Treasury Inflation-Protection Securities
September 25, 1996
On May 16, 1996, the Treasury announced its intention to issue a new type of marketable book-entry security with a nominal return linked to the inflation rate in prices or wages -- inflation-protection securities. The Treasury indicated that it was considering a variety of structures and indices for the new securities. After extensive consultation with potential investors and other interested parties, the Treasury is announcing today the decisions it has reached concerning the structure, the index, and other details of the new inflation-protection securities.
The Treasury is publishing proposed amendments to the uniform offering circular, which is the body of rules governing the sale and issue of marketable Treasury securities, later this week. Concurrent with the filing of the proposed rules, the Internal Revenue Service is issuing a notice concerning the federal income tax treatment of these securities. Later this year, the Treasury expects to publish the final revisions of the offering circular rules, and the IRS expects to issue proposed and temporary regulations concerning the taxation of inflation-protection securities.
Further details about the new securities are described below. (This is a summary, and potential investors are advised to consult the final revised offering circular and the applicable tax regulations when they are available for the terms and conditions of the new securities, including the description of investment considerations, and their tax treatment.)
The first auction will be in January for issuance on January 15. The securities will be auctioned and issued on a quarterly basis thereafter, i.e., issuance will be on the 15th of January, April, July, and October.
STRUCTURE AND INDEX
The inflation-protection securities' structure will be based on the Canadian Real Return Bonds with some modifications. The index to be used to measure inflation will be the non-seasonally adjusted U.S. City Average All Items Consumer Price Index for All Urban Consumers (CPI-U).
The value of the principal will be adjusted for inflation, and every six months the security will pay interest, which will be an amount equal to a fixed percentage of the inflation-adjusted value of the principal. The final payment of principal of the security will not be less than the original par amount of the security at issuance.
Initially, a ten-year note. Other maturities will be added within a year.
The principal of the inflation-protection security will be indexed to the non-seasonally adjusted CPI-U. To calculate the inflation-adjusted principal value for a particular valuation date, the value of the principal at issuance is multiplied by the index ratio applicable to that valuation date. Semiannual coupon interest is determined by multiplying the inflation-adjusted principal amount by one-half of the stated rate of interest on each interest payment date.
If at maturity the inflation-adjusted principal is less than the original principal value of the security, an additional amount will be paid at maturity so that the additional amount plus the inflation-adjusted principal equals the original principal amount. In the case of a stripped security, the holder of the stripped principal component would receive this additional amount. The final interest payment, however, will be based on the final inflation-adjusted principal value, not the original par amount.
The index ratio for any date is the ratio of the reference CPI applicable to such date to the reference CPI applicable to the original issue date.
The reference CPI for the first day of any calendar month is the CPI-U for the third preceding calendar month. (For example, the reference CPI for December 1 is the CPI-U reported for September of the same year, which is released in October.) The reference CPI for any other day of the month is calculated by a linear interpolation between the reference CPI applicable to the first day of the month and the reference CPI applicable to the first day of the following month.
Any revisions the Bureau of Labor Statistics (or successor agency) makes to any CPI-U number that has been previously released will not be used in calculations of the value of outstanding Treasury inflation-protection securities.
In the case that the CPI-U for a particular month is not reported by the last day of the following month, the Treasury will announce an index number based on the last year-over-year CPI-U inflation rate available. Any calculations of the Treasury's payment obligations on the inflation-protection security that need that month's CPI-U number will be based on the index number that the Treasury has announced.
If the CPI-U is rebased to a different year, Treasury will continue to use the CPI-U series based on the base reference period in effect when the security was first issued as long as that series continues to be published.
If the CPI-U is discontinued during the period the inflation-protection security is outstanding, the Treasury will, in consultation with the Bureau of Labor Statistics (or successor agency), determine an appropriate substitute index and methodology for linking the discontinued series with the new price index series. Determinations of the Secretary of the Treasury in this regard are final.
Inflation-adjusted principal or the original par amount, whichever is larger, will be paid on the maturity date as specified in the offering announcement. Interest is payable on a semiannual basis on the interest payment dates specified in the offering announcement through the date the principal becomes payable. In the event any principal or interest payment date is a Saturday, Sunday or other day on which the Federal Reserve Banks are not open for business, the amount is payable (without additional interest) on the next business day.
Eligible for the STRIPS program as of the first issue date. For an inflation-protection security to be stripped into principal and interest components, the original par amount of the security must be in an amount that, based on the coupon rate, will produce a semiannual coupon payment, unadjusted for inflation, in a multiple of $1,000. The minimum original par amount required to strip an inflation-protection security will be provided in the press release announcing the auction results.
The Treasury is releasing a separate paper which summarizes the federal income tax treatment of inflation-protection securities. In addition, the Internal Revenue Service is issuing a notice which provides additional detail concerning this subject.
The Treasury will offer inflation-protection securities through a uniform price auction. Bidders will bid a real yield, and, after the initial auction (not a reopening) the coupon will be set near the highest accepted real yield in increments of 1/8 of 1 percent. Amounts bid for will be in terms of the original principal amount.
MINIMUMS AND MULTIPLES TO BID, HOLD, AND TRANSFER
The minimum to bid , hold, and transfer is $1000 original principal value. Larger amounts must be in multiples of $1000.
Treasury inflation-protection securities will be held and transferred in either of two book-entry systems: the commercial book-entry system (TRADES) and TREASURY DIRECT. The securities will be maintained and transferred at their original par amount, i.e., not at their inflation-adjusted value. STRIPS components will be maintained and transferred in TRADES at their value based on the original par amount of the fully constituted security.