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4.5 Treasury Notes and Treasury Bonds

Treasury notes and bonds differ from T-bills in a number of significant ways. They are quoted differently, their reported yields are computed differently, they have a longer life, and the nature of the contracted cash flows differs. Fortunately, for our purposes, we can treat Treasury notes and bonds in the same way.

Treasury notes are issued with maturities ranging from two to ten years in a wide range of face amounts (from $5,000 to $500 million).

Treasury bonds are now issued with maturities equal to 30 years. Both 15- and 20 year issues were once auctioned, but this practice has since ended.

Treasury notes and bonds have a well defined face value but also carry a fixed coupon or promised interest rate expressed relative to the face value of the note or bond. Coupon payments are generally made every six months, starting approximately six months after the time of issue. The length of the first coupon period is not exactly six months, because it depends on the timing of the auction plus other differences between the issue date and the coupon payment dates. The exact dates depend on the specific security.

Treasury notes and bonds are auctioned much the same way as Treasury bills, except with less frequency. The two year notes are auctioned every month (usually on the last business day of the month). Longer maturities, such as 10 and 30 years, are auctioned only every quarter.

For example, the 30 year Treasury bond is auctioned during February, May, August, and November and then issued on the 15th of each of those months. The bonds mature 30 years from the issue date.

Other issues are not so straightforward. The five year notes are auctioned quarterly in the same months (February, May, August, and November) but are issued on the first day of the next month and mature five years and two months later in the middle of the month. Quirks like this lead to initial long coupon dates. Paying attention to these details is very important when valuing Treasury notes.

Quotations

Treasury notes and bonds are quoted in a different way from Treasury bills. All prices are expressed relative to a par amount of 100. If you are pricing a $100,000 bond, you must multiply the price by 1,000. A bond can trade at par, above par, or below par. Prices are expressed in points plus thirty-seconds of a point. That is, 99:21 is actually 99 + 21/32, which in decimal form equals 99.65625. As a result, you need first to convert note and bond quotations into decimals before starting any value calculations.

Quotations are reported in the financial press each afternoon by the Federal Reserve Bank of New York after it polls registered dealers. The letter "n" distinguishes Treasury notes from Treasury bonds. Yields are based on the ask price (the price that you can currently buy the security for), and all prices are quoted for trades of $1 million or more.

The following Treasury quotes for the week ending September 2, 1994, were reported by Barron’s Market Week.

Rate

Month/Year

Bid

Ask

Bid Yield

7.50%

Nov 01, 1994

102:19

102:21

7.02

15.75%

Nov 01, 1994

148:31

149:03

6.96

In this table, the T-note has a coupon rate of 7.5%, and the T-bond has a coupon rate of 15.75%. Given their current yield to maturity, both are selling at a premium to their face value. At a face amount of $100, then, the bid on the T-note is read as $102 plus 19/32, or, in decimal form, $102.59375. The T-bond’s ask price is $149 plus 3/32, or, in decimal form, $149.09375. As a result, for $100,000 face value, the contract bid price for the T-note is $102,593.75; for the same face value of T-bonds the bid price is $149,093.75. This is not the total cash amount exchanged, because the buyer must compensate the seller for any accrued interest.

Accrued Interest

When T-notes and T-bonds are traded in the secondary markets, the trading day generally falls in between coupon payment dates. The quoted price, however, does not reflect the accrued interest on the note or bond. Instead, when a trade takes place, the buyer pays the seller an additional amount to compensate for accrued interest. As a result, each particular transaction will itemize price and accrued interest paid.

The accrued interest adjustment is calculated as simple fractional interest. It is determined by counting the days between the last and the next coupon payment date, and then computing the proportion that this period represents of the current trading date.

Suppose there are 182 days between two coupon payment dates. Suppose also that the date of a transaction is 150 days into this 182-day period. The next coupon payment is prorated as 150/182 to the seller; that is, the buyer pays the seller (150/182)C, where C is the next coupon payment.

In reality, interest has not actually accrued in this linear manner since the buyer will not receive the coupon payment until the next coupon date. Given that this is the convention, however, the price of the bond presumably adjusts to reflect the present value of the accrued interest payment.

Miscellaneous Features

Some Treasury bonds are callable. That is, the Treasury can buy back some Treasury bonds within five years before their maturity at 100% of their face value. This provision was eliminated for 30 year Treasury bonds in 1985. The convention on the composite quotations sheet is to compute yields assuming 1) the earliest call date for issues quoted above par, and 2) and the maturity date (i.e., if the bond is not called) for issues quoted below par.

Another variable to be aware of in the trading of Treasury notes and bonds is that T-notes and T-bonds distinguish between domestic and foreign targeted bonds. Foreign targeted bonds, which are traded on the (secondary) over-the-counter market, pay coupons annually. This practice is consistent with convention in the Eurobond markets. These issues also have some additional differences, in terms of withholding taxes and the ability of the buyer to remain anonymous. Such differences are designed to make the market more attractive to foreign investors.

Foreign targeted bond interest calculations represent an exception to the practice of calculating accrued interest. Accrued interest is computed relative to a 360-day year, with only one coupon payment date per year.

Online, you can relate the Treasury note and bond information to the Treasury Calculator. You can access the interactive Treasury Calculator below:

The Treasury Note/Bond tab deals with Treasury bonds and notes. The quoted price is entered into the field labeled Quoted Price. Recall that quotes are represented relative to a par amount of $100 (100 points) and prices are usually given in thirty-seconds of a point. This 32nds tick size is entered beside Tick Size. Some data sources convert the tick size to decimals. If this is the case, then you merely change the calculator's tick size to equal 100.

The day count for the remaining life of the T-bond is computed below the Treasury calculator and clicking on Treasury Dates computes the days relative to coupon payments.  Finally, to transfer the results to the Calculator, click on the button Transfer. The Face Value is 100. Finally, in the bottom, righthand corner, you enter the information required by the calculator to compute the accrued interest. This is the coupon rate, the days from the last coupon payment and the days until the next coupon payment. The accrued interest adjustment is calculated as simple fractional interest. As a result, the calculator also computes the proportion of a coupon period that the current trading date represents.

By clicking the OK button for the T-note/bond, the calculator will compute the price that you would pay in dollars for a T-note/bond with a face amount equal to $100. The bond equivalent yield for the T-bill is also automatically computed.

In the next topic, Yield to Maturity on T-note and T-bond, you will work through the calculations for the yield to maturity for longer term Treasury securities, using the online calculator.