u.s. government securities chapter 2 tools techniques of investment planning copyright 2007, the...
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U.S. Government Securities Chapter 2 Tools & Techniques of Investment Planning Copyright 2007, The National Underwriter Company3 What is it? Treasury Bond –A long-term debt security –Pays interest semi-annually –Fixed maturity of more than 10 years –Minimum face value denomination is $1,000 Treasury Inflation-Protected Securities (TIPS) –Interest payments and the principal value of these bonds are adjusted every six months to reflect changes in inflation as measured by the Consumer Price Index (CPI). –Available in 10 year notesTRANSCRIPT
U.S. Government Securities Chapter 2Tools & Techniques of
Investment Planning
Copyright 2007, The National Underwriter Company 1
What is it?
• U.S. government securities are issues of the United States Treasury and various government agencies.– They are used to finance the activities of the federal
government.– They include:
• Direct issues of the Treasury such as bills, notes, and bonds• Bonds of governmental agencies such as the Governmental
National Mortgage Association and the Federal Land Bank
U.S. Government Securities Chapter 2Tools & Techniques of
Investment Planning
Copyright 2007, The National Underwriter Company 2
What is it?
• Treasury Bill (T-Bill)– A short-term debt security – Maturity of either 4, 13, or 26 weeks – Purchased in minimum amounts of $1,000.– They are issued on a “discount basis” and redeemed at face value
without interest on their maturity date.
• Treasury Note– A medium-term debt security– Pays interest semi-annually– Maturity date greater than one year and can extend for up to 10 years
from the date of issue– Minimum face value denomination is $1,000
U.S. Government Securities Chapter 2Tools & Techniques of
Investment Planning
Copyright 2007, The National Underwriter Company 3
What is it?
• Treasury Bond– A long-term debt security– Pays interest semi-annually– Fixed maturity of more than 10 years– Minimum face value denomination is $1,000
• Treasury Inflation-Protected Securities (TIPS)– Interest payments and the principal value of these bonds are
adjusted every six months to reflect changes in inflation as measured by the Consumer Price Index (CPI).
– Available in 10 year notes
U.S. Government Securities Chapter 2Tools & Techniques of
Investment Planning
Copyright 2007, The National Underwriter Company 4
When is the use of this tool Indicated?
• When the individual desires a high quality investment that has little or no risk of default– In more than 225 years, the U.S. government has never defaulted on
even one obligation.
• When an investor needs certainty of income– The Treasure can print money or raise taxes to pay interest on its
obligations.
• When an investor seeks an investment with unquestioned utility as collateral– Lenders accept U.S. government securities as security for loans
because of their low risk of loss of capital and certainty of income.
U.S. Government Securities Chapter 2Tools & Techniques of
Investment Planning
Copyright 2007, The National Underwriter Company 5
When is the use of this tool Indicated?
• When an investor desires a security with the highest degree of marketability– Because of the large volume of government securities traded daily, a
ready market and information on prices and returns are available.
• When an investor is either unable or unwilling to accept the uncertainty and risk inherent in equity, tax-sheltered, and corporate fixed-income investments
• TIPS may be useful when an investor is particularly concerned with the potential loss of purchasing power due to the long-term effect of inflation.
U.S. Government Securities Chapter 2Tools & Techniques of
Investment Planning
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Advantages
• U.S. government securities are virtually free of the risk of default.
• The income from government securities is assured.• They are readily accepted by virtually every financial
institution as collateral for loans.• They are easily and quickly convertible to cash• Government issues provide a high degree of security
and comfort for risk conscious investors.
U.S. Government Securities Chapter 2Tools & Techniques of
Investment Planning
Copyright 2007, The National Underwriter Company 7
Advantages
• A large variety of government issues is available.– Purchases can be tailored to meet the investor’s goals and
objectives
• Interest earned on Treasury securities is not subject to state and local taxation.
• TIPS provide long-term inflation protection.– Semi-annual adjustments are made to interest payments and
principal values to reflect changes in the CPI.
U.S. Government Securities Chapter 2Tools & Techniques of
Investment Planning
Copyright 2007, The National Underwriter Company 8
Disadvantages
• The rate of return on U.S. government securities is generally lower than other fixed-income securities.
• Long-term government issues are subject to a high degree of interest rate risk.– Prices can fluctuate substantially with changes in
interest rates.• With the exception of TIPS, the purchasing power of the
fixed amount of dollars paid by these issues will be eroded over time by the effects of inflation.
U.S. Government Securities Chapter 2Tools & Techniques of
Investment Planning
Copyright 2007, The National Underwriter Company 9
Tax Implications
• All interest from T-bills, notes, and bonds is subject to federal income tax at ordinary income rates.– It is entirely exempt from all state and local taxes.
• Interest from a Treasury bill is not reportable until the year that the T-bill matures.
