What is a Federally Guaranteed Obligations
Federally guaranteed obligations are debt securities issued by the United States government and considered risk-free because they receive the full faith and credit of the federal government. The selling of these securities helps to finance the federal debt.
Federally guaranteed obligations take several forms, but the best-known are U.S. Treasury bonds, Treasury notes, and Treasury bills (T-bills).
BREAKING DOWN Federally Guaranteed Obligations
Federally guaranteed obligations offered by the U.S. Treasury at quarterly auctions. Before the early 1970s, Treasury securities were sold in bulk by subscription and exchange offerings. Demand for these securities fluctuates, driving prices up or down at auction depending on their attractiveness relative to other debt securities.
Each federally guaranteed obligation offers a stated interest rate, known as the coupon rate, which is not to be confused with its yield. Yield is the total return on the investment over its lifetime. Yield tends to increase if the security sells at a discount to its interest rate. A coupon is the annual interest rate paid on a bond, expressed as a percentage of the face value. Other names include coupon rate, coupon percent rate, and nominal yield.
These Treasury securities are heavily traded and highly liquid. Pricing on these debt instruments will vary by product and usually has a basis on the par value. Par value is the face value of a bond and helps determine the maturity value and coupon payment amounts.
Treasury Direct is the online platform which investors may use to purchase federal government securities directly from the U.S. Treasury. All federally guaranteed obligations have the backing and full faith and credit of the U.S. government.
Types of Federally Guaranteed Obligations
Government debt obligations come in various forms, with differing maturities, interest rates, coupons, and yields.
- Treasury bonds (T-bonds) is a marketable, fixed-interest U.S. government debt security with a maturity of more than ten years. Treasury bonds make interest payments semi-annually, and the income received is only taxed at the federal level. Treasury bonds are known in the market as primarily risk-free due to the lack of default risk of the U.S. government.
- Treasury notes reach maturity in one to ten years and have a fixed interest rate. They are available through either a competitive or non-competitive bid. With a competitive bid, investors specify the yield they want, at the risk that their proposal may not be approved. When using non-competitive bid investors accept yield based on the auction results.
- Treasury bills (T-bills) are short-term debt obligation and reach maturity in less than one year. They sell in denominations of $1,000 up to a maximum of $5 million. T-bills have various maturities and sell at a discount from par value. The U.S. government effectively writes investors an IOU as the bill only pays on maturity.
- Treasury inflation-protected securities (TIPS) have an index basis to inflation which protects investors from the effects of inflation. TIPS are a low-risk investment since their par value changes with inflation, while the interest rate remains fixed.
- Floating rate notes (FRNs), also known as floaters, is a variable interest rate note. Interest rates have a benchmark such as the Treasury bill rate, Fed Funds rate or the prime rate. Government agencies and financial institutions issue the notes which have between a two- and five-year maturity.
- U.S. savings bonds have a fixed rate of interest over a fixed period. Many people find these bonds attractive because they are not subject to state or local income taxes. These bonds cannot easily be transferred and are non-negotiable and carry a15-year to 30-year maturities.
Non-Treasury federal agency securities
Other federally guaranteed obligations are not issued directly by the U.S. Treasury. These include mortgage-backed securities (MBS) offered by the Government National Mortgage Association (GNMA). This debt obligation contains a pool of mortgages, segmented according to criteria, and sold to the public with a federal guarantee.
Government-sponsored entities (GSEs) such as the Federal Home Loan Mortgage Corporation (FHLMC) and Federal National Mortgage Association (FNMA) issue debt securities but these are not guaranteed by the federal government.