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Group Members | Ameer Taimur Ali, Muniba Shoaib, Natasha Farooq, Anam Iftikhar, Shumail
Arzu
4/3/2010
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Abstract

For the purpose of our research we have chosen US Treasury bonds also known as T-bonds as
our capital market product. In order to better comprehend the working and system of T-bonds
and forecast its future trends we have done a brief analysis of the growth of US economy over
the years based on the basic GDP model. Furthermore, we have taken in to account the trends of
inflation that have been observed in the United States over the past years, weighed the forecasts
made by the analysts about the future of inflation rate and have chosen upon one based on sound
reasoning and logic.

We have also formulated a sketch of the expected monetary policy of both US and Pakistan and
analyzed their consequences upon the economies of both the countries. Moreover, in this report
to construct a better judgment about the future expectations of T-bonds we have also looked in to
CAPITAL
MARKETS
UNITED STATES OF AMERICAN & T-BONDS
the future analysis of commodities like Oil and Gold and also the stocks and bonds market. In
the end we have laid out few recommendations based on our detailed study

Economic Growth Of US And The GDP Model

Gross Domestic Product (GDP) is a useful framework for closer analysis of emerging trends and
the related investment opportunities they produce. GDP is a measure of the total value of goods
and services produced by a domestic economy. It comprises four components:

GDP = C + I +G (x-m)

C = (consumer consumption expenditures)

I = (fixed or business environment)

G = (government spending)

X-M = (net exports)

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The chart below covers consumer consumption which represents over two-third of GDP.

Consumer Consumption Trend (C):

After remaining mostly flat from 1950-1985, Consumer consumption of GDP has steadily
increased, moving from 64% in 1985 to today’s’ 71% . This steady increase was driven by
several events, including:

The dramatic fall of interest rates, which allowed consumers to take on more debt while
maintaining the same monthly payment, as a result consumer saving rates fell to close to zero,
where as the debt levels has increased very sharply.

U.S Economy Present, Past, Future:

America's economy grew by 3.7 percent in the third quarter of 2007, faster than most other
developed economies around the globe and faster than the historical U.S. growth rate, since
1970, of 3.2 percent.

This paper puts the recent growth of the U.S. economy in perspective and looks forward at how
radically different plans may affect future growth and prosperity.
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Past:

The American economy has grown much faster in recent years than many economists thought
possible, especially in the wake of the terror attacks of 9/11. A vigorous public policy response
turned the 2001 recession into one of the mildest downturns in modern history dating back to
1947, the year comprehensive official statistics were first recorded by the U.S. Bureau of
Economic Analysis (BEA).

Since 1970, GDP growth has averaged 3.16 percent per year, after inflation. During President
Bush's first year in office in 2001, the economy slipped into and pulled out of a recession and yet
overall output managed to grow slightly. Since 2001, real output has grown at an average annual
rate of 3.47 percent. This rapid expansion has been concentrated in the five quarters following
the 2003 Bush tax cuts. Since the third quarter of 2003, growth has averaged 4.62 percent.

Present:

Smart tax policy is a key ingredient of economic growth, and the tax policy moves of the last
three years have had a marked impact on economic activity. This influence has been particularly
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evident since mid-2003 when the Bush tax cuts were passed by Congress: these cuts created
strong incentives for investment, which in turn spurred the American economic engine.

Investment is one of main components of GDP, and also one of most variable. Many observers
believed that the investment boom of the 1990s would cause a long-term surplus of plant and
equipment, stifling further expansion. Nevertheless, recent indicators suggest that the
information technology revolution was real, and booming orders for computer equipment and
software are setting records once again. The average rate of investment growth after the 2003 tax
cut has been 14.6 percent, compared to the average since 1970 of 5.9 percent. In real dollars,
investment is $774 billion higher per year than it was a decade ago. Investment is a sign of a
booming economy, and it is driving the productivity revolution that raises U.S. living standards.

