Investing in Treasury & Mortgagebacked Securities Mutual F

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Investing in Treasury and Mortgage-Backed Secur
ities University of Maryland, Cooperative
Extension Patricia M. Tengel, Family Resource
Management Specialist
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Bond Basics Value of bond Interest rates up
Bond value up Bond value down Interest
rate down
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Treasury Bills (T-Bills) Short term
investment Mature in 13, 26, or 52
weeks Minimum purchase1,000 with
1,000 increments Sold at a discount Purchased
on noncompetitive bid
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Treasury Bills (T-Bills) Figuring the actual
interest rate T-Bill, purchased for 950
Face Value - price annual interest
price rate 1,000 - 950
5.26 950
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Treasury Bills (T-Bills) Figuring the actual
interest rate T-Bill, purchased for 987 for 90
days Face value - Price X 365
Price
Number of days to maturity 1,000 - 987 X
365 987 90 0.0123 X
4.0556 5.34
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Treasury Notes Treasury notes issued in 2-, 3-,
5-, and 10-year maturities. 2- and 5-year
Treasury notes issued monthly 3- and 10-year
Treasury notes issued quarterly in February, May,
August, and November
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Treasury Notes Two-, 3-, 5-, and 10- year notes
issued in 1,000 denominations Interest exempt
from state local taxes but not Federal taxes
Cannot be called before maturity (government
cannot redeem before maturity)
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Inflation-Indexed bonds First issued, Jan.
1997 10 year term Principal indexed to
CPI-U Interest paid semi-annually at 1/2
rate Three month lag in inflation adjustments

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Inflation-Indexed Bonds Auctioned quarterly on
15th of January, April, July, and October All
bidders pay same price Sold in 1,000
multiples Interest and principal increase
taxable annually Causes some of inflation
protection to be lost
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Inflation-Indexed Bonds Guidelines for purchase
When inflation less than expected,
non-indexed bonds best Inflation higher than
expected, inflation- indexed bonds
best Because of taxation, best kept in
tax- deferred accounts401(k)s IRAs When
inflation rates high, real rates of return low.
Stocks perform better.
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Treasury Bonds Issued as 30 year
bonds Interest fixed Interest paid
semi-annually Sold in 1,000, 5,000, 10,000,
50,000 and 100,000 denominations
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Buying New Treasury Securities Purchase through
stockbroker or banker for fee of 25 to
100 Purchase at no charge through Treasury
Direct Treasury securities issued in book entry
form No certificates issued Buy over the
internet and have your bank account debited
starting September 21, 1998
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Buying New Treasury Securities Request a
Treasury Direct Kit. Contact Federal Reserve
Bank of Baltimore Box 1378, 502 South Sharp
Street Baltimore, MD 21203 Phone [phone]
or Capital Area Servicing Center Bureau of the
Public Debt, Dept N 1200 C Street, SW,
Washington, D.C. 20291-1500.
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Buying New Treasury Securities Request a
Treasury Direct Kit. Forms on web site
(www.publicdebt.treas.gov). When forms
arrive One form for Treasury bills, notes, or
bonds Interest deposited directly into savings
or checking account Must send bank routing
account number
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Buying New Treasury Securities First purchase,
fill in W-9 formnot subject to withholding.
Paying for Treasury Securities No need to
send check Treasury can debit bank account
Continue to earn interest until security
issued Must have sufficient funds in account

