[LETTERHEAD OF THE BOND MARKET ASSOCIATION] Via Electronic Mail and Federal Express February 6, 1998 Mr.

Kerry Lanham, Acting Director Department of the Treasury Bureau of the Public Debt Government Securities Regulation Staff 999 E Street N.W., Room 515 Washington, D.C. 20239-0001 Re: Proposed Amendment (Fungible Interest Components of Inflation -Indexed Securities) Dear Mr. Lanham: The Bond Market Association (the "Association")/1/ appreciates the opportunity to comment on the proposed rule amendments/2/ issued by the Department of the Treasury ("Treasury") relating to fungible interest components of inflation-indexed securities under the Uniform Offering Circular for the Sale and Issue of Marketable BookEntry Treasury Bills, Notes and Bonds/3/ (the "Uniform Offering Circular"). As you are aware, the Association has submitted comment letters/4/ in connection with Treasury's previous proposals regarding inflation-indexed securities and continues to have an active interest in the refinement of Treasury's rules with respect to this new class of securities. /1/ The Bond Market Association (formerly known as "PSA The Bond Market Trade Association " or "PSA") is the bond market trade association, representing securities firms and banks that underwrite, trade and sell debt securities, both domestically and internationally. Its members include all of the primary dealers recognized by the Federal Reserve Bank of New York, as well as other government securities dealers. More information about the Association can be found at its Internet website http://www.bondmarkets.com./2/ 62 FR 64528 (December 8, 1997). /3/ 31 CFR Part 356.

/4/ Letters dated July 12, 1996 and November 6, 1996 to Kenneth Papaj, Director, Government Securities Regulation Staff, Bureau of the Public Debt, from Edwin F. Payne, Chairman, PSA Government and Federal Agency Division. In sum, the Association supports Treasury's efforts to make the interest components of inflation-indexed securities fungible./5/ Association members generally believe that the fungibility of interest components is an important step in making the underlying inflationindexed securities market more liquid. Association members appreciate Treasury's foresight and commitment to establishing the mechanism necessary for making interest components of inflation-indexed securities fungible, particularly in advance of any noteworthy increase in inflation. Notwithstanding the foregoing, most market participants continue to be very concerned with the significant

modifications needed for their operational systems to accommodate the trading and maintenance of the adjusted value of stripped interest components to the penny./6/ /5/ Association members recognize that although inflation-indexed securities are currently eligible for Treasury's Separate Trading of Registered Interest and Principal Securities ("STRIPS") program, the stripped components are not fungible. It is our understanding that this is true even if the interest components have the same maturity date because the inflation adjustment to the principal component is based on the CPI reference number for the issue date of the security and securities with the same maturity date may have different issue dates. /6/ In addition, although the Association generally supports the proposed initiative in its current form, some members are also concerned about the ability of investors to comprehend the proposed STRIPS methodology given its complexity. In light of this concern, the Association encourages Treasury to carefully evaluate the benefits of fungibility, using the proposed methodology, against the potential cost to market participants arising from its complexity and the system related demands (independent of the "pennies" issue identified above). Unfortunately, the Association is not in a position at this time to comment on what effect these costs will have on the market for inflation-indexed STRIPS. The Association's comments are divided into two parts. Part I elaborates upon the significant operational system changes most market participants expect will be needed in order to maintain and trade the adjusted value of the interest components of inflationindexed securities to the penny. As one solution to this issue, Association members recommend that Treasury consider truncating the pennies from the adjusted values for stripped interest components. Part II describes Association members' view supporting the establishment of a conversion factor if the Consumer Price Index ("CPI")/7/ is rebased and agree that the availability of such conversion factor will increase fungibility. Association members believe, though, that better liquidity can be achieved if conversions are done on a voluntary basis, and if there is a conversion factor available for converting securities issued under the old base reference period to the new base reference period and vice versa. /7/ The index for measuring the inflation rate for the securities will be the non-seasonally adjusted U.S. City Average All Items Consumer Price Index for All Urban Consumers. I. Operational and Other Concerns Under the proposal, the adjusted value of the interest components stripped from inflation-indexed securities would have to be calculated, transferred and maintained to the penny (e.g. $10, 802.47). Most Association members currently do not have the operational capability to maintain or trade par values or adjusted values of a security in pennies./8/ As a result, these Association members consistently agree that, if the proposal is adopted in its current form, significant changes would need to be made to their internal trading, trade processing, settlement and accounting systems. Association members believe, realistically, that it will require approximately six to

