Section 2.2Investment Vehicle Characteristics

Debt Securities: Treasuries, Agencies & Municipals

Covers U.S. government debt, agency obligations, municipal bonds, corporate bonds, yield calculations, duration, and convexity.

Key Exam Takeaways

Treasury bills mature in 1 year or less and trade at a discount; T-Notes (2-10 yrs) and T-Bonds (20-30 yrs) pay semi-annual coupons.
TIPS adjust principal semi-annually based on CPI; annual principal appreciation is federally taxable as phantom income.
General Obligation (GO) municipal bonds are backed by ad valorem taxes; Revenue bonds are backed by enterprise user fees.

Common Exam Traps

Municipal bond interest is exempt from federal income tax, but capital gains realized on selling munis are fully taxable.
Duration measures price volatility: longer maturity and lower coupon mean higher duration and greater interest rate risk.

U.S. Treasury securities carry negligible credit risk backed by the full faith, credit, and taxing power of the federal government. Treasury interest is federally taxable but completely exempt from state and local income taxes. TIPS adjust their par value with CPI inflation, causing annual phantom income taxation in taxable accounts.

Government National Mortgage Association (GNMA) pass-through certificates are the only agency securities backed by the explicit full faith and credit of the U.S. government. GNMA securities face prepayment risk when interest rates fall and homeowners refinance.

Municipal securities are issued by state and local governments. General Obligation bonds require voter approval and are backed by general taxing authority. Revenue bonds fund self-supporting revenue projects (bridges, toll roads, utilities). Tax-Equivalent Yield (TEY = Municipal Yield / (1 - Tax Bracket)) calculates comparative corporate yield.

🎯 Knowledge Checkpoint

Knowledge Checkpoint • Section 2.2

An advisory client in a 35% federal income tax bracket purchases $100,000 par value of 10-year Treasury Inflation-Protected Securities (TIPS) with a 3.0% real coupon. In the first year, CPI inflation increases by 4.0%. What happens to the TIPS principal value, and how is the inflation adjustment taxed in a non-qualified taxable account?