oversight

Savings Bonds: Actions Needed to Increase the Reliability of Cost-effectiveness Measures

Published by the Government Accountability Office on 2003-06-16.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

             United States General Accounting Office

GAO          Report to the Chairman, Subcommittee
             on Transportation, Treasury, and
             Independent Agencies, Committee on
             Appropriations, House of
             Representatives
June 2003
             SAVINGS BONDS
             Actions Needed to
             Increase the
             Reliability of
             Cost-effectiveness
             Measures




GAO-03-513
             a
                                               June 2003


                                               SAVINGS BONDS

                                               Actions Needed to Increase the Reliability
Highlights of GAO-03-513, a report to the      of Cost-effectiveness Measures
Chairman, Subcommittee on
Transportation, Treasury, and
Independent Agencies, Committee on
Appropriations, House of Representatives




While the Treasury generally pays              Treasury has several alternative vehicles for issuing debt to the public. A
lower interest rates on U.S. Savings           substantial majority of that debt is issued in the form of marketable Treasury
Bonds than it does on other forms              securities. U.S. Savings Bonds today account for about 3 percent of total
of borrowing from the public, it               Treasury securities outstanding. A majority of these bonds have lower
also incurs substantially higher               minimum denominations or face amounts than marketable Treasury
administrative costs to issue and
redeem the paper savings bond
                                               securities and generally pay lower interest rates as well, but provide the
certificates. To determine whether             same assurance of the full faith and credit of the United States, making them
these higher administrative costs              an alternative for investors unable or unwilling to pay the minimum
exceed its interest rate savings,              denominations of marketable Treasury securities. Savings bonds continue to
Treasury’s Bureau of the Public                be issued as paper certificates, rather than in the format of the “book entry”
Debt uses a spreadsheet model to               system for marketable Treasury securities; however, this increases the
compare the costs of issuing Series            administrative costs of issuing, servicing, and redeeming savings bonds,
EE and Series I savings bonds with             relative to the marketable securities.
those of issuing marketable
Treasury securities. GAO was                   The cost-effectiveness of the savings bond program depends on whether
asked to review this model to judge            Treasury’s savings—in terms of the generally lower interest payments on
its reliability in measuring the
relative costs of Treasury’s
                                               savings bonds relative to marketable Treasury securities—exceed the costs
borrowing alternatives.                        that Treasury incurs with processing the paper savings bond certificates. The
                                               question is complicated by the fact that the interest savings occur over the
                                               life of a savings bond, and that Treasury pays costs upfront at issuance and
                                               in the future when the savings bond is redeemed.
GAO is recommending that the
Bureau of the Public Debt revise               As prescribed by the Office of Management and Budget and common
the cost-effectiveness model so                financial practice, in dealing with savings or costs over time, the value of
that it provides reliable information
                                               future savings or costs must be discounted to present value. Treasury has
on the costs of the savings bond
program. As part of that revision,             reported that its cost-effectiveness model does calculate the present values
the bureau should consider                     of the relative costs of savings bonds and marketable Treasury securities.
updating some of the key data on               However, because of flaws in the design and implementation of the
the performance of the savings                 spreadsheet used to calculate these present values, the cost-effectiveness
bond program, particularly on                  model’s results do not provide the Bureau of the Public Debt, Treasury, or
savings bond redemption patterns.              Congress with accurate information that is needed to assess the relative
                                               costs of issuing debt through savings bonds or marketable Treasury
                                               securities, or to manage the savings bond program. Further, the bureau has
                                               not updated some key data elements in the cost-effectiveness model. In
                                               particular, citing budget considerations, the bureau uses data on the
                                               redemption patterns for savings bonds that date back to 1993, which do not
                                               reflect the effects of the wide variety of financial instruments now available
                                               to investors.




www.gao.gov/cgi-bin/getrpt?GAO-03-513.

To view the full report, including the scope
and methodology, click on the link above.
For more information, contact Thomas J.
McCool at (202) 512-8678 or
McCoolT@gao.gov.
Contents



Letter                                                                                                1
                             Results in Brief                                                         2
                             Background                                                               3
                             Conceptual Design for Estimating Savings Bond Cost-effectiveness
                               Is Appropriate, but Model Calculations Contain Errors                  8
                             Key Model Parameters and Components May Not Be Reliable                 15
                             Conclusions                                                             20
                             Recommendations                                                         21
                             Agency Comments and Our Evaluation                                      22


Appendixes
              Appendix I:    Objectives, Scope, and Methodology                                      26
             Appendix II:    Present Value Theory and Model Calculations                             27
             Appendix III:   Future Value Examples for Series EE and Series I Savings
                             Bonds for Bonds 5 Years and Older                                       30
             Appendix IV:    Model Calculations Detail                                               32
              Appendix V:    Comments from the Bureau of the Public Debt                             35
                             GAO Comments                                                            43
             Appendix VI:    GAO Contacts and Staff Acknowledgments                                  44
                             GAO Contacts                                                            44
                             Acknowledgments                                                         44


Tables                       Table 1: Savings Bonds and Selected Treasury Securities                  4
                             Table 2: Key Parameters of the Savings Bond Cost-effectiveness
                                      Model                                                           7
                             Table 3: Redemption Value Calculation for Series EE and Series I
                                      Savings Bonds 5 Years and Older                                12
                             Table 4: BPD Changes to Savings Bond Cost-effectiveness Model
                                      Parameters since 1995                                          16


Figure                       Figure 1: Conceptual Design of the Savings Bond
                                       Cost-effectiveness Model                                       9




                             Page i                                             GAO-03-513 Savings Bonds
Contents




Abbreviations

BPD          Bureau of the Public Debt
CMT          constant maturity Treasury
FV           future value
OMB          Office of Management and Budget
PV           present value

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Page ii                                                         GAO-03-513 Savings Bonds
A
United States General Accounting Office
Washington, D.C. 20548



                                    June 16, 2003                                                                              Lert




                                    The Honorable Ernest J. Istook, Jr.
                                    Chairman, Subcommittee on Transportation, Treasury,
                                     and Independent Agencies
                                    Committee on Appropriations
                                    House of Representatives

                                    Dear Mr. Chairman:

                                    Savings bonds, which offer low-risk, affordable investment opportunities to
                                    many Americans, represent almost 3 percent of the total Department of the
                                    Treasury (Treasury) securities outstanding but nearly 6 percent of the total
                                    nonmarketable Treasury securities outstanding.1 While savings bonds
                                    generally pay lower interest rates than marketable Treasury securities,
                                    Treasury incurs higher administrative costs to produce, market, service,
                                    and redeem savings bond certificates. Concerns have been raised regarding
                                    whether, and to what extent, savings bonds are cost effective for
                                    Treasury—whether Treasury’s administrative and tax deferral costs on
                                    savings bonds are more than offset by lower interest payments. To address
                                    these concerns, in 1985, Treasury introduced the savings bond cost-
                                    effectiveness model that measures, according to model documentation, the
                                    difference between the projected costs for raising funds through the
                                    issuance of $1 billion of new savings bonds and the estimated costs for
                                    comparable borrowing through marketable securities. In 1995, Treasury’s
                                    Bureau of the Public Debt (BPD) assumed responsibility for the model.
                                    BPD believes the model shows that over time savings bonds are a more
                                    cost-effective means of raising funds in that the administrative and tax
                                    deferral costs of issuing savings bonds are offset by the lower interest
                                    payments on savings bonds.

                                    This report responds to your July 16, 2002, request that we assess the
                                    effectiveness of BPD’s cost-effectiveness model. As agreed with your staff,
                                    this report presents our assessment of (1) the appropriateness of the
                                    model’s design to compare the costs associated with savings bonds with
                                    those of other Treasury debt and (2) the reliability of certain key
                                    parameters and components of the model.



                                    1
                                     Treasury Department, Bureau of the Public Debt, Monthly Statement of the Public Debt of
                                    the United States (April 30, 2003). Available from www.publicdebt.treas.gov.




                                    Page 1                                                         GAO-03-513 Savings Bonds
                   To address these objectives, we reviewed an electronic copy of the model,
                   related hard-copy documentation, and savings bond program regulations.
                   We did not assess the overall savings bond program or the accuracy or
                   completeness of all data used in the model. As a result, we do not know
                   what effect such data had on the model’s cost-effectiveness calculation.
                   Appendix I contains a more detailed description of our scope and
                   methodology.

                   We conducted our work in Washington, D.C., from September 2002 through
                   April 2003 in accordance with generally accepted government auditing
                   standards.



Results in Brief   Treasury has presented the savings bond cost-effectiveness model as a way
                   to measure the cost-effectiveness of savings bonds over time, one that is
                   based on a present value approach—calculating the value today of future
                   costs and revenues in order to provide a common basis for comparison
                   between savings bonds and marketable Treasury securities. The
                   conceptual design underlying the savings bond cost-effectiveness model
                   reflects Office of Management and Budget (OMB) guidance and common
                   financial economics practice. According to OMB Circular A-94, such
                   analysis is appropriate when the benefits of competing alternatives—
                   alternative debt instruments in this case that provide equal funds to
                   Treasury—are the same. A program is cost effective if, on the basis of
                   appropriately measuring the costs of competing alternatives over time, it
                   has the lowest costs, expressed in present value terms, for a given amount
                   of benefits. For savings bonds, the question is whether, over time, savings
                   bonds cost less than marketable Treasury securities. However, the model
                   as constructed does not provide Treasury with the information it needs to
                   determine whether savings bonds are cost effective because of errors in
                   several steps in the model. In particular, we found that the model does not
                   accurately calculate the present value of either alternative and thus does
                   not provide a valid comparison.

