Timothy Bitsberger Deputy Assistant Secretary U.S. Treasury Department

Treasury Debt Management

Treasury Inflation-Protection Securities

Treasury’s Perspective

• Widen investor base

• Reduce/eliminate term premium

Investor’s Perspective

• Improve portfolio diversification

• Protect against inflation better than real estate, commodities, or other real assets

TIPS Structure

• The principal value is adjusted for inflation by multiplying the value at issuance by an index ratio that changes daily. The inflation accrual on principal is paid at maturity.

• The coupon payments are a fixed percentage, determined at auction, of the inflation-adjusted value of the principal.

• The principal repayment at maturity is protected against deflation, but the semi-annual coupon payments are not protected against deflation.

• The inflation accrual is based on the CPI-U NSA with a 3-month lag (e.g., index number for July 1st is based on the April CPI report which was released in mid-May).

• Daily indexed numbers are calculated using straight-line interpolation between first-of-month numbers.

• The index ratio for a particular valuation date is the index number for that date divided by the index number for the dated date.

• Index Ratio Value Date = Index number for value date Index number for dated date

TIPS Auction Schedule

July 2004- 10-yr TIPS, auction 7/8/04, settle 7/15/04, mature 7/15/14- 20½-yr TIPS, auction 7/27/04, settle 7/30/04, mature 1/15/25

October 2004- 9¾-yr TIPS, auction 10/7/04, settle 10/15/04, mature 7/15/14- 5½-yr TIPS, auction 10/26/04, settle 10/29/04, mature 4/15/10

January 2005 - 10-yr TIPS, auction 1st half of month, settle on 15th, mature 1/15/15- 20-yr TIPS, auction 2nd half of month, settle last business day of month, mature 1/15/25

April 2005- 9¾-yr TIPS, auction 1st half of month, settle on 15th, mature 1/15/15- 5-yr TIPS, auction 2nd half of month, settle last business day of month, mature 4/15/10

* Tentative Schedule

TIPS SupplyInflation-Adjusted Par Amount Outstanding

0

20

40

60

80

100

120

140

160

180

200

220

1997 1998 1999 2000 2001 2002 2003 June '04

calendar year

$billions

Source: US Treasury

TIPS Annual Issuance

0

10

20

30

40

50

60

70

1997 1998 1999 2000 2001 2002 2003 2004 est

calendar year

$ billions

5-yr TIPS10-yr TIPS20-yr TIPS30-yr TIPS

* 2004 issuance amounts are tentative and not necessarily indicative of future auction sizes.

TIPS Trading Volume IncreasingAverage Daily TIPS Transactions by Primary Dealers

0

2

4

6

8

10

12

14

Jan-98 Jul-98 Jan-99 Jul-99 Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04

$ billions

0

2

4

6

8

10

12

14$ billions

Weeks with a TIPS Auction

Non-Auction Weeks

3-month MA of Nonauction Weeks

* Source: New York Fed

Net Dealer Positions in Treasuries

-2

-1

0

1

2

3

4

5

6

Feb-01 Jun-01 Oct-01 Feb-02 Jun-02 Oct-02 Feb-03 Jun-03 Oct-03 Feb-04 Jun-04

TIPS ($ billions)

-140

-120

-100

-80

-60

-40

-20

0

20

40Nominal Treasuries ($ billions)

TIPS (LHS)

Nominal Treasuries (RHS)

Dealers net short TIPS for the first time

(5/14/03)

nominal zero line

TIPS zero line

* Source: New York Fed

SIZE OF GLOBAL INFLATION-INDEXED BOND MARKET VS. OTHER ASSET CLASSES

0

100

200

300

400

500

600

700

800

900

1,000

Global Inflation Indexed Global High Yield Emerging Market Debt Emerging MarketEquities

European Corporates

Asset Class

US

$ B

illio

ns

Source: Bridgewater Associates

Distribution of Competitive Auction Awards of 10-Year Treasury Notes

10-Year TIPS July '03, Oct '03, Jan '04, & Apr '04

Investment Funds, 31%

Primary Dealers, 54%

Foreign & International,

7%

Financial Insts., 1%

Other, 8%

10-Year Nominal Notes Nov '03, Dec '03, Feb '04, & Mar '04

Other, 3%Financial Insts., 1%

Foreign & International,

22%

Primary Dealers, 64%

Investment Funds, 10%

I/I BOND CORRELATION TO OTHER ASSETS AND INFLATION

US Equities US Nominal BondsJan. 1970 - Feb. 2004 US CPI S&P 500 10-Year Duration1 Month 0.18 0.09 0.603 Month 0.28 0.02 0.671 Year 0.49 -0.21 0.303 Year 0.65 -0.54 -0.275 Year 0.75 -0.56 -0.28

Correlation of TIPS (10-Year Duration) to…

Source: Bridgewater Associates

10-Year TIPS and Nominal Yields

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

Jul-98 Jan-99 Jul-99 Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04

Nominal Yield

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0TIPS Yield

TIPS 10yr(RHS)

Nominal 10yr(LHS)

10-Year TIPS Breakeven Rates

0.0

0.5

1.0

1.5

2.0

2.5

3.0

Jan-98 Jul-98 Jan-99 Jul-99 Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04

Percent

0.0

0.5

1.0

1.5

2.0

2.5

3.0Percent

auction dates

5yr - 10yr Yield Spread

-50

-30

-10

10

30

50

70

90

110

130

Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04

basis points

-50

-30

-10

10

30

50

70

90

110

130basis points

Nominal Treasuries

TIPS

Monthly Inflation Accrual on TIPS

-0.6%

-0.4%

-0.2%

0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

-0.6%

-0.4%

-0.2%

0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

1997 1998 1999 2000 2001 2002 2003 2004

Average Monthly Inflation Accrual