Understanding How Most Lotteries Invest Your Winnings ...

Originally Posted: Thursday, July 1, 2004
Revised: Saturday, July 3, 2004
lottoreport@tx.rr.com

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Understanding Securities
& Zero Coupon Bonds/Strips

As it appears on the US Treasury Web Site
&
If You're an Annual Pay Lotto Winner ...

How You Can Determine If You're Receiving All Your Monies


 

Since I posted the "Should You Win page," I have received a ton of questions about
investments, investments costs, zero's, strips and how to determine if, as a winner,
you are receiving all that you really won. Hopefully this page will answer all your questions.

Important Info To Know First
If you win Lotto Texas and you've chosen annual pay, the Texas Comptroller purchases
US Treasury securities (zero's coupon bonds / strips) with your winnings. You are "suppose"
to receive all monies earned from those investments. And ... each of your
19 OR 24 investments do have CUSIP numbers which you'll read about in a minute.

The Mega Millions group also buys US Treasury Securities.

If you win Lotto Texas, you've won the amount in the jackpot prize pool.

If you win Mega Millions, well, you've won the amount they "advertise." For this game,
they invest however much is necessary to give a return of the advertised amount or
if you take CVO, they will pay you the "investment cost" - NOT the amount in the prize pool.
This is NOT good for the People because they can easily under-estimate the advertised jackpot
amount and this happens regularly. However, they do allocate 31.69% of roll
sales to the jackpot prize pool.

Below you will find, in layman's terms, the basics regarding treasury securities, strips
and finally, my advise on how to determine if you are receiving all of your monies. I
would strongly recommend that all winners verify, on your own, that you
are receiving all that your investments are actually paying.



The Basics of Treasury Securities

What are U.S. Treasury securities?

U.S. Treasury securities are debt instruments. The U.S. Treasury issues securities to raise
the money needed to operate the Federal Government and to pay off maturing obligations -
its debt, in other words.

Why should I buy a Treasury security?

Treasury securities are a safe and secure investment option because the full faith
and credit of the United States government guarantees that interest and principal payments
will be paid on time. Also, most Treasury securities are liquid, which means they can
easily be sold for cash.

What types of securities do you sell to individual investors?

We sell Treasury bills, notes, bonds*, and U.S. savings bonds to individual investors.

What are Treasury bills?

Treasury bills (or T-bills) are short-term securities that mature in one year or less from
their issue date. You buy T-bills for a price less than their par (face) value, and when
they mature we pay you their par value. Your interest is the difference between the
purchase price of the security and what we pay you at maturity (or what you get
if you sell the bill before it matures). For example, if you bought a $10,000
26-week Treasury bill for $9,750 and held it until maturity, your interest would be $250.

What are Treasury notes and bonds*?

Treasury notes and bonds* are securities that pay a fixed rate of interest every six
months until your security matures, which is when we pay you their par value.
The only difference between them is their length until maturity. Treasury notes
mature in more than a year, but not more than 10 years from their issue date. Bonds*,
on the other hand, mature in more than 10 years from their issue date. You
usually can buy notes and bonds* for a price close to their par value.

Treasury sells two kinds of notes, fixed-principal and inflation-indexed. Both
pay interest twice a year, but the principal value of inflation-indexed securities
is adjusted to reflect inflation as measured by the Consumer Price Index --
the Bureau of Labor Statistics' Consumer Price Index for All Urban Consumers
(CPI-U). With inflation-indexed notes and bonds*, we calculate your semiannual
interest payments and maturity payment based on the inflation-adjusted principal
value of your security.

What are U.S. savings bonds?

Savings bonds are Treasury securities that are payable only to the person to
whom they are registered. Savings bonds can earn interest for up to 30 years,
but you can cash them after 6 months if purchased before February 1, 2003
or 12 months if purchased on or after February 1, 2003.

What types of savings bonds are available?

You can buy two types of savings bonds for cash: the Series EE bond or the
Series I bond. You can only buy Series HH bonds in exchange for Series EE/E
bonds and savings notes or when you reinvest the proceeds of matured Series H bonds.
For more information on these types of securities and how to purchase them,
visit our Savings Bonds website.