                   BPD has changed several parameters in the model in an effort to better
                   reflect changes in the savings bond program. However, despite these
                   enhancements, some of the data used to adjust the model’s parameters
                   have not been updated and do not incorporate historical experience. In
                   particular, data on savings bond redemptions do not reflect the most recent
                   experience, possibly affecting the validity of the model’s cost-effectiveness
                   estimates. In addition, the model contains other inaccuracies that could
                   affect its reliability and accuracy. Finally, the model has not been subject to



                   Page 2                                                  GAO-03-513 Savings Bonds
                       ongoing and periodic reviews by independent external reviewers, a
                       common practice endorsed by OMB.

                       This report includes recommendations to the Secretary of the Treasury that
                       are designed to increase the reliability of the savings bond cost-
                       effectiveness model. We obtained comments on a draft of this report from
                       BPD. BPD disagreed with our description of the savings bond cost-
                       effectiveness model and our conclusion that the model’s comparisons were
                       invalid, but agreed in general with our recommendations. However, BPD
                       noted that the goal of moving to an electronic environment for savings
                       bonds would make it appropriate to “shelve” the current model. BPD’s
                       comments are discussed in the Agency Comments and Our Evaluation
                       section, and its written comments are reprinted in appendix V.



Background             Savings bonds offer investors the ability to purchase securities with lower
                       minimum denominations than those for marketable Treasury securities. In
                       response to concerns raised regarding the cost-effectiveness of the savings
                       bond program as a funding mechanism for federal government operations,
                       Treasury created a cost-effectiveness model that is now used and
                       maintained by BPD. The model was intended to compare the projected
                       costs for $1 billion of new savings bond borrowing and comparable
                       borrowing through marketable Treasury securities. The model is based on
                       the characteristics of the Series EE and Series I savings bonds and is
                       intended to compare these costs on a present value basis.



Savings Bond Program   Treasury is authorized to borrow money on the credit of the United States
                       to fund federal government operations. Within Treasury, BPD is responsible
                       for prescribing the debt instruments, limiting and restricting the amount
                       and composition of the debt, paying interest to investors, and accounting
                       for the resulting debt. However, Treasury sets the financial terms and
                       conditions of savings bonds and marketable Treasury securities, including
                       denomination and pricing changes.2


                       2
                        Treasury securities are marketable bills, notes, and bonds issued at various schedules
                       throughout the year. These instruments are negotiable debt obligations of the U.S.
                       government secured by its full faith and credit. Treasury bills are short-term obligations
                       issued with a term of 1 year or less. Treasury notes have a term of more than 1 year, but not
                       more than 10 years. Treasury bonds are long-term obligations issued with a term of more
                       than 10 years.




                       Page 3                                                            GAO-03-513 Savings Bonds
                                              Savings bonds are an alternative for investors unable or unwilling to pay
                                              the minimum denomination of marketable Treasury securities. Table 1
                                              describes several principal differences between Series EE and Series I
                                              savings bonds and selected marketable Treasury securities.



Table 1: Savings Bonds and Selected Treasury Securities

                                      Savings bonds                                        Marketable Treasury securities
                Series EE                    Series I                         Fixed-principal notes          Inflation-indexed notesa
General         Nonmarketable. Sold at 50 Nonmarketable. Sold at face   Marketable. Sold at auction          Marketable. Sold at auction
features        percent of face value in  value in denominations as low with a minimum face value            with a minimum face value
                denominations as low as as $50.                         of $1,000.                           of $1,000.
                $50.
Interest rate   Calculated as 90 percent     Calculated to provide a fixed    Rate is determined at          Rate is determined at
                of 6-month averages of 5-    rate plus a semiannual           auction.                       auction. The fixed rate of
                year Treasury securities     inflation adjustment.                                           interest is applied to the
                yields.                                                                                      inflation-adjusted principal.
Earnings        Interest is paid when the    Interest is paid when the bond   Interest is paid               Interest is paid semiannually
                bond is redeemed; value      is redeemed; generally           semiannually. (Interest        based on the inflation-
                increases monthly with       increases in value monthly,      payment is commonly called     adjusted principal value of
                accrued interest.            but may remain unchanged in      the note’s “coupon”).          the note; in the event of
                                             times of deflation.                                             deflation, interest payments
                                                                                                             will decrease.

                Earn interest for up to 30   Earn interest for up to 30       Interest paid until the note   Interest paid until the note
                years.                       years.                           matures; more than 1 year      matures; more than 1 year
                                                                              but not more than 10 years.    but not more than 10 years.
Redemption      Can be redeemed after        Can be redeemed after first   Marketable, can be sold at        Marketable, can be sold at
and cashing     first 12 months.b A 3-       12 months. A 3-month interest any time prior to maturity        any time prior to maturity
options         month interest penalty       penalty applies to bonds      date.                             date.
                applies to bonds             redeemed during the first 5
                redeemed during the first    years.
                5 years.




                                              Page 4                                                             GAO-03-513 Savings Bonds
(Continued From Previous Page)
                                                 Savings bonds                                         Marketable Treasury securities
                        Series EE                     Series I                           Fixed-principal notes             Inflation-indexed notesa
Special federal         Federal income tax on         Federal income tax on              Interest income is subject to     Interest income is subject to
tax treatment           earnings may be deferred      earnings may be deferred until     federal income tax, which is      federal income tax, which is
                        until redemption; all or      redemption; all or part of         generally reported in the         generally reported in the
                        part of earnings may be       earnings may be excluded           year paid.                        year paid. Inflation
                        excluded from federal         from federal income tax if                                           adjustments must be
                        income tax if used for        used for qualified education                                         reported in the year earned.
                        qualified education           expenses.
                        expenses.
Sources: BPD and the Internal Revenue Service.

                                                       Note: Table data taken from the following publications of the Treasury Department, Bureau of the
                                                       Public Debt: FAQs Regarding Treasury Bills, Notes, and Bonds, The U.S. Savings Bonds Owner’s
                                                       Manual (June 2002), Minimum Holding Period For Savings Bonds Extended to 12 Months (press
                                                       release: January 15, 2003), available from www.publicdebt.treas.gov; and Internal Revenue Service,
                                                       Investment Income and Expenses for 2002 Returns, Publication 550, available from www.irs.gov.
                                                       a
                                                        Treasury notes and bonds for which the interest and redemption payments are tied to inflation.
                                                       Treasury bills are not offered in inflation indexed form.
                                                       b
                                                        The 12-month period, referred to as the minimum holding period, is the length of time from the issue
                                                       date that a bond must be held before it is eligible for redemption. On January 15, 2003, Treasury
                                                       announced that the minimum holding period that applies to U.S. Savings Bonds would be extended
                                                       from 6 to 12 months, effective for bonds issued on and after February 1, 2003. Series EE and Series I
                                                       savings bonds bearing issue dates prior to February 2003 retain the 6-month minimum holding period
                                                       in effect when they were issued.


                                                       In March 2002 the Treasury Assistant Secretary for Financial Markets
                                                       testified before the House Appropriations Committee, Subcommittee on
                                                       Treasury, Postal Service, and General Government that Treasury believes
                                                       that the availability of a savings vehicle with the full faith and credit of the
                                                       United States should not be limited to those who can afford the minimum
                                                       $1,000 denominations available in auctions of marketable Treasury
                                                       securities. The official also said that even though savings bonds are not the
                                                       most efficient form of borrowing in operational terms, Treasury would
                                                       continue to offer them to the public.3




                                                       3
                                                        In March 2002, the Commissioner of the Public Debt testified before the Subcommittee on
                                                       Treasury, Postal Service, and General Government, House Committee on Appropriations
                                                       that savings bonds are the only security sold to the public in the form of paper certificates.




                                                       Page 5                                                                  GAO-03-513 Savings Bonds
                      Treasury is seeking to reduce the operational costs of savings bonds by
                      offering the securities in paperless form. Treasury has started to offer
                      savings bonds that are held in direct Treasury accounts instead of issuing
                      paper certificates for the bonds. The Series EE and Series I savings bonds
                      are available through the new TreasuryDirect system.4 A BPD planning
                      document describes BPD’s objective as enabling Treasury to stop issuing
                      paper savings bonds and thus begin to realize the long-term cost reductions
                      expected from additional automation and more efficient processing.



Savings Bond Cost-    In response to concerns raised regarding the cost-effectiveness of the
effectiveness Model   savings bond program as a funding mechanism for federal government
                      operations, Treasury created a cost-effectiveness model. According to a
                      Treasury report to the House Committee on Appropriations and Committee
                      on Financial Services, the savings bond cost-effectiveness model has been
                      used to assess potential changes in the financial terms and conditions for
                      Series EE and Series I savings bonds.5 According to model documentation,
                      BPD also uses model results to project and trace annual costs and
                      recoveries for distinct cost centers over the life of a savings bond loan.

                      What is collectively referred to as the savings bond cost-effectiveness
                      model comprises two submodels, Series EE and Series I, with the
                      differences between the two reflecting differences between the two series
                      of savings bonds. The results of each submodel are averaged to estimate
                      the overall cost-effectiveness of the savings bond program. According to a
                      BPD official, the model calculates the value of a single savings bond and its
                      costs to Treasury, and extends this to the total savings bond population in a
                      given year. Subsequently, the model attempts to quantify the differences
                      between the savings bonds and marketable Treasury securities (noted in
                      table 1).6


                      4
                       The original TreasuryDirect system was a Web-based system for marketable Treasury
                      securities that is now called Electronic Services for Treasury Bills, Notes, and Bonds. The
                      new TreasuryDirect is a Web-based system that allows investors to establish accounts to
                      purchase, hold, and conduct transactions for Series EE and Series I savings bonds on-line.
                      5
                       Department of the Treasury, Report to the Committee on Appropriations and the
                      Committee on Financial Services, United States House of Representatives: On Federal
                      Debt Financing and the Role of United States Savings Bonds (Washington, D.C.: July 1,
                      2002).
                      6
                       Treasury has not issued bonds of any maturity since its decision in October 2001 to suspend
                      issuance of the 30-year bond.




