module 3: providing investment information
section 2: debt instruments    EXCERPT

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US treasury notes and bonds

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US Treasury Securities - continued

Treasury Notes and Bonds

· Characteristics of U.S. Treasury Notes and Bonds
· Who regulates the Treasury market?
· How are Treasuries issued?
· Secondary Market Trading
· Repurchase Agreements (Repo's)
· Zero Coupon Treasuries
· How are Treasury trades cleared and settled?
· Agency securities

Characteristics of U.S. Treasury Notes and Bonds
· principal: paid at maturity; not callable
quotation: price per $100 par value (fractions in 1/32nds)
· day count convention: actual/actual
· interest: semi-annual coupon (may have short or long coupon)
· normal settlement: T + 1

All Treasury notes and bonds share the characteristics shown here. In the past, the Treasury issued bonds which were callable at par five years prior to maturity. While it no longer does so, some of these bonds are still outstanding.

Be sure you're comfortable with these concepts before you go on. We're going to use them.

Who Regulates the Treasury Market?
U.S. Department of the Treasury
Federal Reserve Bank
Government Securities Act of 1992

U.S. Treasury securities are exempt from SEC registration requirements. Instead, the U.S. Treasury issues rules and generally oversees the market, while the Federal Reserve regulates the activities of the primary dealers. The Government Securities Act of 1992 requires all government securities dealers to register with the SEC and establishes price disclosure and reporting requirements.

How Treasuries are issued
InstrumentTime to maturityAuction schedule
T bills13 weeks
26 weeks
1 year
T notes2 years
3 years
5 years
10 years
monthly (last day)
once per 3 months (15th)
monthly (last day)
once per 2 months (15th)
T bonds30 yearsthree times per year (15th)

moreinfo.GIF - 1466 Bytes

The Primary Market Process for U.S. Treasuries
'When Issued Trading'
normal trading
(T + 1 settlement)
(yield basis)

Announcement date
Settlement on issue date
(price basis)

Auction date
(1 week after Announcement date)

Issue date
(1 week after Auction date)

Secondary Market Trading
worldclx.GIF - 4015 Bytes

The secondary market is a 24-hour market. The official trading day begins in Japan during U.S. evening hours. At about 3:00 a.m. New York time, activity switches to Europe. Finally, at about 8:00 a.m. New York time, the heaviest trading of the day begins with the opening of the U.S. market.

    over-the-counter market
    about 40 primary dealers

The U.S. Treasury market is an over-the-counter market. The most important market makers in this market are called Primary Government Securities Dealers. There are about forty of these and they include many of the largest banks and brokerages in the world as well as a few specialty firms.

Primary Dealers

    designated and monitored by NY Federal Reserve Bank
    must make a
two-sided market in all Treasuries
    Federal Reserve conducts open market operations through them

The New York Fed appoints primary dealers and monitors their activities. To become a primary dealer, a firm must commit to making an ongoing two-sided market in all Treasury securities. In addition, the firm must demonstrate to the Fed that it already has a substantial trading volume in government securities. Once becoming a primary dealer, the firm must report on its government securities trading activities to the Fed. In return, the Fed conducts its open market operations through the primary dealers.

One of the ways the Federal Reserve controls the size of the money supply in the economy is through its open market operations. By purchasing government securities in the open market, the Fed injects more money into the economy. By selling government securities, it removes money from the economy.

A dealer who makes a two-sided market will always quote both a bid and an offered price. In other words, the dealer is always willing to either buy or sell. The existence of market makers willing to make a two-sided market at any time is critical to building investor confidence and market liquidity.

Primary dealers trade with each other - in a market known as the "inside market" - and with their customers. Click to find out more about who these dealers and customers are and how the inside and customer markets work.

Repurchase Agreement ("Repo")
Repo image
  • an agreement to sell a Treasury security at one price and repurchase it at a specific future date at a higher price
  • in effect, a collateralized borrowing
  • term is usually one day
A repurchase agreement, or "repo", is simply an agreement to sell a Treasury at one price and repurchase it at a specific future date at a higher price. In effect, a repo is like a collateralized borrowing where the Treasury security represents the collateral given to the lender, and the difference between the selling price and the repurchase price represents the interest paid for the loan.

The term of a repo is usually one day, though longer-term repos are sometimes done.
practice questions

Zero Coupon Treasuries
  • created by repackaging the cash flows of a regular Treasury bond
  • each coupon and principal payment is sold separately
  • final maturity payment only; no coupon (no reinvestment risk)
  • traded at discount to par value
more information How are Treasury Trades Cleared and Settled?
Most Treasury securities are held in book entry form in accounts maintained by banks at the Federal Reserve. These accounts hold the securities of both the banks themselves and their customers. Because every bank also maintains a reserve account - or cash account - at the Fed, settling a Treasury trade between the customers of two different banks is simply a matter of instructing the Fed to make the proper cash and security transfers.

Suppose, for example, a customer of Bank A wishes to transfer a bond to a customer of Bank B. Upon receiving instructions from its customer, Bank A will simply instruct the Fed via Fedwire to transfer the bonds from its account to the account of Bank B. The Fed will make the appropriate cash and security transfers and notify B of the transaction. Bank B will then record the bonds in the account of its customer.

If both customers have accounts at bank A, no
Fed transfer is required. The bank will simply reduce the bond account of customer A and increase the bond account of customer B on its own books.

The Fed's settlement system for Treasuries is a delivery versus payment system. This means ?

A. payment is always made for a delivery.
B. the transfer of cash and securities is simultaneous.
C. this system makes deliveries but not payments.
D. delivery can be made as long as some form of payment accompanies the delivery.

(Click letter of your choice)

Because of the heavy volume of trade in U.S. Treasury securities, the Fedwire transfer system became cumbersome and experienced frequent backlogs. To rectify the problem, the industry established the Government Securities Clearing Corporation ("GSCC"). The GSCC nets each day's trades within the dealer community and transfers only the net balances over Fedwire.

For example, suppose dealer A sells a bond to dealer B who in turn sells the bond to dealer C. Instead of two Fed wire transfers, GSCC procedures reduce the number to one: a transfer from A to C. Since dealers trade back and forth many times in one day, the GSCC has significantly reduced the required number of wire transfers.

Agency Securities
IssuerExamples:U.S. Government backed?
Government sponsored entities
(private company;public charter)
Federal Farm Credit Bank
Resolution Trust Company
Federal National Mortgage Corp
Federally related institutions
(via the Federal Financing Bank)
Export-Import Bank
Government National Mortgage Assoc.

Agency securities are securities issued by government sponsored entities and federally related institutions.

Government sponsored entities are actually privately owned but publicly chartered companies formed under government sponsorship to help reduce borrowing costs for certain sectors of the economy. As such, their securities are not backed by the full faith and credit of the United States government. However, there is a strong sense that they would not be allowed to default, and the yields on these securities are only slightly higher than those of comparable Treasury securities.

Federally related institutions are actual arms of the government and their securities are backed by the full faith and credit of the government The Federal Financing Bank actually issues most of these securities.

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