freddie Mac purchases residential mortgages from lenders and, in turn, packages them into pools and sells off interests in those pools to investors. Interest earned by investors from FHLMC-issued securities is taxable at all levels: federal, state, and local.
The Federal Farm Credit System is a group of privately owned lenders that provide different types of financing for farmers. The FFCS sells off farm credit securities in order to obtain the funds to provide to the farmers. The securities are the obligations of all the lenders in the system and are not backed by the U.S. government. The securities pay interest every six months and are only available in book-entry form. There are several lenders of which you need to be aware:
A collateralized mortgage obligation is a mortgage-backed security issued by private finance companies, as well as by FHLMC and FNMA. The securities are structured much like a pass-through certificate and their term is set into different maturity schedules, known as tranches. Pools of mortgages on one-family to four-family homes collateralize CMOs. Because CMOs are backed by mortgages on real estate, they are considered relatively safe investments and are given a AAA rating. The only real risk that the owner of a CMO faces is the risk of early refinance. CMOs pay interest and principal monthly. However, they pay the principal to only one tranche at a time in $1,000 payments. The CMO pays off each tranche until the final tranche known as a Z tranche is paid off. The Z tranche is the most volatile CMO tranche.
CMOs, like other interest-bearing investments, will be affected by a change in the interest-rate environment. CMOs may experience the following if interest rates change:
Most CMOs have an active secondary market and are considered relatively liquid securities. However, the more complex CMOs may not have an active secondary market and may be considered illiquid. Interest earned by investors from CMOs is taxable at all levels: federal, state, and local.
Like many other investments there are several different types of CMOs. They are:
Principal-only CMOs, as the name suggests, receives only the principal payments made on the underlying mortgage. Principal-only CMOs receive both the scheduled principal payments as well as any prepayments made by the home owners in the pool. Because the principal-only CMO does not receive any interest payments, it is sold at a discount to its face value. The appreciation of the CMO, up to its face value, represents the investor's return. The price of a principal-only CMO will be sensitive to a change in interest rates. As interest rates fall, the value of the CMO will rise as prepayments accelerate. A rise in interest rates will have the opposite effect.
Interest-only CMOs receive the interest payments made by homeowners in the pool of underlying mortgages. Interest-only CMOs also will sell at a discount to their face value due to the amortization of the underlying mortgages. Interest-only CMOs will increase in value as interest rates rise and decrease in value as interest rates fall, as a result of the changes in prepayments on the underlying pool of mortgages. The changes in the prepayments on the underlying mortgages will affect the number of interest payments the holder of the CMO will receive. As interest rates rise, prepayments will slow, thus increasing the number of interest payments the investor receives. The more interest payments the CMO holder receives, the more valuable the CMO becomes.
Planned amortization class CMOs are paid off first and offer the investor the most protection against prepayment risk and extension risk. If prepayments come in too quickly, those principal payments will be deferred to another CMO known as a support class to protect the owner of the PAC from prepayment risk. If principal payments are made more slowly, principal payments will be taken from a support class to protect the investor against extension risk.
Targeted amortization class CMOs only offer the investor protection from prepayment risk. If principal payments are made more quickly, they will be transferred to a support class. However, if principal payments come in more slowly, payments will not be taken from a support class and will be subject to extension risk.
Private-label CMOs are issued by investment banks and the payment of interest and principal payments are the responsibility of the issuing investment bank. The payments due to a holder of a private-label CMO are not guaranteed by any government agency. The credit ratings of the private-label CMOs are based on the collateral that backs the CMO and the credit rating of the issuer. If the private-label CMO uses agency issues as collateral for the CMO, those agency issues still carry the guarantee of the issuing government agency.