Every debt question begins with the repayment source

Welcome to Smarti Exam Prep. Securities Industry Essentials Exam, Lesson Seven. The debt landscape includes Treasury, agency, corporate, municipal, securitized, and money-market instruments. This complete lesson follows the authoritative long Private source and restores the money-market branch named in the official outline. Multiple-choice practice remains in the rapid-fire video. Build one decision map: identify the issuer, identify what supports repayment, identify the maturity and cash-flow pattern, and then identify the risks and tax treatment. Those four checks separate most debt products before any calculation begins.

A bond is a contract between borrower and lender

A bondholder lends money to an issuer rather than purchasing an ownership interest. The issuer promises to repay principal and, in most structures, pay interest under the bond contract. Par value, also called face value, is the principal amount due at maturity. For ordinary SIE calculations, assume one thousand dollars of par unless the question states another amount. The coupon rate determines the stated annual interest based on par, not the changing market price. Maturity is the date the principal becomes due. These three terms—par, coupon, and maturity—anchor the debt relationship.

Coupon dollars stay tied to par value

Multiply the coupon rate by par value to find annual stated interest. A five-percent coupon on one thousand dollars of par pays fifty dollars per year. Traditional U.S. notes and bonds usually split that amount into two semiannual payments of twenty-five dollars. If the bond later trades at nine hundred dollars or eleven hundred dollars, the coupon dollars remain fifty because the rate is applied to par. The investor’s current yield changes with market price, but the stated coupon does not. Keep coupon rate, coupon dollars, market price, and yield in separate boxes.

Term and serial structures schedule principal differently

A term bond issue places the bonds in a common maturity, so the principal becomes due at one stated future date. A serial issue staggers maturities, with portions of the issue coming due in a sequence of years. Municipal issuers often use serial maturities to align repayment with expected tax or project revenue. Do not confuse a serial maturity schedule with semiannual interest payments; one describes when principal is returned, while the other describes the coupon schedule. If the question says the entire issue matures together, choose term. If principal retires in installments across years, choose serial.

Treasury marketables carry U.S. full-faith-and-credit backing

Treasury marketable securities are direct obligations of the United States government and are backed by its full faith and credit. That makes credit or default risk very low relative to other debt, but it does not remove every risk. A Treasury sold before maturity can lose market value when interest rates rise. Inflation can reduce the purchasing power of fixed payments, and longer maturities generally create greater price sensitivity. Treasury bills, notes, bonds, TIPS, and floating-rate notes are sold at public auction and can trade in the secondary market. Start by separating credit safety from market-price stability.

Treasury bills are short-term discount instruments

Treasury bills mature in one year or less. Instead of paying a stated coupon every six months, they are generally issued at a discount and redeemed at face value. The difference between purchase price and face value is the investor’s interest. Current TreasuryDirect terms include four, six, eight, thirteen, seventeen, twenty-six, and fifty-two weeks. Their short maturities and active market make T-bills common liquidity instruments, but their price can still change before maturity. The exam cues are short term, no periodic coupon, discount purchase, and face-value payment at maturity.

Treasury notes and bonds pay fixed semiannual interest

Treasury notes currently mature in two, three, five, seven, or ten years. Treasury bonds currently mature in twenty or thirty years. Both pay a fixed rate of interest every six months and return principal at maturity. That creates a clean maturity test: notes occupy the intermediate range, while bonds are the long-term Treasury obligations. Longer duration generally makes a security more sensitive to changing interest rates. Do not use an outdated rule that any maturity beyond ten years is automatically a newly issued Treasury bond; use the current Treasury terms, while recognizing that outstanding securities can have different remaining maturities.