                      Page 6                                                           GAO-03-513 Savings Bonds
The model was intended to compare the projected costs for $1 billion of
new savings bond borrowing and those for $1 billion in marketable
Treasury securities on a present value basis, that is, discounting the costs
over time to permit a valid comparison. The savings bond cost-
effectiveness model utilizes seven key parameters: administrative costs,
historic redemption patterns, sales volume, savings bond yields, maturity
period, equivalent marketable yield, and tax recovery. Table 2 describes the
key parameters of the model in detail.



Table 2: Key Parameters of the Savings Bond Cost-effectiveness Model

Key parameters         Description
Administrative costs   Includes all federal government costs for marketing/issuing,
                       servicing, and redeeming savings bonds.a Issue cost comprises
                       marketing/issuing costs plus one-half of servicing costs.
                       Redemption cost comprises cost of redemption plus one-half of
                       servicing costs. Each of these total costs is then divided by its
                       respective transactions during the prior fiscal year budget activity
                       to return unit cost to issue per bond and unit cost to redeem per
                       bond. Unit costs per bond are the same across all
                       denominations.
Historic redemption    A probability distribution of the number of bonds redeemed by
patterns               denomination and period outstanding. The data were derived
                       from the redemption patterns from 1957 through 1993. Monthly
                       rates of redemption in the first 3 years outstanding are
                       expressed as the quotient of the total bonds redeemed at a given
                       age by the total bonds of that age outstanding. Annual rates of
                       redemption for bonds that remain outstanding for 3 years or
                       longer were similarly derived. The annual rates are prorated to
                       allocate bond redemptions equally among the 12 months in a
                       year. The model applies the redemption probabilities of Series
                       EE bonds to similarly priced Series I bonds (that is, the
                       probabilities for a $100 Series EE bond and a $50 Series I bond
                       are equal).
Sales volume           The number of bonds issued by denomination in the prior fiscal
                       year.
Savings bond yields    Series EE – 90 percent of 6-month averages of 5-year Treasury
                       securities yields. Series I - a fixed rate of return and a
                       semiannual inflation rate.
Maturity period        Series EE and Series I bonds earn interest for 30 years. The
                       model incorporates an additional 20 years of redemption
                       patterns beyond final maturity.




Page 7                                                           GAO-03-513 Savings Bonds
                            (Continued From Previous Page)
                            Key parameters                     Description
                            Equivalent marketable              An estimate of the comparable borrowing costs for marketable
                            yield                              Treasury securities based on the constant maturity yield curve.
                            Tax recovery                       An estimate of taxes paid by an investor upon redeeming the
                                                               bond. b
                            Source: BPD model documentation.
                            a
                             According to model documentation, since BPD’s administrative costs for marketable Treasury
                            securities are negligible to the total amount financed, they are not built into the model.
                            b
                             The tax recovery rate is provided by Treasury’s Office of Tax Policy, which, among other functions,
                            provides the official estimates of all government receipts for Treasury cash management decisions.




Conceptual Design for       OMB guidelines state that a cost-effectiveness analysis is appropriate to
                            use in an analysis of government programs when the benefits of competing
Estimating Savings          alternatives are the same or where a policy decision has been made that the
Bond Cost-                  benefits of a program must be provided.7 A program is cost effective if, on
                            the basis of life cycle cost analysis of competing alternatives, it is
effectiveness Is            determined to have the lowest costs expressed in present value terms for a
Appropriate, but Model      given amount of benefits.8 The conceptual design underlying the savings
Calculations Contain        bond cost-effectiveness model reflects this OMB guidance. However, the
                            present value calculations in the model contain errors. As a result, the
Errors                      model’s estimated “present values” do not follow OMB guidance and
                            common financial economics practice, and the model does not provide
                            Treasury with the information it needs to determine whether savings bonds
                            are cost-effective.



Model’s Conceptual Design   The model’s conceptual design follows OMB guidelines for cost-
Follows OMB Guidelines      effectiveness analysis. Figure 1 shows the conceptual design of the model.




                            7
                             Office of Management and Budget, Guidelines and Discount Rates for Benefit-Cost
                            Analysis of Federal Programs, Circular A-94 (Washington, D.C.: October 29, 1992). This
                            circular provides general guidance for conducting benefit-cost and cost-effectiveness
                            analyses and serves as a checklist of whether an agency has considered and properly dealt
                            with all the elements for sound benefit-cost and cost-effectiveness analyses.
                            8
                             OMB states that life cycle cost represents the overall estimated cost for a particular
                            program alternative over the time period corresponding to the life of the program, including
                            direct and indirect initial costs plus any periodic or continuing costs of operation and
                            maintenance.




                            Page 8                                                                    GAO-03-513 Savings Bonds
Figure 1: Conceptual Design of the Savings Bond Cost-effectiveness Model




OMB Circular A-94, which is applicable to executive branch agencies,
provides that the standard criterion for deciding whether a government
program is cost-effective is net present value—a comparison of the
discounted monetized value of the expected life cycle costs of alternative
means of achieving the same stream of benefits. However, in its comments
on this report BPD asserted that the model’s approach follows an
alternative OMB method to determine cost-effectiveness. BPD stated that
the model measures cost-effectiveness as the “relative financial benefit
from two borrowing options whose overall costs are identical. Treasury’s
benefit from each alternative is the amount of financing realized at the time




Page 9                                                  GAO-03-513 Savings Bonds
borrowing occurs.” We have addressed this comment in the Agency
Comments and Our Evaluation section.

A key concept in finance is recognizing that the value associated with funds
received or paid at different points changes over time. Funds have a time
value because of the opportunity to invest them at different interest rates
and in different financial alternatives. Investors demand some
compensation for making funds available today in return for future
repayment. For example, the interest paid on a loan is a measure of this
compensation.

Essentially, a present value calculation measures the value today that
would be equivalent to a future payment, or stream of payments, by
discounting the future payments (using an appropriate discount rate).9 For
Treasury, this is the value today of the future payments to investors of
securities offered for sale which, in the context of the model, is the
redemption value of Series EE and Series I savings bonds and the
repayment stream of the alternative marketable Treasury security (that is,
any coupons plus maturity value). Calculating the present value for each
alternative takes the monetary value of costs over time and discounts them
at an appropriate discount rate. Discounting transforms costs occurring in
different time periods to a common unit of measurement (app. II describes
this in greater detail).

As table 1 notes, there are several distinctions between savings bonds and
marketable Treasury securities; several of these are relevant to the model.
Most notably, the interest rates and the timing of the interest payments are
different. Accurate implementation of the conceptual design requires that
the model address these issues in order to construct comparable present
values for the costs of savings bonds and marketable Treasury securities.
The model attempts to address these distinctions by (1) creating an after-
tax present value discount factor for the marketable Treasury security from
a 6-month average of the constant maturity yield curve, commonly referred
to as the “constant maturity Treasury,” or CMT),10 and (2) reducing the


9
The interest rate used in calculating the present value of expected future benefits and costs.
10
   The Federal Reserve Bank of New York collects prices for all actively traded U.S. Treasury
securities. Treasury takes this information and calculates a yield curve. The curve is known
as the constant maturity yield curve because it gives an estimate of the yield on Treasury
securities at the maturities shown even if no current Treasury security has a remaining
maturity exactly equal to one of those points.




Page 10                                                           GAO-03-513 Savings Bonds
                            present value of the marketable Treasury security by subtracting its
                            estimated (that is, not paid) “discounted” coupons.



Model Creates Cost-         In general, the model is conceptually designed to create a marketable
effectiveness Ratio Based   Treasury security comparable to a savings bond such that the repayment
                            stream (that is, any coupons plus maturity value) to an investor is equal to
on Calculated “Present      that of a savings bond’s net cost to Treasury (that is, redemption value
Values” for Both            adjusted for administrative unit costs and tax revenue implications). The
Alternatives                repayment stream of the created marketable Treasury security and the
                            adjusted redemption value of the savings bonds represent costs to Treasury
                            from offering these securities for sale. From this point, the model is
                            intended to compare the costs of these two financing alternatives on a
                            present value basis.

                            According to model documentation, the present value of the marketable
                            Treasury security is constructed by discounting the savings bond’s
                            redemption value, adjusted for Treasury’s unit cost of redemption and tax
                            revenue implications, at an equivalent after-tax rate for marketable
                            Treasury securities of the same maturity.11 The model’s calculation of the
                            redemption value of the Series EE and Series I savings bond is similar;
                            changes are due to the different structures of the two series. Table 3
                            provides additional detail on the redemption value calculation and
                            variables for both the Series EE and Series I savings bond. Appendix III
                            provides examples of redemption value calculations for both the Series EE
                            and Series I savings bond.




                            11
                             According to model documentation, the model assumes that the tax recovery for the
                            marketable Treasury security occurs simultaneously with each interest payment.




                            Page 11                                                       GAO-03-513 Savings Bonds
Table 3: Redemption Value Calculation for Series EE and Series I Savings Bonds 5
Years and Older

Series EE, FV = PV * {[1+(i/2)](m/6)}, where                          Series I, FV = PV * {[1+(CR/2)](m/6)}, where

FV (future value) = redemption value on                               FV (future value) = redemption value on
redemption (accrual) date rounded to the                              redemption (accrual) date rounded to the
nearest cent                                                          nearest cent
PV (present value) = redemption value at                              PV (present value) = redemption value at
the beginning of the semiannual rate period                           the beginning of the semiannual rate period
i = savings bond rate                                                 CR (composite rate) = fixed rate of return
m = number of full calendar months elapsed                            plus the semiannual inflation rate
during the semiannual rate period                                     m = number of full calendar months elapsed
                                                                      during the semiannual rate period
Sources: Series EE: 31C.F.R. § 351.2-(k)(4)(ii)(A); Series I: 31C.F.R. § 359.2-(e)(4)(ii)(A).