The overall level of GDP was $9.89 trillion (in 2000 dollars) when Bush was elected and $9.87
trillion in the third quarter of 2001, when the 9/11 terrorist attacks occurred. Exactly three years
later, GDP is $10.88 trillion, a 10 percent real increase. To put that in perspective, just the
growth of the U.S. economy over the past three years is larger than half of the entire French
economy.
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Not only is the present growth path of the U.S. economy faster than the historical average, but it
has also been roughly double the European economic growth rate since the 2001 tax cuts.
According to OECD data, European economic growth has slowed dramatically since 2000,
declining from a growth rate of 3.7 percent in 2000 to 1.6 percent in 2004. In contrast, the U.S.
economy has strengthened since the 2001 recession, and in 2004, economic growth again
reached boom-era levels and still growing.

Chart 3 compares the growth rates of the United States, Japan, and the Euro zone from 1999 to
2004, in real terms. America had higher living standards to begin with, and it has been growing
faster to boot. In Europe especially, bigger and more intrusive government has led to a seemingly
permanent state of slow growth, with unemployment rates roughly double those in the United
States. Greater government intervention combined with slow growth is a recipe for failure that
more than a few European nations have begun to reject but unfortunately, that the United States
may be starting to emulate.

The Federal Reserve Bank’s policy-making committee announced some good news in August
2009, saying it believes the recession is ending. The announcement came almost exactly two
years after the Fed embarked on what was the biggest financial rescue in American history.
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Though the central bank stopped well short of declaring victory, policy makers issued an upbeat
assessment.

The bank cautioned that the recovery would be slow and that unemployment was likely to
remain high for another year.

The economy was last in recession in 2001. Contrary to widespread belief, the terrorist attacks of
2001 did not cause the downturn that year. The economy slowed as the dot-com bubble started
leaking in early 2000 and began to shrink in early 2001. The recession ended in November 2001.

Over the last few decades, recessions have become less common than they once were. Ben S.
Bernanke, the Federal Reserve chairman, and others have described this development as the
"great moderation." While the economy used to swing between expansion and contraction every
few years, there had been only two relatively brief recessions over the last 25 years before the
current downturn.Read More...

Perhaps the most important reason for the change is the new flexibility of businesses. Executives
can now track the ups and downs of their sales and inventories more closely than they used to,
thanks in large part to computers. Better transportation, like FedEx, also helps companies to keep
their warehouses lean. So a company is less likely to find itself suddenly stuck with too many
workers and products -- and then have to make sharp cutbacks.

Yet there are also now increasing worries that a boom in consumer spending, helped along by
more consumer debt, played a large role in lifting economic growth and moderating its swings
over the last generation. If this is the case and if the end of the debt boom leads to slower
consumer spending, as seems to be happening economic growth may slow significantly in
coming years, even after the recession ends.

Despite the economic growth from 2001 to 2007, many families did not receive large pay
increases. Starting in the mid-1970s, compensation pay and benefits for the typical worker began
to grow more slowly than it had in the 1950s and '60s. Over the last 30 years, there has been only
one period, from about 1996 to 2002, when hourly pay grew for most workers a lot faster than
inflation. The most recent expansion, which began in late 2001, will likely end up being the first
one on record in which median household income did not reach a new inflation-adjusted record.

Future:
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Nobody can predict the future but based on the current hypothesis is that there is a 50%
probability that this is a U shaped recession. Which means we are at the bottom which would
remain anywhere between 6 months to 2 years. There is a 30% probability this is a W shaped
recession. Meaning that the current period is the calm before the storm. If that is correct, it’s
obviously advisable to pull money out of the market at the first sign of a downturn. We would
see a massive fall in the economy. The recession would last for another 6 months; we would see
recovery after that. The third scenario (saving the worst for the last) is an L shaped recession.
This basically means that there would be massive stagflation and there would be no growth in
US economy for next 10 years.

So what determines which one of 3 above outcomes to happen

1.) Oil prices: US economy needs oil prices in the range of 60-70 dollars for the economy to
recover. If they go above $100 all small industries would perish since the raw material cost
would go up. If it falls below $50, new research in alternative energy would not occur.Hence no
new growth projects will be seen.
2.) What happens to excess money flow: A big reason why the economy has not gone further
down in last 3 months is the massive interference by the governments of all countries.
Economists know that pumping money into recession is a must. But no one has a clue of when
and how to pull it back. If the money is not pulled back at right time, it can lead to serious
stagflation problems.

