Certificate of Accrual on Treasury Securities (CATS): Zero-Coupon Treasury Security

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.

Comparisons

• 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.

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.

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.