manchester88

Which of the following statements regarding U.S. Treasury securities is least accurate?

A) Due to the way Treasury STRIPS are taxed, U.S. investors may face negative cash flows before the maturity date.

B) The U.S. Treasury issues zero coupon notes, but not bonds.

C) A 5-year Treasury note can be stripped into 11 different zero coupon securities.

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The Treasury does not issue zero-coupon notes or bonds. That is why STRIPS were created. A 5-year Treasury note can be stripped into 11 zero coupon securities, consisting of its 10 coupon payments and the principal repayment. The U.S. Internal Revenue Service regards the accrued interest on a zero coupon security as income on which the security holder must pay taxes even though he has not received a cash interest payment.

manchester88

Which of the following refers to the U.S. Treasury bonds that are sold in the form of zero-coupon securities?

A) Strip-Ts.

B) Treasury calls.

C) Pass-throughs.

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The U.S. Treasury does not issue zero coupon notes and bonds, therefore investment bankers began stripping the coupons from Treasuries to create synthetic zeros to meet investor demand. The Separate Trading of Registered Interest and Principal Securities (STRIP) was introduced in 1985 to meet this need.

manchester88

Which of the following statements regarding separate trading of registered interest and principal of securities (STRIPS) is CORRECT? A 20-year Treasury bond can be used as the basis for:

A) 40 principal strips and 1 coupon strip.

B) 40 coupon strips and 1 principal strip.

C) 41 coupon strips.

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A 20-year Treasury bond can be used as the basis for 40 coupon strips and 1 principal strip.

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.