Federated U.S. Government Securities Fund: 2-5 Years

Transcription

1 January 31, 2016 Share Class R Institutional Service Ticker FIGKX FIGTX FIGIX Federated U.S. Government Securities Fund: 2-5 Years Not FDIC Insured May Lose Value No Bank Guarantee

2 CONTENTS Management s Discussion of Fund Performance... 1 Portfolio of Investments Summary Tables... 5 Portfolio of Investments... 7 Financial Highlights Statement of Assets and Liabilities Statement of Operations Statement of Changes in Net Assets Notes to Financial Statements Report of Independent Registered Public Accounting Firm Shareholder Expense Example Board of Trustees and Trust Officers Evaluation and Approval of Advisory Contract Voting Proxies on Fund Portfolio Securities Quarterly Portfolio Schedule... 41

3 Management s Discussion of Fund Performance (unaudited) The total return of Federated U.S. Government Securities Fund: 2-5 Years (the Fund ), based on net asset value for the 12-month reporting period ended January 31, 2016, was -0.87% for the Class R Shares, -0.12% for the Institutional Shares and -0.35% for the Service Shares. The -0.12% total return of the Institutional Shares consisted of 1.22% in taxable dividends and -1.34% of price depreciation in the net asset value of the shares. The BofA Merrill Lynch 3-5 Year Treasury Index (BAML3-5T), 1 the Fund s broad-based securities market index, returned 1.57% during the same period. The total return of the Morningstar Short Government Funds Average (MSGFA), 2 a peer group average for the Fund, was 0.21% during the same period. The Fund s and the MSGFA s total returns for the most recently completed fiscal year reflected actual cash flows, transaction costs and other expenses, which were not reflected in the total return of the BAML3-5T. During the reporting period, the Fund s investment strategy focused on: (a) duration; 3 (b) yield curve positioning; (c) security selection; and (d) derivatives. 4 These were the most significant factors affecting the Fund s performance relative to the BAML3-5T. The following discussion will focus on the performance of the Fund s Institutional Shares. MARKET OVERVIEW During the reporting period, interest rates rose across the U.S. Treasury curve. The two-year Treasury yield rose 33 basis points, and the five-year Treasury yield increased by 17 basis points. 5 Yields on five-year Treasury Inflation- Protected Securities (TIPS) rose 40 basis points. Five-year breakeven rates, the yield difference between five-year Treasury bonds and five-year TIPS, decreased 25 basis points to finish the reporting period at 1.19%. The U.S. economy continued its steady growth rate. While slower than previous expansions, the growth has been steady and durable since the Great Recession. Domestic employment improved during the reporting period. Employment averaged gains of over 200,000 jobs per month created. The unemployment rate fell to 5%. Inflation was contained during the reporting period. An appreciating U.S. dollar and falling commodity prices kept headline inflation low. Consumers have benefited from lower gas prices but have been prudent in spending these savings. The Federal Reserve (the Fed) began its long anticipated normalization of overnight lending rates by increasing the federal funds target rate by 25 basis points in December Interest rates rose in the fall of 2015 in anticipation of the Fed action, but the actual hike wasn t a market moving event. The Fed forecasted a deliberate and patient normalization policy that is intended to support financial conditions and help increase inflation to its 2% goal. 1

4 International events continued to have a significant impact on domestic interest rates. Economic weakness and deteriorating financial conditions have caused international central banks to pursue expansionary monetary policy. This divergence in monetary policy and economic strength versus the U.S. appreciated the dollar and made U.S. Treasuries an attractive investment for foreign investors. Fear of weakening global demand and its impact on the U.S. economy muted the rise on interest rates given the Fed s intention of raising rates. DURATION The Fund had less interest rate risk (i.e., a shorter average duration) than the BAML3-5T for much of the reporting period, anticipating that interest rates would rise. The Fund s dollar-weighted average duration at the end of the reporting period was 3.4 years versus the BAML3-5T at 3.8 years. This defensive positioning added to Fund performance relative to the BAML3-5T. YIELD CURVE Yield curve positioning was adjusted during the reporting period between a neutral positioning and a flattening position. This strategy detracted from Fund performance. The Fund s longer maturity positions were in TIPS which increased more in yield than nominal Treasuries. Also, the hedging of longer dated TIPS and mortgage-backed securities (MBS) positions 6 via Treasury futures added to the underperformance on the yield curve. SECURITY SELECTION The Fund had positions in TIPS, agency debt and agency MBS. TIPS underperformed due to the global drop in inflation expectations due to an appreciation of the U.S. dollar and the fall in commodity prices. Agency debt and MBS added small, positive contributions. On the whole, security selection subtracted from Fund performance. DERIVATIVES The Fund used Treasury futures and options to hedge duration and yield curve exposure. These derivatives caused underperformance due to defensive positioning at the end of the reporting period. 1 Please see the footnotes to the line graph under Fund Performance and Growth of a $10,000 Investment below for the definition of, and more information about, the BAML3-5T. 2 Please see the footnotes to the line graph under Fund Performance and Growth of a $10,000 Investment below for the definition of, and more information about, the MSGFA. 3 Duration is a measure of a security s price sensitivity to changes in interest rates. Securities with longer durations are more sensitive to changes in interest rates than other securities of shorter durations. 4 The Fund s use of derivative instruments involves risks different from, or possibly greater than, the risks associated with investing directly in securities and other traditional instruments. 5 Bond prices are sensitive to changes in interest rates, and a rise in interest rates can cause a decline in their prices. 6 The value of some mortgage-backed securities may be particularly sensitive to changes in the prevailing interest rates, and although the securities are generally supported by some form of government or private insurance, there is no assurance that private guarantors or insurers will meet their obligations. 2