How do Treasury bills, notes, and bonds* differ from savings bonds?

Unlike savings bonds, Treasury bills, notes, and bonds* are transferable, so you can
buy or sell them in the securities market. Also, bills, notes, and bonds* are electronic -
they're not paper securities like savings bonds. You can buy Treasury bills, notes,
and bonds* for a minimum of $1,000, and you can buy savings bonds for as little as $25.

How can I buy a Treasury bill, note, or bond*?

It's easy. Buy Treasury bills, notes, or bonds* either at one of the auctions we conduct
or in the securities market. If you want to buy a Treasury security at auction, contact us,
a Federal Reserve Bank, a financial institution, or a government securities broker or dealer.
If you want to buy a Treasury security in the securities market, contact your financial
institution, broker, or dealer for more information.

What is a Treasury auction?

Each Treasury bill, note, or bond* (except savings bonds, of course) is sold at a
public auction. In Treasury's auctions, all successful bidders (we'll discuss bids in a little bit)
are awarded securities at the same price, which is the price equal to the highest rate or yield
of the competitive bids we accept. You can find a complete explanation of the auction
process in our Uniform Offering Circular, which is in the Code of Federal Regulations (CFR)
at 31 CFR Part 356.

How can I find out when an auction will be held?

About one week before each auction, we issue a press release announcing the security being
sold, the amount we're selling, the auction date, and other pertinent information. This information
is available from us and from your financial institution, broker, or dealer. Many newspapers
also report Treasury auction schedules in their financial sections.

How can I participate in an auction?

Simply submit a bid for the security you want to buy. You can bid either noncompetitively
or a competitively, but not both in the same auction.

If you bid noncompetitively, you'll receive the full amount of the security you want at the return
determined at that auction. Therefore, you don't have to specify the return you'd like to receive.
You can't bid for more than $1 million in a bill auction or $5 million in a note auction. Most
individual investors bid noncompetitively.

If you bid competitively, on the other hand, you have to specify the return -- the "rate" for bills
or the "yield" for notes -- that you would like to receive. If the return you specify is too high,
you might not receive any securities, or just a portion of what you bid for. However, you can
bid competitively for much larger amounts than you can noncompetitively.

How do I submit my bid?

Once we announce the auction of a security, you can submit a bid for an auction directly
to us, to a Federal Reserve Bank, or through a financial institution, broker, or dealer. We
accept bids by mail or, for current customers, over the Internet and by touch-tone phone.
A financial institution, government securities broker, or dealer can also submit bids on
your behalf. Although we don't charge fees to process a bid, some financial institutions,
brokers, and dealers may charge for that service.

What is the minimum purchase amount for Treasury securities?

The minimum amount that you can purchase of any given Treasury bill or note is $1,000.
Additional amounts must be in multiples of $1,000.

Do I have a choice as to where my Treasury securities are kept?

All Treasury securities are issued in what we call "book-entry" form -an entry in a central
electronic ledger. You can hold your Treasury securities in one of two systems, TreasuryDirect
or the commercial book-entry system. TreasuryDirect is a direct holding system where you
have a direct relationship with us. The commercial book-entry system is an indirect holding
system where you hold your securities with your financial institution, government securities
broker, or dealer. The commercial book-entry system is a multi-level arrangement that involves
the Treasury, the Federal Reserve System (acting as Treasury's agent), banks, brokers, dealers,
and other financial institutions. So, in the commercial book-entry system, there can be one
or more entities between you (the ultimate owner of the security) and Treasury.

What features does TreasuryDirect offer?

TreasuryDirect makes payments by direct deposit to your bank account and sends
statements directly to you. We don't charge any fees when you open an account or
buy securities. (The only fee we charge is a maintenance fee ONLY IF your account
has a total par amount of more than $100,000.) TreasuryDirect also allows you to
automatically reinvest most maturing securities. Although you have a direct relationship
with us, your financial institution, government securities broker, or dealer can submit
a bid for a security to be delivered to TreasuryDirect for you. For more information
on TreasuryDirect, please click here.

