Question

Unit 7 Discussion

Treasury Bills versus Treasury Notes and Changes in Interest Rates

The daily market transactions for treasury instruments are in the billions. The current average daily volume of “Treasuries” is approximately $150 billion. Like you, corporations may have extra cash to invest. In this case, you, as a finance manager, are considering investing $50,000 in either a Treasury bill that you will renew every 6 months or investing in a 5-year Treasury note that you will hold until maturity. Current interest rates are expected to increase.

Would you invest in the Treasury bill or Treasury note? Discuss your reasoning.

Answer 1

If interest rates rise, in case of buying 5 year Treasury note I am locked with the earlier rate which was lower. However, in case of 6 month TBill we are renewing every 6 months and hence we will be getting higher rate.

Alternatively, we know that interest rate risk is directly proportional to duration. Higher the duration higher is the interest rate risk that is the price of the bond with highest duration would fall highest if rates increase. As 5 year note is having higher duration than 6 month bill, 5 year bond's price would fall more than 6 month bill. Hence, one should invest in 6 month bill