Treasury auctions separate competitive and noncompetitive bids

Treasury announces marketable-security auctions and accepts competitive and noncompetitive bids through authorized channels. A competitive bidder specifies the desired yield, discount rate, or spread and risks receiving less than requested or no award. A noncompetitive bidder agrees to accept the auction result and is awarded the requested amount within the applicable limit. TreasuryDirect accepts noncompetitive bids, while institutions commonly submit competitive bids through permitted systems. After issuance, marketable Treasuries can be bought and sold at prevailing prices. The key distinction is whether the bidder names a rate or accepts the rate established by the auction.

Special Treasury structures change inflation or cash flow

TIPS protect against inflation by adjusting principal with the Consumer Price Index. They pay a fixed rate every six months on the adjusted principal, and at maturity Treasury pays at least the original principal under the stated rules. Floating-rate notes have a rate that resets using the thirteen-week T-bill index plus a spread and currently mature in two years. Treasury receipts or STRIPS separate interest and principal components into zero-coupon securities that pay no periodic interest and mature at face value. Match the feature: inflation adjustment means TIPS, resetting rate means FRN, and separated zero-coupon cash flow means a receipt or STRIP.

Agency securities do not all share one guarantee

Agency securities are issued by federal agencies or government-sponsored enterprises. The name agency does not automatically mean full U.S. government backing. Ginnie Mae is a federal government corporation, and its guarantees carry full-faith-and-credit backing. Fannie Mae and Freddie Mac are government-sponsored enterprises; their obligations are not technically direct Treasury guarantees. Markets may view them as having strong support, but the legal distinction matters. Agency debt usually offers more yield than comparable Treasuries because the backing, liquidity, call, and prepayment features can differ. Identify the issuer before assigning a guarantee.

Ginnie, Fannie, and Freddie occupy different legal boxes

Ginnie Mae is part of the Department of Housing and Urban Development and guarantees qualifying mortgage-backed securities with the full faith and credit of the United States. Fannie Mae and Freddie Mac are shareholder-owned government-sponsored enterprises created to support mortgage-market liquidity. Their securities and guarantees are not direct obligations of the U.S. Treasury. For the exam, avoid treating every housing-related name as interchangeable. Ginnie points to explicit federal backing. Fannie and Freddie point to GSE credit. All mortgage-backed structures can also expose investors to cash-flow timing and prepayment behavior, which are separate from default backing.

Mortgage pass-throughs return principal before final maturity

A mortgage-backed pass-through collects homeowners’ principal and interest payments and passes the cash, after applicable servicing, to security holders. Unlike a plain bond that returns principal in one lump sum at maturity, the investor receives principal over time. Borrowers can prepay when homes are sold or mortgages are refinanced. When rates fall, faster refinancing can return principal precisely when reinvestment opportunities pay less. When rates rise, slower prepayments can extend the investment. Those two directions are prepayment and extension risk. The cash-flow source is the mortgage pool, not a fixed corporate coupon alone.

Asset-backed securities depend on borrower cash collections

Asset-backed securities are supported primarily by cash flows from pools of financial assets. Examples include auto loans or leases, credit-card receivables, student loans, and other qualifying payment obligations. A special-purpose issuer or trust holds the pool and issues securities to investors. Borrower payments provide the money used for distributions, so credit quality, prepayments, delinquencies, servicing, and the structure of any tranches affect risk. The exam clue is a pool of receivables rather than a government taxing pledge or one corporation’s general promise. Always identify the underlying cash-producing assets.

Municipal debt begins with GO versus revenue support

States, cities, counties, school districts, authorities, and other municipal issuers borrow for public purposes and projects. General obligation bonds rely on the issuer’s full faith, credit, and taxing power. Revenue bonds rely on specified project or enterprise revenues. This is the first municipal fork because it controls the credit analysis. A school or police station that does not charge users often points toward GO debt. A toll road, airport, water system, hospital, or dormitory can support revenue debt. Do not assume every municipal bond is tax-free or supported by taxes; read the security and tax terms.

