HOW SAFE ARE INVESTMENTS IN GOVERNMENT AGENCY BONDS?

While agency bonds are extremely solid investments, backed implicitly by the U.S. Government, they are, of course, slightly less solid than investments in Treasury securities. And because Ginnie Mae is operated through a U.S. agency—the Department of Housing and Urban Development—its bonds are considered slightly more solid than those of Fannie Mae and Freddie Mac. Both Fannie Mae and Freddie Mac are former government agencies that now are publicly traded companies chartered by Congress. For all practical purposes, however, all of these securities are as strong as Plymouth Rock.

Yet investors in U.S. Government agency bonds still face certain risks. Perhaps the biggest of these is the prepayment risk. Prepayments directly affect an investment's average life and yield. And accurately predicting the home mortgage interest rates five or more years out is as much of a challenge as correctly forecasting a bull or bear market.

Just the opposite happens when mortgages in the pool mature more slowly. If fewer homeowners sell their home or refinance, for instance, the average life of the investment grows longer than planned. This extension risk reduces the amount of money with which the investor has to buy other securities at a time of high interest rates.

Investors who trade U.S. Government agency bonds on the secondary market also face market risk—much as they would with common stocks. The value of their investment can vary according to such factors as changing interest rates, time to maturity, and liquidity.

Despite these risks, many individual investors and organizations buy U.S. Government agency bonds. They believe that the low likelihood of default coupled with a generally reasonable return compensates them for the potential volatility and other risk factors.