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Buying New Treasury Securities Paying by check
Notes and bondspersonal check
Billscashiers check or a check issued
directly by bank or credit union Make
payable to the Federal Reserve Bank of
Baltimore for Baltimore FR transactions
or Bureau of Public Debt for Washington, D.C.
transactions
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Buying New Treasury Securities Mailing
forms Baltimore Federal Reserve
Bank or Capital Area Service Center Mark
envelope TENDER FOR TREASURY SECURITIES
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Buying New Treasury Securities Master Record
established when first tender form submitted
Request record be mailed to you Master
Record contains Treasury Direct account number
and other info related to your account Updated
record mailed whenever account activity
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Renewing and Selling Treasury Securities Maturing
securities Renew by phone, call toll free
800-943-6864 Selling securities before
maturity Contact Chicago Federal Reserve
Bank, P.O. Box 834, Chicago, IL 60690 Cost
34.00 Request form PD 5179-1, Security
Transfer and Sale Request from Bureau of Public
Debt
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Renewing and Selling Treasury Securities Selling
securities before maturity Signature on Form
5179-1 must be guaranteed by stock broker or
insured financial institution Record
keeping Keep copy of the original purchase
documentation all records related to
purchase Federal Reserve Bank does not send
annual statements
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Mortgage-Backed Securities Also called agency
bonds Include Ginnie Maes, Fannie Maes,
and Freddie Macs High yields1.5 higher than
Treasuries Safety and convenience Pass
through certificates--pass through home mortgage
principal interest monthly
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Mortgage-Backed Securities Receive part of
principal back each month. For example, if
monthly payment is 100, 8 interest payment
92 return of principal When the bond
matures, no return lump sum invested already
paid over term of bond
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Ginnie Maes Government National Mortgage
Association Corporation owned by Federal
Government operated by HUD Interest
principal fully guaranteed by full faith and
credit of U.S. Government Contain mortgages
guaranteed by the Federal Housing Administration
and Veterans Administration
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Ginnie Maes Guarantee protects against
foreclosure on mortgages and late mortgage
payments Yield not guaranteed When interest
rates fall, homeowners refinance mortgages
Causes stepped-up return of principal
reducing yield
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Ginnie Maes Advantage Checks received monthly
Payment varies Disadvantage for small
investors Issued in 25,000 lots with 5,000
increments Purchase in smaller allotments
through mutual funds Monthly interest is taxed
but the principal payment is not
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Freddie Macs Issued by the Federal Home Loan
Mortgage Corporation Issued in 25,000 units
Called participation certificates
Mortgage-backed certificates VA insured
mortgages and Nongovernmental privately
insured mortgages
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Freddie Macs Interest guaranteed If home owner
defaults, investor must wait several months for
return of principal Because of slightly
greater risk, interest rate is higher for Freddie
Macs than for Ginnie Maes Purchase smaller
units through mutual funds
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Fannie Maes Issued by the Federal National
Mortgage Private corporation Trade on New
York Stock exchange Invests in conventional
mortgages Have Standard and Poors and Moodys
AAA rating so are safe Issued in 25,000
units Purchase in smaller units in mutual
funds
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Investing in Treasury Mortgage-backed
Securities Mutual Funds Differences in bond
mutual funds over direct ownership of bonds.
Pay monthly income distributed directly or
reinvested Bonds never maturewhen interest
rates rise or fall, there is gain or loss
Managers trade bonds continuously to keep
maturity date of the portfolio at set time
such as 10 years or 25 years
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U.S. Government-Issue Money Market Funds Money
market funds invest in Treasury bills notes
Average maturity of money market fundsup to 90
days according to Federal law Cost of one
share1.00 Safest money market
fundsgovernment guarantees underlying securities
Interest rate½ percent less than regular
money market funds
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Short-Term Treasury Mutual Funds Increase
interest rate on savings Average maturityless
than 3 years Extending the term increases
interest rate ½ to 2 Positive return unless
short-term bond rates increase very rapidly
For highest returns, invest in fund without
sales fee (load) and with low management fee

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Intermediate- and Long-Term Treasury Bond Mutual
funds Intermediate Term Average maturity of 3
to 10 years Long Termaverage maturity over ten
years with 18 to 22 years Contain bonds with
longer maturities when interest rates expected to
fall Magnifies the capital gainlonger term
bonds rise and fall to a larger extent whenever
interest rates change Strategy reverses when
interest rates expected to rise
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Intermediate- and Long-Term Treasury Bond Mutual
funds Limited pool of government bonds on market
at any one time All managers purchase from same
pool Funds from different mutual fund
companies contain many of same bond issues For
best return, select fund with lowest annual fees
and funds without sales fee
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Mortgage-Backed Mutual Funds Alternative to
agency certificates Pay dividend only
Principal reinvested into fund Causes daily
fluctuation of market value of shares When
mortgage rates fall and homeowners
refinance, value of fund falls Resulting
repayment of homeowners principal is reinvested
at lower rate
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Mortgage-Backed Mutual Funds Funds come in many
varieties Some Ginnie Maes Some all agency
certificates Some combine agency certificates
with Treasury securities Combination funds
help manager manage interest-rate risk
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Mortgage-Backed Mutual Funds Name of fund may
not tell whats in it Read the prospectus
carefully Kinds of securities
characteristics of fund Whether fund invests
in more risky investments such as puts and
calls, options, and futures contracts.
Increases earnings increases risk if
manager guesses wrong
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Mortgage-Backed Mutual Funds Every 1 percent
change in interest rates, value of fund changes
almost 6 percent in either direction, up or down
Purchase for income rather than capital gains

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Conclusion Sell it before Treasury maturesmay
be a loss Three maturities Treasury
billsshortest maturity Treasury notesmedium
Treasury bondslongest Purchase redeem
treasury securities through Treasury Direct
Higher interest rate mortgage-backed
securities or mutual funds