Note: Bonds are subject to a 12-month holding period and those redeemed before 5 years are subject
to a 3-month interest penalty. All calculations of interest are based on a hypothetical savings bond with
a denomination of $25.


The tax revenue implications are reflected in the model as a tax recovery
rate. The model assumes that all savings bond tax recoveries are deferred
until redemption.12 Tax recovery—the taxes collected on savings bond
earnings that had been deferred until redemption—increases the revenues
to Treasury. The model calculates the effect of tax recovery, in terms of life
cycle costs for the model, by reducing the amount Treasury pays to an
investor at redemption. However, the tax recovery rate is reduced in the
model to reflect the education bond program. In general, as shown in table
1, savings bonds are eligible for tax benefits upon redemption when used
for qualified education expenses.




12
 An investor may choose to use the accrual method of accounting, where increases in the
redemption value are reported as interest each year, or the cash method of accounting,
where reporting of interest earned is postponed until the earlier of the year in which the
bond is cashed or disposed of or the year in which the bond matures.




Page 12                                                                                         GAO-03-513 Savings Bonds
The administrative unit cost to Treasury from redeeming savings bonds
reduces the revenues to Treasury. The model calculates the effect of
administrative unit redemption cost, in terms of life cycle costs for the
model, by increasing the amount Treasury pays to an investor at
redemption. The model constructs an after-tax “discount factor” based on a
6-month average of the CMT.13 At the time of our review, the window was
the 6-month period ending October 31, 2001.

According to BPD officials, the model is intended to perform an additional
step to calculate the “present value” of the marketable Treasury security.
This additional step, according to model documentation, is intended to
reflect the difference between savings bonds, which do not pay periodic
interest, and marketable Treasury securities that do pay such interest in the
form of coupons. The model treats the coupon payments that the
marketable Treasury security would pay as a separate security in which the
tax recovery is simultaneous with the payment. First, the estimated
coupons are created based on the savings bond’s redemption value,
adjusted for Treasury’s unit cost of redemption and tax revenue estimates.
Second, these coupons are “discounted” by an after-tax “discount factor”
based on a 6-month average of the CMT.

BPD believes that these coupons would reduce the benefit of the initial
marketable Treasury security and therefore its “present value.” According
to model documentation, these are subtracted from the “discounted”
savings bond final payout, adjusted for Treasury’s unit cost of redemption
and tax revenue implications. The model calculations for the “present
value” of the marketable Treasury security, however, do not follow model
documentation in that the savings bond final payout is not discounted. BPD
officials confirmed that the model calculations actually construct the
“present value” of the marketable Treasury security as equal to the
redemption value of the savings bond, adjusted for Treasury’s unit cost of
redemption and tax revenue implications, net of estimated “discounted”
coupons.

According to model documentation, the “present value” of the savings bond
is its issue price less the unit cost to issue. The model’s calculation returns
a value that is equal to Treasury receipts from a savings bond, net of the
administrative unit cost of issuance.


13
 The tax rate applied to the 6-month average of the CMT is the unadjusted tax recovery rate
provided by Treasury’s Office of Tax Policy.




Page 13                                                         GAO-03-513 Savings Bonds
                              As previously mentioned, the model is intended to compare a savings bond
                              and a marketable Treasury security on a present value basis. The
                              difference, according to a BPD official, is then translated to the total
                              savings bond population in a given year and converted to a ratio of millions
                              of dollars in cost per $1 billion borrowed. The model calculation takes the
                              difference between the two “present values” described above, projects the
                              difference across the sales volume for the prior fiscal year, and then
                              converts the difference to a ratio that measures cost savings in millions per
                              $1 billion borrowed. Appendix IV provides a more detailed discussion of
                              the model calculations.



BPD’s Definition of Present   Although Treasury has presented the model as measuring cost-
Value Does Not Follow OMB     effectiveness on a present value basis, most notably in a July 2002 report to
                              Congress, the model does not construct a present value comparison in
Guidance
                              accordance with OMB guidance. Our review indicates that the model does
                              not accurately incorporate all the life cycle costs in the present value
                              calculations for either alternative, does not calculate and apply a true
                              economic discount factor needed to derive present value that would be
                              relevant to the time periods, and ultimately compares values that are not
                              equivalent based on the time value of money. The result is that the model’s
                              calculation of a cost-effectiveness ratio does not provide an accurate
                              present value assessment of the alternatives.

                              As previously discussed, to create comparable borrowing between the two
                              alternatives, the model is intended to set the repayment stream (that is, any
                              coupons plus maturity value) of the marketable Treasury security equal to
                              that of a savings bond’s net cost to Treasury (that is, redemption value
                              adjusted for administrative unit costs and tax revenue implications).
                              However, the model calculation does not incorporate all the life cycle costs
                              of the savings bond into the marketable Treasury security’s “present value”
                              calculation — the initial administrative cost of issuing the savings bond
                              (that is, unit cost to issue) is not included. In addition, the model
                              calculation does not incorporate all the life cycle costs of the savings bond
                              into the saving bond’s “present value” calculation — the redemption value
                              paid to an investor and the final administrative cost of the savings bond
                              (that is, unit cost to redeem) is not included.

                              The present value of a bond (or bond price) is equal to the present value of
                              its expected cash flows (that is, any coupons plus maturity value). As noted
                              previously, BPD officials confirmed that the model measures what it terms
                              the “present value” of the marketable Treasury security as equal to the



                              Page 14                                                GAO-03-513 Savings Bonds
                       redemption value of the savings bond, adjusted for Treasury’s unit cost of
                       redemption and tax revenue implications, net of estimated “discounted”
                       coupons. However, this calculation implicitly values current and future
                       funds as the same. In addition, as previously discussed, the model treats
                       coupons as if they reduce the benefit of the marketable Treasury security
                       and therefore its “present value.” However, since the CMT already reflects
                       the value of the coupons that Treasury is obligated to pay, reducing the
                       benefit to Treasury essentially counts the coupons twice. Additionally, the
                       construction of the discount factor in the model departs from OMB
                       guidance since the model’s “discount factor” does not create an appropriate
                       time value.

                       Further, the model treats Treasury receipts from a savings bond, net of the
                       administrative unit cost of issuance, as the “present value” of the savings
                       bond. However, the model does not include or discount over time the
                       savings bond’s redemption value in this calculation, and therefore the
                       model does not reflect a time value associated with these funds, or present
                       value as the term is used in OMB guidance or in general finance usage.



Key Model Parameters   The savings bond cost-effectiveness model utilizes seven key parameters:
                       administrative costs, historic redemption patterns, sales volume, savings
and Components May     bond yields, maturity period, equivalent marketable yield, and tax recovery.
Not Be Reliable        Since 1995, when BPD assumed responsibility for the model, it has made
                       four model enhancements in an effort to better reflect changes in the
                       savings bond program, three of which directly affect these parameters.14
                       Table 4 presents BPD’s changes to the three key model parameters since
                       1995. However, despite these enhancements, some of the data used to
                       adjust the model’s parameters have not been updated and do not
                       incorporate historical experience. In addition, the model contains other
                       inaccuracies that could affect its reliability and accuracy. Finally, the model
                       has not been subject to ongoing and periodic reviews by independent
                       external reviewers, a common practice endorsed by OMB.




                       14
                            The fourth change, building cost centers, does not directly affect the model parameters.




                       Page 15                                                             GAO-03-513 Savings Bonds
                           Table 4: BPD Changes to Savings Bond Cost-effectiveness Model Parameters since
                           1995

                           Parameters                         BPD changes
                           Redemption                         The model originally based bond redemption projections on
                           probabilities                      current snapshots of redemption activity. To limit the model’s
                                                              exposure to short-term market swings, BPD developed
                                                              redemption patterns based on longer-term historical data
                                                              (1957-93).
                           Activity beyond                    Series EE and Series I bonds earn interest for 30 years.
                           maturity                           However, not all bonds are redeemed before or at this final
                                                              maturity; some owners choose to hold them even though they
                                                              are no longer earning interest. For this reason, BPD refined the
                                                              model to incorporate redemption patterns for 20 years beyond
                                                              final maturity.
                           Tax recovery                       Savings bonds have an education bond feature that is a tax
                                                              benefit to investors; participation does not occur until investors
                                                              actually redeem their bonds. According to BPD, while the full
                                                              effects of the program are not known, BPD estimates the
                                                              program’s effect in the model by reducing savings bond tax
                                                              recovery by 10 percent, an estimate it believes to be at or above
                                                              the maximum reduction in tax recovery.
                           Source: BPD model documentation.




Despite Enhancements,      The first enhancement affects a key calculation in the savings bond cost-
Model Results May Not Be   effectiveness model: the redemption value, or future value, of the savings
                           bond over time. These values form the basis for constructing a marketable
Accurate
                           Treasury security that is the alternative to savings bonds. The earlier bonds
                           are redeemed, the less administrative costs are offset. Therefore, the
                           accuracy of the model’s cost-effectiveness calculation depends heavily on
                           the accuracy of predicted early redemptions.

                           The key driver for the redemption values in the model is probability of
                           redemption. The model accounts for redemption probabilities differently
                           than in the original model transferred to BPD in 1995. According to BPD
                           officials, the original model estimated redemption probabilities with the
                           most recent 13 months of Series EE redemption data. When BPD assumed
                           responsibility for the model, staff began estimating redemption
                           probabilities for each denomination of Series EE savings bonds back to
                           1957. The current model continues to incorporate the historical redemption
                           patterns from 1957 to 1993. However, citing cost concerns, BPD has not
                           updated the probabilities to reflect redemption patterns of the most recent
                           10 years. Since then, however, a wide variety of financial instruments have



                           Page 16                                                                     GAO-03-513 Savings Bonds
become available to investors, which could affect the patterns of
redemption. Further, the redemptions do not reflect current interest rates.

