|
Skip to a different definition: |
|
A
- B - C -
D - E
- F - G -
H - I
- J - K -
L - M
- N - O -
P - Q
- R - S -
T - U
- V - W -
X - Y
- Z |
|
| Agency
Bond |
What It Is:
Agency bonds are bonds issued by agencies of the U.S. government
How It Works/Example:
Two types of entities issue agency bonds: government corporations, which are
entities owned or controlled by the federal government, and government-sponsored
enterprises (GSEs), which are chartered by Congress but owned by investors (in
fact, shares of many GSEs trade on the New York Stock Exchange). The
classification may vary, but the reasons behind the bond issues are the same: to
finance the agency's specific activities or policies.
Below is a table of major agency issuers. Each of these issuers commonly has one
or more different types of debt instruments outstanding.
| Issuer |
Description |
| Federal
National Mortgage Association (FNMA or �Fannie
Mae�) |
A GSE that buys certain
types of mortgages from banks and uses them to collateralize
mortgage-backed securities. |
| Federal
Home Loan Mortgage Corporation (FHLMC
or �Freddie Mac�) |
A GSE
that buys certain types of mortgages from banks and uses them to
collateralize mortgage-backed securities. |
| Government
National Mortgage Association (GNMA or �Ginnie
Mae�) |
A government-owned
corporation in essentially the same business as Fannie Mae and Freddie
Mac. |
| Certain
banks that participate in the Federal Home Loan System
(FHL Banks) |
A group
of regional banks that issue bonds through the Federal Home Loan Banks
Office of Finance. |
| Certain
banks that participate in the Federal
Farm Credit System (FFCS banks) |
A group of cooperatively
owned banks that issue bonds through the Federal Farm Credit Banks Funding
Corporation. |
| Student
Loan Marketing Association (SLMA or �Sallie Mae�) |
A GSE
that guarantees and purchases student loans from banks and uses them to
collateralize pooled interests in loans (called participations). |
| Tennessee
Valley Authority (TVA) |
A GSE that develops utility
and defense functions in the Tennessee Valley region. |
Agency bonds come in a wide variety of
structures, maturities, and coupons rates. Most make semiannual interest
payments. Many require $10,000 minimum investments (with $5,000 increments
thereafter), although GNMA securities come in $25,000 increments. Like the U.S.
Treasury, agencies consider the demands of the market when structuring the size
and terms of their debt issues. Thus some agency bonds are callable, some have
fixed coupon rates, some have floating coupon rates, and some have unusual
interest payment dates. Each agency auctions bonds according to its own needs
and routine, but many agencies issue bonds monthly.
Unlike Treasuries, agency bonds are not backed by the full faith and credit of
the U.S. government. As a result, the yields on agency bonds are typically
higher than on Treasuries but lower than corporate bonds. The degree to which an
agency is independent from the government affects the default risk associated
with its securities. For example, Ginnie Mae is a corporation owned by the
government and operated by the Department of Housing and Urban Development; its
securities are therefore considered less risky than similar ones offered by
Fannie Mae or Freddie Mac. However, the likelihood that the federal government
would allow these entities to go bankrupt is considered quite low, and so both
Fannie Mae and Freddie Mac securities are generally considered safe. Moody's and
S&P rate many agency bonds.
Most, but not all, agency bonds are exempt from local and state taxes. This is
especially beneficial to residents of states with high local taxes.
Income investors can purchase agency bonds from a broker/dealer or through
mutual funds that target these securities. Mutual funds are usually more
appropriate for smaller investments, as diversification is much more expensive
when the investor wants to hold the bonds outright.
Why It Matters:
In general, agency bonds are not good investments for those seeking capital
appreciation, but they do offer income investors a unique combination of high
credit quality, liquidity, and reliable income. Like all bonds, they are
sensitive to changes in interest rates. When interest rates increase, agency
bond prices fall, and vice versa. The low returns on agency bonds, relative to
corporate bonds, also means their investors are more affected by inflation. This
inflation risk is somewhat mitigated in cases where the agency bonds have
floating-rate coupons, but these "floaters" often have caps or collars
that limit how high or how low the coupon rate can go. Changes in the
independence or regulation of the issuing agencies can also have dramatic
effects on the prices of their bonds.
In general, the agency-bond market is very liquid (though not as much as
Treasuries). However, the more �structured� an agency bond is (that is, the
more unusual its features), the smaller the market tends to be for the bond.
Obviously, this can create liquidity problems for the investor.
It is important to note that agency bonds are a key component of a GSE's ability
to provide its intended public service. Usually this public service is to lower
the cost of capital for certain groups of citizens by issuing, purchasing,
and/or guaranteeing debt. For example, Freddie Mac buys mortgages from financial
institutions and then sells unit shares in these pools of mortgages. It does
this not only to earn income, but to facilitate homeownership by supplying banks
with cash to provide more mortgages. Freddie Mac's purchases of mortgages puts
cash back in the hands of lenders, who in turn make more mortgage loans. This
increases the supply of funds for mortgages, makes the mortgage industry more
competitive, lowers mortgage rates, and thus gives Americans more affordable
opportunities to become homeowners.
|
|
