Debt Securities II: Government, Corporate, and Municipal Securities

Module Focus

You will connect basic bond mechanics to specific issuers: U.S. Treasury, federal agencies, corporations, and municipalities, with emphasis on credit risk and tax treatment.

Four Major Issuer Types

• U.S. Treasury
• Federal agencies and GSEs
• Corporations
• Municipal issuers (states, cities, authorities)

Each has different risk and tax features.

Key Exam Themes

For SIE, you must: identify who issues each security, compare credit quality, and recall typical tax treatment at federal vs state/local levels.

Common Pitfalls

Exam traps include: assuming all agency debt is risk-free, all munis are fully tax-free, or that Treasuries are tax-free. We will clarify each pattern.

Treasury Types

Treasuries are issued by the U.S. Department of the Treasury: T-bills (≤1 year, discount), T-notes (2–10 years, semiannual coupon), T-bonds (20–30 years), and TIPS (inflation-adjusted).

Risk Profile

Treasuries have virtually no credit risk but do have interest-rate risk (especially long maturities). They are among the most liquid securities in the world.

Tax Treatment

Treasury interest is taxable at the federal level, but exempt from state and local income tax. Capital gains are taxable at all levels.

Exam Cue

On SIE, “highest credit quality” or “risk-free benchmark” usually points to U.S. Treasury securities, not corporates or munis.

Agency vs GSE

Federally backed agencies like GNMA carry full faith and credit of the U.S. government. GSEs like FNMA and FHLMC do not, though they are highly rated.

Risk Profile

GNMA MBS are very high credit quality but add prepayment risk. GSE debt is strong but not risk-free; yields are slightly higher than Treasuries.

Tax Treatment

For SIE, assume agency and GSE interest is taxable at federal, state, and local levels unless the question clearly says otherwise.

Exam Trap

Do not assume all agency securities have full faith and credit backing. That applies to GNMA, not to Fannie Mae or Freddie Mac.

Corporate Bond Basics

Corporations issue bonds to raise capital. They typically pay fixed semiannual interest and mature in 5–30 years, though terms vary.

Secured Bonds

Secured bonds are backed by specific assets: mortgage bonds (real estate), equipment trust certificates, and collateral trust bonds (securities).

Unsecured Bonds

Debentures and subordinated debentures are unsecured, backed only by the issuer’s general credit. Subordinated debentures rank below other debt.

Risk, Yield, and Taxes

Corporate bonds have higher credit risk and yields than Treasuries. Secured < unsecured < subordinated in risk. Interest is fully taxable at all levels.

Definition of Munis

Municipal securities are debt issued by states, municipalities, or their agencies and authorities, including GO and revenue bonds, often with federally tax-exempt interest.

Issuers and Uses

States, cities, and special authorities issue munis to fund schools, roads, water systems, transit, hospitals, and to refinance existing debt.

Risks

Munis carry credit risk, interest-rate risk, and sometimes project risk. They are generally safer than many corporates but not risk-free.

Tax Appeal

Most traditional muni interest is exempt from federal income tax, making munis attractive to high-bracket investors seeking tax-advantaged income.

GO Bonds

General obligation bonds are backed by the issuer’s taxing power and full faith and credit. Used for schools, parks, and general public projects; often need voter approval.

Revenue Bonds

Revenue bonds are backed only by revenues from a specific project, like toll roads, airports, or water systems. Debt service comes from user fees, not taxes.

Risk Comparison

GO bonds are generally lower risk because they rely on broad tax revenues. Revenue bonds are riskier, tied to project performance and usage levels.

Exam Shortcut

GO = taxes; revenue = user fees. GO for conservative investors, revenue for those accepting higher risk for potentially higher yields.

Treasury Taxes

Treasury interest is taxable at the federal level but exempt from state and local income tax. Capital gains are fully taxable.

Agencies and Corporates

For SIE, agency and corporate bond interest is fully taxable at federal, state, and local levels. Capital gains are also taxable.

Muni Taxes

Most muni interest is exempt from federal income tax. In-state munis are often also exempt from that state’s tax; out-of-state munis usually are not.

Memory Hook

Quick rule: Treasuries = federal tax only; munis = usually no federal tax on interest. Corporates and most agencies = taxable everywhere.

Example 1: High-Tax Investor

Maria in a high tax bracket compares a 4.0% taxable corporate bond to a 3.0% in-state GO muni. After taxes, the muni may deliver more income.

Example 2: Safety and Liquidity

Alex wants maximum safety. Among a Treasury note, GNMA MBS, and investment-grade corporate bond, the Treasury note is typically safest and most liquid.

Example 3: Toll Bridge

A city issues bonds to build a toll bridge, paid from tolls. That is a revenue bond. If backed by property taxes for a school, it would be a GO bond.

Pattern Recognition

On the SIE, look for key words: taxes → GO, user fees/tolls → revenue, federal government → Treasuries, corporations → taxable corporate bonds.