How can I tell if I am going to pay a premium or discount at a TIPS auction?

In response to reader questions, I have added this to my ‘Q&A about TIPS‘ page on the site. It’s linked in the top navigation. There are two key questions: 1) is this a new TIPS or a reopening? and 2) Will the yield to maturity end up above or below the TIPS’ coupon rate?

What is the difference between new and reissued TIPS?

While they are all Treasury Inflation-Protected Securities, there are slight differences.

New issue. The Treasury does a TIPS auction each month, and sometimes it is a new issue. That means the base interest rate (coupon rate) and yield to maturity will be set at auction. So for a new issue, you won’t know coupon rate for certain, and the yield you get will end up close to the coupon rate, as long as the yield is positive. The price you pay for the TIPS will be close to par value, as long as the yield is positive.

Reissue. When the Treasury reissues (also called ‘reopens’) a TIPS, it carries the coupon rate from the original auction. A few months will have passed, so the yield could have moved up or down from the coupon rate, meaning the price you pay for the TIPS could be less or more than par value.

Once a TIPS is issued, it trades on the secondary market, so it is easier to estimate its likely value at auction. With a new issue, the price can be a little harder to estimate.

Take a look at this post for a recap of all the new and reissues of 2013 and you can see the pattern: https://tipswatch.com/2013/12/25/recapping-2013-the-year-in-tips/

When I buy a TIPS, how can I tell if I am going to pay a premium or discount to par value?

For a new TIPS issue going to auction, the coupon rate will be set slightly below the yield to maturity that results from the auction. Coupon rates rise in 0.125% increments. So if the TIPS auctions with a yield of 0.661%, the coupon rate will be set at 0.625% and the buyer will get it at a slight discount to par.

But this does not hold true when the yield to maturity is negative. In that case, the coupon rate is set at 0.125%, the lowest it can go, and the buyer pays a premium to make up the difference.

For reopening auctions, a buyer can look at sources of secondary-market information on the current market yield of the TIPS being auctioned. That can give the buyer an indication of whether the TIPS is going to go off at a discount or premium to par.

A reliable source is the Wall Street Journal’s chart of closing TIPS prices. You need to know the maturity date of the TIPS that’s being auctioned, then check the price on that chart. Here is an example for a TIPS with a coupon rate of 0.625%:

example

In this case, the yield is 0.583%, so a buyer today would need to pay a premium, which in this case is about $100.40 for $100 of value, based on the asked price of 100.13. By the way, the .08 and .13 in that chart actually mean 8/32 and 13/32, not cents. The Wall Street Journal explains this:

Figures after periods in bid and ask quotes represent 32nds; 101.26 means 101 26/32, or 101.8125% of 100% face value; 99.01 means 99 1/32, or 99.03125% of face value.

Also, the accrued principal will factor in what you pay for a reopened TIPS, because you are also getting the existing boost from inflation since the first auction. In this case, accrued principal of 1001 is very small and not much of a factor. If it is higher, it will factor into what you pay, but you are also getting the benefit of the additional principal.

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2 Responses to How can I tell if I am going to pay a premium or discount at a TIPS auction?

  1. Len says:

    Damn, I know you are a journalist but that is still an exemplary explanation. Treasury should hire you to write the material on the website, it would be a vast improvement in my book.

  2. tipswatch says:

    Len, thanks. Sometimes having less knowledge makes it easier to explain something complex. If you know too much, you can no longer grasp simplicity. I am in no danger of knowing too much.

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