Zero-Coupon Bonds: Zero-coupon bonds are debt securities issued at a deep discount from par, with the difference between the discount and the face value paying out at maturity. These bonds do not make regular interest, or coupon, payments. Corporations, municipalities and the U.S. government all offer zero-coupon bonds.

In the case of corporate and U.S. government zeros, the income received upon redemption, sometimes referred to as phantom income or accreted interest, is taxable each year up to the redemption date, despite the fact that the bondholder does not receive the interest until maturity. Zero coupons are more sensitive to interest rate changes and are thus more volatile than other bonds of similar quality. An investor who needs to sell the bond before maturity risks losing principal if the investor sells the bonds during a time of rising interest rates. Zeros are great investments for people who need the exact redemption value on a certain date and no sooner - which is why zero-coupon bonds are popular college savings tools.

Exam Tips and Tricks
Three concepts regarding debt retirement that you will need
to know for the exam are redemption, conversion and call provisions.

CMOs: CMOs, short for collateralized mortgage obligations, are mortgage-backed securities purchased in $1,000 denominations that pool together a large number of private mortgages (usually on single-family residences), mortgage pass-through securities like those issued by Fannie Mae and Ginnie Mae (as discussed above), and other CMOs. All of these mortgage-backed securities are divided into maturity classes called tranches. Each tranche is given its own estimated life, interest rate and payment priority, even though all tranches are backed by the same pool of mortgages.

All tranches receive  interest payments according to the tranche-specific rate; however, only the "youngest" tranche receives principal payments - in $1,000 increments - as well. When the principal payments of the youngest tranche are exhausted, the life of that tranche effectively expires, and principal payments begin on the next tranche, with other tranches receiving interest-only payments. This process continues until all tranches have run out of principal payments.

Because changes in interest rates affect the rate of mortgage prepayments, CMO tranches will not strictly adhere to the length of their initial life spans, and so the amount of interest paid and the amount of principal returned over time may vary. In this way, CMOs are complex investment vehicles and should only be used when the client is an experienced investor.

Money Market Instruments

Related Articles
  1. Investing

    What are Tranches?

    Tranches often describe specific classes of bonds within a security that hold different degrees of risks and maturities.
  2. Investing

    3 Bonds You May Have Never Heard Of

    These lesser-known bonds may give your portfolio a boost when other investments products fall short.
  3. Investing

    What Are Tranches?

    “Tranche” is a French word that refers to a slice.
  4. Investing

    All About Zero Coupon Bonds

    Zero-coupon bonds are bonds that do not make any interest payments (which investment professionals often refer to as the "coupon") until maturity. For investors, this means that if you make an ...
  5. Personal Finance

    Profit From Mortgage Debt With MBS

    Mortgage-backed securities can offer monthly income, a fixed interest rate and even government backing.
  6. Investing

    How Are Zero-Coupon Municipal Bonds Taxed?

    What every investor needs to know about taxes and zero-coupon muni bonds.
  7. Investing

    Understanding Collateralized Mortgage Obligations

    A collateralized mortgage obligation (CMO) is a security consisting of a pool of mortgages organized by maturity and risk.
  8. Personal Finance

    CDOs and the Mortgage Market

    These structured products contribute to keeping borrowing rates low.
Frequently Asked Questions
  1. Where do most fund managers get their market information?

    Many fund managers, whether they manage a mutual fund, trust fund, pension or hedge fund, have access to resources that the ...
  2. What's the difference between short-term investments and marketable securities?

    Understand the difference between short-term investments and marketable equity securities, and learn the importance of short-term ...
  3. Are fringe benefits direct or indirect costs?

    Learn how to allocate costs associated with fringe benefits provided to employees and how to determine when a cost is either ...
  4. How is a bank guarantee different from a traditional loan?

    Read about the differences between a traditional bank loan and a bank guarantee, and why a third party might require a guarantee ...
Trading Center