About Government/Agency Bonds

Overview
One of the worlds largest and most liquid bond markets is comprised of debt securities issued by the U.S. Treasury, by U.S. government agencies and by U.S government-sponsored enterprises. U.S. Treasury securities, used to finance the federal government debt, are also considered to have the bond markets lowest risk because they are guaranteed by the U.S. governments full faith and credit or, in other words, its taxing authority. Government agencies and government-sponsored enterprises such as Ginnie Mae, Fannie Mae and Freddie Mac also issue debt to support their role in financing mortgages. Use this section to learn more about:

The different types of U.S. government and agency securities The advantages and risks of investing in Treasuries and government securities

Go to the Government/Federal Agency Market At A Glance page to get news affecting the government and federal agency bond markets as well as recent price and yield information on:

Treasury bills with maturities of less than one year Treasury notes with maturities between one and ten years, and Treasury bonds with maturities of 10 years or more Federal agency bonds

Stay informed on government bond market news and opportunities by visiting this page often for new content and market information.

Agency Bonds
Agency bonds are issued by two types of entities1) Government Sponsored Enterprises (GSEs), usually federally-chartered but privately-owned corporations; and 2) Federal Government agencies which may issue or guarantee these bondsto finance activities related to public purposes, such as increasing home ownership or providing agricultural assistance. Agency bonds are issued in a variety of structures, coupon rates and maturities. Each GSE and Federal agency issues its own bonds, with sizes and terms appropriate to the needs and purposes of the financing. There are usually minimums to invest in agency bonds$10,000 for the first investment and increments of $5,000 for additional investments. Investing in Ginnie Mae Federal Agency bonds requires a $25,000 minimum investment. The degree to which an agency bond issuer is considered independent from the federal government impacts the level of its default risk. The interest from most but not all agency bond issues is exempt from state and local taxes; some of the biggest issuers such as GSE entities Freddie Mac and Fannie Mae are fully taxable.

In general the agency bond market is considered a liquid market, in which investments can quickly and easily be bought and sold. However, as explained below, some agency bond issues have features that make the bond issues more "structured" and complex, which can reduce liquidity of these investments for investors and make them unsuitable for individual investors. Agency Bonds issued by GSEsBonds issued by GSEs such as the Federal Home Loan Mortgage Association (Freddie Mac), the Federal Home Loan Mortgage Association (Fannie Mae) and the Federal Home Loan Banks provide credit for the housing sector. Federal Agricultural Mortgage Corporation (Farmer Mac); the Farm Credit Banks and the Farm Credit System Financial Assistance Corporation do the same for the farming sector. The bulk of all agency bond debtGSEs and Federal Government agenciesis issued by the Federal Home Loan Banks, Freddie Mac, Fannie Mae and the Federal Farm Credit banks. GSEs are not backed by the full faith and credit of the U.S. government, unlike U.S. Treasury bonds. These bonds have credit risk and default risk and the yield on these bonds is typically slightly higher than on U.S. Treasury bonds. Some GSEs such as Fannie Mae and Freddie Mac are publicly traded companies that register their stock with the SEC and provide publicly available documents such as annual reports on the SEC website. Agency Bonds issued by Federal Government agenciesBonds issued or guaranteed by Federal Government agencies such as the Small Business Administration, the Federal Housing Administration and the Government National Mortgage Association (Ginnie Mae) are backed by the full faith and credit of the U.S. government, just like U.S. Treasury bonds.* Full faith and credit means that the U.S. government is committed to pay interest and principal back to the investor at maturity. Because different bonds have different structures, bonds issued by federal government agencies may have call risk. In addition, agency bonds issued by Federal Government agencies are less liquid than Treasury bonds and therefore this type of agency bond may provide a slightly higher rate of interest than Treasury bonds. *A significant exception to this full faith and credit guarantee for Federal Government agency bonds are those issued by the Tennessee Valley Authority (TVA). Its bonds are secured by the power revenue generated by the Authority. Types of Structures of Agency Bonds As noted above, most agency bonds pay a fixed rate of interest or fixed coupon rate semiannually. Most agency bonds are non-callable or bullet bonds. Like all bonds, agency bonds are sensitive to changes in interest rateswhen interest rates increase, agency bond prices fall and vice versa. However, in addition to fixed rate coupon and non callable agency bonds, agencies do structure their bond issues to meet different investor needs. Variable or floating coupon rate agency bonds: so-called "floating rate" or "floaters" are agency bonds that have interest rates that adjust periodically. Adjustments are usually linked to an index such as U.S. Treasury bond yields or LIBOR according to a predetermined formula (with limits on how much the interest or coupon rate can change).

No-coupon agency bond notes or "discos": no-coupon discount notes are issued by agencies to meet short-term financing needs and are issued at a discount to par value. Investors who sell such discos prior to maturity may lose money. Callable agency bonds with "step up" coupon rates: callable agency bonds that have a pre set coupon rate "step up" that provides for increases in interest rates or coupon rate as the bonds approach maturity to minimize the interest rate risk for investors over time. Step ups are often called by issuers at a time of declining interest rates. Declining interest rates may accelerate the redemption of a callable bond, causing the investor's principal to be returned sooner than expected. As a consequence, an investor might have to reinvest principal at a lower rate of interest. The interest from most but not all agency bond issues is exempt from state and local taxes and it is important for investors to understand the tax consequences of agency bonds; some of the biggest agency bond issuers such as GSE entities Freddie Mac and Fannie Mae are fully taxable for example. Capital gains or losses when selling agency bonds are taxed at the same rates as stocks. Consult your financial advisor before determining whether agency bonds are a suitable investment for you. Buying and Selling Agency Bonds Agency securities are generally bought and sold through brokers and are likely to include fees or transaction costs. The agency bond market in which individuals might participate is considered relatively liquid. However, not all kinds of agency bond issues are considered liquid, including some of which may be structured for a particular issuer or class of investors and may not be suitable for individual investors. Investment dollar minimums may make buying and selling individual bonds less suitable to many individual investors than buying an agency bond fund or U.S. Treasuries directly. Investors should take into account that the tax status of various agency bond issues varies depending on the agency issuer. As with any investment, it is important to understand the work of the agency or enterprise that is issuing the bonds and know the credit rating of the issue. This allows an investor to know the basis on which a bond is being issued. Go to the Government/Federal Agency Market-at-a-Glance page to see Agency bond price information. You can find helpful information in The GSE Debt Market: An Overview. For additional investor resources on bond issuance programs see the following:

For more information and documentation for investors on Federal Farm Credit Banks Funding Corporation bond issuance programs, click here. For more information and documentation for investors on Federal Home Loan Banks Office of Finance (FHLB) bond issuance programs, click here. For more information and documentation for investors on Federal Home Loan Mortgage Corporation (FHLNC, also known as Freddie Mac) bond issuance programs, click here. For more information and documentation for investors on Federal National Mortgage Association (FNMA, also known as Fannie Mae) bond issuance programs, click here.

For more information and documentation for investors on Government National Mortgage Association (GNMA, also known as Ginnie Mae) bond issuance programs, click here. For more information and documentation for investors on Tennessee Valley Authority (TVA) bond issuance programs, click here.

The GSE Debt Market: An Overview

GSE Issuers and Their Financing Needs
Government-sponsored enterprises (GSEs) are financing entities created by Congress to fund loans to certain groups of borrowers such as homeowners, farmers and students. Through the creation of GSEs, the government has sought to address various public policy concerns regarding the ability of members of these groups to borrow sufficient funds at affordable rates. GSEs are also sometimes referred to as federal agencies or federally sponsored agencies. The reader should note, however, that there are organizational differences among the GSEs although all are established with a public purpose: Federal National Mortgage Association (Fannie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac) are privately owned corporations, while the Federal Home Loan Banks and the Federal Farm Credit Banks are systems comprising regional banks. All GSE debt is not guaranteed by the federal government, whereas government agencies such as Government National Mortgage Association (Ginnie Mae) are divisions of the government whose securities are backed by the full faith and credit of the United States. To conduct their lending business, GSEs have significant funding requirements. While many are stockholder-owned companies that can raise equity capital, most GSEs rely primarily on debt financing to fund their day-to-day operations. Among the most active issuers of debt securities are:

Federal Home Loan Banks Freddie Mac Fannie Mae Federal Farm Credit Banks and Tennessee Valley Authority (TVA).

Supranational and international institutions, such as the World Bank, also issue debt securities. See complete descriptions of each GSE. Buyers of GSE-issued debt securities include domestic and international banks, pension funds, mutual funds, hedge funds, insurance companies, foundations, other corporations, state and local governments, foreign central banks, institutional investors and individual investors.

The Credit Quality of GSEs

In general, debt securities issued by GSEs are considered to be of high credit quality. The senior debt of the GSEs is rated AAA/Aaa, while the subordinated debt of Fannie Mae and Freddie Mac is currently rated AA-/Aa-. Some GSEs have explicit, though limited, lines of credit from the U.S. Treasury. As a group, GSEs benefit from a perceived tie to the federal government as institutions established under federal legislation. In September 2008, the Federal Housing Finance Agency became the conservator of the housing GSEs. In connection with the conservatorship, Treasury has now committed to provide necessary funding to correct any deficiencies in their net worth. However, debt securities issued by GSEs are solely the obligation of their issuer and, unless explicitly stated, do not carry any guarantee by the federal government. They are considered to carry greater credit risk than securities issued by the U.S. Treasury and certain government agencies (e.g., Ginnie Mae) whose securities have the full-faith-and-credit guarantee of the U.S. government. For this reason, GSE debt obligations often carry a yield premium over Treasury securities with comparable maturities. The premium varies with market volatility, and the structure, maturity, and general supply and demand for the particular security.

