Question

How does the treasury call in bonds? Trace the effect of calling in bonds on the US economy

Answer 1

a) All the US treasury bonds issued since 1985 are non-callable bonds which means they cannot be called by US treasury. The Treasury bonds are guaranteed by the Federal Government of USA. However, non-government finance companies can add call feature via derivatives to the debt bonds and issue them to investors. However prior to 1985, Treasury bonds were issued as callable bonds with maturity periods of 5 years and 10 years. These callable bonds had the feature of early redemption. Many investors in the US still have callable bonds ( bonds that are issued before 1985) which they can return to Treasury and redeem the investment. The Treasury purchases such callable bonds and reissue them in the market as non-callable bonds. There are also another form of Treasury bonds called Treasury Inflation Protected Securities (TIPS) that provide investors protection from inflation. Such portfolio offers only real rate of return. The investment returns of TIPS are comparatively less than the bonds of fixed maturities. TIPS are also available for early redemption which means investors can reedem money by returning TIPS back to Treasury at any time.

b) There has been adverse impact on both government and common people in United States with calling in bonds. Government has to collect money for investment in different sectors. Prior to 1985, all bonds issued by Treasury were callable bonds which meant that investors can return those debt papers back to Treasury before the maturity period. With calling feature, investors may return bonds in large number to Treasury which would decrease the money supply to Federal government and also affects different government projects in the United States.

When treasury bonds are high in demand, the investment returns of Treasury bonds decreases. In that circumstances, many investors sale the calling in investment securities before the maturity period, which also affects the key interest rates of Fed and different sectors of the US economy. For this, government had removed calling feature from fixed term Treasury bonds since 1985.