Types of Agencies

Agency bonds can be structured to meet a specific need of an investor, issuer or both.

For instance, in addition to the traditional coupon-paying agency bond, some organizations issue no-coupon discount notes—called "discos"—generally to help them meet short-term financing demands. This explains why disco maturities are usually quite short, ranging from a single day to a year. Discos resemble STRIPS in that they are zero-coupon securities that are issued at a discount to par. As with all bonds that trade at such a discount, if you sell the bond before it matures, you may lose money.

Another type of structured agency security is a step-up note, or "step-up." These securities are callable with a coupon rate that "steps up" over time according to a pre-set schedule. The goal of a step-up is to minimize the impact of interest rate risk. Provided the security is not called, the step-up will keep providing the bondholder with an increased coupon rate, cushioning the investor from interest rate risk. Step-ups are not problem-free, however, as they often offer limited call protection.

Yet another type of agency is a floating-rate security, or "floater." Floaters pay a coupon rate that changes according to an underlying benchmark, such as the six-month T-bill rate.

Keep in mind that such structured notes, and other esoteric products such as index floaters and range bonds, can be quite complicated and may be unsuitable for individual investors.

Agency Risk Report Card Credit and default risk are real for GSE-issued agencies: The federal government is under no legal obligation to save a GSE from default. Call risk: Many agency securities—step-ups in particular—carry call provisions that allow the issuer to pay you prior to the bond's maturity date, typically when interest rates drop, leaving you to reinvest at lower prevailing rates. Interest rate risk: If interest rates rise, the value of an agency bond on the secondary market will likely fall.

Agency Bonds Snapshot Issuer Government Sponsored Enterprises (GSEs) Minimum Investment Varies—generally $10,000 Interest Payment Fixed coupon or floating/variable coupon rates. Interest is paid semiannually for fixed-coupon security. How to Buy/Sell Through a broker Bond Interest Rate Determined at origination and varies by bond Price Information Issue price and secondary trade data available through a broker and data vendors Web Site for More Info Securities Industry and Financial Markets Association (SIFMA)—The GSE Debt Market: An Overview