5 FUND PERFORMANCE AND GROWTH OF A $10,000 INVESTMENT The graph below illustrates the hypothetical investment of $10,000 1 in Federated U.S. Government Securities Fund: 2-5 Years from January 31, 2006 to January 31, 2016, compared to the BofA Merrill Lynch 3-5 Year Treasury Index (BAML3-5T) 2 and the Morningstar Short Government Funds Average (MSGFA). 3 The Average Annual Total Return table shows returns for each class averaged over the stated periods. GROWTH OF A $10,000 INVESTMENT Growth of $10,000 as of January 31, 2016 $16,000 $15,000 $14,000 $13,000 $12,000 $11,000 $10,000 Federated U.S. Government Securities Fund: 2-5 Years - Class IS Shares Federated U.S. Government Securities Fund: 2-5 Years - Class R Shares BAML3-5T MSGFA $9,000 1/31/06 1/07 1/08 1/09 1/10 1/11 1/12 1/13 1/14 1/15 1/31/16 $15,124 $13,860 $12,960 $12,637 The fund offers multiple share classes whose performance may be greater than or less than its other share class(es) due to differences in sales charges and expenses. See the Average Annual Total Return table below for the returns of additional classes not shown in the line graph above. Average Annual Total Returns for the Period Ended 1/31/ Year 5 Years 10 Years Class R Shares -0.87% 0.52% 2.63% Institutional Shares -0.12% 1.17% 3.32% Service Shares -0.35% 0.94% 3.08% BAML3-5T 1.57% 2.32% 4.22% MSGFA 0.21% 0.78% 2.48% 3

6 Performance data quoted represents past performance which is no guarantee of future results. Investment return and principal value will fluctuate so that an investor s shares, when redeemed, may be worth more or less than their original cost. Mutual fund performance changes over time and current performance may be lower or higher than what is stated. For current to the most recent month-end performance and after-tax returns, visit FederatedInvestors.com or call Returns shown do not reflect the deduction of taxes that a shareholder would pay on Fund distributions or the redemption of Fund shares. Mutual funds are not obligations of or guaranteed by any bank and are not federally insured. 1 The Fund s performance assumes the reinvestment of all dividends and distributions. The BAML3-5T and MSGFA have been adjusted to reflect reinvestment of dividends on securities in the index and averages. 2 The BAML3-5T is an index tracking U.S. Treasury securities with maturities of 3 to 4.99 years. The BAML3-5T is not adjusted to reflect sales charges, expenses or other fees that the Securities and Exchange Commission requires to be reflected in the Fund s performance. The index is unmanaged and, unlike the Fund, is not affected by cash flows. It is not possible to invest directly in an index. 3 Morningstar figures represent the average of the total returns reported by all the mutual funds designated by Morningstar as falling into the respective category indicated. They do not reflect sales charges. 4

7 Portfolio of Investments Summary Tables (unaudited) At January 31, 2016, the Fund s portfolio composition 1 was as follows: Percentage of Portfolio Composition Total Net Assets U.S. Treasury Securities 87.4% U.S. Government Agency Mortgage-Backed Securities 7.4% U.S. Government Agency Commercial Mortgage-Backed Securities 3.9% Derivative Contracts 2 (0.2)% Other Security Types 3,4 0.0% Cash Equivalents 5 2.7% Other Assets and Liabilities Net 6 (1.2)% TOTAL 100.0% At January 31, 2016, the Fund s effective maturity 7 schedule was as follows: Securities With an Effective Maturity of: Percentage of Total Net Assets Less than 2 Years 8 4.8% 2-5 Years 81.6% Greater than 5 Years 12.3% Derivative Contracts 2 (0.2)% Other Security Types 3,4 0.0% Cash Equivalents 5 2.7% Other Assets and Liabilities Net 6 (1.2)% TOTAL 100.0% 1 See the Fund s Prospectus and Statement of Additional Information for a description of the principal types of securities and derivative contracts in which the Fund invests. 2 Based upon net unrealized appreciation (depreciation) or value of the derivative contracts as applicable. Derivative Contracts may consist of futures, forwards, options and swaps. The impact of a derivative contract on the Fund s performance may be larger than its unrealized appreciation (depreciation) or value may indicate. In many cases, the notional value or amount of a derivative contract may provide a better indication of the contract s significance to the portfolio. More complete information regarding the Fund s direct investments in derivative contracts, including unrealized appreciation (depreciation), value and notional values or amounts of such contracts, can be found in the table at the end of the Portfolio of Investments included in this Report. 3 Represents less than 0.1%. 4 Other Security Types consists of a purchased put option. 5

8 5 Cash Equivalents include any investments in money market mutual funds and/or overnight repurchase agreements. 6 Assets, other than investments in securities and derivative contracts, less liabilities. See Statement of Assets and Liabilities. 7 For callable investments, effective maturity is the unexpired period until the earliest date the investment is subject to prepayment or repurchase by the issuer (and market conditions indicate that the issuer will prepay or repurchase the investment). For all other investments effective maturity is the unexpired period until final maturity. 8 Does not include repurchase agreements purchased with collateral received in securities lending transactions or cash held to cover payments on derivative contracts and when-issued and delayeddelivery transactions. 6

