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A Beginner's Guide to Treasury Bonds and Notes
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 Material Information
Title: A Beginner's Guide to Treasury Bonds and Notes
Physical Description: Fact Sheet
Creator: van Blokland, P.J.
Publisher: University of Florida Cooperative Extension Service, Institute of Food and Agriculture Sciences, EDIS
Place of Publication: Gainesville, Fla.
Publication Date: 2001
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Acquisition: Collected for University of Florida's Institutional Repository by the UFIR Self-Submittal tool. Submitted by Melanie Mercer.
Publication Status: Published
General Note: "Published November 2001."
General Note: "FE 324"
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Source Institution: University of Florida Institutional Repository
Holding Location: University of Florida
Rights Management: All rights reserved by the submitter.
System ID: IR00001936:00001

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A Beginner's Guide to Treasury Bonds and Notes1 P.J. van Blokland and Justin Teuton2 1. This is EDIS document FE 324, a publication of the Department of Food and Resource Economics, Florida Cooperative Extension Service, Institute of Food and Agricultural Sciences, University of Florida, Gainesville, FL. Published November 2001. Please visit the EDIS website at http://edis.ifas.ufl.edu 2. P.J. van Blokland, professor, and Justin Teuton, graduate student, Department of Food and Resource Economics, Florida Cooperative Extension Service, Institute of Food and Agricultural Sciences, University of Florida, Gainesville, FL. The Institute of Food and Agricultural Sciences is an equal opportunity/affirmative action employer authorized to provide research, educational information and other services only to individuals and institutions that function without regard to race, color, sex, age, handicap, or national origin. For information on obtaining other extension publications, contact your county Cooperative Extension Service office. Florida Cooperative Extension Service/Institute of Food and Agricultural Sciences/University of Florida/Christine Taylor Waddill, Dean. Objective The main purpose of this paper is to introduce Treasury notes and bonds to potential investors and to people interested in learning a little about them. What Are Treasury Bonds and Notes? Treasury bonds and notes are loans or IOUs issued by the federal government, which uses the money to pay for a wide variety of federally funded projects and debt payments. Investors who purchase these instruments have a low risk and, therefore, low return investment, which is backed by the word of the U.S. government. The Treasuries (Ts) usually run for 10 to 30 years for bonds and from one to 10 years for notes. Interestingly, in November 2001, the Treasury will no longer issue 30-year bonds because they do not meet the government's cash flow requirements. Treasury bonds generally are issued in units of $1,000 and notes range from $1,000 to over $1 million. The $1,000 increment is the most common issue for both as it is for the T-bill, which until recently was only issued in denominations of $10,000. Types of Treasury Bonds and Notes The two types of T bonds and notes are marketable and non-marketable treasury securities. The marketable instruments are those that are traded on the open market and are by far the most popular. The open market is the secondary market where buyers and sellers transact business by trading orders for customers like us or for themselves. The open market is like the New York Stock Exchange and Bond Market where customers typically buy these things from those who already own them. The non-marketable treasury securities are those that are not traded on the open market, but can be purchased from or redeemed by the government. If customers want to buy primary market issues directly from the government, they submit a bid at a local Federal Reserve Bank. At maturity, these issues are offered at the local Federal Bank and are redeemed at par value. Terminology There are a lot of terms associated with bonds and notes, and unfortunately, they have to be learned.