The Growing Use of Regular Issuance Programs & Auctions

The GSEs utilize a variety of issuance formats for their securities. Most long-term debt is issued in public monthly security sales through designated dealer groups using both syndicate and auction pricing methodologies. Currently, the majority of GSE term debt is issued through various programmatic issuance formats, as outlined in greater detail below. All the GSEs have created issuance programs that incorporate funding calendars for large-size issues. Due to differences in the GSEs organizational and corporate structures, the separate funding calendars will vary as to specified issuance details. In 1997, the Federal Home Loan Banks Office of Finance began using auctions in its issuance of short-term discount notes. Since then Freddie Mac and Fannie Mae have also incorporated auction formats in their programmatic short-term funding. Additionally, all the GSEs post daily rates for discount notes. Currently, most of the non-callable term debt that is issued is in the form of conventional notes having maturities of one, two, three, five, ten and thirty years. However, many GSEs have incorporated floating-rate and callable securities into their issuance programs and regularly issue these structures as well. Today, GSEs increasingly choose to raise funds through a variety of formal debt issuance programs.

Freddie Mac Reference Notes, Reference Bonds and Reference Bills; Fannie Mae Benchmark Notes, Benchmark Bonds and Benchmark Bills; Federal Home Loan Bank TAP Issues; and Federal Farm Credit Bank Designated Bonds and Calendar Bond Program

have all been developed to brand these particular securities with certain attributes of liquidity and pricing transparency.

The selective application of auction methodology in debt issuance by the GSEs in the last few years has introduced greater regularity and transparency to the securities pricing process and made possible for the first time a true when issued (WI) market in those short- and long-term issues which are scheduled to be auctioned. Working through the Securities Industry and Financial Markets Association, the dealers and issuers have helped establish commonly used trading guidelines that govern WI trading in GSE auctioned issues of term debt with a maturity of two years and longer. (See Practice Guidelines for When-Issued Trading in GSE Auctioned Securities.) Additionally, advances in technology have enhanced the market for customized interest rate swaps, options and futures, and allowed the GSEs to issue a variety of structured products that can be highly tailored to simultaneously meet the very specific needs of issuers and investors. For instance, the GSEs have various medium-term-note (MTN) programs that allow them to come to market on a continuous basis with different debt offerings. As a result, GSEs have gained the flexibility to structure the size and terms of their debt issues to meet the requirements of a particular investor or class of investors. Under these programs, issuers may choose a variety of maturities with either callable or fixed maturities as well as floating interest rates, interest rates linked to one or more market indices, different interest payment dates and other key features. The same flexibility can be achieved through individually negotiated security offerings. The variety of issued securities enable GSEs to lower their cost of funding by targeting an issue to a particular investor need, since investors are typically willing to pay a premium to obtain a desired cash flow or implement a particular market view. Issuers also use the structures to obtain options from investors in a cost-effective manner. For example, an investor will demand a yield premium for allowing the issuer the option to call a bond or note, but if interest rates decline the issuer might ultimately save money by exercising the call option. In connection with these structures, issuers often enter into customized options and/or swap agreements with a third party. The third party may be an investment bank, a subsidiary of an investment bank, a swap dealer or another entity. Under these agreements, the issuer receives a cash flow needed to fulfill the terms of the security offering while agreeing to pay its counterparty a rate that might better match the incoming cash flow on its assets. The GSE issuer assumes all counterparty credit risk; a default by the issuers counterparty on an option or swap agreement does not change the issuers obligations to investors in the related security.

Other Agency Issuers

Resolution Funding Corporation (REFCORP) Tennessee Valley Authority (TVA) Federal Farm Credit System Financing Corporation (FICO)

The Private Export Funding Corporation (PEFCO) Government Trust Certificates (GTC) The U.S. Agency for International Development (AID) The Financial Assistance Corporation (FAC) The General Services Administration (GSA) The Small Business Administration The U.S. Postal Service

You can find out more about Agency Bonds here.

Investor Benefits
The variety of GSE-issued debt securities and programs offer investors a unique combination of high credit quality, liquidity, pricing transparency and cash flows that can be customized to closely match an investors objective to:

implement a current interest rate or currency view; hedge a specific risk; enhance portfolio liquidity: balance portfolio performance characteristics; or minimize transaction costs.

The wide range of debt securities can be viewed as a way of enabling investors to achieve the benefits available from interest rate (and other) swap and option arrangements without incurring the operational and transactional expenses required to establish and manage swap agreements and the related counterparty credit risk.

Investor Risks
The wide variety of GSE debt structures require a level of investor sophistication and awareness. Different structures behave differently when interest rates, yield curve shapes, exchange rates and/or other market indices change. Typically, structured debt securities preserve investors principal if purchased at par and held to maturity. However, some structured securities add features that can accelerate final maturities and place interest flows, and in some cases principal, at risk. Certain structures have become common, while others remain unique in both issuance and investor applicability. As the variations expand, it is crucial that investors know exactly how the instrument is affected by market changes. Investors should fully understand the price sensitivity and performance characteristics of the instrument they are considering, and make a complete analysis of both potential risks and benefits. The key to success in this market is to be fully aware of all the characteristics of the particular

instrument and to understand how the security will react to changes in relevant market rates and in combination with other portfolio holdings. Once investors purchase these securities, they should also monitor their performance continuously. Furthermore, certain MTN issues can have limited liquidity. Certain structured securities have a narrower base of potential investors, because securities that have been structured for a particular investors needs may not match the needs of other investors. With such products, buyers in the secondary market may be much more difficult to find

Federal & Congressional Oversight of the GSEs

To assure that the GSEs continue to fulfill their public mission of reducing borrowing costs for certain groups, their activities are monitored and periodically reviewed by their respective regulators and congressional oversight committees. Recent changes in the GSE oversight structure include the creation of the Federal Housing Financing Board in 2008 as the regulator of the housing GSEs. In addition, as part of President Obama's Financial Regulatory Reform proposal, the Treasury and HUD will develop recommendations for the future of housing GSEs. Public criticism of the GSEs can obviously create some level of political uncertainty and price volatility in these markets. This political headline risk has so far never affected the current credit of outstanding GSE debt, but it can impact trading spreads and temporarily disrupt liquidity in the GSE market. Investors should therefore remain cognizant that, as large as the GSE debt market has become, Congress and other federal oversight authorities will continue to play a key role in assuring that the GSEs do their utmost to fulfill their missions, maintain their high credit ratings and adhere to their charters. At times this may create a certain amount of short-term volatility in these markets. Yet, responsible federal oversight ultimately helps strengthen the long-term viability of the GSE debt market.

General Description of GSE Debt Securities

GSE-issued debt securities can be structured to offer investors fixed or floating interest rates. While the basic structures share many characteristics of non-structured fixed- or floating-rate debt, many variations are possible. This overview attempts to describe some forms common in todays market, moving from the simplest to the most complex.

Fixed-Rate Securities
Standard Fixed-Rate Features
Fixed-rate debt securities have fixed interest rates and fixed maturities. If held to maturity, they offer the benefits of preservation of principal and certainty of cash flow. Prior to maturity, however, the market value of fixed-rate securities fluctuates with changing interest rates. In a

falling-rate environment, market values will rise, with the degree of increase determined by the time remaining to maturity or call date, creating the potential for capital gains. In a rising-rate environment, prices will fall, creating the risk of loss when securities that have declined in market value are sold prior to maturity.

Debt Variations

Callable Securities
These structures give the issuer the right to redeem the security on a given date or dates (known as the call dates) prior to maturity. Essentially, an option to call the security is sold by the investor to the issuer, and the investor is compensated with a higher yield. The value of the call option at any time depends on current market rates relative to the interest rate on the callable securities, the performance of assets funded with the proceeds of callable issues, and the time remaining to the call date. The period of call protection between the time of issue and the first call date varies from security to security. Documentation for callable securities usually requires that investors be notified of a call within a prescribed period of time. Issuers typically exercise call options in periods of declining interest rates, thereby creating reinvestment risk for the investor. On the other hand, if an investor expects a security to be called and it is not, the investor faces an effective maturity extension that may or may not be desirable. Certain securities may be called only in whole (i.e., the entire security is redeemed), while others may be called in part (i.e., a portion of the total face value is redeemed) and possibly from time to time as determined by the issuer. The three most common callable features are:

Europeancallable only at one specific future date; Bermudiancallable only on interest payment dates; and Americancallable on any date, normally with 30 days notice.

In almost all cases, the right of the issuer to exercise a call is deferred to the end of an initial lockout period.

The Valuation of Callable GSE Debt

When interest rates move, the values of almost all debt securities change. For non-callable fixedrate instruments, the price of the security will go down as rates go up (and up as rates go down) so that yields remain in line with prevailing market rates. For securities with embedded options, however, the market price also has to account for the change in the value of the embedded option. A call option, for example, becomes more valuable to the issuer as interest rates fall and the yield to investors adjusts to reflect that higher value. The degree of such shifts, however, may be difficult to determine accurately in advance. Market volatility will also affect the price investors are willing to pay for a given security.

