Because of the Board's current policy of investing only in short-term securities, there is also no market risk in the G Fund.  Market risk is the risk of fluctuations in the value of securities due to changes in overall market rates of interest.  If you are uncomfortable with market risk, the G Fund may be the most appropriate investment fund for you.  However, G Fund rates of return may well be lower than those of the other TSP funds over the long term.

The F Fund is invested in the Barclays U.S. Debt Index Fund, a commingled bond index fund which holds a representative sample of the bonds in the LBA index.  A commingled fund is a fund in which the assets of many plans are combined and invested together.

Because the LBA index contains a large number of securities, it is not practical for the Barclays U.S. Debt Index Fund to invest in each security in the index.  Instead, a mathematical model is used to select a representative sample of the various types of U.S. Government, mortgage-backed, corporate, and foreign government sector securities included in the overall index.

The Barclays U.S. Debt index fund uses a "passive" investment strategy of replicating the performance of the LBA index, rather than an "active" investment strategy, in which the fund manager selects bonds on the basis of economic, financial, and market analyses.  The performance of the Barclays U.S. Debt Index fund is evaluated by comparing how closely its returns match those of the LBA index.

Mortgage-backed securities constituted approximately 37 percent of the LBA index.  They include fixed-rate, pass-through securities backed by residential mortgage pools of the Government National Mortgage Association (GNMA or Ginnie Mae), Fannie Mae, and Freddie Mac (Federal Home Loan Mortgage Corporation).  Mortgage-backed pass-through securities are those in which investors own an interest in a pool of mortgages; investors receive a proportional share of the monthly payments of the mortgages in the pool.  The mortgage-backed securities sector also includes commercial mortgage-backed securities.

The mortgage pools underlying Ginnie Mae pass-through securities contain Federal Housing Administration (FHA)-insured or Department of Veterans Affairs (VA)-guaranteed mortgages.  Ginnie Mae guarantees the payment of principal and interest on its pass-through securities, which are backed by the full faith and credit of the U.S. Government.  Ginnie Mae pass-through securities represented approximately 17 percent of the mortgage-backed securities sector.

Fannie Mae and Freddie Mac pass-through securities are based on pools of residential mortgages and represented approximately 43 and 34 percent, respectively, of the mortgage-backed securities sector.  Both Fannie Mae and Freddie Mac guarantee the payment of principal and interest on their pass-through securities.

Fannie Mae and Freddie Mac, like the Federal Home Loan Bank and the Federal Farm Credit Bank System, are Government-sponsored enterprises — private entities with a Federal charter.  However, because Fannie Mae and Freddie Mac mortgage-backed securities are not explicitly guaranteed by the U.S. Government, yields on these securities are slightly higher than the yields on Ginnie Mae mortgage-backed securities.

Commercial mortgage-backed securities represented 6 percent of the mortgage-backed securities sector.  They are issued by private corporations and are backed by commercial real estate mortgages.  Commercial mortgage-backed securities are not guaranteed by agencies of the U.S. Government or Government-sponsored enterprises.

U.S. Government obligations were approximately 35 percent of the LBA index.  Of this, the Treasury portion — approximately 22 percent of the index — consisted of virtually all public obligations of the U.S. Treasury with maturities greater than 1 year.  The Government-sponsored enterprise portion, approximately 13 percent of the index, comprises the publicly issued obligations of entities such as the Federal Home Loan Bank System and the Federal Farm Credit Bank System.

The corporate sector, approximately 24 percent of the LBA index, contains all publicly issued, fixed-rate, investment-grade securities of both U.S. and non-U.S. companies in many different industries.  (Investment-grade securities are those rated at least Baa3 by Moody's Investors Service or BBB– by Standard & Poor's Corporation.)

The foreign government sector (approximately 4 percent of the index) includes U.S. dollar-denominated securities issued or guaranteed by foreign or international entities (sovereigns, multilateral lending institutions, foreign agencies, and foreign local governments) which are traded in the United States.  

The F Fund also carries market risk, the risk that the market value of the investment may fluctuate as interest rates fluctuate.   This risk is reduced by holding securities with shorter maturities, rather than holding only longer-term bonds.  Nevertheless, market risk is a major influence on the returns of the F Fund because the average maturity of securities in the LBA bond index is approximately 6.8 years, as of December 31, 2002.  If you compare the past performance table for the G Fund (which is representative of general interest rate trends in the economy) with the LBA bond index, you can see that the index has generally benefited from declining interest rates in the economy in several recent years.  The interest rate increases of 1994 and 1999, however, resulted in negative returns for the LBA index.

There is prepayment risk for mortgage-backed securities and for certain corporate bonds that may be "called," i.e., prepaid, by the issuers.  For mortgage-backed securities, prepayment risk is the risk that during periods of declining interest rates, homeowners may refinance their high-rate mortgages and prepay the principal.  Such prepayments generally have a negative effect on mortgage-backed securities, because cash from the prepayments must be reinvested in securities with lower yields.  The result is that prices on mortgage-backed securities may not increase as much as the prices on other fixed-income securities.  To compensate for prepayment risk, mortgage-backed securities generally have higher yields than securities of similar credit quality and maturity.  Similar considerations apply to callable corporate bonds.