Chapter 12 Part 5 Flashcards
Corporate zero-coupon bonds arc taxed a bit differently. Each year the bond’s
cost basis (the amount that the investor originally paid for the bond) is increased (accreted) for tax purposes. This process is called accretion and the investor must pay taxes on the increase even though he has not actually received any money. This is a disadvantage of zero-coupons for investors in high tax brackets
U.S. government securities are direct obligations of the
federal government.
Agency securities are issued by
agencies of the federal government such as the Federal National Mortgage Association. Although most agency securities are not direct obligations of the United States government, they are usually considered very safe investments, since it is unlikely that the federal government would permit a default on these securities
U.S. government securities are divided into two major groups
marketable securities (Treasuries) and nonmarketable securities (savings bonds)
Marketable securities are
negotiable. This means that investors can sell their securities to other investors after they are issued
nonnegotiable
Savings bonds are nonrnarketable-they may only be sold back to the U.S. government
Treasuries are much more important of the two groups, since they may be freely transferable after issuance. These securities include
Treasury bonds; Treasury notes; Treasury bills; Treasuiy STRIPS; Treasury TIPS
Key advantages of treasury securities for investors include
Safety, Liquidity, Interest exempt fro1n state and local income taxes
Treasury notes (t notes) andtreasury bonds (t bonds) are like most corporate bonds. They pay a
fixed rate of interest semiannually (twice a year) and the investor receives the face value of the security when it matures. For this reason, t notes and t bonds are referred to as interest-hearing securities
treasury notes mature in
2 to 10 years
Treasury bonds can take up to
30 years to mature
Treasury Notes and Bonds are sold in denominations of
$100
Prices for Treasury notes and bonds are quoted as
a percentage of their par value, the same way as for most corporate bonds
The difference between government bonds and other bonds is that government securities are
quoted in increments of 1 /32, while the prices for most other bonds are expressed in increments of 1 /8th.
For example, a Treasury bond quoted as 101 24/32 would appear in the paper as 101.24 or 101 :24. Anything to the right of the decimal is a fraction with 32 as its denominator. In order to translate this quote into the bond’s dollar price, you need to do the following
Step 1: Express the quote as a fraction. (Put everything that is to the right of the decimal over 32.) 101.24 = 101 24/32. Step 2: Change the fraction to a decimal. 24/32 =. 75 Thus, 101 24/32 = 101. 75%. Step 3: Change the percentage to a decimal. 101.75% becomes 1.0175 (Move the decimal two places to the left.). Step 4: Multiply the result by the par value ($1,000). 1.0175 x $1,000 = $1,017.50 The dollar price of a Treasury bond quoted as 101.24 is $1,017.50.
Treasury Inflation-Indexed Securities
Often referred to as Treasury Inflation-Protected Securities (TIPS), the principal value of these securities is inflation-adjusted, based on the Consumer Price Index (CPI). With TIPS the rate of interest is fixed. However, the principal amount on which that interest is paid may vary
Treasury Bills
Currently an investor can purchase T-bills with maturities of one month (4 weeks), three months (13 weeks), six months (26 weeks), and one year (52 weeks). They are sold with a minimum denomination of $100, and in multiples of$100. T-bills are only issued in book-entry form
T-bills are always sold
at a discount from their face value. Unlike Treasury bonds and notes, T-bills do not make interest payments to investors. The difference between what the investor pays for the T-bill and what he receives when the T-bill matures is his interest. Consequently, T-bills are referred to as discount securities and noninterest-bearing securities
T-Bill Prices
the prices of T-bills are not quoted as a percentage of their par value. T-bills are quoted on a discounted yield basis. This means that their prices represent the yield that the buyer will earn on the T-bill. Since T-bills are always sold at a discount and do not make interest payments to investors, their yield refers to the size of the discount from the T-bill’s face value
Treasury STRIPS are
zero-coupon bonds issued by the United States government. As with other zero-coupon bonds, the investor does not receive periodic interest payments. He receives a lump sum when the bond matures