• The sale of a T-bill on the open market before maturity will have the following tax implications on taxable income:– Sold for more than amount paid – ordinary income– Sold for less than amount paid – capital loss
U.S. Government Securities Chapter 2Tools & Techniques of
Investment Planning
Copyright 2007, The National Underwriter Company 10
Tax Implications
• A Treasury note or bond may be subject to capital gains treatment.– If a note or bond is sold before maturity, gain or loss is treated
as capital gain or capital loss.• If the gain includes original issue discount or market discount, it
may be necessary to treat part of the gain as ordinary income.
• In any year when the principal value of a TIPS bond increase due to inflation adjustment, that gain is considered reportable income for the year.– The investor does not receive the inflation-adjusted principal
until the security matures.
U.S. Government Securities Chapter 2Tools & Techniques of
Investment Planning
Copyright 2007, The National Underwriter Company 11
Alternatives
• Short-term certificates of deposit (CDs) issued by banks and savings institutions are comparable to Treasury bills.– May offer a slightly higher return than the T-bill rate
• Longer-term CDs (issued by banks, savings and loans, and mutual savings banks) are competitive with Treasury notes and bonds.
• High quality corporate bonds should be considered as an alternative to long-term government securities such as notes and bonds.– Greater risk accompanied by considerably higher returns
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Investment Planning
Copyright 2007, The National Underwriter Company 12
Where and How do I get it?
• T-bills are offered according to a regular schedule.– 13 and 26 week bills are offered every week.– The offering is announced every Thursday in major public
newspapers (i.e. The Wall Street Journal)– The bills are auctioned the following Monday.
• 4 week T-bills auctions are announced on Monday and auctioned on Tuesday.
– Call 1-800-722-2678 or go to www.publicdebt.treas.gov
U.S. Government Securities Chapter 2Tools & Techniques of
Investment Planning
Copyright 2007, The National Underwriter Company 13
Where and How do I get it?
• Federal government securities (such as TIPS) can be purchased:– Directly from the U.S. Treasury through a Federal Reserve
bank (on issue)– From a commercial bank– Through a brokerage firm– Using the Treasury Direct system on the Internet
U.S. Government Securities Chapter 2Tools & Techniques of
Investment Planning
Copyright 2007, The National Underwriter Company 14
Where and How do I get it?
• An investor who wants to purchase a new issue directly from the U.S. Treasury submits a standardized form known as a “tender.” – This can be done either by mail or in person at the
appropriate Federal Reserve Bank or one of its branches
• They can also be purchased from a local bank or brokerage firm.– Many investors find this method the most convenient.
U.S. Government Securities Chapter 2Tools & Techniques of
Investment Planning
Copyright 2007, The National Underwriter Company 15
Where and How do I get it?
• Treasury Direct system – www.treasurydirect.gov– To open a Treasury Direct account, the investor must first
submit a paper form that links the account to an his/her checking account.
– Once the account is open, new issues of bills, notes, and bonds can be purchased by computer in amounts as small as $1,000.
• The amount of the purchase is deducted from the investor’s checking account.
• When the security matures, the par value is deposited into the account.
– Treasury Direct purchases are free of commissions or other fees.
U.S. Government Securities Chapter 2Tools & Techniques of
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What Fees or Other Acquisition Costs Are Involved?
• When an investor purchases a security directly from the U.S. Treasury, there are no charges or commissions.
• Purchases through a bank or broker will typically be more expensive.– Banks may charge a commission as well as a premium on
purchases under $100,000.– The investor will pay the market price, which may be higher or
lower than the issued price.• The investor may have to pay for interest accrued since
the last interest payment date.– On the next payment date, the investor receives the full amount
of interest for the period.
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Investment Planning
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How Do I Select the Best of Its Type
• All government securities with similar maturities have the same risk and reward characteristics.
• Selecting the “best of its type” depends on investor’s goals and objectives.
• In selecting among T-bills, notes, and bonds, planners should focus on the investor’s needs for:– Liquidity– Income– Tax Deferral
U.S. Government Securities Chapter 2Tools & Techniques of
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Example
Anne Lewis desires to have a high degree of liquidity since she feels interest rates are likely to increase sharply in the months ahead. Clearly, she should not purchase long-term notes or bonds since they will decline in value as rates increase. Anne should concentrate any investments in short-term issues such as T-bills that mature relatively quickly and that will enable her to reinvest at the higher interest rate.
U.S. Government Securities Chapter 2Tools & Techniques of
Investment Planning
Copyright 2007, The National Underwriter Company 19
Where Can I Find Out More About It?
• Various financial institutions– Banks and brokerage firms
• Financial newspapers and magazines– Wall Street Journal– New York Times– Barron’s– Investor’s Business Daily
• Direct contact to the Treasury– Bureau of the Public Debt, Department W, Washington D.C.,
20226– www.publicdebt.treas.gov
• Electronic Data Networks– www.dowjones.com