Definition
An Agency Bond is a type of security issued by a governmental or quasi-governmental agency that is not fully guaranteed by the government itself. These bonds are used to fund a variety of public projects such as infrastructure, affordable housing or support in specific industries. Given they carry some form of governmental backing, they are typically considered less risky than corporate bonds.
Key Takeaways
- An agency bond is a security issued by a federal or quasi-federal organization or a government-sponsored enterprise. It provides a higher yield than Treasury bonds as they do not carry an implicit guarantee from the U.S. Government.
- They are considered to be of high quality and are seen as a safe investment, because while they are not backed directly by the full faith and credit of the U.S. Government, they’re backed by government-sponsored entities that have strong financial positions.
- Agency bonds are exempt from state and local taxes, often making them more attractive to investors in high tax brackets or those residing in states with high income taxes.
Importance
Agency bonds are a significant part of the financial market landscape because they allow entities such as agencies and Government Sponsored Enterprises (GSEs) to raise funds for specific public purposes, such as agriculture, housing, and education.
The importance of agency bonds rests on their lower risk level compared to corporate bonds, making them more attractive to conservative investors.
They provide a relatively safe investment alternative with more competitive returns than treasuries.
Moreover, agency bonds help diversify an investment portfolio while offering liquidity because they are highly tradable in secondary markets.
Thus, the existence and trading of agency bonds have relevance from both an economic and an investor perspective.
Explanation
An Agency Bond is an investment tool with a specific purpose. Its main purpose is to support the financial operations of government-related institutions and, occasionally, to finance public projects.
Federal agencies or government-sponsored enterprises (GSEs) issue these bonds to fund their initiatives. In the United States, notable examples include housing mortgage financiers Fannie Mae and Freddie Mac.
These entities may issue bonds to raise capital for loans, to support infrastructure development, or other such initiatives that align with their respective missions. Agency Bonds are widely used by investors to lend money while also diversifying their bond portfolio.
The attraction for investors lies in their relative security compared to corporate bonds, and often higher yields compared to Treasury bonds. Most of these bonds have strong credit ratings because they are either directly backed by the full faith and credit of the Federal government (agency bonds) or indirectly through some form of guarantee (GSE bonds). Their purpose, therefore, not only falls into the financial support of vital public interests but also providing an investment tool on the bond market.
Examples of Agency Bond
U.S. Government-Sponsored Enterprises (GSEs): These are types of agency bonds that are backed by the government but not fully guaranteed. The prominent examples of these are Fannie Mae (Federal National Mortgage Association), Freddie Mac (Federal Home Loan Mortgage Corporation), and Federal Home Loan banks. They generally have a lower risk compared to corporate bonds because they are backed by the US government, so they pay slightly lower yields than corporate bonds.
Supranational organizations: These are international institutions that issue agency bonds. The World Bank, for instance, regularly issues bonds on the global markets to raise funds for development projects worldwide.
Municipal Housing Agencies: These are local or state government bodies that issue agency bonds to finance public projects such as infrastructure, schools, and housing. An example of this is the New York City Housing Development Corporation, which issues bonds to raise funds for low-income housing in New York City.
FAQs about Agency Bond
What is an Agency Bond?
An Agency Bond is a type of bond issued by Government Sponsored Enterprises (GSEs) or Non-Governmental Entities (NGEs). These bonds are not fully backed by the full faith and credit of the US Government, but they usually have a higher yield than Treasury Bonds due to their slightly higher risk nature.
Who issues Agency Bonds?
Agency Bonds are issued by two types of entities: GSEs like the Federal National Mortgage Association (Fannie Mae) or the Federal Home Loan Bank, and Federal Government agencies that are Non-Governmental Entities like the Tennessee Valley Authority.
What are the risks associated with Agency Bonds?
Although Agency Bonds are fairly safe investments, there are some risks involved. For example, although the issuers are connected to the federal government, their bonds aren’t fully backed by the U.S. government. Therefore, there’s a slight credit risk. Another risk is interest rate risk – if interest rates rise, the value of the bonds will drop.
What is the difference between Agency Bonds and Treasury Bonds?
The main difference between the two is the level of risk and return. Treasury Bonds are considered the safest investments as they are backed by the full faith and credit of the U.S. government. They generally have lower yields. On the other hand, Agency Bonds present a slightly higher risk since they are not fully guaranteed by the government, but they usually offer higher yields.
How can I invest in Agency Bonds?
Investing in Agency Bonds can be done through a broker-dealer or through the organization that is issuing the bond. Some organizations have set up programs that allow individuals to invest in their bonds directly without having to pay a broker-dealer fee.
Related Entrepreneurship Terms
- Coupon Rate
- Maturity Date
- Par Value
- Yield to Maturity
- Callable Bond
Sources for More Information
- Investopedia is a reliable source that provides detailed information about various finance-related topics, including Agency Bond.
- The Balance covers a wide range of finance and business topics, offering extensive content on Agency Bonds.
- Corporate Finance Institute provides resources and guides giving comprehensive details about finance concepts such as Agency Bonds.
- TreasuryDirect is a U.S. government website offering information on securities including Agency Bonds.
