Solution Chapter

ANSWERS TO QUESTIONS FOR CHAPTER 6

(Questions are in bold print followed by answers.)

1. What are the differences among a Treasury bill, Treasury note, and Treasury bond? Fixed-principal Treasury securities are fixed-income principal securities that include Treasury bills, Treasury notes, and Treasury bonds. As discussed below the main differences involve maturity and how earnings are received over time. Treasury bills are issued at a discount to par value, have no coupon rate, and mature at par value. The current practice of the Treasury is to issue all securities with a maturity of one year or less as discount securities. As discount securities, Treasury bills do not pay coupon interest. Instead, Treasury bills are issued at a discount from their maturity value; the dollar return to investors is the difference between the maturity value and the purchase price. All securities with initial maturities of two years or more are issued as coupon securities. Coupon securities are issued at approximately par and, in the case of fixed-principal securities, mature at par value. Treasury coupon securities issued with original maturities of more than one year and no more than 10 years are called Treasury notes. Treasury coupon securities with original maturities greater than 10 years are called Treasury bonds. (On quote sheets, an “n” is used to denote a Treasury note. No notation typically follows an issue to identify it as a bond.) While a few issues of the outstanding bonds are callable, the Treasury has not issued new callable Treasury securities since 1984. 2. The following questions are about Treasury Inflation Protected Securities (TIPS). (a) What is meant by the “real rate”? In terms of TIPS, the real rate is the coupon rate. This is discussed below. On January 29, 1997, the U.S. Department of the Treasury issued for the first time Treasury securities that adjust for inflation. These securities are popularly referred to as Treasury inflation protection securities,...