Series 7 Exam: Types of U.S. Government Securities - dummies

Series 7 Exam: Types of U.S. Government Securities

By Steven M. Rice

On the Series 7 exam, you need to know the basic types of U.S. government securities, their initial maturities, and certain characteristics. As you may already know, the U.S. government also issues bonds. U.S. government bonds are considered the safest of all securities. However, even U.S. government securities are subject to certain risks such as interest risk, reinvestment risk, purchasing power risk, and so forth.

U.S. government securities are now all issued and held in electronic (book-entry) form. However, because Treasury Bonds have maturities of up to 30 years, some are still out there in paper form.

With government bonds, you use some of the same types of calculations you use for corporate bonds. The methods for determining accrued interest, for instance, are very similar.

Here is an overview of different types of U.S. government securities and their specifics. Memorize all the information in the following chart so you can ace U.S. government securities questions on the Series 7 exam.

Security Initial Maturity Characteristics
T-bills (Treasury bills) 4, 13, 26, and 52 weeks Issued at a discount and mature at par
T-notes (Treasury notes) 2, 3, 5, 7, and 10 years Pay interest every 6 months
T-bonds (Treasury bonds) 10 to 30 years Pay interest every 6 months
T-STRIPS (Separate Trading of Registered Interest and Principal
of Securities)
6 months to 30 years Issued at a discount and mature at par
TIPS* (Treasury Inflation-Protected Securities) 5, 10, and 20 years Pay interest every 6 months; par value and interest payments
adjust according to inflation or deflation

*TIPS are tied to the Consumer Price Index (CPI), which measures inflation. The par value changes according to inflation. If inflation is high, the par value increases. If we’re in a period of deflation, the par value decreases. Because investors are getting a percentage of par value as their interest payments, the interest payments vary along with the par value.

For the Series 7, remember that the interest received on U.S. government securities is exempt from state and local taxes. The interest received on municipal bonds is exempt from federal taxes.

The following question concerns various types of bonds and U.S. government securities.

One of your new customers calls to tell you that his wife just had a baby. He would like to start saving for the child’s higher education. He has $30,000 to invest and seems genuinely concerned about the safety of his investment. Which of the following bonds would you MOST likely recommend to help him meet his goals?

(A)    AA-rated corporate bonds with 18 years until maturity

(B)    T-STRIPS with 18 years until maturity

(C)    T-bonds with 18 years until maturity

(D)    High-yielding corporate bonds

The right answer is Choice (B). The question gives you a couple clues. The investor is concerned about safety, so Choice (D) is definitely out. High-yielding corporate bonds are low-rated bonds and are a speculative investment. Of the other three choices, (B) makes the most sense. If this customer were to invest $30,000 in the AA-rated corporate bonds or the T-bonds, he’d receive $30,000 at maturity, along with interest payments.

However, interest entails risk. T-STRIPS, on the other hand, don’t pay interest, so investors can purchase them at a discount. Because the bonds mature in 18 years, perhaps this investor can purchase the T-STRIPS for around $400 each. He could buy 75 bonds with $1,000 par value, which would probably be worth $75,000 in 18 years.

When you see a question on the Series 7 exam about the best investment when planning for a future event (for instance, college), the right answer will most likely be either zero-coupon bonds or T-STRIPS.