Buying TIPS in the secondary market

[Maurice]

Does anyone have any experience buying TIPS in the secondary market as a retail investor?

My brokerage (e*trade) has them available but the spread seems pretty ugly (~2%). If there were a cheaper place to buy them, I'd love to hear about it.



(note this question is only about secondary market buying, I can participate in treasury auctions for next to nothing through e*trade)

 

[ziggy29]

Your only other options are to buy at issue in Treasury auctions or to buy into a TIPS fund (the latter has principal risk since you can't hold a fund to maturity).

 

[Maurice]

Well, I figure the other options might be brokers who don't have such a spread. Hence I'm trolling for others' experiences.


I wonder if there are any direct access brokers who give customers access to any of the bond ecns.

 

[clifp]

2% wow that is high. Schwab charges either 0 for new offerings or $1/bond with a $10 minimum.

 

[Maurice]

Its not a commission, their commission is reasonable. Its the offer itself I don't like.


Get a quote on Schwab for the 2028s, for example, and compare that to what you see on bloomberg's website.

 

[clifp]

The Schwab quote I see for the 2028 1.75 coupons is 91.72 on Bloomberg I see 90 14/32 which looks like a 1% spread, but it isn't clear if Bloomberg is bid/ask or last trade.

So maybe your right and Schwab has a higher mark up than the advertised.

 

[FIRE'd@51]

The Schwab quote I see for the 2028 1.75 coupons is 91.72 on Bloomberg I see 90 14/32 which looks like a 1% spread, but it isn't clear if Bloomberg is bid/ask or last trade.

So maybe your right and Schwab has a higher mark up than the advertised.

The only way to tell is to look at the bid-ask from the same broker.

 

[clifp]

The WSJ has a bid ask of 90 12/32, 90 13/32 for the same TIP bond.

 

[2B]

The WSJ has a bid ask of 90 12/32, 90 13/32 for the same TIP bond.

The WSJ is using multi-million $ transactions. I'm also at Etrade and I've been eyeing TIPS. The problem with the spread is the size. The little guy always pays a higher spread to own individual bonds. I'm looking at holding to maturity so the issue isn't the bid/ask spread. My issue is the total return to maturity.

I'm worried what impact a deflationary period over the next year or two would have on the redemption price of a two year TIP. Could the TIP fall below a redemption price of $1000? Anyone have any insight?

 

[ziggy29]

The WSJ is using multi-million $ transactions. I'm also at Etrade and I've been eyeing TIPS. The problem with the spread is the size. The little guy always pays a higher spread to own individual bonds. I'm looking at holding to maturity so the issue isn't the bid/ask spread. My issue is the total return to maturity.

Right. I bought some 7/16s and 1/25s a few weeks ago despite the spread. All we little folks can do is decide whether the YTM based on the ask price is worth pulling the trigger on. When I did so, these YTMs were something like 3.4%, which for a relatively risk-free investment when held to maturity, a real 3.4% seemed pretty solid.

I'm worried what impact a deflationary period over the next year or two would have on the redemption price of a two year TIP. Could the TIP fall below a redemption price of $1000? Anyone have any insight?

When held to maturity, TIPS will never drop in value below par. So in a strongly deflationary environment, once TIPS drop back to $1000 par value, even if deflation continues the bond will not be worth less than $1000. Plus you continue to earn the coupon yield. What that means is that if deflation rages for (say) 7% some year and your TIPS with a 2% coupon are at par, you're actually earning a real 9% -- a +2% nominal yield with -7% inflation. At least that's how I understand it -- I know that TIPS can't be worth less than par when held to maturity.

 

[FIRE'd@51]

When held to maturity, TIPS will never drop in value below par. So in a strongly deflationary environment, once TIPS drop back to $1000 par value, even if deflation continues the bond will not be worth less than $1000. Plus you continue to earn the coupon yield. What that means is that if deflation rages for (say) 7% some year and your TIPS with a 2% coupon are at par, you're actually earning a real 9% -- a +2% nominal yield with -7% inflation. At least that's how I understand it -- I know that TIPS can't be worth less than par when held to maturity.

I agree that the accrued principle of TIPS will be 1000 at maturity, even if there has been net deflation over the lifetime of the TIPS.

However, prior to maturity, it is my understanding that the index ratio can go below 1.000. This will reduce the accrued principle below 1000, and since the coupon is multiplied by the accrued principal, the interest payment can go down as well.

So in your example, assume you bought the TIPS at auction (index ratio = 1.000) with a coupon of 2%, which means an annual interest payment of $20 per $1000 bond. If deflation were 7% the first year, the index ratio would become 0.930, so your accrued principle would be 930, and this is what you would get if you sold the TIPS in the secondary market, assuming real rates haven't changed. Since your annual interest payment is determined by multiplying the coupon rate by the accrued priciple, it would now be $18.60. So your nominal interest would drop by 7% as well, resulting in maintaining a real interest rate of 2%.

