Derivatives Markets

Faculty: Mr. Aneesh Day

Division C, MBA 2018-20

TOPIC – TREASURY INSTRUMENTS

NAME PRN ROLL NO
Girivasan Kinnera Ayyar 18020441103 15
Himanshu Dutta 18020441111 16
Ikshita Tevatia 18020441113 17
Kajal 18020441125 18
Kajal Singh 18020441126 19
Kalappurakkal Sisira 18020441127 20
Ajaykumar
Kevin D Nott 18020441135 21
INTRODUCTION TO TREASURY MARKET AND INSTRUMENTS

A Treasury Market is a market where the government of a country raises money by issuing
debt. The vast majority of Treasury securities also trade in the secondary market in the same
manner as other types of bonds. Their prices rise accordingly when interest rates drop and
vice-versa. They can be bought and sold through virtually any broker or retail money
manager as well as banks and other savings
institutions. Investors who purchase Treasury
securities in the secondary market are still
guaranteed to receive the remaining interest
payments on the bond plus its face value at
maturity.
Treasury securities are used by virtually every
type of investor in the market. Individuals, institutions, estates, trusts and corporations
all use Treasury securities for various purposes. Many investment funds use
Treasuries to meet certain objectives while satisfying their fiduciary requirements, and
individual investors often purchase these securities because they can count on
receiving their principal and interest according to the specified schedule — without
fear of them being called out prematurely.
Fixed-income investors who live in staes with high-income tax rates can also benefit
from the tax exemption of Treasuries at the state and local levels.

NEED FOR TREASURY MARKET

• No return from holding excess reserves for a bank.
• Treasury investments yield returns for the holding period.
• Treasury investments provide maximum safety as they are the Sovereign’s
commitment.
• Treasury investments are needed to meet cash requirements of banks.

ADVANTAGE OF TREASURY MARKET

• Held in dematerialized form, hence there is no requirement for safekeeping of
instrument.
• Available in the market with different maturity durations to meet the long (30 years)
as well as short term (91 days) fund and investment requirements of banks.
• Secondary market provides required liquidity for trading in treasury investments.
• Used as collateral to borrow funds in the repo market.
• Simple and efficient system of settlement (delivery on payment) thereby reducing
settlement risk.
• Statutory needs of the bank are met through holding of treasury investments.

TREASURY INSTRUMENTS
There are four types of Treasury Instruments:
1. T-Bills
2. T-Notes
3. T-Bonds
4. TIPS

These are explained as follows:

1. T-BILLS: These have the shortest range of maturities of all government bonds.
Among bills auctioned on a regular schedule, there are five terms: 4 weeks, 8
weeks, 13 weeks, 26 weeks, and 52 weeks. Another bill, the cash management
bill, isn't auctioned on a regular schedule. It is issued in variable terms, usually
of only a matter of days. These are the only type of treasury security found in
both the capital and money markets, as three of the maturity terms fall under
the 270-day dividing line between them. T-Bills are issued at a discount and
mature at par value, with the difference between the purchase and sale prices
constituting the interest paid on the bill.

2. T-NOTES: These notes represent the middle range of maturities in the treasury
family, with maturity terms of 2, 3, 5, 7 and 10 years currently available. The
Treasury auctions 2-year notes, 3-year notes, 5-year notes, and 7-year notes
every month. The agency auctions 10-year notes at original issue in February,
 May, August, and November, and as reopening in the other eight months.
Treasury notes are issued at a $1,000 par value and mature at the same price.
They pay interest semiannually.

3. T-BONDS: Commonly referred to in the investment community as the “long

bond”, T-Bonds are essentially identical to T-Notes except that they mature in
30 years. T-Bonds are also issued at and mature at a $1,000 par value and pay
interest semiannually. Treasury bonds are auctioned monthly. Bonds are
auctioned at original issue in February, May, August, and November, and then
as reopening in the other eight months.

4. TIPS: Treasury Inflation-Protected Securities are inflation-indexed

bonds issued by the U.S. Treasury. The principal is adjusted with respect to
the Consumer Price Index (CPI), the most commonly used measure of inflation.
When the CPI rises, the principal is adjusted upward; if the index falls, the
principal is adjusted downwards. The coupon rate is constant, but generates a
different amount of interest when multiplied by the inflation-adjusted principal,
thus protecting the holder against the inflation rate as measured by the CPI.
TIPS were introduced in 1997. TIPS are currently offered in 5-year, 10-year and
30-year maturities.

EURODOLLAR

The term Eurodollar refers to U.S. dollar-denominated deposits at foreign banks or at

the overseas branches of American banks. Because they are held outside the United
States, Eurodollars are not subject to regulation by the Federal Reserve Board,
including reserve requirements. Dollar-denominated deposits not subject to U.S.
banking regulations were originally held almost exclusively in Europe, hence the name
Eurodollar. They are also widely held in branches located in the Bahamas and the
Cayman Islands.

