Z-Bond
Key Highlights
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Z-Bond is a financial tool that provides liquidity to banks with excess reserves.
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Z-bonds provide a unique opportunity for investors seeking additional yields by absorbing prepayment risks, therefore helping to stabilize returns.
What is a Z-Bond?
Z-Bond, developed by the Federal Reserve in 2018, is a financial tool that provides liquidity to banks with excess reserves. Banks can exchange their reserves for US Treasury securities of equivalent value and maturity, enabling them to deploy funds more efficiently while preserving a strong balance sheet.
Key Features of Z-Bonds
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Unlike ordinary bonds, Z-bonds do not pay periodic interest. Rather, the interest builds over time and is credited to the principal, which is paid out either at maturity or upon the satisfaction of all other CMO tranches.
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Because of their subordinate position, Z-bonds carry more risk than other tranches; nonetheless, they pay better as compensation for this risk.
How does Z-Bonds Work?
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Accrual of Interest: On a Z-bond, the interest builds over time without monthly payment. The principle value picks up this growing interest.
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Maturity Payment: The Z-bond pays the principal and the accrued interest at maturity or when other tranches are fully paid.
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Investment Considerations: For those ready to incur risk, Z-bonds offer superior returns even if their high risk profile makes them speculative investments.
Advantages of Z Bonds
Z-bonds provide a unique opportunity for investors seeking additional yields by absorbing prepayment risks, therefore helping to stabilize returns.
Disadvantages of Z Bonds
Underlying mortgages default and the subordinate position of Z-bonds create a significant risk. There is also possibilities for major losses.