nine months to both make and test the appropriate system changes before they can begin trading the new stripped securities. In addition, the same members have expressed concerns about whether adequate internal resources can be dedicated to the project since currently many are making operational system adjustments to prepare for the Year 2000, the European Monetary Unit and the GCF Repo product of the Government Securities Clearing Corporation ("GSCC"). /8/ Based on an informal survey conducted by the Association, an extremely limited number of market participants seem to have the ability, or with minimal effort will have the ability, to trade securities maintained to the penny. The Association has come to understand that other industry participants would need to make significant modifications to their computer systems to enable them to handle securities denominated to the penny. In order to make these securities eligible for trade comparison and netting services, registered clearing corporations, such as GSCC, would have to reconfigure multiple components of their systems. GSCC estimates that it would require four to six months to develop, test and implement modifications to its systems once final specifications regarding the introduction of fungible interest components of inflation-indexed securities are established by Treasury. In addition, one of the two major clearing banks that needs to acquire the ability to clear a security carried to the penny has indicated that significant program changes and a quality assurance effort would be required. GSCC and this clearing bank are concerned whether they will have adequate resources to give a high priority to these modifications in light of the other important industry initiatives described earlier in this letter. Association members suggest that the significant cost associated with modifying operational systems to accommodate maintaining and trading the adjusted value to the penny could be avoided by incorporating one modification in the present proposal-truncating the pennies from the adjusted value. Treasury's proposal provided the example of an inflation-indexed security submitted for stripping with a 10-year maturity, a par amount of $1 million, a coupon rate of 3.5% and an issue-date reference CPI of 162.00000. The adjusted value for each interest component was calculated as $1 million x (0.035/2) x (100/162), or $10,802.47. Using the truncation methodology we suggest, the adjusted value of each stripped interest component would equal $10,802.47, but a par value equaling $10,802 would actually be issued. In other words, the dealer would forego receiving $0.47 per interest component or a maximum aggregate of $9.40 (20 interest components x $0.47) per $1 million stripped. All such penny truncations would accrue to the benefit of Treasury, and dealers would treat the forgone value as a variable cost associated with participating in the stripping business. Generally, for a 10-year issue, the adjusted value of pennies truncated would be expected to average $0.50 per maturity date per $1 million of inflation-indexed securities stripped or a total of $10 for all 20 interest components, with a market value significantly less than $10 per $1 million. The truncation would discourage the stripping of trivial amounts. In the example above, 1,000 transactions of $1,000 would create costs of $0.80 x 20 x 1,000 or $16,000 per $1 million compared to $9.40 ($0.47 x 20) per $1 million for one transaction. In addition, the associated transfer fee imposed

