Help me understand secondary market for treasuries

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Post Reply
User avatar
Topic Author
bligh
Posts: 1533
Joined: Wed Jul 27, 2016 9:13 pm

Help me understand secondary market for treasuries

Post by bligh »

I am looking at the daily yield curve chart on treasury.gov and I see the yield on 1 year treasuries is 2.67%.

I then used the Treasury Bond search tool to see the options on the secondary market on Fidelity and see that there are a number of options ranging in effective yield of 2.67% to 2.75%. What is the reason for getting a higher yield on the secondary market as compared to buying directly on treasury.gov? Why is there such a big variance in the yields available on the secondary market for treasuries that mature within 1 week of each other?

Never having purchased treasuries on the secondary market, I am kind of confused by the options.

For example.

UNITED STATES TREAS BILLS ZERO CPN 0.00000% 11/07/2019 has a yield of 2.658 with an ask price of 97.491. I think I understand this. I am buying the treasury at the price of 97.491 and at maturity it will be worth $100 giving me the yield I am looking for. How does that actually work though? Do I log in on 11/08/2019 and the treasury will disappear while Fidelity will have credited $100 to my account?

How is the yield on zero coupon bonds reported on my 1099? Is it interest?

In contrast the other option is :
UNITED STATES TREAS NTS 3.37500% 11/15/2019 has a yield of 2.713 with an ask price of 100.634. The way I understand this is that I will earn a higher yield through out the year, but at the end of the year I will only get back $100 instead of the 100.634. So the effect yield will be 2.713. How does that work with taxes? Will my 1099 show the higher interest with a small capital loss for the 0.634 lost at redemption?

I am completely new to this and am trying to educate myself. Are there any resources I can find that will educate me on the purchase and tax implications (if any) of the various options to buy treasuries on the secondary market? If you are buying treasuries on the secondary market, how did you learn about how to do it?
FactualFran
Posts: 2751
Joined: Sat Feb 21, 2015 1:29 pm

Re: Help me understand secondary market for treasuries

Post by FactualFran »

Likely, the 1099 you receive for a Treasury Bill will show the difference between the price you paid and the maturity value as interest ($2.059 per $100 of maturity value in the example you gave). However, it has been years since I held a Treasury bill. The maturity value will be automatcially credited to the settlement account and the Treasury Bill will disappear from your holdings.

The 1099 you receive for a Treasury Note should show the total amount of interest paid. You should also receive from the brokerage a tax statement that provides additional information: accrued interest and amortized bond premium. Because in the example you gave the Note matures next year and makes interest payment only next year, the accured interest and amortized bond premium will be reported on the tax return for next year only.

The accured interest is the amount of interest the Note earned between its last interest payment and when you bought the Note. That amount is in the bottom line price you pay for the Note (in addition to the ask price). You will receive the full amount of the next interest payment and on your tax return you will indicate that you paid accrued interest that will be subtracted from the interest to determine the net interest on which you owe income tax.

The bond premium is the difference between the purchase price (not including the accrued) and the maturity value. On your tax return you will indicate that the bond premium was amortized (over only one year for the example you gave). That amount will be subtracted from interest the Note paid to determine the net interest on which you own income tax.

You will report the interest and adjustments to it on Schedule B of you federal income tax return. Statements that you receive from the brokerage should indicate the amounts to be reported on Schedule B.
Grt2bOutdoors
Posts: 25617
Joined: Thu Apr 05, 2007 8:20 pm
Location: New York

Re: Help me understand secondary market for treasuries

Post by Grt2bOutdoors »

Search IRS publications on Interest and Dividends. www.irs.gov think it’s Pub. 550
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions
User avatar
Topic Author
bligh
Posts: 1533
Joined: Wed Jul 27, 2016 9:13 pm

Re: Help me understand secondary market for treasuries

Post by bligh »

Thanks FactualFran that does clarify the tax handling! The bond premium being subtracted from the interest makes sense. I am going to read up pub 550 on the IRS website that Grt2bOutddors (Thanks!) linked to, but my guess is the zero coupon bond will be handled similarly, as in the gain in value will be amortized over the duration and be taxed as interest.

