Greetings traders and welcome back to another Survival Guide.
Chris here, bringing you some more information.
Today, we're going to be talking about treasury securities.
That's right, you heard me right. We're going
to be talking about treasure. Treasury securities that is.
That means treasury bills, notes, bonds, even treasury note futures.
But before we go any further, please do me a favor and just
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so I appreciate it a great deal. Without further ado,
let's dive on into that information and learn about how some
of these derivatives are traded, as well as talk about some
of the strategy as well, so here we go.
When it comes to low-risk investments, nothing says conservative
like treasury securities. Many investors turn to these instruments
to preserve their capital in times of turbulence
and in other market uncertainty in the financial sector.
In fact, there's hardly ever any other investment opportunity
that carries such strong safety guarantees for both principal
and interest returns. But first, let's talk about exactly
what treasury securities are. Treasury securities are debt
instruments that are issued by the US government when it
wants to raise funds for itself. They are also known as treasury bonds.
If you hear treasury security or treasury bonds, they
are synonymous. People who buy these instruments are essentially
loaning money to the government to be paid back with interest
over a given period of time. Buying treasury securities is
considered one of the safest investments because they are
protected by the full backing of the US government.
This means that no matter what happens; inflation,
recession, pandemic, as long as there is a government, as long
as there is a United States, then our principle is protected.
Additionally, any interest earned on said principle is only
taxed at the federal level.
This safety guarantee is one of the key fundamentals of the
economy itself. It is what makes the treasury security so
attractive to both individual and institutional investors
who are looking for steady returns over the long term.
There are three main categories of treasury securities: treasury bills,
treasury bonds, and treasury notes, and we will take
a look at each of these in detail. First, we have treasury bills.
These are securities that mature in the short term, usually
which ranges from a few days to a year, and they're also referred to as T-bills.
There is no interest earned on T-bills. Instead,
you can buy them at a discounted price compared to their
actual face value. On the date that they mature, the principal
amount will be returned to you,
but this time at its actual worth. For example, if you were
to purchase a $10,000 T-bill that was going to expire in two months
and you only had to buy it for $9,900, after two months,
the government will pay you the full $10,000 value, giving you that $100 of profit.
The maturity period for treasury bills are usually available in 5 different terms.
We have 52 weeks, 26 weeks, 13 weeks, 8 weeks, and 4 weeks.
There's also another variation of T-bills known as
the cash management bill, which doesn't follow a regular schedule
and usually matures after a few days.
Treasury bills are the only type of treasury security
that exists in both the money and capital markets.
Then, we have the treasury notes. Treasury notes are also known
as T-notes and they are intermediate to long-term treasury securities
with maturity dates typically ranging from 2 to 10 years.
There are 5 available terms for treasury notes.
There is the 2-year, 3-year, 5-year, 7-year and even
the 10-year note. Like treasury bonds, T-notes are issued
at a par value with fixed interest payments
paid out to the bearer twice a year. The principle is then
paid out at maturity. Auctions are also conducted every month
with original notes being issued on February, May, August, and
November, and re-openings during the remaining eight months.
The treasury notes offer a viable middle ground between the
relatively higher risks associated with the long-term T-bonds
and the low-term payouts of the short-term T-bills.
This makes them an ideal choice for beginners who are looking
to get started with treasury securities. Prior to 1984, the
US Treasury issued callable treasury notes, meaning under certain conditions
the notes could be repurchased.
The interest rates do vary, typically depending on the length
of the term. Finally, we have the treasury bonds. The treasury bonds
have the longest maturity of all treasury securities,
usually 10 years and above. Sometimes even as high as 30 years.
Interest rates earned on T-bonds is paid out twice a year until maturity.
You can buy treasury bonds directly from the government or
through a broker. They are issued at actual par value.
Let's say you purchased a 20-year T-bond worth $50,000
with a 5% yearly coupon. The government will pay you
$2500 every year, for the next 20 years, and at the
maturity date, pay back the original $50,000 on top of the
interest that you earned. Original issues of treasury bonds
are auctioned four times a year. February, May, August, and
November are those months at which the auctions occur.
The reopening of existing T-bonds and the re-auctioning is done
within the other eight months. Because of the longer maturity
date, treasury bonds typically have higher yields compared to other
treasury securities. Still, they usually offer better interest
rate returns than bank savings accounts and even
some time deposits. This is a very appealing option
if you are planning on playing the long game or gifting it
to someone beneath your generation in your family.
The history of treasury note futures is relatively young.
Interest rate futures were introduced in 1975
by the Chicago Board of Trade, which we always refer to as the CBOT.
At the time, the cost of money was experiencing frequent volatility
and it became necessary to come up with some kind of instrument
to help mitigate the risks, and thus gave birth to the treasury note futures.
This led to the creation of treasury bond futures
and then later the treasury note futures for the 2, 5, and 10-year terms.
The treasury futures can help manage risks that are
typically associated with fixed income security investments.
In this case, however, we are speculating on how high or low we believe
interest rates will rise or fall in the future.
By investing in treasury note futures, we can assess which
direction interest rates will likely go over the maturity period
and protect against associated risks, especially towards the end of a yield curve.
The 10-year T-note futures contract is one of the most commonly traded treasury securities.
It is used both by individual and institutional investors.
It is generally considered to be a good indicator of the
current state of the economy. During times of economic turbulence,
many investors flock to the safety of treasury note futures to protect
their wealth. This is known as "flight to quality" investing.