As previously discussed, the model also applies the redemption
probabilities of Series EE bonds to similarly priced Series I bonds (that is,
the redemption probabilities for a $100 Series EE bond and a $50 Series I
bond are equal). BPD has not estimated the redemption probabilities of
Series I bonds, introduced in 1998, therefore the redemption probabilities
applied in the Series I submodel have no direct relation to the Series I bond
redemption patterns since 1998.

The second model enhancement deals with the maturity period. The
original model assumed the stated maturity date for both securities of 30
years. BPD adjusted the current model to include an additional 20-year
horizon beyond the stated maturities of savings bonds and marketable
Treasury securities to account for those investors who hold on to the
securities past the maturity date. However, according to a statement made
by Treasury, the regulations governing savings bonds provide that bonds
for which no claims have been filed within 10 years of the maturity date will
be presumed to have been properly paid. The 20-year horizon enhancement
appears to be inconsistent with this Treasury statement. Further, adding
the 20 years appears to be inconsistent with OMB guidance for the
alternatives to be compared over their stated life cycles, which for both
alternatives should be the 30-year maturity period.

Finally, the third enhancement to the model adjusts the tax recovery rate
for savings bonds by 10 percent to account for the education bond
program. The 10 percent adjustment was an estimate since there was no
program experience to guide the adjustment. The education bond benefit,
which allows for the exclusion of interest earned subject to certain rules
and limits, applies only to savings bonds. Adjusting the tax recovery rate
for savings bonds to reflect this program is appropriate. However, the
education bond program was introduced in 1990, providing program
experience of at least 12 years. BPD has not analyzed whether the
historical experience is consistent with the 10 percent adjustment and thus
does not know whether the adjustment improves the model’s accuracy.




Page 17                                                GAO-03-513 Savings Bonds
Discontinuance of 30-Year    A BPD official told us that the equivalent marketable yield, or CMT, has the
Marketable Treasury Bonds    strongest impact on model results. The CMT is the basis for BPD’s
                             “discount factor” used to derive the “present value” of the alternative
Directly Affects the         marketable Treasury security. Treasury discontinued the issuance of the 30-
Marketable Yield Model       year Treasury bond in October 2001, however, directly affecting how the
Parameter                    discount rate is calculated.

                             Beginning on February 18, 2002, Treasury ceased publication of the 30-year
                             constant maturity series. Instead, Treasury publishes a Long-Term Average
                             Rate and a linear extrapolation factor that can be added to the Long-Term
                             Average Rate to allow interested parties to compute an estimated 30-year
                             rate.15 BPD staff told us that BPD is still considering how to reflect this
                             change in the model’s “discount factor.”



Other Model Features Could   The model coding contains additional inaccuracies that, in comparison to
Affect the Reliability of    the present value inaccuracy, appear to have a minor impact. Also, the
                             model’s use of older software and lack of controls over changes may allow
Model Results                additional errors to remain undetected.

                             A coding error in the bonds redeemed calculation occurs in some
                             denominations for both submodels. From the time of issuance through 4
                             months outstanding, the formula uses the probability of redemption for the
                             month following the correct month. BPD staff told us this error occurred
                             during model maintenance by BPD staff. Additionally, BPD staff told us
                             that this error would be corrected (app. IV describes the correction for this
                             calculation).

                             Another inaccuracy involves the redemption value calculation in the Series
                             I submodel. The calculation there does not match the savings bond
                             regulations since the redemption value does not reflect the accrued value
                             at the beginning of each semiannual period.




                             15
                               The Long-Term Average Rate is the arithmetic average of the bid yields on all outstanding
                             fixed-coupon securities (i.e., excludes inflation-indexed securities) with 25 years or more
                             remaining to maturity. This series first appeared on February 19, 2002, following
                             discontinuation of the 30-year Treasury constant maturity series.




                             Page 18                                                          GAO-03-513 Savings Bonds
                           In addition, the savings bond cost-effectiveness model is maintained in
                           older software.16 Use of the older software can be appropriate, but does
                           increase the difficulty in maintaining and updating the model without
                           introducing errors. As noted above, BPD acknowledged one such error.
                           BPD staff told us that they have not moved the model into current software
                           because of concerns that the software’s features used to calculate the
                           scenario effects of program changes will not function properly.

                           During the course of our review, we also found that the model contained
                           unlabeled and undocumented data fields. BPD staff told us that these fields
                           were remnants of scenarios that staff had run on the model in the past,
                           which were accidentally left in the model when it was sent to us for review.
                           One aspect of an effective general control and application environment is
                           the protection of data, files, and programs from unauthorized access,
                           modification, and destruction. BPD staff could, by saving scenario data in
                           the master model file, inadvertently add, alter, or delete sensitive data or
                           coding.



BPD Has Not Requested an   While OMB guidance calls for an independent external review of cost-
Independent External       effectiveness models, as well as assessments of their accuracy and
                           reliability, BPD has not commissioned such analysis. As a result, BPD
Review of the Model
                           cannot assess the accuracy and reliability of the model.

                           OMB guidelines provide elements for a cost-effectiveness analysis and
                           promote subjecting such analyses to independent external reviews.
                           Verification and explicit assumptions are two of the four elements OMB
                           identified for a cost-effectiveness analysis. OMB states that verification
                           through retrospective studies to determine whether anticipated benefits
                           and costs have been realized are potentially valuable. Such studies can be
                           used to determine necessary corrections in existing programs, and to
                           improve future estimates of benefits and costs in these programs. Agencies
                           should have a plan for periodic, results-oriented evaluation of program
                           effectiveness. OMB adds that a cost-effectiveness analysis should be
                           explicit about the underlying assumptions used to arrive at estimates of
                           future benefits and costs and include a statement of the assumptions, the
                           rationale behind them, and a review of their strengths and weaknesses. Key



                           16
                             The model is maintained in version 5 of a spreadsheet program that is currently marketed
                           in version 9.




                           Page 19                                                         GAO-03-513 Savings Bonds
              data and results should be reported to promote independent analysis and
              review.

              OMB guidance also acknowledges that estimates are typically uncertain
              because of imprecision in both underlying data and modeling assumptions
              and states that analyses should attempt to characterize the sources and
              nature of uncertainty. In analyzing uncertain data, objective estimates of
              probabilities, such as those derived from market data, should be used
              whenever possible. Any limitations of the analysis because of uncertainty
              or biases surrounding the data or assumptions should be discussed. In
              addition, major assumptions should be varied and net present value and
              other outcomes recomputed to determine how sensitive outcomes are to
              changes in the assumptions. In general, sensitivity analysis should be
              considered for estimates of benefits and costs, the discount rate, the
              general inflation rate, and distributional assumptions of probabilities.
              Models used in the analysis should be well documented and, where
              possible, available to facilitate independent review.

              BPD has not independently verified the cost-effectiveness model.
              According to BPD officials, a survey and investigations team from the
              House Committee on Appropriations, which visited BPD’s Parkersburg,
              West Virginia, location in 1996, conducted the only review of the savings
              bond cost-effectiveness model. Since the team did not initiate further
              inquiry, BPD officials said they assumed that the team had found no issues
              requiring further review and discussion. Although BPD and Treasury
              officials have maintained in congressional testimonies and in a recent
              report that the model results are accurate, to date neither BPD nor
              Treasury has requested an independent external review to validate the
              savings bond cost-effectiveness model. Further, while BPD has used the
              model to estimate the potential effects of changes in the savings bond
              program, it has not sought to conduct any sensitivity analysis that could
              reveal the model’s limitations.



Conclusions   Our review of BPD’s savings bond cost-effectiveness model indicates that
              the model’s results do not provide BPD, Treasury, OMB, or Congress
              appropriate information to assess the relative costs of the savings bond
              program versus marketable Treasury securities as a source of raising funds.
              Although the model was intended to compare savings bonds and
              marketable Treasury securities on a present value basis, the model’s
              comparison is not based on present values and thus does not follow OMB
              guidance and common financial economics practice. As previously



              Page 20                                              GAO-03-513 Savings Bonds
                  discussed, a discount factor brings future costs and revenues into present
                  value terms to permit comparisons. While the model calculates a value that
                  BPD terms a “discount factor,” the calculation is incorrect and, as a result,
                  the model does not correctly calculate the present value of the alternatives.
                  In addition, this calculated value is not applied consistent with the model’s
                  conceptual design and OMB guidance. Therefore the cost-effectiveness
                  ratio that the model creates does not provide BPD with the information it
                  needs to assess the relative costs of the savings bond program and
                  marketable Treasury securities to determine which financing approach
                  offers a greater financial benefit to Treasury.

                  The model also uses data that may not be reliable. In particular, the
                  probabilities of redemption for the Series EE bond are 10 years out of date
                  and BPD has not estimated any probabilities of redemption that have any
                  direct relation to the Series I bond redemption patterns since 1998 when
                  these bonds were first introduced. The model also incorporates a time
                  horizon that extends beyond the life cycles of either security and distorts
                  the cost-effectiveness analysis, allowing a longer time period for the
                  administrative costs of savings bonds to be offset. Finally, the reduction in
                  the tax recovery rate to reflect the education bond program is not based on
                  actual program experience and may be over- or underestimating the
                  financial impact of the program to Treasury.

                  Given that the model uses data that may not be reliable and BPD has not
                  decided how to reflect the discontinuance of the 30-year constant maturity
                  series in the model’s “discount factor,” we did not make corrections to the
                  model. As a result, we do not know to what degree the present value errors
                  and these data affect the model’s cost-effectiveness ratio.