3.) Innovation: In the end every economy has grown due to some innovation or other. In the
prehistoric times it was fire and agriculture. Arabs grew due to trade. Europeans grew due to
internal combustion engine. Americans grew due to Assembly lines and efficient manufacturing.
There are several industries which have the capability of growth biotechnology, smart phones,
alternative energy, and green jobs. It would be seen which among these is able to drive the next
era of growth.

Inflation:
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“Price Inflation” is the percentage increase in the price of the basket of products over a specific
period of time. The government chooses an arbitrary date to be the base year and sets that equal
to 100. In the United States currently that date is 1984. (Or more accurately the average of the
years 1982-1984) previously the base year was 1967. Apart from setting the base year, CPI
(Consumer Price Index) is required to calculate the rate of inflation. Every month the Bureau of
Labor Statistics (BLS) surveys prices around the country for a basket of products and publishes
the CPI denoted as a number.

Normally, the inflation rate is calculated on an annual basis from July 2007 until July 2008. This
gives us the amount of inflation in one year. Which is typically called "The Inflation Rate". On
the other hand, a general decline in the price levels is known as deflation, often caused by the
reduction in the supply of money or credit. Deflation can also be brought about by direct
contractions in spending, either in the form of a reduction in government spending, personal
spending or investment spending. And in some cases, increase in the supply of goods if country
is able to produce goods on cheaper costs.

Inflation’s Past History In U.s:

In order to study the past trends of inflation that have occurred in the United States we have
analyzed the data from year 1914 up to the present year. From year 1914 till 1920s the inflation
rate was extremely high averaging between 17% and 15%. However, after that it took a sharp
turn towards decline and inflation of 15% turned into a deflation of -8%. From there onwards
throughout the time period of late 1920s to late 1930s the inflation rate was lower and mostly
deflation was the common prevailing trend in those years. This situation continued till 1945 but
from 1946-47 there was a sudden rise in the inflation rate and it jumped up from 2.27% to
14.65%.

The years that elapsed between 1950 till 1965, US experienced somehow stable rate of inflation
averaging 1%-2%. Then again the trend took a turn for the worse and the rate of inflation went
up and this continued until 1982 having minor fluctuations in between.

Nonetheless, from year 1983 till year 2008 US inflation trend again turned a twist and the
inflation rate came down from 10.35% in 1981 to 3.22% in 1983. This rate of inflation continued
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to remain as the average level going up as high to 5.39% and as low to 1.55% till 2008.
However, the present fiscal year of 2009 US has been experiencing overall deflation in the price
of its commodities due to the recent recession. As a result of the stock market crash all the
liquidity has been sucked out of the market place, the economy has contracted, people lost their
jobs and banks have stopped loaning money because people were defaulting. The problem
compounded as more people lost their jobs and money supply fell further causing more people to
lose their jobs. According to the latest data available in October 2009 the rate of deflation is
-0.18%.

Central Banks Expected Monetary Policy For Pakistan For December-January.

Pakistan's central banks cut on Tuesday, its key policy rate by 50 basis points to 12.5 percent for
December and January, but warned that the level of risk and uncertainty in the economy had
increased because of poor security. The State Bank of Pakistan kept its rate unchanged at 13
percent on Sept. 29 after a cut in August of 100 basis points.

The Inflation has fallen to 8.9 percent in October 2009 and is expected to remain in the area of
11 percent by the end of current fiscal year. External current account has improved considerably.
With government borrowings from the SBP remaining within the quarterly limits, the broad
money (M2) has also remained along the projected path. The real sector is also showing signs of
improvement as the large scale manufacturing (LSM) stage a recovery after a prolonged
declining phase. The poor administration in the supply chain of some food items is not helpful
either in positively altering inflation expectations. A higher than projected fiscal deficit for FY09
has also changed some underlying assumptions for inflation outlook in FY10. In addition, the
full impact of electricity and gas price adjustments, a necessary part of fiscal consolidation
measures, and recent resurgence of international commodity prices, on the back of early signs of
global economic recovery, remains a source of uncertainty for inflation outlook. The recovering
global economy is expected to revive global trade and flow of liquidity across borders, which
promises well for Pakistan’s exports and private financial flows. The recent strong inflow of
workers’ remittances and a substantially improved external current account deficit of $1.1 billion
in the first four months of FY10 may allow Pakistan’s economy to absorb the likely swelling of
import bill induced by a hopeful domestic recovery and higher international oil prices. However,
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the strength and sustainability of its overall balance of payments crucially depends on
continuation of foreign financial flows. Of these, portfolio inflows have picked up, direct
investment has fallen, and official inflows, other than IMF, remain lower compared to
projections

