So although agency bond traders recognize this distinction between true agencies and
GSEs, for instance Ginnie Mae and Fannie Mae, when you're buying or selling bonds,
but yields for both kinds of debt tend to trade virtually identical.
So if you picked up the newspaper and
the newspaper market data page will have the prices and
yields of securities from Ginnie Mae, Fannie Mae, Freddie Mac, and so on.
You would find that the difference between the returns or the yields that you
get from Ginnie Mae which has explicit guarantee from the US government and
Fannie Mae which only has an implicit guarantee from the US government.
The spreads are almost negligible.
So now even though you know agencies in general carry government guarantee,
implicit or explicit, agency bonds tend to trade at a premium or
a spread about comparable government bonds or treasury bonds.
Now, a couple of reasons why investors expect a higher return on
agency bonds vis-a-vis treasuries.
Firstly, now there are some additional risks, however little,
because it's stemming from political risk that
the government guarantee of agency that could be modified or
revoked in the future, leaving the bondholders more susceptible to default.
So it's possible that the guarantees may be revoked in the future
because of change of government, change of economic environment, and so on.
The second reason is that treasury bonds, or a government debt, is arguably
the most liquid financial instrument on the planet and or at least in the market.
And are used by central banks and very large institutions,
financial institutions, requiring the ability to buy or
sell securities in vast quantities very quickly and efficiently.
So they're extremely liquid.
Agencies, on the other hand, are not as liquid as government debt.
And they are not as efficient in terms of trading as government debt.
So, now a large portion of, one of the distinction between government debt and
agencies is that a large portion of agency debt is callable.
Now, which can be a good thing for you, because if, let's say,
the debt is callable and the agencies have the right to call the security,
they normally would provide a slightly higher return to compensate you for
the risk of the fact that the bond may be called.
Now since callable bonds contain this embedded call option,
which is exercisable by the seller, they, as I said, typically carry a higher
yield to compensate you for the risk for holding this bond which can be called.