1. Economics 434 Financial Markets Professor Burton University of Virginia Fall 2015 October 15, 2015

2. Present Value is the most Crucial Concept in Finance Value of future stream of payments As valued today Emphasis on “discounting” future revenue streams Common practice to use higher rates to reflect higher uncertainty of receipt of future payments

3. Default Free Securites (Sovereign Debt) US Treasuries ($ 18 trillion outstanding) – Bills (less than one year in original maturity) – Notes (ten years or less, longer than one year) – Bonds (greater than ten years at issuance) Random facts – Bills are called discount issues: 3 mo, 6 mo, year bills. Year assumed to be 360 days. – Notes and bonds are “coupon” issues; pay fixed coupons twice yearly October 15, 2015

4. Naming conventions Bills named by their maturity date – “12/15 14” for example Notes and bonds are named by: (i) their coupon rate; and (ii) their maturity date – “14s of Nov 11” was originally issued in mid- November of 1981 with a 14 coupon. It matured on November 15, 2011. (Assume $ 100,000 principal. Then, it paid $ 7,000 on May 15 th and Nov 15 th starting May 15 th 1982, ending Nov 15 th, 2011 October 15, 2015

5. US Treasury Bill Market 4 week, 13 week, 26 week, 52 week Every non-holiday Monday there is a 4, 13, 26 week auction; 52 week is on Tuesday, once a month Settlements are always on non-holiday Thursday (settlement is the day the security “exists” and payment is received) Most recent: – 4 wk: Issued 10/14/15, matures on 11/12 0.00% – 13 wk: Issued 10/13/15 matures on 1/14/16 0.00% – 26 week 10/13/15 matures on 4/14/16 0.080% – 52 week 10/14/15 matures on 10/13/16 0.205% https://www.treasurydirect.gov/instit/annceresult/annceresult.htm October 15, 2015

6. Bills are quoted at a discount 10 % quote means you pay $ 900,000 for a 52 week bill that pays $ 1 million at maturity 10% quote on a 26 week bill means you pay $ 950,000 for $ 1 million on maturity date True yield is higher than discount quote October 15, 2015

7. Notes and Bonds 3, 10, 30 auctioned monthly 2, 5, 7 auctioned monthly Assume that principal is $ 100,000 (that is the amount paid at maturity plus the last coupon) For, example: Last 30 yr auctioned is the “Aug 2 7/8s of 45” Pays 1/2 of 2.875 %, or $1,437.50 twice a year beginning Feb 15 th, ending August 15 th, 2044. October 15, 2015

8. The Money Market Default Free Money Markets – Treasury Bills Defaultable Money Markets – Federal Funds/Repos (Repurchase Agreements) – Commercial Deposits (CDs) – Commercial Paper Key is “short term” nature of the underlying security, typically less than one year in maturity October 15, 2015

9. National Debt in US $ 18,151,323 as of July 31, 2015 Funded debt: $ 13,135 Trillion (GDP 18) Trillion)

10. Yield curve Junk bonds TreasuriesCorp Bonds Rates Maturities

11. October 15, 2015