Help me understand zero coupon bonds

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protagonist
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Help me understand zero coupon bonds

Post by protagonist » Thu May 24, 2018 1:39 pm

This is new territory for me.

Fidelity is offering zero coupon treasuries maturing in 6 months at 2.09%.

My understanding is that these would be state tax exempt.

Under those circumstances they seem like a great place to stash cash that you may need 6 months from now but do not need immediately.

But I never hear them mentioned on Bogleheads which makes me suspicious.

Am I missing something?
Last edited by protagonist on Thu May 24, 2018 11:26 pm, edited 1 time in total.

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triceratop
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Re: Help me understand zero coupon bonds

Post by triceratop » Thu May 24, 2018 1:46 pm

Treasuries of initial maturity of 52 weeks or less are called Bills, and there is indeed discussion on bogleheads. Furthermore, they are always zero coupon, as the T-bills are sold at a discount to face (redemption) value. Here is a thread on the front page: viewtopic.php?p=3942906

Treasury interest is state tax exempt but federally taxable. They are not "offered by Fidelity", but as the name suggests issued by the US Treasury.
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AlmstRtrd
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Re: Help me understand zero coupon bonds

Post by AlmstRtrd » Thu May 24, 2018 2:06 pm

And someone correct me if I am wrong, but I believe when buying zeros in small lots, one wouldn't actually get the full 2.09% on those.

And a follow up question... Is there a difference worth considering when buying zeros at auction versus on the secondary market?

dkeeney
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Re: Help me understand zero coupon bonds

Post by dkeeney » Thu May 24, 2018 2:10 pm

triceratop wrote:
Thu May 24, 2018 1:46 pm
Treasuries of initial maturity of 52 weeks or less are called Bills, and there is indeed discussion on bogleheads. Furthermore, they are always zero coupon, as the T-bills are sold at a discount to face (redemption) value. Here is a thread on the front page: viewtopic.php?p=3942906

Treasury interest is state tax exempt but federally taxable. They are not "offered by Fidelity", but as the name suggests issued by the US Treasury.
Yes. I just laddered into 13-week T-Bills (13 weekly purchases that I can reinvest for up to 7 quarters) and the cost was $4,980 for a $5,000 purchase. Then as they mature and are re-invested, I receive the "discount" as interest.

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Re: Help me understand zero coupon bonds

Post by Grt2bOutdoors » Thu May 24, 2018 2:11 pm

protagonist wrote:
Thu May 24, 2018 1:39 pm
This is new territory for me.

Fidelity is offering zero coupon treasuries maturing in 6 months at 2.09%.

My understanding is that these would be federal tax exempt. Not sure about state.

Under those circumstances they seem like a great place to stash cash that you may need 6 months from now but do not need immediately.

But I never hear them mentioned on Bogleheads which makes me suspicious.

Am I missing something?
Sounds like Treasury bills, not true zero coupon bonds. The yield to maturity is 2.09%, but that is the annual yield.
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alex_686
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Re: Help me understand zero coupon bonds

Post by alex_686 » Thu May 24, 2018 2:12 pm

AlmstRtrd wrote:
Thu May 24, 2018 2:06 pm
And someone correct me if I am wrong, but I believe when buying zeros in small lots, one wouldn't actually get the full 2.09% on those.

And a follow up question... Is there a difference worth considering when buying zeros at auction versus on the secondary market?
If you buy at auction you get the rate at auction. Simple and transparent.

Interest rates fluctuate minute by minute, if not second by second. If not bought at auction you will get some other rate - maybe better, maybe worse. Who knows? The open market is very competitive, so if not the best possible rate it will not be far off.

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Kevin M
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Re: Help me understand zero coupon bonds

Post by Kevin M » Thu May 24, 2018 3:51 pm

protagonist wrote:
Thu May 24, 2018 1:39 pm
This is new territory for me.