9 Portfolio of Investments January 31, 2016 Principal Amount or Shares Value U.S. TREASURY 87.4% U.S. Treasury Notes 87.4% $40,000, %, 11/30/2019 $ 39,730,360 40,000, %, 12/31/ ,890,644 45,000, %, 3/31/ ,827,317 35,000, %, 10/31/ ,126,658 20,000, %, 10/31/ ,053,788 25,430, %, 12/31/ ,807,882 9,000, %, 3/31/2019 9,163,379 10,000, %, 7/31/ ,177,767 45,000, %, 8/31/ ,800,275 25,000, %, 6/30/ ,373,933 15,000, %, 11/30/ ,215,874 76,000, %, 7/31/ ,568,374 24,200, %, 7/31/ ,528,307 15,203,100 U.S. Treasury Inflation-Protected Note, 0.125%, 4/15/ ,245,859 15,982,560 U.S. Treasury Inflation-Protected Note, 0.625%, 1/15/ ,136,143 TOTAL U.S. TREASURY (IDENTIFIED COST $437,291,698) 445,646,560 COMMERCIAL MORTGAGE-BACKED SECURITIES 3.9% Agency Commercial Mortgage-Backed Securities 3.9% 9,100,000 FHLMC REMIC K052 A1, 2.598%, 1/25/2025 9,345,518 10,350,000 FHLMC REMIC K504 A2, 2.724%, 9/25/ ,680,852 TOTAL COMMERCIAL MORTGAGE-BACKED SECURITIES (IDENTIFIED COST $19,942,191) 20,026,370 MORTGAGE-BACKED SECURITIES 7.4% Federal Home Loan Mortgage Corporation 2.1% 9,869, %, 9/1/ ,315,085 Federal National Mortgage Association 5.3% 25,842, %, 7/1/ /1/ ,074,909 TOTAL MORTGAGE-BACKED SECURITIES (IDENTIFIED COST $37,224,662) 37,389,994 PURCHASED PUT OPTION 0.0% 100 United States Treasury Note 5 -Year Future, Put Option, Strike Price: $118.00, Expiration Date: 2/20/2016 (IDENTIFIED COST $33,819) 781 7

10 Principal Amount or Shares Value REPURCHASE AGREEMENT 2.7% $13,684,000 Interest in $715,000,000 joint repurchase agreement 0.34%, dated 1/29/2016 under which Bank of America, N.A. will repurchase securities provided as collateral for $715,020,258 on 2/1/2016. The securities provided as collateral at the end of the period held with BNY Mellon as tri-party agent, were U.S. Government Agency securities with various maturities to 2/25/2044 and the market value of those underlying securities was $736,470,867. (AT COST $13,684,000) $ 13,684,000 TOTAL INVESTMENTS 101.4% (IDENTIFIED COST $508,176,370) 2 516,747,705 OTHER ASSETS AND LIABILITIES - NET (1.4)% 3 (7,060,672) TOTAL NET ASSETS 100% $509,687,033 At January 31, 2016, the Fund had the following outstanding futures contracts: Description Number of Contracts Notional Value Expiration Date Unrealized Appreciation (Depreciation) 4 United States Treasury Note 2-Year Long Futures 1,040 $227,370,000 March 2016 $ 937,869 4 United States Treasury Note 5-Year Short Futures 950 $114,638,281 March 2016 $(1,895,973) 4 United States Treasury Note 10-Year Short Futures 50 $ 6,478,906 March 2016 $ (45,435) NET UNREALIZED DEPRECIATION ON FUTURES CONTRACTS $(1,003,539) Net Unrealized Depreciation on Futures Contracts is included in Other Assets and Liabilities Net. 1 Pledged as collateral to ensure the Fund is able to satisfy the obligations of its outstanding futures contracts. 2 The cost of investments for federal tax purposes amounts to $508,232, Assets, other than investments in securities, less liabilities. See Statement of Assets and Liabilities. 4 Non-income-producing security. Note: The categories of investments are shown as a percentage of total net assets at January 31,

11 Various inputs are used in determining the value of the Fund s investments. These inputs are summarized in the three broad levels listed below: Level 1 quoted prices in active markets for identical securities. Level 2 other significant observable inputs (including quoted prices for similar securities, interest rates, prepayment speeds, credit risk, etc.). Also includes securities valued at amortized cost. Level 3 significant unobservable inputs (including the Fund s own assumptions in determining the fair value of investments). The inputs or methodology used for valuing securities are not an indication of the risk associated with investing in those securities. The following is a summary of the inputs used, as of January 31, 2016, in valuing the Fund s assets carried at fair value: Valuation Inputs Level 1 Quoted Prices Level 2 Other Significant Observable Inputs Level 3 Significant Unobservable Inputs Total Debt Securities: U.S. Treasury $ $445,646,560 $ $445,646,560 Commerical Mortgage-Backed Securities 20,026,370 20,026,370 Mortgage-Backed Securities 37,389,994 37,389,994 Purchased Put Option Repurchase Agreement 13,684,000 13,684,000 TOTAL SECURITIES $ $516,746,924 $ $516,747,705 Other Financial Instruments* Assets $ 937,869 $ $ $ 937,869 Liabilities (1,941,408) (1,941,408) TOTAL OTHER FINANCIAL INSTRUMENTS* $(1,003,539) $ $ $ (1,003,539) * Other financial instruments include futures contracts. The following acronyms are used throughout this portfolio: FHLMC Federal Home Loan Mortgage Corporation REMIC Real Estate Mortgage Investment Conduit See Notes which are an integral part of the Financial Statements 9

