1. Economics 434: The Theory of Financial Markets
Professor Burton
Fall 2016
Sept 13, 2016

2. Readings Through The End of This Week
Chapters 7 and 8
Now in all, first 8 chapters
Sept 13, 2016

3. Default Free Securities – An Example
US Treasury Market
Bills (one year or less original maturity)
Notes and Bonds (more than one year of original maturity)
Notes are 2, 3, 5,7, and 10 year maturities (anything more than one year and not more than 10 years in original maturity
Bonds are anything with more than 10 years original maturity – currently just the 30 year bond
Auctioned on a regular basis
Calculating yields
Bills different than Notes and Bonds
Sept 13, 2016

4. Use the Web for Latest Treasury Information
Sept 13, 2016

5. Maturity: What Does It Mean?
That’s the last of the treasury securities life
On that day, it pays the “principal” of the security
Bills -- $ 1,000,000
Coupon Issues (notes and bonds) -- $ 100,000
For bills, that is the only payment
For coupon issues, the final interest (coupon) payment is made on the maturity date
Sept 13, 2016

6. Treasury Bills
Anything issued with less than 1 year in original maturity
Everything else is a note or a bond
Three main types
4 week bill (30 day bill)
3 month (90 day bill)
6 month (180 day bill)
Year bill (360 day bill)
Also, from time to time
Cash management bills

7. Key facts about treasury bills
Always have “original maturity” less than one year
Quotes are “discounts”
Year is assumed to be 360 days long
Actual annual yield higher than quote because
Quote is a discount
Year has more days than 360

8. Example: The Year Bill Assume the quote is 0.40 %
Assume the principal amount is $ 1 million (always assume this in this class for treasury bills)
What is the price of this bill?
Discount is .004 times $ 1 million = $ 4,000
Price then must be $ 996,000
What is the annual yield of this bill?
Yield for 360 days is 4/996 = %
Yield for 365 days is 365/360 times % or or percent

9. To calculate annual yield
General Principles
To calculate annual yield
First calculate the amount of the discount
Quote times t/360 times $ 1 million where is t is the days remaining to maturity
Then note that the amount of the discount is your profit and $ 1 million minus the discount is your cost, so that the yield for t days is:
Yield for t days = discount/($ 1milion – discount)
Then annualize:
Annual yield = (365/t) times (Yield for t days)

10. US Treasury Notes and Bonds
Assume that principal (payoff) amount is $100,000, paid at maturity date of bond
Two payments annually, approx. six months apart
If coupon is 10 percent, each payment is $ 5,000; if coupon is 1 percent, each payment is $ 500
Name is: coupon (plus) maturity date
For example: 2 1/4s of Aug ‘46

11. 2 1/4’s of August 2046
Pays $ 100,000 on Aug 15, 2046
Also pays $ 1,125 on Feb 15, 2017 and Aug 15, 2017
Similarly for every year until payment of $ 1,125 on Aug 15, 2013 plus the $ 100,000 payment on that same date
Was auctioned on Aug 11,2016

12. There is a 30 year auction today
Competitive Bids Due in by 1 PM EST
$ 12 billion
“Reopening” of the 2 1/4s of Aug ’46
$ 16 billion already outstanding
Also 4 week and 52 week auction
Settlement is Thursday, the 15th
Sept 13, 2016

13. Sept 13, 2016