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Zvi WienerBased on Chapter 6 in Fabozzi

Bond Markets, Analysis and Strategies

Treasury and Agency Securities

Zvi Wiener Fabozzi Ch 6 slide 2

Treasury Securities

Issued by the US department of the Treasury and are backed by US government.

1997 the market was $3.4T with 260 issues

For comparison:

1997 corporate bonds $1.4T with 10,000 issues,

1997 municipals $1.8T with 70,000 issuers.

Zvi Wiener Fabozzi Ch 6 slide 3

Types of Treasuries

Treasury Bills – discounted, with initial maturities of 91, 182 and 364 days.

T-Notes – one to ten years

T-Bonds – more than 10 years to maturity

Recently many changes – no more 20 and 3 year issues, etc.

Zvi Wiener Fabozzi Ch 6 slide 4

TIPS

Inflation protected securities, similar to Israeli CPI linked bonds.

Taxation problems.

Zvi Wiener Fabozzi Ch 6 slide 5

Auction

Primary market – primary dealers

Secondary market

When-issued market, TBA etc.

Zvi Wiener Fabozzi Ch 6 slide 6

Price quotes for T-Bills

tF

DYd

360

Yd = annualized yield

D = dollar discountF = face valuet = number of days to maturity

Zvi Wiener Fabozzi Ch 6 slide 7

Price quotes for T-Bills

%75.8100

360

000,100

569,97000,100

A T-Bill with 100 days to maturity

And face value of $100,000 is traded for

$97,569 will be quoted at

8.75% on a bank discount basis

Zvi Wiener Fabozzi Ch 6 slide 8

Bond Equivalent Yield

d

d

Yt

YyieldequivCD

360

360.

Zvi Wiener Fabozzi Ch 6 slide 9

Price quotation of bonds

In units of 1/32, for example 92-14 means that the price is

92+14/32% of par (plus accrued interest)

+ means 1/64

Zvi Wiener Fabozzi Ch 6 slide 10

Accrued Interest

Additional payment for part of the coupon

periodcouponinDays

periodAIindayscouponAnnualAI

2

time

$

Zvi Wiener Fabozzi Ch 6 slide 11

Price Quotes and Accrued Interest

Assume that the par value of a bond is $1,000.

Price quote is in % of par + accrued interest

the accrued interest must compensate the

seller for the next coupon.

Zvi Wiener Fabozzi Ch 6 slide 12

Trade date

Settlement date

Safekeeping

Zvi Wiener Fabozzi Ch 6 slide 13

STRIPS

Separate Trading of Registered Interest and

Principal of Securities.

Reconstitution of a bond.

Zvi Wiener Fabozzi Ch 6 slide 14

Government Sponsored Enterprises

Federal Home Loan Bank System

Federal National Mortgage Association

Federal Home Loan Mortgage Corporation

Federal Farm Credit Bank System

Zvi Wiener Fabozzi Ch 6 slide 15

Government-Sponsored Enterprises

Fannie Mae “benchmark” and Freddie Mac “reference” notes and bond.

Can be electronically transferred through clearing houses as Euroclear and Cedel and NBES.

Outstanding amount $150B with 2-30 years to maturity.

Zvi Wiener Fabozzi Ch 6 slide 16

Government-Sponsored Enterprises

GNMA - Government National Mortgage Association

FHLBS - Federal Home Loan Bank System

Sallie Mar - Student Loan Marketing Association

Zvi Wiener Fabozzi Ch 6 slide 17

Repurchase Agreements

Borrowing and lending using Treasuries and other debt as collateral.

Repo (loan). You sell a security to counterparty and agree to repurchase the same security at a specified price at a later date (often next day).

Reverse Repo - you agree to purchase a security and sell it back at a specified price later.

Zvi Wiener Fabozzi Ch 6 slide 18

Repurchase Agreements

Most repos are general-collateral repo rate.

Some securities are special (for example on-the-run).

Specialness peaks around next auction, then declines sharply.

NY FED operates a securities lending for primary dealers using FED’s portfolio while posting other Treasury security as collateral.

Zvi Wiener Fabozzi Ch 6 slide 19

Treasury Based Derivatives

Futures and options for 2, 5, 10 year notes and bonds are listed by CBOT and CFFE. CNE offers futures and options on bills and other short term interest rate products.

End of October 99 open interest for CBOT long-bond futures was 635,000 (each one based on $100,000 face value).

Daily volume 300,000 contracts.

Zvi Wiener Fabozzi Ch 6 slide 20

Treasury Based Derivatives

CBOT also offers options on Treasury futures

- contract that allows the holder to buy/sell a

future contract at a specified price.

Cheapest-to-deliver option and conversion

factor (compare to commodities).

Zvi Wiener Fabozzi Ch 6 slide 21

TIIS = TIPS

Treasury Inflation Indexed (Protected) Securities.

Since 97, $92B were issued, based on the non-seasonally adjusted CPI lagged 2.5 months.

The quoted price do not reflect the accumulated inflation compensation.

Real price = quoted*index ratio + accrued interest

I-bonds saving bonds that are also CPI indexed.

Zvi Wiener Fabozzi Ch 6 slide 22

TIIS = TIPS

5, 10, 30 years notes and bonds.

Less liquid: 2-6 cents per $100 face.

CBOT offers options and futures on TIPS

Canada, France, England, Israel have similar types of debt.

Zvi Wiener Fabozzi Ch 6 slide 23

T-bills markets

Issuance of T-bills was cut sharply.

Between Dec-96 and Sep-99 the total

outstanding amount of coupon securities

declined 7% while bills declined 16%.

Treasury Debt buybacks. Reverse auctions

trying to remove small issues.

Zvi Wiener Fabozzi Ch 6 slide 24

Questions 1, 5, 7

Home AssignmentChapter 6

Zvi Wiener Fabozzi Ch 6 slide 25

UST example

8.75 UST 11/08

Security was purchased 06-Jun-01 @ 110-31

Security was sold 06-Sep-01 @ 109-27+

Calculate the loss (10,000 units) …

Zvi Wiener Fabozzi Ch 6 slide 26

UST example

Bought 11,096,875.00

Accrued 23 days 54,687.50

11,151,562.50

Sold 10,984,375.00

Accrued 115 days 273,437.50

11,257,812.50

Profit of $106,350.00