In conclusion, the overall level of risk and uncertainty in the economy has increased
considerably given the present law and order situation. As a consequence, the pressure on the
fiscal position, especially from the financing side, has escalated and growth in the real economy
is limited. Striking a balance between monetary and financial stability and real economic activity
has become increasingly difficult. In this perspective, SBP has decided to support the
reproduction.

Centrals Bank Expected Monetary Policy For United States:

U.S is going through the worst recession since the depression of 1930’s due to mortgage crisis.
The U.S government had to spend millions of dollars to rescue the banks and other industries
including AIG, GM motors and automobile companies (Ford) etc. The US Government has also
reduced the interest rates substantially which are currently at 2.5 pc to increase the money supply
and increase liquidity which in turn will boost the demand, thereby, ultimately arresting the
current recession.

US trade deficit is also in billions of dollars adversely impacting the balance of payments
position. The trade deficit in the U.S. widened in October as the growing economy resulted in
imports to rise faster than the exports.

The gap grew to $36.8 billion, the widest since January, from $36.5 billion the prior month,
according to the median estimate of 75 economists surveyed by Bloomberg News hence making
US a highly indebted country. Because of the trade deficit, the Dollar is weakening against the
international currencies resulting in a growing concern amongst the leading countries to consider
an alternate currency as a reserve currency.

The US Government has invested billions of dollars in the economy to give a boost to its ailing
economy unfortunately however it hasn’t yielded the desired results so far. As the
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unemployment is rising and is currently at 10pc which is the worst in the last two decades.
Dollar’s value is the lowest against Japanese yen in the last 14 years.

US will have to maintain interest rate below 1 pc to ensure liquidity and maintain the purchasing
power of the public until the recession ends and the economy takes a u-turn towards

Oil And Its Future Impact

Few inputs impact the U.S. economy as much as the price of oil. Oil powers the cars, trucks, and
airplanes that transport people and products for the entire economy. As oil prices rise, costs go
up for transportation companies such as airlines and freight delivery companies, squeezing their
profit margins. Downstream of these companies, customers who rely on them to get products to
market are similarly impacted by higher prices. In contrast, most companies in the energy
business benefit from higher oil prices, either from higher revenues for oil, or because of

Increased demand for substitute energy sources such as ethanol and clean energy. Car companies
with fuel conservation technology such as hybrid engines can expect sales to go up as consumers
feel the pinch of higher prices at the pump, while those who rely on sales of SUVs may find their
business models challenged.