HISTORY OF EURODOLLAR

The Eurodollar market dates back to the period after World War II. Much of Europe
was devastated by the war, and the United States provided funds via the Marshall
Plan to rebuild the continent. This led to wide circulation of dollars overseas, and the
development of a separate, less regulated market for the deposit of those funds. Unlike
domestic U.S. deposits, the funds are not subject to the Federal Reserve Bank's
reserve requirements. They are also not covered by FDIC insurance. This results in
higher interest rates for Eurodollars. Many American banks have offshore branches,
usually in the Caribbean, through which they accept Eurodollar deposits. European
banks are also active in the market. The transactions for Caribbean branches of U.S.
banks are generally executed by traders physically situated in U.S. dealing rooms, and
the money is on loan to fund domestic and international operations.

EURODOLLAR MARKETS

The Eurodollar market is one of the world's primary international capital markets. They
require a steady supply of depositors putting their money into foreign banks. These
Eurodollar banks may have problems with their liquidity if the supply of deposits drops.

EURODOLLAR PRICING AND SIZE

Deposits from overnight out to a week are priced based on the fed funds rate. Prices
for longer maturities are based on the corresponding London Interbank Offered Rate
(LIBOR). Eurodollar deposits are quite large; they are made by professional
counterparties for a minimum of $100,000 and generally for more than $5 million. It is
not uncommon for a bank to accept a single deposit of $500 million or more in the
overnight market. A 2014 study by the Federal Reserve Bank showed an average daily
volume in the market of $140 billion.

EURODOLLAR MATURITIES

Most transactions in the Eurodollar market are overnight, which means they mature
on the next business day. With weekends and holidays, an overnight transaction can
take as long as four days. The transactions usually start on the same day they are
executed, with money paid between banks via the Fed wire and CHIPS systems.
Eurodollar transactions with maturities greater than six months are usually done as
certificates of deposit (CDs), for which there is also a limited secondary market.
TRADING EURODOLLAR FUTURES

Easily confused with the currency pair EUR/USD or euro FX futures, Eurodollars have
nothing to do with Europe’s single currency that was launched in 1999. Rather,
Eurodollars are time deposits denominated in U.S. dollars and held at banks outside
the United States. A time deposit is simply an interest-yielding bank deposit with a
specified date of maturity. As a result of being outside U.S. borders, Eurodollars are
outside the jurisdiction of the Federal Reserve and subject to a lower level of
regulation. As Eurodollars are not subject to U.S. banking regulations, the higher level
of risk to investors is reflected in higher interest rates.

The name Eurodollars was derived from the fact that initially dollar-denominated
deposits were largely held in European banks. At first, these deposits were known
as euro bank dollars. However, U.S. dollar-denominated deposits are now held in
financial centers across the globe and still referred to as Eurodollars. Similarly, (and
also confusingly), the term eurocurrency is used to describe currency deposited in a
bank that is not located in the home country where the currency was issued. For
example, Japanese yen deposited at a bank in Brazil would be defined as
eurocurrency.

EURODOLLAR FUTURES

The Eurodollar futures contract was launched in 1981 by the Chicago Mercantile
Exchange (CME), marking the first cash-settled futures contract. On expiration, the
seller of cash-settled futures contracts can transfer the associated cash position rather
than making a delivery of the underlying asset. Eurodollar futures were initially traded
on the upper floor of the Chicago Mercantile Exchange in its largest pit, which
accommodated as many as 1,500 traders and clerks. However, the majority of
Eurodollar futures trading now takes place electronically. The underlying instrument in
Eurodollar futures is a Eurodollar time deposit, having a principal value of $1
million with a three-month maturity.
The “open outcry” Eurodollar contract symbol (i.e. used on trading floors, where orders
are communicated by shouts and hand signals) is ED and the electronic contract
symbol is GE. Electronic trading of Eurodollar futures takes place on the CME Globex
electronic trading platform, Sunday through Friday, 6 p.m. to 5 p.m. EST. The
expiration months are March, June, September and December, as with other financial
futures contracts. The tick size (minimum fluctuation) is one-quarter of one basis point
(0.0025 = $6.25 per contract) in the nearest expiring contract month and one-half of
one basis point (0.005 = $12.50 per contract) in all other contract months. The
leverage used in futures allows one contract to be traded with margin of about $1,000.

Eurodollars have grown to be the leading contract offered on the CME in terms of
average daily volume and open interest (the total number of open contracts). As of
February 2018, Eurodollars far surpassed E-Mini S&P 500 futures (an electronically
traded futures contract one-fifth the size of the standard S&P 500 futures
contract), crude oil futures and 10-Year Treasury Note futures in average daily trading
volume and open interest.

HEDGING WITH EURODOLLAR FUTURES

Eurodollar futures provide an effective means for companies and banks to secure an
interest rate for money it plans to borrow or lend in the future. The Eurodollar contract
is used to hedge against yield curve changes over multiple years into the future.

For example: Say a company knows in September that it will need to borrow $8 million
in December to make a purchase. Recall that each Eurodollar futures contract
represents a $1-million-time deposit with a three-month maturity. The company can
hedge against an adverse move in interest rates during that three-month period by
short selling eight December Eurodollar futures contracts, representing the $8 million
needed for the purchase.

