What Can Affect Treasury Bond Returns?

by Tim Plaehn

Treasury securities are considered to by one of the safest income-earning investments. The Treasury sells a wide range of securities ranging from 30-day Treasury bills out to 30-year bonds. As safe, U.S. government-backed investments, Treasury bonds usually pay lower rates of interest than other investment choices, and several factors can affect the rate they pay.

Current Market Rates

The Treasury bond market is a very large and liquid trading market. The U.S. Treasury sells several trillion dollars worth of securities each year and the secondary market trades even more. The interest rates are set in the market by supply and demand, with the growth of the economy and inflation as underlying factors. The current interest rates for Treasury bonds go up and down, based on these factors. However, when an investor buys a Treasury bond paying the current interest rate, the investor locks in that rate for as long as she owns the bond.

Term Selected

The different maturities of Treasury securities will pay different rates of interest. The rate paid based on time to maturity is called the yield curve. When the yield curve is in its normal configuration, rates on short-term Treasuries will be the lowest and interest rates will increase the longer term the bond is.

Hold or Trade

When an investor buys a Treasury bond, the bond will earn a rate of return called the yield to maturity. The yield to maturity uses the market price of the bond plus the rate of interest the bond pays to determine a total return yield to the investor. If an investor holds the Treasury bond until it matures, he will earn the yield to maturity. If an investor sells a Treasury bond before maturity, the price he receives could be higher or lower than the price paid for the bond, resulting in a capital gain or loss for the investor. This gain or loss affects the total return to the investor earned from the bond.

Changing Rates and Prices

The market price of a Treasury bond is affected by changing interest rates. If interest rates increase, the market value of a bond will decline. If interest rates fall, the market price increases. This opposite reaction occurs because Treasury bonds pay a fixed rate of interest, so to adjust for changing market rates, the price of a bond must change to bring the interest rate in relation to the price in line with market interest rates.

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