1. Investing Through the Interest Rate Cycle & Custodians Doug Milliken Arapahoe County Treasurer March 25, 2010

2. 2 Interest rate cycle

3. 3 Different strategies for interest rates Four scenarios: – Increasing rates – Near the top – Decreasing rates – Near the bottom

4. 4 Increasing interest rates Prices will decrease with rate increase Keep investments short If increases come quickly, you are better off in money market fund Don’t be fully invested: you’ll want to buy the higher yielding bonds once rates rise

5. 5 Rates near the top You won’t know for sure when you are at the top Use strategies with a portion of portfolio Lock in long term rates Consider allowable investments, terms Non-callable bullets Prices increase as rates fall

6. 6 Compare MM to long term yields When rates near the top of cycle, long term rates will be lower than money market Strategy is to buy lower yielding long term bonds than money market, expecting that MM will decline soon, while long term rates stay high

7. 7 Example of scenario Long term rates lower than MM

8. 8 Decreasing interest rates Portfolio value remains at or above purchase price, useful in case of emergencies requiring early sale Value of portfolio rises Under concept of total return, increased value is equal to interest earnings Usually, you won’t know when rates hit bottom

9. 9 Rates near the bottom Maximum increase to market value Bonds at increased value earning very low yield Consider selling to take capital gains if allowed and putting proceeds in money market

10. 10 Yield curves

11. 11 Usual shape of yield curve Shown on lower portion of previous chart Yield increases with term No significant changes expected to interest rates

12. 12 Inverted yield curve Shown on upper portion of previous graph Yield declines with term Market in flux Market has sold off short and medium term bonds, and yield has risen Often predictive of recession

13. 13 Concept of total return Realized and unrealized capital gains equal to interest earnings Compare market value at beginning and end of period

14. 14 How are you reviewing your performance? Just interest earned, or also market gain? How does your government view performance? How do various components of return show up on CAFR? What do state statutes and investment policy allow?

15. 15 Call-ability Issuers gain what you lose Mathematically, callable issues are worth less than non-callable Callable issues create asset to issuer Sometimes, you want bonds called Mostly, you want the choice of selling or keeping

16. 16 Current opportunity in agencies Callable step-up Issue date 11/18/09 First coupon 5/18/10 Final maturity 11/18/14 Beginning coupon 2% Steps up to 4% on 11/18/11 if not called Callable at 11/18/11 at par Selling at premium to yield 1.5%

17. 17 Reason I bought it FNMA thinks rates will jump up in next year and 7 months. I consider this unlikely, based on current state of economy FNMA has right to call at par if rates don’t rise I get 1.5% for 1 year 7 months, higher than bullet I’m happy if it’s called Success of strategy depends on correct prediction of interest rate movements

18. 18 Another example – FHLMC

19. 19 Current investment idea I purchase CDs in banks based in my county slightly below market interest rate I request that the banks makes loans <$500,000 to small and medium sized businesses in county. Banks make all credit decisions In Colorado, banks must collateralize with US government securities valued at 102% of deposit, so no risk

20. 20 Banks report quarterly on each loan: - loan terms - type of business - location Public good in keeping businesses alive, allowing expansion and job creation Yield is higher than agency or money market

21. 21 Benefit to issues with larger issue size Trade with lower spread Readily salable Analogous to Global Corporate Issues

22. 22 Custodians Insist on Delivery versus Payment Money leaves your account only when security put in your ownership Security leaves ownership only when money enters your account Securities lending can be profitable, but some investors have lost when agents fail Sample Banking/Custodian RFP on GIOA website

23. 23 Feel free to contact me… Doug Milliken Arapahoe County Treasurer 5334 S. Prince St. Littleton, CO 80166 dmilliken@co.arapahoe.co.us 303-681-5505