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Chapter 16. Treasury Securities Markets. Treasury Securities Primary Market Secondary Market Stripped Treasuries. I. Treasury Securities. Treasury is largest debt issuer in world large trading volume high liquidity zero default risk. currently issued securities. Tbills zero coupon

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chapter 16 treasury securities markets
Chapter 16. Treasury Securities Markets
  • Treasury Securities
  • Primary Market
  • Secondary Market
  • Stripped Treasuries
i treasury securities
I. Treasury Securities
  • Treasury is largest debt issuer in world
    • large trading volume
    • high liquidity
    • zero default risk
currently issued securities
currently issued securities
  • Tbills
    • zero coupon
    • 4, 13, 26 weeks
  • Tnotes, Tbonds
    • coupon
    • 2, 5, 10 years
    • 30 yrs stopped in 11/2001
slide4
TIPS
  • inflation-indexed 10-year Tnote
  • guarantee a real return if held until maturity
    • purchasing power of cash flows held constant, not dollar value
how do they work
how do they work?
  • coupon rate set when issued
    • does NOT change
  • face value adjusted annually
    • % increase in CPI
    • face value will not fall
example
example
  • at issue: F = $10,000, coupon = 4%
    • payment = (.04)(.5)(10,000) = $200
  • year 1: CPI 3%
    • new F = $10,000(1.03) = $10,300
    • payment = (.04)(.5)(10300) = $206
slide7
year 2: CPI = 2%
    • new F = $10,300(1.02) = $10,506
    • payment = (.04)(.5)(10506) = $210.12
advantage of tips
advantage of TIPS
  • little inflation risk
  • federal gov’t has incentive to keep inflation low
disadvantage
disadvantage
  • coupon rate is lower
  • additions to face value taxed in the year they occur
    • but face value not received until maturity
ii primary market
II. Primary Market
  • by auction
    • debt is issued by Treasury Dept.
    • auction ran by Federal Reserve
auction frequency
auction frequency
  • weekly
    • 4, 13, 26 week Tbills
  • monthly
    • 2 year Tnotes
  • quarterly
    • 5, 10 year Tnotes
    • 10 yr. TIPS
types of bids
types of bids
  • $1000 minimum
  • increments of $1000
competitive bids
competitive bids
  • bid by yield
    • lowest yields (highest price) are successful
  • quantity limited to 35% of offering for a single buyer
  • only primary dealers submit competitive bids
slide14
primary dealers
    • large Treasury dealers
    • sufficient volume for Fed OMO
    • about 20 primary dealers
noncompetitive bids
noncompetitive bids
  • bid by quantity
    • $1 million limit for Tbills
    • $5 million limit for Tnotes, Tbonds
  • agree to pay average yield of successful competitive bids
  • anyone may submit a noncompetitive bid
tradeoff
tradeoff
  • naming your reservation price (yield)
    • competitive bid
  • vs.
  • guarantee of success in filling bid
    • noncompetitive bid
awarding treasuries
awarding Treasuries
  • total amount auctioned

- Federal Reserve purchases

- noncompetitive bids

= amount for competitive bids

slide18
competitive bids awarded,
    • starting with lowest yield
    • & going up until all Treasuries are awarded
slide19
stop yield
    • highest yield of accepted competitive bid
    • bidders at stop only get a fraction of requested quantity
  • tail

= stop yield - av. of successful yield bids

    • small tail means agreement about value
slide20
what do the bidders pay?
    • 1990s single price auction
    • all bidders pay price equivalent to stop yield
    • no “winner’s curse”

-- low yield bidder would pay highest price relative to others

example1
Example
  • 26 week Tbills, 3/18/02
  • total $17 billion
  • noncompetitive bids = $1.5 billion
  • Federal Reserve = $5 billion
  • competitive bids = $38 billion
  • how to award competitive bids?
slide22

$10 billion

accepted in full

stop yield

  • $10.5 billion for competitive bids
  • suppose bids are:

$ 5 billion 1.78%

$ 3 billion 1.8%

$ 2 billion 1.85%

$ 5 billion 1.87%

$ 23 billion over 1.87%

unsuccessful

slide23
stop yield = 1.87%
    • bidders at stop yield got 10% of quantity requested

(.5 million left /5 million requested)

1991 auction scandal
1991 auction scandal
  • Salomon Bros.
    • submitted fraudulent bids to exceed quantity limits
  • results
    • single price auction
    • switch from sealed written bids to open computerized process
iii secondary market
III. Secondary Market
  • OTC market
    • dealers w/ bid-ask prices
  • “on-the-run” Treasuries
    • closer to auction date
    • more liquid
  • “off-the-run” Treasuries
    • farther from auction date
    • less liquid
slide26
“wi” market
    • when issued
    • Treasuries bought/sold prior to auction date
price quotation in treasury market

F - P

360

x

F

d

Price quotation in Treasury market
  • Tbills
    • quoted by “discount yield”

discount yield =

slide28

F - P

360

x

F

d

F - P

365

x

P

d

discount yield =

YTM =

YTM > discount yield

example2
example
  • F = $100,000
  • 90 days
  • discount yield = 5.25%
  • what is Tbill price?
slide30

100,000 - P

360

x

90

100,000

.0525 (100,000) =

4

.0525 =

100,000 - P

P = $98,687.50

slide31

365

100,000 - 98687.5

x

90

98687.5

  • what is yield to maturity?

YTM =

YTM = 5.39%

slide32
Tnotes and Tbonds
    • quoted by price
    • per $100 of face value
    • up to 1/32 of $1
example3
example
  • F = $100,000
  • ask price 117:19
  • what is price?
    • $117 19/32 per $100

-- 19/32 = .59375

    • P = $117,593.75
regulation
Regulation
  • exempt from most SEC regulation in debt markets
  • no reporting of trades
  • no display of bid/ask quotes for public
    • reported among primary dealers
iv stripped treasuries
IV. Stripped Treasuries
  • Treasury does NOT issue zero coupon Tnotes or Tbonds
  • 1982 firms created own synthetic zero coupon Treasuries
    • trademarked securities
how did it work
how did it work?
  • firms issued own zero coupon debt
    • backed by Treasury cash flows
  • Merrill Lynch--TIGRs
  • Salomon Bros. -- CATS
problems
problems
  • trademarked securities have some default risk
    • not direct obligations of U.S.
  • trademarked securities not intertradeable
    • TIGRs were different from CATS
treasury strips 1985
Treasury STRIPS (1985)
  • standardized the market
  • certain Tnotes, Tbonds eligible for stripping
    • STRIPS direct obligation of U.S.
    • STRIPS are intertradeable