Definition
An agency bond is a type of debt security issued by a government-sponsored enterprise or by a federal government department other than the U.S. Treasury. They carry a higher degree of credit safety than corporate bonds as they have government backing, but they usually offer lower yields. Although not technically government debt, these bonds hold the implicit backing of the government which makes default highly unlikely.
Phonetic
The phonetics of the keyword “Agency Bond” is /ˈeɪdʒənsi bɒnd/
Key Takeaways
Three Main Takeaways About Agency Bonds
- Lower Risk: Agency bonds are issued by government-affiliated organizations and are considered to be relatively low risk when compared to other types of bonds, such as those issued by corporations. Their default rate is lower because they are backed by the government.
- Interest Rates: Agency bonds typically offer higher interest rates than Treasury bonds. This is chiefly because they are not directly issued by the U.S. government but by government-sponsored entities. However, they generally provide lower rates of return than corporate bonds due to their lower risk.
- Liquidity: Agency bonds can be bought and sold in the secondary market, which provides more liquidity to investors. This advantage allows investors to buy and sell these instruments fairly easily, unlike some other types of debt securities.
Importance
Agency bonds are important in the business/finance sector as they offer a reliable means of investment. They are debt securities issued by government-sponsored enterprises (GSEs) or federal government agencies. Investors tend to consider them a secure investment because they have a low risk of default—some are even backed by the full faith and credit of the US government. Furthermore, agency bonds often provide a higher yield compared to Treasury bonds, making them an attractive option for investors looking for higher returns with moderate risk. Therefore, they play a significant role in the economic system, broadening the pool of investment opportunities and providing funding for public-serving entities.
Explanation
An agency bond serves a valuable purpose in the finance and business sectors by offering a reliable form of investment that supports various operations of government-affiliated organizations. It’s an efficient financial instrument used by these entities to raise capital for initiatives such as infrastructure development, financial assistance programs, or other public services projects. Essentially, when these bonds are issued, the buying investors are essentially lending money to the agency with the expectation that they will receive the principal amount back at a future date, along with periodic interest payments.It’s critical to understand that agency bonds are viewed as relatively low-risk investments due to their affiliation with government entities. Furthermore, the income generated from these bonds can be utilized by investors in diverse ways, like supplementing retirement income or reinvesting it into other ventures. Although these types of bonds may offer a lower return on investment in comparison to corporate bonds, their appeal lies in their lower risk profile, making them suitable for cautious investors who are primarily interested in wealth preservation.
Examples
1. Fannie Mae Agency Bonds: The Federal National Mortgage Association (Fannie Mae) is a government-sponsored enterprise or GSE. It issues agency bonds to finance its operations and mortgage financing. These bonds are implicitly backed by the U.S. government and tend to pay a slightly higher yield than U.S. Treasury securities because they carry a slight risk of default although the default risk is generally perceived as being very low.2. Freddie Mac Agency Bonds: Just like Fannie Mae, the Federal Home Loan Mortgage Corporation (Freddie Mac) is a GSE that issues agency bonds to help finance its operations and its mission to provide liquidity, stability and affordability to the U.S. housing market. Freddie Mac agency bonds are also implicitly backed by the U.S. government with a very low risk of default and they tend to provide slightly higher yields than U.S. government bonds.3. World Bank Agency Bonds: The International Bank for Reconstruction and Development (IBRD), more commonly known as the World Bank, issues agency bonds to finance development projects in emerging countries. These bonds are backed by the World Bank’s member countries and are considered relatively safe investments. The yield and the risk associated with these bonds can vary depending on the creditworthiness of the member country backing the bond.
Frequently Asked Questions(FAQ)
What is an Agency Bond?
An Agency Bond is a type of investment security issued by government-affiliated or government-sponsored entities. These are usually backed by the government, providing a relatively safe investment with moderate returns. They are considered highly credible and almost risk-free.
What are some examples of entities that issue Agency Bonds?
Examples of entities that issue agency bonds include Government-Sponsored Enterprises like Fannie Mae, Freddie Mac, and Federal Home Loan Banks.
How are Agency Bonds different from Treasury Bonds?
Though both are backed by the U.S. government, Agency Bonds are issued by government-sponsored enterprises and government-affiliated organizations, while Treasury Bonds are issued directly by the U.S. Department of Treasury. Agency Bonds typically offer a higher yield than Treasury Bonds due to their slightly higher risk.
How risky are Agency Bonds?
Agency Bonds are considered to be low-risk securities because they are backed by government-sponsored enterprises. While they are not fully guaranteed by the U.S. government like Treasury securities, the likelihood of a default is extremely low.
Where can I buy Agency Bonds?
Agency Bonds can be purchased from brokerages, similar to other types of securities. They are typically sold in the secondary market, but some can be bought during the initial offering from the government-affiliated organizations that issue them.
What is the typical maturity period for Agency Bonds?
Agency Bonds can have a variety of maturity periods, ranging from a few months to 30 years or more. The yield generally increases with the length of the maturity period.
Are the interest payments from an Agency Bond tax-free?
Interest earned on Agency Bonds is usually subject to federal income tax. However, it is typically exempt from state and local taxes.
Do Agency Bonds pay interest regularly?
Yes, most Agency Bonds pay interest semi-annually. The regular interest payments and the return of principal at maturity make Agency Bonds an attractive investment for those seeking regular income, like retirees.
Can I sell my Agency Bonds before maturity?
Yes, you can sell your Agency Bonds prior to maturity on the secondary market. However, the market value of the bond may be higher or lower than the purchase price, depending on interest rates and other market conditions.
Related Finance Terms
- Principal Amount
- Coupon Rate
- Maturity Date
- Underwriting
- Yield to Maturity
Sources for More Information
