1. Ming Fu April 30th STRIPS and TIPS

2. STRIPS = Separate Trading of Registered Interest and Principal of Securities

3. Introduction of STRIPS Principal STRIPS (hen) Coupon STRIPS (eggs) Treasury Bond Coupon Stripping Coupon Stripping

4. History of STRIPS TIGRs By Merrill Lynch Treasury Income Growth Receipts CATS By Salomon Brothers Certificates of Accrual on Treasury Securities COUGARs By A.G. Becker Paribas Coupon Government Accrual Receipts LIONs By Lehman Brothers Lehman Investment Opportunities Notes DOGs Dibs On Government Securities

5. An Example of STRIPS U.S. Treasury Bond 3 Years to Maturity Semiannual Coupons

6. An Example of STRIPS (cont’d) YearPrice of Treasury bondsPrice of Treasury STRIPS 0.5$60/(1.04) 1 = $58$60/(1.020) 1 = $59 1.0$60/(1.04)² = $55$60/(1.025)² = $57 1.5$60/(1.04) 3 = $53$60/(1.030) 3 = $55 2.0$60/(1.04) 4 = $51$60/(1.035) 4 = $52 2.5$60/(1.04) 5 = $49$60/(1.0375) 5 = $50 3 $60/(1.04) 6 = $47 $1000/(1.04) 6 = $790 Total$1,103$1,110 $1,000 principal with 12% Coupon rate and 8% Yield To Maturity $7 profit !!!

7. Compare Yield to Maturity

8. Summary of STRIPS PrincipalCoupons

9. TIPS = Treasury Inflation Protection Securities or TIIS = Treasury Inflation Index Securities First TIPS in 1997

10. Introduction of TIPS U.S. Treasury Bond 3 Years to Maturity Semiannual Coupons Adjusted Principal= Principal*(1+inflation rate) Coupon payment= Adjusted Principal*fixed coupon rate *Inflation based on Consumer Price Index-Urban Consumers (CPI-U) Inflation

11. An Example of TIPS YearInflation (Annual) Inflation (Semi-A) PrincipalCoupon (Annual) Coupon (Semi-A) Coupon Payment 0.0$1,0004%2% 0.52%1%$1,0104%2%$20.20 1.03%1.5%$1,025.154%2%$20.50 1.54%2%$1,045.654%2%$20.91 2.05%2.5%$1,071.794%2%$21.44 2.52%1%$1,082.514%2%$21.65 3.01%0.5%$1,087.924%2%$21.76 1025.15=1010+1010*1.5% 20.5=1025.15*2%

12. Year Deflation (Annual) Deflation (Semi-A) PrincipalCoupon (Annual) Coupon (Semi-A) Coupon Payment 0.0$1,0004%2% 0.5-2%-1%$9904%2%$19.8 1.0-3%-1.5%……4%2%…… 1.5-4%-2%……4%2%…… 2.0-5%-2.5%……4%2%…… 2.5-2%-1%……4%2%…… 3.0-1%-0.5%$917.834%2%$18.36 An Example of TIPS (cont’d)

13. Deflation on TIPS You have this safeguard at maturity: If the adjusted principal < the original principal You are paid the original principal! Coupons are still paid based on deflationary principal.

14. 1983-2012 U.S. CPI-U (in %) Latest deflation in the U.S. was in 1954.

15. Summary of TIPS The great inflation hedge No free lunch: opportunity cost Alternative investment: municipal bonds? We will see in Marcus’s presentation soon

16. Reference http://www.treasurydirect.gov/indiv/research/indepth/tips/res_tips_faq.htm http://www.treasurydirect.gov/indiv/research/indepth/tips/res_tips.htm http://www.treasurydirect.gov/instit/research/faqs/faqs_basics.htm http://www.raymondjames.com/fixed_income_tips.htm http://www.jpmorgan.com/tss/General/Tips_on_TIPS/1300313797124%2Bcorrela tion+of+nominal+and+real+yields&oe=utf-8&rls=org.mozilla%3Aen- GB%3Aofficial&client=firefox-a&channel=np&hl=en&ct=clnk http://www.jpmorgan.com/tss/General/Tips_on_TIPS/1300313797124%2Bcorrela tion+of+nominal+and+real+yields&oe=utf-8&rls=org.mozilla%3Aen- GB%3Aofficial&client=firefox-a&channel=np&hl=en&ct=clnk http://www.newyorkfed.org/aboutthefed/fedpoint/fed42.html http://www.finra.org/Investors/InvestmentChoices/Bonds/SmartBondInvesting/ty pesofbonds/P133240 http://www.finra.org/Investors/InvestmentChoices/Bonds/SmartBondInvesting/ty pesofbonds/P133240 http://seekingalpha.com/article/107144-tips-strips-redux

17. Thank you! Questions?

18. Appendix

19. 35 TIPS