1. 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-U).
At maturity, pays adjusted principal or par, whichever is greater.
TIPS can be used to impute expected rates of inflation in future periods.

2. Consumer Price Index (CPI-U)
Dec
Jan

3. 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?

4. 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.

5. 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?

6. Bearer Bonds (not many left)

7. National Debt (in trillions)
Held by
Intragovernmental
Public
Holdings
TOTAL
18-Sep
15.7
5.8
21.5
17-Sep
14.7
5.6
20.2
16-Sep
14.2
5.4
19.5
15-Sep
13.1 5
18.2
14-Sep
12.8
17.8
13-Sep 12
4.8
16.7
12-Sep
11.3
16.1
11-Sep
10.2
4.7
14.9
10-Sep 9
4.5
13.6
Intragovernmental Holdings include:
Social security trust fund
Fed employees and military retirement trust funds
Disability insurance trust funds
Other (airport, highway, unemployment, etc.)

8. Distribution of Debt Held by Public
Of the $15.7 trillion held by the public, roughly
T-Bills %
Notes %
Bonds %
TIPs %
Other %
half held by foreign governments.
Ave interest rate is 2.52% (up from 2.33 last year).
Intergovernmental Holdings are not marketable.

9. Social Security (OASI) Trust Fund
2017: $2.820 trillion in trust fund (“piggybank”)
Old-Age and Survivors Insurance
2017: $825 billion in, $807 billion out.
Piggybank forecast to be empty by Then, on “pay as you go” basis. Only be able to pay out about 70% of promised benefits.

10. OASI Trust Fund (in billions)
Expendi-
Net
Receipts
tures
Increase
Balance
2010
677
585 92
2,429
2011
699
604 95
2,524
2012
731
645 86
2,610
2013
743
679 64
2,673
2014
769
714 55
2,729
2015
801
750 51
2,780
2016
797
776 21
2,801
2017
825
807 18
2,820
11/26

11. Things to know for the Quiz
Given CPI data, how to compute coupon payments and adjusted principal of a TIPS.
Given Treasury yield data, how to compute a 1-year forward rate starting x years from now.
How many $1000 (zero coupon) strip securities can be created from a given holding of a US Treasury security.
T-bill auctioning process: (a) bid-to-cover ratio, (b) high rate, (b) amount allocated at high rate.

12. Bond Indenture
Indenture is the complete legal contract. Covenants are the legally binding terms in the indenture.
Specifies 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.

13. Bond Indenture 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
There may also be covenants about the paying of dividends on stocks.
11/29

14. 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 project (toll roads, sewage treatment plants, professional sport facilities, etc.) it finances.
11/29

15. 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 state, too).
A relationship for comparing after-tax yields between different debt instruments is
where on debt instrument a, ia is its yield and ta is your marginal tax rate on it. Same for b.
Typically sold as serial bond issues (see book)

16. Comparing Yields on Diff Types of Bonds
Corporate (Taxed at both Fed and state levels)
Treasuries (Taxed at Fed level, only)
Munis (tax free)

17. Junk Bonds
Junk bonds were not sellable in the primary market until late 1970s.
Junk bonds also known euphemistically 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.

18. 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.