Chapter 16. Chapter 16. Treasury Securities MarketsTreasury Securities Markets
Chapter 16. Chapter 16. Treasury Securities MarketsTreasury Securities Markets
• Treasury Securities
• Primary Market
• Secondary Market
• Stripped Treasuries
• Treasury Securities
• Primary Market
• Secondary Market
• Stripped Treasuries
I. Treasury SecuritiesI. Treasury SecuritiesI. Treasury SecuritiesI. Treasury Securities
• Treasury is largest debt issuer in world• large trading volume• high liquidity• zero default risk
• Treasury is largest debt issuer in world• large trading volume• high liquidity• zero default risk
currently issued securitiescurrently issued securitiescurrently issued securitiescurrently issued securities
• Tbills• zero coupon• 4, 13, 26 weeks
• Tnotes, Tbonds• coupon• 2, 5, 10 years• 30 yrs stopped in 11/2001
• Tbills• zero coupon• 4, 13, 26 weeks
• Tnotes, Tbonds• coupon• 2, 5, 10 years• 30 yrs stopped in 11/2001
TIPSTIPSTIPSTIPS
• inflation-indexed 10-year Tnote
• guarantee a real return if held until maturity• purchasing power of cash flows
held constant, not dollar value
• 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?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
• coupon rate set when issued• does NOT change
• face value adjusted annually • % increase in CPI• face value will not fall
exampleexampleexampleexample
• 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
• 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
• year 2: CPI = 2%• new F = $10,300(1.02) = $10,506• payment = (.04)(.5)(10506) = $210.12
• year 2: CPI = 2%• new F = $10,300(1.02) = $10,506• payment = (.04)(.5)(10506) = $210.12
advantage of TIPSadvantage of TIPSadvantage of TIPSadvantage of TIPS
• little inflation risk
• federal gov’t has incentive to keep inflation low
• little inflation risk
• federal gov’t has incentive to keep inflation low
disadvantagedisadvantagedisadvantagedisadvantage
• coupon rate is lower
• additions to face value taxed in the year they occur• but face value not received until
maturity
• coupon rate is lower
• additions to face value taxed in the year they occur• but face value not received until
maturity
II. Primary MarketII. Primary MarketII. Primary MarketII. Primary Market
• by auction• debt is issued by Treasury Dept.• auction ran by Federal Reserve
• by auction• debt is issued by Treasury Dept.• auction ran by Federal Reserve
auction frequencyauction frequencyauction frequencyauction frequency
• weekly• 4, 13, 26 week Tbills
• monthly• 2 year Tnotes
• quarterly• 5, 10 year Tnotes• 10 yr. TIPS
• weekly• 4, 13, 26 week Tbills
• monthly• 2 year Tnotes
• quarterly• 5, 10 year Tnotes• 10 yr. TIPS
types of bidstypes of bidstypes of bidstypes of bids
• $1000 minimum
• increments of $1000• $1000 minimum
• increments of $1000
competitive bidscompetitive bidscompetitive bidscompetitive 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
• 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
• primary dealers• large Treasury dealers• sufficient volume for Fed OMO• about 20 primary dealers
• primary dealers• large Treasury dealers• sufficient volume for Fed OMO• about 20 primary dealers
noncompetitive bidsnoncompetitive bidsnoncompetitive bidsnoncompetitive 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
• 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
tradeofftradeofftradeofftradeoff
• naming your reservation price (yield)• competitive bid
• vs.
• guarantee of success in filling bid• noncompetitive bid
• naming your reservation price (yield)• competitive bid
• vs.
• guarantee of success in filling bid• noncompetitive bid
awarding Treasuriesawarding Treasuriesawarding Treasuriesawarding Treasuries
• total amount auctioned
- Federal Reserve purchases
- noncompetitive bids
= amount for competitive bids
• total amount auctioned
- Federal Reserve purchases
- noncompetitive bids
= amount for competitive bids
• competitive bids awarded,• starting with lowest yield• & going up until all Treasuries are
awarded
• competitive bids awarded,• starting with lowest yield• & going up until all Treasuries are
awarded
• 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
• 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
• 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
• 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
ExampleExampleExampleExample
• 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?
