Treasury Securities by jolinmilioncherie


									Treasury Securities

 Fixed Income Society
             What is a Treasury?
• U.S. Treasury Securities-such as bills, notes and bonds-
  are debt obligations of the U.S. government
• When a Treasury Security is bought, the investor lends
  money to the government for a specified period of
• Considered “risk-free” investments because the are the
  safest of all investments
• Viewed in the market as having no “credit risk”
• This means it is almost 100% certain that the investor’s
  principal and interest will be paid on time
• Because of the high degree of safety, interest rates are
  generally lower than other traded debt
       Market Size and Liquidity
• Amount of marketable U.S. Treasury
  securities is about $11 trillion
• Average daily trading volume in 2007 =
  $561.8 billion
• Treasuries are considered on of the most
  liquid debt markets in the entire world
• This means the pricing, executing and settling
  a trade is very inexpensive and efficient due
  to tight bid/ask spreads
        Who buys U.S. Treasuries?
•   5% held by state and local governments
•   7% held by individuals
•   7% held by public and private pension funds
•   9% held by banks and mutual funds
•   15% held by category of “other investors”
•   47% held by foreign investors
•   Today, the largest purchaser of American debt
    is China
        Role of Treasury Securities
               in a Portfolio
• Primary advantage – SAFETY!
• Invest in Treasuries to preserve and increase
  capital and to receive a dependable income
• Pay lower interest rates than other taxable fixed-
  income investments
• Investors take this as a trade-off for a secure
• In a portfolio, treasuries represent money
  investors want to keep safe from risk
            Benefits in the Portfolio
• 1) Predictability
    – Treasury has not issued a “callable” securities since 1985
    – Call provision-permit issuer to pay off the bond in full before the
      scheduled maturity
    – This happens when interest rates decline (issuer will refinance debt to
      obtain lower interest rate)
    – This forces investors to pay more for the same interest rate
• 2) Availability with a wide range of maturity dates
    – Allows investors to structure a portfolio to specific time horizons
• 3) Interest payments exempt from state and local income taxes
• 4) High level of liquidity
    – The spreads between bid/ask prices are much tighter than other
                     Market Risk
• Affected by interest-rate risk and inflation risk
• Underlying value of the bond itself may change
  depending on direction of interest rates
• If interest rates rise, the value of the issued security will
  fall, since bonds paying higher rates will come into the
• If rates fall, the value of the older bond will rise in
  comparison with new issues
           Differences Between Bills,
                Notes and Bonds
• Bills
   – Short-term instruments with maturities of no more than one
   – Fill investment needs similar to MM funds and savings accounts
   – Quick investments
   – Highly liquid market
   – Function like zero-coupon bonds
• Notes
   – Intermediate to long-term investments
   – Typically mature in two, three, five and ten years
   – Used for such things as college tuitions
• Bonds
   – Cover terms of more than ten years
       Other Treasury Securities
• TIPS-Treasury Inflation Protected Securities
  – CPI (Consumer Price Index) is the guide the value
    of the principal is adjusted to reflect the effects of
  – Fixed interest rate paid semi-annually
  – If inflation has increased the value of the principal,
    the investor receives the higher value
  – If deflation decreases the value, the investor
    receives the original face amount of the security
                     TIP Example
• Here’s an example of how inflation-indexed securities work.
  Let’s say you invested $1,000 in January on a new 10-year
  inflation-indexed note paying 3% interest. At mid-year, the
  Consumer Price Index indicates that inflation has been 1%
  during the first six months. Your principal is adjusted
  upward to $1,010 and your interest payment (one-half of
  3%) is based on that figure. Your payment is $15.15. At the
  end of the year, the index indicates that inflation was 3%,
  which brings the value of your principal to $1,030. Your
  second interest payment is $15.45 ($1,030 times 3%
  divided by 2).
• Because of the built-in inflation protection, these securities
  usually offer lower coupon rates than Treasuries of similar
  maturities without the feature.
              Other Treas. Sec. Cont…
• STRIPS-Separate Trading of Registered Interest and Principal (Zero-Coupon
    – Separates the principal and interest components (“Coupon Stripping”)
    – Coupon-the part of a bond certificate that denotes the amount of interest
      due, and on what date and where payment will be made
    – Traded as individual securities
    – Once a bond is stripped, investors can buy any or all of the available STRIPS
• Savings Bonds
    – Price is half of the face amount (minimum investment is $25)
    – Series EE
        •   Accrue interest according to a floating rate
        •   Rate is adjusted twice a year
        •   Investor does not receive maturity until the bond is cashed in
        •   Guaranteed full maturity no longer than 17 years
    – Series I
        • Built-in inflation adjustment
        • Pay interest according to an earning rate that is partly fixed and partly inflation adjusted
Security Type    Minimum Investment   Current Maturities Available

Treasury Bills         $1,000         13-week, 26-week and 52-week;
                                      other maturities offered by
                                      Treasury on an as-needed basis

Treasury Notes         $1,000         2-year, 5-year and 10-year
     TIPS              $1,000         10-year securities
   STRIPS              $1,000         2 years to 10 years
  Series EE             $25           Payable after 6 months, but earns
                                      interest for 30 years
   Series I             $50           Payable after 6 months, but earns
                                      interest for 30 years
    Buying and Selling Treasuries
• Bought and sold through investment professional,
  a commercial bank or a broker
• “On the run” issues are traded on the primary
• “Off the run” issues are traded on the secondary
• Investor can trade directly from the Treasury
  – Treasury Direct and Sell Direct account needs to be set
    up (Fed. Res. Bank of Chicago sells the securities for
    the investor)
  – Can participate directly in Treasury auctions

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