Fidelity is offering zero coupon treasuries maturing in 6 months at 2.09%.
Looks like you are looking at the auction expected yield. This is not for sure what you'll get. The auction closes 5/29, so next Tuesday, so the yield will depend on the low-price (high-yield) bid by close of auction. The 6-month CMT has come down from 2.14% to 2.09% from 5/21 to 5/24,which you can see here: https://www.treasury.gov/resource-cente ... data=yield. Note that the 5/24 yield is same as the expected yield displayed at Fidelity.

Looking at secondary market quotes for Treasuries maturing 11/30/2018, I'm seeing ballpark 2.09%, but these are for large quantities, and they're actually notes (so not zero coupon). Yield for minimum quantity 25 is about 2.05%, and for minimum quantity 1 about 2.04%.

There is a bill maturing 11/23/2018 with yield of 2.07% for minimum quantity 3,000 ($3,000,000 face value), and 1.954% for minimum quantity 1.

An advantage of buying at auction is you essentially get the large-quantity yield.
My understanding is that these would be federal tax exempt. Not sure about state.
All Treasuries are exempt from state taxes, not from federal taxes.
Under those circumstances they seem like a great place to stash cash that you may need 6 months from now but do not need immediately.
Yes, it is a nice yield premium over say Prime MM at 1.87%, and the higher your marginal state tax rate, the better. For me, the Treasury at 2.09% would be TEY of about 2.35%.
But I never hear them mentioned on Bogleheads which makes me suspicious.
I have been mentioning Treasuries quite a bit lately, and a Treasury Bill (which are all zero coupon) is just one type of Treasury. There is nothing to be suspicious about. You just earn all your interest in the form of capital return--i.e., the difference between maturity value of 100 and the discounted price you pay.

Kevin
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boardwalkmike
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Re: Help me understand zero coupon bonds

Post by boardwalkmike » Thu May 24, 2018 3:59 pm

Just a question on a treasury bill.
If I buy a 6 month bill in Oct 2018 is the tax due in 2018 or 2019 when in matures?

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madsinger
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Re: Help me understand zero coupon bonds

Post by madsinger » Thu May 24, 2018 4:05 pm

boardwalkmike wrote:
Thu May 24, 2018 3:59 pm
Just a question on a treasury bill.
If I buy a 6 month bill in Oct 2018 is the tax due in 2018 or 2019 when in matures?
The income from a treasury bill is considered "paid" at the maturity date. In the case of a six month bill purchased in October 2018, the "taxable event" (assuming you hold to maturity) is April 2019 (so it's 2019 taxable income, and theoretically, the tax is not "due" until April 2020, when you pay your 2019 taxes).

-Brad.

boardwalkmike
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Re: Help me understand zero coupon bonds

Post by boardwalkmike » Thu May 24, 2018 4:06 pm

Thanks

protagonist
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Re: Help me understand zero coupon bonds

Post by protagonist » Thu May 24, 2018 4:37 pm

Thanks. Got it. Forgive me for my ignorance.

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Re: Help me understand zero coupon bonds

Post by Valuethinker » Fri May 25, 2018 4:56 am

protagonist wrote:
Thu May 24, 2018 1:39 pm
This is new territory for me.

Fidelity is offering zero coupon treasuries maturing in 6 months at 2.09%.

My understanding is that these would be state tax exempt.

Under those circumstances they seem like a great place to stash cash that you may need 6 months from now but do not need immediately.

But I never hear them mentioned on Bogleheads which makes me suspicious.

Am I missing something?
As per other posters:

- US govt security issued w less than or equal to 1 year to maturity is a Treasury Bill or T Bill & is issued at a discount

- US govt security up to 10 yrs to maturity at issue is a T Note (including exactly 10 years maturity, I believe)

- US govt security more than 10 years to issue is a T Bond

AFAIK the US government does not issue T Notes or T Bonds zero coupon. However you can buy such - Merrill Lynch invented them (TIGRS & something else) - where a broker buys the bond and turns it into a stream of coupons (Interest Only) and the cash payment at the maturity of the bond (Principal Only - PO) by "stripping" off the coupons.

I'd have to look up the term for those bonds.

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