• 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?
• $10.5 billion for competitive bids
• suppose bids are:• $10.5 billion for competitive bids
• suppose bids are:
$ 5 billion 1.78%
$ 23 billion over 1.87%
$ 3 billion 1.8%$ 2 billion 1.85%
$ 5 billion 1.87%
$10 billionaccepted in full
stop yield
unsuccessful
• stop yield = 1.87%• bidders at stop yield got 10% of
quantity requested
(.5 million left /5 million requested)
• stop yield = 1.87%• bidders at stop yield got 10% of
quantity requested
(.5 million left /5 million requested)
1991 auction scandal1991 auction scandal1991 auction scandal1991 auction scandal
• Salomon Bros.• submitted fraudulent bids to
exceed quantity limits
• results• single price auction• switch from sealed written bids to
open computerized process
• Salomon Bros.• submitted fraudulent bids to
exceed quantity limits
• results• single price auction• switch from sealed written bids to
open computerized process
III. Secondary MarketIII. Secondary MarketIII. Secondary MarketIII. 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
• 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
• “wi” market• when issued• Treasuries bought/sold prior to
auction date
• “wi” market• when issued• Treasuries bought/sold prior to
auction date
Price quotation in Treasury marketPrice quotation in Treasury marketPrice quotation in Treasury marketPrice quotation in Treasury market
• Tbills• quoted by “discount yield”
• Tbills• quoted by “discount yield”
discount yield = F - P
Fx
360d
discount yield = F - P
Fx
360d
YTM = F - P
Px
365d
YTM > discount yield
exampleexampleexampleexample
• F = $100,000
• 90 days
• discount yield = 5.25%
• what is Tbill price?
• F = $100,000
• 90 days
• discount yield = 5.25%
• what is Tbill price?
.0525 = 100,000 - P
100,000x
36090
100,000 - P.0525 (100,000) =
4
P = $98,687.50
• what is yield to maturity?• what is yield to maturity?
YTM = 100,000 - 98687.5
98687.5x
36590
YTM = 5.39%
• Tnotes and Tbonds• quoted by price• per $100 of face value• up to 1/32 of $1
• Tnotes and Tbonds• quoted by price• per $100 of face value• up to 1/32 of $1
exampleexampleexampleexample
• F = $100,000
• ask price 117:19
• what is price?• $117 19/32 per $100
-- 19/32 = .59375• P = $117,593.75
• F = $100,000
• ask price 117:19
• what is price?• $117 19/32 per $100
-- 19/32 = .59375• P = $117,593.75
RegulationRegulationRegulationRegulation
• exempt from most SEC regulation in debt markets
• no reporting of trades
• no display of bid/ask quotes for public• reported among primary dealers
• 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 TreasuriesIV. Stripped TreasuriesIV. Stripped TreasuriesIV. Stripped Treasuries
• Treasury does NOT issue zero coupon Tnotes or Tbonds
• 1982 firms created own synthetic zero coupon Treasuries• trademarked securities
• 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?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
• firms issued own zero coupon debt• backed by Treasury cash flows
• Merrill Lynch--TIGRs
• Salomon Bros. -- CATS
• trademarked securities have some default risk• not direct obligations of U.S.
• trademarked securities not intertradeable• TIGRs were different from CATS
• trademarked securities have some default risk• not direct obligations of U.S.
• trademarked securities not intertradeable• TIGRs were different from CATS
problemsproblemsproblemsproblems
Treasury STRIPS (1985)Treasury STRIPS (1985)Treasury STRIPS (1985)Treasury STRIPS (1985)
• standardized the market
• certain Tnotes, Tbonds eligible for stripping• STRIPS direct obligation of U.S.• STRIPS are intertradeable
• standardized the market
• certain Tnotes, Tbonds eligible for stripping• STRIPS direct obligation of U.S.• STRIPS are intertradeable
Top Related