The price of Eurodollar futures reflects the anticipated London Interbank Offered Rate
(LIBOR) at the time of settlement, in this case, December. By short selling the
December contract, the company profits from upward movement in interest rates,
reflected in correspondingly lower December Eurodollar futures prices.
Let’s assume that on Sept. 1, the December Eurodollar futures contract price was
exactly $96.00, implying an interest rate of 4.0%, and that at the expiry in
December, the final closing price is $95.00, reflecting a higher interest rate of 5.0%. If
the company had sold eight December Eurodollar contracts at $96.00 in September,
it would have profited by 100 basis points (100 x $25 = $2,500) on eight contracts,
equaling $20,000 ($2,500 x 8) when it covered the short position.

In this way, the company was able to offset the rise in interest rates, effectively locking
in the anticipated LIBOR for December as it was reflected in the price of the
December Eurodollar contract at the time it made the short sale in September.

SPECULATING WITH EURODOLLAR FUTURES

As an interest rate product, the policy decisions of the U.S. Federal Reserve have a
major impact on the price of Eurodollar futures. Volatility in this market is normally
seen around important Federal Open Market Committee (FOMC) announcements and
economic releases that could influence Federal Reserve monetary policy. A change
in Federal Reserve policy toward lowering or raising interest rates can take place over
a period of years. Eurodollar futures are impacted by these major trends in monetary
policy. The long-term trending qualities of Eurodollar futures make the contract an
appealing choice for traders using trend-following strategies. Consider the following
chart between 2000 and 2007, where the Eurodollar trended upward for 15
consecutive months and later trended lower for 27 consecutive months.

The high levels of liquidity along with relatively low levels of intraday volatility (i.e.
within one day) create an opportunity for traders using a “market making” style of
trading. Traders using this non-directional strategy (neither bullish nor bearish) place
orders on the bid and the offer simultaneously, attempting to capture the spread. More
sophisticated strategies such as arbitrage and spreading against other contracts are
also used by traders in the Eurodollar futures market.

Eurodollars are used in the TED spread, which is used as an indicator of credit risk.
The TED spread is the price difference between interest rates on three-month futures
contracts for U.S. Treasuries and three-month contracts for Eurodollars with the same
expiration months. TED is an acronym using T-Bill and ED, the symbol for the
Eurodollar futures contract. An increase or decrease in the TED spread reflects
sentiment on the default risk level of interbank loans.

Figure 1: Eurodollars have historically shown long periods of trending price

movement between long periods of trading sideways.

T-BILLS
When the government is going to the financial market to raise money, it can do it by
issuing two types of debt instruments – treasury bills and government bonds. Treasury
bills are issued when the government need money for a shorter period while bonds
are issued when it need debt for more than say five years.

Treasury bills; generally shortened as T-bills, have a maximum maturity of a 364 days.
Hence, they are categorized as money market instruments (money market deals with
funds with a maturity of less than one year).

Treasury bills are presently issued in three maturities, namely, 91 days, 182 days and
364 days. Treasury bills are zero coupon securities and pay no interest. Rather, they
are issued at a discount (at a reduced amount) and redeemed (given back money) at
the face value at maturity. For example, a 91-day Treasury bill of Rs.100/- (face value)
may be issued at say Rs. 98.20, that is, at a discount of say, Rs.1.80 and would be
redeemed at the face value of Rs.100/-. This means that you can get a hundred-rupee
treasury bill at a lower price and can get Rupees hundred at maturity.

The return to the investors is the difference between the maturity value or the face
value (that is Rs.100) and the issue price. The Reserve Bank of India conducts
auctions usually every Wednesday to issue T-bills. The rational is that since their
maturity is lower, it is more convenient to avoid intra period interest payments.

Treasury bills are usually held by financial institutions including banks. They have a
very important role in the financial market beyond investment instruments. Banks give
treasury bills to the RBI to get money under repo. Similarly, they can keep it as part of
SLR.

ADVANTAGES OF TREASURY BILLS:

Objective of issuing T-Bills is to fulfill the short term money borrowing needs of the
government. T-bills have an advantage over the other bills such as:
Zero Risk weightage associated with them. They are issued by the government and
sovereign papers have zero risk assigned to them, High liquidity because 91 days and
36 days are short term maturity.

The secondary market of T-Bills is very active so they have a higher degree of
tradability. Treasury Bills are issued only by the central government in India. The State
governments do not issue any treasury bills. Interest on the treasury bills is determined
by market forces. Treasury bills are available for a minimum amount of Rs. 25,000 and
in multiples of Rs. 25,000.

The above image is a Dated Security. T-Bills with long term investment period is a
Dated Securities. Dated securities are long term instruments issued by the
government for borrowing. Short term instruments are treasury bills that have a
maturity of less than one year (91 days, 182 days (now not issued) and 364 days). For
treasury bills, there is no interest payments but the bill is obtained at a discount. For
example, for a Rs 100 treasury bill can be availed at Rs 97.5 rupees and at the maturity
date, Rs 100 will be paid to the buyer.
India’s appetite for US treasury bills rising
India has once again started gaining an appetite for US treasury securities, increasing
its purchases of the US paper by almost $7 billion between November and January.
With yields on the US sovereign bond falling, India could well make some mark-to-
market (MTM) gains on its investments. The RBI held $144.9 billion of US treasury
securities at the end of January, according to the latest data released by the
Department of the Treasury. That compares with $138.2 billion at the end of October,
which was the lowest level in 2018. India’s purchases over the three months
aggregated to about $6.7 billion. “Of the many possible reasons for the rise in US
treasury investment, one could have been a redeployment from other currencies into
the US dollar, given expectations of valuation gain with the Fed increasingly moving
towards a more accommodating policy,” said Saugata Bhattacharya, chief economist
at Axis Bank. After losing almost $30 billion from its forex kitty between April and early
November, India’s forex reserves slowly started increasing in mid-November.

