Chapter 16 – Treasury Market Debt Instruments of the U.S. Government Largest borrower in the world Very liquid markets Considered risk-free Main Types Treasury Bills (maturity less than 1 year at issue) Treasury Notes (maturity 2 to 10 years) Treasury Bonds (maturity greater than 10 years)

Chapter 16 – Treasury Market Current Level of Debt Currently Over $10 trillion Repayment of Debt Interest and principal at maturity (discount) Interest as you go and principal at the end (notes and bonds) Price = FV / (1 + r )^n + PMT ( 1 – [1/(1+r)^n])/( r) Another Feature of Debt – Callable Bonds

Chapter 16 – Treasury Market Pricing a bond Present Value of Interest Payments PMT ( 1 – [1/(1+r)^n])/( r) PMT is six month payment determined by the coupon rate and par value of the bond r is the periodic interest rate (yield to maturity) n is the number of payments Present Value of Face (Par) Value FV / (1 + r )^n FV is the Par Value of the bond

Chapter 16 – Treasury Market Treasury Auctions Set Schedule for the different maturities Competitive Bidding Process Amount Announced Ahead of Time Non-Competitive Bids – up to $1 million Non-Competitive subtracted from offer size  Will receive at the stop bid Bid by quantity and yield Stop Yield is the last yield necessary to sell out the issue (highest yield accepted) – every bidder and non-competitive bidder gets this yield

Chapter 16 – Treasury Market Secondary Market Trading of Treasuries Over the Counter Market New York, London, and Tokyo U.S. Government Security Dealers Settlement is next day Traded before Issue When-issued trading Starts at auction announcement day Dealers and Interdealer Brokers Inside market

Chapter 16 – Treasury Market Two Special Bonds – STRIPS and TIPS STRIPS – Separate Trading of Registered Interest and Principal of Securities The individual coupons and principal trade separately The individual assets are discount bonds TIPS - Treasury Inflation Protected Securities Par Value (principal) adjusted semi-annual to inflation rate New Par Value used to compute interest payment Protected at maturity

Chapter 16 – Treasury Market STRIPS First started by Merrill-Lynch August 1982 TIGRs – Treasury Interest Growth Receipts Stripped U.S. Government Bonds Others followed – Trademark Zero’s Traded only within the “issuer” Secondary market not very liquid Treasury Receipts – Generic to improve liquidity Government STRIPS starts in 1985

Chapter 16 – Treasury Market Adjusting the TIPS Principal Initial Par Value ($100,000) Six-month Inflation rate adjusts the principal prior to determining the interest payment Fixed coupon rate for interest payment Increase in principal is a capital gain and taxable If deflation occurs, potential for ending principal to be lower than issue principal Ending principal adjusted back to issue principal if below issue principal

Chapter 16 – Treasury Market Repurchase Agreements – REPOS A contract that sells a financial asset but also provides for buying back the same asset Collateral is identified Buying and Selling price is set Time of purchase and sale is set Overnight Repo Term Repo Cheaper borrowing than unsecured Federal Funds Rate

Chapter 16 – Treasury Market Federal Agency Securities – More Later Federal Related Institutions Agencies owned by the Federal Government TVA and Ginnie Mae Government Sponsored Institutions Private Organizations Freddie Mac, Fannie Mae, Sally Mae, etc. Debentures vs. Mortgage Backed Non U.S. Government Bonds Issues from other central governments Example, United Kingdom’s Gilts