The crude oil storage industry, larger investments are expected to come from national oil
companies during 2008-15, especially the Chinese national oil companies. However in the crude
oil pipeline industry, private players will continue to dominate the overall industry.
The global crude oil industry has been hit by the global economic slowdown. The slowing
demand, low crude oil prices and tight credit market have posed serious challenges to the
industry. The low global demand and unavailability of credit have led to the delay of many major
projects across the crude oil value chain. The worst hit has been the Canadian oil sands industry.
With the falling of crude oil prices to as low as $35 a barrel, the oil sands projects were rendered
uneconomical. The situation caused the suspension of many major oil sands projects. Globally
approximately 69 major E&P projects were delayed, suspended or cancelled altogether of which
23 projects were Canadian oil sands projects. However with the crude oil prices reviving the
situation is expected to ease.
In addition to this, the current crisis has also forced almost all major international oil companies
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to cut down on their capital expenditure (CAPEX). As a result of the current economic
slowdown, the majority of companies are formulating their capital budgets more realistically in
line with their internal cash flows. For example, Canadian Natural Resources has reduced its
Capex from $6.4 billion in 2008 to $2.7 billion in 2009, reduced by approximately 57.8%. BP
reduced its Capex from $22 billion in 2008 to $19 billion in 2009, a reduction of 13.6%
With huge heavy oil reserves in Venezuela and huge oil and gas discoveries in Brazil, the Latin
American countries are expected to play a major role in supplying the crude oil needs of the
world in future years. The region has been one of the active areas in terms of new oil and gas
discoveries which make it one of the most prospective regions for the future.
The Latin American countries led the other regions in terms of significant discoveries in 2008.
The region witnessed six major oil and gas discoveries last year with five major discoveries in
Brazil and one in Peru. With major discoveries in 2008 and huge resources, the region is
expected to be one of the major sought after locations for future investments.
The Asia Pacific and Middle East and Africa regions will drive the growth of refining capacity
during 2008-15. The overall crude oil refining capacity of Asia Pacific is expected to increase at
an average annual growth rate of 3.1% during 2008-15. The refining capacity of Middle East and
Africa region is expected to increase at a rate of 8.09% annually.

There are 33 new planned refineries in the Middle East and Africa region and 22 new refinery
projects in Asia Pacific. The two regions together will add approximately 450 million tones of
refining capacity to global refining capacity which will account for approximately 80% of the
new planned refinery capacity added during 2008-15..

Gold And Its Future Impact:

• The Oil Price Will Affect The Gold Price

The coming massive oil crisis is just over the horizon. Markets won’t wait until they arrive they
discount the changes well ahead of them. The picture of a swing in wealth and power to the east,
from the west is shown by the changing shape of oil demand and supply. Add to that the crises
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that always attend such power swings and oil market changes are pointing to the time when gold
will hit peak demand and gold price rise to unseen levels. Then the oil price will influence the
gold price as a joint measure of the state of the global monetary scene.

• How Will Recession Of U.S Economy Affect Gold Prices

From 1990s until today, Americans have maintained their life style by borrowing. As the
American consumer is about to find out, the bill for that life style is coming due.

So to where will it lead the U.S. economy? Simply stated, surveying the landscape of current
events, many of them are nothing else but direct consequences of excessive debt and inevitable
slowdown in consumer spending, we expect stagflation. Loosely defined, this term refers to a
general economic slowdown – a recession – but coupled with rising prices triggered by massive
infusions of liquidity into the market.

That liquidity can be originated by governments: witness billions and billions thrown by leading
central banks into the fray ; or it can come, let's say, as a certain percentage of over $6- trillion in
assets possessed by foreigners who are coming home to roost. On that latter point, almost every
day we have heart news about wealth funds of foreign corporations and sovereigns unloading
their greenbacks in exchange of shares of some America’s largest financial institutions

• Gold in a Recession 2009-10

Traditionally gold has been a safety net against inflation. Inflation is good for gold, a case we
don’t need to make again here.
But, in a typical recession, the demand for everything slows and , as a result, the prices drop. The
knee-jerk reaction of most casual market observers, therefore, might be that if inflation is always
good for gold, then the opposite is always bad.

However, from the historical perspective it isn't always the rule. The chart below shows the
price of gold overlaid against official periods of recession as defined by the National Bureau of
Economic Research. As you can see, about half of the time gold actually raised its value
within recession periods.
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Forward Expectations:

The common opinion among the analysts about the future expectations is that they believe that
US may have seen the last of deflation for a long period of time. As predicted earlier the Annual
deflation has almost played itself out. The current rate is just below zero at -0.18%. It reached a
low of -2.10% in July and was at -1.48% in August. It was -1.29% in September.

So with the current rate almost back to zero there are chances of facing some massive
inflation before the end of this fiscal year for the history has repeatedly shown in the past that
when it comes to hyperinflation it is like a dam breaking. At this point the MIP (The Moore
Inflation Predictor is a highly accurate graphical representation forecasting the future
direction of the inflation rate) is projecting that a year from now US could once more be at
5% inflation just as it were a year ago.
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Forward View On Stocks And Bonds:

According to the stock market analysts, the U.S. Economy in 2009 will be worse than ever. All
the surprises are going to be on the downside. They believe that the current recession that is
currently being experienced by the country is not going to just blow over.