What features does the commercial book-entry system offer?

In the commercial book-entry system, you'll maintain your relationship with your
financial institution, broker, or dealer and potentially pay fees for their services.
The commercial book-entry system allows you to easily buy and sell securities
as well as, unlike TreasuryDirect, use them for collateral. You can also hold
Treasury securities in stripped form, known as STRIPS or zero-coupon
Treasuries, in the commercial book-entry system.

What are STRIPS or zero-coupon Treasuries? (Texas Buys Strips - More info below)

STRIPS, also known as zero-coupon securities, are Treasury securities that don't
make periodic interest payments. Market participants create STRIPs by separating
the interest and principal parts of a Treasury note or bond*. For example, a 10-year
Treasury note consists of 20 interest payments -- one every six months for 10 years --
and a principal payment payable at maturity. When this security is "stripped," each of
the 20 interest payments and the principal payment become separate securities and
can be held and transferred separately. STRIPS can only be bought and sold through
a financial institution, broker, or dealer and held in the commercial book-entry system.

How can I sell my Treasury security before maturity?

If you hold your security in the commercial book-entry system, contact your financial
institution, government securities dealer, broker, or investment advisor. Normally there
is a fee for this service. If you hold your security in TreasuryDirect, you can transfer
it to an account in the commercial book-entry system or let us sell your security
through our Sell Direct program for a modest fee.

How do I transfer my securities from one system to the other?

It's easy to transfer securities between TreasuryDirect and the commercial book-entry system.
To transfer into TreasuryDirect, just ask your financial institution, broker, or dealer to
handle it or click here. If you don't already have a TreasuryDirect account, you
will need to create one before transferring any securities, however. To do that,
just complete and submit a New Account Request to a Federal Reserve Bank.
Likewise, if you want to move your TreasuryDirect securities to an account in
the commercial book-entry system, you will need to create an account in the
commercial book-entry system first. Contact your financial institution, broker,
or dealer to do that. You'll also need to fill out and submit to your TreasuryDirect
office a Security Transfer Request. Check with your broker, dealer, or financial
institution about what wire transfer information you must include. You can
download or order the necessary forms from the Internet, or get them by
calling your TreasuryDirect office.

How do I receive my interest and principal payments in each system?

In the TreasuryDirect system, Treasury makes interest and principal payments
directly to the bank account you choose. In the commercial book-entry system,
Treasury's interest and principal payments may flow through several institutions
on their way to you. For example, a payment could go from the Federal Reserve
to a large bank to a smaller bank to your bank or broker before it gets to you.

What happens when my security matures?

When your security matures, we pay you the principal and the final interest
payment through TreasuryDirect or the commercial book-entry system.
TreasuryDirect allows you to reinvest the principal proceeds from maturing
securities by mail, phone, or over the Internet.

How can I get more information about Treasury securities?

You can get information about Treasury securities on our website or your financial
institution, broker, or dealer. If you're interested in TreasuryDirect, ask for our
TreasuryDirect Investor Kit (PD P 009).

*The Treasury Department hasn't offered a Treasury bond since its decision
in October 2001 to suspend issuance of the 30-year bond

The page can be viewed by clicking here.

Treasury STRIPS

The Treasury STRIPS program was introduced in January 1985. STRIPS is
the acronym for Separate Trading of Registered Interest and Principal of Securities.
The STRIPS program lets investors hold and trade the individual interest and principal
components of eligible Treasury notes and bonds as separate securities.

What is a stripped security?

When a Treasury fixed-principal or inflation-indexed note or bond is stripped, each
interest payment and the principal payment becomes a separate zero-coupon security.
Each component has its own identifying number and can be held or traded separately.
For example, a Treasury note with 10 years remaining to maturity consists of a single
principal payment at maturity and 20 interest payments, one every six months for 10 years.
When this note is converted to STRIPS form, each of the 20 interest payments and
the principal payment becomes a separate security. STRIPS are also called zero-coupon
securities because the only time an investor receives a payment during the life of a STRIP
is when it matures.