“Part of this might also have been due to deployment of fresh forex assets of RBI with
higher dollar inflows seen in late 2018,” said Bhattacharya. Other economists
corroborated the view. “RBI’s foreign currency reserves have increased since the end
of October 2018 and some of these additional reserves have likely been deployed into
US treasuries,” said Ananth Narayan, associate professor of finance at SP Jain
Institute of Management and Research. US treasury yields have come down this
quarter and the RBI should have revaluation MTM gains on its bond portfolio. The 10-
year US Treasury yields have fallen 60-70 bps since November and are now at 2.44
per cent. Bond yields and prices move in opposite directions. “However, such gains
are not booked as income unless they are recognised through sale of bonds,” Narayan
said. A Morgan Stanley report said the US FOMC kept the federal funds target range
unchanged at 2.25-2.5 per cent at its March meeting, leaving all the action for the
accompanying materials where policymakers indicated no plans for rate hikes this
year, and a more dovish policy path over the next couple of years, alongside plans to
wind down balance sheet normalisation beginning in May and concluding at the end
of September 2019.

This could mean that if yields move down and bond prices rise, there is a good
opportunity for the RBI to book profit by again offloading securities and moving to
other eligible investments.

TREASURY BOND

A Treasury Bond is the longest term security that the government issues into the fixed
income market. Because it is a government security it is essentially
a risk free instrument, but because of its longevity it has a higher interest rate than that
of the t bill. It is fairly liquid in the markets and is sold in denominations of $1,000 or
more for 10 years or longer.

MATURITY RANGE

Treasury bonds are issued with maturities that can range from 10 to 30 years. They
are issued with a minimum denomination of $1,000, and coupon payments on the
bonds are paid semiannually. The bonds are initially sold through auction in which the
maximum purchase amount is $5 million if the bid is noncompetitive or 35% of the
offering if the bid is competitive. A competitive bid states the rate the bidder is willing
to accept; it is accepted depending on how it compares with the set rate of the bond.
A noncompetitive bid ensures the bidder gets the bond, but he has to accept the set
rate. After the auction, the bonds can be sold in the secondary market.

There is an active secondary market for Treasury bonds, making the investments
highly liquid. The secondary market also makes the price of Treasury bonds fluctuate
considerably on the trading market. As such, current auction and yield rates of
Treasury bonds dictate their pricing levels on the secondary market. Similar to other
types of bonds, Treasury bonds on the secondary market see prices go down when
auction rates increase, as the value of the bond’s future cash flows is discounted at
the higher rate. Inversely, when prices increase, auction rate yields decrease.

STRUCTURE OF A TREASURY BOND

Treasury bonds offer investors a basic fundamental investment structure, as follows:

 Treasury notes and bonds come with maturities of 10 to 30 years. Both a 10-
year and 30-year Treasury holds a minimum face value amount of $1,000,
although both are sold in $100 increments if purchased directly from the U.S.
Treasury.

 Treasury securities are traded in a highly liquid secondary market, known as

the fixed-income market (more commonly known as the bond market.) They
can also be purchased directly at TreasuryDirect.com. Investors also can buy
Treasury bonds through a bank or broker, but they will likely pay a fee or
commission for doing so and may not be able to purchase T-bonds in the
smaller $100 allotments offered by the government.

 The term “fixed income” means that Treasury bonds deliver a fixed interest rate
pay out, paid to investors twice annually, or every six months.

 In addition to the semi-annual interest rate payments, bondholders eventually

get all of their investment principal back. When a Treasury bond matures –
meaning it has reached its maturity date and expires – the investor is paid out
 the full face value of the T-bond. That means if the bondholder holds a Treasury
bond worth $10,000, he or she will receive the $10,000 principal back, as well
as earning interest on the investment.

 Treasury bonds are liquid, meaning they can be sold by bondholders before
they mature. Or, the bondholder can elect to hang on to the Treasury bond until
the bond’s maturity date.

 Bonds, which tend to be less volatile and less prone to big price swings than
stocks, are a great way to keep investment portfolio assets in safety mode, an
investment strategy known as capital preservation. Treasury bonds are widely
considered a risk-free investment, as they have extremely low odds of default
since they are backed fully by the U.S. government.

TAX IMPLICATION

Tax-wise, Treasury bonds are fairly straightforward.

Any interest earned on a Treasury bond investment is tax-exempt at the state and
local levels, but that interest is taxed by the federal government.