Several valuation methods are available to help investors calculate the value of a specific debt security. Results can vary widely from model to model. While no single valuation method is universally preferred, some are used more commonly than others. The option-adjusted spread (OAS), for example, calculates the annual value of an embedded call option (in basis points, based on an assumed rate of volatility) and subtracts it from the securitys yield spread. This adjusted spread can then be compared to the available spread on a non-callable security of similar credit quality with the same maturity. If the callable GSE securitys adjusted spread is less than the yield on a non-callable GSE security, the non-callable security may be a better investment choice. The current calculations of the OAS on most outstanding GSE structured debt securities are available through leading information vendors. Other approaches involve comparing the risk/reward profile of the security to that of other securities; performing a forward-rate analysis, which assumes forward rates will reflect current yield curve assumptions; reviewing the range of performance possibilities based on historical distribution of interest rates or under a stress scenario (e.g., a 200-basis-point shift in the yield curve); and calculation of an instruments internal rate of return.

Step-Up Securities
An initial fixed interest rate is paid until a specified date, generally a call date. On a five-year note, for example, the call date may be two years after issuance. On the prescribed date, if the security has not been called, the interest payment steps up to a specified higher rate that was fixed prior to the issuance of the security. A single security can have more than one step-up period. Step-up securities are typically structured so that they are callable by the issuer at any interest payment date on or after the first call, or step-up, date. Some step-up securities have been issued so that they are continuously callable after the first call date, meaning they can be called at any time, not just on the payment dates. A less common variation is the step-down security, also callable, which provides the investor with a higher initial interest rate but greater uncertainty about maturity.

Indexed Amortization Notes

(IANs; also known as Indexed Principal Redemption Bonds, Principal Amortization Notes or Indexed Sinking-Fund Debentures.) These securities pay a fixed rate of interest and repay principal usually according to an amortization schedule which is typically linked to the level of a designated interest rate index such as the three-month U.S. dollar London Interbank Offered Rate (LIBOR). The amortizing principal payments usually begin at the end of a prescribed lock-out period. For example, a five-year IAN might have a two-year lockout period during which interest is paid on the full principal amount. Between years three and five, investors receive partial repayments of principal, at an amortization rate determined by the designated index, and interest based on the

amount of principal still outstanding. At the stated maturity date, any outstanding principal is retired regardless of the level of the index. Note: IANs are often compared to Planned Amortization Class (PAC) tranches in collateralized mortgage obligations (CMOs). Like some CMO PAC bonds, they have a guaranteed minimum life and an expected amortization schedule, although the actual amount of future cash flows remains unknown because it depends on interest rate movements. Unlike with CMO PAC bonds, however, any prepayment risk that exists is created by movements in the selected index rather than by actual prepayments on underlying mortgage loan collateral. Furthermore, an IAN does not depend on the amount or timing of principal repayment of other tranches in the same offering, as is typical in the case of CMO PAC bonds.

Floating-Rate Securities
Rather than paying a fixed rate of interest, floating-rate securities (or floaters) offer interest payments which reset periodically, with rates tied to a representative interest rate index. Floaters were first issued during a period of extreme interest rate volatility during the late 1970s. From the investors perspective, floaters can offer enhanced yields when compared to a strategy of rolling over comparably rated short-term instruments and paying the related costs associated with each transaction. Floating-rate securities also allow investors to match asset and liability cash flows.

Standard Features:

Base Index
Indices used to set the interest rate on floaters include:

CMT: Constant Maturity Treasury Index COFI: Cost of Funds Index, typically the one published by the 11th District Federal Home Loan Bank CP: Federal Reserve Commercial Paper Composite Fed Funds Rate LIBOR: London Interbank Offered Rate for U.S. dollars and other currencies: three-month, six-month or one year Prime Rate Treasury bill rates: three-month, six-month or one year Foreign interest rate or currency exchange rate: see non-dollar section. page 15.

The rate may also be set as some combination of the above, such as Prime minus 10-year CMT plus three-month LIBOR. The glossary beginning on page 23 describes each index in more detail.

Yield Spreads
Floater yields are typically defined as a certain number of basis points (or spread) over or under the designated index. Floaters based on indices such as T-bills will generally add the spread (e.g., the interest rate will be T-bill plus 40 basis points), while those based on other indices such as the prime rate might have the spread subtracted from the rate (e.g., the interest rate will be Prime minus 240 basis points). Typically, spreads are set when the securities are priced and remain fixed until maturity so that changing interest rates affect the amount of interest paid on the security but not the spread. When floating-rate securities are purchased at a price other than par, the difference between the purchase price and par is converted to a percentage and discounted for the remaining life of the security to calculate an effective yield, also known as the discount margin or sometimes as spread for life.

Reset Periods
The interest rate on floaters may be reset daily, weekly, monthly, quarterly, semiannually or annually. In some cases, the reset period will be determined by the index used. Fed funds floaters, for example, might reset daily because the rate is an overnight rate, while T-bill floaters usually reset weekly following the weekly T-bill auction. Some floaters, particularly those with more frequent resets, set their rate as of a date prior to the coupon payment date. The period between the date the rate is set and the payment date is referred to as a lock-out period. Floaters with longer reset periods may be more vulnerable to interest rate and price volatility.

Day Count Periods

Floating-rate securities generally use a month/year day count convention of 30/360, actual/360 or actual/actual to calculate the number of days in the interest payment period. For example, a security with a 30/360 convention assumes there are 30 days in every month and 360 days in every year. As a result, the rate of interest accrues daily at 1/360th of the nominal interest rate for the calculated number of days in the interest period; even in a 31-day month, interest is calculated on the basis of 30 days. Actual/360 uses the actual number of days in the month and a 360-day year; actual/actual uses the actual number of days in both the month and the year. Day count periods can vary by issuer and by issue. They are disclosed in offering documents.

Payment Periods
Interest payments on floaters may be made monthly, quarterly, semiannually or annually. Interest on floaters is usually not compounded, but the more frequent the payments, the more the investor

stands to earn from reinvesting. The higher the prevailing interest rate for reinvested funds, the more noticeable this potential compounding effect will be.

Maturity
Floaters may be issued with any maturity, and those with longer maturities generally carry a slight yield premium. With a fixed-rate security, the yield premium for longer maturities tends to compensate investors for credit and interest rate risk during the time the security is outstanding. Yield premiums for longer maturities on floating-rate securities can also reflect the possibility of credit changes and, to a lesser degree, interest rate movements.

Interest Rate or Coupon

Because the interest payment on a floater is tied to an index through some formula, the actual interest paid may be lower than the rate paid on a conventional fixed-rate debt security. For some issues, a zero interest rate is possible. Note too that floaters tied to indices such as COFI or Prime, which tend to lag behind the market, may perform better in a falling-rate environment, while floaters tied to coincident market indices such as LIBOR may do better in a rising-rate environment. Floaters tied to T-bills, meanwhile, can suffer from falling rates created by high T-bill demand during times of political crisis or extreme market shifts. Investors should remember that not all indices perform alike under different interest rate scenarios.

Valuation
The secondary market value of a floater is based on the volatility of the base index, the time remaining to maturity, the outstanding amount of such securities, market interest rates and the credit quality or perceived financial status of the issuer. Each of these factors is dynamic, and can result in higher or lower secondary market values. As with all securities, supply and demand must be taken into consideration. With respect to demand, investors should keep in mind that securities structured to meet the needs of a particular investor may have limited liquidity because of the challenge of finding another buyer.

Basis Risk
Basis generally refers to the difference between two indices. Basis risk refers to the possibility that this difference will change in an unanticipated manner. For example, if an investor with liabilities tied to one index, such as the T-bill rate, matches those liabilities to assets tied to another rate, such as LIBOR, the investor could be subject to basis risk if the two rates move in different directions than expected or at differing rates of change.

Non-Dollar Programs and Structures

Programmatic and MTN platformissued debt securities with either fixed or floating-rate interest may incorporate features that allow investors to hedge foreign currency risk or to participate in higher overseas interest rates. Investors may also use these structures to take a position on an expected movement in foreign exchange or interest rates. For example, an inverse floater tied to an overseas interest rate would allow the investor to benefit from falling interest rates in that particular market. These structures may be denominated in a currency other than U.S. dollars, or they may have their interest rate payment linked to a non-dollar interest rate or to an exchange rate between two or more currencies. Interest can be payable in a foreign currency or in U.S. dollars even though the rate is based on a foreign rate. Generally, structures that are denominated in U.S. dollars and pay in U.S. dollars do not expose the investor to currency risk, although some of the other variations will be denominated and pay interest in a foreign currency. Maturities generally range from two to 10 years and can be accompanied by an issuance calendar and a highly liquid secondary market. The special risk in these instruments is related to the possibility of changing relationships in foreign exchange rates and/or a marked change in the value of the dollars exchange rate with a particular foreign currency. If the spread between the U.S. interest rate and the relevant foreign interest rate changes in an unexpected way, investors may earn a lower or higher relative rate.

