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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)

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chapter 16 treasury market
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 market2
Chapter 16 – Treasury Market
  • Current Level of Debt
    • http://www.brillig.com/debt_clock
    • Currently Over $7 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 market3
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 market4
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
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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 market6
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
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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
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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
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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
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Chapter 16 – Treasury Market
  • Federal Agency Securities – More Later 5-19-05
    • 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
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