Treasury Note - Explained
What is a Treasury Note?
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Table of ContentsWhat is a Treasury Note?How Does a Treasury Note Work?Interest Rate and Risk Duration Changes in Yield Curves of a Treasury Note
What is a Treasury Note?
A treasury note is a US government debt instrument with fixed interest rate and can be resold in the market to increase its value. Treasury notes have a maturity of at least a year and can last up to 10 years. Treasury Notes can be obtained by either a competitive or non-competitive bid, where investors specify the amount they want in the former, or accept whatever is offered in the latter. In a competitive bid, investors requests can be denied based on several factors, while it is a rare occurrence in a noncompetitive bid.
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How Does a Treasury Note Work?
Treasury notes, just like T-bonds, also have a secondary market which increases price and interest liquidity (the rate of purchase or presence of cash). A Treasury note is fairly similar to a T-bond in the sense that interests are released every six months (coupons in T-bonds), and they are only taxed at the federal level. However, Treasury notes have a maturity of 1-2 years up till 10 years.
Interest Rate and Risk
Treasury bonds gain exposure to interest rate risks depending on the length of their maturity. The value of a treasury note is evaluated by its sensitivity to interest rate changes as well as its credit strength. It is important to note that rate changes mostly occur beyond the control of the central bank, or within the yield curve.
In 2015, the U.S. Federal Reserves increased fund rate range by 0.25 points from 0.25% up to 0.50%. This event is a perfect example of a shift in the interest rate of a Treasury Note. In turn, this increase had a negative effect on the prices of Treasury Notes and Bonds during that period. However, as we stated before, the value of a note is dependent on its sensitivity to change, and most of these note had interest changes of different values. Sensitivity to rate changes is measured by the length of a note and measured in years (6 months will be 0.5years, 3 years and 4 months will be 3.3years). The length of a note is determined by its coupon, yield, value, maturity, and call features (an agreement that allows an issuer to buy back bonds at a set price on a later date).
Changes in Yield Curves of a Treasury Note
Investors expectations as well as interest rates are two factors which brings about shifts in the yield curve (popularly termed the yield curve risks). The yield curve risk is associated with a steep or flat pattern of the yield curve, which occurs due to varying returns as a result of the maturity length of similar bonds. For a steep curve, the spread between short-term and long-term interest rates increase. This results in long-term notes having lower prices compared to short-term notes. The reverse is the case for a flat curve.