12 Financial Highlights Class R Shares (For a Share Outstanding Throughout Each Period) Year Ended January Net Asset Value, Beginning of Period $11.20 $11.11 $11.43 $11.69 $11.75 Income From Investment Operations: Net investment income Net realized and unrealized gain (loss) on investments and futures contracts (0.16) 0.09 (0.23) (0.10) 0.41 TOTAL FROM INVESTMENT OPERATIONS (0.10) 0.15 (0.18) (0.07) 0.51 Less Distributions: Distributions from net investment income (0.06) (0.06) (0.05) (0.04) (0.10) Distributions from net realized gain on investments and futures contracts (0.09) (0.15) (0.47) TOTAL DISTRIBUTIONS (0.06) (0.06) (0.14) (0.19) (0.57) Net Asset Value, End of Period $11.04 $11.20 $11.11 $11.43 $11.69 Total Return 2 (0.87)% 1.36% (1.55)% (0.61)% 4.40% Ratios to Average Net Assets: Net expenses 1.26% 1.14% 1.19% 1.27% 1.27% Net investment income 0.51% 0.53% 0.45% 0.27% 0.84% Expense waiver/reimbursement % 0.00% 0.00% 0.02% 0.03% Supplemental Data: Net assets, end of period (000 omitted) $13,697 $14,380 $15,499 $22,646 $24,890 Portfolio turnover 233% 252% 312% 187% 153% 1 Per share numbers have been calculated using the average shares method. 2 Based on net asset value. 3 This expense decrease is reflected in both the net expense and the net investment income ratios shown above. See Notes which are an integral part of the Financial Statements 10

13 Financial Highlights Institutional Shares (For a Share Outstanding Throughout Each Period) Year Ended January Net Asset Value, Beginning of Period $11.20 $11.11 $11.43 $11.69 $11.75 Income From Investment Operations: Net investment income Net realized and unrealized gain (loss) on investments and futures contracts (0.14) 0.08 (0.23) (0.11) 0.41 TOTAL FROM INVESTMENT OPERATIONS (0.01) 0.21 (0.11) Less Distributions: Distributions from net investment income (0.14) (0.12) (0.12) (0.11) (0.18) Distributions from net realized gain on investments and futures contracts (0.09) (0.15) (0.47) TOTAL DISTRIBUTIONS (0.14) (0.12) (0.21) (0.26) (0.65) Net Asset Value, End of Period $11.05 $11.20 $11.11 $11.43 $11.69 Total Return 2 (0.12)% 1.91% (0.96)% 0.02% 5.12% Ratios to Average Net Assets: Net expenses 0.58% 0.58% 0.58% 0.58% 0.58% Net investment income 1.18% 1.08% 1.05% 0.96% 1.54% Expense waiver/reimbursement % 0.11% 0.09% 0.09% 0.08% Supplemental Data: Net assets, end of period (000 omitted) $441,379 $461,400 $471,634 $558,704 $628,861 Portfolio turnover 233% 252% 312% 187% 153% 1 Per share numbers have been calculated using the average shares method. 2 Based on net asset value. 3 This expense decrease is reflected in both the net expense and the net investment income ratios shown above. See Notes which are an integral part of the Financial Statements 11

14 Financial Highlights Service Shares (For a Share Outstanding Throughout Each Period) Year Ended January Net Asset Value, Beginning of Period $11.20 $11.11 $11.43 $11.69 $11.75 Income From Investment Operations: Net investment income Net realized and unrealized gain (loss) on investments and futures contracts (0.14) 0.09 (0.23) (0.11) 0.42 TOTAL FROM INVESTMENT OPERATIONS (0.04) 0.19 (0.14) (0.03) 0.57 Less Distributions: Distributions from net investment income (0.11) (0.10) (0.09) (0.08) (0.16) Distributions from net realized gain on investments and futures contracts (0.09) (0.15) (0.47) TOTAL DISTRIBUTIONS (0.11) (0.10) (0.18) (0.23) (0.63) Net Asset Value, End of Period $11.05 $11.20 $11.11 $11.43 $11.69 Total Return 2 (0.35)% 1.68% (1.19)% (0.21)% 4.88% Ratios to Average Net Assets: Net expenses 0.81% 0.81% 0.81% 0.81% 0.81% Net investment income 0.95% 0.85% 0.83% 0.73% 1.29% Expense waiver/reimbursement % 0.07% 0.07% 0.04% 0.03% Supplemental Data: Net assets, end of period (000 omitted) $54,610 $73,550 $64,766 $103,042 $136,237 Portfolio turnover 233% 252% 312% 187% 153% 1 Per share numbers have been calculated using the average shares method. 2 Based on net asset value. 3 This expense decrease is reflected in both the net expense and the net investment income ratios shown above. See Notes which are an integral part of the Financial Statements 12

15 Statement of Assets and Liabilities January 31, 2016 Assets: Total investment in securities, at value (identified cost $508,176,370) $516,747,705 Cash 175 Income receivable 2,411,820 Receivable for shares sold 569,946 TOTAL ASSETS 519,729,646 Liabilities: Payable for investments purchased $9,287,601 Payable for shares redeemed 390,894 Payable for daily variation margin on futures contracts 136,335 Income distribution payable 25,702 Payable to adviser (Note 5) 17,605 Payable for distribution services fee (Note 5) 5,706 Payable for other service fees (Notes 2 and 5) 49,226 Accrued expenses (Note 5) 129,544 TOTAL LIABILITIES 10,042,613 Net assets for 46,132,778 shares outstanding $509,687,033 Net Assets Consist of: Paid-in capital $525,146,204 Net unrealized appreciation of investments and futures contracts 7,567,796 Accumulated net realized loss on investments, futures contracts and written options (23,483,922) Undistributed net investment income 456,955 TOTAL NET ASSETS $509,687,033 Net Asset Value, Offering Price and Redemption Proceeds Per Share Class R Shares: $13,697,275 1,240,208 shares outstanding, no par value, unlimited shares authorized $11.04 Institutional Shares: $441,379,473 39,949,465 shares outstanding, no par value, unlimited shares authorized $11.05 Service Shares: $54,610,285 4,943,105 shares outstanding, no par value, unlimited shares authorized $11.05 See Notes which are an integral part of the Financial Statements 13

