Question

What types of Treasury securities are available? How does the use of Treasury securities vary between large banks and small banks?

Answer 1

Treasury securities are debt issued by the United States government. Essentially, investing in treasury securities means you're loaning the government money. They are considered very safe investments because your principal is protected. The interest gained is not taxed on local or state levels, but they are taxed federally.

Treasury notes are another type of treasury security. They are mid-term investments that mature between two and ten years. Like treasury bills, they can be bought in denominations of $100, but unlike treasury bills, they pay interest every six months.

If Lorena decides to buy $1000 in treasury notes instead of treasury bills, she'll pay $1000 for them. But let's say that the notes she buys mature in five years and pay 4% interest. That means that every six months Lorena will get $20. In five years, she'll get her $1000 back.

Treasury bonds work very similarly to treasury notes. They pay interest every six months and are sold in denominations of $100. So if Lorena buys $1000 of treasury bonds that pay 4% interest, she'll pay $1000 for them and get $20 every six months. But treasury bonds are long-term investments that mature in thirty years. That means that she'll get the $40 in yearly interest for thirty years and then get her $1000 back.

The banking sector's profitability increases with interest rate hikes. Institutions in the banking sector, such as retail banks, commercial banks, investment banks, insurance companies, and brokerages have massive cash holdings due to customer balances and business activities.

Increases in the interest rate directly increase the yield on this cash, and the proceeds go directly to earnings. An analogous situation is when the price of oil rises for oil drillers. The benefit of higher interest rates is most notable for brokerages, commercial banks, and regional banks.

If the central bank brings up rates by 1%, and the federal funds rate rises from 2% to 3%, the bank will be yielding $30 million on customer accounts. Of course, the payout to customers will still be $10 million. This is a powerful effect. Whenever economic data or comments from central bank officials hint at rate hikes, these types of stocks begin to rally first.