If you turn your TV to CNBC for a snapshot of what the market is doing, you will see figures that probably look familiar to you – the S&P 500, or perhaps the Dow. But did you notice the figure called “US 10 Year” that is often quoted? Did you ever wonder what that number means?
The “US 10 Year” represents the yield an investor can receive if they purchase a US Treasury maturing in 10 years. A US Treasury is a debt obligation of the US Government. If you buy a US Treasury, you are essentially lending money to the federal government for a specified period of time. You purchase the bond, receive interest payments periodically along the way, and then receive your principal (or loan) amount back at maturity. This loan amount is typically referred to as “par.” US Treasuries typically trade in par amounts that are multiples of $1,000.
According to Bloomberg, as of January 2019, the amount of outstanding US Treasury securities is approximately $20 trillion. That is a very large number! Who is buying all of these US Treasuries? Foreign governments, central banks, mutual funds and other institutions purchase Treasuries for various reasons. And of course, individual investors also buy US Treasuries.
For individual investors, US Treasuries can provide predictable cash flows with very low default risk since they are backed by the US Government. Treasuries are also exempt from State and Local Income taxes, however, Federal taxes must be paid on the income from these investments. You didn’t think Uncle Sam was going to let you get away that easily, did you?
There are many US Treasury securities with different lengths of maturities. These are split into 3 categories: Bills, Notes, and Bonds.
Treasury bills (T-Bills) have a maturity of one year or less. They are typically purchased at a discount, so you are paying 98-99 cents on the dollar for every T-Bill purchased. T-Bills do not pay an interest payment since their maturity is so short. This is why they are sometimes referred to as zero coupon T-Bills.
Here is an example of a T-Bill transaction. On January 1st, 2019, you pay $990 for a T-Bill that has a par value of $1,000. It will mature in 6 months on June 30th, 2019. Since you’re only paying $990 for a $1,000 T-Bill, you are getting a 1% discount. On June 30th, you will receive $1,000. Your total income on this transaction would be $10. In summary, this is what the transaction looks like:
Treasury Notes (T-Notes) work a little differently than T-Bills. T-Notes have longer maturities than Bills, with maturity dates between 2 and 10 years. When you purchase a T-Note, you receive periodic interest payments until the note matures. These are sometimes called “coupon payments”. At maturity, you receive your principal, or “par”, value back.
Let’s look at an example of a T-Note that is purchased at a discount.
Treasury Bonds (T-Bonds) are a third type of Treasury security. T-Bonds work the same as T-Notes, except T-Bonds have a maturity anywhere between 10 and 30 years.
One difference between T-Bonds and the other Treasury securities is that T-Bonds can be more frequently purchased at a premium. This means you are paying more than $1 for each $1 in par value. Why would anyone want to do that? Well, it depends on the interest rate or coupon that the Bond is paying. Let’s say an investor finds a T-Bond that matures in 3 years and is paying a coupon of 4.0%. This may have been a T-Bond that was originally issued 15 years ago, when interest rates were much higher. So, a bond with that high of an interest rate may be very attractive to an investor today, and the investor may be willing to pay more than $1 for each $1 in par value.
Hopefully this helped you to more fully understand the different types of US Treasuries, and how a Treasury transaction may work. US Treasuries may not be appropriate for every portfolio. There are many variables to consider, including risk level, time horizon, par values, and coupon rates. If you have any further questions, please do not hesitate to reach out to a Domani Wealth advisor.
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this article serves as the receipt of, or as a substitute for, personalized investment advice from Domani. A copy of Domani’s current written disclosure brochure discussing our advisory services and fees continues to remain available upon request.
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Post Written by: Angela Berkosky, CFA & Chris Rice, CFP® CPA/PFS