And the reason for it to get worst is that the interest rates are now at all-time lows, and the bond
market is much, much bigger than the stock market. What’s inevitable is much higher interest
rates. And when they go up, it will mark the end of already ailing stock and real estate’s market
and it will wipe out a huge amount of capital in the bond market as well. Furthermore, the higher
interest rates will bring on even more bankruptcies.
Although, some consider these bankruptcies to be benefit in disguise for they believe that these
higher interest rate would encourage people to save.

Treasury Bonds

Treasury bonds (T-Bonds, or the long bond) have the longest maturity, from twenty years to
thirty years. They have a coupon payment every six months like T-Notes, and are commonly
issued with maturity of thirty years. The secondary market is highly liquid, so the yield on the
most recent T-Bond offering was commonly used as a proxy for long-term interest rates in
general. This role has largely been taken over by the 10-year note, as the size and frequency of
long-term bond issues declined significantly in the 1990s and early 2000s.

The U.S. Federal government suspended issuing the well-known 30-year Treasury bonds (often
called long-bonds) for a four and a half year period starting October 31, 2001 and concluding
February 2006. As the U.S. government used its budget surpluses to pay down the Federal debt
in the late 1990s. The 10-year Treasury note began to replace the 30-year Treasury bond as the
general, most-followed metric of the U.S. bond market. However, because of demand
from pension funds and large, long-term institutional investors, along with a need to diversify the
Treasury's liabilities and also because the flatter yield curve meant that the opportunity cost of
selling long-dated debt had dropped the 30-year Treasury bond was re-introduced in February
2006 and is now issued quarterly. This brought the U.S. in line with China and European
governments issuing longer-dated maturities and growing global demand from pension funds.
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Series EE

Series EE bonds are issued at 50% of their face value and reach final maturity 30 years from
issuance. Interest is added to the bond monthly and paid when the holder cashes the bond. They
are designed to reach face value in approximately 17 years, although an investor can hold them
for up to 30 years and continue to accrue interest. For bonds issued before May 2005 the rate of
interest is recomputed every six months at 90% of the average five-year Treasury yield for the
preceding six months. Bonds issued in May 2005 or later pay a fixed interest rate for the life of
the bond, although the Treasury does guarantee that the bond will reach face value after 20 years.
In the space of a decade, interest dropped from well over 5% to 0.7% for new bonds in 2009.

Interest is taxable at the federal level only. Investors can elect to defer taxation until the bond
ceases to pay interest (30 years after issuance) or until it is redeemed.

Series EE bonds are designed for individual investors, sold at a discount, and redeemed at an
amount that includes the interest income. Hence, while interest is calculated monthly, the interest
on a Series EE bond is not paid until redemption.

All Series I Savings Bonds and Series EE Savings Bonds issued in May 1997 or later increase in
value monthly. All other Savings Bonds, including Series HH bonds issued after May 1997, pay
interest on a six-month cycle. These bonds should be cashed near the beginning of their month of
issue or of the month exactly six months later.

Series HH

Series HH bonds are sold at a discount and mature at face value. Unlike T-Bonds (Treasury
Bonds) and agency issues, Series HH bonds are nonmarketable. They also pay interest semi-
annually, as do most bonds.

Issuance of Series HH bonds stopped as of August 31, 2004, but there are still many yet that
have not matured.

Series I

Series I bonds are issued at face value and have a variable yield based on inflation. The interest
rate consists of two components: the first is a fixed rate which will remain constant over the life
of the bond and the second is a variable rate reset every six months from the time the bond is
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purchased based on the current inflation rate. New rates go into effect on May 1 and November 1
of every year. The fixed rate is determined by the Treasury Department; the variable component
is based on the Consumer Price Index from a six month period ending one month prior to the
reset time. Like EE bonds, I bonds are issued to individuals with a limit of $5,000 per person
(by Social Security number) per year. A person may purchase the limit of both paper and
electronic bonds for a total of $10,000 per year. Redeeming the bonds before five years will
incur a penalty of three months of interest. The Treasury Department announced in early
November 2008 the return of a fixed rate component, which the Treasury removed in July. For
newly purchased securities, the Series I will pay 0.7% fixed annual rate, in addition to the
inflation adjustment. Combining the fixed rate and the inflation adjustment as of November
2008, new I-bonds will earn interest at a 5.64% annual percentage rate.