So, then is there a reason _not_ to buy treasuries on the secondary market to take advantage of the better yields (provided one can meet the minimums)? Are there any "gotchas" that explain the higher yields you get versus buying direct?
User avatar
grabiner
Advisory Board
Posts: 35265
Joined: Tue Feb 20, 2007 10:58 pm
Location: Columbia, MD

Re: Help me understand secondary market for treasuries

Post by grabiner »

bligh wrote: Wed Nov 21, 2018 5:06 pm So, then is there a reason _not_ to buy treasuries on the secondary market to take advantage of the better yields (provided one can meet the minimums)? Are there any "gotchas" that explain the higher yields you get versus buying direct?
Besides trading costs, you may need to check whether the Treasuries are actually identical; two Treasuries maturing on the same date may have different coupon schedules. For example, a Treasury maturing in 2027 could have been issued as a 10-year bond in 2017, or a 30-year bond in 1997. Since rates were higher in 1997, the 1997 bond will have more of its value in coupon payments, and thus a shorter effective duration.
Wiki David Grabiner
User avatar
Topic Author
bligh
Posts: 1533
Joined: Wed Jul 27, 2016 9:13 pm

Re: Help me understand secondary market for treasuries

Post by bligh »

grabiner wrote: Wed Nov 21, 2018 5:27 pm
bligh wrote: Wed Nov 21, 2018 5:06 pm So, then is there a reason _not_ to buy treasuries on the secondary market to take advantage of the better yields (provided one can meet the minimums)? Are there any "gotchas" that explain the higher yields you get versus buying direct?
Besides trading costs, you may need to check whether the Treasuries are actually identical; two Treasuries maturing on the same date may have different coupon schedules. For example, a Treasury maturing in 2027 could have been issued as a 10-year bond in 2017, or a 30-year bond in 1997. Since rates were higher in 1997, the 1997 bond will have more of its value in coupon payments, and thus a shorter effective duration.
Interesting! I had never considered that, but it makes sense. Even though two identical bonds have the same effective yield, the one with the higher coupon payments has a shorter effective duration because you are getting more of your money back sooner.
User avatar
Kevin M
Posts: 15750
Joined: Mon Jun 29, 2009 3:24 pm
Contact:

Re: Help me understand secondary market for treasuries

Post by Kevin M »

bligh wrote: Wed Nov 21, 2018 12:42 pm I am looking at the daily yield curve chart on treasury.gov and I see the yield on 1 year treasuries is 2.67%.

I then used the Treasury Bond search tool to see the options on the secondary market on Fidelity and see that there are a number of options ranging in effective yield of 2.67% to 2.75%. What is the reason for getting a higher yield on the secondary market as compared to buying directly on treasury.gov?
The yields you see on treasury.gov are synthetic yields constructed by an algorithm to come up with constant maturity Treasury (CMT) yields. So every day you look at the 1-year yield, it is a modeled yield with exactly one year to maturity and a coupon rate approximately equal to the yield (a par yield).

The inputs to the algorithm are primarily the daily close bid yields for the most recently issued (on the run) Treasuries. These Treasuries will have coupon rates very close to the yields at issuance. Note that when you buy on the secondary market, you are getting the ask yield, which will be lower than the bid yield for that security at that time. As others have explained, the yield depends not only on the term to maturity, but also on the coupon rate. There also are liquidity factors that impact the yields, so even when adjusted for duration, you will see some apparent anomalies.

There is text on the Treasury.gov page briefly explaining the CMT algorithm, and there is a link to a Treasury Yield Curve Methodology page that goes into more detail.

Since the yields on Treasury.gov are synthetic, you cannot actually buy the Treasuries you see on that web page. The yields will be in the ballpark of yields of Treasuries you can buy with maturities that are close to what you see. The closer the actual maturity is to the CMT maturity, and the closer the coupon is to the yield, the closer the bid yield will be to the yield you see on Treasury.gov, but of course yields change daily and during the day while the market is open.

The yield you actually get also depends on the quantity you buy on the secondary market. At Fidelity and Vanguard, the yield can be significantly lower if you're buying less than $100K, $200K or $500K of face value. At Schwab, you often get the best yield for a minimum quantity of 10 ($10K face value). If you buy at auction, you get the same price/yield as institutional investors buying millions of dollars of face value; this is true for any of the three brokers mentioned.

I believe the rest of your questions have been answered.

