Chapter 17 Government Securities Copyright 2003 SouthWesternThomson Learning

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Chapter 17 Government Securities Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Chapter 17 Government Securities Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Federal Government Securities • Non marketable federal government debt – series EE (Patriot) bonds

Federal Government Securities • Non marketable federal government debt – series EE (Patriot) bonds – series HH bonds Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Federal Government Securities • Marketable federal government debt – Treasury bills – Treasury notes

Federal Government Securities • Marketable federal government debt – Treasury bills – Treasury notes and bonds – Zero coupon bonds (STRIPS) Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Federal Debt • Amount of federal debt in existence primarily consists of – Treasury

Federal Debt • Amount of federal debt in existence primarily consists of – Treasury bills – Intermediate - term notes – Debt held by U. S. government agencies and trust funds Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Federal Debt and Risk • • Safe from default Risk from price fluctuations Purchasing

Federal Debt and Risk • • Safe from default Risk from price fluctuations Purchasing power risk Measured by standard deviation of returns Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

The Discount Yield • Applies to Treasury bills • Based on face value and

The Discount Yield • Applies to Treasury bills • Based on face value and not the discounted price • Uses a 360 day year Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

The Discount Yield • Id = (Par value - Price) / Par value x

The Discount Yield • Id = (Par value - Price) / Par value x 360 / Number of days to maturity ($10, 000 - $9, 800) / $10, 000 x 360 / 90 = 8% Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

The Annualized Yield • Based on the discounted price of the Treasury bill •

The Annualized Yield • Based on the discounted price of the Treasury bill • Uses a 365 day year Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

The Annualized Yield • Id = (Par value - Price) / Price x 365

The Annualized Yield • Id = (Par value - Price) / Price x 365 / Number of days to maturity ($10, 000 - $9, 800) / $9, 800 x 365 / 90 = 8. 277% Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Inflation-Index Securities • Offer investors a “real yield” • Interest and principal adjusted for

Inflation-Index Securities • Offer investors a “real yield” • Interest and principal adjusted for inflation (CPI) • Erases purchasing power risk Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Federal Government Agency Debt • May be supported by “full faith and credit” of

Federal Government Agency Debt • May be supported by “full faith and credit” of the federal government • Moral backing Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Mortgage Backed Securities • Ginnie Mae bonds • Fannie Mae bonds Copyright © 2003

Mortgage Backed Securities • Ginnie Mae bonds • Fannie Mae bonds Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Collateralized Mortgage Obligations (CMOs) • Issued in tranches • More certainty of timing of

Collateralized Mortgage Obligations (CMOs) • Issued in tranches • More certainty of timing of payment Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

State and Local Government Debt • The tax exemption – interest is exempt from

State and Local Government Debt • The tax exemption – interest is exempt from federal income taxation • The taxable equivalent equation: ic (1 - t) = im Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Interest on Federal Government Securities • Is exempt from state and local income taxation

Interest on Federal Government Securities • Is exempt from state and local income taxation • The taxable equivalent equation for both exemptions: ic (1 - tf - ts) = im Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Yield Spread • Between triple A and triple B rated municipal bonds Copyright ©

Yield Spread • Between triple A and triple B rated municipal bonds Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Yield Spread • Between triple A and the 30 -year federal government bond Copyright

Yield Spread • Between triple A and the 30 -year federal government bond Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Types of Municipal Bonds • General obligation bond (GOs) – Supported by "full faith

Types of Municipal Bonds • General obligation bond (GOs) – Supported by "full faith and credit” (Taxing authority of issuing government) • Revenue Bond – Supported by revenues generated by project financed by the debt Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Risks Associated with Municipal Bonds • Changes in interest rates • Price volatility •

Risks Associated with Municipal Bonds • Changes in interest rates • Price volatility • Possibility of default • Purchasing power risk Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Default • Revenue bonds are riskier than GOs • Importance of credit ratings •

Default • Revenue bonds are riskier than GOs • Importance of credit ratings • Insured bonds • The lack of marketability Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Additional Topics in Municipal Debt • Taxable municipal bonds – used to finance private

Additional Topics in Municipal Debt • Taxable municipal bonds – used to finance private projects • Tax-exempt interest – may be subject to the alternative minimum federal income tax Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Foreign Government Bonds • • • Higher yields Exchange rate risk Possibility of default

Foreign Government Bonds • • • Higher yields Exchange rate risk Possibility of default High yield foreign government debt Brady bonds Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Government Securities and Investment Companies • Mutual funds and closed-end investment companies – may

Government Securities and Investment Companies • Mutual funds and closed-end investment companies – may specialize in government securities – offer diversification and convenience Copyright © 2003 South-Western/Thomson Learning. All rights reserved.