by the Federal Reserve Bank of New York would be higher for 1,000 transactions. The Association believes as part of this suggestion that, during the reconstitution process, it would be necessary for Treasury to accept interest components in the same truncated denominations that were previously issued to market participants during the stripping process. For example, the $10,802 par value in the case above would be an acceptable STRIPS component -- even though, the adjusted value credited will be equivalent to $10,802.47 in the reconstituted note, and the interest payment on the securities would be calculated as stated in Treasury's proposal and paid to the penny. Should Treasury require pennies for reconstituting the securities, the initial investor to strip the issue would find himself/herself unable to reconstitute them if no other inflation-indexed securities were stripped with the same interest payment dates. In fact, it would be impossible to extinguish all outstanding STRIPS unless the truncated adjusted value of the STRIPS received is acceptable for reconstituting. Stripping and reconstituting in like amounts, would appear to be revenue neutral. The truncated pennies Treasury kept during stripping would be returned during the reconstitution process. The Association believes that truncating pennies from the adjusted value furthers Treasury's goal of making the securities attractive to a broader investor base and developing a liquid market. Moreover, stripped interest components would be eligible for netting by clearing corporations and clearance by both major clearing banks. Therefore Association members suggest Treasury consider making this modification. Association members recognize that theoretically a dealer could profit from stripping a large par amount in one transaction and subsequently reconstituting that same par amount using multiple transactions. Using the same example above, if a dealer strips $1 million, thereby walking away from $9.40 of adjusted value of interest components, and later decides to reconstitute 1,000 $1,000 lots so as to receive $10.80 for every $10 submitted, the dealer will have an adjusted value benefit of $15,990.60 ($16,000-$9.40). This benefit, however, is only theoretical, because it does not factor the transaction costs associated with reconstitution. The Federal Reserve Bank of New York's existing transfer fee of $2.25 per CUSIP number submitted for reconstituting a security, whereby the principal and each interest component is counted, makes it less costly to submit larger amounts for reconstituting (in the example, 21 CUSIPS x $2.25 or $47.25 for one transaction versus $47,250 for 1,000 transactions). If Treasury decides that the transfer fees fail to offer enough protection from potential abuse, Treasury could consider requiring a $1 million minimum par amount of notes and bonds for stripping and reconstituting. Market participants agree with Treasury's assessment that the differences in payment amount between a stripped interest component and an interest payment of a fully-constituted security are very small and revenue neutral. Therefore, market participants support Treasury's proposal not to change its current rounding conventions to eliminate these differences. II. Rebasing the CPI Association members consistently believe that if the base reference

period for the CPI is changed from 1982-1984 ("the old period") to 1993-1995 ("the new period"), the benefits of increased fungibility will justify the cost of creating a conversion factor between securities originally issued with different reference CPI periods, the cost of making any necessary system changes and the possibility of creating additional small payment discrepancies./9/ Association members recommend, though, that the conversion be done on a voluntary basis because the conversion undoubtedly will create pennies. Since, as described above, most dealers' systems would be unable to accommodate pennies, the pennies would have to be truncated in the same fashion as described in Part I when inflation-indexed securities are stripped. However, unlike a fully constituted security being submitted for stripping, most outstanding stripped interest components will be held by investors rather than dealers. Therefore, any truncating would be at the cost of an investor (assuming dealers would not be willing to absorb this cost for the benefit of an investor). By making conversion voluntary, investors will be permitted to decide for themselves whether the benefits outweigh the associated costs of conversion. Association members also recommend that an additional conversion factor be created that will allow interest components of inflation-indexed securities based on the new period to be converted to the old period. Association members believe that this additional convertibility and the voluntary conversion feature will further increase the marketability of the stripped interest components. /9/ As the Association mentioned in its comment letter to Treasury dated July 12, 1996, the likelihood that redefinition of the CPI may occur during the life of a 10-year or 30-year inflation-indexed note or bond is a real and serious concern to potential investors. The Association agrees with Treasury's observation that interest components stripped from inflation-indexed securities issued under different indices with fundamentally different methodologies would not be fungible. The Association appreciates the opportunity to comment on the proposed amendment and looks forward to continuing the exchange of ideas between Treasury and market participants. Any questions may be directed to the undersigned at 212-440-9431 or Paul Saltzman, Senior Vice President and General Counsel at 212-440-9459. Sincerely yours, /s/ Paula H. Simpkins Paula H. Simpkins Vice President and Assistant General Counsel cc: Members of the IIS STRIPS Task Force Members of the Primary Dealers Executive Committee Members of the Primary Dealers Committee Michael D. McCarthy, Jr., Goldman, Sachs & Co. Mark B.Werner, J.P. Morgan Securities Inc. Susan M. Estes, Morgan Stanley & Co., Inc. Selected Staff, The Bond Market Association