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Treasury Inflation-Protected Securities

• Issued in terms of 5, 10 and 30 years a few times a year in par increments of $100.

• Usual noncompetitive/competitive auction process.

• Coupon rate determined at auction, fixed thereafter.

• Principal amount (upon which semi-annual coupon payments are based) is adjusted twice per year in accordance with the Consumer Price Index (CPI).

• At maturity, pays adjusted principal or par, whichever is greater.

• TIPS can be used to impute expected rates of inflation in future periods.

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Consumer Price Index (CPI-U)

endJan

endDec

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Example 1

Assume a $1,000 TIPS with a 2.5% coupon rate. If first three semiannual inflations are 1.8%, 2.3% and 2.1%, what are the first three coupon payments? What is adjusted principal after 1.5 years?

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Treasury STRIPS Program• Separate Trading of Registered Interest and Principal of

Securities.

• When a Treasury is stripped, each cash flow is used to construct separate zero-coupon securities denominated in $1,000 increments.

• Not created by Treasury Department. Created by any of the dealers that work with Treasury.

• At the request of any such dealer, Treasury will procure separate CUSIP numbers for each strip component.

• Strips created when sum of parts worth more than the whole.

• Used for duration matching, lottery annuity payments, by pension funds, insurance companies, etc.

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Example 2

How many $1,000 strip securities can a dealer create from the purchase of $1 million in face value of a 5% 4-year Treasury note?

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National Debt

Intragovernmental Holdings include:Social security trust fundFed employees and military retirement trust fundsDisability insurance trust fundsOther (airport, highway, unemployment, etc.)

http://www.treasurydirect.gov/govt/reports/pd/pd_debtposactrpt_fy2014.htmIntragovernmental

Held by Public Holdings Total9/29/2014 12.78 5.04 17.829/30/2013 11.97 4.76 16.739/30/2012 11.26 4.79 16.059/30/2011 10.12 4.66 14.789/30/2010 9.02 4.53 13.559/30/2009 7.55 4.35 11.90

9/30/2008 5.80 4.21 10.019/30/2007 5.05 3.95 9.009/30/2006 4.84 3.66 8.509/30/2005 4.60 3.33 7.939/30/2004 4.30 3.07 7.37

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Distribution of Debt Held by Public

T-Bills 10 %Notes 60 %Bonds 15 %TIPs 10 %Other 5 %

Of the $12.78 trillion held by the public, roughly

Half held by foreign governments.

Ave interest rate is 2.38%. This requires how much per year to pay interest on the public portion of the debt?

Intergovernmental Holdings are not tradable.

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Social Security (OASI) Trust Fund

2013: $2.673 trillion in trust fund (“piggybank”) Old-Age and Survivors Insurance2013: $743B in, $679B out.

Piggybank empty by 2040. Then can pay only about 70% of promised benefits.

OASI Trust Fund (in billions)

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http://www.ssa.gov/OACT/STATS/table4a1.html

  Receipts Benefits Net Inc Balance2005 604 442 162 1,6632006 642 461 181 1,8442007 675 496 179 2,0242008 695 516 179 2,2032009 698 564 134 2,3372010 677 585 92 2,4292011 699 604 95 2,5242012 731 645 86 2,610

2013 743 679 64 2,673

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Municipal Bonds

• General Obligation Bonds. Backed by “full faith and credit” of issuing political entity. Require voters’ approval which often refused. Very safe when available.

• Revenue Bonds. Be careful. Coupon and principal payments can only be made with cash flows from the specific project (toll roads, sewage treatment plants, professional sport facilities, etc.)

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Municipal Bonds

• Issued by states, counties, cities, school districts, university systems, transit systems, etc.

• Distinguishing feature of munis is that coupon payments are exempt from federal tax (usually from state tax in state of issue, too).

• When comparing muni with a comparable taxable bond

(1 )at bti i t

• Typically sold as serial bond issues (see pp. 250-51)

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Bearer Bonds (not many left)

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Bond IndentureSpecifies collateral

• Mortgage bond - real assets pledged.• Equipment trust certificates - specific, titled, or

identifiable equipment.• Collateral bonds - secured by financial assets.• Debentures - unsecured bonds.

Specifies priority of claims on assets• Senior debt - first priority on general assets.

• Subordinated (junior) debt - below senior. Debentures at

bottom.

Considerations concerning repayment of principal • Sinking fund provisions. The putting aside of sums for the

repayment of principal when due, or the periodic retirement of a number of bonds selected randomly.

• Call and/or put provisions

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Junk Bonds

• Junk bonds were not sellable in the primary market until late 1970s.

• Junk bond also known as High Yield bonds, so don’t be misled.

• Secondary market appeared in early 1980s.

• “Low credit quality” firms now able to issue long-term fixed rate marketable debt, rather than be at mercy of commercial banks.

• Many investors attracted to junk bonds because of high yield.

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Foreign Bonds

• Issued in a financial market of a nation by a foreign company in that country.• If a foreign firm issues a bond in the US, it is called

a Yankee bond. • Bonds issues by foreign firms in Japan are called

Samurai bonds.

• Must conform to the regulations of country in which sold.