A Certificate of Accrual on Treasury Securities (CATS) is a type of zero-coupon U.S. Treasury security. Unlike traditional bonds, CATS do not pay periodic interest. Instead, they are sold at a discount and mature at their face value. The difference between the purchase price and the face value represents the interest earnings for the investor.
What are Zero-Coupon Treasury Securities?
A zero-coupon bond is one that does not pay interest (a coupon) during its life. Instead, it is sold at a deep discount and matures at its face value. The investor profits from the difference between the purchase price and the amount received at maturity.
Calculation of Yield
The yield on a zero-coupon bond can be calculated using the formula:
where:
- \( Y \) = Yield
- \( F \) = Face value of the bond
- \( P \) = Purchase price of the bond
- \( t \) = Number of years until maturity
History of CATS
Certificates of Accrual on Treasury Securities (CATS) were popular in the 1980s, a period that saw a variety of innovative financial instruments designed to meet the needs of different types of investors. CATS were one among several zero-coupon securities introduced during this era.
Comparison with Other Zero-Coupon Bonds
- CATS vs. TSTRIPS: Treasury Separate Trading of Registered Interest and Principal Securities (TSTRIPS) also function as zero-coupon securities. However, TSTRIPS are modern instruments created from U.S. Treasury securities by separating the interest and principal payments, effectively creating two separate zero-coupon bonds.
- CATS vs. Zeros: Generic zero-coupon bonds issued by corporations or municipalities function similarly but carry different risk profiles due to issuer creditworthiness.
Applicability
CATS are particularly suitable for investors looking to receive a lump sum at a future date. These might include:
- Education Savings: Parents saving for children’s education.
- Retirement: Individuals setting aside funds for retirement.
- Institutional Investors: Institutions aiming to match future liabilities with corresponding assets.
Special Considerations
- Tax Implications: Investors must pay federal income tax on the imputed interest annually, even though no actual interest is received. This phenomenon is known as “phantom income.”
- Investment Horizon: Given that CATS have specified maturity dates, they are more suited to long-term investment horizons.
- Interest Rate Sensitivity: Zero-coupon bonds are more sensitive to interest rate changes compared to coupon-paying bonds.
Examples
Consider an investor who purchases a CATS for $500, with a face value of $1,000, maturing in 10 years.
- Purchase Price: $500
- Maturity Value: $1,000
- Yield Calculation:
$$ Y = \left( \frac{1000}{500} \right)^{\frac{1}{10}} - 1 \approx 7.18\% $$
Related Terms
- Coupon Bond: A bond that pays interest at regular intervals.
- T-Bill: Short-term U.S. Treasury security maturing in one year or less.
- T-Note: Medium-term U.S. Treasury security with maturities ranging from 2 to 10 years.
- Yield-Yield Curve: Graphical representation of interest rates for bonds of equal credit quality but different maturities.
FAQs
Q1: Are CATS still issued today? No, CATS as originally issued are no longer available; they have been replaced by TSTRIPS.
Q2: How do zero-coupon bonds benefit long-term planners? They are beneficial due to predictable returns and the lump-sum payment at maturity, aligning well with future financial goals.
Q3: Why is the yield on zero-coupon bonds higher than on coupon bonds? The yield appears higher because zero-coupon bonds are purchased at a discount and have no periodic interest payments, thus compounding more intensely over time.
References
- U.S. Department of the Treasury. “Zero-Coupon Bonds.”
- Investopedia: “What is a Zero-Coupon Bond?”
Summary
A Certificate of Accrual on Treasury Securities (CATS) represents a unique investment vehicle in the form of zero-coupon U.S. Treasury securities. While no longer issued, they remain a significant part of financial history, symbolizing innovative financial instruments designed to cater to diverse investor needs. Understanding their structure, use, and implications helps investors make more informed decisions about their portfolio, especially in the context of long-term financial goals.