How do I buy STRIPS?

The Treasury does not issue or sell STRIPS directly to investors. STRIPS can be
purchased and held only through financial institutions and government securities
brokers and dealers.

Why do investors hold STRIPS?

STRIPS are popular with investors who want to receive a known payment at a specific
future date. For example, some State lotteries invest the present value of large lottery
prizes in STRIPS to be sure that funds are available when needed to meet annual
payment obligations that result from the prizes. Pension funds invest in STRIPS
to match the payment flows of their assets with those of their liabilities to make
benefit payments. STRIPS are also popular investments for individual retirement
accounts, 401(k)-type savings plans, and other income tax-advantaged accounts
that permit earnings to accumulate without incurring immediate income tax
consequences. See the Federal income tax treatment of STRIPS section of this document.

The Department of the Treasury does not provide investment advice. Your investment
advisor, financial institution, government securities broker or dealer, accountant,
and/or tax advisor can discuss STRIPS in the context of your investment needs.

Which Treasury securities are eligible to be stripped?

All Treasury notes and bonds are strippable.

How is a Treasury security stripped?

A financial institution, government securities broker, or government securities
dealer can convert an eligible Treasury security into interest and principal
components through the commercial book-entry system. Generally, an
eligible security can be stripped at any time from its issue date until its
call or maturity date.

Securities are assigned a standard identification code known as a CUSIP number.
CUSIP is the acronym for Committee on Uniform Security Identification Procedures.
Just as a fully constituted security has it a unique CUSIP number, each STRIPS
component has a unique CUSIP number. All interest STRIPS that are payable
on the same day, even when stripped from different securities, have the same generic
CUSIP number. However, the principal STRIPS from each note or bond have
a unique CUSIP number.

For example, if several fixed-principal notes and bonds that pay interest
on May 15 and November 15 are stripped, the interest STRIPS that
are payable on the same day (for example, May 15, 2005) have the
same CUSIP number. However, the principal STRIPS of each
fixed-principal note and bond have a unique CUSIP number, and
principal STRIPS with different CUSIP numbers that pay on the
same day are not interchangeable (or "fungible").

In the case of inflation-indexed notes and bonds, the semiannual
interest STRIPS that are payable on the same day (for example April 15, 2005)
have the same CUSIP number. The principal STRIPS also have a unique
CUSIP number. The CUSIP numbers for STRIPS from inflation-indexed
securities are different from those for STRIPS from fixed-principal securities.

See the Federal rules pertaining to STRIPS on this website (31 C.F.R. 356.31)
for more information on stripping. Also, see Appendix B to 31 C.F.R., Part 356,
for an example of the adjustment that must be made to the value of a stripped
interest component of an inflation-indexed security to make it interchangeable
with the interest components of other inflation-indexed securities with the
same payment date.

What are minimum par amounts for stripping?

Fixed-principal securities: The minimum face amount needed to
strip a fixed-principal note or bond is $1,000 and any par amount
to be stripped above $1,000 must be in a multiple of $1,000.

Inflation-indexed securities: The minimum face amount needed to
strip an inflation-indexed note or bond is $1,000 and any
par amount to be stripped above $1,000 must be in a
multiple of $1,000.

Are STRIPS safe investments?

STRIPS are obligations of the Treasury and are backed by
the full faith and credit of the United States.

Market prices of STRIPS fluctuate more than the prices of fully constituted
securities of the same maturity. The market price of a STRIP reflects
the fact that there is only one payment on a specific date in the future.
The market price of a fully constituted Treasury note or bond reflects the
fact that there is a series of semiannual interest payments and a final
payment at maturity. The longer the maturity of STRIPS, the greater
is the potential market price fluctuation.

