Presentation on theme: "2-1 Chapter 2 BOND ISSUERS. 2-2 The United States Treasury The U.S. Treasury performs primarily the following functions. Collects taxes. Pays the."— Presentation transcript:
2-2 The United States Treasury The U.S. Treasury performs primarily the following functions. Collects taxes. Pays the bills of the government. There is a deficit if taxes are less than payments. There is a surplus if taxes are greater than payments.
2-3 Several Things Noteworthy about U.S. Treasury Debt The total debt is huge, in the vicinity of 14 trillion dollars. The Treasury has a very large number of debt issues. Individual debt issues are extremely large in size and therefore highly liquid. Liquid securities can be bought and sold rapidly without affecting the price.
2-4 LINKS TO TREASURY WEBSITE http://www.treasurydirect.gov/govt/rep orts/pd/mspd/mspd.htm http://www.treasurydirect.gov/govt/rep orts/pd/mspd/mspd.htm INTEREST ON NATIONAL DEBT http://www.treasurydirect.gov/govt/cha rts/charts_expense.htm http://www.treasurydirect.gov/govt/cha rts/charts_expense.htm
2-7 The Treasury Must Raise Very Large Amounts of Money. One reason for the large dollar volume of securities that must be sold is the need to replace maturing securities by new issues. The Treasury must finance deficits.
2-8 Marketable Debt vs. Nonmarketable Basically the Treasury sells two types of debt. Marketable debt is sold to the public and can be resold to other buyers. This is approximately half of the debt. Nonmarketable debt cannot be resold. It is composed of two major components. Savings bonds. Government retirement accounts.
2-9 Three Types of Marketable Debt Treasury bills. Maturities of one year less. No coupons. Treasury notes. Original maturities of up to 10 years. Semi-annual coupons. Treasury bonds. Original maturities of 30 years. Semi-annual coupons. The most recently issued Treasury bond is usually called the long bond.
2-11 n +6 +100 +c +PAR-P+c -100+6 102... +c... +6 Notes and Bonds
2-12 DEBT DISTRIBUTION http://www.treasurydirect.gov/govt/cha rts/principal/principal_debt.htm http://www.treasurydirect.gov/govt/cha rts/principal/principal_debt.htm
2-13 Maturity of Debt Spreads out maturities Interest Rates Most common pattern is upward slope 28% Bills Maturity 58% Notes 14% Bonds
2-14 Bills only would alter shape Interest Rates Bills only Maturity
2-15 Auction Procedures The Treasury announces auctions to the public. It states the total amount of a particular issue that it would like to sell and then solicits bids. There are two types of bids.
2-16 Types of Bids Noncompetitive bids are for par values < $5 million. These bidders agree to pay the price of the average winning competitive bid. Competitive bidders specify a par value and a price. Typically competitive bids are submitted by bond dealers who resell these bonds to the public.
2-20 Announcement Date, Auction Date, and Issue Date Announcement date Auction date Issue date Time
2-21 Treasury Inflation Protected Securities (TIPS) c = Stated coupon Par = Original par value j = Inflation rate in period j Time 1 par value: Par(1 + 1 ) Time 1 coupon: c(Par)(1 + 1 ) Time 2 par value: Par(1 + 1 ) (1 + 2 ) Time 2 coupon: c(Par)(1 + 1 )(1 + 2 ) Time j par value: Par(1 + 1 ) … (1 + j ) Time j coupon: c(Par)(1 + 1 ) … (1 + j ) 11 22 33 0123
2-22 Municipal Bonds Bonds issued by state and local governments. General obligation bonds. Backed by the full taxing authority of the municipality. Revenue bonds. Backed by the revenues from a particular project. Much higher default rate.
2-23 In recent years, a large proportion of revenue bonds have been insured against defaults by private insurance companies.
2-24 Yields on Municipal Bonds Suppose that the interest rate on a default free taxable bond is y and that the tax rate for the marginal bond buyer is t. Then the yield to maturity for a default free municipal bond would be y(1 – t). However, the yield for a municipal bond is also affected by two other factors.
2-25 Municipal Bond Yield Factors Default risk. Lower liquidity. Suppose that the default risk adds a premium of d and liquidity risk adds a premium of l. Then, the yield to maturity for a municipal bond equals y(1 – t) + d + l.
2-27 Benefits and Costs of Municipal Bonds The yield to maturity for a municipal bond is less than the yield for a taxable bond that is otherwise identical. This represents a subsidy to the borrowing municipality. The tax free status of municipal bonds represents a subsidy to buyers, that is, individuals in high tax brackets – wealthy individuals.