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A Beginner's Guide to Treasury Bonds and Notes 2 1. Par Value: This is what the bond or note is worth at issue and at maturity. Bonds and notes are generally sold in the primary market at issue in units of $1,000. This $1,000 is its par value, and regardless of what the price is in the secondary market, the investor will receive $1,000 when it matures. Par value is also known as face, or face value. For traditional reasons, par value and price are listed in 32nd units rather than $1,000. So if the financial press records that a bond was worth 100:01, its monetary par value is $1,000.31.25 (every 1/32nd is $31.25). Note that the price has a colon after the whole number, signifying that the number on the right of the colon is in thirty seconds rather than decimals. This distinctly odd methodology is only used for T notes and bonds. 2. Maturity: This represents the end of the bond's or note's life. Most bonds run from 10 to 30 years, and most notes run from one to 10 years. At maturity the bond expires, and the holder of that bond or note receives par value from the government, regardless of its original purchase price. 3. Coupon Rate: The interest rate paid by the government to the investor. It is fixed for the life of the bond. This rate is normally paid in quarterly intervals. For example, if the coupon rate is 6%, then the investor receives 1 1/2% every three months. The rate is always on the par value of the bond, not the purchase price. If, for example, the price was $1,100 for a $1,000 bond with a 6% coupon rate, the investor will receive 6% of $1,000 (3% semi-annually), not 6% of the $1,100. The riskier the bond, the higher the coupon rate must be to attract investors. However, with treasury issued bonds and notes there is virtually no risk, so coupon rates are the lowest for both instruments. 4. Price: There is considerable confusion about the price of a bond or note. This is largely because of unawareness of the difference between the primary market, where the bond is originally issued, and the secondary market, where most of us will buy and sell bonds. Bond prices in the secondary market vary just like stock prices or the price of anything else. Prices rise and fall with changes in supply and demand. The only price that is fixed in a bond is its par value in the primary market. So it is possible to pay a premium price for a bond in the secondary market if a lot of investors want that bond or a discount price if there are few purchasers in this market. Bond prices are conventionally recorded in the financial press in terms of 100, where 100 equals par or is the equivalent of the typical $1,000 bond. Thus a bond priced at 101 is priced at a premium because it is greater than 100. It actually costs $1,010 (101 x 10). A bond priced at 98 is a discounted bond because the price is less than 100 and actually costs $980. 5. Yield: What an investor will have earned annually after buying the bond at that price and holding it to maturity. It is probably the most important number to look at for a bond investor. It is calculated using the coupon rate, the price, and the time to maturity. These are complicated calculations and generally require a financial calculator. Simply accept what the financial press says the current yield is and compare this yield with other investment alternatives. Or use a website with a bond calculator (e.g., http://www.fidelity.com). Price and yield vary inversely. If the price goes up, the yield goes down. This is because an investor always receives par value at maturity, regardless of price. Thus if the price is 98, the investor will receive 100 at maturity and receive 6% on 100 while holding the bond and the remaining two [i.e., (100 98), or $20; ($1,000 $980) plus the 100; $1,000 at maturity]. The investor ends up with $1,020 and the interest. Because the bond was discounted, the yield is greater than the coupon because of the $20. Conversely, if a 6% bond costs 103, the yield will be less than the coupon because of the $1,000 par value at maturity when it originally cost $1,030. So the total return is reduced by the $30. Thus as prices rise, yields fall, and vice versa.

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A Beginner's Guide to Treasury Bonds and Notes 3 Reading Treasury Bonds and Notes in The Wall Street Journal Table 1 shows how to read bonds and notes. If there is an "n" behind the maturity date, it signifies that this is a note; if there is no "n", it is a bond. The first column shows the rate of coupon. This rate is 8 3/4, which means that the bond will pay 8 3/4% annually. The maturity date shows the month and year when the bond matures. This bond will mature in August 2020, at which time the par value will be paid to the investor. The bid is the bid price, or the best offer to buy from an investor by mid-afternoon of that day. This particular bond bid price is 135:20, or $1,356.25. The asked price is 135:26 or $1,358.13, which is the highest offer to sell by mid-afternoon. The difference between them is the spread, and so most investors will pay somewhere between the two. The net change signifies the change from the previous day's close to yesterday's close (in 32nds). Its net change was -5, or minus the price. The asked yield shows the annual rate earned by an investor who pays the asked price and holds the bond until maturity. Here it is 5.66%. References http://www.bondmarkets.com. August 1, 2001. van Blokland, P.J. and Justin Teuton. "Introducing Corporate Bonds. Staff Paper 01-11. Department of Food and Resource Economics, University of Florida, Gainesville, FL. August 2001, 11pp. Wurman, Alan Siegel, and Kenneth M. Morris. Guide to Understanding Money and Markets. New York, NY: AccessPress Publication, 1990, pp. 42-61.

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A Beginner's Guide to Treasury Bonds and Notes 4 Table 1. Reading Treasury bonds and notes. Rate Maturity Month/Year Bid Price Asked Price Change Yield 1.7 1/2May 2001n 103:04 103:06 ... 3.48 2.11November 2002 110:00 110:02+ 23.69 3.7 1/4May 2004 107:22 107:24+ 14.29 4.5 February 2011n 99:02 99:0335.12 5.8 3/4August 2020 135:20 135:2655.66 6. 5 February 2031 97:16 97:17 7 5.55 The Wall Street Journal, July 23, 2001, C15.