GO analysis follows the issuer’s ability to tax

A general obligation bond is secured by the governmental issuer’s full faith and credit, usually based on taxing power. State GO debt can rely on broad state revenues such as income or sales taxes. Local GO debt often relies heavily on ad valorem property taxes, which are assessed according to property value. Analysts consider the tax base, collection record, economy, debt burden, budget practices, and legal authority. GO bonds often finance public facilities that do not produce their own operating revenue. The decisive source is the government’s pledged taxing resources, not tolls or user fees from one project.

Voter approval and debt limits can constrain GO issuance

Because GO debt can obligate taxpayers, applicable state or local law may require voter approval before issuance. Statutory or constitutional debt limits can also restrict how much debt the issuer may have outstanding. These rules vary by jurisdiction, so do not turn them into a universal claim for every municipal security. For exam recognition, voter approval and debt-limit language generally point toward general obligation financing rather than a self-supporting revenue project. Ad valorem means according to value and usually describes property taxation. Keep legal authority, assessed property value, tax rate, and collection strength in the GO analysis.

Revenue bonds live or fail with the pledged revenue stream

A revenue bond is repaid from the fees or other revenue generated or collected by the financed facility or enterprise. Toll roads, bridges, airports, utilities, hospitals, and university housing are common examples. Bondholders generally cannot force the municipality to use unrelated tax revenue unless another pledge is expressly included. Analysts therefore study feasibility, demand, rates charged, operating costs, debt-service coverage, management, and competition. Revenue debt often stands outside a municipality’s general debt limit because it is designed to be self-supporting. The question’s cash-flow source—not the public purpose—determines the classification.

Revenue-bond covenants protect the promised cash flow

The bond indenture or contract can include protective covenants. A rate covenant requires the issuer to set charges at levels intended to cover operating expenses and debt service. A maintenance covenant requires the facility to be kept in working condition. Additional-bonds tests can limit new debt unless financial conditions are met. Insurance, reporting, audit, and flow-of-funds provisions can add protection. These promises do not eliminate project risk, but they define how the issuer must manage the pledged enterprise. When the question describes toll increases, required maintenance, or coverage tests, connect the language to a revenue-bond covenant.

Municipal interest and capital gains receive different tax treatment

Interest on many municipal bonds is exempt from federal income tax, but exemptions depend on the security and investor. Capital gain from selling a municipal bond above the investor’s adjusted basis is not converted into tax-exempt interest and generally remains taxable. Private-activity bonds can create alternative-minimum-tax considerations, and some municipal securities are explicitly taxable. Interest from an in-state issue may also be exempt from the investor’s state or local income tax, while out-of-state interest may not be. Never label every municipal payment tax-free. Identify the bond, the income type, and the investor’s jurisdiction.

Tax-equivalent yield makes taxable and exempt income comparable

To compare a tax-exempt municipal yield with a taxable bond, divide the municipal yield by one minus the investor’s marginal tax rate. A four-percent municipal yield for an investor in a thirty-percent bracket has a tax-equivalent yield of four percent divided by point seven, or about five point seven one percent. A taxable bond must yield more than that to provide the same after-tax income, assuming the compared risks and other features are appropriate. The shortcut is municipal yield on top, one minus tax rate on the bottom. Convert the tax rate to a decimal before calculating.

Mortgage bonds are secured by a lien on real property

A corporate mortgage bond is secured by a lien on real property such as land, buildings, or facilities. If the issuer defaults, the collateral can be sold and the proceeds applied according to the bondholders’ claim. An open-end mortgage permits additional bonds against the same collateral when stated tests are satisfied, potentially sharing the lien. A closed-end mortgage restricts additional debt against that property except under its terms. Collateral improves the creditor’s position but does not guarantee full recovery if the property value is insufficient. The exam cue is a specific real-property pledge rather than the issuer’s general credit alone.