It eventually leads to lower interest rates, since more and more
investors are entering the treasury market. On the flip side,
times of economic growth emboldens investors to opt for instruments
with higher potential returns.
This leads to less demand for treasuries and rising interest rates.
The treasury note futures contracts are traded on
the Chicago Mercantile Exchange,
otherwise known as the CME. This is what the T-note contract
looks like, if you just take a look, we have our contract unit
and it is $100,000 as the face amount. Then for the product code,
we have ZN and that is how we're going to find it.
The price quote is going to be 100 points on a basis.
The trading hours are pretty standard in that regard.
The rest of this information is actually available on our site
if you're curious on pulling it up, or even over at the
Chicago Mercantile Exchange website.
Let's take a moment to talk about the relationship between price and interest rates.
The prices of treasury securities typically have an inverse
relationship with interest rates, since the rate of return
is fixed at the time of issuance.
This is the case for most fixed-income securities.
This means that if the price goes up, the interest rates go down and vice versa.
It is important to be aware of this inverse relationship
because it can help determine ideal times to buy treasury securities.
Let's say a 10-year treasury bond pays a coupon rate
of 6% and interest rates go down to 5%. It makes sense
to buy more bonds.
There are many reasons why interest rates may rise over a
given period, and some of those reasons include things like
rising demand for loans and other forms of external funding.
or allocation of bond's assets into stocks in a bid to maximize
potential returns, or fiscal policy changes, or monetary policy changes.
Conversely, interest rates may drop for a number of reasons that
include lower demand for loans, financial uncertainty that
causes stock investors to turn to treasury securities as
their safe haven, or introduction of interest rate cuts as
deemed necessary by the Federal Reserve board. Barring any
events that can cause sudden economic changes,
for example the Covid-19 pandemic, broad changes in interest rates
in the US have often occurred over several months or even a few years.
This makes the treasury market relatively stable over the long term.
Now let's jump into everybody's favorite part
and talk about some strategy. Some trading strategy for treasury securities.
The first strategy that is generally accepted is the buy and hold strategy.
As the name suggests, you simply by the treasuries
and hold them until maturity. It's pretty simple.
This strategy is ideal for beginners and investors who favor
the passive approach. Keep in mind that this takes discipline
because we have to hold, and not do anything else, and sometimes
not doing something is harder than doing something.
Don't underestimate the buy-and-hold strategy, and it is
considered to be a relatively safe strategy after all.
Then, we have laddering.
If you're looking to be more active with your trades, then
you can buy or sell treasuries directly on the secondary market.
Of course, this means the purchase prices and subsequent
returns will no longer be based on the face value of the
security, since you won't be holding it to its maturity.
In this instance, laddering can be a great starting point if
you're interested in not holding to maturity. The strategy
simply means you're acquiring multiple bonds, each with its
own maturity period, whether long or short. When one bond matures,
you collect the returns and use it to buy another security
with a longer-term maturity. This way you have a steady income
stream while also being able to withstand possible changes
in value to the other treasuries in your portfolio.
Then we have swapping.
This is similar to the laddering strategy, except it involves
taking advantage of tax write-offs. Under swapping, you're
selling treasuries that are not likely to recover and get
a tax write-off for the loss itself.
You'll then use the proceeds to buy securities with a high
probability of profitable yields.
It's basically cutting your losses and investing in stronger
assets in order to maximize returns and to hedge your portfolio.
Obviously, this strategy is more suited to experienced investors
who can afford to take on more risk and can absorb
more potential losses over a short period of time.
The advantages of trading treasury securities are quite wonderful.
The first being, the fact that there is guaranteed returns.
They are among the safest investment options that are available today.
As long as the US government is functional,
you can be sure that you're going to be receiving what you are owed when due.
Then we also have a steady income aspect. T-notes
and T-bonds pay a fixed interest rates semi-annually.
This means that you'll know exactly how much you're getting and when to expect it.
Then we have the various maturity terms.
There are several maturities to choose from with the treasury securities,
so it's easy to find the one that best suits your goals.
Then also, we have tax exemption, and everybody likes this one right?
Interest on treasuries is only taxable at the federal level.
State and local levels are tax-free.
Finally, we have the high liquidity aspect.
Treasuries boast the most liquid markets when it comes to fixed income instruments.
Even if you're not willing to wait until the
maturity period, you can easily sell your treasuries on the secondary market.
As far as the disadvantages, we start off with
the fact of inflation. This risk refers to the inflation rate
potentially being higher than the interest an investor may
earn while holding the treasuries. In this case,
your real return is negative and your investment actually
loses value over time if the inflation outpaces it.
Then also, we have the idea behind the changes in interest rates
that can negatively affect the treasury security.
Fixed-income securities can lose value if the interest rates increase,
which kind of ties into number one.
Then, we have number three which is the economic growth aspect.
During good economic growth, businesses thrive
and compete for capital from investors.
As a result, the value of treasury securities decrease as
there's more demand for higher risk investments that have better returns.
To sum it all up, treasury securities have
been around for a substantial amount of time with a quite
wonderful track record for the investors that have choosed
to use them, and use them properly.
It's up to you to use due diligence, of course as with all
forms of investing, to decide if treasury securities will
fit your trading style or your trading goals.
Other than that, they're relatively straightforward and
have some very cool aspects about them.
But until next time folks, thank you for joining me, as always.
I wish you the best of luck in all of your trading
and if you're still here, please click that like and subscribe button below,
if you haven't yet. I will see all of you very soon.