T.I.P.S

Treasury Inflation-Protected Securities (or TIPS) are the inflation-indexed bonds issued by the
U.S. Treasury. The principal is adjusted to the Consumer Price Index, the commonly used
measure of inflation. The coupon rate is constant, but generates a different amount of interest
when multiplied by the inflation-adjusted principal, thus protecting the holder against inflation.
TIPS are currently offered in 5-year, 10-year and 30-year maturities. The U.S. Treasury replaced
the 20-year maturity with the new 30-year maturity in February 2010.

How U.S Treasury Bonds Work

For the ultimate safety with your bond investments, you can turn to the U.S. government, the
most reliable borrower in the world. The U.S. government has never defaulted on a loan, and it
would take a mighty big catastrophe before the U.S. Treasury could collapse. To put it simply,
you'll never have to worry about the U.S. not paying you back if you buy some of its bonds.

Since U.S. government bonds are among the safest in world, they almost always have lower
yields than other bonds of the same maturity. That's the price you pay for quality. And they do
have some risks. For instance, you can't predict what price you'll be able to get for your bonds if
you need to sell at some point before maturity.
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Another advantage of Treasuries is that interest payments are exempt from local and state taxes
however, not from Federal income taxes.

Treasury securities cannot be redeemed before maturity and do not have call provisions. Some
Treasury bonds issued before 1985 did have call provisions, however, so you need to watch out
if you buy these bonds in the secondary market. As soon as the bonds are called, interest
payments cease.

You can buy Treasuries through a broker, or you can buy them directly from the federal
government, which holds regular auctions that individual investors can participate in. However,
if you buy directly from the government, you can't redeem the security prior to maturity. You'd
have to use the services of a broker to sell your bond in the secondary markets.

Treasury Bonds, Bills and Notes

The United States government issues several different kinds of bonds through the Bureau of the
Public Debt, an agency U.S. Department of the Treasury. Treasury debt securities are classified
according to their maturities:

• Treasury Bills have maturities of one year or less.

• Treasury Notes have maturities of two to ten years.
• Treasury Bonds have maturities greater than ten years.
Treasury Bonds, Bills, and Notes are all issued in face values of $1,000, though there are
different purchase minimums for each type of security.

Investors often shorten the word Treasury to just the letter "T" when referring to these bonds.
Thus, Treasury Bonds are known as T-Bonds, Treasury Notes are called T-Notes, and Treasury
Bills are T-Bills.

Treasury Bonds are usually issued in thirty-year maturities, and pay interest twice a year.
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No matter what you're buying, you can often get a better deal when you buy direct. And the U.S.
Treasury has a special program for individual investors to help cut out the middleman (in this
case, your broker) and help you to purchase T-Bonds

T-Bond Present

The U.S. Treasury Bond market rallied to historical highs in late 2008 as investors flocked to
these safe-haven assets amid the global credit crisis, bringing the yield on the 30-yr Treasury
Bond to as low as 3%, something never before seen. Since then, prices have retreated, pushing
long-term yields higher, as credit-crunch fears have eased and investor's have returned
aggressively to traditional assets such as equities.

The rapid and voluminous injection of money by the Federal Reserve Board into the financial
system during the credit crisis, coupled with a return to economic growth among the major
industrial nations, has some investors speculating that inflation may soon become a problem.
These investors can find an easy trade in the futures and options market for U.S. Treasury
Bonds: sell a futures or buy a put option or bear put option spread.
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Future Of T-Bond

• Treasury bonds futures offer substantial protection from unexpected changes in

corporate bond prices
• Treasury bonds futures are more effective in fabricate high-quality corporate debt
• And nearer treasury bonds futures contracts are superior to more distant contracts
in hedging corporate debt

China's holdings of US Treasury bonds tumbled in December, allowing Japan to take over as the
top holder of American government debt, according to Treasury data. China’s bond holdings
dropped substantially to 755.4 billion dollars in the last month of December from 789.6 billion in
November, said the Treasury's international capital data report. Beijing had expressed fears late
last year about the safety of its dollar-linked assets in view of Washington's growing budget
deficit and the declining greenback at that time as the American economy struggled to emerge
from a brutal recession.

