Economics 434
Financial Markets
Professor Burton
University of Virginia
Fall 2015
October 15, 2015
Present Value is the most Crucial
Concept in Finance
• Value of future stream of
payments
• As valued today
• Emphasis on
“discounting” future
revenue streams
• Common practice to use
higher rates to reflect
higher uncertainty of
receipt of future
payments
Default Free Securites
(Sovereign Debt)
• US Treasuries ($ 18 trillion outstanding)
– Bills (less than one year in original maturity)
– Notes (ten years or less, longer than one year)
– Bonds (greater than ten years at issuance)
• Random facts
– Bills are called discount issues: 3 mo, 6 mo, year
bills. Year assumed to be 360 days.
– Notes and bonds are “coupon” issues; pay fixed
coupons twice yearly
October 15, 2015
Naming conventions
• Bills named by their maturity date
– “12/15 14” for example
• Notes and bonds are named by: (i) their
coupon rate; and (ii) their maturity date
– “14s of Nov 11” was originally issued in midNovember of 1981 with a 14 coupon. It matured
on November 15, 2011. (Assume $ 100,000
principal. Then, it paid $ 7,000 on May 15th and
Nov 15th starting May 15th 1982, ending Nov 15th,
2011
October 15, 2015
US Treasury Bill Market
• 4 week, 13 week, 26 week, 52 week
• Every non-holiday Monday there is a 4, 13, 26 week auction; 52 week is on
Tuesday, once a month
• Settlements are always on non-holiday Thursday (settlement is the day the
security “exists” and payment is received)
• Most recent:
– 4 wk: Issued 10/14/15, matures on 11/12 0.00%
– 13 wk: Issued 10/13/15 matures on 1/14/16 0.00%
– 26 week 10/13/15 matures on 4/14/16
0.080%
– 52 week 10/14/15 matures on 10/13/16 0.205%
• https://www.treasurydirect.gov/instit/annceresult/annceresult.htm
October 15, 2015
Bills are quoted at a discount
• 10 % quote means you pay $ 900,000 for a 52
week bill that pays $ 1 million at maturity
• 10% quote on a 26 week bill means you pay
$ 950,000 for $ 1 million on maturity date
• True yield is higher than discount quote
October 15, 2015
Notes and Bonds
• 3, 10, 30 auctioned monthly
• 2, 5, 7 auctioned monthly
• Assume that principal is $ 100,000 (that is the
amount paid at maturity plus the last coupon)
• For, example:
• Last 30 yr auctioned is the “Aug 2 7/8s of 45”
• Pays 1/2 of 2.875 %, or $1,437.50 twice a year
beginning Feb 15th, ending August 15th, 2044.
October 15, 2015
The Money Market
• Default Free Money Markets
– Treasury Bills
• Defaultable Money Markets
– Federal Funds/Repos (Repurchase Agreements)
– Commercial Deposits (CDs)
– Commercial Paper
• Key is “short term” nature of the underlying security,
typically less than one year in maturity
October 15, 2015
National Debt in US
• $ 18,151,323 as of July 31, 2015
• Funded debt: $ 13,135 Trillion (GDP 18)
Trillion)
Yield curve
Junk bonds
Rates
Maturities
Corp Bonds
Treasuries
October 15, 2015