TIPS FOR INVESTING IN TREASURY BONDS

1. Buy direct. If possible, it’s preferable to buy Treasury bonds directly at

TreasuryDirect.gov. That way, you’re buying your bonds directly from the
federal government, thus eliminating the fees that come with buying bonds
through a middleman, as you would with a brokerage firm.
2. Buy closer to retirement. When you’re young, investing in higher-risk, but
higher-reward stocks represent capital appreciation. In short, you’re creating
long-term wealth with your stock investments. However, when you’re either
nearing or already in retirement, you want to preserve all that wealth you’ve
created. You can accomplish that via capital preservation tools like T-bonds,
which represent lower-risk investments that reduce your odds of losing money
in a market downturn.
 3. Go the ETF route. An effective, low-cost way to get in on the Treasury bond
game is to invest in Treasury ETFs, or exchange traded funds. Any low-cost,
diversified Treasury-oriented ETF that emphasizes a long-term T-bond
component is worth looking at. You can even mix and match different Treasury
security funds without having to pony up the $1,000 minimum needed to buy
Treasury bonds from many banks and brokers.

TREASURY NOTES

A treasury note is a marketable U.S. government debt security with a fixed interest
rate and a maturity between one and ten years. They mature in two, three, five, or ten
years.

Treasury notes are extremely popular investments, as there is a large secondary

market that adds to their liquidity. Interest payments on the notes are made every six
months until maturity. The income for interest payments is not taxable on a municipal
or state level but is federally taxed, similar to the Treasury bond.

o Interest Rate Risk

The longer the maturity, the higher the note’s or bond’s exposure to interest rate
risks. In addition to credit strength, a note or bond’s value is determined by its
sensitivity to changes in interest rates. Most commonly, a change in rates occurs at
the absolute level underneath the control of a central bank or within the shape of the
yield curve.

o Duration

A good example of an absolute shift in interest rates occurred in December 2015,

when the Federal Reserve (Fed) raised the federal funds rate range by 25 basis points
to 0.25 to 0.50%. This increase in benchmark interest rates has had the effect of
decreasing the price of all outstanding U.S. Treasury notes and bonds. Moreover,
these fixed-income instruments possess differing levels of sensitivity to changes in
rates, which means that the fall in prices occurred at various magnitudes. This
sensitivity to shifts in rates is measured by duration and expressed in terms of
years. Factors that are used to calculate duration include coupon, yield, present value,
final maturity, and call features.
o Shifts in the Yield Curve

In addition to the benchmark interest rate, elements such as changing investors’

expectations create shifts in the yield curve, known as yield curve risk. This risk is
associated with either a steepening or flattening of the yield curve, a result of altering
yields among similar bonds of different maturities. For example, in the case of a
steepening curve, the spread between short- and long-term interest rates
widens. Thus, the price of long-term notes decreases relative to short-term notes. The
opposite occurs in the case of a flattening yield curve. The spread narrows and the
price of short-term notes decrease relative to long-term notes.

 HOW THEY WORK

T-notes make semi-annual interest payments at fixed coupon rates. The notes usually
have $1,000 face values, although those with two- or three-year maturities have
$5,000 face values.

Treasury notes help fund shortfalls in the federal budget, regulate the nation's money
supply, and execute U.S. monetary policy. Like any bond issuer, the U.S. Treasury
considers the market's risk and return requirements in order to successfully and
efficiently raise capital.

As with all Treasuries, T-notes are backed by the full faith and credit of the U.S.
government. This means default is extremely unlikely and would really only occur if
the U.S. government could not print additional money to pay off its debt. For this
reason, the notes are generally considered risk-free investments and act as
benchmarks against which other investments are compared. Their low risk and
extremely high level of liquidity result in treasury notes to usually have the lowest
yields of any bonds on the market.

Birth of a Treasury Note: The Auction Process

First, the Treasury announces the sizes of any upcoming auctions and the bidding
deadline. The Treasury then awards the securities to the highest institutional bidder
first, then the second-highest, and so on. This way, the government takes in the most
revenue. Individual investors can buy at the average price bid by the institutional
dealers.
Ways to Purchase Treasuries

Institutional investors make up most of the market for Treasuries, but individual
investors can easily purchase and trade the notes as well.

o Buy from the U.S. Treasury: Visit the Treasury Direct website and open an account.
(There is no charge.) Once your account is open, you choose the type of security
you want to buy (in this instance, a Treasury Note) and the amount. You also agree
to accept the yield that is determined at the auction.
o Make a Purchase through your Bank, a Dealer or Broker: If you decide to buy
Treasury Notes through one of these sources, you can specify the yield you will
accept (competitive) or agree to accept the yield as determined at auction (non-
competitive).

With a competitive bid, investors specify the yield they want, at the risk that their bid
may not be approved; with a non-competitive bid, investors accept whatever yield is
determined at auction.

