05-20-2009, 02:25 AM
Pete's explanations are right on, but I can't resist piling on...
ex. You buy a T-bill that matures in 6 months for $99.50
-> Six months later the T-bill is worth $100
[quote name]
= "If you plan to sell your T-bill, you need to wait at least a year after having purchased it, or there won't be a noticeable profit" ? [/quote]
T-bills are traded every day, you can sell or trade them at every day up to maturity. However, if you buy a T-bill and then choose to sell it before it matures you are subject to interest rate risk and might sell at a loss.
ex. You buy a T-bill that matures in 6 months for 99.50. The interest rate enviroment goes up (investors are demanding more return for their money) and now a 6 month T-bill trades at $99.25.
If you hold to maturity -> six months later the T-bill is worth $100
If you trade -> you sell the T-bill on the market for $99.25 and loss $0.25
Notice how this risk is only apparent if you plan on trading your T-bills (you probably won't). Also, the market rates could've gone down and then you could've traded for a profit.
[quote = 2) What is a coupon payment?
Would you mind explaining this? [/quote]
T-bills are known as zero-coupon bonds. Bonds with coupons work as follows.
Ex. A $100 face value bond that pays a 5%coupon annually
-> Once a year this bond will make a $5 (100*.05) payment to the investor until maturity.
And now to explain the inverse relationship between price and yield:
Assume in the above example that the current rate demanded by the market on this type of bond is 5%. The bond will sell at face value, ie the $100 face value bond will trade at $100.
-> Assume the market rate changes to 4.5%. The 5% coupon is now above the rate of return required by the market. The price of the bond will increase from 100 until the yield is 4.5%, or the bond will trade at ~$111.
-> Assume the market rate chages to 5.5%. The coupon is now below the rate of return required by the market. The price of the bond will go down until it yields 5.5%, and the bond will trade at ~$91.
Note that if rates that up or down, the bond will stay pay face value at maturity and the same coupon payment throughout.
It's been a long day- apologies in advance for any mental errors :whistling:
Cheers,
Naverone
Quote: They are sold for less than their actual value?T-bills are sold at a discount to face value. Face value is what the T-bill will be worth at maturity.
ex. You buy a T-bill that matures in 6 months for $99.50
-> Six months later the T-bill is worth $100
[quote name]
= "If you plan to sell your T-bill, you need to wait at least a year after having purchased it, or there won't be a noticeable profit" ? [/quote]
T-bills are traded every day, you can sell or trade them at every day up to maturity. However, if you buy a T-bill and then choose to sell it before it matures you are subject to interest rate risk and might sell at a loss.
ex. You buy a T-bill that matures in 6 months for 99.50. The interest rate enviroment goes up (investors are demanding more return for their money) and now a 6 month T-bill trades at $99.25.
If you hold to maturity -> six months later the T-bill is worth $100
If you trade -> you sell the T-bill on the market for $99.25 and loss $0.25
Notice how this risk is only apparent if you plan on trading your T-bills (you probably won't). Also, the market rates could've gone down and then you could've traded for a profit.
Quote: = 1) Other forms of lending money to the government for profit takes even longer to yield any profit?Other forms of debt take longer to mature but typically offer a higher yield.
[quote = 2) What is a coupon payment?
Would you mind explaining this? [/quote]
T-bills are known as zero-coupon bonds. Bonds with coupons work as follows.
Ex. A $100 face value bond that pays a 5%coupon annually
-> Once a year this bond will make a $5 (100*.05) payment to the investor until maturity.
And now to explain the inverse relationship between price and yield:
Assume in the above example that the current rate demanded by the market on this type of bond is 5%. The bond will sell at face value, ie the $100 face value bond will trade at $100.
-> Assume the market rate changes to 4.5%. The 5% coupon is now above the rate of return required by the market. The price of the bond will increase from 100 until the yield is 4.5%, or the bond will trade at ~$111.
-> Assume the market rate chages to 5.5%. The coupon is now below the rate of return required by the market. The price of the bond will go down until it yields 5.5%, and the bond will trade at ~$91.
Note that if rates that up or down, the bond will stay pay face value at maturity and the same coupon payment throughout.
It's been a long day- apologies in advance for any mental errors :whistling:
Cheers,
Naverone