1. Treasury Inflation-Protected Securities
Issued in terms of 5, 10 and 30 years a few times a year in par increments of $100.
Usual noncompetitive/competitive auction process.
Coupon rate determined at auction, fixed thereafter.
Principal amount (upon which semi-annual coupon payments are based) is adjusted twice per year in accordance with the Consumer Price Index (CPI-U).
At maturity, pays adjusted principal or par, whichever is greater.
TIPS can be used to impute expected rates of inflation in future periods.

2. Consumer Price Index (CPI-U)
Dec ave
Jan

3. Example 1
Assume a $1,000 TIPS with a 2.5% coupon rate. If first three semiannual inflations are 1.8%, 2.3% and 2.1%, what are the first three coupon payments? What is adjusted principal after 1.5 years?

4. Treasury STRIPS Program
Separate Trading of Registered Interest and Principal of Securities.
When a Treasury is stripped, each cash flow is used to construct separate zero-coupon securities denominated in $1,000 increments.
Not created by Treasury Department. Created by any of the dealers that work with Treasury.
At the request of any such dealer, Treasury will procure separate CUSIP numbers for each strip component.
Strips created when sum of parts worth more than the whole.
Used for duration matching, lottery annuity payments, by pension funds, insurance companies, etc.

5. Example 2
How many $1,000 strip securities can a dealer create from the purchase of $1 million in face value of a 5% 4-year Treasury note?

6. National Debt (in trillions)
Held by
Intragovernmental
Public
Holdings
TOTAL
9/16
14.2
5.4
19.5
9/15
13.1
5.0
18.2
9/14
12.8
17.8
9/13
12.0
4.8
16.7
9/12
11.3
16.1
9/11
10.2
4.7
14.9
9/10
9.0
4.5
13.6
9/9
7.6
4.4
11.9
9/8
5.8
4.2
10.0
9/7
5.1
4.0
Intragovernmental Holdings include:
Social security trust fund
Fed employees and military retirement trust funds
Disability insurance trust funds
Other (airport, highway, unemployment, etc.)

7. Distribution of Debt Held by Public
Of the $14.2 trillion held by the public, roughly
T-Bills %
Notes %
Bonds %
TIPs %
Other %
half held by foreign governments.
Ave interest rate is 2.33%.
Intergovernmental Holdings are not marketable.

8. Social Security (OASI) Trust Fund
2015: $2.780 trillion in trust fund (“piggybank”)
Old-Age and Survivors Insurance
2015: $801 billion in, $750 billion out.
Piggybank forecast to be empty before Then, on “pay as you go”basis, will only be able to pay out about 70% of promised benefits.

9. OASI Trust Fund (in billions)
Receipts
Expendi
tures
Net
Increase
Balance
2005
604
442
162
1,663
2006
642
461
181
1,844
2007
675
496
179
2,024
2008
695
516
2,203
2009
698
564
134
2,337
2010
677
585 92
2,429
2011
699 95
2,524
2012
731
645 86
2,610
2013
743
679 64
2,673
,729
,780

10. Municipal Bonds
General Obligation Bonds. Backed by “full faith and credit” of issuing political entity. Require voters’ approval which often refused. Very safe when available.
Revenue Bonds. Be careful. Coupon and principal payments can only be made with cash flows from the project (toll roads, sewage treatment plants, professional sport facilities, etc.) it finances.

11. Municipal Bonds
Issued by states, counties, cities, school districts, university systems, transit systems, etc.
Distinguishing feature of munis is that coupon payments are exempt from federal tax (usually from state tax in state of issue, too).
When comparing a muni with a similar taxable bond use
where t is marginal tax rate.
Typically sold as serial bond issues (see pp )

12. Bearer Bonds (not many left)

13. Bond Indenture Specifies collateral
Mortgage bond - real assets pledged.
Equipment trust certificates - specific, titled, or identifiable equipment.
Collateral bonds - secured by financial assets.
Debentures - unsecured bonds.
Specifies priority of claims on assets
Senior debt - first priority on general assets.
Subordinated (junior) debt - below senior. Debentures at bottom.
Considerations concerning repayment of principal
Sinking fund provisions. The putting aside of sums for the repayment of principal when due, or the periodic retirement of a number of bonds selected randomly.
Call and/or put provisions
11/29

14. Junk Bonds
Junk bonds were not sellable in the primary market until late 1970s.
Junk bonds also known euphemistically as High Yield bonds, so don’t be misled.
Secondary market appeared in early 1980s.
“Low credit quality” firms now able to issue long-term fixed rate marketable debt, rather than be at mercy of commercial banks.
Many investors attracted to junk bonds because of high yield.

15. Foreign Bonds
Issued in a financial market of a nation by a foreign company in that country.
If a foreign firm issues a bond in the US, it is called a Yankee bond.
Bonds issues by foreign firms in Japan are called Samurai bonds.
Must conform to the regulations of country in which sold.