ShmoopTube

00:00

llooprinciples of finance a la shmoop Uncle Sam's debt treasure it's not just

00:08

for pirates anymore however we're not talking about those big bins of booty [pirate with parrot takes treasure out of chest]

00:13

but US federal bonds aka Uncle Sam's debt and yes it's a stretch but federal [bond on a table]

00:19

bonds are known as Treasuries at least in pirate circles they're backed by The

00:24

Full Faith and Credit of the US ie our ability to tax our hard-working citizens [money being processed]

00:29

meaning that Uncle Sam guarantees that every dollar of debt in whatever flavor

00:33

it comes he builds denotes bonds and so on will be paid back big uncle can make

00:38

this guarantee because he also owns the only bond printing presses for money [bond printing press]

00:43

the only legal ones anyway if it had to the government could crank up the

00:47

printing presses and literally print money to pay everyone of course it [women printing money]

00:51

doesn't guarantee that this money will actually be worth anything if it does

00:55

that print too much paper wealth out of thin air and it can end up well not

00:59

buying much check out this carton of milk in Zimbabwe it costs two Zimbabwean

01:04

dollars in 1957 today it costs sixteen million yeah they got a little carried

01:10

away with their printing presses and in reality just to keep things fair and [money printing press]

01:14

square the actual paper money like $20 bills tens fibers etc well they

01:19

represent a very small fraction of the total dough that Uncle Sam actually [pie chart]

01:23

prints meaning that most of the money raised by the government comes in the

01:27

form of bonds they sell to the investing public in batches of zillions like one

01:33

bond offering can place a little fifty billion dollars in fifteen minutes and

01:37

it take the US Mint while an awfully long time to print that much in 20s but

01:41

Uncle Sam's financial cooking comes in a few flavors let's cruise them here just [money thrown onto a skillet]

01:45

so everyone's on the same red white and blue page well first up Treasury bonds

01:50

Treasuries are referred to by different names depending on the duration or their

01:53

maturity let's start with tea bills here short maturity like ours here in the

01:58

shmoop writing stable of eleven-year-old their longest maturity is one year but [child typing on laptop]

02:02

while most of them are three and six month maturities technically 91 and

02:07

82 days accountant well these are very actively traded in secondary markets [money passing hands in alley]

02:12

their liquidity is immense so much so that tea bills are considered to be the

02:16

equivalent of cash on balance sheets because of their safety and liquidity

02:20

yields are very low like you don't get much interest for owning them also [writing on white board]

02:25

t-bills don't carry any stated interest rate rather they're sold at a discount

02:30

meaning that you pay less than their face value at maturity you receive the

02:34

entire face value and the difference between the face and what you paid is

02:38

considered the interest or appreciation ie you Biman two dollars and then six

02:45

months later they pay you a grand so that eighteen bucks and appreciation

02:48

that's considered interest or Lutz's tax that ways ordinary income in this

02:52

respect tea bills are the only federal zero coupon bonds

02:56

next stop tea notes well these bonds carry a stated interest rates actually

03:00

an interest rate number on the face of them the maturity is medium-term and tea

03:04

notes are issued n maturities of two three five seven and ten years interest

03:08

is paid every six months like a normal bond the sharp-eyed among you might have

03:12

noticed that there is a gap between the one year maximum tea bill and the two [t-bill and t-note on table]

03:16

year tea note no that's not a typo there's no maturity offered between one

03:21

and two years and we have no idea why okay next

03:24

tbonz oh wait that's a tea bond so because we had a typo there in the

03:28

script to get rid of the e there should be a deep anything with a maturity

03:31

longer than 10 years is called a tea bond for a long time the Treasury [writing on white board]

03:35

30-year bond was the benchmark for all long-term bonds right it's called just

03:40

the 30 because it was so popular well the government discontinued their

03:44

issuance in the 1990s but demand was so great that the government reinstituted

03:48

them it was a big oops well lastly show us your tips wait what [bond does strip tease]

03:52

does that mean tea notes and tea bonds do not adjust for inflation and

03:56

inflation risk is one of the risks that investors assume in purchasing [writing on white board]

04:01

Treasuries right because the interest is so low a lot of times inflation beats

04:05

them well inflation over the last decade or

04:07

so has been around two and a half percent a year give or take with

04:11

government paper hovering right around the same rate well if you're a 40%

04:15

marginal tax payer your after-tax return on two and a half percent paper is only [writing on white board]

04:19

about one and half percent meaning that you're actually

04:22

losing a percent in buying power each year and it's compounded year after year

04:27

that you're invested in this kind of government paper so you're losing more

04:30

and more as you go along well not everyone in the government is completely

04:34

clueless however and the Fed came up with a piece of paper which answers the [government meeting]

04:38

above big issue in the form of tips that is Treasury inflation-protected

04:42

securities well these bonds carry interest which [writing on white board]

04:46

goes up and down based on government stated interest rates avoiding much of

04:50

the inflation risk associated with very low interest rate government bonds well

04:55

these bonds will typically have maturities of between five and fifteen

04:58

years and as the name suggests they adjust in lockstep with inflation so

05:02

your purchasing power will be M more or less protected that's the upside the

05:07

downside is that the interest rate on tips is usually really paltry so you're

05:11

in for the long run and I'll think about equities instead how do you invest in

05:15

Treasuries well if you're buying in size like in hundreds of millions of dollars

05:19

well you call different dealers and you just get quotes the unwashed masses like

05:24

the rest of us can buy them through a normal broker but a cheaper way to do it

05:27

is just through an arm of the US Treasury called Treasury direct recall [website]

05:31

that the interest that any bond pays is called the coupon and it's expressed as [writing on white board]

05:36

a percentage of the face value and remember that bonds are usually issued

05:39

with face values of a thousand bucks so a five percent bond will pay five

05:43

percent of a thousand dollars or fifty dollars each year paid in two

05:47

installments of twenty five dollars every six months the most issuers come

05:51

right out and say what the coupon will be Treasuries do not know the feds like

05:56

to toy with investors those back interest rates for Treasuries are set by [uncle sam with a rattle plays with baby]

06:00

what's called an auction process think eBay for government bonds know the

06:04

details of Treasury auction are way above what you need to know in real life [Ebay website]

06:08

and for this course but here are the basics one the Treasury announces that

06:11

it'll be auctioning a particular maturities say five hundred million

06:14

dollars worth of three year notes interested buyers will then submit the

06:19

amount they want to purchase and the yield or interest rate they're willing

06:22

to accept all of this is done electronically it's not a physical [hands typing]

06:25

auction where the Treasury secretary drops the hammer and yells I sold to the

06:29

lady in the fish at three on auction day the Treasury opens the submitted bids

06:33

and then parcels out the bonds the folks with the lowest yield bids get their

06:37

orders filled first followed by the next lowest yield and so on and so on until

06:41

all the bonds are sold well if you wonder why it's done based on yield

06:45

remember that the price and yield are inverse to each other the lower the [writing on white board]

06:49

yield of the higher the price of the bond and the government is trying to pay

06:52

the lowest amount of yield that has to to rent money perceived as the safest

06:56

debt on the planet everything is priced in the world as a spread to Treasuries

07:01

that is whatever Treasuries are paying plus some incremental markup because

07:05

well regardless of whom you're lending to it's riskier than US Treasuries so

07:09

want to guaranteed but maybe modest retirement yeah all right set sail for

07:14

Treasury Island yeah safest pirate island [pirate sailing on ship with parrot]

Full Transcript