Definition
The term agency security refers to bonds issued or guaranteed by a federal agency or those issued by a government-sponsored enterprise. Agency securities are considered low risk investments.
Explanation
In order to reduce the cost to borrow money, government sponsored agencies (GSEs) were created to serve certain sectors of the economy. This includes agencies such as the Federal Home Loan Mortgage Corporation (Freddie Mac), the Federal National Mortgage Association (Fannie Mae), the Federal Agricultural Mortgage Corporation (Farmer Mac), and the Student Loan Marketing Association (Sallie Mae).
Agency securities can be issued by a federal agency, guaranteed by an agency, or issued by a GSE. While these securities are not always backed by the full faith and credit of the United States Government, they are considered low risk investments due to an implied guarantee. This implied federal backing results in very high credit ratings. This low risk of default also results in relatively low rates of interest paid to bondholders. These securities are oftentimes exempt from state and local income taxes.
Minimum investments are generally $10,000, and agency bonds typically pay a semiannual fixed coupon rate. Some notable exceptions to this rule include:
Step-Up Securities: callable with a coupon that steps-up over time according to a pre-established schedule.
Floaters / Variable Rate Securities: pay a coupon rate that adjusts periodically according to a benchmark such as T Bills.
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