Chapter 3 Security Markets Copyright 2003 SouthWesternThomson LearningChapter 3 Security Markets Copyright 2003 SouthWesternThomson Learning
Chapter 14 Dividend Policy Copyright 2003 SouthWesternThomson LearningChapter 14 Dividend Policy Copyright 2003 SouthWesternThomson Learning
Chapter 19 Lease Financing Copyright 2003 SouthWesternThomson LearningChapter 19 Lease Financing Copyright 2003 SouthWesternThomson Learning
Chapter 8 Investment Companies Copyright 2003 SouthWesternThomson LearningChapter 8 Investment Companies Copyright 2003 SouthWesternThomson Learning
Chapter 6 Investment Companies Copyright 2003 SouthWesternThomson LearningChapter 6 Investment Companies Copyright 2003 SouthWesternThomson Learning
CHAPTER Market Efficiency Copyright 2003 by SouthWesternThomson LearningCHAPTER Market Efficiency Copyright 2003 by SouthWesternThomson Learning
Chapter 5 Currency Derivatives SouthWesternThomson Learning 2003 ChapterChapter 5 Currency Derivatives SouthWesternThomson Learning 2003 Chapter
15 Chapter Multinational Restructuring SouthWesternThomson Learning 2003 Chapter15 Chapter Multinational Restructuring SouthWesternThomson Learning 2003 Chapter
Chapter 5 Currency Derivatives SouthWesternThomson Learning 2003 ChapterChapter 5 Currency Derivatives SouthWesternThomson Learning 2003 Chapter
18 Chapter LongTerm Financing SouthWesternThomson Learning 2003 Chapter18 Chapter LongTerm Financing SouthWesternThomson Learning 2003 Chapter
15 Chapter Multinational Restructuring SouthWesternThomson Learning 2003 Chapter15 Chapter Multinational Restructuring SouthWesternThomson Learning 2003 Chapter
Chapter 20 ShortTerm Financing SouthWesternThomson Learning 2003 ChapterChapter 20 ShortTerm Financing SouthWesternThomson Learning 2003 Chapter
Chapter 5 Currency Derivatives SouthWesternThomson Learning 2003 ChapterChapter 5 Currency Derivatives SouthWesternThomson Learning 2003 Chapter
Chapter 5 Currency Derivatives SouthWesternThomson Learning 2003 ChapterChapter 5 Currency Derivatives SouthWesternThomson Learning 2003 Chapter
Chapter 20 Financing with Derivatives Copyright 2003 SouthWesternThomsonChapter 20 Financing with Derivatives Copyright 2003 SouthWesternThomson
Chapter 12 Capital Structure Concepts Copyright 2003 SouthWesternThomsonChapter 12 Capital Structure Concepts Copyright 2003 SouthWesternThomson
Chapter 12 Capital Structure Concepts Copyright 2003 SouthWesternThomsonChapter 12 Capital Structure Concepts Copyright 2003 SouthWesternThomson
Chapter 4 Sources of Information Copyright 2003 SouthWesternThomsonChapter 4 Sources of Information Copyright 2003 SouthWesternThomson
Chapter 20 Financing with Derivatives Copyright 2003 SouthWesternThomsonChapter 20 Financing with Derivatives Copyright 2003 SouthWesternThomson
Chapter 6 The Tax Environment Copyright 2003 SouthWesternThomsonChapter 6 The Tax Environment Copyright 2003 SouthWesternThomson
Demand Supply Analysis CHAPTER 3 2003 SouthWesternThomson LearningDemand Supply Analysis CHAPTER 3 2003 SouthWesternThomson Learning
Cost of Capital Chapter 12 2003 SouthWesternThomson LearningCost of Capital Chapter 12 2003 SouthWesternThomson Learning