6 TREASURY AND AGENCY

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TREASURY SECURITIES

Issued by the US Department of the Treasury and are backed

by the full faith of the US Government.

•NO CREDIT RISK

•BENCHMARK INTEREST RATES •MOST LIQUID MARKET

•$11 TRILLION OUTSTANDING WITH 260 ISSUES (corporate market is $3.8 trillion with > 10 000 issuers)

•NOT CALLABLE

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3 TYPE OF

TREASURY SECURITIES

TREASURY BONDS TREASURY NOTES TREASURY BILLS

> 10 YEARS

2 – 10 YEARS

< 1 YEAR

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TREASURY BONDS TREASURY NOTES TREASURY BILLS

•ISSUED CLOSE TO PAR

•COUPON RATE

•MATURES AT PAR VALUE

•ISSUED CLOSE TO PAR

•COUPON RATE

•ISSUED AT DISCOUNT

• NO COUPON RATE

TREASURY COUPON SECURTIES

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•24 HOUR TRADING OF TREASURY SECURITIES

•THE SECONDARY MARKET : MOST LIQUID

ON-THE-RUN ISSUE

: Most recently auctionned Treasury

OFF-THE-RUN ISSUE

: Issues auctioned before the most recent one

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TIPS

( 5 – 10 – 30 years)

T

reasury

I

nflation

P

rotection

S

ecurity

•Coupon is variable (coupon is called the

real rate

)

•Coupon

and

maturity

adjusted every

6 months

(

called « inflation adjusted capital »)

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Principal :$100 000

Annual coupon rate : 3.5%

Inflation rate (yearly basis) : 2%

SEMI ANNUAL INFLATION RATE :

1%

6-MONTH INFLATION ADJUSTED PRINCIPAL :

$101 000

DOLLAR AMOUNT OF COUPON PAYMENT (every 6 months) :

101 000 x 1.75% = $1767.50

Suppose than in the next period, inflation rate (yearly basis) is 3% ?

1,5%

$102 515

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TREASURY AUCTIONS

•Treasury Securities are all issued on an auction basis

•Congress imposes a restriction on the total amount of bonds outstanding (debt ceiling)

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•3-months and 6-months bills weekly (Monday)

1-year bill every fourthweek (Thursday)

2-year - 5-year notes monthly (last day of each month)

10-year and 30-year bonds quarterly (Feb, May, Aug , Nov)

Types of Treasury securities

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Bid-to-Cover Ratio Definition

A ratio that compares the number of bids received in a Treasury security auction to the number of bids accepted. The bid-to-cover ratio is an indicator of the strength or

demand for a Treasury offering relative to investor bids deemed suitable in the auction process. A higher ratio would be an indication of a strong or "bought" auction.

Investopedia Says

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Non competitive bidder

Competitive bidders

FEDERAL RESERVE

$50 BILLION of 2-year note to be distributed by the Treasury

$5 Billion

BROKER DEALERS

$45 Billion

Average price of Competitive bidders

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$15 Billion of 10 year Note Auction

Fed needs 2 Billion

Bids

•Bank America: 7 billion@3.62%

•Goldman Sachs : 4 billion @3.60%

•Morgan Stanley : 2 billion@3.57%

•JP Morgan : 1 billion @ 3.58%

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SECONDARY MARKET

•24-HOUR TRADING

•Primary trading locations :

•Most liquid financial market in the world

•

On

-the-run issue vs.

Off

-the-run-issue

Which is more liquid ?)

•Over the counter (OTC) trading

NEW YORK

LONDON

TOKYO

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Day Count Conventions

in the U.S.

Treasury Bonds:

CorporateBond:

Money Mkt:

Actual/Actual

30/360

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Treasury Bond Price Quotes

in the U.S

Cash price = Quoted price + Accrued Interest

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TREASURY BILLS

•

3-MONTH TREASURY BILLS

•

6-MONTH TREASURY BILLS

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Treasury Bill Quote in the U.S.

If

Y

is the

yield

of a Treasury bill that has

t

days to maturity the

quoted price

is

Y= D/F x 360/t

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T-BILL PRICING

What is the

quoted yield

of a 100 day T-Bill with a face value of

$100,000 if its cash price is 97.56?

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TREASURY BOND FUTURES (CBOT)

EURODOLLAR FUTURES (CME)

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Treasury Bond Futures

One contract = $100 000 worth of

non-callable 15-year bonds or more.

Cash price received by party with short

position =

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To make delivery equitable to both parties, the CBOT

has introduced

Conversion factors

for determining the invoice

price of each acceptable deliverable Treasury issue against

the T Bond Future contract.

The conversion factor for a bond is approximately

equal to the value of a 20-year bond on the

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CBOT

T-Bonds & T-Notes

Factors that affect the futures price:

–Delivery can be made any time during the

delivery month

–Any of a range of eligible bonds can be

delivered

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Conversion Factor

The conversion factor for a 20-year bond is

approximately equal to the value of the

bond on the assumption that the yield curve

is flat at 6% with semiannual compounding

Because the different deliverable bonds have different coupons and

maturities they need to be put on a common basis.The futures

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The price that the buyer must pay the seller when a Treasury Bond is delivered is called the invoice price

The invoice price is the is the settlement future price’s value + Accrued on the bond delivered.

The invoice price , depending on what bond is chosen for delivery must be adjusted. It is The Conversion factor that ajusts the invoice price.

Suppose that the Tbond futures contract settles at 94-8 and that the short elects to deliver a Treasury bond issue with a conversion factor of 1.20. The future contract

settlement price of 94-08 means 94,25% of face value. As the contract size is $100,000, the invoice price the buyer pays the seller is:

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CHEAPEST TO DELIVER

The party with the short position can choose which of the available bond, from the CBOT list, is CHEAPEST TO DELIVER.

The party with the short position receives :

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Party with the short position receives (+):

(Quoted futures price × Conversion factor) + Accrued interest

…..and

Cost of purchasing a bond is (-) :

Quoted price + Accrued interest

The CTD bond is the one where (=) : …..and

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BOND

QUOTED PRICE

CONV FACTOR

1

99.50

1.0382

2

143.50

1.5188

3

119.75

1.2615

Assume the futures contract price is 93-08. What is the CTD bond ?

X

2.68

1.87

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EURODOLLAR FUTURES

(CME LIFFE)

•

The most popular futures contract on

short-term

interest rates (pegged to the LIBOR)

•

A eurodollar is a dollar deposited in a US or foreign

bank outside the United States.

•

The size of the contract is $1 000 000.

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•

If

Z

is the quoted price of a Eurodollar futures

contract, the value of one contract is :

10,000[100-0.25(100-Z)]

•

A change of one basis point or 0.01 in a

Eurodollar futures quote corresponds to a

contract price change of $25

Eurodollar Futures

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The quote of 94.32 for the September 1998

contract corresponds to a contract price of :

10,000 [100 - 0.25(100 - 94.32)] = $985,800

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Eurodollar Futures

• A Eurodollar futures contract is settled in cash ( no

possible delivery)

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STRIPS

•Zero coupon treasury bonds

•Accrued interest is taxed yearly

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Federal Agency Securities

•Federal Home Loan bank System

•Federal National Mortgage Association (FNMA)

•Student Loan Marketing Association

•Federal Farm credit bank system

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