Treasury Bonds are used to finance national debt. Treasury bonds are long term investments with a maturity of 10-30 years. They have the longest time to maturity compared to treasury notes which mature in 1-10 years and the highly liquid Treasury bill which matures in less than one year.
The prices of treasury notes, bills and bonds are all quoted as a percentage of a 100 dollar face value. So if the bond is quoted at 10 percent for example, the face value would be 10 dollars.
Federal government notes and bonds are free of default risk. This is only because if the bond is close to defaulting the government always has the ability to print as much money as needed to pay off the debt. However this does not mean treasury bonds are risk free. There will always be interest rate risk associated with these bonds.
What is interest rate risk? Basically when Interest rates rise, bond prices fall and vice-versa. When interest rates increase, the opportunity cost of holding a bond decreases since investors are able to gain better returns by switching to other investments. For example, a 5% bond is worth more if the interest rates decrease because the person who holds the bond receives a fixed return rate relative to the market. Which would mean he is currently making better return rates, than what the market is currently offering. Next slide
Treasury bonds do however have very low interest rate risk. Investors often earn a higher rate of return on longer maturing bonds than they do on shorter term bonds. Partly because the long term bonds are less liquid, and partly because shorter term bonds are more volatile than long term bonds. Short term bonds are influenced by the current rate of inflation, whereas investors expect the inflation on longer term bonds to average out over a longer period of time; resulting in a more consistent return.
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In 1997 the treasury department started offering a bond designed to remove inflation risk. Basically these bonds have