Quick Answer
Treasuries are the safest debt: T-bills sell at a discount, T-notes and T-bonds pay semiannual coupons, and all are exempt from state and local tax. Treasury Inflation-Protected Securities and zero-coupon strips throw off phantom income. Ginnie Mae carries full faith and credit; Fannie Mae and Freddie Mac carry only implied backing.
The whole unit on one sheet: the Treasury lineup, the inflation and zero-coupon twists, agency backing, mortgage-product mechanics, and the day-count rules the exam loves.
The Treasury Lineup
- Treasury bills (T-bills): maturities up to 52 weeks; sold at a discount, no coupon, so effectively zero-coupon; quoted on a discount-yield basis; the most liquid, lowest-risk marketable securities.
- Treasury notes (T-notes): 2 to 10 years; fixed semiannual coupon; quoted in 32nds of par (99-16 = 99.50% of par). The 10-year yield is the key long-rate benchmark.
- Treasury bonds (T-bonds): 20 to 30 years; semiannual coupon; quoted in 32nds; longest maturity means the greatest interest rate risk.
- All three: full faith and credit, zero default risk, book-entry only, sold at auction, trade over-the-counter.
The One-Liners That Win Points
- Treasuries are exempt from state and local tax but NOT federal. The exam tests this constantly.
- TIPS (Treasury Inflation-Protected Securities): the coupon rate is fixed; only the principal adjusts with the Consumer Price Index (CPI-U), so the dollar payment moves.
- STRIPS (Separate Trading of Registered Interest and Principal of Securities) are direct obligations with full faith and credit; Treasury receipts (TIGRs, CATS) are trust products with counterparty risk, not direct obligations.
- Ginnie Mae = full faith and credit. Fannie Mae and Freddie Mac = implied backing only. Sallie Mae = no government backing.
- Pass-through rate is LOWER than the mortgage rate (servicing and guarantee fees are deducted).
- CMOs (Collateralized Mortgage Obligations) redistribute prepayment risk; they do not eliminate it.
- CDOs (Collateralized Debt Obligations) redistribute credit/default risk; CMOs redistribute timing (prepayment) risk.
Numbers to Lock In
| Item | Value |
|---|---|
| T-bill maturities | up to 52 weeks (zero-coupon, discount) |
| T-note maturities | 2 to 10 years |
| T-bond maturities | 20 to 30 years |
| TIPS maturities | 5, 10, and 30 years |
| Treasury minimum purchase | $100, in $100 increments |
| Treasury / TIPS / TIPS note quote | 32nds of par (T-notes and T-bonds) |
| Treasury day-count | actual/actual |
| Agency, MBS, CMO day-count | 30/360 |
| GNMA pass-through minimum | $25,000 |
Phantom Income and Prepayment (Core Mechanics)
- Phantom income: both TIPS and STRIPS are taxed annually as ordinary income on value the investor does not receive until maturity, so both fit tax-deferred accounts. TIPS also carry a deflation floor: at maturity you get the greater of adjusted principal or original par.
- Pass-through MBS (Mortgage-Backed Securities) pay monthly (interest plus principal); investors own a pro rata share of the pool.
- Contraction risk: rates fall, borrowers refinance, principal comes back early, reinvested at lower rates.
- Extension risk: rates rise, borrowers hold on, principal comes back late, locked into below-market yield.
- CMO tranches: PAC (Planned Amortization Class) = dual-sided protection, lowest risk, lowest yield; TAC (Targeted Amortization Class) = contraction protection only; companion = absorbs variability, highest risk, highest yield; Z-tranche = paid last, accrues interest like a zero.
- CDO tranches: senior (paid first, AAA), mezzanine, then equity (paid last, absorbs losses first, riskiest despite the name).
Top Gotchas
- T-bills have NO accrued interest and pay no semiannual coupon; the return is the discount to face value.
- Treasuries are the day-count exception: notes and bonds use actual/actual; agencies, CMOs, corporates, and munis use 30/360.
- Agency securities are NOT exempt from state and local tax; only direct Treasury obligations get that exemption.
- Prepayment risk is not default risk; it is about the timing of repayment, not whether you get paid.
- Ginnie Mae guarantees the MBS but does not originate or purchase mortgages. Fannie Mae and Freddie Mac remain GSEs (Government-Sponsored Enterprises), not government agencies, even in conservatorship.
- The equity tranche of a CDO is the riskiest and is often unrated; it absorbs losses first.
One-Breath Recap
Treasuries are the safe base: bills sell at a discount, notes and bonds pay semiannual coupons in 32nds, and all escape state and local tax but not federal. TIPS and STRIPS both throw off phantom income taxed yearly. On the mortgage side, remember Ginnie Mae alone carries full faith and credit, CMOs redistribute prepayment timing risk while CDOs redistribute credit risk, and Treasuries use actual/actual while everything else uses 30/360.
Need more than the recap? This is a condensed summary. If it is not enough, read the full US Government and Agency Securities unit for the complete lesson.