Why Every Investor Cares about Treasury Notes

Treasury notes are bonds that are sold by the US government. The bonds mature between one and ten years, have a fixed interest rate and are marketable throughout their lifetime. There are a number of types of treasury notes, known as T-notes, which an investor can choose from. Even if you are not interested in buying t-notes directly, understanding the current t-note market can help you make better decisions about investments.

Differences Between Stocks and Bonds

To understand the significance of t-note rates, it is first important to understand key differences between stocks and bonds. When you purchase a stock, you are investing in a company. Your return will be based on how well the company performs in the future; stocks are a form of equity. When you purchase a bond, you are lending a company or organization money for a limited period of time. The organization promises a set return; bonds are a form of debt. Generally speaking, stocks are riskier than bonds. However, determining which is the best investment relies on how risky they are compared to how much more profit they can generate. This measure is called the “risk premium.”

Calculating the Risk Premium

The risk premium is a measurement of the extra return expected on a risky purchase, versus a risk free purchase. To know risk premium, you must first know the expected rate of return on a risk free purchase. This is called the risk-free rate of return, and it can be measured by the current t-note interest rates. Since there is absolutely no risk in t-notes because they are backed by the US government, the rate of return on a current t-note purchase can be substituted for the risk-free rate of return. An investor measures the risk premium on a stock by determining how much more profit they can expect from purchasing that stock, when compared to a t-note.

Using T-Note Rates as Market Predictors

T-note rates are set by financial professionals within the government. These individuals are highly qualified and have key information about market movement. As a result, the changes they make to t-note interest rates can be used to determine overall market sentiment. When the rates go down, the government is essentially telling you it expects inflation to decrease and bonds to become less profitable in the immediate future. When rates go up, the government is telling you it anticipates a period of high inflation, or potentially high return in the market.

The exact meaning of t-note rate changes cannot be simplified to one factor alone. However, tracking the performance of t-notes overtime can show you market movement. Further, tracking this performance against a market indicator, such as a single stock or a group of stocks, can give you a big picture look at the risk premium for that indicator.

blog comments powered by Disqus