Types of Fixed Income Securities

B is correct. GNMA (Ginnie Mae) securities are the only agency securities backed by the full faith and credit of the U.S. government, giving them the same credit quality as Treasury securities. GNMA guarantees the timely payment of principal and interest on its mortgage-backed securities.

A (FNMA/Fannie Mae) is incorrect because it is a government-sponsored enterprise (GSE) that is not backed by government guarantee. C (FHLMC/Freddie Mac) is incorrect for the same reason as FNMA. These agencies carry implicit but not explicit government backing. D (Federal Farm Credit Bank) is incorrect because it is also a GSE without full faith and credit backing.

A is correct. General obligation (GO) bonds are backed by the taxing power of the issuing municipality, including property taxes (ad valorem) for local governments and income or sales taxes for state governments. The issuer's ability to raise taxes to meet debt obligations makes GO bonds generally lower risk than revenue bonds.

B (Project revenue) is incorrect because this describes revenue bonds, not GO bonds. C (Federal government) is incorrect because municipal bonds are issued by state and local governments, not backed by federal guarantee. D (Specific collateral) is incorrect because GO bonds are backed by taxing authority rather than pledged assets.

B is correct. TIPS provide inflation protection by adjusting the principal value based on changes in the Consumer Price Index (CPI). The coupon rate remains fixed, but it is applied to the inflation-adjusted principal, resulting in higher interest payments when inflation rises. At maturity, investors receive the greater of the adjusted principal or the original principal amount.

A (Adjusting coupon rate) is incorrect because TIPS maintain a fixed coupon rate. The inflation adjustment is made to the principal, not the rate. C (Tax-exempt interest) is incorrect because TIPS interest is subject to federal taxation, and investors must also pay taxes on the principal adjustment each year even though they don't receive that amount until maturity. D (Minimum 3% real return) is incorrect because TIPS do not guarantee any specific real return level.

D is correct. Subordinated debentures have the lowest priority among the choices listed. In bankruptcy, they are paid only after all senior debt, including regular debentures and secured bonds, has been satisfied. This higher risk typically results in higher yields to compensate investors.

A (Mortgage bonds) and B (Collateral trust bonds) are incorrect because both are secured bonds with claims on specific collateral, giving them higher priority than unsecured debt. C (Debentures) are incorrect because while they are unsecured, they are senior to subordinated debentures and get paid before subordinated debt in bankruptcy.

A is correct. The tax-equivalent yield is calculated using the formula: municipal yield ÷ (1 - tax bracket) = 4.2% ÷ (1 - 0.32) = 4.2% ÷ 0.68 = 6.18%. This means a taxable bond would need to yield 6.18% to provide the same after-tax return as the 4.2% tax-exempt municipal bond for someone in the 32% bracket.

B (5.47%) is incorrect because it uses an incorrect calculation. C (2.86%) is incorrect because it represents the after-tax yield of a 4.2% taxable bond, which is the reverse of what the question asks. D (4.20%) is incorrect because it's simply the municipal yield without any tax adjustment.

B is correct. Revenue bonds are backed by the revenue generated from the specific project being financed. In this case, tolls collected from drivers using the road would provide the income stream to pay bondholders. The creditworthiness of the bond depends on the project's ability to generate sufficient revenue.

A (Property taxes) is incorrect because property taxes back general obligation bonds, not revenue bonds. C (General taxing authority) is incorrect for the same reason. This describes GO bonds rather than revenue bonds. D (Federal highway funding) is incorrect because revenue bonds are repaid from project-specific revenue, not government appropriations or external funding sources.

B is correct. Treasury STRIPS are zero-coupon bond securities created by separating the principal and interest payments of Treasury bonds. Although they pay no interest until maturity, investors must pay federal income tax annually on the imputed or "phantom" interest that accrues. This makes them most suitable for tax-deferred accounts like IRAs.

A (Semiannual interest) is incorrect because STRIPS pay no current interest. They are sold at a deep discount and mature at face value. C (Lowest duration) is incorrect because STRIPS actually have the highest duration of Treasury securities since all cash flows occur at maturity, making them extremely price-sensitive to interest rate risk changes. D (Callable) is incorrect because STRIPS are not callable, eliminating reinvestment risk from call provisions.

D is correct. GNMA securities are fully taxable at the federal, state, and local levels. Unlike Treasury securities (which are state tax-exempt) or municipal bonds (which are typically federal tax-exempt), GNMA securities offer no tax advantages despite having government backing.

A (Monthly cash flow) is correct and therefore not the exception. GNMA securities make monthly payments, unlike most bonds which pay semiannually. B (Pass-through) is correct. GNMA issues pass-through certificates that distribute mortgage payments from homeowners to investors. C (Prepayment risk) is correct. When interest rates fall, homeowners refinance their mortgages, causing early principal return to investors who must then reinvest at lower rates.

C is correct. A mortgage bond is a secured bond backed by real estate owned by the corporation. If the issuer defaults, bondholders have a claim on the specified real property, providing greater security than unsecured bonds and typically resulting in lower yields.

A (Debenture) is incorrect because debentures are unsecured bonds backed only by the general creditworthiness of the issuer, not by specific collateral. B (Equipment trust certificate) is incorrect because these are secured by equipment, typically used by transportation companies for rolling stock (trains, trucks, planes), not real estate. D (Subordinated debenture) is incorrect because these are unsecured bonds with even lower priority than regular debentures.

C is correct. The primary distinction between Treasury notes and Treasury bonds is maturity length. Treasury notes have original maturities ranging from 2 to 10 years, while Treasury bonds have original maturities exceeding 10 years (typically 20 or 30 years). Both pay semiannual interest and are backed by the full faith and credit of the U.S. government.

A (Interest payment frequency) is incorrect because both notes and bonds pay interest semiannually, not at different frequencies. B (State taxation) is incorrect because both notes and bonds are exempt from state and local taxes while being subject to federal taxation. D (Callable) is incorrect because neither Treasury notes nor bonds issued in recent decades are callable. The Treasury stopped issuing callable bonds in the 1980s.