UNIT-9

Market For Government Securities

 Treasury Securities
• Securities issued by the federal government is called
treasury securities.
• In Nepal, federal government has issued different
types of securities and raises the funds to meet the
deficit budget.
• Treasury securities are backed by full faith of the
government. So, they are considered as risk-free
securities. For e.g. development bonds, saving bonds
and treasury bills.
 Types of Treasury Securities
• There are two types of treasury securities.
1. Coupon Treasury Securities
• Government pays interest on coupon securities periodically
and maturity value at their maturity.
• Interest on interest on coupon securities is paid in every six
months.
• Coupon rates (interest rate) on securities are fixed on the basis
of competitive bids of investors.
2. Discount Securities
• Discount securities do not pay interest periodically. Discount
securities are sold on discount and paid the investors the
maturity face value of the securities.
• The difference between discounted value and par value
represents interest on bill.
• For e.g. Treasury bills and maturity period of treasury bills is
maximum on year and it ranges from 28 days to 364 days. All
treasury bills are discount securities.
 Treasury inflation protection securities (TIPS)
• Treasury securities in for which interest rate is set at fixed rate
via auction process and principal amounts are adjusted
according to the inflation rate semiannually.
• Such securities were issued for the first time in the USA in
1977. so far the government of Nepal has not issued this type
of securities.
• Coupon rate is calculated on the basis of inflation adjusted
principal.
•• We
  use the following equation to adjust the inflation to the
principal in every six month period.
• =
Where,
= compounded principal for t year
P= face value of securities
f= inflation rate
t= compounding period

 Primary Markets
• The primary market of the treasury securities is the market for
the newly issued treasury securities.
• In discount securities, auction of the purchase price is
submitted and in the case of coupon securities auction is done
for coupon rate.
• In Nepal, Public Debt Department of Nepal Rastra Bank
determines and publishes the auction cycles.
• Auction cycle depends on the maturity period of the securities.
In general, the auction cycle is longer for the securities with
longer maturity period. For e.g. auction cycle for three month
and six month bill is weekly and for two year note and five
year note is monthly.
 Determination of the results of an Auction
• Auction for Treasury securities is conducted on competitive
bidding basis.
• In the process of determining the results of an auction, first
noncompetitive tenders and nonpublic purchase are deducted
from the total securities being auctioned.
•• The
  remaining amount is the total amount to be awarded to the
competitive bidders.
• The treasury securities purchase by the central bank and other
government agencies is called nonpublic purchase.
• Non competitive tenders are based only on quantity not yield.
• )
Where,
= Amount available to the competitive bidders
= total amount of issue
= amount of nonpublic purchase
= amount of noncompetitive bids
• In the second step of determining the results of an auction for
treasury securities, we arrange the competitive bids in the
ascending order of highest yield to lowest yield.
• We started to allocate the securities to the bidders who submit
the bids for lowest yield and keeps on the allocation until the
amount to be distributed to the competitive bidders is
completely allocated.
• The highest yield accepted by the treasury is called stop yield.
• Any of the new issue is not distributed to the bidders who
submit their bids for more than stop yield. Such bidders are
called shot out or missed bidders.
• Let assume total competitive bid amount is Rs. 4600 Million

Amount ( in Million) Bid (yield) Cumulative Bid amount

500 5% 500
700 5.5 120
900 6 2100
1000 6.5 3100
1200 7 4300
1400 7.5 (stop yield) 5700
1500 (missed bidders) 8
1600 (missed bidders) 8.5
Secondary
•   Markets
• The secondary market for treasury securities are the over the
counter market where large number of government securities
dealers offer continuous bid and ask prices on the outstanding
securities. ( Bid price- purchase price, Ask price- Sell price)
• In Nepal, Nepal stock exchange ltd. Functions as the
secondary market for government securities.
1. Discount Yield
• The yield on treasury bill on a bank discount basis.
Y=
Where,
Y= Annualized yield on bank discount basis
D= Discount (In Rs)
F= Face Value
t= number of days remaining to maturity
• Discount
2.  
• Discount is the difference between the face value and the
price.
• D=F-V
Where,
D= Discount in Rs
F= Face value
V= price of the treasury bills
Or
D=Y*F*
3. Price of treasury bills
V= F-D
 Strips Treasury Securities
 Concept of Coupon Stripping
• Stripped treasury securities are called STRIPS which stands for the
acronym for separate trading of registered interest and principal
securities.
• Stripping the securities implies to detach the coupon of bonds from
the securities.
• Stripping the coupon treasury securities means to separate the
coupon from the principal of the securities.
 Process of Coupon Stripping
• Holders of coupon treasury securities can issue zero coupon bonds
by depositing them in bank custody account.
• Firms or dealer purchase the treasury securities and then they
deposit them into the bank custody account. And then the firms
issue the receipts that represents the ownership in each coupon
payment on the underlying treasury bond and a receipt for
ownership of the ownership of the underlying bonds’ maturity value.
 Security
Face Value= Rs. 100,000
Coupon=5%, semiannually
Maturity= 10 years