16 Statement of Operations Year Ended January 31, 2016 Investment Income: Interest (including income on securities loaned of $72,012) $ 9,308,386 Expenses: Investment adviser fee (Note 5) $2,110,012 Administrative fee (Note 5) 412,773 Custodian fees 27,748 Transfer agent fee (Note 2) 405,342 Directors /Trustees fees (Note 5) 10,622 Auditing fees 26,450 Legal fees 9,595 Portfolio accounting fees 120,595 Distribution services fee (Note 5) 70,082 Other service fees (Notes 2 and 5) 613,766 Share registration costs 85,717 Printing and postage 30,610 Miscellaneous (Note 5) 20,430 TOTAL EXPENSES 3,943,742 Waiver/reimbursement of other operating expenses (Notes 2 and 5) (605,185) Net expenses 3,338,557 Net investment income 5,969,829 Realized and Unrealized Gain (Loss) on Investments, Futures Contracts and Written Options: Net realized loss on investments (3,790,943) Net realized gain on futures contracts 131,120 Net realized gain on written options 33,169 Net change in unrealized appreciation of investments (3,077,611) Net change in unrealized depreciation of futures contracts (586,539) Net realized and unrealized loss on investments, futures contracts and written options (7,290,804) Change in net assets resulting from operations $(1,320,975) See Notes which are an integral part of the Financial Statements 14

17 Statement of Changes in Net Assets Year Ended January Increase (Decrease) in Net Assets Operations: Net investment income $ 5,969,829 $ 5,398,918 Net realized gain (loss) on investments, futures contracts and written options (3,626,654) 1,213,160 Net change in unrealized appreciation/depreciation of investments and futures contracts (3,664,150) 3,134,728 CHANGE IN NET ASSETS RESULTING FROM OPERATIONS (1,320,975) 9,746,806 Distributions to Shareholders: Distributions from net investment income Class R Shares (79,531) (80,486) Institutional Shares (5,468,885) (4,785,471) Service Shares (689,821) (525,218) CHANGE IN NET ASSETS RESULTING FROM DISTRIBUTIONS TO SHAREHOLDERS (6,238,237) (5,391,175) Share Transactions: Proceeds from sale of shares 119,977, ,963,480 Net asset value of shares issued to shareholders in payment of distributions declared 5,657,644 4,818,251 Cost of shares redeemed (157,718,721) (166,706,744) CHANGE IN NET ASSETS RESULTING FROM SHARE TRANSACTIONS (32,083,893) (6,925,013) Change in net assets (39,643,105) (2,569,382) Net Assets: Beginning of period 549,330, ,899,520 End of period (including undistributed net investment income of $456,955 and $302,531, respectively) $ 509,687,033 $ 549,330,138 See Notes which are an integral part of the Financial Statements 15

18 Notes to Financial Statements January 31, ORGANIZATION Federated U.S. Government Securities Fund: 2-5 Years (the Fund ) is registered under the Investment Company Act of 1940, as amended (the Act ), as a diversified, open-end management investment company. The Fund offers three classes of shares: Class R Shares, Institutional Shares and Service Shares. All shares of the Fund have equal rights with respect to voting, except on class-specific matters. The Fund s investment objective is to provide current income. 2. SIGNIFICANT ACCOUNTING POLICIES The following is a summary of significant accounting policies consistently followed by the Fund in the preparation of its financial statements. These policies are in conformity with U.S. generally accepted accounting principles (GAAP). Investment Valuation In calculating its net asset value (NAV), the Fund generally values investments as follows: Fixed-income securities acquired with remaining maturities greater than 60 days are fair valued using price evaluations provided by a pricing service approved by the Fund s Board of Trustees (the Trustees ). Fixed-income securities and repurchase agreements acquired with remaining maturities of 60 days or less are valued at their cost (adjusted for the accretion of any discount or amortization of any premium), unless the issuer s creditworthiness is impaired or other factors indicate that amortized cost is not an accurate estimate of the investment s fair value, in which case it would be valued in the same manner as a longer-term security. Derivative contracts listed on exchanges are valued at their reported settlement or closing price, except that options are valued at the mean of closing bid and asked quotations. Over-the-counter (OTC) derivative contracts are fair valued using price evaluations provided by a pricing service approved by the Trustees. Shares of other mutual funds or non-exchange-traded investment companies are valued based upon their reported NAVs. For securities that are fair valued in accordance with procedures established by and under the general supervision of the Trustees, certain factors may be considered such as: the last traded or purchase price of the security, information obtained by contacting the issuer or dealers, analysis of the issuer s financial statements or other available documents, fundamental analytical data, the nature and duration of restrictions on disposition, the movement of the market in which the security is normally traded, public trading in similar securities or derivative contracts of the issuer or comparable issuers, movement of a relevant index, or other factors including but not limited to industry changes and relevant government actions. If any price, quotation, price evaluation or other pricing source is not readily available when the NAV is calculated, or if the Fund cannot obtain price evaluations from a pricing service or from more than one dealer for an investment within a reasonable period of time as set forth in the Fund s valuation policies and procedures, the Fund uses the fair value of the investment determined in accordance with the procedures described below. There can be no assurance that the Fund could obtain the fair value assigned to an investment if it sold the investment at approximately the time at which the Fund determines its NAV per share. 16

