manchester88

Which of the following statements about Treasury securities is NOT correct?

A) Designated government securities dealers can buy treasuries, strip out the coupons and principal, and reissue these stripped cash flows as zero-coupon bonds.

B) The U.S. Treasury auctions 10-year Notes weekly.

C) Taxable investors holding zero-coupon bonds can have negative cash flows prior to maturity.

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U.S. Treasury Notes are issued quarterly. Both of the other statements are true. It is possible that taxable investors will have negative cash flows from holding zero-coupon securities, since there is no cash income, but taxes must be paid at least annually on the implicit interest.

manchester88

Which of the following statements about the taxation of separate trading of registered interest and principal of securities (STRIPS) is NOT correct?

A) The STRIPS program began in 1985.

B) Implicit interest taxation is a paramount issue for pension plans.

C) Treasury STRIPS can be based upon either coupon payments or principal payments.

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Pension plans are not taxable entities so they do not have to worry about implicit interest taxation. Both of the other statements are true.

manchester88

Which of the following statements regarding federal agency securities is least accurate?

A) Government sponsored enterprises are owned by the U.S. government and therefore have essentially no credit risk.

B) Federally related institutions are not required to register their securities with the Securities and Exchange Commission.

C) Debentures and mortgage passthrough securities are two types of securities issued by federal agencies.

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Government sponsored enterprises are privately owned, and therefore investors assume some credit risk. Federally related institutions are agencies owned by the U.S. government which are exempt from SEC registration. Agencies issue debentures, mortgage passthrough securities, or collateralized mortgage obligations (CMO). CMOs are split into tranches, with each tranche having a different claim and risk structure on the pool of cash flows.

manchester88

Which of the following institutions has debt that is backed by the full faith and credit of the U.S. government?

A) Government National Mortgage Association (Ginnie Mae).

B) Federal Home Loan Mortgage Association.

C) Student Loan Marketing Association.

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The Government National Mortgage Association is the only item listed that is backed by the full faith and credit of the U.S. government.

manchester88

A mortgage-backed security has the following characteristics:

• It was created by pooling a collection of more than a thousand mortgages

• Not all investors face the same prepayment risk

• Investors receive three distinct kinds of cash flows

• Freddie Mac issued the security

This security is a(n):

A) collateralized mortgage obligation.

B) agency debenture.

C) mortgage passthrough security.

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While most mortgage-backed securities pay three types of cash flows, only mortgage passthroughs and collateralized mortgage obligations (CMOs) are formed by pooling mortgages. Only CMOs divide investors into tranches with different cash flows and risk profiles. Debentures are securities not backed by collateral.

manchester88

Which of the following institutions is NOT a government-sponsored enterprise (GSE)?

A) Federal Farm Credit System.

B) Student Loan Marketing Association.

C) Government National Mortgage Association.

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Federally-related (or government-owned) agencies are arms of the federal government. Both of the other institutions listed are government-sponsored enterprises.

manchester88

Which of the following institutions are federally-related institutions?

A) Government National Mortgage Association.

B) Student Loan Marketing Association.

C) Federal National Mortgage Association.

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Federally-related (or government-owned) agencies are arms of the federal government. Both of the other institutions listed are government-sponsored enterprises.

manchester88

A debenture is:

A) a short-term debt.

B) an unsecured bond.

C) a bond secured by specific assets.

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A debenture by definition is unsecured debt.

manchester88

The most popular form of credit enhancement is the senior-subordinated structure. What does the senior-subordinated collateral structure shown below indicate?

Senior tranche: $560 million

Subordinated tranche: $40 million

A) The subordinated tranche investor receives $40 million in repayment first. Then the cash flow goes to the senior tranche.

B) The first $40 million of losses are absorbed by the subordinated tranche.

C) The subordinated tranche is protected by the senior tranche.

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The loss of $40 million is applied to the subordinated tranche first and since it is large enough to absorb the entire loss, all $40 million is applied to the subordinated tranche.

manchester88

Which of the following statements least likely describes a mortgage passthrough security?

A) Participation certificates are sold, representing shares of a mortgage pool.

B) The security may be retired before maturity at face value with no penalty.

C) The payment structure redistributes the prepayment risk among various investors.

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A collateralized mortgage obligation (CMO), not a passthrough security, redistributes the prepayment risk among the investors through tranches. Because mortgage holders may prepay the mortgage, the passthrough may indeed be retired before maturity at face value with no penalty.