The debt scale of the U.S. had shrunk, but further expanded after the international financial
crisis, and whereas only private enterprises were in debt in the past, the public sector has now
also incurred debt. The expanding debt scale of the federal government and local government
departments as well as the huge budget deficit will inevitably result in issuance of additional
money and the depreciation of the U.S. dollar, which will cause a sharp shrink in the value of the
U.S. dollar assets held by creditor countries.

Bonds control the amount of money in an economy. If China sells US treasury bonds, it basically
gets money in exchange for the bond, that would mean more money is out of the control of the
U.S, and inflation will result.

Recommendations:

Due to recession in the global economy highly developed countries are a bit hesitant in buying
treasury bonds and also due to falling value of the dollar, so the government can focus more on
the individual investors by providing them with proper information via advertisement about the
treasury. Some of the elements are described below
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Lock in a Purchase Price

If you plan to purchase fixed-income securities in the futures and are concerned about the
possibility of higher prices, you can buy Treasury futures and secure a maximum purchase price.

Preserve Investment Value

By selling Treasury futures, you can lock in an attractive selling price and protect the value of a
portfolio or individual security against possible decreasing prices.

Cross-Hedge

U.S. Treasury bond and note futures can be used to control risk and enhance the returns of non-
U.S. government securities. Treasury futures can be effective risk-management tools for
corporate bonds, and other fixed-income instruments.

Trade Changes in the Yield Curve

Because Treasury futures cover a wide spectrum of maturities from short-term notes to long-term
bonds, you can construct trades based on the differences in interest rate movements all along the
yield curve.

Efficiency

The unparalleled liquidity of CBOT Treasury bond, bill and note futures enables you to enter
and exit positions quickly and easily - and receive the best fills on your order.

Market Integrity

Counterparty credit risk is a major concern in today's marketplace. Trading at the CBOT is
structured to protect all parties involved from that risk. Our own professional audit staff
oversees the trading at the exchange. The Board of Trade Clearing Corporation provides a
performance guarantee. And the Commodity Futures Trading Commission, whose primary
function is to protect the integrity of the markets and its participants, regulates all U.S. futures
markets. With these safeguards, counterparty credit risk is no longer an issue.

Pricing
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The prices of Treasury bond and note futures contracts are determined by open outcry in the
designated trading pits, enabling you to receive the best prices available. These prices are
global interest rate barometers, reflecting moves in national and international rates, and are
available to the public immediately.

Trading Versatility

Because of CBOT Treasury bond and note futures respond to the same economic forces that
affect cash fixed-income securities, you can use them to help control the risk of holding these
securities as well as to improve returns.

Final Recommendation

U.S major treasury bond holder China Has dumped most of its treasury holdings of U.S sue to
falling rate of dollar and recession in the global economy but still U.S treasury bonds will never
default which is quite a big opportunity for individual investors they can benefit from it,
Government needs to focus more on these investors and try to resolve any political issues with
China. If U.S.A is able to resolve the monk-issue going on in china then perhaps because of the
goodwill China may reconsider her opting out option.

Reference
• China Threatens to Dump U.S. Treasury Bonds Over Taiwan Arms Sales « The Washington
Independent;
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○ http://washingtonindependent.com/76320/china-threatens-to-dump-u-s-
treasury-bonds-over-taiwan-arms-sales
• Monetary Inflation is Our Future

○ http://dailyreckoning.com/monetary-inflation-is-our-future/

• Future U.S. Inflation – Currency Thoughts

○ http://currencythoughts.com/2009/04/15/future-us-inflation/

• U.S. Treasury - Office of Performance Budgeting

○ http://www.ustreas.gov/offices/management/budget/

• Treasury Direct

○ http://www.treasurydirect.gov/

• NY Times
•