STRIPS sell at a discount because there are no periodic interest payments.
An investor's income on a STRIP that is held to maturity is the difference
between the purchase price and the amount received at maturity.
Long-term STRIPS have lower market prices than short-term STRIPS,
because long-term STRIPS accrue interest over a longer period of time.
For example, assume that three STRIPS are quoted in the market at a
yield of 6.50 percent. The price for STRIPS with 25 years remaining
to maturity would be $202.07 per $1,000 face amount; that for STRIPS
with 10 years remaining to maturity would be $527.47 per $1,000 face
amount, while that for 2-year STRIPS would be $879.91 per $1,000
face amount.

The total income from a STRIPS security is fixed at the time of purchase
when the security is held to maturity. When STRIPS are sold before maturity,
however, the investor could realize a gain or loss because the market price
could be more or less than the purchase price plus the amount of interest
(and the inflation adjustment to principal in the case of inflation-indexed
notes and bonds) that has accrued between the time the security was purchased
and the sale date.

Are STRIPS readily available?

There is a large and active market for STRIPS components of fixed-principal securities.
Many brokers and dealers make markets in these securities and other market participants
include pension funds, financial institutions, investment funds, and individuals.
While the liquidity of particular issues may vary from time to time, in general a
busy market exists for STRIPS with maturities from a few months to 30 years.
A market has not yet developed for stripped components of inflation-indexed securities.

What is the Federal income tax treatment of STRIPS?

Generally, an investor must report as income, for Federal income tax purposes,
the interest earned on STRIPS in the year in which it is earned. Inflation adjustments
to principal on inflation-indexed securities must also be reported in the year earned.
Income must be reported even though it is not received until maturity or the STRIPS
are sold. Every investor in STRIPS receives a report each year displaying the
amount of STRIPS interest income from the financial institution, government
securities broker, or government securities dealer that maintains the account
in which the STRIPS are held. This statement is known as IRS Form 1099 - OID,
the acronym for original issue discount. The income-reporting requirement has
meant that STRIPS are attractive investments for tax-deferred accounts, such
as individual retirement accounts and 401(k) plans, and for non-taxable accounts,
which include pension funds.

The income tax treatment of STRIPS also takes into account market discount
and capital gains or losses, if any. Therefore, an investor would be well advised
to review possible income tax implications before investing in STRIPS. For further
information on the tax treatment of STRIPS and other zero-coupon securities, see
Internal Revenue Service Publication 550, "Investment Income and Expenses"
on the Internal Revenue Service website (http://www.irs.gov/formspubs/)

Can the STRIPS components be reassembled into a whole security?

STRIPS components can be reassembled or "reconstituted" into a fully constituted
security in the commercial book-entry system. To reconstitute a security, a financial
institution or government securities broker or dealer must obtain the appropriate
principal component and all unmatured interest components for the security being
reconstituted. The principal and interest components must be in the appropriate
minimum or multiple amounts for a security to be reconstituted.

The flexibility to strip and reconstitute securities allows investors to take advantage
of various holding and trading strategies under changing financial market conditions
that may tend to favor trading and holding STRIPS or fully constituted Treasury securities.

Further questions?

If you have questions about buying or selling STRIPS, contact your financial institution,
broker, dealer, or investment advisor. See also 31 CFR 356.31 for rules relating to
stripping and reconstituting Treasury securities. If you have specific questions on the
process for stripping or reconstituting Treasury securities, call the Bureau of the
Public Debt at (202) 691-3550.

More ... click here

How to Determine If You're Receiving All Your Monies

If you previously won the lottery, chose annual pay, and the lottery is paying
you the exact amount advertised
. Well, first of all you need to know that in Texas,
the official game rules have NEVER stated that the lottery would pay the amount advertised.
That is, until Feb 2002 and even then it was "the greater of" either the prize pool or the investment cost.

Between Feb 2002 and May 2003, the TLC guaranteed the greater of either the
amount in the prize pool or the costs to fund the advertised amount. However, the
new 5/44 rule, effective May 7, 2003, changed to say that the TLC will pay the
greater of either
the amount advertised or the amount in the jackpot prize pool
(39.104% of roll sales) for the first 4 draws in a roll only. After that 4th draw,
you will receive the amount that is in the prize pool and this is GOOD.

