Cash Equivalents and Fixed Income Securities - Mortgage-Backed Securities - MBS

There are a number of U.S. government agencies that also issue debt. While most of these are not backed by the full faith and credit of the U.S. government, they are still considered less risky than most other bonds. Yields are usually slightly higher than Treasury debt with a similar maturity. Also, like Treasury bonds, government agency bonds are tax-free at the state level (but are subject to federal income taxes).

These four agencies make a secondary market in home mortgages, thus allowing local banks to sell their loans and use the proceeds to make new mortgages:

  1. Federal Home Loan Bank - FHLB
    • This agency loans money to savings and loans, using mortgages issued by those institutions as collateral for the loans.
    • It creates the funds to buy these loans by issuing non-callable, book-entry bonds.

  2. Federal National Mortgage Association - FNMA (aka "Fannie Mae")
    • This agency buys government-guaranteed and -insured mortgages, such as FHA and VA, as well as conventional mortgages.
    • It creates the funds to buy the loans by issuing bonds and notes.
    • FNMA also issues pass-through mortgage certificates with minimum denominations of $25,000.

  3. Government National Mortgage Association - GNMA (aka "Ginnie Mae")
    • Like FNMA, this agency also buys insured loans from banks, such FHA, VA and Farmer's Home Administration, but then creates pools of these mortgages.
    • It then issues pass-through certificates similar to the FNMA certificates.
    • The main difference is that GNMA certificates are actually directly guaranteed by the U.S. government.
    • As a result, GNMAs are considered slightly safer and therefore offer a slightly lower yield than other agency securities.

  4. Federal Home Loan Mortgage Corp. - FHLMC (aka "Freddie Mac")
    • This agency is unique because it is privatized and its stock is traded on the NYSE.
    • It purchases conventional mortgages only and in turn issues "participation certificates".

Exam Tips and Tricks
It is important to understand the above subject, since you can expect a question that offers a number of choices of obligations that are guaranteed by the full faith and credit of the U.S. government. Typical correct answers include Treasury bills, Treasury bonds and GNMA certificates, while incorrect answers would include FNMA or FHLMC securities.
You might encounter a question like this on the exam:

  1. The Federal National Mortgage Association is involved in which of these activities?
    1. Financing low-income housing projects
    2. Making new mortgage loans
    3. Purchasing existing mortgage loans
    4. All of the above

The correct answer is "c". FNMA buys existing mortgages from banks to provide liquidity for banks to make new loans.

Municipal Bonds
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