Cash Flow

Coupon: Rs. 2,500 Coupon: Rs. 2,500 Maturity Value: Rs. 100,000
Receipt in: 6 months Receipt in: 1 years Receipt in: 10 years

Zero Coupon Treasury Securities

Maturity Value: Rs. 2,500 Maturity Value: Rs. 2,500 Maturity Value: Rs. 1,00,000
Receipt in: 6 months Receipt in: 1 years Receipt in: 10 years
 Municipal Securities Markets
• In the federal system of the state, local government includes the
provincial (state) government, municipalities and other lower level
structure of the government such as district and village level
governments.
• All these local governments issue the municipal securities to finance
their deficit budget. Interest on municipal securities is exempted from
the taxes.
• These securities are not risk free.
1. Types and Features of Municipal Securities
• There are two basically two types of municipal security types: Tax
backed debt and revenue bonds.
a. Tax backed debt
• Tax backed debt is the security issued by local government secured
by some form of tax revenue. There are different types of tax backed
debt obligations. It includes general obligation debt, appropriation
backed obligations and debt obligations supported by public credit
enhancement program.
i. General obligation Debt
• The broadest type of tax backed debt is general obligation debt.
These bonds are usually serviced by the taxing power of the
issuing state or local authority.
ii. Appropriation backed obligations
• Debts backed by appropriation of funds from the state’s general
tax revenue are called appropriation backed obligations.
iii. Debt obligation supported by public credit enhancement
programs.
• State or federal is morally bound in the case of appropriation
backed obligation, but state is not legally bound to meet the debt
obligations.
• The credit enhancement provided by the guarantee of state or
federal agencies is legally enforceable.
b. Revenue Bonds
• The revenue bonds are those that are issued to raise the funds
to finance the particular project or enterprise and issued pledge
the revenue generated by the financed project or enterprise to
the bondholders.
 Municipal Bond Rating
• Treasury securities are risk free. But municipal bonds are not
risk free bonds. They are ranked in the second position after
the treasury securities with a view point of credit risk.
• Bond’s rating shows the credit risk inherent in municipal
bonds.
• The rating agency provides independent opinion about the
capability of an issuer to repay the debt.
• In Nepal, Municipal Bond has not issued yet.
• In Nepal, there are two credit rating agency: ICRA Nepal and
Care Rating Nepal
• ICRA Nepal’s Long Term Rating Scale

Rating Scale Definition

LAAA Highest Degree of safety regarding timely servicing of financial
obligations. Such instruments carry lowest credit risk.
LAA Highest Degree of safety regarding timely servicing of financial
obligations. Such instruments carry very low credit risk.
LA Adequate Degree of safety regarding timely servicing of financial
obligations. Such instruments carry low credit risk.
LBBB Moderate Degree of safety regarding timely servicing of financial
obligations. Such instruments carry moderate credit risk.
LBB Have moderate risk of default regarding timely servicing of financial
obligations.
LB Have high risk of default regarding timely servicing of financial
obligations.
LC Have very high risk of default regarding timely servicing of financial
obligations.
LD Instruments with this rating are in default or are expected to be in
default soon.
 Government Securities and Markets in Nepal
• Nepal Rastra Bank on behalf of Government of Nepal (GON)
issues different types of government securities to finance the
ever increasing deficit budget.
1. Treasury Bills
• Nepal Rastra Bank issues treasury bills with different maturity
periods. It issues 28 day, 91 day and 364 day treasury bills.
Treasury bills do not bear the coupon rate and they are fixed
by bidding process.
2. Development bonds
• Coupon rate on the development bonds are fixed through the
auction process. The maturity period of development bonds
ranges from 5 years to 15 years and sold through bidding
system.
3. National Saving Bonds
• Coupon rate of national saving bonds is specified and Nepal
Rastra Bank declares the coupon rate on bond on the notice
published for the invitation of the application. They are open
for both business firms and individual investors.
4. Citizen savings bonds
• These bonds are only issues for Nepalese Citizens. These
bonds bear the specific interest rate and coupon payment is
made in every six months. Maturity period is 5 years.
5. Foreign employment bonds
• These bonds are issued for Nepalese citizen working abroad
and Nonresident Nepalese. They are coupon bonds. They bear
specified coupon rate and coupon payment is made in every
six month.
6. Special Bonds
• The maturity of these bonds ranges from 1 year to 10 years.
Government has issued sometimes zero coupon bond special
bonds and sometime coupon bonds. Similarly, coupon
payments are made in some bonds in every six months or
annually and sometimes payment of coupon and principal is
made in lump sum. These bonds have special feature regarding
the tax on interest. Taxes on coupon payment on some bonds
are exempted and on some are taxable depending upon the
issues.