 

[ziggy29]

So in your example, assume you bought the TIPS at auction (index ratio = 1.000) with a coupon of 2%, which means an annual interest payment of $20 per $1000 bond. If deflation were 7% the first year, the index ratio would become 0.930, so your accrued principle would be 930, and this is what you would get if you sold the TIPS in the secondary market, assuming real rates haven't changed. Since your annual interest payment is determined by multiplying the coupon rate by the accrued priciple, it would now be $18.60. So your nominal interest would drop by 7% as well, resulting in maintaining a real interest rate of 2%.

Ah, yes -- I messed up some on the explanation. I should have mentioned that this really applies as the bond is approaching maturity. After all, if your index ratio is down to 0.930, you eventually have to get that 7% back even if deflation continues. So someone who buys down there would eventually get the boost from the built-in discount (assuming a hold to maturity). It would be interesting to see how the market prices these in that scenario, though I don't want to see it (long-term deflation probably means a depression).

 

[SteveL]

Below is the Dec. index for a TIP that I own:
Contact: Office of Financing 202-504-3550
DESCRIPTION: TIPS of April 2032
CUSIP NUMBER: 912810FQ6
DATED DATE: October 15, 2001
ORIGINAL ISSUE DATE: October 15, 2001
AUCTION DATE: October 10, 2001
MATURITY DATE: April 15, 2032
Ref CPI on DATED DATE: 177.50000
TABLE FOR MONTH OF: December 2008
NUMBER OF DAYS IN MONTH: 31

CPI-U (NSA) August 2008 219.086
CPI-U (NSA) September 2008 218.783
CPI-U (NSA) October 2008 216.573

Month Calendar Day Year Ref CPI Index Ratio

December 1 2008 218.78300 1.23258
December 2 2008 218.71171 1.23218
December 3 2008 218.64042 1.23178
December 4 2008 218.56913 1.23138
December 5 2008 218.49784 1.23097
December 6 2008 218.42655 1.23057
December 7 2008 218.35526 1.23017
December 8 2008 218.28397 1.22977
December 9 2008 218.21268 1.22937
December 10 2008 218.14139 1.22897
December 11 2008 218.07010 1.22856
December 12 2008 217.99881 1.22816
December 13 2008 217.92752 1.22776
December 14 2008 217.85623 1.22736
December 15 2008 217.78494 1.22696
December 16 2008 217.71365 1.22656
December 17 2008 217.64235 1.22615
December 18 2008 217.57106 1.22575
December 19 2008 217.49977 1.22535
December 20 2008 217.42848 1.22495
December 21 2008 217.35719 1.22455
December 22 2008 217.28590 1.22415
December 23 2008 217.21461 1.22374
December 24 2008 217.14332 1.22334
December 25 2008 217.07203 1.22294
December 26 2008 217.00074 1.22254
December 27 2008 216.92945 1.22214
December 28 2008 216.85816 1.22174
December 29 2008 216.78687 1.22133
December 30 2008 216.71558 1.22093
December 31 2008 216.64429 1.22053

Yes, there has been a decline in the value of the bond this month.
However, I have owned for seven years.
With the Democrats in power, inflation will be back!

 

[FIRE'd@51]

CPI-U for November 2008 (released 8:30 AM EST this morning) was 212.425. This means that the Index Ratio for TIPS will drop 2% over the month of January 2009.

 

[ziggy29]

CPI-U for November 2008 (released 8:30 AM EST this morning) was 212.425. This means that the Index Ratio for TIPS will drop 2% over the month of January 2009.

It'll be interesting to see the market today and how much of this was already priced in. I suspect most of it was already.

 

[SteveL]

The January TIPs index numbers are already posted.
Contact: Office of Financing 202-504-3550
DESCRIPTION: A-2012
CUSIP NUMBER: 9128277J5
DATED DATE: January 15, 2002
ORIGINAL ISSUE DATE: January 15, 2002
AUCTION DATE: January 09, 2002
MATURITY DATE: January 15, 2012
Ref CPI on DATED DATE: 177.56452
TABLE FOR MONTH OF: January 2009
NUMBER OF DAYS IN MONTH: 31

CPI-U (NSA) September 2008 218.783
CPI-U (NSA) October 2008 216.573
CPI-U (NSA) November 2008 212.425

Month Calendar Day Year Ref CPI Index Ratio

January 1 2009 216.57300 1.21969
January 2 2009 216.43919 1.21893
January 3 2009 216.30539 1.21818
January 4 2009 216.17158 1.21743
January 5 2009 216.03777 1.21667
January 6 2009 215.90397 1.21592
January 7 2009 215.77016 1.21516
January 8 2009 215.63635 1.21441
January 9 2009 215.50255 1.21366
January 10 2009 215.36874 1.21290
January 11 2009 215.23494 1.21215
January 12 2009 215.10113 1.21140
January 13 2009 214.96732 1.21064
January 14 2009 214.83352 1.20989
January 15 2009 214.69971 1.20914
January 16 2009 214.56590 1.20838
January 17 2009 214.43210 1.20763
January 18 2009 214.29829 1.20688
January 19 2009 214.16448 1.20612
January 20 2009 214.03068 1.20537
January 21 2009 213.89687 1.20461
January 22 2009 213.76306 1.20386
January 23 2009 213.62926 1.20311
January 24 2009 213.49545 1.20235
January 25 2009 213.36165 1.20160
January 26 2009 213.22784 1.20085
January 27 2009 213.09403 1.20009
January 28 2009 212.96023 1.19934
January 29 2009 212.82642 1.19859
January 30 2009 212.69261 1.19783
January 31 2009 212.55881 1.19708[–] Text Size [+]

