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Government Agencies and
Related
Securities
- The Main Issuers
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Background of the main GSE
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Types of Securities
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Types of Securities
These government
agencies offer a wide range of equity and debt securities. Most of these
investment instruments are boiler plate investments. The mortgage backed
securities, however, have unique features that deserve extra attention.
Mortgage-Backed
Securities (MBS)
Mortgage-backed
securities are debt obligations collateralized by mortgages and issued by
the housing agencies and various mortgage lenders. The main issuers are
Fannie Mae and Freddie Mac. (Ginnie Mae insures certain mortgage-like FHA &
VA loans, to ensure housing availability throughout the country.) MBS have
attractive yields, solid credit ratings, and fluid liquidity.
Bonds are normally sold
for a minimum investment of $10,000 with $5,000 increments. Ginnie Mae
requires a minimum investment of $25,000.
Types of MBS
Pass-throughs –
A pass-through security is created when an originating company pools a
group of assets, in this case mortgages, and converts them to debt
securities. Some sort of credit enhancement is needed, and an investment
grade rating is obtained. The securities are then sold to income-oriented
investors. When the mortgage payments are received, they are passed along to
the bondholders. Monthly, the bondholders receive a combination of interest,
principal and prepayments, if any. Pass-through bonds are usually investment
grade securities and are ideal for investors looking for a steady cash flow
stream and an attractive yield. The downside with pass-through bonds is that
the prepayments are uncertain and are thereby considered to be a risk.
Normally, prepayments occur when interest rates decline. Thus, the
bondholders are receiving their funds early, but in a lower interest rate
environment, reducing their income on a going forward basis. The monthly
payment received consists of interest and principal.
Collateralized
Mortgage Obligations (CMOS)
CMOs are similar to
pass-through securities, except that the composite of the principal
repayments reimbursed to the bondholders is restructured. The cash flows are
segregated into different classes, called tranches, and sold separately to
investors. The tranches are determined by the types of cash flows, rates
(yields), average life (terms), credit ratings and projected prepayment
rates that bond investors require. Interest is normally paid on all the
classes first. The priority of the principal repayment portion of the cash
flows is what makes a CMO unique, and it also determines the rating and
yield of the security. For example: some investors may need an average life
of 2 years, some 10 years, and some 20 years. Naturally, the first tranche
to be paid off is more secure than subsequent ones; usually the longer the
average life of the security, the higher the yield. There are all sorts of
“slicing and dicing” of the cash flow streams, including interest only
tranches (IO strips), principal only tranches (PO strips), and zero-coupon bonds
(tranche Z); the possibilities are unlimited. They also convert fixed rate
mortgages to floating rate bonds, and have inverse floaters. The MBA’s
really do some “wild things” with these bonds. Insurance companies are good
examples of MBS investors; they need to match the maturity dates on their
investments with expected benefit payments. Insurers time cash inflows from
their investments, to their projected cash outflows. The discipline of
matching the runoff of assets with liabilities is called asset and liability
management. Since many of these products are customized for particular
customers or industries, it is preferred that they are held to maturity.
CMOs are also known as REMICs - Real Estate Mortgage Conduits
For young adults, all of
these agency securities have solid credit ratings and pay competitive rates.
The best strategy, however, may be to use the money that these agencies
provide in terms of mortgages and loans. Their rates and credit terms are
usually extremely competitive. Many of these agencies offer funds that can
truly improve the quality and richness of one’s life.
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