Agency Debt
Bonds issued by the government sponsored enterprises (GSEs), Freddie Mac and Fannie Mae. Agency debt is accorded a higher status than other corporate debt. Banks are permitted to hold more agency paper than that issued from other private sources and the Federal Reserve accepts them as collateral on discount window loans.

Basis Point
One one-hundredth of one percent. 0.01%. An eighth of a point equals 12.5 basis points.

Basis Risk
The risk that the price of a hedge instrument does not move as expected relative to the price of the security being hedged.

Bid-To-Cover Ratio
The ratio of the face value dollar amount in bids for Treasury securities in an auction to the total face value of the securities being offered. Bids equaling $24 billion for $10 billion being offered would be 2.4:1 or just 2.4.

Bunds
German government debt securities.

Callable Bond
A bond that can be redeemed by the issuer prior to its maturity. Since price appreciation is limited by the likelihood of a call at some point, compensation for this price compression risk is required and can take the form of a deeper discount at issuance or a premium paid when the bond is called.

Carry
The borrowing cost for financing bond market purchases. Negative carry means the cost exceeds the yield on the securities purchased; positive carry means the cost is less than the yield.

Competitive Bid
A bid in a Treasury auction for a specific quantity of securities at a specific yield or price.

Convexity
If a graph of the relationship between price and yield on a bond is plotted, the result will not be a straight line but a curved line. The degree of curvature is called its convexity and the statistic measuring the curvature is also known as convexity. A change in the price/yield relationship will change convexity so the degree of curvature is important in assessing the value of a security. Duration is an acceptable gauge in evaluating the effect of a small change in yield but for larger changes, convexity is required. Positive convexity refers to a situation in which a fixed-income security's value increases at least as much as duration predicts when interest rates drop and decreases less than duration predicts when rates rise.

Coupon
The interest rate paid to bond holders by bond issuers.

Discount
A bond valued at less than its face amount is said to be selling at a discount.

Duration
A measure of exposure to interest rate risk. The longer the duration, the higher the risk involved. The statistic, while depicted in units of time, should be viewed as a measure of comparison with securities having similar characteristics, or with the same security should interest rates change.

The statistic is determined by the weighted average time to the receipt of the future cash flows of a security. The future cash flows are weighted by their present value. The resulting statistic measures the sensitivity of the price of the security to a change in the required net yield.

To understand duration one must understand that a dollar in the future is worth less than a dollar now. This concept is known as the time value of money and it applies to many financial calculations. This lesser amount of the future dollar is known as the present value of that dollar.

To determine duration, the present value of all the cash-flows from a bond are computed. Then the time it would take to accumulate half of the entire present value amount equals the duration. Something to keep in mind is that at the end of the entire stream of cash flows is the face value pay-off and that additional weight plays a part in the determination of the amount of time it takes to accumulate half the present value of the security.

For instance, a larger coupon rate will shorten duration because the present value of the regular cash flows will be greater relative to the present value of the final face value payment in comparison with a bond having all the same characteristics except for a smaller coupon rate. It will take less time to reach that point when half of the entire present value is accumulated.

If there are no intermediate cash flows, such as is the case with a Treasury bill, the time it would take to receive half of the present value is the same time it would take to receive the entire present value; that is, the duration equals maturity. For typical securities that offer periodic interest payments, the duration will be less than the maturity.

Another thing to understand is that as the yield of a security changes, the present value of future cash-flows change in this calculation because the payments are weighted by their present value and that is determined by the yield to maturity.

Duration is further complicated in mortgage-backed securities because changes in interest rates change the speed of prepayments.

Dutch Auction
Auction in which the lowest price that would allow for the sale of all the securities being issued is used as the price for the entire issue. A bid that is beneath that price would not be honored.

Face Value
The stated principal amount of a bill, note, or bond.

Gilts
British government debt securities.

Hedging
Offsetting risk by taking a position that would counter the effect of a loss in another position.

JGBs
Japanese government debt securities.

Long end of the market (or long end of the curve)
Longer term Treasuries

Mortgage Backed Security (MBS)
A security backed by mortgage pools.

Mortgage pass-through security Mortgage payments are passed through to the investor.

Collateralized mortgage obligation Mortgage issue having a number of classes (or tranches), each class having different risk characteristics. The differences allow a variety of instruments that an investor may choose from.

