GSE bonds can boost cash flow |
| By Laura Bruce • Bankrate.com |
|
The housing crisis, credit crunch and the reaffirmed backing by the federal government of the beaten-up housing giants Freddie Mac and Fannie Mae could provide an investment opportunity for those looking for better yields.
Sometimes the search for decent yields in a low-rate environment can lead to taking too much risk. Government-sponsored enterprises, or GSEs, issue bonds that can provide some intriguing yields and yet they're close to top-tier investments
when it comes to safety.
GSE bonds are not totally risk-free, but none have
defaulted, and many people believe the government wouldn't allow
a default. We still don't know if they'll always be in the "too
big to fail" category, but the government certainly appears to have
put them there for the foreseeable future with the announcement
that billions of dollars will be available to shore up the institutions,
should they need it.
GSEs are financial services corporations created by Congress to facilitate lending in certain key sectors of the
economy, such as housing and agriculture. Federal Home Loan Bank, the Federal National Mortgage Association (Fannie Mae), the Federal Home
Loan Mortgage Corp. (Freddie Mac), the Federal Farm Credit Bank and the Federal Agricultural Mortgage Corp. (Farmer Mac)
are GSEs. These organizations have the implied backing of the federal government, which differs from the implicit
backing carried by official government agencies such as the Government National Mortgage Association (Ginnie Mae).
As you may have surmised from reading the names of these GSEs,
they have not escaped unscathed from the mortgage crisis and credit
crunch. The result is that their bonds
are often sporting high coupons
and are selling at low premiums. The government's stand-by bailout
should eventually narrow the gap between price and yield, but these
bonds may still deserve a place in your portfolio.
Let's look at a Federal Home Loan Bank bond recently offered on the secondary market, meaning this isn't the first
time the bond has been up for sale.
 |
| Federal Home Loan Bank bond |
|
|
| Issue |
Coupon |
Maturity |
Price |
Yield to worst |
Yield to maturity |
|
Federal Home Loan Bank issued this bond with the right to recall it, or redeem it, before the maturity date. In
this case, the maturity date is September 2009, but the bond can be called as early as September 2008.
How bonds are priced
New bonds are usually issued at par, or face value, which is $1,000 per bond. When a new bond is sold and then bought by someone
else on the secondary market, the value of the bond changes because interest rates have changed. The bond may still trade at par,
but it often trades for more or less than $1,000 -- in which case it's said to trade at a premium or a discount.
In our example, the bond is trading at a premium; its price is $1,006.60. Bond prices are based on 100, meaning
100 percent of par. When the price is listed as 100.66000, move the decimal point one place to the right to get the price you'll pay.
For more on how bonds work, see Bankrate's section on investing in bonds. |
