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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

  • 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)


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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


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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


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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


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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