 ADVANTAGES OF INVESTING IN T-NOTES

o T-Notes and Interest Rates

The Treasury Department Sells T-Notes with a fixed interest rate at an auction.
Bidders are free to pay more than the face value of the note to get the benefit of the
fixed rate during times when demand for T-Notes is high. When demand is lower,
investors can buy T-Notes for less than their face value.

o Treasury Notes Are Safe Investments

One of the main advantages of choosing T-Notes is that they are considered one
of the safest investments, according to the Securities Industry and the Financial
Markets Association. Since they are backed by the full faith and credit of the United
States government and are considered to be the safest of all investments, T-Notes
are not rated by any credit rating agency, such as Standard and Poor's or Moody's,
because they are considered to have no risk of default.

o No Surprises with Investment Return

Unlike some other types of investments which fluctuate in value over time and with
 changes in market conditions, Treasury Notes pay out at a set interest rate until
their maturity date. Since the interest rate stays constant, you will be able to plan
how much you can expect to get back over the term.

o Sell Your T-Notes Anytime

You have the option of holding your Treasury Notes until they mature, or you can
sell them in the secondary market if you decide you want to convert them to cash
at any point. The market for T-Notes and other U.S. government securities is one
of the largest and most liquid bond markets in the world. You can sell your T-Notes
in the secondary market through your bank, investments broker or dealer.

o Exempt from Certain Income Taxes

T-Notes pay regular interest every six months. The interest paid on your T-Notes is
fully taxable on your federal income tax return in the year you receive it, but it is
exempt from all state and local income taxes.

 WHY THEY MATTER?

All investors, even those who don't own treasury notes, should understand that
treasury rates affect the entire economy. This is partially because the government's
sale or repurchase of treasuries affects the money supply and influences interest
rates. For example, when the Federal Reserve repurchases treasuries, sellers deposit
the proceeds at their local banks, which in turn lend to customers, who deposit their
loan proceeds in their bank accounts, and so on. Thus, every dollar of treasuries
repurchased by the government increases the money supply by several dollars. This
causes the supply of money for lending to increase, causing lending rates to fall.

T-notes are widely regarded as some of the safest investments around. They can be
especially attractive for the most risk-averse investors and those primarily interested
in preserving capital or maintaining a consistent stream of income.

 T-NOTES FUTURES

Treasury futures are derivatives that track the prices of specific Treasury securities.
 To go long a Treasury futures contract is to agree to take delivery of the underlying
securities at the price at which you went long (adjusted for differences between various
deliverable bonds). Because Treasury futures (like other futures contracts) go up and
down with their underlying assets, you would go long Treasury futures for the same
reason you would buy the underlying Treasuries: You expect the underlying
Treasuries to go up in price.

U.S. Treasury futures and options contracts are available for each of the Treasury
benchmark tenors: 2-year, 5-year, 10-year, and 30-year.

Of the three t-note types, the most commonly quoted and discussed is the 10-year t-
note because it articulates long-term expectations of the market.

o Participating in 10-year T-Note futures allows a trader to assess directionality of

interest rates as well the ability to hedge risk at the end of a yield curve. Participating
in 10-year T-Note futures can also allow one to use a variety of trading strategies
like spread trading and trading against different Treasury futures.

10-YEAR U.S. TREASURY NOTE CONTRACT SPECIFICATIONS

Underlying Unit One U.S. Treasury note having a face value at maturity of $100,000.
Deliverable Grades U.S. Treasury notes with a remaining term to maturity of at least six
and a half years, but not more than 10 years, from the first day of the
delivery month. The invoice price equals the futures settlement price
times a conversion factor, plus accrued interest. The conversion
factor is the price of the delivered note ($1 par value) to yield 6
percent.
Price Quote Points ($1,000) and halves of 1/32 of a point. For example, 126-16
represents 126 16/32 and 126-165 represents 126 16.5/32. Par is on
the basis of 100 points.
Tick Size One-half of one thirty-second (1/32) of one point ($15.625, rounded
(minimum up to the nearest cent per contract), except for intermonth spreads,
fluctuation) where the minimum price fluctuation shall be one-quarter of one
thirty-second of one point ($7.8125 per contract).
Contract Months The first five consecutive contracts in the March, June, September,
and December quarterly cycle.
Last Trading Day Seventh business day preceding the last business day of the delivery
month. Trading in expiring contracts closes at 12:01pm on the last
trading day.
Last Delivery Day Last business day of the delivery month.
Delivery Method Federal Reserve book-entry wire-transfer system.

o Participating in 5-year T-Note futures allows a trader to assess directionality of

interest rates as well the ability to hedge risk at the midpoint of a yield curve.

5-YEAR U.S. TREASURY NOTE CONTRACT SPECIFICATIONS

Underlying Unit One U.S. Treasury note having a face value at maturity of $100,000.
Deliverable U.S. Treasury notes with an original term to maturity of not more than
Grades five years and three months and a remaining term to maturity of not
less than four years and two months as of the first day of the delivery
month. The invoice price equals the futures settlement price times a
conversion factor, plus accrued interest. The conversion factor is the
price of the delivered note ($1 par value) to yield 6 percent.
Price Quote Points ($1,000) and quarters of 1/32 of a point. For example, 119-16
represents 119 16/32, 119-162 represents 119 16.25/32, 119-165
represents 119 16.5/32, and 119-167 represents 119 16.75/32. Par is
on the basis of 100 points.
Tick Size One-quarter of one thirty-second (1/32) of one point ($7.8125,
(minimum rounded up to the nearest cent per contract), including intermonth
fluctuation) spreads.
Contract Months The first five consecutive contracts in the March, June, September,
and December quarterly cycle.
Last Trading Last business day of the calendar month. Trading in expiring contracts
Day closes at 12:01 p.m. on the last trading day.
Last Delivery Third business day following the last trading day.
Day

Delivery Method Federal Reserve book-entry wire-transfer system.

