US Government Debt Flashcards

A “riskless” security maturing in 52 weeks or less is a:

A. Money market instrument
B. Non-callable funded debt
C. Treasury bill
D. Treasury note

The best answer is C.

The key word is “riskless.” Treasury bills mature in 52 weeks or less and are issued by the U.S. Government, the safest issuer available.

All of the following statements are true about Treasury Bills EXCEPT:

A. the U.S. Treasury issues 1 week T- Bills
B. the U.S. Treasury issues 13 week T- Bills
C. the U.S. Treasury issues 26 week T- Bills
D. T-Bills are issued at a discount from par

The best answer is A.

The U.S. Treasury issues 4 week, 13 week, 26 week, and 52 week T-Bills at a discount from par. The Treasury does not issue 1 week T-Bills.

The smallest denomination available for Treasury Bills is:

The best answer is A.

The minimum denomination on a Treasury Bill is $100 maturity amount. The minimum denomination on Treasury Notes and Bonds is also $100 maturity amount. Note that this is different than the typical minimum $1,000 par amount for other debt issues.

Which of the following is an example of a derivative product?

A. collateral trust certificate
B. American depositary receipt
C. collateralized mortgage obligation
D. mutual fund

The best answer is C.

A “derivative” product is one whose value is “derived” via a “formula” from an underlying investment. Options are the most basic derivative - option values are derived from the price movements of the underlying stock, in addition to time premiums on the contracts. Collateralized mortgage obligation values are derived from the underlying mortgage backed pass-through certificates held in trust by recutting the cash flows and applying them to the CMO tranches. Again, these are derived via a formula. Mutual fund shares are not a derivative, because Net Asset Value per share is a direct correlation to the value of total net assets divided by the number of shares outstanding. Collateral trust certificates are directly issued by corporations - these are not derivative investments. Finally, each American Depositary Receipt represents a fixed number of foreign shares held in trust. These are also not a derivative product.

All of the following securities would be used as “collateral” for a collateralized mortgage obligation EXCEPT:

A. “Sallie Maes”
B. “Freddie Macs”
C. “Ginnie Maes”
D. “Fannie Maes”

The best answer is A.

Only mortgage backed pass-through certificates are used as the backing for CMOs - and Ginnie Mae (Government National Mortgage Assn.), Fannie Mae (Federal National Mortgage Assn.), and Freddie Mac (Federal Home Loan Mortgage Corp.) all issue pass-throughs. Sallie Mae issues debentures, and uses the funds to make a secondary market, buying student loans from originating lenders (Sallie Mae stands for Student Loan Marketing Association).

The collateral backing private CMOs consists of:

A. private placements offered under Regulation D
B. mortgage backed securities created by a bank-issuer
C. mortgage backed securities issued by a “privatized” government agency
D. mortgages on privately owned homes and apartments

The best answer is B.

Private CMOs (Collateralized Mortgage Obligations) are also called “private label” CMOs. Instead of being backed by mortgages guaranteed by Fannie, Freddie or Ginnie, they are backed by “private label” mortgages - meaning mortgages that do not qualify for sale to these agencies (either because the dollar amount of the mortgage is above their purchase limit or they do not meet Fannie, Freddie or Ginnie’s underwriting standards). Bank issuers make non-conforming mortgages that cannot be sold to Fannie, Freddie or Ginnie and rather than hold them as investments, they can pool them into mortgage backed securities which are then placed into trust and sold as private label CMOs.

All of the following statements are true about CMOs EXCEPT:

A. CMO issues have a serial structure
B. CMO issues are rated AAA
C. CMO issues are more accessible to individual investors than regular pass-through certificates
D. CMO issues have the same market risk as regular pass-through certificates

The best answer is D.

CMOs have a lower level of market risk (risk of price volatility due to movements in market interest rates) than do mortgage backed pass-through certificates. Because CMO issues are divided into tranches, each specific tranche has a more certain repayment date, as compared to owning a mortgage backed pass-through certificate. Thus, the price movement of that specific tranche, in response to interest rate changes, more closely parallels that of a regular bond with a fixed repayment date. As interest rates rise, CMO values fall; as interest rates fall, CMO values rise.

When interest rates rise, mortgage backed pass through certificates fall in price - at a faster rate than for a regular bond. This is true because when the certificate was purchased, assume that the average life of the underlying 15 year pool (for example) was 12 years. Thus, the certificate was priced as a 12 year maturity. If interest rates rise, then the average maturity will lengthen, due to a lower prepayment rate than expected. If the maturity lengthens, then for a given rise in interest rates, the price will fall faster.

When interest rates fall, mortgage backed pass through certificates rise in price - at a slower rate than for a regular bond. This is true because when the certificate was purchased, assume that the average life of the underlying 15 year pool (for example) was 12 years. Thus, the certificate was priced as a 12 year maturity. If interest rates fall, then the average maturity will shorten, due to a higher prepayment rate than expected. If the maturity shortens, then for a given fall in interest rates, the price will rise slower.

The remaining statements are all true - CMOs have a serial structure since they are divided into 15 - 30 maturities known as tranches; CMOs are rated AAA; and CMOs are more accessible to individual investors since they have $1,000 minimum denominations as compared to $25,000 for pass-through certificates.

Which of the following statements are TRUE about CMOs?

I CMO issues have a serial structure
II CMO issues are rated AAA
III CMO issues are more accessible to individual investors than regular pass-through certificates
IV CMO issues have a lower level of market risk than regular pass-through certificates

A. I and II only
B. III and IV only
C. I, II, III
D. I, II, III, IV

The best answer is D.

All of the statements are true about CMOs. CMOs have a lower level of market risk (risk of price volatility due to movements in market interest rates) than do mortgage backed pass-through certificates. Because CMO issues are divided into tranches, each specific tranche has a more certain repayment date, as compared to owning a mortgage backed pass-through certificate. Thus, the price movement of that specific tranche, in response to interest rate changes, more closely parallels that of a regular bond with a fixed repayment date. As interest rates rise, CMO values fall; as interest rates fall, CMO values rise.

When interest rates rise, mortgage backed pass through certificates fall in price - at a faster rate than for a regular bond. This is true because when the certificate was purchased, assume that the average life of the underlying 15 year pool (for example) was 12 years. Thus, the certificate was priced as a 12 year maturity. If interest rates rise, then the average maturity will lengthen, due to a lower prepayment rate than expected. If the maturity lengthens, then for a given rise in interest rates, the price will fall faster.

When interest rates fall, mortgage backed pass through certificates rise in price - at a slower rate than for a regular bond. This is true because when the certificate was purchased, assume that the average life of the underlying 15 year pool (for example) was 12 years. Thus, the certificate was priced as a 12 year maturity. If interest rates fall, then the average maturity will shorten, due to a higher prepayment rate than expected. If the maturity shortens, then for a given fall in interest rates, the price will rise slower.

CMOs have a serial structure since they are divided into 15 - 30 maturities known as tranches; CMOs are rated AAA; and CMOs are more accessible to individual investors since they have $1,000 minimum denominations as compared to $25,000 for pass-through certificates.