19 Fair Valuation Procedures The Trustees have ultimate responsibility for determining the fair value of investments for which market quotations are not readily available. The Trustees have appointed a valuation committee ( Valuation Committee ) comprised of officers of the Fund, Federated Investment Management Company ( Adviser ) and certain of the Adviser s affiliated companies to assist in determining fair value and in overseeing the calculation of the NAV. The Trustees have also authorized the use of pricing services recommended by the Valuation Committee to provide fair value evaluations of the current value of certain investments for purposes of calculating the NAV. The Valuation Committee employs various methods for reviewing third-party pricingservice evaluations including periodic reviews of third-party pricing services policies, procedures and valuation methods (including key inputs, methods, models and assumptions), transactional back-testing, comparisons of evaluations of different pricing services, and review of price challenges by the Adviser based on recent market activity. In the event that market quotations and price evaluations are not available for an investment, the Valuation Committee determines the fair value of the investment in accordance with procedures adopted by the Trustees. The Trustees periodically review and approve the fair valuations made by the Valuation Committee and any changes made to the procedures. Factors considered by pricing services in evaluating an investment include the yields or prices of investments of comparable quality, coupon, maturity, call rights and other potential prepayments, terms and type, reported transactions, indications as to values from dealers and general market conditions. Some pricing services provide a single price evaluation reflecting the bid-side of the market for an investment (a bid evaluation). Other pricing services offer both bid evaluations and price evaluations indicative of a price between the prices bid and asked for the investment (a mid evaluation). The Fund normally uses bid evaluations for any U.S. Treasury and Agency securities, mortgage-backed securities and municipal securities. The Fund normally uses mid evaluations for any other types of fixed-income securities and any OTC derivative contracts. In the event that market quotations and price evaluations are not available for an investment, the fair value of the investment is determined in accordance with procedures adopted by the Trustees. Repurchase Agreements The Fund may invest in repurchase agreements for short-term liquidity purposes. It is the policy of the Fund to require the other party to a repurchase agreement to transfer to the Fund s custodian or sub-custodian eligible securities or cash with a market value (after transaction costs) at least equal to the repurchase price to be paid under the repurchase agreement. The eligible securities are transferred to accounts with the custodian or subcustodian in which the Fund holds a securities entitlement and exercises control as those terms are defined in the Uniform Commercial Code. The Fund has established procedures for monitoring the market value of the transferred securities and requiring the transfer of additional eligible securities if necessary to equal at least the repurchase price. These procedures also allow the other party to require securities to be transferred from the account to the extent that their market value exceeds the repurchase price or in exchange for other eligible securities of equivalent market value. The insolvency of the other party or other failure to repurchase the securities may delay the disposition of the underlying securities or cause the Fund to receive less than the full repurchase price. Under the terms of the repurchase agreement, any amounts received by the Fund in excess of the repurchase price and related transaction costs must be remitted to the other party. 17

20 The Fund may enter into repurchase agreements in which eligible securities are transferred into joint trading accounts maintained by the custodian or sub-custodian for investment companies and other clients advised by the Fund s Adviser and its affiliates. The Fund will participate on a pro rata basis with the other investment companies and clients in its share of the securities transferred under such repurchase agreements and in its share of proceeds from any repurchase or other disposition of such securities. Repurchase agreements are subject to Master Netting Agreements which are agreements between the Fund and its counterparties that provide for the net settlement of all transactions and collateral with the Fund, through a single payment, in the event of default or termination. Amounts presented on the Portfolio of Investments and Statement of Assets and Liabilities are not net settlement amounts but gross. As indicated above, the cash or securities to be repurchased, as shown on the Portfolio of Investments, exceeds the repurchase price to be paid under the agreement reducing the net settlement amount to zero. Investment Income, Gains and Losses, Expenses and Distributions Investment transactions are accounted for on a trade-date basis. Realized gains and losses from investment transactions are recorded on an identified-cost basis. Interest income and expenses are accrued daily. Dividend income and distributions to shareholders are recorded on the ex-dividend date. Positive or negative inflation adjustments on Treasury Inflation- Protected Securities (TIPS) are included in interest income. Distributions of net investment income are declared daily and paid monthly. Non-cash dividends included in dividend income, if any, are recorded at fair value. Investment income, realized and unrealized gains and losses, and certain fund-level expenses are allocated to each class based on relative average daily net assets, except that Class R Shares, Institutional Shares and Service Shares may bear distribution services fees, other service fees and transfer agent fees unique to those classes. The detail of total fund expense waivers and reimbursements of $605,185 is disclosed in various locations in this Note 2 and Note 5. For the year ended January 31, 2016, transfer agent fees for the Fund were as follows: Transfer Agent Fees Incurred Transfer Agent Fees Reimbursed Class R Shares $ 31,488 $ Institutional Shares 298,844 (204,982) Service Shares 75,010 TOTAL $405,342 $(204,982) Dividends are declared separately for each class. No class has preferential dividend rights; differences in per share dividend rates are generally due to differences in separate class expenses. 18

21 Other Service Fees The Fund may pay other service fees up to 0.25% of the average daily net assets of the Fund s Institutional Shares and Service Shares to unaffiliated financial intermediaries or to Federated Shareholder Services Company (FSSC) for providing services to shareholders and maintaining shareholder accounts. Subject to the terms described in the Expense Limitation note, FSSC may voluntarily reimburse the Fund for other service fees. For the year ended January 31, 2016, other service fees for the Fund were as follows: Other Service Fees Incurred Other Service Fees Reimbursed Institutional Shares $443,723 $(342,643) Service Shares 170,043 (56,287) TOTAL $613,766 $(398,930) Premium and Discount Amortization All premiums and discounts are amortized/accreted using the effective-interest-rate method. Federal Taxes It is the Fund s policy to comply with the Subchapter M provision of the Internal Revenue Code (the Code ) and to distribute to shareholders each year substantially all of its income. Accordingly, no provision for federal income tax is necessary. As of and during the year ended January 31, 2016, the Fund did not have a liability for any uncertain tax positions. The Fund recognizes interest and penalties, if any, related to tax liabilities as income tax expense in the Statement of Operations. As of January 31, 2016, tax years 2013 through 2016 remain subject to examination by the Fund s major tax jurisdictions, which include the United States of America and the Commonwealth of Massachusetts. When-Issued and Delayed-Delivery Transactions The Fund may engage in when-issued or delayed-delivery transactions. The Fund records when-issued securities on the trade date and maintains security positions such that sufficient liquid assets will be available to make payment for the securities purchased. Securities purchased on a when-issued or delayed-delivery basis are marked to market daily and begin earning interest on the settlement date. Losses may occur on these transactions due to changes in market conditions or the failure of counterparties to perform under the contract. Futures Contracts The Fund purchases and sells financial futures contracts to manage duration and yield curve risks. Upon entering into a financial futures contract with a broker, the Fund is required to deposit in a segregated account a specified amount of cash or U.S. government securities. Futures contracts are valued daily and unrealized gains or losses are recorded in a variation margin account. Daily, the Fund receives from or pays to the broker a specified amount of cash based upon changes in the variation margin account. When a contract is closed, the Fund recognizes a realized gain or loss. Futures contracts have market risks, including the risk that the change in the value of the contract may not correlate with the changes in the value of the underlying securities. There is minimal counterparty risk to the Fund since futures are exchange traded and the exchange s clearing house, as counterparty to all exchange-traded futures, guarantees the futures against default. 19