• How Treasury Auctions Work
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• Savings Bond Data

 

[ziggy29]

Interesting. The 10-year July 2018s will have an index value of 0.98571 on January 31. Are these the first issues to have an index value below par?

 

[SteveL]

Yes, I think it is a first.
However if you are looking to buy, it is not a bad thing. It just means you pay less to buy one. I bought one with a higher coupon this morning. When you look at what people are paying for a 10-year T-bill a TIP that will pay 2.5% plus inflation sure looks good.

 

[FIRE'd@51]

However if you are looking to buy, it is not a bad thing. It just means you pay less to buy one. I bought one with a higher coupon this morning. When you look at what people are paying for a 10-year T-bill a TIP that will pay 2.5% plus inflation sure looks good.

This may be true, although, from your Dec and Jan tables of index ratios, it looks like you are guaranteed to lose about 2.4% of accrued principal between today and the end of January.

 

[samclem]

So, how does one look at the secondary market to figure out what news TIPS will likely yield? I'm thinking about buying 20 year TIPS in the January auction, but would like to know going in what the result is likely to be.

 

[SteveL]

Buying right

This may be true, although, from your Dec and Jan tables of index ratios, it looks like you are guaranteed to lose about 2.4% of accrued principal between today and the end of January.

Since I hold all bonds until maturity, the trick is to time a TIP purchase so that the price paid, plus the current inflation index for that bond adds to about the amount of principal you get back at maturity.

For the TIP I bought yesterday, the price plus index meant I paid about $25100 for a $25k TIP. At maturity, you always get back face no matter what.

For those who are interested in buying individual TIPS, this is a list of all the TIPS issues from the Treasury.

• 3-5/8% 30-year TIPS due April 15, 2028
• 3-7/8% 10-year TIPS due January 15, 2009
• 3-7/8% 30-year TIPS due April 15, 2029
• 4-1/4% 10-year TIPS due January 15, 2010
• 3-1/2% 10-year TIPS due January 15, 2011
• 3-3/8% 30-1/2-year TIPS due April 15, 2032
• 3-3/8% 10-year TIPS due January 15, 2012
• 3% 10-year TIPS due July 15, 2012
• 1-7/8% 10-year TIPS due July 15, 2013
• 2% 10-year TIPS due January 15, 2014
• 2% 10-year TIPS due July 15, 2014
• 2-3/8% 20-1/2-year TIPS due January 15, 2025
• 0-7/8% 5-1/2-year TIPS due April 15, 2010
• 1-5/8% 10-year TIPS due January 15, 2015
• 1-7/8% 10-year TIPS due July 15, 2015
• 2% 10-year TIPS due January 15, 2016
• 2% 20-year TIPS due January 15, 2026
• 2-3/8% 5-year TIPS due April 15, 2011
• 2-1/2% 10-year TIPS due July 15, 2016
• 2-3/8% 10-year TIPS due January 15, 2017
• 2-3/8% 20-year TIPS due January 15, 2027
• 2% 5-year TIPS due April 15, 2012
• 2-5/8% 10-year TIPS due July 15, 2017
• 1-5/8% 10-year TIPS due January 15, 2018
• 1-3/4% 20-year TIPS due January 15, 2028
• 0-5/8% 5-year TIPS due April 15, 2013
• 1-3/8% 10-year TIPS due July 15, 2018

More recent TIPS have lower indexes. Your broker will usually have most of these available for resale, and can quote to you the yield to maturity for each bond.
Yesterday, pricing for most bonds produced YTM of about 3%+.

 

[Maurice]

So, how does one look at the secondary market to figure out what news TIPS will likely yield? I'm thinking about buying 20 year TIPS in the January auction, but would like to know going in what the result is likely to be.

You can look at how the closest maturity is trading on Bloomberg the week of the auction, it should be a good indicator.

Bloomberg.com: Government Bonds

 

[Maurice]

I'll also add that the Treasury tries to estimate the yield when setting the coupon - it seems they are targeting these to sell around par. They don't get it exactly right, of course, but they're close. Last year they set the coupon at 1.75 and I think the auction came out around 1.8.

 

[SteveL]

There is an ETF for TIPS symbol TIP which is a good tool to use to get an idea of the current pricing of and demand for TIPS. The 52week range was 84 to 112. Pricing is volatile. Today, the TIP etf is trading over 101. Just two days ago before the latest FED cut, it was in the 96 range. It is obviously better to buy at the lower end.