Primary GSE Issuance Programs

Federal Farm Credit Banks Designated Bonds, MasterNotessm, Calendar Bond Program, Discount Notes Federal Home Loan Banks TAP Issues, Medium-Term Notes, MasterNotessm, Discount Notes Freddie Mac Reference Notes, Reference Bonds, Reference Bills, Euro Reference Programme, Discount Notes, Medium Term Notes, FreddieNotes, and EstateNotes Fannie Mae Benchmark Notes and Benchmark Bonds, Benchmark Bills, Callable Benchmark Notes, Discount Notes, Medium-Term Notes and Fannie Mae Investment Notes TVA Electronotes, Power Bonds and Discount Notes

Offering Documentation for GSE Structured Debt Securities

In offering structured debt securities, GSEs generally prepare disclosure documents that discuss all the material terms of the investment. Dealers routinely provide these documents before settlement, and investors may obtain documentation directly from the issuer or, in some cases, from one of several financial information vendors. The investor should carefully read and fully understand the information in the offering documentation.

The Secondary Market for GSE Debt

A liquid and active secondary market in most of the GSEs programmatic debt issues has developed over the last few years. The enhanced liquidity of GSE programmatic debt issues, with regular and broad investor distribution, has been accompanied by an active repo and securities lending market in many of these issues. Almost all of the programmatic issues and many of the MTNs are quoted through electronic information systems, and secondary market prices are provided by many domestic and foreign dealers. Further, a number of electronic exchanges have listed programmatic GSE debt in their systems. It is important for investors to understand that GSE-issued MTNs are often tailored to the needs of a particular investor or class of investors. As a result, they are generally intended to be held until maturity. The underwriter of a GSE-issued structured debt security will usually agree to make a market for a customer who wants to sell the security prior to maturity; in fact, some issuers have obligated their underwriting dealers to do so. However, the high level of customization in this market can make it difficult to find another buyer. Still, as stated earlier, investors need to understand the characteristics of structured securities before they invest in them, particularly the ways in which their value will be affected by different interest rate scenarios and other market conditions. In most cases, they should be prepared to hold the investment to maturity or to risk a loss of principal due to both interest rate movements and illiquid markets if they need to sell before maturity. They should also consider the potential impact of changing values if they have to mark the securities to market for financial reporting purposes.

A Caution on Tax and Accounting Issues

Apart from legal investment issues, the variations of structured debt securities make it impossible to generalize about appropriate tax and accounting treatment for an investor. Investors should consult with their own tax advisors and accountants prior to investment.

Questions Investors Should Ask and Information Resources

Many dealers and information vendors provide detailed research and product information on GSE debt securities. Additionally, the GSEs own Web sites contain much descriptive information about their debt securities. Following are some questions that should be asked before investing in any GSE debt securities: 1. Does this investment conform to my investment guidelines?

2. Does it also conform to my suitability standards in terms of: portfolio objectives, liquidity needs, cash-flow requirements, credit diversity and structure diversity? 3. What interest rate assumptions are embedded in this security? 4. How much additional yield am I receiving in this structure and for what risk? 5. What is the best-case interest rate scenario for this product? 6. How might it perform if rates move in the opposite direction? 7. What is the worst-case interest rate scenario? 8. Is there leverage in this structure? If so, how does it apply in the best-case and worst-case scenarios? 9. If the investment has a floating rate, is there a cap, floor or collar? If so, how will these features affect the securitys performance under different interest rate scenarios? 10. Am I taking the risk of a zero or negative interest payment? 11. How is my principal repayment affected under different interest rate scenarios? To what extent is principal at risk? 12. Will there be a buyer for this security at a price that reflects its current value if I have to sell it sooner than I anticipate? 13. Are there high minimum denominations indicating a complex security that may have a limited universe of possible buyers? 14. Have I seen all the relevant documentation on this issue? 15. How can I get a price and analysis on this security? 16. Do I understand the structure, the issuer and its business? Investors should keep asking questions until they feel completely secure in their knowledge of the security they are considering for purchase and of the ways it fits with their investment goals.

The Issuers: Who Are They and What Do They Do?

Federal Farm Credit System (FFCB)
Created by Congress in 1916, this nationwide system of banks and associations provides mortgage loans, credit and related services to farmers, rural homeowners, and agricultural and rural cooperatives. The banks and associations are cooperatively owned, directly or indirectly, by their respective borrowers. The banks of the Farm Credit System issue securities on a consolidated basis through the Federal Farm Credit Banks Funding Corporation.

Federal Home Loan Bank System (FHLBanks)

Created in 1932, this system consists of 12 regional banks, which are owned by private member institutions and regulated by the Federal Housing Finance Board. Functioning as a credit reserve system, the system facilitates extension of credit through its owner-members in order to provide access to housing and to improve the quality of communities. Federal Home Loan Bank issues are joint and several obligations of the 12 Federal Home Loan Banks and issued through the Federal Home Loan Banks Office of Finance.

Freddie Mac
A stockholder-owned corporation established by Congress in 1970 to provide a continuous flow of funds to mortgage lenders, primarily through developing and maintaining an active nationwide secondary market in conventional residential mortgages. Freddie Mac purchases a large volume of conventional residential mortgages and uses them to collateralize mortgage-backed securities. Freddie Mac is a publicly held corporation; its stock trades on the New York Stock Exchange.

Fannie Mae
A federally chartered but privately owned corporation which traces its roots to a government agency created in 1938 to provide additional liquidity to the mortgage market. Today, Fannie Mae carries a congressional mandate to promote a secondary market for conventional and FHA/VA single- and multifamily mortgages. Fannie Mae is a publicly held company whose stock trades on the New York Stock Exchange.

Tennessee Valley Authority (TVA)

A wholly owned corporation of the U.S. government that was established in 1933 to develop the resources of the Tennessee Valley region in order to strengthen the regional and national economy and the national defense. Power operations are separated from non-power operations. TVA securities represent obligations of TVA, payable solely from TVAs net power proceeds, and are neither obligations of nor guaranteed by the United States. TVA is currently authorized to issue debt up to $30 billion. Under this authorization, TVA may also obtain advances from the Treasury of up to $150 million.

GSE Debt Securities Glossary

Amortization Repayment of debt principal through periodic installment payments rather than in a lump sum Average life On a security where principal is subject to prepayment, the average time to receipt of each dollar of principal, weighted by the amount of each principal prepayment, based on prepayment assumptions Benchmark and Reference Notes Large ($2 to $4 billion minimum size) debt tranches issued by Fannie Mae and Freddie Mac, respectively, in a non-scheduled but regular pattern of maturity and size meant to establish a yield curve framework for the government and the GSE marketplace.

Blended yield to maturity The combination and average of two points on the yield curve to find a yield at the midpoint Bond An interest-bearing debt obligation Bond equivalent yield An adjustment to yield on a note which has monthly or quarterly interest payments. The frequency of such interest payments, compared to semiannual interest payments on most other types of securities, may result in a different present value of the interest income. Bought Deals GSE-issued securities sold through negotiated direct placements or competitive bids, with terms and size determined by the immediate needs of the GSE Bullet A security with a fixed maturity and no call feature Call risk See Reinvestment risk Callable security A security that the issuer has the right to redeem prior to maturity Cap A maximum interest rate on a floating-rate security. The rate paid can never exceed the cap even though the calculation of the rate at the time might be higher CMT See Constant Maturity Treasury Series COFI See Cost of Funds Index Collar

Upper and lower limits (cap and floor, respectively) on the interest rate of a floating-rate security Constant Maturity Treasury Series (CMT) The average yield of a range of U.S. Treasuries with various fixed maturities. The five- and ten-year CMTs are commonly used as indices on floating-rate notes whose rates are tied to long-term interest rates. The index may be found in the Federal Reserve H.15 Report Convexity A measure of the change in a securitys duration with respect to changes in interest rates. The more convex a security is, the more its duration will change with interest rate changes Cost of Funds Index (COFI), 11th District The monthly weighted average cost of funds for savings institutions in Arizona, California and Nevada that are members of the 11th Federal Home Loan Bank District. Published on the last day of the month, the rate reflects the cost of funds for the prior month and is used to set rates on adjustable-rate mortgages, mortgage-backed securities and public issues of floating-rate debt. Some issues may use the national COFI rather than the 11th Districts. CP Index Usually the Federal Reserve Commercial Paper Composite calculated each day by the Federal Reserve Bank of New York by averaging the rate at which the five major commercial paper dealers offer AA industrial Commercial Paper for various maturities. Most CP-based floating-rate notes are reset according to the 30- and 90-day CP composites Credit Spread A yield difference, typically in relation to a comparable U.S. Treasury security, that reflects the issuers credit quality. Credit spread also refers to the difference between the value of two securities with similar interest rates and maturities when one is sold at a higher price than the other is purchased. Coupon The stated interest rate on a security Day Count The convention used to calculate the number of days in an interest payment period. A 30/360 convention assumes 30 days in a month and 360 days in a year. An actual/360 convention assumes the actual number of days in the given month and 360 days in the year. An actual/actual convention uses the actual number of days in the given interest period and year.

