Fixed Income Test 2 (Answerd) Verified Solution

Fixed Income Test 2 (Answerd) Verified Solution Two factors account for prominence of US Treasuries 1) Volume 2) Liquidity Department of Treasury = largest global single issuer of debt. Most active/liquid market in the world. All Treausury securities are noncallable. Thus, investors are not subject to call risk Marketable Treasury secs fixed-principal securities or inflation-indexed securities Treasury Bills - issued at discount - no coupon - one year or less - return to the investor = the difference between the maturity value and purchase price Treasury notes - pay coupons - 1 to 10 years Treasury bonds - pay coupons - Greater than 10 years Fixed-Rate vs. Floating-Rate Fixed-Rate: pays interest semiannually Floating-Rate: makes quarterly payments TIPS Treasury Inflation Protection Securities - both the coupon payment and maturity are adjusted for inflation semiannually (inflation-adjusted principal) Treasury Auction Process - noncompetitive bids - lazy entity willing to purchase the sec at the yield determined by the auction process - $ bid amount reserved at beginning Treasury Auction Process - competitive bid - bidder specifies the quantity and yield sought stop-out yield ("high yield") - The highest yield accepted by the Treasury - everyone gets it on-the-run issue ("current issue") most recently auctioned issue when-issued market - when Treasury securities are traded prior to the time they are issued Treasury bills are quoted on... bond discount basis (not price basis) Price Quoted on TBills Formula Y = (D/F) * (360/t) bond equivalent yield - the measure that seeks to make the TBill quote comparable to Treasury notes & bonds - CD equivalent yield also does the same taking into consideration the price of a TBill 91-19+ 19/32 + 1/64 = 91.0609375 107-222 22/32 + 2/256 = 107.6953125 109-066 6/32 + 6/256 = 109.2109375 Accrued Interest - investor compensating the seller of a bond for the coupon interest earned from the time of the last coupon payment to the settlement date - number of days = days in which the investor has earned interest trade date date on which the transaction is executed settlement date transaction completed (next day) Interest accrues... - from the date including the previous coupon payment - up to (but excluding) the settlement date For Treasury coupon securities... the actual day count convention is used Coupon stripping (STRIPS) - the process of stripping the interest on a bond form the underlying principal - creates a zero-coupon instrument Is accrued interest taxed? Yes - even though interest is not paid - Negative Cash Flow instruments: because tax payments on interest until the maturity date Reconstituting a Bond process of coupon stripping and reconstituting that will prevent the actual spot rate curve observed on zero-coupon Treasuries from departing notably from the theoretical spot rate curve GSEs privately owned, publicly chartered entities - instruments of of the US government that like federally related institutions provide them privileges that are not granted to private sector corps Federal Agency Securities - very little risk; carry an implicit guarantee - slightly higher yield than Treasury securities 2 types of Federal Agency Securities: debenture: typical bond