U.S. Treasury securities are the governemnt securities issued by the U.S. Treasury acting through the Bureau of its public debt. This is a financing instrument of government debt. There are four types of treasury securities:
Short-term Treasury bills, (Bills)
The medium-term treasury bonds, (Notes)
Long-term Treasury bonds, (Bonds)
Treasury inflation-protected bonds (TIPS).
Quote information Treasury securities can be found in the Market Data Center (subsection Bonds, Rates & Credit Markets) of the newspaper The Wall Street Journal.
In this paper we will consider the U.S. Treasury Bonds. The information, which was taken from Bloomberg Journal is below
Let’s construct the graph of the U.S. Treasury bonds yields:
Note: I took 30 years bond instead on 20 years, because there are no information about 20 years bonds.
There are some problems with getting data of Best Buy Co Inc. bond yields for the same period. I found the following information:
http://quicktake.morningstar.com/stocknet/bonds.aspx?symbol=bby
This is not exactly what we need, but the yield levels gives us enough to understand how to compare these two bonds.
As we may see, there are 3 types of bonds:
For approximately 2.5 years (wih 3.75% yield)
For approximately 4 years (with yield 5%)
For approximately 8 years (with yield 5.5%)
Assume that for 1 year bond the yield is like for 2.5 years, for 5 years like for 4 years bond and for 10 years like for 8 years bond. Then we can compare the graphs.
If we could find the exact information, we shouldn’t do any assumptions.
We have no information for 20 years bonds, so we leave that space empty. But even with this data we can answer all the questions needed:
◦Which yield curve is higher?
The Best Buy Co Inc. curve is higher.
◦What is the reason for the difference in the yields?
The main factor for the difference in the yields is the level of risk. The U.S. government bonds are very low-risked securities. Guarantor of the payments on the bonds in this case is the U.S. Treasury. The U.S. AAA credit rating, the risk does not deter investors who want to buy these bonds. And Best Buy Co Inc. is just a big company, which have some troubles from time to time. This makes the investment in Best Buy bonds more risky than the investment in the U.S. Treasury. The difference between the yields is a risk premium.
◦Are any of the yield curves positively sloped? If not, are any of them inverted?
The both curves is positively sloped. This is because in both cases level of yield increases as the term of a bond increases.
◦What do the shapes of the yield curves tell you about future interest rates?
Both curves could be interpreted as increased functions. This may give us an assumption that the interest rates will increase in the future.
Conclusion
Bonds are one of the most reliable types of securities that are present in the market. Despite the fact that, at first glance, investing in this type of security can not lead to financial losses, there are some risks of owning bonds.
Now experts are two main risks associated with investing in bonds. The most high-risk for bonds is credit risk.
No matter how reliable were the issuer, there is always a chance that he will not be able to pay the interest on the bonds or coupons to buy this type of securities. Rate this risk can be quite difficult, as the bonds are issued usually reliable companies that have significant weight in the market.
Many of the analytical company assigned issuers that issue various securities, a rating of reliability on the basis of which an investor can make a conclusion about the need to purchase this type of securities. It is also worth noting that the higher the rating the company's reliability, the smaller the yield on the bonds or any other type of securities may obtain investor.
On the other hand, many investors remember the situation of default on short-term government bonds, which was formed in 1998, which led to the collapse of the stock market in the Russian Federation. Also, many investors have been cases where large Russian corporations are significantly delayed or not paid cash expense on their bonds.
Another form of risk bonds, which the investor may face is the market risk related to changes in the cost of this type of securities, due to the market situation in the country. Typically, bonds are very sensitive to changes in interest rates or inflation in the country, so investors who invest money in bonds, you need to carefully monitor developments in financial markets.
It should be noted that fluctuations in the value of the company's bonds are less visible than the fluctuations in the value of shares that can reach several tens of percent in a few days.
Typically, bonds are a significant part of the portfolio of investments, so the risk associated with changes in market conditions that may substantially affect the value of the bonds is minimal.
The risk is the main factor of the yield level of the bond. The high-risked bonds usually propose the higher level of yield, compared to the low-risked securities.
Sources
The United States Department of Treasury. Website, retrieved 21 November, 2013.
Bloomberg LT Financial Statements. Website, retrieved 21 November, 2013.