2-YEAR U.S. TREASURY NOTE CONTRACT SPECIFICATIONS
Underlying Unit One U.S. Treasury note having a face value at maturity of
$200,000.
Deliverable Grades U.S. Treasury notes with an original term to maturity of not more
than five years and three months and a remaining term to maturity
of not less than one year and nine months from the first day of the
delivery month and a remaining term to maturity of not more than
two years from the last day of the delivery month. The invoice
price equals the futures settlement price times a conversion
factor, plus accrued interest. The conversion factor is the price of
the delivered note ($1 par value) to yield 6 percent.
Price Quote Points ($2,000) and quarters of 1/32 of a point. For example, 109-
16 represents 109 16/32, 109-162 represents 109 16.25/32, 109-
165 represents 109 16.5/32, and 109-167 represents 109
16.75/32. Par is on the basis of 100 points.
Tick Size One-quarter of one thirty-second (1/32) of one point ($15.625,
(minimum rounded up to the nearest cent per contract), including intermonth
fluctuation) spreads.
Contract Months The first five consecutive contracts in the March, June,
September, and December quarterly cycle.
Last Trading Day Last business day of the calendar month. Trading in expiring
contracts closes at 12:01pm on the last trading day.
Last Delivery Day Third business day following the last trading day.
Delivery Method Federal Reserve book-entry wire-transfer system.

o Participating in 2-year T-Note futures allows a trader to assess directionality of

interest rates as well the ability to hedge risk at the short end of a yield curve

TREASURY MARKET IN INDIA

 First issued in India in 1917.
 The period does not exceed a year.
 Treasury bills are instrument of short-term borrowing by the Government of
India, issued as promissory notes under discount.
  The interest received on them is the discount, which is the difference between
the price at which they are issued and their redemption value.
 They have assured yield and negligible risk of default. Under one classification,
treasury bills are categorised as ad hoc, tap and auction bills.
 Under another one, it is classified on the maturity period like 91-days TBs, 182-
days TBs, 364-days TBs and also 10-days TBs which has two types.
 In the recent times (2002–03, 2003–04), the Reserve Bank of India has been
issuing only 91-day and 364-day treasury bills.
 The auction format of 91-day treasury bill has changed from uniform price to
multiple price to encourage more responsible bidding from the market players.
 The bills are of two kinds- Ad-hoc and regular.
 The ad-hoc bills are issued for investment by the state governments, semi
government departments and foreign central banks for temporary investment.
They are not sold to banks and general public. The treasury bills sold to the
public and banks are called regular treasury bills. They are freely marketable
and commercial banks buy entire quantities of such bills, issued on tender.
They are bought and sold on discount basis. Ad-hoc bills were abolished in
April 1997.
Treasury bills or T-bills, which are money market instruments, are short term debt
instruments issued by the Government of India and are presently issued in three
tenors, namely, 91 days, 182 days and 364 days. Treasury bills are zero coupon
securities and pay no interest. They are issued at a discount and redeemed at the face
value at maturity. For example, a 91-day Treasury bill of ₹100/- (face value) may be
issued at say 98.20, that is, at a discount of say, ₹1.80 and would be redeemed at the
face value of ₹100/-.

FEATURES OF TREASURY BILLS

Form: T-bills are issued either in physical form as a promissory note or dematerialised
form by crediting to Subsidiary General Ledger (SGL) Account.
Eligibility: Individuals, firms, companies, trust, banks, insurance companies,
provident funds, state government and financial institutions are eligible to invest in
treasury bills.
Minimum Bid: The minimum amount of bid is Rs. 25000 and in multiples thereof.
Issue price: T-bills are issued at a discount, but redeemed at par.
Repayment: The repayment of the bill is made at par on the maturity of the term.
Availability: Treasury bills are highly liquid negotiable instruments, that are available
in both financial markets, i.e. primary and secondary.
Method of the auction: Uniform price auction method for 91 days T-bills, whereas
multiple price auction method for 364 days T-bill.
Day count: The day count is 364 days, in a year, for treasury bills.
Besides this, other characteristics of treasury bills include market-driven discount rate,
selling through auction, issued to meet short-term mismatches in cash flows, assured
yield, low transaction cost, etc.

TYPES OF TREASURY BILLS

Ordinary or Regular Treasury Bills:
 Issued to public and other financial institutions
 These bills are freely marketable
Ad Hoc:
 Issued in favour of RBI only.
 They are not sold through tender or auction.
At present there are three types of auctioned T-bills, which are:
91 days T-bills: The tenor of these bills complete on 91 days. These are auctioned
on Wednesday, and the payment is made on following Friday.
182 days T-bills: These treasury bills get matured after 182 days, from the day of
issue, and the auction is on Wednesday of non-reporting week. Moreover, these are
repaid on following Friday, when the term expires.
364 days T-bills: The maturity period of these bills is 364 days. The auction is on
every Wednesday of reporting week and repaid on the following Friday after the term
gets over.
Treasury bills are backed by some advantages like no tax deducted at source, high
liquidity and trade-ability, zero risks of default, transparency, good return on
investment and so on.
PARTICIPANTS
 RBI and SEBI
 Commercial banks
 State governments
 DFHI
 STCI
 Financial institutions like LIC, GIC, UTI, IDBI, ICICI, IFCI, NABRD
 Corporate customers
 Public
MERITS:
 Safety
 Liquidity
 Ideal short term investment
 Ideal fund management
 Statutory liquidity requirement
  Source of short term funds
 Non-inflationary monetary tool

