Question

You have a 9-month investment horizon, and are looking at US Treasury securities as an investment. The yield curve of interest rates vs. various UST maturities is currently upward sloping. Describe the transactions, benefits, and possible detractions, of investing in a 5-year, 4.5% UST note vs. a 0.25% 9-month T-Bill.

Answer 1

As the interest rate yield is seeing an increasing slope we will notice a decline in the price of UST over time depending on the curren prevalent interest rate.

In this case the 4.5% UST would still be better because youll get a coupon of $2.25 at the end of 6 months and your selling price in the 9th month will include a dirty price element which is be for around $1.12 but in terms of fair value it will be cheaper than the price at which you purchased due to the upward slope of the interest yield curve. Still you walk away with at least 2.5% return on every $100 invested as interest rate changes arent that drastic so ive a decline of around 0.77% which could still be on the higher side.

The T-bill doesnt have a coupon element and it matures at the end of 9 months meaning there will be no impact in terms of interest rate yield curves over the span of the 9 months but the return is quite low at 0.25%. This is a more stable and safer choice in general.

In case of an extreme scenario where the interest yield curve shoots up drastically you could end up losing on the UST note as the price of the note would end up going down resulting in washing away of all the return due to the coupon so that needs to be kept in mind as well.