Fixed Income Securities

The whole bond universe on one sheet: who issues, how it is backed, and how it is taxed.

Which One-Liners Win Points?

• T-Bills pay no coupon: sold at a discount, mature at par, most liquid government security. T-Notes, T-Bonds, and TIPS all pay semiannual coupons; only T-Bills and STRIPS are zero-coupon.
• Treasury Floating Rate Notes (FRNs) are the only Treasury security with a rate that changes after issuance: 2-year maturity, quarterly interest, rate tied to the most recently auctioned 13-week T-Bill discount rate plus a fixed spread.
• Treasury interest is subject to federal tax but exempt from state and local tax; agency interest is taxable at all levels.
• Government National Mortgage Association (GNMA, Ginnie Mae) is the ONLY agency with the full faith and credit of the U.S. government. Fannie Mae and Freddie Mac carry only an implied moral obligation.
• Mortgage-backed securities (MBS) pass-throughs pay monthly, not semiannually, because homeowners pay monthly.
• Prepayment risk hits when rates fall (homeowners refinance); extension risk hits when rates rise. They move in opposite directions.
• General obligation (GO) bonds are backed by full faith, credit, and taxing power (ad valorem property taxes) and usually need voter approval; revenue bonds are backed by a specific project and do not.
• Municipal interest is federally tax-exempt, but municipal capital gains are fully taxable.
• Debt always beats equity in liquidation: a junior subordinated debenture still ranks above senior preferred stock.
• Yankee bonds are U.S.-dollar-denominated foreign bonds issued in the U.S., so they eliminate currency risk for U.S. investors.

Which Numbers Matter Most?

Which Gotchas Trip Students Up?

• TIPS versus STRIPS: Treasury Inflation-Protected Securities protect against inflation risk by adjusting principal daily to the Consumer Price Index (CPI-U), with interest paid semiannually; Separate Trading of Registered Interest and Principal of Securities (STRIPS) carry the highest interest-rate risk (zero coupon, long duration, no cash until maturity). STRIPS are created from eligible T-Notes, T-Bonds, and TIPS. Both throw off phantom income taxed annually: for TIPS it is the annual principal adjustment, for STRIPS it is the annual accretion toward par, so both suit tax-deferred accounts.
• Zero-coupon and STRIPS holders owe tax every year on accreted discount despite receiving no cash.
• A municipal bond is unsuitable inside a retirement account, the exact mirror of the phantom-income rule above. The exemption is already priced into the lower yield, so an Individual Retirement Account (IRA) or 401(k) buys a tax break the wrapper already supplies. In a traditional account the exempt interest even comes back as ordinary income on withdrawal. The same reasoning bars munis for a pension plan or a charitable foundation.
• Agency securities are fully taxable at every level and are constantly confused with state-exempt Treasuries.
• Industrial development revenue bonds (IDRBs) are backed by the private corporation, not the municipality, and may trigger Alternative Minimum Tax (AMT).
• Bond insurance covers credit risk only, lifting the rating to the insurer's own (today typically AA, not the AAA of pre-2008 insurers), never interest-rate risk.
• Asset-backed securities (ABS) are backed by non-mortgage assets (auto loans, credit cards, student loans, home equity loans) through a bankruptcy-remote special-purpose vehicle (SPV); MBS are backed by mortgages.
• Collateralized mortgage obligations (CMOs) slice MBS cash flows into tranches with different maturities and risk; prepayment and extension risk are redistributed, not eliminated. Generally unsuitable for most retail investors.
• Sovereign risk is more than default: it includes political instability, currency controls, and policy changes.
• Foreign bond interest is fully taxable at the federal, state, and local level; there is no special exemption, unlike U.S. Treasury interest.

One-Breath Recap

Fixed income is debt sorted by issuer. Treasuries have no default risk and are state-tax-exempt, with Treasury bills sold at a discount and only notes and bonds paying coupons. Agencies are fully taxable, and only Ginnie Mae carries full faith and credit; mortgage-backed pass-throughs pay monthly and face opposing prepayment and extension risk. Corporates pay $1,000 par with debt always ranking above equity. Municipals deliver federally tax-exempt interest split into general obligation (taxing power, voter approval) and revenue (project-backed) bonds, and their capital gains stay taxable. Nail each issuer's backing and tax treatment, and remember Treasury Inflation-Protected Securities and STRIPS phantom income.

Need more than the recap? Read the full Fixed Income Securities unit.