The federal government recently announced that the budget deficit for fiscal year 2016 (the year that ran from October 1, 2015 to September 30, 2016)…

  • The federal government recently announced that the budget deficit for fiscal year 2016 (the year that ran from October 1, 2015 to September 30, 2016) was $616 billion.  Of the $3.95 trillion in total spending, $215 billion was spent on interest expense.  At the end of the fiscal year, the total federal debt outstanding was $17.4 trillion. 

To finance the budget deficit, the federal treasury issued 30-year bonds recently.  The bonds have a $10,000 face value and an annual coupon rate of 2.25% with semi-annual coupons so they pay coupons of $112.50 every April 30 and October 31 from 2017 until 2046.  The bonds sold for $9,370.  What was the yield to maturity on the bonds? The treasury also issued one year bonds that have no coupons and a face value of $10,000.  They were priced to yield 82 basis points (0.82%).  At what price were the bonds issued? For simplicity, assume that the federal government only issues one year bonds and 30 year bonds like those above.  At the end of fiscal year 2016, approximately 70% of the debt outstanding had a one-year maturity and the remaining 30% had a 30-year maturity (there are actually more maturities than this but this split approximates the average maturity outstanding).  Based on this split, what is your forecast of federal interest expense that will be paid in 2017? Given the historically low interest rates, many have called on Treasury to issue more of the debt in the form of 30-year Treasuries rather than one-year bonds.  If Treasury were to follow that recommendation such that they instead had 50% of the debt due in 30 years and the other 50% due in one year, what is your revised estimate of federal interest expense that will be paid in 2017? Even though Treasury does not have two year bonds outstanding (for purposes of this example), imagine that similar securities suggest that a two-year Treasury bond would have a yield of 1.12%.  What does that imply will be the one-year rate on a one-year Treasury issued one year from now?  If the debt at the beginning of fiscal year 2018 was expected to be $18 trillion and the US government maintained the mix of 70% one-year and 30% 30-year debt at the yield found in (a), what is your estimate of what federal interest expense will be in 2018?

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