Discount margin The effective spread to maturity of a floating-rate security after discounting the yield value of a price other than par over the life of the security Discount note Short-term obligations issued at discount from face value with maturities ranging from overnight to 360 days. Discount notes have no periodic interest payments; the investor receives the notes face value at maturity Duration A measure of the price sensitivity of fixed-income securities for a given change in interest rates. Fed Funds effective rate The overnight rate at which banks lend funds to each other, usually as unsecured loans from regional banks to money center banks. The Fed Funds rate is the average dollarweighted rate of overnight funds. It is reported with a one-day lag (Mondays rate is reported Tuesday morning) and may be found in various financial information services. Federal Reserve Commercial Paper Composite See CP Index. Floor The lower limit for the interest rate on a floating-rate security Global Debt Facility The issuance platform used by most GSEs when issuing global debt into the international marketplace or a particular foreign market. Has same credit characteristics as nonglobal debt but is more easily cleared through international clearing facilities Inflation-Indexed Securities Notes periodically issued by the GSEs whose return is adjusted with changes in the PPI or CPI Lock-Out Period A prescribed period of time before principal repayments begin on a security that has amortizing principal repayments. On some floating-rate securities, the term lock-out

period also applies to the interval between the day the rate for the current interest period is set and the actual payment date, which may be several days apart (see page 10) Maturity The date on which a bond or note must be fully redeemed by its issuer if not subject to prior call or redemption Medium-Term Note A debt security issued under a program that allows an issuer to offer notes continuously to investors through an agent. The size and terms of medium-term notes may be customized to meet investors needs. Maturities can range from one to 30 years Note In the government securities market, a note is a coupon issue with a maturity of one to ten years Option-Adjusted Spread (OAS) For a security with an embedded option, the yield spread over a comparable Treasury security after deducting the cost of the option Optional Principal Redemption Bond Term used to describe callable securities issued with either fixed- or floating-rate structures. Perpetual floating-rate note A floating-rate note with no stated maturity date Prime Rate A commercial banks stated reference rate for lending Rate reset The adjustment of the interest rate on a floating-rate security according to a prescribed formula Reinvestment risk For an investor, the risk that interest income or principal repayments will have to be reinvested at lower rates in a declining-rate environment. Reinvestment risk applies to fixed-rate callable securities. Because issuers typically call fixed-rate securities when rates

are falling, the investors will have to reinvest their returned principal at a lower prevailing rate. This risk is sometimes referred to as call risk Sinkers A security with a sinking fund. In a sinking fund, an issuer sets aside money on a regular basis, sometimes from current earnings, for the specific purpose of redeeming debt Subordinated debt (Sub-debt) A type of debt that places the investor in a lien position behind or subordinated to a companys primary creditors. Securities issued as subordinated debt will pay interest and principal but only after all interest that is due and payable has been paid on any and all senior debt. T-Bill Rate The weekly average auction rate of the three-month Treasury bill stated as the bond equivalent yield Term funding A financing done to meet specific cash-flow needs for a specific period of time Trigger The market interest rate at which the terms of a security might change. Triggers are common on index amortization notes and range securities Undated issue A floating-rate note with no stated maturity date (see also Perpetual floating-rate note) Volatility A representation of the uncertainty of future securities prices. Technically, volatility is the amount of price variation around a general trend. It is a major determinant of the value of any option Yield The annual percentage rate of return earned on a security, as computed in accordance with standard industry practice. Yield is a function of a securitys purchase price and coupon interest rate Yield curve

The charting of yields on a particular type of security over a spectrum of maturities ranging from three months to 30 years Yield to call A yield on a security calculated by assuming that interest payments will be paid until the call date, at which point the security will be redeemed. Yield to maturity A yield on a security calculated by assuming that interest payments will be paid until the final maturity date, at which point the principal will be repaid by the issuer

What Are U.S. Treasury Securities?

U.S. Treasury securitiessuch as bills, notes and bondsare debt obligations of the U.S. government. When you buy a U.S. Treasury security, you are lending money to the federal government for a specified period of time. Because these debt obligations are backed by the full faith and credit of the government, and thus by its ability to raise tax revenues and print currency, U.S. Treasury securities or "Treasuries" are generally considered the safest of all investments. They are viewed in the market as having virtually no credit risk, meaning that it is highly probable your interest and principal will be paid fully and on time. Because of this unique degree of safety, interest rates are generally lower for this class of secruities than for other widely traded debt, riskier debt securities such as corporate bonds. A good rule of thumb to follow is that safer investments offer lower returns. Conversely, the higher the risk, the higher the return. The amount of marketable U.S. Treasury securities is huge, with $7.3 trillion in outstanding bills, notes and bonds as of December 31, 2009*. The Treasury market is one of the world's most liquid debt markets, meaning it is one where pricing, executing and settling a trade is very efficient and thus inexpensive due, in part, to very tight bid/ask spreads. The average daily trading volume in U.S. Treasuries was $409.8 billion in 2009** and these securities trade virtually 24 hours a day with the U.S. primary dealers making live and continuous markets in these securities each business day via trading desks in cities across the globe like Tokyo, London, and New York. In 2009, the U.S. Federal Reserve estimated that 10.2% of bills, notes and bonds were held by individuals, 11.7% by banks and mutual funds, 6.6% by public and private pension funds, 47.7% by foreign investors, 6.8% by state and local governments and 16.9% by other investors. The focus of this section is on marketable U.S. Treasury securities, those that are of most interest to individual investors because they trade on the open market. There are other classes of Treasury debtnon-marketable securitiesthat are not transferable but can be purchased from and redeemed by the government. U.S. Savings Bonds fall into this category, and, even though they are non-marketable, are discussed here because they are designed for individual investors. * Source: U.S. Treasury ** As reported by the primary dealers to the Federal Reserve Bank of New York. Specific statistics can be found at http://www.newyorkfed.org/markets/gsds/search.cfm.

The Role of U.S. Treasury Securities in an Investment Portfolio

The primary advantage of U.S. Treasury securities is safety. No other investment carries as strong a guarantee that interest and principal will be paid on time. Because these payments are predictable, many people invest in them to preserve and increase their capital and to receive a dependable income stream. The benefit of predictability is enhanced by the fact that Treasuries generally do not have call provisions. In fact, the U.S. Treasury has not issued callable securities since 1985. Call provisions, common in municipal and corporate bonds, permit the issuer to pay off the bond in full before its scheduled maturity. This is especially likely to happen when interest rates decline, as an issuer will refinance its debt to obtain the lower prevailing interest rate. When that happens, the investor would be forced to pay more to earn the same interest rate. If you own Treasuries that have no call provisions, you know exactly how long your income stream will last. Another advantage of Treasuries is that they are available with a wide range of maturity dates. This allows an investor to structure a portfolio to specific time horizons. Because many consider them the safest investments available, Treasury securities pay somewhat lower interest rates than other taxable fixed-income investments. Many investors accept this as a trade-off for security. In a diversified portfolio, U.S. Treasury securities usually represent money that investors want to keep safe from risk. An added benefit of Treasuries is that their interest payments are exempt from state and local income taxes (but not federal taxes). This has the effect of increasing the after-tax benefits of these investments. Investors in high-tax states should take special note of this benefit. Another important characteristic of the U.S. Treasury market is its high level of liquidity, which means that Treasuries are easy to buy and sell. Because they trade so frequently in large volume, the spreads between what a dealer would be willing to pay and what a dealer would be willing to sell for is lower than for other securities. Lower trade transaction costs and more efficient price discovery (determining the best possible price for buyers and sellers) result from such great liquidity in the U.S. Treasury market, benefits which are ultimately translated to the individual investor.

Market Risk and U.S. Treasury Securities

Although Treasuries are considered to have very low free credit risk, they are affected by other types of risk, mainly interest-rate risk and inflation risk. While investors are effectively guaranteed to receive interest and principal payments as promised, the underlying value of the bond itself may change depending on the direction of interest rates. As with all fixed-income securities, if interest rates in general rise after a U.S. Treasury security is issued, the value of the issued security will fall, since bonds paying higher rates will come into the market. Similarly, if interest rates fall, the value of the older, higher-paying bond will rise in comparison with new issues.

In a period of low inflation and moderate shifts in interest rates, investors often are content to hold their bonds to maturity, disregarding the interim changes in market value of their bonds. However, some investors strive to structure their bond holdings to minimize market risks and take advantage of market opportunities. One such technique is called laddering. Here, the portfolio is structured so that securities mature at regular intervals, allowing the investor to make new investments with cash available from the maturing securities. To help investors deal with inflation risk, the U.S. Treasury has created inflation-indexed notes and bonds called TIPS, and inflation-indexed savings bonds called I Bonds. Please see the section entitled Other U.S. Treasury Securities for more information. U.S. Treasury securities, like all things that are bought and sold, are affected by the laws of supply and demand. From 1997 until 2001, the U.S. Treasury reduced the total amount of its outstanding marketable securities. It did this by curtailing, and ultimately eliminating, the sale of certain securitiesin particular 30-year bonds. In addition, long-dated bonds held by the public were repurchased by the U.S. Treasury before their due dates. Together, these actions resulted in a perceived shortage of long-maturity U.S. Treasury securities. Prices for outstanding long-bond securities rose and yields fell. By mid-2003, as the fiscal situation had reversed from surplus to deficit, the U.S. Treasury had ceased to buy back existing bonds, significantly increasing the amount outstanding. The U.S. Treasury has also reintroduced 3-year, 7-year and 30-year maturities. Treasury Securities at a Glance Minimum Current Maturities Available*

Security Type

Investment Treasury Bills $100 4-week, 13-week, 26-week and 52-week; Other maturities offered by Treasury on an as-needed basis 2-year, 3-year, 5-year, 7-year and 10-year 30-year 5-year, 10-year, and 30-Year 6 months to 30 years Payable after 6 months, but earns interest for 30 years Payable after 6 months, but earns interest for 30 years

Treasury Notes $100 Treasury Bonds $100 Treasury Inflation$100 Protected Securities (TIPS) Treasury STRIPS $100 Savings Bonds (Series EE) $50 Savings Bonds (Series I) $50 * as of March 20, 2010

For the most current information on treasury offerings visit the Treasurys Bureau of the Public Debt Web site.