22 Futures contracts outstanding at period end are listed after the Fund s Portfolio of Investments. The average notional value of long and short futures contracts held by the Fund throughout the period was $91,674,495 and $86,603,846, respectively. This is based on amounts held as of each month-end throughout the fiscal period. Securities Lending The Fund participates in a securities lending program providing for the lending of government securities to qualified brokers. The Fund normally receives cash collateral for securities loaned that is invested in an affiliated money market fund or in short-term securities including repurchase agreements. Collateral is maintained at a minimum level of 100% of the market value of investments loaned, plus interest, if applicable. In accordance with the Fund s securities lending agreement, the market value of securities on loan is determined each day at the close of business and any additional collateral required to cover the value of securities on loan is delivered to the Fund on the next business day. Earnings on collateral are allocated between the borrower of the security, the securities lending agent, as a fee for its services under the program and the Fund, according to agreed-upon rates. As of January 31, 2016, the Fund had no outstanding securities on loan. Option Contracts The Fund buys or sells put and call options to manage duration and yield curve risks and to increase income and total return. The seller ( writer ) of an option receives a payment or premium, from the buyer, which the writer keeps regardless of whether the buyer exercises the option. When the Fund writes a put or call option, an amount equal to the premium received is recorded as a liability and subsequently marked to market to reflect the current value of the option written. Premiums received from writing options which expire are treated as realized gains. The Fund, as a writer of an option, bears the market risk of an unfavorable change in the price of the underlying reference instrument. When the Fund purchases a put or call option, an amount equal to the premium paid is recorded as an increase to the cost of the investment and subsequently marked to market to reflect the current value of the option purchased. Premiums paid for purchasing options which expire are treated as realized losses. Premiums received/paid for writing/purchasing options which are exercised or closed are added to the proceeds or offset against amounts paid on the underlying reference instrument to determine the realized gain or loss. The risk associated with purchasing put and call options is limited to the premium paid. Options can trade on securities or commodities exchanges. In this case, the exchange sets all the terms of the contract except for the price. Most exchanges require investors to maintain margin accounts through their brokers to cover their potential obligations to the exchange. This protects investors against potential defaults by the counterparty. The following is a summary of the Fund s written option activity: Contracts Number of Contracts Premium Outstanding at 1/31/2015 $ Contracts written 1, ,312 Contracts bought back (1,250) (183,312) Outstanding at 1/31/2016 $ 20

23 The average market value of written options held by the Fund throughout the period was $2,103. This is based on amounts held as of each month-end throughout the fiscal period. The average market value of purchased put options held by the Fund throughout the period was $9,180. This is based on amounts held as of each month-end throughout the fiscal period. Additional Disclosure Related to Derivative Instruments Fair Value of Derivative Instruments Derivatives not accounted for as hedging instruments under ASC Topic 815 Interest rate contracts Asset Statement of Assets and Liabilities Location Fair Value Total investments in securities at value-options $781 Statement of Assets and Liabilities Location Liability Fair Value Payable for daily variation margin on futures contracts $1,003,539* * Includes cumulative depreciation of futures contracts as reported in the footnotes to the Portfolio of Investments. Only the current day s variation margin is reported within the Statement of Assets and Liabilities. The Effect of Derivative Instruments on the Statement of Operations for the Year Ended January 31, 2016 Amount of Realized Gain or (Loss) on Derivatives Recognized in Income Futures Contracts Purchased Option Contracts Written Option Contracts Total Interest rate contracts $131,120 $(144,054) $33,169 $20,235 Change in Unrealized Appreciation or (Depreciation) on Derivatives Recognized in Income Futures Contracts Purchased Option Contracts Total Interest rate contracts $(586,539) $(33,038) $(619,577) Other The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts of assets, liabilities, expenses and revenues reported in the financial statements. Actual results could differ from those estimated. The Fund applies Investment Company accounting and reporting guidance. 21