DEMERITS:
 Poor yield
 Absence of competitive bids
 Absence of active trading
T-BILLS CALCULATION

TREASURY MARKET IN US:

Treasury securities, also called Treasuries, are debt instruments issued by the U.S.
Department of Treasury and backed by the full faith and credit of the U.S. government.
U.S. Government securities are attractive to investors because they are free of
default risk, benefit from state and local tax exemption, and are among the most liquid
of financial instruments. Before the development of the European bond market due to
the creation of the EMU, the U.S. market was the largest in the word in terms of
volume, followed by the Japanese, Italian, German and French markets. In the U.S.A.,
market participants can rapidly execute large-volume transactions for government
debt, and the spread between ask and bid price is low if compared with other sectors
of the bond market. These conditions ensure one of the highest degrees of liquidity in
the Treasury securities markets worldwide.
There are two categories of Treasury securities:

1. Coupon securities

2. Discount securities.

The first type pays interest every six months, plus principal at maturity. Discount
securities pay a contractually fixed amount at maturity (face value or maturity value).
The positive spread between the face value and the issue value represents the
corresponding returns. The categories of Treasury Securities available are Treasury
Bills, Treasury Notes, Treasury Bonds and Treasury Inflation-Protected Securities
(TIPS). The auctions for Treasury securities are run by the US Federal Reserve of
New York and the Bureau of Public Debt (BPD) in Washington D.C. and they are
based on the competitive bidding method. Typically, a high volume of Treasury
securities is purchased at auction by "primary dealers" through the submission of
competitive bids.

Stripped US Treasury Zero Bonds: Even if the Treasury does not issue zero-coupon
bonds, these are purchased by investment and banking firms that are allowed to
create their own receipt using the process of coupon stripping. These receipts are
generally referred to as Stripped US Treasury Zero Bonds.
WHY US MARKET INSTRUMENTS?

The debt obligations of US markets are backed by the “full faith and credit” of the
government, and thus by its ability to raise tax revenues and print currency, U.S.
Treasury securities – or "Treasuries" – are generally considered the safest of all
investments. They are viewed in the market as having virtually no “credit risk,”
meaning that it is highly probable your interest and principal will be paid fully and on
time.

Because of this unique degree of safety, interest rates are generally lower for this class
of securities than for other widely traded debt, riskier debt securities such as corporate
bonds. A good rule of thumb to follow is that safer investments offer lower returns.
Conversely, the higher the risk, the higher the return.

VOLUME OF US TREASURY SECURITIES MARKET:

The total amount of marketable U.S. Treasury securities, that is Treasuries that trade
on the open market, is massive with $13.9 trillion in outstanding bills, notes, bonds,
FRNs, and TIPS as of December 31, 2016. The Treasury market is one of the world’s
most liquid debt markets, meaning it is one where pricing, executing and settling a
trade is highly efficient.
The average daily trading volume of marketable Treasuries was $514.22 billion in
2016. Because of their low risk of default and relatively high level of liquidity,
Treasuries are popular with all types of investors. As of the end of 2016, the U.S.
Federal Reserve estimated that 8.8% of bills, notes and bonds were held by
individuals, 15.1% by banks and mutual funds, 14.5% by public and private pension
funds, 38.2% by foreign investors, 4.5% by state and local governments and 18.9%
by other investors.

TREASURY RISK:

The rise of electronic trading, another market feature highlighted in the Joint Staff
Report, helped to identify a third priority area: the market practices and risks
associated with the Treasury market. Market infrastructure-including the financing of
Treasury transactions, as well as the clearing and settlement of those transactions-
seldom merits investor attention until an element that is vital to smooth functioning of
the market goes awry.

A major infrastructure issue for the Treasury market has been the clearing and
settlement practices of the cash market. This can be opaque, with a majority of trades
cleared away from central counterparties (CCPs). While central clearing is more
uniformly used in other segments of the Treasury market-such as futures-many market
participants elect to clear and settle cash Treasury transactions in a bilateral fashion.

Since the financial crisis, there has been an effort to strengthen the resiliency of repo
market infrastructure, which is another important element of Treasury market
plumbing. Immediately after the crisis, the Federal Reserve was active in pushing
reform of the tri-party repo market, which had been a locus of stress in 2008. More
recently, Treasury repo markets have undergone further changes, including market
adaptations to post-financial crisis regulations, and the introduction of multiple
programs expanding access to central clearing to a wider range of market
participants. These markets also have been affected by efforts to set heightened
expectations for CCPs with regard to liquidity risk management, margins, and
governance and recovery planning.
 The EURODOLLAR cash market
Eurodollar futures contract
Theoretical pricing of Eurodollar futures contracts
Arbitrage pricing of Eurodollar pricing contract
Shortening the maturity of a Eurodollar time deposit
Lengthening the maturity of a Eurodollar time deposit