About Bills, Notes and Bonds

You dont actually receive a certificate when you buy a U.S. Treasury bill, note or bond. Your investment is tracked in a book-entry system of accounts that generates a receipt and periodic statements. Investors should understand the differences among Treasury bills, notes and bonds. Treasury Bills, as the table "Treasury Securities at a Glance" indicates, are short-term instruments with maturities of no more than one year. They fill investment needs similar to money market funds and savings accounts. They could be a place to "hold" money an investor may need to be able to access quickly, for example in the event of an emergency. The Treasury bill market is highly liquid; investors can quickly convert bills to cash through a broker or bank. Treasury bills function like zero-coupon bonds, which do not pay periodic interest payments. Investors buy bills at a discount from the par, or face value, and then receive the full amount when the bill matures. For example, an individual could buy a 26-week bill that pays the full $1,000 at maturity for $970.28 at the time of purchase, effectively earning an annualized yield of 6.28% on the investment. Treasury Notes are intermediate- to long-term investments, typically issued in maturities of two, three, five, seven and 10 years. These are typically purchased for specific future expenses, such as college tuition, or used to generate cash flow during retirement. Interest is paid semi-annually. Treasury Bonds cover terms of longer than 10 years, and are currently being issued in maturities of 30 years. Interest is also paid semi-annually.

Other U.S. Treasury Securities

Three other forms of U.S. Treasury securities available to individual investors are, TIPS, STRIPS, and U.S. Savings Bonds.

Treasury Inflation-Protected Securities ("TIPS").

In 1997, the U.S. Treasury introduced notes and bonds in a new form designed to protect the investor from the effects of inflation. These inflation-indexed securities are known as Treasury Inflation-Protected Securities, or "TIPS". Using the Consumer Price Index (CPI) as a guide, the value of the principal is adjusted to reflect the effects of inflation. A fixed rate of interest is paid semi-annually on this adjusted principal. At maturity, if inflation has increased the value of the principal, the investor receives the higher, adjusted value back. If deflation has decreased the value, the investor nevertheless receives the original face amount of the security. Heres an example of how inflation-indexed securities work. Lets say you invested $1,000 in January in a new 10-year inflation-indexed note. The note pays 3% annualized interest semiannually. At mid-year, the Consumer Price Index indicates that inflation has been 1% during the first six months. Your principal is adjusted upward to $1,010 ($1,000 times $101%) and your resulting interest payment would be $15.15 ($1,010 times 3% divided by 2, as interest payments are made semi-annually). At the end of the year, the index indicates that inflation was 3%, which brings the value of your principal to $1,030. Your second interest payment is $15.45 ($1,030 times 3% divided by 2). Because of the built-in inflation protection, these securities usually offer lower interest rates than U.S. Treasuries of similar maturities without the protection feature. The U.S. Treasury suspended issuance of the 30-year TIPS in 2001, but reinstated this offering in 2009. However, they had also issued five- and 20-year TIPS during those years in addition to the 10-year offering.

Separate Trading of Registered Interest and Principal Securities ("STRIPS").

For many years, securities firms have offered special products to investors by separating the principal and interest components of U.S. Treasury securities, a process called coupon stripping. Initially, stripped securities were available only through proprietary programs of a few firms. Since 1985, the process has been facilitated through a program created by the U.S. Treasury Department Separate Trading of Registered Interest and Principal Securities (STRIPS). STRIPS components, also called zero-coupon securities or zeros, are traded as individual securities. Stripping a bond with 20 years to maturity, for example, generates 40 coupon STRIPS (one for each semiannual coupon payment) plus one principal STRIP. Once a bond is stripped, investors can buy any or all of the available components.

U.S. Savings Bonds.

U.S. Savings Bonds are available in either a Series EE or Series I. An investor may buy as much as $5,000 per year, and may redeem the bonds anytime after 12 months (there is a 3-month penalty loss of interest if redeemed prior to five years). Popular gifts, the familiar Series EE savings bonds are sold electronically at face value in any amount between $25 and $5,000, and are sold in paper at one half the face value in standard denominations. Series EE bonds issued in May 2005 or later earn a fixed interest rate based on 10-year U.S. Treasury note market yields, which are adjusted twice a year. Series EE bonds that were issued from May 1997 through April of 2005 accrue interest according to a floating rate90% of the average market yields on 5-year Treasuriesthat is also adjusted twice a year. The holder doesnt receive the interest until the bonds are cashed in. If the bonds are redeemed less than five years from the time they are purchased, the holder must sacrifice three-months worth of interest. The U.S. Treasury guarantees that Series EE bonds will mature at full face value in no more than 17 years. If you want to hold them longer, they will continue to accrue interest for 30 years. Series I savings bonds have a built-in inflation adjustment. They are sold electronically at face value in any amount between $25 and $5,000, and are sold in paper at full value in standard denominations. While issued in the same denominations as Series EE bonds, Series I savings bonds pay interest according to an earning rate that is partly a fixed rate of return and partly adjusted for inflation. Other rules are similar, but not identical, to Series EE bonds. Unlike most investments, Series EE and I bondholders are allowed to defer paying income taxes on the interest earned until they redeem the bonds. Under certain circumstances, the interest may be tax-deductible when it is applied against expenses for higher education.

How to Buy And Sell U.S. Treasury Securities

Treasuries can be bought and sold through an investment professional, a commercial bank or an on-line broker. They can provide you with the most recent issues that are trading in the secondary market. There often is no commission charged for buying or selling U.S. Treasury securities. Dealers earn a profit by buying bonds at one price and selling them at a slightly higher price. Some individuals prefer to buy new issues directly from the government at auction through a Treasury Direct account with the U.S. Treasury. If you plan to sell Treasuries held in a Treasury Direct account, the Federal Reserve Bank of Chicago will sell your security in the secondary market for a fee; the process is the same with both a Legacy Treasury Direct account (through the Sell Direct program) and Treasury Direct program. If you use the Treasury Direct program to buy a security and wish to sell it through a dealer, you must arrange to move it out of your account with the U.S. Treasury. You cant buy securities in the secondary market through the U.S. Treasury. Investors may choose to invest in a mutual fund specializing in Treasuries. Some funds hold other fixed-income securities or derivatives along with Treasuries, so investors should be sure they understand the purpose of the fund and the makeup of its portfolio. U.S. Savings Bonds may be purchased directly from the U.S. Treasury or from commercial banks and are often available through employee savings plans. The owner of a savings bond receives a registered certificate and, unlike other U.S. Treasury securities discussed in this guide, cannot resell or even give the bond away to another individual. When purchasing a U.S. Savings Bond as a gift, the recipient will be registered as the sole owner of the bond and it will not count towards your annual purchase limit, nor will you incur any tax liability.

Understanding Price and Yield Information

There is a tremendous amount of information available on prices and yields of Treasuries from a wide variety of sources. Local and national newspapers, cable TV stations, investment advisors and a multitude of websites offer in-depth background and up-to-the-minute data. Two useful websites to look for general information are the U.S. Treasurys Bureau of the Public Debt and Investing in Bonds, this website from the Securities Industry and Financial Markets Association. The price and yield of a U.S. Treasury security are linked. From the time a bond is originally issued until the day it matures or is called, its price in the marketplace will fluctuate depending on the particular terms of that bond as well as general market conditions, including prevailing interest rates, the bonds credit and other factors. Because of these fluctuations, the value of a bond will likely be higher or lower than its original face value if you sell it before it matures. In general, when interest rates fall, prices of outstanding bonds with higher rates rise. The inverse also holds true: when interest rates rise, prices of outstanding bonds with lower rates fall to bring the yield of those bonds into line with higher-interest bearing new issues. Take for example, a $1,000 bond issued at eight percent. If during the term of that bond interest rates rise to nine percent, it is expected that the price of the bond will fall to about $888, so that its yield to maturity will be in line with the market yield of nine percent ($80 / $888 = 9.00%). When interest rates fall, prices of outstanding bonds rise until the yield of older bonds match the lower interest rate on new issues. In this case, if interest rates fall to seven percent during the term of the bond, the bond price will rise to about $1,142 to match the market yield of seven percent ($80 / $1,142 = 7.00%). As a first step, its helpful to learn how to read the prices and yields that are reported in daily newspapers. Below, please find an example of a typical news article on Treasury bond and note prices. The calculations are based on a purchase of $1,000 face amount.

Treasury Bills. Treasury bills are quoted differently from quotes for other government obligations since Treasury bills are issued at a discount from par, or face value, with the holder receiving full value at maturity. Here is an Example of a Typical Newspaper Table. Maturity Days to Maturity Bid Asked Change Ask Yield May 25 10 43 5.59 5.55 -0.01 5.66

As was mentioned earlier, Treasury bills are short-term instruments with maturities of no more than one year. This particular Treasury bill matures in 43 days, on May 25, 2010. The "bid" is the price at which the buyer is willing to purchase the security, while the "asked" is the price being sought for the security by the seller. Change shows that yesterdays bid price was 5.60.

The ask yield is the return investors would receive if they paid the ask price and held the bond to maturity.