24 3. SHARES OF BENEFICIAL INTEREST The following tables summarize share activity: Year Ended January Class R Shares: Shares Amount Shares Amount Shares sold 410,204 $ 4,527, ,579 $ 3,772,080 Shares issued to shareholders in payment of distributions declared 6,572 72,552 6,660 73,771 Shares redeemed (461,010) (5,084,249) (458,197) (5,074,565) NET CHANGE RESULTING FROM CLASS R SHARE TRANSACTIONS (44,234) $ (483,765) (110,958) $(1,228,714) Year Ended January Institutional Shares: Shares Amount Shares Amount Shares sold 7,824,556 $ 86,303,136 10,995,845 $ 121,865,984 Shares issued to shareholders in payment of distributions declared 449,156 4,959, ,509 4,283,474 Shares redeemed (9,523,252) (105,090,277) (12,636,144) (139,965,047) NET CHANGE RESULTING FROM INSTITUTIONAL SHARE TRANSACTIONS (1,249,540) $ (13,827,565) (1,253,790) $ (13,815,589) Year Ended January Service Shares: Shares Amount Shares Amount Shares sold 2,641,393 $ 29,146,116 2,652,184 $ 29,325,416 Shares issued to shareholders in payment of distributions declared 56, ,516 41, ,006 Shares redeemed (4,323,209) (47,544,195) (1,955,569) (21,667,132) NET CHANGE RESULTING FROM SERVICE SHARE TRANSACTIONS (1,625,169) $(17,772,563) 738,212 $ 8,119,290 NET CHANGE RESULTING FROM TOTAL FUND SHARE TRANSACTIONS (2,918,943) $(32,083,893) (626,536) $ (6,925,013) 4. FEDERAL TAX INFORMATION The timing and character of income and capital gain distributions are determined in accordance with income tax regulations, which may differ from GAAP. These differences are due to TIPS deflation adjustments. For the year ended January 31, 2016, permanent differences identified and reclassified among the components of net assets were as follows: Undistributed Net Investment Income (Loss) Increase (Decrease) Accumulated Net Realized Gain (Loss) $422,832 $(422,832) Net investment income (loss), net realized gains (losses), and net assets were not affected by this reclassification. 22

25 The tax character of distributions as reported on the Statement of Changes in Net Assets for the years ended January 31, 2016 and 2015, was as follows: Ordinary income $6,238,237 $5,391,175 As of January 31, 2016, the components of distributable earnings on a tax-basis were as follows: Undistributed ordinary income $ 493,535 Net unrealized appreciation $ 8,548,544 Capital loss carryforwards and deferrals $(24,501,250) The difference between book-basis and tax-basis net unrealized appreciation/depreciation is attributable to differing treatments for the deferral of losses on wash sales and TIPS deflation adjustments. At January 31, 2016, the cost of investments for federal tax purposes was $508,232,197. The net unrealized appreciation of investments for federal tax purposes excluding any unrealized appreciation/depreciation from futures contracts was $8,515,508. This consists of net unrealized appreciation from investments for those securities having an excess of value over cost of $8,548,546 and net unrealized depreciation from investments for those securities having an excess of cost over value of $33,038. At January 31, 2016, the Fund had a capital loss carryforward of $22,689,551 which will reduce the Fund s taxable income arising from future net realized gains on investments, if any, to the extent permitted by the Code, thereby reducing the amount of distributions to shareholders which would otherwise be necessary to relieve the Fund of any liability for federal income tax. Pursuant to the Code, a net capital loss incurred in taxable years beginning after December 22, 2010, retains its character as either short-term or long-term and does not expire. All of the Fund s capital loss carryforwards were incurred in taxable years beginning after December 22, The following schedule summarizes the Fund s capital loss carryforwards: Short-Term Long-Term Total $22,689,551 $22,689,551 At January 31, 2016, for federal income tax purposes, the Fund had $1,811,699 in straddle loss deferrals. 5. INVESTMENT ADVISER FEE AND OTHER TRANSACTIONS WITH AFFILIATES Investment Adviser Fee The advisory agreement between the Fund and the Adviser provides for an annual fee equal to 0.40% of the Fund s average daily net assets. Subject to the terms described in the Expense Limitation note, the Adviser may voluntarily choose to waive any portion of its fee and/or reimburse certain operating expenses of the Fund. For the year ended January 31, 2016, the Adviser voluntarily reimbursed $204,982 of transfer agent fees. 23

26 Administrative Fee Federated Administrative Services (FAS), under the Administrative Services Agreement, provides the Fund with administrative personnel and services. For purposes of determining the appropriate rate breakpoint, Investment Complex is defined as all of the Federated Funds subject to a fee under the Administrative Services Agreement. The fee paid to FAS is based on the average daily net assets of the Investment Complex as specified below, plus certain out-of-pocket expenses: Average Daily Net Assets Administrative Fee of the Investment Complex 0.150% on the first $5 billion 0.125% on the next $5 billion 0.100% on the next $10 billion 0.075% on assets in excess of $20 billion Subject to the terms described in the Expense Limitation note, FAS may voluntarily choose to waive any portion of its fee. For the year ended January 31, 2016, the annualized fee paid to FAS was 0.078% of average daily net assets of the Fund. Distribution Services Fee The Fund has adopted a Distribution Plan (the Plan ) pursuant to Rule 12b-1 under the Act. Under the terms of the Plan, the Fund will compensate Federated Securities Corp. (FSC), the principal distributor, from the daily net assets of the Fund s Class R Shares and Service Shares to finance activities intended to result in the sale of these shares. The Plan provides that the Fund may incur distribution expenses at the following percentages of average daily net assets annually, to compensate FSC: Percentage of Average Daily Share Class Name Net Assets of Class Class R Shares 0.50% Service Shares 0.05% Subject to the terms described in the Expense Limitation note, FSC may voluntarily choose to waive any portion of its fee. For the year ended January 31, 2016, distribution services fees for the Fund were as follows: Distribution Services Fees Incurred Distribution Services Fees Waived Class R Shares $70,082 $(1,273) For the year ended January 31, 2016, FSC did not retain any fees paid by the Fund. When FSC receives fees, it may pay some or all of them to financial intermediaries whose customers purchase shares. For the year ended January 31, 2016, the Fund s Service Shares did not incur a distribution services fee; it may begin to incur this fee upon approval of the Trustees. Other Service Fees For the year ended January 31, 2016, FSSC received $1,769 and reimbursed $398,930 of the other service fees disclosed in Note 2. 24