Certificate of Accrual on Treasury Securities (CATS): An In-Depth Overview

Highlights:

• CATS are zero-coupon US Treasury securities.
• Sold at a deep discount, without regular coupon payments.
• The face value is paid at maturity, ensuring a return on investment.

Introduction The Certificate of Accrual on Treasury Securities (CATS) is a unique financial instrument offered by the U.S. Treasury. It represents a form of zero-coupon bond that allows investors to buy government debt at a significant discount compared to its face value. Unlike regular Treasury securities that offer periodic interest payments, CATS do not pay any coupon interest during their lifespan. Instead, the full face value of the security is paid out to the investor upon maturity.

Understanding CATS CATS are issued with a set maturity date, typically in 10 to 30 years. The key feature of these securities is that they do not offer any periodic interest payments. Instead, investors acquire these securities at a price substantially lower than their par value. The difference between the discounted purchase price and the par value represents the interest earned by the investor over the life of the security.

At maturity, the full face value of the CATS is redeemed, which results in a lump sum payment to the bondholder. This structure makes CATS an attractive investment option for those who are seeking long-term growth and prefer a lump sum payment over regular income streams.

How CATS Work CATS are created by separating the interest and principal components of a regular Treasury bond. When the bond is issued, it is divided into separate parts: the principal portion, which represents the face value of the bond, and the interest portion, which represents the periodic coupon payments. Investors who purchase CATS are buying the principal portion of the Treasury bond, which will be paid at maturity.

The absence of periodic interest payments means that CATS do not generate taxable income until they mature. This is an appealing feature for investors looking for a tax-efficient investment strategy. The discount at which CATS are sold reflects the amount of interest that will accrue over the life of the security.

The Appeal of CATS For investors with a long-term horizon, CATS provide an efficient way to accumulate wealth. The fact that they are backed by the U.S. government adds a layer of security that makes them an attractive option for conservative investors. The deep discount at which they are sold ensures that the return on investment is considerable when the security matures.

Since CATS do not make periodic interest payments, they can be an ideal choice for investors who do not need regular income but are focused on long-term capital appreciation. The fact that they are sold at a discount also allows for the potential of a higher yield than other forms of Treasury securities that provide regular coupon payments.

Tax Considerations One of the notable tax features of CATS is that, while no interest is paid out during the life of the bond, the imputed interest that accrues on the bond is still taxable as income. This means that even though investors do not receive regular interest payments, they will still owe taxes on the accrued interest annually, even though they do not physically receive the payment until the bond matures. This tax treatment is important for investors to consider when determining whether CATS are a suitable investment for their financial strategy.

Risks Associated with CATS Like any investment, CATS come with certain risks. The primary risk is interest rate risk. If interest rates rise after the purchase of CATS, the value of the bond can decline on the secondary market, even though it will be redeemed at face value at maturity. Additionally, investors in CATS are exposed to the risk of inflation, as the real purchasing power of the face value paid at maturity could be eroded if inflation rises significantly over the life of the bond.

However, the credit risk associated with CATS is minimal, as they are issued by the U.S. Treasury, which is considered one of the safest borrowers in the world. Nonetheless, investors should carefully assess their long-term financial goals and risk tolerance before investing in CATS.

Conclusion In conclusion, CATS are a unique and appealing investment for those looking for long-term, secure growth. They offer the benefit of purchasing U.S. Treasury securities at a deep discount and redeeming them for their full face value at maturity. While they do not provide periodic interest payments, the potential for growth over time and the safety of being backed by the U.S. government make them an attractive option for certain investors. However, it’s important to consider the tax implications and interest rate risks associated with this type of security when determining if CATS are right for your portfolio.