In early 2014, the U.S. Government had more than $17 trillion in debt (approxima
ID: 2778838 • Letter: I
Question
In early 2014, the U.S. Government had more than $17 trillion in debt (approximately $55,000 for every citizen in the US) outstanding in the form of Treasury bills, notes, and bonds. From time to time, the US Treasury changes the mix of securities that it issues to finance government debt, issuing more bills than bonds or vice versa.
With short-term interest rates near 0 percent in early 2014, suppose the Treasury decided to replace maturing notes and bonds by issuing new Treasury bills, thus shortening the average maturity of US debt outstanding. Discuss in detail both the pros and cons of this strategy. Provide a reference(s) for your posting(s).
Explanation / Answer
The Strategy of the Government is to reduce the overall cost of funds. The total exposure of $17 trillion will be having a weighted average cost of capital bsedon the the proportion of each type of debt taken. Treasury bills relatively contain a low cost of service.
Pros
1. The cost of service is relatively less compared to bonds.
2. The average cost of debt and redemption obligation also gets reduced
3. The frequency of payment of interest is more in bonds and notes, whereas for T bills, it is discounted while issuing and redeemed at par. This reduces periodic requirement of funds to service finance charges.
Cons
1. If the existing proprotion of notes and bonds are more than T bills, then replacing them with T bills requires the issue of a higher number of T bills. For example to replace $10 million worth of bonds with T bills discounted at 2%, it requires the issue of 10.2 million worth of T bills. If the GDP and economic growth of the country does not look good for a year, it will be difficul to sell T bills in such quanitity
2. The long term economic outlook of the country and finance planning also needs to be considered. T bills are short term methods. If the country is planning for more outlay in long term reaping investments, bonds would be a better chice than T bills.