                  BPD’s ability to assess the impact of policy changes to the savings bond
                  program, project cost centers for the savings bond program, and determine
                  cost-effectiveness in relation to marketable Treasury securities is
                  hampered by fundamental errors in the present value calculations. When
                  combined with model data that may not be reliable, the need for
                  independent reviews of cost-effectiveness and sensitivity analyses, which
                  are called for in OMB Circular A-94, becomes particularly important.



Recommendations   Because of the importance of measuring the cost-effectiveness of financing
                  mechanisms used to fund the operations of the federal government, we
                  recommend that the Secretary of the Treasury direct that the
                  Commissioner of the Public Debt in conjunction with Treasury’s Office of



                  Page 21                                                GAO-03-513 Savings Bonds
                      Domestic Finance revise the savings bond cost-effectiveness model to
                      estimate the relative (or net) present value of the life cycle costs of issuing
                      savings bonds versus marketable Treasury securities.

                      As part of that revision, the Commissioner should do the following:

                      • Update the Series EE probabilities of redemption to capture any
                        changes in redemption patterns caused by the proliferation of financial
                        products or interest rate changes in the last 10 years. At a minimum,
                        Treasury and BPD should collect data for a sample of the more recent
                        time period to test the validity of the 1957-93 data.

                      • Base Series I bond redemption patterns on actual experience with those
                        bonds.

                      • Validate the cost estimate of education bond program participation
                        based on the historical, 12-year data to date.

                      • Replace the 30-year equivalent marketable rate.

                      • Update the software used for the model to enhance BPD’s ability to
                        maintain the model and protect against unauthorized modification.

                      • Put in place a process for ongoing verification, sensitivity analysis, and
                        independent external review of the model.



Agency Comments and   In a June 4, 2003, letter commenting on a draft of this report, the
                      Commissioner of the Public Debt wrote that the cost-effectiveness model
Our Evaluation        conformed to OMB Circular A-94, sec. 5b, since it “measures Treasury’s
                      relative financial benefit from two borrowing options whose overall costs
                      are identical. Treasury’s benefit from each alternative is the amount of
                      financing realized at the time borrowing occurs.” Noting that the model “is
                      not intended to be a classic present value exercise,” the Commissioner
                      explained that the model “compares the present value of a projected
                      stream of payments associated with the sale of savings bonds with the
                      amount realized from the sale.” BPD suspects it may have inadvertently
                      misused the terms “discount factor” and “present value” in internal
                      Treasury discussions. Further, BPD said that we did not understand the
                      model’s life-cycle duration, the minimum holding period, and the Series I
                      redemption values.




                      Page 22                                                 GAO-03-513 Savings Bonds
The Commissioner noted that while BPD disagreed with our conclusion
that the model’s comparisons were invalid, BPD generally agreed with our
recommendations for updating the model. However, the Commissioner
also noted that, with Treasury’s goal of moving toward a totally electronic
environment for the savings bond program, “we think it's appropriate for us
to shelve the existing model, which is based on paper bonds, and focus our
attention on the transition to a fully electronic program.”

We disagree with the Commissioner’s portrayal of the cost-effectiveness
model as measuring “…Treasury’s relative financial benefit from two
borrowing options whose overall costs are identical.” Neither the model
documentation nor BPD’s public statements are consistent with this
explanation. BPD’s model documentation explained that the savings bond
cost-effectiveness model compares the projected costs for $1 billion of new
savings bond borrowing and those for $1 billion in marketable Treasury
securities on a present value basis. In March 2002 testimony before the
House Appropriations Subcommittee on Treasury, Postal Service, and
General Government, the Commissioner described the model as one that
“…measures the cost-effectiveness of savings bonds vis-à-vis borrowing
equivalent amounts of money with marketable issues. …Our latest
calculations indicate that every $1 billion borrowed through Series EE and
Series I savings bonds is $35 million less expensive than borrowing with
marketable securities.” Additionally, the July 2002 report to the House
Committees on Appropriations and Financial Services explained the
savings bond cost-effectiveness model as one based on a present value
analysis:

The model compares the amount of funds raised by selling a given amount of Series EE and
I bonds in various denominations and the present value of the future costs to Treasury in
connection with issuing the bonds. If the amount raised is greater than the present value of
the future costs associated with the bonds, taking into account administrative costs and tax
benefits, then the program is deemed to be cost-effective.

While we agree that an approach comparing the benefits of two approaches
having identical costs would be a valid alternative to the present value
approach that we described in our report, the model’s calculations do not
support this analysis. Marketable Treasury securities and savings bonds
can be compared by either comparing the costs of raising identical sums
using two alternative debt instruments or by comparing the funds raised
when the costs of the two instruments are identical. However, if BPD were
to base the cost-effectiveness model on a comparison of the “financial
benefit from two borrowing options whose overall costs are identical,” the
key issue that this approach would have to address is that marketable



Page 23                                                          GAO-03-513 Savings Bonds
Treasury securities and savings bonds do not necessarily have identical
overall costs.

The challenge of this modeling approach would be to appropriately
measure costs over time of the two options in a way that would permit
treating the costs as identical. Since the costs vary over time, accurately
calculating the present value of the costs of the two options would be an
essential step. However, we did not find, for reasons noted in the report,
that the model accurately or reliably calculates the present value of the
stream of costs associated with the sale of savings bonds. In particular, the
report explains that the discount rate used to calculate the present value of
the projected stream of costs is inappropriate.

We have changed the report to recognize that BPD allocates a small
number of redemptions prior to 6 months to reflect hardship waivers; these
waivers are not discussed in BPD’s model documentation. We have not,
however, changed the report in response to the Commissioner’s statements
regarding life cycle costs and Series I redemption values. As the report
notes, the 20-year extension on the life cycle appears to be inconsistent
with regulations that provide that bonds for which no claims have been
filed within 10 years of the maturity date are presumed to have been
properly paid. Our analysis of the Series I savings bond redemption value
found that the formula does not correctly recognize the savings bond’s
accrued value at the beginning of each semiannual period.

The Commissioner’s letter noted that BPD generally agrees with the
recommendations for updating the model, but that BPD believes it
appropriate to “shelve” the existing model and focus on the transition to a
fully electronic retail securities program. We agree that the importance of
many administrative costs will decline if BPD successfully transforms the
current paper-based savings bond program to an electronic environment.
Further, there may be changes in investors’ purchases and redemptions of
savings bonds in an electronic environment.

However, important differences will continue to exist between the costs of
savings bonds and marketable Treasury securities, particularly the
payment of coupons and the tax treatment of the two debt instruments. A
model that accurately recognizes these differences will continue to be as
crucial to understanding the relative cost-effectiveness of the two debt
instruments as it is in the current paper-based environment. That model,
furthermore, will have to be updated regularly to reflect the effect of any
changes in investor preferences and behavior on the savings bond program



Page 24                                                GAO-03-513 Savings Bonds
as it moves into this new electronic environment. Our recommendations
will remain appropriate for assessing the cost-effectiveness of the savings
bond program managed in an electronic environment.


As agreed with your office, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 30 days from its
date. At that time, we will send copies to the Secretary of the Treasury, the
Treasury Under Secretary for Domestic Finance, and the Commissioner of
the Public Debt. Copies will be made available to others upon request. In
addition, this report is also available at no charge on GAO’s Web site at
http://www.gao.gov.

If you have any further questions, please call me at (202) 512-8678 or
mccoolt@gao.gov or James M. McDermott, Assistant Director, at (202) 512-
5373 or mcdermottjm@gao.gov.

Sincerely yours,




Thomas J. McCool
Managing Director, Financial Markets
 and Community Investment




Page 25                                                GAO-03-513 Savings Bonds
Appendix I

Objectives, Scope, and Methodology                                                           A
                                                                                             A
                                                                                             ppep
                                                                                                nen
                                                                                                  d
                                                                                                  xIeis




              To assess the savings bond cost-effectiveness model, we obtained an
              electronic copy of the model as of fiscal year 2001 in addition to hard-copy
              background and supporting documentation. Given that the model is
              maintained in older software, Lotus 1-2-3 version 5, we reviewed the model
              using the same program and version to avoid corruption or translation
              errors. We then identified and reviewed the various regulations regarding
              the Series EE and Series I savings bond structure on which the cost-
              effectiveness model is based. In addition, we reviewed relevant portions of
              Internal Revenue Service publications regarding the tax implications of the
              savings bond program. We compared these information sources with the
              model coding to verify that the calculations reflect the structure of the
              savings bond program.

              To determine if the model constructed a present value comparison, we
              analyzed the model coding and supplied documentation to determine if
              (1) the model’s design matched Office of Management and Budget and
              conventional approaches and (2) the model’s calculations accurately
              implement the model’s design to arrive at a present value comparison.

              Given that the model calculations did not result in a present value
              comparison, we did not assess the accuracy or completeness of the data
              input used in the various model parameters and assumptions. As a result,
              we do not know what effect such data had on the model’s cost-
              effectiveness calculation.

              We conducted our work in Washington, D.C., from September 2002 through
              April 2003 in accordance with generally accepted government auditing
              standards.




              Page 26                                               GAO-03-513 Savings Bonds
Appendix II

Present Value Theory and Model Calculations                                                                                                 AppenIx
                                                                                                                                                  di




                             The present value of a bond (or, bond price) is equal to the present value of
                             its expected cash flows (any coupons plus maturity value). Each cash flow
                             must be discounted at the relevant rate for the time period.




                t                              0             1      2      3        ...        n-1         n         n+1          ...


discount rate                                               r0,1   r1,2   r2,3      ...      rn-2,n-1    rn-1,n      rn,n+1       ...
cash flows
                    coupon                     0            C1     C2     C3        ...       Cn-1        Cn           0          ...
                    face                       0             0      0      0        ...         0          M           0          ...

