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CHAPTER 7

Credit Bank, Federal Home Loan Mortgage Corporation (Freddie Mac), and the International Bank for Reconstruction and Develop- ment (World Bank). Typically, the yields on these securities are greater than regular U.S. government securities.

PASS-THROUGH SECURITIES. These securities, also known as par- ticipation securities, are characterized by participation in a pool of assets from which investors receive certificates documenting their claims in the underlying assets. The most common of these are the Ginnie Mae pass-throughs. These certificates entitle investors to acquire high mortgage yields with both the principal and interest payments guaranteed by the federal government.

An important characteristic of these securities is that, unlike cor- porate or muni bonds, T-notes, and T-bonds, a portion of the principal is repaid with every interest payment as the underlying mortgages in the asset pool are amortized by the borrowers. This way, the investor is receiving a higher level of secure income. However, pass-through securities are highly susceptible to interest rate risk. As the interest rate drops, borrowers are more likely to refinance their debt, thus paying off the mortgages and returning the principal to the participa- tion investors. The investors would then have to reinvest this money at a lower interest rate.

There is a number of different types of pass-through securities. Participation in pools of mortgages is called mortgage-based securi- ties and participation in pools of consumer loans is called asset- backed securities. Collateralized mortgage obligations are a type of mortgage-based securities, but they may have some different invest- ment characteristics.

Zero-Coupon Bonds Zero-coupon bonds (zeros) are bonds in which there is no stated coupon rate, and so there is no current interest paid on them. Zeros are also sold at a discount, which is usually quite substantial. Their return to the investor is measured by their yield to maturity.

For example, you wish to purchase a zero with a face value of $10,000 and a maturity date of 2018. You buy it for $2000. Because it is a zero-coupon bond, you will receive no interest payments. How-

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