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Chapter 6 – Treasury SecuritiesTreasuries:Issued by the US Treasury to finance deficits and the debt backed by the “full faith and credit” of the US government Minimal or no default risk or credit riskPolitical risk?Therefore they are the benchmark (bellwether)Note that other sovereign bonds might pay less – or have even have negative yieldsThis might be due to differences in expected inflation Or changes currency exchange ratesFixed Principal - Fixed Coupon: Bills, Notes, BondsBills: 1 year or lessNotes: 2 years to 10 yearsBonds: more than 10 yearsThree types notes and bondsFixed Principal - Fixed CouponFixed Principal - Floating Coupon (Floating Rate Notes – FRN)Floating Principal - Fixed Coupon (Treasury Inflation Protection Securities - TIPS) See the Treasury Auction SchedulePrimary market is at an auctionSecondary market is a 24 hour dealer market.Treasury BillsQuote is on a “Bank discount basis“Sort of a yield measureBut think of it as a “code” to get the pricePrice = Face – Dollar DiscountP = F – D D = Yd x F x t/360t = days to maturityYd = Annualized Yield on a “bank discount basis” (This is the “quote”)Example:$10,000 Face value T-bill with 100 days to maturityQuote is 5.00%Calculate the Price:D = Yd x F x t/360 = .05 x $10,000 x 100/360 = $139.89P = F – D = $10,000 – $139.89 = $9,861.11Another Example:What if you want to earn 4.00% over 183 days?What will be the price and Quote (Yd)?Find P, the D then Yd:D = Yd x F x t/360 Yd = D/F x 360/tP = F/(1 + 0.04 x 183/365) = 10,000/(1 + 0.0200548) = $9803.39D = $10,000 – $9803.39 = $196.61Yd = 196.61/10,000 x 360/183 = 3.8676% This is the QUOTE!Quote of 3.8676% means you pay $9,803.39 and earn 4.00% CD Equivalent Yield Aka the Money Market Yield Aka the Yield on an Actual/360 BasisThis is how most other Money Market securities are quoted.Calc CD Equiv for 3.8676% Bank Discount Basis over 183 daysCD Equivalent Yield = (360 x Yd)/(360 – t x Yd) = (360 x 0.038676)/(360 – 183 x 0.038676) = 3.9452%Quote will be 3.9452% for a CD or CPSame price, maturity value and therefore return for a for a T-Bill quoted at 3.8676%So to earn an annualized return of 4.00% over the next 183 days:T-bill quoted at Yd (aka Bank Discount Rate) = 3.8676%Commercial Paper Quoted at CD Equiv (Aka Money Market Rate) = 3.9452%T-Bill Auction Results 2019-02-11 91-day T-Bill auction t = May 16, 2019 – Feb 14, 2019 = 91 daysYd = High Rate = 2.400%Price:D = Yd x F x t/360 = 0.02400 x $10,000 x 91/360 = $60.67P = F – D = $10,000 – $60.67 = $9,939.33Annual Return = Investment Rate = (F/P – 1) x 365/t = (10,000/9,939.33 – 1) x 365/91 = 0.6104% x 4.011 = 2.4482%So earn 0.6104% over the next 91 days.There are 4.0011 91-day periods in one yearSo annualized (in APR terms) = 2.4482%We will talk about Competitive bids, and Non-Competitive bids and Bid-to-Cover when we go over T-Bond auctions.Treasury Notes and Treasury Bonds“Notes” 2 years to 10 years“Bonds” 20 years and 30 years$1,000 par value Price quote is percentage of par plus a number of “32nds” of a percentage point of par.“?” means an extra ? of a 32nd = 1/128 = 0.0078125 “+” means an extra ? of a 32nd = 2/128 = 1/64 = 0.015625“?” means an extra ? of a 32nd = 3/128 = 0.0234375Quote?% of Par97-2797% + 27.00/32%97.8437500%97-27?97% + 27.25/32%97.8515625%97-27+97% + 27.50/32%97.8593750%97-27?97% + 27.75/32%97.8671875%97-2897% + 28.00/32%97.8750000%Treasury Auction ExampleThe Treasury will auction $62 million of 10 year bonds (really called “notes”. There are $5 million dollars of non-competitive bids. The competitive bids are shown in the table below. All rates in BEY terms.Millions of DollarsRate102.95%152.96%202.97%152.98%102.99%53.00%Compute the high yield for the auction.Amount to Competitive = Auction Amount – Amount of Non-competitive = 62 – 5 = 5710 at 2.95%15 at 2.96%20 at 2.97% 12 at 2.98%: 10 + 15 + 20 + 12 = 57 So 2.98% is the high pute the fraction of the amount requested by those bidding the high yield received12/15 = 80%Compute the price of the issue The rule is the coupon rate is rounded down to the nearest 1/8th Coup = 2.875%N = 10 x 2 = 20RATE = 2.98%/2 = 0.0149PMT = 2.875%/2 x $100 = 1.4375FV = 100PV = $99.097757Compute the price non-competitive bidders pay for bonds. Same price: $99.097757 ................
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