                             Here, t represents time, where t = 0 represents the present moment, t = 1
                             represents the end of the first period, t = 2 represents the end of the second
                             period, and so on. A given cash flow is specified to occur at the end of the
                             given period. The discount rate, rs-1,s , is the appropriate one-period
                             discount rate from s – 1 to s, at t = s (for s = 1, …, n).1 The appropriate one-
                             period discount factor (or deflator) is as follows:
                                          1
                             ----------------------------
                             ( 1 + r s – 1, s )
                             For example, to determine the value of C1 at t = 0, the appropriate discount
                             rate is r0,1 and the appropriate one-period discount factor is as follows:2
                                       1                                                                                   C1
                             ----------------------- ; thus the present value at t = 0 of C1 received at t = 1 is: ----------------------
                                                                                                                                        -
                             ( 1 + r 0, 1 )                                                                        ( 1 + r 0, 1 )
                             For the cash flows specified in the above table, which are designed to
                             mimic the cash flows of an n-period bond paying coupon Cs at t = s (for s =
                             1, …, n) and M at maturity, t = n, the present value at t = 0 is as follows:




                             1
                              In many explanations of present value, the discount rate is held constant, removing the
                             need for rs-1,s to vary over time.
                             2
                              The factor that translates expected benefits or costs in any given future year into present
                             value terms.




                             Page 27                                                                      GAO-03-513 Savings Bonds
                                               Appendix II
                                               Present Value Theory and Model Calculations




                                                                                             η                       Ct
                                                                                                ----------------------------------------------                        M
                                                                                                                                             - + ---------------------------------------------
                                                                                                                                                                                             - , in which
                                 PV t = 0 (coupon + face) =                                  Σ
                                                                                            t=1         t                                               η
                                                                                                       Π ( 1 + r s – 1, s )                            Π ( 1 + r t – 1, t )
                                                                                                              s=1                                                t=1

                     t
                     Π ( 1 + r s – 1, s ) = ( 1 + r 0, 1 )* ( 1 + r 1, 2 )*...* ( 1 + r t – 1, t ) for some t >2, for example.
                    s=1

                                               Based on the above table, the following illustrations assume that the
                                               periods correspond to years (for example t = 1 represents the end of the
                                               first year).

                                               The present value of a one-period (that is 1-year) bond is as follows:

                                                            C1                         M
                                               PV = ----------------------- + -----------------------
                                                    ( 1 + r 0, 1 ) ( 1 + r 0, 1 )

                                               The present value of a two-period bond is as follows:
                                                            C1                                    C2                                                M
                                               PV = ----------------------- + ---------------------------------------------- + ----------------------------------------------
                                                    ( 1 + r 0, 1 ) ( 1 + r 0, 1 ) ( 1 + r 1, 2 ) ( 1 + r 0, 1 ) ( 1 + r 1, 2 )

                                               Note that if r is identical through all time periods, such that r = r0,1 = r1,2 ,
                                               the above two-time period present value is equivalent to the following:
                                                         C1                  C2                     M
                                               PV = ---------------- + -----------------2- + -----------------2-
                                                    (1 + r) (1 + r)                          (1 + r)

                                               The present value of a three-period bond is as follows:
             C1                                    C2                                                           C3                                                                      M
PV = ----------------------- + ---------------------------------------------- + --------------------------------------------------------------------- + ---------------------------------------------------------------------
     ( 1 + r 0, 1 ) ( 1 + r 0, 1 ) ( 1 + r 1, 2 ) ( 1 + r 0, 1 ) ( 1 + r 1, 2 ) ( 1 + r 2, 3 ) ( 1 + r 0, 1 ) ( 1 + r 1, 2 ) ( 1 + r 2, 3 )


                                               In the illustrations above, the rate or rates used to discount each
                                               component is relevant to the time period.




                                               Page 28                                                                                                                      GAO-03-513 Savings Bonds
                                                   Appendix II
                                                   Present Value Theory and Model Calculations




                                                   Model Calculation for the “Present Value” of the Marketable Treasury
                                                   Alternative
                                                   Based on model documentation, the coupon payments are subtracted to
                                                   reflect that the coupon payments on the Treasury alternative would reduce
                                                   the benefit Treasury would receive from the initial security.

                                                   Redemption Valuen substituted for M in the prior equation, where n =
                                                   months outstanding

                                                   Redemption Valuen * rn substituted for C in the prior equation, where n =
                                                   months outstanding
                                                   rn = Monthly after-tax “discount rate” (derived from CMT), where n =
                                                   months outstanding

                                                   The “present value” of a 1-month marketable alternative is calculated as
                                                   follows:
                                                                             Redemption Value 1 *r 1
                                                   PV = Redemption Value 1 – -------------------------------------------------------
                                                                                               ( 1 + r1 )
                                                   However, the “present value” of a 2-month marketable alternative is
                                                   calculated as follows:

                                                                           Redemption Value 2 * r 2 Redemption Value 2 * r 2
                                                 PV = Redemption Value 2 – -------------------------------------------------------- + --------------------------------------------------------
                                                                                              ( 1 + r2 )                                        ( 1 + r2 ) ( 1 + r1 )

                                                   Further, the “present value” of a 3-month marketable alternative is
                                                   calculated as follows:

                          Redemption Value 3 * r 3 Redemption Value 3 * r 3 Redemption Value 3 * r 3
PV = Redemption Value 3 – -------------------------------------------------------- + -------------------------------------------------------- + --------------------------------------------------------
                                             ( 1 + r3 )                                        ( 1 + r3 ) ( 1 + r2 )                            ( 1 + r3 ) ( 1 + r 2 ) ( 1 + r1 )

                                                   The discounting is incorrect in the model, and is carried through for
                                                   periods two and greater. Appendix IV provides a more detailed discussion
                                                   of the model calculations, including the monthly after-tax “discount rate”
                                                   mentioned above.




                                                   Page 29                                                                                                     GAO-03-513 Savings Bonds
Appendix III

Future Value Examples for Series EE and
Series I Savings Bonds for Bonds 5 Years and
Older                                                                                                                                               Appen
                                                                                                                                                        Ix
                                                                                                                                                         di




               All calculations of interest are based on a hypothetical savings bond with a
               denomination of $25,1 such that for the following:
                     Series EE, FV = PV * {[1+(i/2)](m/6)}
                            Example: An EE savings bond rate of 5.07 percent will result in
                            a newly purchased hypothetical $25 bond increasing in value
                            after 6 months to $12.82, when rounded to the nearest cent.
                                   At the beginning of the first semiannual rate period, the present
                                   value (PV) is equal to $12.50 such that
                                   Month 1: FV = 12.50 * {[1 + (.0507/2)](1/6) = 12.55
                                   Month 2: FV = 12.50 * {[1 + (.0507/2)](2/6) = 12.60
                                   Month 3: FV = 12.50 * {[1 + (.0507/2)](3/6) = 12.66
                                   Month 4: FV = 12.50 * {[1 + (.0507/2)](4/6) = 12.71
                                   Month 5: FV = 12.50 * {[1 + (.0507/2)](5/6) = 12.76
                                   Month 6: FV = 12.50 * {[1 + (.0507/2)](6/6) = 12.82
                                   Thus, a $5,000 bond purchased at the same time as the
                                   hypothetical $25 bond will be worth $2,564 after 6 months
                                   ([$5,000 ÷ $25] x $12.82 = $2,564).
                                   The PV variable changes in months 7 through 12 such that the
                                   PV is equal to the redemption value at the beginning of the
                                   semiannual rate period, which in the above example is equal to
                                   month 6 future value (FV) such that
                                   Month 7: FV = 12.82 * {[1 + (.0507/2)](1/6) = 12.87
                                   Month 8: FV = 12.82 * {[1 + (.0507/2)](2/6) = 12.93
                                   Month 9: FV = 12.82 * {[1 + (.0507/2)](3/6) = 12.98
                                   Month 10: FV = 12.82 * {[1 + (.0507/2)](4/6) = 13.04
                                   Month 11: FV = 12.82 * {[1 + (.0507/2)](5/6) = 13.09
                                   Month 12: FV = 12.82 * {[1 + (.0507/2)](6/6) = 13.14
                                   The PV variable changes in months 13 through 18 such that the
                                   PV is equal to the redemption value at the beginning of the
                                   semiannual rate period, which in the above example is equal to
                                   month 12 FV, and so on.
               Sources: 31C.F.R. § 351.2-(k)(4)(ii)(A), U.S. Savings Bond Series EE Information Statement for bonds issued May 1997 or later, and
               GAO analysis.

               Note: Savings bonds are subject to a 12-month holding period and those redeemed before 5 years are
               subject to a 3-month interest penalty.




               1
                Series EE - 31C.F.R. §351.2-(k)(1)(iii); Series I – 31C.F.R. § 359.2-(e)(1)(vi).




               Page 30                                                                                       GAO-03-513 Savings Bonds
Appendix III
Future Value Examples for Series EE and
Series I Savings Bonds for Bonds 5 Years and
Older




      Series I, FV = PV * {[1+(CR/2)](m/6)}
              Example: An I composite rate of 5.07 percent will result in a
              newly purchased hypothetical $25 bond increasing in value
              after 6 months to $25.63, when rounded to the nearest cent.
                    At the beginning of the first semiannual rate period, the PV is
                    equal to $25 such that
                    Month 1: FV = 25 * {[1 + (.0507/2)](1/6) = 25.10
                    Month 2: FV = 25 * {[1 + (.0507/2)](2/6) = 25.21
                    Month 3: FV = 25 * {[1 + (.0507/2)](3/6) = 25.31
                    Month 4: FV = 25 * {[1 + (.0507/2)](4/6) = 25.42
                    Month 5: FV = 25 * {[1 + (.0507/2)](5/6) = 25.53
                    Month 6: FV = 25 * {[1 + (.0507/2)](6/6) = 25.63
                    Thus, a $5,000 bond purchased at the same time as the
                    hypothetical $25 bond will be worth $5,126 after 6 months
                    ([$5,000 ÷ $25] x $25.63 = $5,126).
                    The PV variable changes in months 7 through 12 such that the
                    PV is equal to the redemption value at the beginning of the
                    semiannual rate period, which in the above example is equal to
                    month 6 FV such that
                    Month 7: FV = 25.63 * {[1 + (.0507/2)](1/6) = 25.74
                    Month 8: FV = 25.63 * {[1 + (.0507/2)](2/6) = 25.84
                    Month 9: FV = 25.63 * {[1 + (.0507/2)](3/6) = 25.95
                    Month 10: FV = 25.63 * {[1 + (.0507/2)](4/6) = 26.06
                    Month 11: FV = 25.63 * {[1 + (.0507/2)](5/6) = 26.17
                    Month 12: FV = 25.63 * {[1 + (.0507/2)](6/6) = 26.28
                    The PV variable changes in months 13 through 18 such that the
                    PV is equal to the redemption value at the beginning of the
                    semiannual rate period, which in the above example is equal to
                    month 12 FV, and so on.
Sources: 31C.F.R. § 359.2-(e)(4)(ii)(A), U.S. Savings Bond Series I Information Statement, and GAO analysis.