To determine if you are receiving ALL monies the state has or is collecting
from your investments (strips), here's what I suggest you do.

FIRST contact a financial adviser, broker, lender or The Lotto Report (972-686-0660)
to find out what the zero coupon bond rate was on the first business day after you won.
It wouldn't hurt to check several sources. Do not ask the TLC at this point.

SECOND, add up Texas roll sales (roll sales is defined as total sales for all draws leading
up to and including sales for the draw that you won). Then take 32% OR 37.532%
OR 39.104% of roll sales to determine how much you really won. The percentage for
you depends on when you won - read on to see which percentage is applicable to your win.

If you are outside Texas, you will have to obtain draw sales and the official game rule
from your state lottery. This is public information. IF I were you though, I'd ask a friend
to obtain draw sales for the whole year that you won. Asking a friend to do this keeps
you from being identified.

Simply send a letter to the lottery addressed to the lottery, ATT: FOIA Specialists
(Freedom of Information). In your letter, simply say 'I would like to obtain total draw sales
for all LOTTO draws held in 2001 and a copy of the official game rule that was in effect
during 2001
' or whatever year you need. You need the game rule so you can see what
percentage of sales you "really" won. Be sure and include a mailing address for them to
send it to - but not your address - By law, they cannot ask you why you want the information.
Now to continue on for Texans ...

If you won between Nov 1992 - July 18, 2000, take 32% of roll sales to
determine how much you really won. (If in another state, see the game rule for this information)

If you won between July 19, 2000 and May 3, 2003, take 37.532% of roll sales
to determine how much you really won. This time frame is posted on my web site.
(If in another state, see the game rule for this information)

If you've won since May 7, 2003, add roll sales and take 39.104% to determine
your real winnings IF you won after the 4th draw in the roll. This time frame is posted
on my web site. (If in another state, see the game rule for this information)

THIRD, take the gross payments that you have and will receive starting with year
two (2) and add them up. Now divide the gross total by the rate you obtained.
Now add your first payment to the figure. This figure should equal the amount
in the jackpot prize pool or it should be very, very close.

FYI - The reason you start with year two (2) is because the lottery makes the first
payment and then they buy investments with the balance in the pool to cover
the next 24 years payments.

Do understand, rates can vary a little (brokering is competitive), so before
jumping to any conclusions, simply ask the lottery what their rate was for
your win and do the same calculations. IF the rate is a BIG difference,
I'd dig deeper to find out why.

Also, keep in mind that the bigger the jackpot, the better the rate may be for
the lottery which means that it may have required less money to invest.

If you won but chose CVO - Add roll sales and take whatever percentage
of sales was applicable at the time. This is how much you should have collected.

To figure approximate rates: First, add roll sales and figure out what 39.104% of roll
sales is - that's the winners share. Let's say that the lottery advertises the jackpot at $6 million.
You simply divide 6,000,000 by the winners share: 6,000,000/$3,460,208 = 1.734%.
FYI
- I keep the winners share figure on my web site at all times. This figure can
be found on one of three pages. The drawing results page (look under lotto Texas results),
the IF You Win page and the Lotto Texas Money page.

In Conclusion

I feel very strongly that jackpot winners should receive ALL that they won from state
lotteries. As it stands today, the states and the federal government are seeing what
I consider to be more than their FAIR share of lottery sales.

If you want to contact me but are leary, that's OK. I understand. You can send me
a note by US mail, include a self addressed stamped envelope, and ask me for the rate
for the day you won. I will simply write the rate down and return to you. I will not contact
you unless you want to talk to me. My address is: P. O. Box 495033, Garland, Texas 75049-5033.
If you don't include the self addressed stamped envelope, you will not get an answer.
I will not pay postage. OK?


Kiplinger- More About Zero Coupon Bonds


The Lotto Report
Dawn Nettles
P. O. Box 495033
Garland, Texas 75049-5033
(972) 686-0660
(972) 681-1048 Fax
lottoreport@lottoreport.com