US Treasury Inflation-Protected Securities: Contents

What you should know The U.S. Treasury Market and TIPS Potential Benefits for Investors Potential Investors Summary of the Structure and Index An Example of How TIPS Work The Index General Tax Treatment Investment Considerations Sale and Issuance of Inflation-Indexed Securities How can I buy TIPS? Are there other inflation-indexed securities available? Glossary

The U.S. Treasury Market and Inflation-Protected Securities

The United States Department of the Treasury currently offers a special kind of security, called a Treasury Inflation-Protected Security (TIPS)*, whose principal amount is adjusted for inflation. The Treasury Department issues TIPS because it believes their issuance will reduce interest costs to the Treasury over the long term and will increase the different types of investors that buy their debt instruments. *Prior to 2004 this security was referred to by Treasury as a Treasury Inflation-Indexed Security. However, Treasury renamed these securities to inflation-protected securities so that the resulting acronym, TIPS, conforms with the way these securities are commonly referred to by market participants and the press.

Potential Benefits for Investors

TIPS offer a number of potential benefits for investors. TIPS are direct obligations of the United States government, and are backed by the full faith and credit of the government. The principal is protected against inflation. Since the principal is indexed to the Consumer Price Index and grows with inflation, the investor is guaranteed that the real purchasing power of the principal will keep pace with the rate of inflation.** Although deflation could cause the principal to decline, Treasury will pay at maturity an amount that is no less than the par amount as of the date the security was first issued. Interest is also protected from inflation. The investor will receive semiannual interest payments, based on a fixed semiannual interest rate applied to the inflation-adjusted principal, so that the investor is guaranteed a real rate of return above inflation.

**Based on the Reference CPI-U, which has a three-month lag. See The Index.

Potential Investors
Americans want to save for retirement, education and a home. While inflation is lower now than at any time since the 1960s, many people are concerned that investments, including Treasury securities, may lose purchasing power over the long run. Institutional investors, such as pension funds, mutual funds, unit investment trusts, endowments, insurance companies and others looking for diversification or to match liabilities can use these securities to help ensure their investment goals are met and to protect the value of their investments. Because of the tax treatment of these securities, tax-advantaged purchasers, such as qualified pension funds and tax deferred retirement accounts, including 40l(k) plans and individual retirement accounts (IRAs), may view an investment in inflation-protected securities as appropriate. (See the section on General Tax Treatment.)

Summary of the Structure and Index

Principal amount.
The principal amount of TIPS are adjusted for changes in the level of inflation. The inflation adjusted principal amount of the securities can be calculated daily. However, the inflation adjustment will not be payable by Treasury until maturity, when the securities will be redeemed at the greater of their inflation-adjusted principal amount or the principal amount of the securities on the date of original issuance (i.e., par). (See the section on Payment at Maturity below.)

Index.
The index for measuring the inflation rate is the non-seasonally adjusted CPI-U.* CPI-U was selected by Treasury because it is the best known and most widely accepted measure of inflation.

Interest payments.
Every six months Treasury pays interest based on a fixed rate of interest determined at auction. Semiannual interest payments are determined by multiplying the inflation-adjusted principal amount by one-half the stated rate of interest on each interest payment date.

Payment at maturity.
If at maturity the inflation-adjusted principal is less than the par amount of the security (due to deflation), the final payment of principal of the security by Treasury will not be less than the par amount of the security at issuance. In such a circumstance, Treasury will pay an additional amount

at maturity so that the additional amount plus the inflation-adjusted principal amount will equal the par amount of the securities on the date of original issuance.

Maturity.
Currently, TIPS are issued with 5-year, 10-year, and 20-year maturities.

Stripping.
TIPS are eligible for the STRIPS program (Separate Trading of Registered Interest and Principal of Securities) as of the first issue date.

An Example of How TIPS Work

Suppose an individual invests $1,000 on January 15 in a new inflation-protected 10-year note with a 3% real rate of return.

If inflation was 1% during the first six months of that year, then by mid-year the inflationadjusted principal amount of the security would be $1,010. ($1,000 x 1.01 = $1,010). In addition, at mid-year, on July 15, the investor would receive the first semiannual interest payment of $15.15 ($1,010 times 3% divided by 2). Suppose, then, that inflation accelerated during the second half of the year, so that it reached 3% for the full year. By the second semiannual interest payment date, January 15, the inflation-adjusted principal amount of the security would be $1,030. ($1,000 x 1.03 = $1,030). The second semiannual interest payment would be $15.45 ($1,030 times 3% divided by 2).

The Index
Description of the index.
The CPI-U is published monthly by the Bureau of Labor Statistics of the U.S. Department of Labor. It is a measure of the average change in consumer prices over time for a fixed market basket of goods and services, including food, clothing, shelter, fuels, transportation, charges for doctors and dentists services, and drugs.

In calculating the index, price changes for the various items are averaged together with weights that represent their importance in the spending of urban households in the United States. The contents of the market basket of goods and services and the weights assigned to the various items are updated periodically to take into account changes in consumer expenditure patterns. The CPI-U is expressed in relative terms in relation to a time base reference period for which the level is set at 100. For example, if the CPI-U for the 1982-84 reference period is 100, an increase of 16.5% from that period would be shown as 116.5. The CPI-U for a particular month is released and published during the following month.

How to follow the CPI-U.

The Bureau of Labor Statistics of the U.S. Department of Labor is the primary source of the monthly CPI-U numbers. The CPI-U numbers are also widely available on the major financial wire services. Treasury issues a press release monthly that will provide the nonseasonally adjusted CPIU for each of the prior three months. Treasury also provides this information through media such as the Internet and automated facsimile systems. Treasury maintains the records of this information for reference going forward, which will be available to the public. Treasury also publishes on an initial basis the daily Reference CPI-Us and the daily index ratios for outstanding inflationprotected securities.

Changes to the CPI-U.

Revisions to a previously released CPI-U will not be used in calculations of inflation adjustments on outstanding Treasury inflation-protected securities. The base reference period for a particular inflation-protected security will be provided in the Treasury offering announcement for that security. If the CPI-U is rebased to a different year, Treasury will continue to use the old base reference period for outstanding securities. If, while an inflation-protected security is outstanding, the CPI-U is discontinued or, in the judgment of the Secretary of the Treasury (i) fundamentally altered in a manner materially adverse to the interests of an investor, or (ii) altered by legislation or Executive Order in a manner materially adverse to the interests of an investor, Treasury will substitute an appropriate alternative index after consultation with the Bureau of Labor Statistics.

The indexing process.

The inflation-adjusted principal amount of TIPS can be calculated daily by multiplying the stated principal amount at issuance, or par amount, by an index ratio. To calculate the inflation-adjusted principal amount for a particular valuation date, the par amount is multiplied by an index ratio applicable to that valuation date. The index ratio for any valuation date is the ratio of the Reference CPI-U applicable to such date to the Reference CPI-U applicable to the original issue date of the security.

Reference CPI-U.
The Reference CPI-U for any valuation date incorporates a three-month lag. Thus, the Reference CPI-U for the first day of any calendar month is the CPI-U published for the third preceding

calendar month. For example, the Reference CPI-U applicable to April 1 in any calendar year is the CPI-U published for January. The Reference CPI-U for any other day of the month is determined by a linear interpolation between the Reference CPI-U applicable to the first day of the month in which such a day falls (in the example, January) and the Reference CPI-U applicable to the first day of the month immediately following (in the example, February). Thus, in the example, the Reference CPI-U for any day of April, after April 1, will be determined by a linear interpolation between the Reference CPI-U for April (i.e., the CPI-U published for January) and the Reference CPI-U for May (i.e., the CPI-U published for February).

General Tax Treatment

Federal tax.
The semiannual interest payments on TIPS are taxable to a holder of securities when received. This is consistent with the tax treatment of other Treasury securities. If the holder is a corporation or other institutional investor, the interest payments will be taxable when received or accrued, in accordance with the holders method of accounting. Investors will also be taxed on inflation adjustments to the principal in the year in which the adjustments occur, even though the principal adjustments would not actually be received from Treasury until maturity (a situation that is sometimes described as taxing phantom income). Conversely, a decrease in the inflation-indexed principal amount (due to deflation) will first reduce the interest income attributable to the semiannual interest payments for the year of the adjustment; and if the amount of the decrease exceeds the income attributable to the semiannual interest payments, the excess will generally be an ordinary deduction to the extent that interest from the security was previously included in income. Any remaining decrease will be carried forward to reduce interest income on the inflation-protected security in future years. A taxpayer will generally recognize a capital loss if the taxpayer sells or exchanges the inflation-protected security, or if the security matures, before the taxpayer has used all that decrease. If a Treasury Inflation Protected Security is purchased at a discount you should consult your tax advisor.

State tax.
Like all securities issued by the U.S. Treasury, TIPS are exempt from taxation by a state or a political subdivision of a state, except for state estate or inheritance taxes and other exceptions provided by law. Consult your tax adviser for advice appropriate to your particular circumstance.

Investment Considerations

Liquidity.
The U.S. Treasury securities market is one of the largest and most liquid securities market in the world, and there is currently an active secondary market for TIPS with over $8 billion traded each day.

Changes to the CPI-U.

While the CPI-U measures changes in the prices for goods and services, movements in the CPI-U that have occurred in the past are not necessarily indicative of changes that may occur in the future.

Three-month lag in Reference CPI-U.