Note: Savings bonds are subject to a 12-month holding period and those redeemed before 5 years are
subject to a 3-month interest penalty.




Page 31                                                                                        GAO-03-513 Savings Bonds
Appendix IV

Model Calculations Detail                                                                            Appen
                                                                                                         V
                                                                                                         Id
                                                                                                          xi




               The cost-effectiveness calculations in the Series EE and Series I
               submodels, as well as preceding steps, are similar; coding changes are due
               to the different structures of the two series, as noted in table 3, and
               modeling errors, as previously discussed. Though not shown here, both
               submodel calculations for savings bond redemption value incorporate the
               3-month interest penalty for bonds redeemed before 5 years from issue.

               Calculations for Marketable Treasury “Present Value” — Five Steps

               Where n = months outstanding

               Step 1: Savings bond redemption valuen respective to denomination (as
                       previously shown in table 3).

               Step 2: Savings bond redemption valuen after unit cost to redeem and tax
                       revenue implications = Adjusted Redemption Valuen:
                       Redemption Valuen – ((Redemption Valuen – savings bond issue
                       price) * savings bond tax recovery rate) + unit cost to redeem1

               Step 3: Algebraic after-tax “present value discount factor”n (comprising
                       several component calculations):
                         3a. after-tax semiannual CMTn = (6-month average of CMTn/2) *
                             (1 – tax recovery rate)
                         3b. after-tax semiannual CMTn expressed as a monthly rate = Yn =
                             ((after-tax semiannual CMTn + 1) ^ (1/6)) – 1
                         3c. Yn algebraic conversion leading to after-tax “present value
                             discount factor”:
                            3c.1. Sn = 1/(1 + Yn)
                            3.c.2 Month 1 FAC (that is, FAC1) = S1; for all other n, FACn = Sn
                                  * (FACn-1 + 1)
                         3d. After-tax “present value discount factor”n = FACTn = 1 – (Yn *
                             FACn)

               Step 4: Algebraic after-tax “present value discount factor”n expressed as a
                       monthly rate: Ien = (((1/FACTn) ^ (1/n)) – 1)


               1
                Adjusted for the education bond program such that savings bond tax recovery = tax
               recovery rate provided by the Treasury’s Office of Tax Policy * ( 1 - .10).




               Page 32                                                        GAO-03-513 Savings Bonds
Appendix IV
Model Calculations Detail




Step 5: Treasury “present value”n: Adjusted Redemption Valuen / (1 + Ien) ^ n

The resulting marketable Treasury “present value”n = Adjusted Redemption
Valuen * FACTn , which returns the following:

Month 1 marketable Treasury “present value” = Adjusted Redemption
Value1 - Adjusted Redemption Value1 * Y1 / (1 + Y1)

Month 2 marketable Treasury “present value” = Adjusted Redemption
Value2 – [Adjusted Redemption Value2 * Y2 / (1 + Y2) + Adjusted Redemption
Value2 * Y2 / (1 + Y2)( 1 + Y1)], and so on.

Calculation for Savings Bond “Present Value” — One Step

Savings bond issue price respective to denomination – savings bond unit
cost to issue

Calculations for Cost-effectiveness Ratio — Six Steps

Where n = months outstanding

Step 1: “present value” differencen
        Savings bond “present value” - marketable Treasury “present
        value”n

Step 2: Bonds redeemedn:
        Month 0 bonds redeemed = probability of redemption0 * savings
        bond sales volume respective to denomination
          Month 1 bonds redeemed = probability of redemption1 * (savings
          bond sales volume respective to denomination – bonds redeemed0);
          for all other bonds redeemedn = probability of redemptionn *
          (savings bond sales volume respective to denomination – bonds
          redeemed0..n)

Step 3: Projected “present value” differencen:
        “present value” differencen * bonds redeemedn

Step 4: Cumulative projected “present value” difference:
        Month 0 cumulative projected “present value” difference =
        projected “present value” difference0; for all other cumulative
        projected “present value” differencen = projected “present value”
        differencen + cumulative projected “present value” differencen-1



Page 33                                               GAO-03-513 Savings Bonds
Appendix IV
Model Calculations Detail




Step 5: Bonds outstandingn:
        Month 0 bonds outstanding = sales volume respective to
        denomination – bonds redeemed0; for all other bonds outstandingn
        = bonds outstandingn-1 - bonds redeemedn

Step 6: Cost-effectiveness ratio for each denomination (comprising several
        component calculations):
          6a. (cumulative projected “present value” difference50 years – pieces
              outstanding50 years * savings bond unit cost to issue)
          6b. (sales volume respective to denomination * savings bond issue
              price)
          6c. (result of 6a. / results of 6b.) * 1,000

The resulting cost-effectiveness calculation returns a ratio of millions
saved per $1 billion borrowed.

Additional Calculations That Are Not Relevant to the Model’s Cost-
effectiveness Calculation

Though not detailed above, the model includes five calculations that do not
produce output relevant to the cost-effectiveness calculation.

In addition, the model performs an additional step in the after-tax “present
value discount factor” calculation that is not necessary. The model creates
an after-tax “present value discount factor” expressed as a monthly rate,
shown above as step 4 in the calculations for the marketable Treasury
“present value.” Step 5, as shown above in the calculations for the
marketable Treasury “present value,” reverses this calculation through the
30-year life cycle of the marketable Treasury alternative.




Page 34                                                  GAO-03-513 Savings Bonds
Appendix V

Comments from the Bureau of the Public Debt                  Appen
                                                                 V
                                                                 di
                                                                 x




Note: GAO comments
supplementing those in
the report text appear at
the end of this appendix.




                            Page 35   GAO-03-513 Savings Bonds
Appendix V
Comments from the Bureau of the Public
Debt




Page 36                                  GAO-03-513 Savings Bonds
Appendix V
Comments from the Bureau of the Public
Debt




Page 37                                  GAO-03-513 Savings Bonds
                 Appendix V
                 Comments from the Bureau of the Public
                 Debt




See comment 1.




                 Page 38                                  GAO-03-513 Savings Bonds
Appendix V
Comments from the Bureau of the Public
Debt




Page 39                                  GAO-03-513 Savings Bonds
Appendix V
Comments from the Bureau of the Public
Debt




Page 40                                  GAO-03-513 Savings Bonds
                 Appendix V
                 Comments from the Bureau of the Public
                 Debt




See comment 2.




See comment 3.




                 Page 41                                  GAO-03-513 Savings Bonds
                 Appendix V
                 Comments from the Bureau of the Public
                 Debt




See comment 4.




                 Page 42                                  GAO-03-513 Savings Bonds
               Appendix V
               Comments from the Bureau of the Public
               Debt




GAO Comments   The following are GAO's comments on the Bureau of the Public Debt's
               (BPD) letter dated June 4, 2003.

               1. As we note in this report's Agency Comments and Our Evaluation
                  section, the approach that BPD outlines here would be an appropriate
                  alternative to the cost-effectiveness model based on a present value
                  analysis described in the report. The description in this report is based
                  on documentation for the cost-effectiveness model that BPD provided
                  in an October 16, 2002, meeting; on a July 2002 report that BPD
                  prepared for the House Committees on Appropriations and on
                  Financial Services; and on March 2002 testimony by the Commissioner
                  of the Public Debt before the House Appropriations Subcommittee on
                  Treasury, Postal Service, and General Government.

               2. As we note in the report, the 20-year extension is not consistent with a
                  statement previously made by the Department of the Treasury
                  regarding the presumption of payment 10 years beyond the maturity
                  date.

                   We agree that all administrative costs are included in the model. As the
                   report notes, however, the model calculation does not accurately
                   incorporate these costs in computing the present value of the
                   marketable Treasury security and the savings bond.

               3. Based on BPD's explanation that redemptions within 6 months of a
                  savings bond's issuance are sometimes granted in hardship cases, we
                  have deleted discussion of their inclusion in the model from the report.

               4. As we note in the report, the model's compound interest formula for the
                  Series I bonds does not recognize the bond's accrued value at the
                  beginning of each semiannual period. When calculated out over 30
                  years, the difference between the formula in the regulation and the
                  model's calculation is minor but still exists.




               Page 43                                               GAO-03-513 Savings Bonds
Appendix VI

GAO Contacts and Staff Acknowledgments                                                        AppenV
                                                                                                   d
                                                                                                   xiI




GAO Contacts      Thomas J. McCool, (202) 512-8678
                  James M. McDermott, (202) 512-5373



Acknowledgments   In addition to those named above, Heather T. Dignan, Mitchell B. Rachlis,
                  and Barbara M. Roesmann made key contributions to this report.




(250098)          Page 44                                              GAO-03-513 Savings Bonds
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