Debt (2) Tbonds

Front 1

Auction-Based

Back 1

-US GOV Debt is sold at auction

-Weekly auction: Tbills

-Monthly Auction: all other Treasury debt

-direct Us debt: highest rating

-agency debt: implicit backing of the US

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Tbonds

Back 2

-30 year maturity

-multiples of 100$ par

- i paid semi-annually

-quoted in 32nds

-callable 5 years prior to maturity

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TStrips

Back 3

-Separate Trading of Registered Interest and Principal of Securities

-treasury zero coupon bonds

-sold at discount and paid on at maturity

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TReceipts (Old TSTRIPS)

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-large basket of 30 year T bonds deposited with a trustee

-the tbonds are stripped of coupons and sold representing the payment at maturity

-imagine a 30 year zero coupon

*if you want a 6 months zero coupon they would just pay you the 1st 6months interest payment

-are not subject to reinvestment risk

-subject to price swings

-AAA TSTRIPS

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TIPS

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-Treasury Inflation Protection

-fixed interest rate over the life of the security

*** the interest rate is adjusted to the CPI

-semi- annual payments are fixed

-NOT subject to purchasing power risk

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TNotes

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- maturity range from 1<t<10 years

-multiples of 100$ par

-semi annual i payments

- quoted in 32nds

-non-callable

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Tbills

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-issued with 1 3 6 12 month maturities

-issued at a discount from par

-quoted on a discount yield basis

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Cash Management Bills

Back 8

-issued with maturities from several days to 6 months

-sold on a need basis depending on the treasuries cash needs

-issued at a discount from par $100 min with slightly higher interest rates than Tbills

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T Debt Tax Implications

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-interest income is subject to FED but not state and local

-STRPS and TOPS are only suitbale for retirement plans

-discount on TIPS is annually taxable

-annual inflation adjustment is also taxable

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Federal Farm Credit Banks Funding Corp

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Us agency that provides farmers with short term loans for harvesting and planting

-and long term to lease land

-available form large commercial banks

-AAA (backed implicitly by gov)

.25+ backing than government bonds

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Farm: Discount Notes

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- 1 year or less

-sold at a discount with 5k FV

-1000$ increments thereafter

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Farm: Designated Bonds

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-non callable 2-10 year maturities

-semi annual payments

-100 increments there after

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Farm: Retail Bonds

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- 1000 increments with estate planning feature

-"survivor's option" bonds redeemed at par plus accrued interest at death

-estate taxes due 9 months after death, can be redeemed to pay death tax liability

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Farm: Bonds

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- callable

- maturity of 30 years

-5k FV min

-1k increments there after

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FHLB

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Federal Home Loan Banks

-loan funds to savings and loans intituations

-collateral S&L mortgages

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FHLB: Discount Notes

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-1 year or less maturity

-sold at discount FV 100k

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FHLB: Bonds

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-10k FV

-semi annual i payments

-callable

-maturity 30 year

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Bullet Bonds

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-non callable bonds

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MBS

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-pooling of mortgages fromm originating banks

-break down pool in 25k FV

-as mortgages are paid they pass through to the certificate holder

-payments are monthly

-"self-liquidating" each payment represents a piece of the interest and principal

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Federal National Mortgage Association

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Frannie Mae

-buys gov guaranteed and insured mortgages

-income derived from spread between rate at which it borrows from public and the rate earned on mortgages

-its debt is implicitly backed by US

-Publicly Traded: Now listed on Pink Sheets

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Government National Mortgage Association

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Ginnie Mae

-loans directly guaranteed by the US government

-builds mortgages pools

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Federal Home Loan MortgageCorp

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-buys conventional mortgages that are not gov-insured or guaranteed

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Student Loan Marketing Association

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Sallie Mae

-purchases student loans from qualified lending institutions

-sells debentures backed by these loans

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Collateralized Mortgage Obligations

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-derivative security

-fixed rate of interest

-equal level payments

-"self amortizing" each payment pays off interest and principal

-30 or 15 year terms

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Fixed Rate Mortgage

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-fixed monthly payment towards the mortgage

-each payment represents a bit of the principal and interest

-early year payments are mainly interest

-late years are mainly principal

-pre payment makes the principal drop faster

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Payment Speed Assumption

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-30 year mortgages are paid off in 12

-15 year are paid off in 7

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Prepayment Risk

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-similar to call risk

-home owner sold house and is paying off the balance

-interest rates drop and the homeowner wants to refinance at lower rates

- when the homeowner refinances the investor is forced to reinvest at the new lower rates

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Extension Risk

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-risk that maturity will be longer than expected

-the case when interest rates increase and the homeowner wants to lock in low rate

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Plain Vanilla CMO

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-old cmos with simple repayment

-as payments are received interest payments are distributed to each tranche equally

-principal repayments are paid sequentially so that early tranches are paid off first

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Planned Amortization Class

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(PAC)

-principal payments made later than expected are distributed here

-more certain maturity than companion class

-protects against prepayment and extension risk

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Companion Class

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-principal payments that are more than expected are distributed here

-high level of prepayment risk

-high level of extension risk

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Target Amortization Class

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-target amount of principal paid each month

-protects against pre payment risk

-does not protect against extension risk

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ZERO Tranche

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-does not receive payment until all interest and principal payments are made

-greatest price volatility

-greatest interest rate risk

-0 call risk

-0 reinvestment risk

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Floating Rate Tranches

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-interest rate tied to an index

-market risk is minimized since it is adjusted to the market

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CMO: Interest Only

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-breaks off from the principal payments

-only paid on interest received

-prices move in the same direction as the market interest rates!!

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CMO: Principal Only

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-only pays out on the principal payments

-sells at a deep discount: high price volatility

-prices shares inverse relationship to interest rates

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CDO: Collateralized Debt Obligations

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-CMOS bundled from subprime mortgages

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CMO

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-offered in 1k denominations

-credit of underlying collateral

-quoted in 32nds

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Trading of GOV and Agency Debt

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-Secondary Market: 2nd market

-OTC

-participants: commercial bank, foreign banks, US Gov security dealers, full brokerage firms, FED

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Primary Dealers

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-Citi Group, Goldman... 20 firms

-appointed by the Fed

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Secondary Dealers

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-buy and sell securities through primary dealers

-smaller banks and brokerage firms

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FED

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-dealer

-maintains own account

-OMO open market operations expansionary and contractionary

-Us Gov Debt- offered at competitive bid

-Agency Debt- offered by fiscal agents

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Settlement: Tbills/ TNotes/ TBonds

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-regular way on next business day after trade date

-cash settlement: same business day if in before 2:30pm

-trades settle in Federal Funds

-NEVER Trade Flat

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Accrued interest: Treasury Debt

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Actual Day/Month/ Year Basis

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Accrued interest: Agency Debt

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30/360 basis

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Tax Status: Agency and T Dect

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-interest income subject to Federal income tax

-discount on Tbills taxed as interest at end of year

-STRIPS accreted and taxed annually