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Hypothetical Situations
• You worked for a company called Akiyoshi– President, Akiyoshi, did not pay you well
• 55 Years• Own $300,000 by cash• Have a bad heart condition by working
with Aki for a long time– No tolerance to Stress
Appropriate Place to Put Money?
• Savings Account• Professer Brooks portfolio• My Pocket • Stock Market• Treasury Bill• Municipal Bond
Typical Return of Investment
My Pocket
-100%
Municipal Bond
5.5%
Savings Account
1.04%
Treasury Bound
4.0%
Stock Market
11.1%
Go Back to Savings Account
ROI
1.04%
Inflation
3%
Real ROR
-1.96%
IS SAVINGS ACCOUNTS REALLY APPROPRIATE FOR YOUR INVESTMENT?
ROR of Investment
My Pocket
-100%
Municipal Bond
2.5%
Savings Account
-1.96%
Treasury Bond
1.0%
Stock Market
8.1%
Risk of Investment
• Variance of Market Price– Stock Price– Bond Price
• Inflation Rate– Typically positive every year
No Risk Investment?
• TIPS
Treasury Inflation-Protected Securities
• STRIPS– Separate Trading of Registered Interest
and Principal of Securities
TIPS
CPI
•CPI
•Increase
Face
•Face Value
•Increase Increase in Tax Expense
ROR
•Fixed
•No Risk of Inflation
STRIPS
• STRIPS are effectively zero coupon bonds– Separated in Coupon Strips and Principle Strips
• Effectively zero coupon bonds?• Year to Maturity of STRIPS
will be used to discount future cash flow
STRIPS
• Can be purchased from Bank• Bank will use spot rate to price each of
Zero coupon bounds, whose rate can be calculated by observed yields of Treasury bills and treasury Coupon securities
SPOT Rate Example
• Purchased 1.5 years, semiannual coupon of 8.5% and $100 par bound
• Observed YTM of .5 and I year are 8% and 8.3% respectively without no coupon.
• Price of 1.5 Maturity bill is $99.45
STRIPS : History
• Originally started by – Merrill Lynch and Salomon Bros in 1982– less liquid bounds and indirect obligation of
US movement bounds
• In 1985, US government announced STPRIPS program– All of 10 years and longer treasuries are
qualified
Caused
To address those Problems
STRIPS : Quiz
• Face $100,000• Coupon rate 3%• YTM 4%• Annual Interstate Payment• Year to Maturity 10
• How many Zero Coupon bonds can be created ?
• What would be the rough projected price of Zero Coupon bounds for year 2 interest rate Payment?
Source
• http://www.money-rates.com/savings.htm• Foundation of Finance Market and Institutions• http://www.youtube.com/watch?v=pvTCTl86rrg• http://www.investopedia.com/terms/t/treasurystri
ps.asp• http://www.newyorkfed.org/aboutthefed/fedpoint/
fed42.html• http://www.wikinvest.com/wiki/Treasury_STRIPS
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