109 Government Agency Bonds and Safety
Government Agency Bonds and Safety
While government agency bonds can be solid investments, backed implicitly by the US government, they are, of course, slightly less solid than investments in Treasury securities. And because Ginnie Mae is operated through a US agency—the Department of Housing and Urban Development—its bonds are considered slightly more solid than those of Fannie Mae and Freddie Mac. Both Fannie Mae and Freddie Mac are former government agencies that now are publicly traded companies chartered by Congress.
Things To Know
- Perhaps the biggest risk with government agency bonds is prepayment risk.
- Agency bonds have a low likelihood of default.
What are the risks?
Yet investors in US government agency bonds still face certain risks. Perhaps the biggest of these is prepayment risk. Prepayments directly affect an investment’s average life and yield. And accurately predicting the home mortgage interest rates five or more years out is as much of a challenge as correctly forecasting a bull or bear market.
Just the opposite happens when mortgages in the pool mature more slowly. If fewer homeowners sell their home or refinance, for instance, the average life of the investment grows longer than planned. This extension risk reduces the amount of money with which the investor has to buy other securities at a time of high interest rates.
Investors who trade US government agency bonds on the secondary market also face market risk—much as they would with common stocks. The value of their investment can vary according to such factors as changing interest rates, time to maturity, and liquidity.
What are the advantages?
Despite these risks, many individual investors and organizations buy US government agency bonds. They believe that the low likelihood of default coupled with a generally reasonable return compensates them for the potential volatility and other risk factors.