Kevin
If I make a calculation error, #Cruncher probably will let me know.
TBillT
Posts: 1001
Joined: Sat Sep 17, 2011 1:43 pm

Re: Help me understand secondary market for treasuries

Post by TBillT »

Kevin M wrote: Wed Nov 28, 2018 11:46 am
bligh wrote: Wed Nov 21, 2018 12:42 pm
The yield you actually get also depends on the quantity you buy on the secondary market. At Fidelity and Vanguard, the yield can be significantly lower if you're buying less than $100K, $200K or $500K of face value.
Kevin
I was not aware (at Fidelity) that buying bigger gives a better yield...typically I nickel and dime it (say $10K to $25k) per shot
User avatar
Kevin M
Posts: 15750
Joined: Mon Jun 29, 2009 3:24 pm
Contact:

Re: Help me understand secondary market for treasuries

Post by Kevin M »

TBillT wrote: Wed Nov 28, 2018 11:58 am
Kevin M wrote: Wed Nov 28, 2018 11:46 am The yield you actually get also depends on the quantity you buy on the secondary market. At Fidelity and Vanguard, the yield can be significantly lower if you're buying less than $100K, $200K or $500K of face value.
I was not aware (at Fidelity) that buying bigger gives a better yield...typically I nickel and dime it (say $10K to $25k) per shot
Yep. I was going to use a recently auctioned 6-month Treasury as an example, but as of this moment, you can't even buy less than 50 ($50K face value) of the 5/23/2019 bill at Fidelity! Interesting -- looking at most of the 0% coupon Treasuries maturing in about six months, I don't see any available for quantity less than 50 or 75.

However, I do see one, a stripped interest 0% maturing 5/15/2019, where you only lose about 2 basis points going from min qty 250 at 2.362% to min qty 1 at 2.340%. I've seen large/small quantity spreads much larger than this in the past.

Randomly checking a few other maturities, I'm seeing small/large spreads of one basis point or less on some. Maybe Fidelity has figured out that they were losing customers over these spreads?

As of this moment, Schwab still has the advantage of being able to buy smaller quantities of recently issued 6-month bills. You can even buy the most recently issued 5/30/2019, with the highest yield for min qty 1. This isn't available at all at Fidelity.

Comparing the 5/23/2019 bill, you can buy min qty 5 at Schwab at 2.515. At Fidelity, smallest min qty is 50 at 2.495, with min qty 100 at 2.513 and min qty 3000 at 2.514. This is the first time I've seen that you can't buy less than 50 at Fidelity.

Kevin
If I make a calculation error, #Cruncher probably will let me know.
User avatar
Artsdoctor
Posts: 6017
Joined: Thu Jun 28, 2012 3:09 pm
Location: Los Angeles, CA

Re: Help me understand secondary market for treasuries

Post by Artsdoctor »

I'm not sure there's anything to be gained by buying T-bills on the secondary market. 52-week bills are offered monthly, and 26-week (and 13-week) bills are offered weekly. With the frequency of auctions, especially with the quantities you're describing, I'd just buy the bills at auction and be done with it.
longinvest
Posts: 5672
Joined: Sat Aug 11, 2012 8:44 am

Re: Help me understand secondary market for treasuries

Post by longinvest »

bligh wrote: Wed Nov 28, 2018 11:19 am
grabiner wrote: Wed Nov 21, 2018 5:27 pm
bligh wrote: Wed Nov 21, 2018 5:06 pm So, then is there a reason _not_ to buy treasuries on the secondary market to take advantage of the better yields (provided one can meet the minimums)? Are there any "gotchas" that explain the higher yields you get versus buying direct?
Besides trading costs, you may need to check whether the Treasuries are actually identical; two Treasuries maturing on the same date may have different coupon schedules. For example, a Treasury maturing in 2027 could have been issued as a 10-year bond in 2017, or a 30-year bond in 1997. Since rates were higher in 1997, the 1997 bond will have more of its value in coupon payments, and thus a shorter effective duration.
Interesting! I had never considered that, but it makes sense. Even though two identical bonds have the same effective yield, the one with the higher coupon payments has a shorter effective duration because you are getting more of your money back sooner.
If the duration of two 10-year Treasuries differ, they shouldn't have the same effective yield! If it happens, it's probably because a clueless bond investor is being skinned alive. See these posts: My suggestion is to always use an index fund or ETF to buy bonds.
Variable Percentage Withdrawal (bogleheads.org/wiki/VPW) | One-Fund Portfolio (bogleheads.org/forum/viewtopic.php?t=287967)
Post Reply