The index ratio which is used to determine the amount of the inflation adjustment to the original principal amount incorporates an approximate three-month lag in the Reference CPI-U that is applicable to any valuation date. Thus, the Reference CPI-U applicable to April in any calendar year is the CPI-U published for January. The three-month lag in the Reference CPI-U for any month may have an impact on the price of the securities in the secondary market, particularly during periods of significant, rapid changes in the CPI-U.

Principal and interest variability.

An investment in securities with principal or interest determined by reference to an inflation index involves factors not associated with an investment in a fixed-principal security. Such factors may include the possibility that the inflation index may be subject to significant changes, that changes in the index may or may not correlate to changes in interest rates generally or with changes in other indexes, that the resulting interest may be greater or less than that payable on other securities of similar maturities and that, in the event of sustained deflation, the amount of the semiannual interest payments and the inflation-adjusted principal amount of the security will decrease. However, if at maturity the inflation-adjusted principal amount is less than a securitys par amount, an additional amount will be paid at maturity so that the additional amount plus the inflationadjusted principal amount equals the original par amount. Regardless of whether or not such an additional amount is paid, interest payments will always be based on the inflation-adjusted principal as of the interest payment date.

Sale and Issuance of Inflation-Protected Securities

Auction schedule.
The U.S. Treasury currently auctions 10-year TIPS on a quarterly basis and has an expanded auction schedule to include semi-annual 5- and 20-year TIPS issuances. Thus, auctions currently occur in January, April, July and October of each year. Specific terms and conditions of each issue are announced prior to each auction. The offering announcement issued by the Department of the Treasury for each new TIPS offering contains the specific details for that offering. Similar to

Treasury fixed-principal securities, the Treasurys Inflation-Indexed Securities are sold at discount, par or at a premium, depending on auction results.

Secondary market trading of inflation-indexed securities.

After original issue, the securities can be bought or sold in what is known as the secondary market at prevailing market prices through financial institutions and government securities brokers and dealers. (See discussion of liquidity risks.)

Minimum denominations.
The securities will be available in denominations as small as $1,000 and multiples thereof.

Payment dates.
The inflation-adjusted principal amount or the original par amount, whichever is greater, will be paid on the maturity date as specified in the offering announcement. Interest is payable on a semiannual basis on the interest payment dates specified in the offering announcement through the date the principal becomes payable. In the event any principal or interest payment date is a Saturday, Sunday or other day on which the Federal Reserve Banks are not open for business, the amount is payable (without additional interest) on the next business day.

Form of ownership.
Ownership of Treasury Inflation-Protected Securities, like fixed-principal Treasury securities, is evidenced through book-entry. That means the issuance and maintenance of these securities are represented by an accounting entry or electronic record and not by a certificate. The securities will be maintained and transferred in the commercial book-entry system at their par amount, i.e., not at their inflation adjusted principal amount.

How Can I Buy TIPS?

Treasuries can be bought and sold through an investment professional, a commercial bank or an online broker. Some individuals prefer to buy new issues directly from the government at auction through its TreasuryDirectsm program. You can sell a Treasury held in a TreasuryDirect account, through a Treasury program called Sell Direct. For more information on TreasuryDirect, visit the Bureau of Public Debts Web site. TIPS are available for purchase as individual securities and in mutual funds. Ten-year TIIS notes can be purchased in minimum denominations of $1,000 and multiples of thereof.

Are there other inflation-indexed securities available?

Treasury issues another type of inflation-adjusted security called Series I savings bonds. They are sold at face value in denominations ranging from $50 to $10,000 and pay interest according to an earning rate that is partly a fixed rate of return and partly adjust for inflation. I Bonds earn interest for up to 30 years. Interest earnings on Series I bonds are exempt from state and local taxes and investors may qualify for certain federal tax exemptions on all or part of the interest if the proceeds are used to pay for tuition and fees at eligible post secondary educational institutions. Series I bonds may be purchased directly from the Treasury or from commercial banks and are often available through employee savings plans. The owner of a savings bond receives a registered certificate and unlike other Treasury securities, savings bonds cannot be resold or given away. For more information on Series I bonds and on TIPS, visit the U.S. Treasury Departments Web site, or Treasurys Bureau of the Public Debt site.

Inflation-Protected Securities Glossary

Auction Sealed-bid public sale of Treasury securities; method of determining the rate or yield. Bill A short-term direct obligation of the U.S. Treasury that has a maturity of not more than one year (for example, 4 -, 13- or 26- week maturity). Bond A long-term direct obligation of the U.S. Treasury that typically has a maturity of more than 10 years (for example, a 30-year maturity). Book-entry security A security, the issuance and maintenance of which are represented by an accounting entry or electronic record and not by a certificate. CPI-U The nonseasonally adjusted U.S. City Average All Items Consumer Price Index for All Urban Consumers, published by the Bureau of Labor Statistics of the U.S. Department of Labor. Index ratio: For any particular date and any particular inflation-protected security, the Reference CPI-U applicable to such date divided by the Reference CPI-U applicable to the original issue date (or dated date, when the dated date is different from the original issue date). Inflation-adjusted principal: For an inflation-protected security, the principal

amount of the security, derived by multiplying the par amount by the applicable index ratio. Interest rate The annual percentage rate of interest paid on the inflation-adjusted principal of a specific issue of notes or bonds. Note A medium-term direct obligation of the U.S. Treasury that has a maturity of at least one year but not more than 10 years. Par amount The stated principal amount of a security at original issuance. Real yield For an inflation-indexed security, the yield based on the payment stream in constant dollars, i.e., before adjustment by the index ratio. STRIPS (Separate Trading of Registered Interest and Principal of Securities) The Treasury Departments program under which eligible securities are authorized to be separated into principal and interest components, and transferred separately. These components are maintained in commercial book-entry accounts and transferred in TRADES (Treasury/ Reserve Automated Debt Entry System). Yield For an inflation-indexed security, yield means the real yield.

European Government Bonds

Bonds issued by governments of countries in the European Union and non-Euro European countries (including Germany, Italy, France, the United Kingdom, Spain, Belgium, the Netherlands, Greece, Austria, Denmark, Sweden, Portugal, Finland and Ireland) can help investors diversify their investments and gain exposure to international markets whose business and economic cycles may be at different points than those in the United States. At the end of 2007, European issuers had a higher volume of outstanding government securities than the U.S.Treasury. Among the issues to consider when investing in international bonds are: Volume outstanding. The more volume outstanding, the more liquid the market is likely to be. The top three countries in terms of volume outstanding in 2007 were Italy, France, Germany followed by the United Kingdom, Spain and Belgium. Country credit ratings. Sovereign issuers are assigned credit ratings from Moodys and Standard & Poors, and these can change from time to time. Most European issuers listed above are investment grade, but not all are AAA. European Central Bank policy. The European Central Bank controls short-term interest rates for countries in the European Union the way the Federal Reserve does in the United States. Historically the ECB has shifted rates later than the Fed and in smaller increments. The cost of investment. Transaction costs for European bonds can be higher than for U.S. Treasuries. Currency relationships. The relation of the dollar to the euro will also be a factor in the investors returns. When the dollar is strong, the initial investment may be cheaper, but interest payments made in euros will be worth less. When the dollar is weak, the initial investment may be more expensive, but the euro-based interest payments may be worth more. The transaction costs of currency conversion may also reduce total return. For more information, consult your investment adviser.

U.S. Treasury Securities Glossary

Accrued interest. Interest deemed to be earned on a security but not yet paid to the investor. Ask price. The price at which the sellers offers to sell a security. Ask yield. The return an investor would receive on a Treasury security if he or she paid the ask price. Bid price. The price at which a buyer is willing to purchase a security. Book-entry. A method of recording and transferring ownership of securities electronically, eliminating the need for physical certificates. Callable bonds. Bonds that are redeemable by the issuer prior to the maturity date, at a specified price at or above par. (The Treasury has not issued callable bonds since 1985.) Coupon. A feature of a bond that denotes the amount of interest due and the date payment will be made. Current yield. The ratio of the interest rate payable on a bond to the actual market price of the bond, stated as a percentage. For example, a bond with a current market price of par ($1,000) that pays eighty dollars ($80) per year in interest would have a current yield of eight percent. Discount. The amount by which the par value of a security exceeds its purchase price. For example, a $1,000 par amount bond which is currently valued at $980 woud be said to be trading at a two percent discount.

Face (or Par value or Principal value). The principal amount of a security that appears on the face of the instrument. Hedge. An investment made to minimize the impact of adverse movements in interest rates or securities prices. Issuer. The entity obligated to pay interest and principal on a bond it issues. Laddering. A technique for reducing the impact of interest-rate risk by structuring a portfolio with different bond issues that mature at different dates. Maturity. The date when the principal amount of a security is due to be repaid. Off-the-run Treasuries. Those sold in the secondary market rather than "on-the-run" Treasury securities, which are those most recently issued by the Government. Secondary market. Market for issues previously offered or sold. Yield. The annual percentage rate of return earned on a bond calculated by dividing the coupon interest rate by its purchase price. Yield to maturity. The yield on a bond calculated by dividing the value of all the interest payments that will be paid until the maturity date, plus interest on interest, by the principal amount recieved at the maturity date, taking into consideration whatever gain or loss is realized from the bond at the maturity date. Zero-coupon bond A bond which does not make periodic interest payments; instead the investor receives one payment, which includes principal and interest at redemption (call or maturity).