Transcript of video below.
Treasury notes (T-Notes) pay interest every six months and are issued with maturities of two to 10 years, in denominations of $100 to $5,000,000, while Treasury bonds (T-Bonds) have the longest maturity of government securities. They pay interest every six months, like T-Notes, and are currently issued with a maturity of 30 years. Treasury inflation-protected securities (TIPS) are inflation-indexed bonds issued by the U.S. Treasury
Let’s Try a Practice Question
A U.S. Treasury security pays fixed coupon interest every six months and has an original maturity of 5 years. It is a:
- T-Note
- TIPS
- T-Bond
- T-Bill
T-Notes are issued with maturities two to 10 years, so that’s answer ‘A.’ What about TIPS? We talked about this. You want to fight inflation. You have the same power to do every coupon. There’s a word. Yes, the same purchasing power. Let’s say it’s a 3% TIP. So a 3% TIP pays semi-annual interest of how much? Just like a 3% bond,$15 semi-annually, because 3% of 1,000 equals 30. Split in half, two payments.
How Does a TIP Work?
In an inflationary period, what used to cost $15, now cost how much? Somebody give me an example. What costs about 15 bucks? That doesn’t cost up to $30. That would be crazy bananas inflation. What costs 15 bucks? A CD? Do you people still buy CDs? A roll of sushi, your sushi roll. You’re in a major city. You’re in a good restaurant. So your sushi roll costs 15 bucks. You bought dinner for the family; your sushi roll costs 15 bucks. Six months later, how much does that same sushi roll cost? 16 bucks. And the TIP now pays you how much? 16 bucks. So are you better off? Are you worse off? Are you the same? You are the same. You have maintained your purchasing power.
Let’s say now that the sushi roll drops at $13. How much is the TIP going to pay you now? It’s only $13, because you’re in a deflationary environment. And are you better off, worse off or you are the same? You’re the same. That’s the TIP story. We the government, are going take the inflation risk off you. You’re not going to be able to buy more stuff. You’re still getting 15 bucks, but we’re going to adjust it so you can buy $15 worth of stuff in the future.
How Does a T-Bond Work?
Give me the T-Bond, long or short? It’s a long bond, up to 30 years. Credit risk, yes or no? Credit risk, risk of default. Who issues the T-Bond? So is this super safe? Who knows the risk that we’ve got here? What’s the risk that you have to be careful about here? How long are you in the game for here? 30 years. You’ve got your interest rate risk. Who could fill in my blanks here? The “what” of the bonds are going to move up and down as “what” changes? Give me both words. The price of the bond is going to move up and down as the interest rates change. Which will only be an issue if I what? Sell the bond. What’s my coupon stay? Flat. Anybody know what’s the 30-year note paying right now? Anybody know? Zero? It’s not quite zero. The 30-year yield curve, right from the Treasury, it’s paying one and a half.
“The price of a bond is going to move up and down as the interest rates change.”
How much are you getting? How much are you getting a period here? It’s paying 1.5%. Your semi-annual coupon is $7.50. So that sushi roll that cost you 15 bucks in 2020, you can buy after you hold the T-Bond for one year. It’s now 2040. It’s 20 years from now. As a general matter, what’s that sushi roll cost? What’s that sushi roll going cost in 20 years? Only 18 bucks. Anyone else? 20 bucks. 25 bucks. So who knows? It’s going to cost $22.50, 20 years from now, that same sushi roll. How much interest are you getting in 2040? How much interest are you getting on the bond you bought today? How much cash in the coupons? You’re not getting $22.50. How much cash are you going to get in 2040, for the year? The same $15. Can you buy a sushi roll anymore? You can’t even buy one sushi roll anymore.