Equipment trust certificates finance movable equipment

Equipment trust certificates are secured corporate obligations commonly associated with transportation equipment such as aircraft, railcars, or ships. A trustee can hold legal title to the equipment while the issuer makes scheduled payments. The equipment supports the investors’ claim, and default can permit repossession or sale under the agreement. This structure helps a capital-intensive company finance assets that retain identifiable value and can be moved or resold. Separate it from a mortgage bond, which uses real property, and from a debenture, which has no specific collateral. The named equipment is the deciding clue.

A debenture relies on the corporation’s general credit

A debenture is an unsecured corporate bond backed by the issuer’s full faith and credit rather than a lien on specified property. Strong, stable companies can borrow this way because investors trust their ability to generate cash and repay. Without collateral, the issuer’s credit rating, financial condition, cash flow, and covenant protections become central. A subordinated debenture is also unsecured but agrees to stand behind senior unsecured debt in liquidation. Because lower priority increases recovery risk, subordinated debt generally must offer a higher yield than otherwise similar senior debt. Unsecured does not mean no legal claim; it means no specific collateral claim.

Liquidation priority follows the legal strength of the claim

In a corporate liquidation, secured creditors look first to their pledged collateral. Administrative expenses and the applicable senior claims are paid under bankruptcy law, followed by unsecured creditors according to priority, including debenture holders. Subordinated creditors stand behind senior unsecured claims. Preferred shareholders follow creditors, and common shareholders receive the residual only after every senior claim is satisfied. If collateral does not cover a secured obligation, the deficiency can become an unsecured claim rather than keeping secured priority for the missing amount. The exam principle is strict: each higher tier must be satisfied before value moves to the next tier.

Money-market instruments emphasize short maturity and liquidity

Money-market instruments are short-term debt products used by governments, corporations, and financial institutions for liquidity and working-capital needs. Common examples include Treasury bills, commercial paper, bankers’ acceptances, and negotiable certificates of deposit. Their short maturities generally reduce price sensitivity compared with long-term bonds, but short term does not mean risk free. Credit support, insurance status, marketability, and issuer quality still matter. Do not confuse a money-market instrument with a money-market mutual fund or a bank money-market deposit account. One is a debt instrument, one is an investment company, and one is a bank deposit product.

Match each money-market instrument to its issuer and purpose

Treasury bills are short U.S. government discount obligations. Commercial paper consists of short-term unsecured promissory notes issued primarily by corporations; common maturities remain within two hundred seventy days. A banker’s acceptance is a time draft accepted and guaranteed for payment by a bank and is commonly linked to international trade. A negotiable certificate of deposit is a bank time-deposit instrument that can be transferred in the market under its terms. The exam shortcut is issuer and purpose: Treasury financing, corporate working capital, bank-supported trade, or a transferable bank deposit.

Apply the repayment-source test

A public authority finances a toll bridge. Bondholders are paid only from tolls and other revenue collected by the bridge, and the municipality does not pledge its general taxing power. Which security is described? The project’s user fees are the promised repayment source, so this is a revenue bond. A general obligation bond would rely on the issuer’s full faith, credit, and taxing power. The fact that a government entity issued the bond does not decide the answer. Trace the money that services the debt. Specific facility revenue means revenue bond; general taxes mean GO bond.

The complete Lesson Seven debt map

Bring the Lesson Seven map together. Bonds connect borrower, par, coupon, maturity, and repayment source. Treasury bills are short discount instruments; notes and bonds pay fixed semiannual interest; TIPS, FRNs, and STRIPS alter inflation or cash flow. Agency backing depends on the issuer, and mortgage or asset pools create pass-through, prepayment, and borrower risks. Municipal GO bonds rely on taxing power, while revenue bonds rely on pledged project income and covenants. Corporate debt can be secured by property or equipment, unsecured as a debenture, or subordinated. Money-market instruments separate Treasury, corporate, trade, and bank issuers. Continue at Smarti Exam Prep.

Continue learning

Continue to Lesson Eight for bond prices and yields, or choose the Products and Risks rapid-fire practice.