U.S. Treasury bills notes bonds and inflation protection securities

written by: Rosa Geminava; article published: year 2006, month 08;


In: Categories » Legal and finance » Bonds and Leads » U.S. Treasury bills notes bonds and inflation protection securities

Treasury securities are issued by the US Department of Treasury, andare backed by the full faith and credit of the USgovernment. They are considered as having no credit risk.

There are two types of T-securities: discount and coupon securities.Treasury coupon securities come in two forms: fixed rate and variable-ratesecurities.

  • T-Bills are also called discount securities. They have the following features:
    • Issued at a discount to parvalue.
    • No coupon rate.
    • Mature within a year or less.There are three initial maturities: 91 days (3-month), 182 days(6-month), and 364-days (1-year).
    • The return to the investor is thedifference between the maturity value (par value) and the purchase price.
  • T-Notes and T-Bonds: all securities with initial maturities of two years or more are issued as Treasury coupon securities. They have are issued at approximately par, have a coupon rate, and mature at par value.
    • T-Notes are issued withmaturities of more than one year and no more than 10 years. There arethree initial maturities: 2 year, 5 year and 10 years. T-notes areidentified with an "n" on quote sheets.
    • T-Bonds are issued withmaturities greater than 10 years. The initial maturity is 30 years.
    • None of the currently issuedTreasury coupon securities are callable, although there are outstandingT-bonds that are callable.
  • Treasury Inflation Protection Securities (TIPS) are T-notes or T-bonds that are adjusted for inflation. TIPS works as follows:
    • The coupon rate on an issue isset at a fixed rate. The rate is called the real rate since it is therate that the investor ultimately earns above the inflation rate.
    • Every six months some adjustmentsare made.
      • The principal that the Treasury Department will base both the dollar amount of the coupon payment and the maturity value is adjusted: adjusted principal = principal before adjustment x ( 1 + inflation rate). This is called inflation-adjusted principal.
      • The coupon payment is determined as: coupon payment = inflation-adjusted principal x fixed coupon rate.

Because of the possibility of disinflation (price declines), theinflation-adjusted principal at maturity may turn out to be less than theinitial par value. However, TIPS are structured to be redeemed at the greaterof the inflation-adjusted principal and the initial par value.

For example, an investor purchases on January 1 $100,000 of parvalue of an TIPS issue with a coupon rate of 3.5%. For the first 6 months theannual inflation is 3% and thus the semiannual inflation rate is 1.5%. At theend of the first six-month period the inflation-adjusted principal is $100,000x ( 1 + 1.5%) = $101,500. The coupon payment is then $101,500 x 1.75% =$1,776.25. At the end of the second six-month period (suppose the semiannualinflation rate has been changed to 1%), the inflation-adjusted principal isthen $101,500 x ( 1 + 1%) = $102,515. The coupon payment is then $102,515 x1.75% = $1,794.01.

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