Since Treasuries are so safe ( the ony way you are not going to get your interest payments and principle back is if the U.S. Treasury went bankrupt!), they offer lower interest rates than corporate or municiple bonds.
Types and Yields of Treasuries
There are three types of Treasuries: bills, which mature in less than a year; notes, which mature in two to ten years; and bonds, which mature in twenty to thirty years.
Usually, the longer the time frame on a Treasury, the higher the yield. As of 9/23, the current yield on the 30 year bonds (4.500%) was higher than those of the 10 year notes (3.625%), which was higher than the 5 year notes (2.375%); investors want a higher return for allowing their money to be tied up for a longer periods of time. The 30 year bonds are particularly popular because the interest received is exempt from state income tax.
Treasury notes and bonds are sold at auction by the Treasury Department, which sets a fixed face value and interest rate. Treasuries can be sold before maturity, like other bonds. Treasuries can be bought for more or less than the face value, depending on demand.
Demand Determines Price Paid and Effective Yields
If there is a lot of demand for the note or bond, it will go to the highest bidder at a price above the face value. This decreases the effective yield, (since more was paid than the face value) because the government only pays back the face value plus the stated interest rate. If, on the other hand, there is not a lot of demand, then the bidders will pay less than the face value, which will increase the yield. So, yields always move in the opposite direction of Treasury bill, note and bond prices.
Treasuries pay a stated rate of interest, and this stated rate is what is used to find out what the actual interest payments will be. But, investors decide to purchase bonds based on the current market rate, not the stated rate, which may not be the same. Also, Treasury note and bond market rates change every day, because just about everyone doesn’t keep them to maturity: they are bought and sold every day. Because of these factors, there is often a difference between the face value and the price actually paid for the note.
If a note or bond is paying more than the market rate, the note will be attractive to investors, and the note will sell at a premium, that is, more than the face value. If the stated rate is less than the market rate, the note will not be attractive to investors, and the note will sell at a discount, less than the face value.
So, the stated rate adjusted for the premium or discount gives the actual rate of return on the note, known as the market, yield, or the effective interest rate. The 30 bond had an effective interest rate of 4.19%, the 10 year note, 3.41%, and the 5 year note, 2.37.%. Evidently, all three sold for a premium.
The closer to retirement, the more bonds should be in your portfolio, since these debt instruments offer the safety you require. Treasuries, in particular, offer that safety.
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