Mortgage-backed bond MBS in which principal is distributed at maturity while interest payments follow a periodic schedule (usually every six months)

Stripped mortgage-backed security
MBS in which a payment component is excluded, or stripped. The security holder might receive principal payments only (PO) or interest payments only (IO).

Mortgage Pool
A group of mortgages, sharing certain common features, used to back a security.

Noncompetitive Bid
A bid in a Treasury auction for a specific quantity of securities at whatever the price determined by the competitive bidding process.

Option Adjusted Spread (OAS)
Since prepayments act as partial calls (see callable bonds) the cost of the call can be used when evaluating a mortgage backed security. Determining the impact of the call option depends on calculating such things as rate volatility and prepayment performance. A factor that clouds the calculations is the fact that borrowers often refinance for reasons other than a change in interest rates.

Par Value
The face value of a bond, generally $1,000.

Participation Certificate (PC)
Freddie Mac's name for passthrough securities. PCs are created in two ways. They may be created through the cash program, whereby Freddie Mac purchases loans from its authorized sellers, then pools the loans, securitizes them, and sells the securities in the secondary securities market. The other way is through the Guarantor Swap program which allows the authorized seller to sell pools to Freddie Mac and receive PCs for them. The PCs can then be held, used as collateral, or sold by the correspondent. Fannie Mae also has cash and guarantor programs.

Point
In the bond market a point is a price designation equal to one percent of a security's face value. In the stock market a point equals one dollar of a share's price.

Pool Factor
The remaining principal balance on a pool of mortgages divided by the original principal amount.

Premium
A bond selling for more than its face amount is said to be selling at a premium.

Prepayment
A payment made before the scheduled date for payment. Mortgage prepayments may be in the form of additional principal being paid or by all of the remaining principal being paid when the loan is retired through a sale of the property or through refinancing. Prepayment is important to the value of mortgage backed securities because by paying down the principal before it is due, the amount of interest originally anticipated is reduced.

Principal
The amount owed; the face value of a debt.

Rate Lock
Besides being an agreement between a lender and a loan applicant on an interest rate for a certain period of time, the phrase also refers to a hedging technique whereby underwriters of non-Treasury bond offerings sell Treasuries short to protect against interest rate risk. If yields rise and hurt their offering, they make up some of the loss through the short sale. Following the successful placement of their offerings, the short positions are reversed through the purchase of Treasuries.

Short end of the market (or short end of the yield curve)
Shorter termed securities

Spread
The difference between the bid and asked prices on an investment security. The term is also used to denote the difference between the price or yield on two securities.

STRIPS
Separately Traded Registered Interest and Principal Securities.

Tail
The difference between the average price and the low bid price accepted at a Treasury auction.

TIPS
Treasury Inflation Protected Securities. A type of 10-Year Note offered by the Treasury in which the principal amount changes each year by the percent change in the Consumer Price Index. The coupon rate does not change but the coupon payments will vary due to the adjustment in the principal amount.

Tranche
A securities classification within a collateralized mortgage obligation characterized by a particular payment structure. For instance, a CMO may include one bond class (tranche) in which the holder receives all principal payments and prepayments until the face value of the security has been satisfied. Another class may stipulate that the holder receives principal payments only after the first tranche holders have been paid. This division does not change the risk profile of the underlying pool of mortgages but it does apportion the risk in different ways.

Weighted Average Coupon (WAC)
The average interest rate for a pool of mortgages at a particular time weighted by the remaining principal balances of each mortgage. The interest rate of each mortgage is multiplied times the remaining balance on the loan. The sum of these calculations is then divided by the total remaining balance of the mortgages.

Weighted Average Life (WAL)
The weighted average time until the regular payments in a pool of mortgages equals the remaining principal amount.

Weighted Average Loan Age (WALA)
Weighted average number of months since the loans in a mortgage pool were issued.

Weighted Average Maturity (WAM)
Weighted average number of months remaining on the loans in a mortgage pool.

Yield
A measure of the income generated by a bond. The amount of interest paid on a bond divided by the price.

Yield Curve
The plot of yields for Treasuries over a range of maturities. The change in the yield curve in which the longer maturity yield moves higher relative to the shorter maturity yield is known as curve steepening. A change that has the shorter maturity moving higher relative to the longer maturity is known as curve flattening.

Yield to Maturity
The rate of return anticipated on a bond if it is held until the maturity date.