AISE_FIM7e_ch10

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Treasury and Federal Agency Bonds (cont’d)

Treasury bond auction (cont’d)
The Salomon Brothers scandal In a 1990 bond auction, Salomon Brothers purchased 65 percent of the bonds issued (exceeding the 35 percent maximum) Salomon resold the bonds at higher prices to other institutions In August of 1991, the Treasury Department temporarily barred Salomon Brothers from bidding on Treasury securities In May 1992 Salomon paid fines of $190 million to the SEC and Justice Department Salomon created a reserve fund of $100 million to cover claims from civil lawsuits
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Chapter Outline
Bond background Treasury and federal agency bonds Municipal bonds Corporate bonds Institutional use of bond markets Bond market globalization
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Treasury and Federal Agency Bonds (cont’d)

Treasury bond quotations

Published in financial newspapers


The Wall Street Journal Barron’s Investor’s Business Daily
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Treasury and Federal Agency Bonds (cont’d)

Treasury bond auction
Normally
held in the middle of each quarter Financial institutions submit bids for their own accounts or for clients Bids can be competitive or noncompetitive
Several

securities firms create their own versions of stripped securities
Merrill Lynch’s TIGRs The Treasury created the STRIPS program in 1985
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Treasury and Federal Agency Bonds (cont’d)
Chapter 10
Bond Markets
Financial Institutions and Markets, 7e, Jeff Madura Copyright ©2006 by South-Western, a division of Thomson Learning. All rights reserved.

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Treasury and Federal Agency Bonds (cont’d)

Stripped Treasury bonds
One
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Computing the Interest Payment of an Inflation-Indexed Bond
A 10-year bond has a par value of $1,000 and a coupon rate of 5 percent. During the first six months after the bond was issued, the inflation rate was 1.3 percent. By how much does the principal of the bond increase? What is the coupon payment after six months?

The holding period return is used by investors who do not hold a bond to maturity
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Treasury and Federal Agency Bonds

The U.S. Treasury issues Treasury notes or bonds to finance federal government expenditures

Profit from the bid-ask spread Conduct trading with the Fed during open market operations Typical daily volume is about $200 billion
Online trading TreasuryDirect program ()

security represents the principal payment and a second security represents the interest payments

Investors who desire a lump sum payment can choose the PO part Investors desiring periodic cash flows can select the IO part Degrees of interest rate sensitivity vary

2
Background on Bonds


Bonds represents long-term debt securities that are issued by government agencies or corporations Interest payments occur annually or semiannually Par value is repaid at maturity Most bonds have maturities between 10 and 30 years Bearer bonds require the owner to clip coupons attached to the bonds Registered bonds require the issuer to maintain records of who owns the bond and automatically send coupon payments to the owners
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Background on Bonds (cont’d)

Bond yields

The issuer’s cost of financing is measured by the yield to maturity



The annualized yield that is paid by the issuer over the life of the bond Equates the future coupon and principal payments to the initial proceeds received Does not include transaction costs associated with issuing the bond Earned by an investor who invests in a bond when it is issued and holds it until maturity

Bond quotations are organized according to their maturity, with the shortest maturity listed first Bid and ask prices are quoted per hundreds of dollars of par value Online quotations at

Inflation-indexed Treasury bonds
In
1996, the Treasury started issuing inflation-indexed bonds that provide a return tied to the inflation rate The coupon rate is lower than the rate on regular Treasuries, but the principal value increases by the amount of the inflation rate every six months Inflation-indexed bonds are popular in high-inflation countries such as Brazil


Competitive bids specify a price the bidder is willing to pay and a dollar amount of securities to be purchased Noncompetitive bids specify only a dollar amount of securities to be purchased