What is the 10-Year US Treasury Note?
The 10-year US Treasury Note is a debt obligation that is issued by the Treasury Department of the United States Government and comes with a maturity of 10 years. It pays interest to the holder every six months at a fixed interest rate that is determined at the initial issuance. The US Government pays the par value of the note to the holder at the expiry of the maturity period. The issuer uses the funds collected to fund its debts and settle ongoing expenses such as employee salaries and equipment.
Treasury notes are issued for a term not exceeding 10 years, and the 10-year US Treasury note offers the longest maturity. Other treasury notes mature in 2, 3, 5 and 7 years. Each of these notes pays interest every six months until the maturity period expires. The 10-year treasury note pays a fixed interest rate that also guides other interest rates in the market. For example, it is used as a benchmark for other interest rates such Treasury bonds and mortgage rates. One exception is the adjustable rate mortgages that are guided by the federal funds rate. When setting the federal funds rate, the Federal Reserve takes into account the current 10-year treasury rate of return.
Investing in 10-Year US Treasury Notes
The 10-year US treasury can be purchased at auctions through competitive and non-competitive bidding. It is one of the most popular and most tracked debt instruments compared to other treasury bills and treasury bonds, and it is seen as one of the safest investments since it is backed up by a guarantee from the US Government. Even though the U.S. debt is more than 100% debt to GDP ratio, the government is less likely to default on its obligations. Hence the note is attractive to investors.
Investors who buy treasury notes can choose to hold them until maturity or sell them on the secondary market. The US Treasury does not impose limitations on how long investors can hold these investments. Unlike treasury notes with short maturities of 2 to 7 years that are issued every month, the 10-year US Treasury notes are issued in February, May, August, and November. The reopening of the 10-year Treasury notes occurs in the remaining months, with maturity dates and interest rates being similar to the treasury bills issued during the other months.
How the 10-Year US Treasury Note Works
When markets are volatile, there is high demand for 10-year US treasuries as investors look for safe investments that will earn them interest. When these debt instruments are sold at auctions by the US Treasury, the high demand pushes investors to bid at or above the par value of the face value. The investors are primarily looking for safe investments that will safeguard their funds, even though their yield is low. The yield is low because the rate of return falls during the recession phase of the business cycle. The effect of this is that the low 10-year Treasury interest rate will cause a reduction of interest rates of other debt instruments.
On the other hand, during an expansion phase of the business cycle, there is low demand for the 10-year Treasuries since other debt instruments are more attractive. In such case, investors look for high return investments as opposed to safe investments. Since treasuries have a low rate of return, the investors will invest their money in alternative investments that will give them a high yield. This lowers the demand for 10-year T-notes. Investors interested in the 10-year T-notes will bid at a price lower than the face value of the note. Therefore, there will be higher returns on their investments and investors will be expecting to get a high yield at maturity or when they sell their investments in the secondary market.
Impact of Changes in Demand for Treasury Notes
The demand for 10-year Treasury Notes directly affects the interest rates of other debt instruments. As the yield on 10-year T-notes rises during periods of low demand, there will be an increase in interest rates on longer-term debts. The longer-term debts that are not backed by the US Treasury must pay a higher rate of interest than the treasuries to compensate investors for the high risk of default that comes with investing in these securities.
Similarly, if the yields on 10-year Treasury Note fall, the interest on the less secure investments will decline but remain above the treasury interest rate. It allows them to stay competitive and compensate the investors for taking additional risks when they could have invested in the government-backed investments.
Importance of the 10-Year US Treasury Note
Financial Modeling and Valuation
When calculating a company’s Weighted Average Cost of Capital (WACC) one of the assumptions that has to be made in the cost of debt is the “risk-free rate”, which is usually equal to the yield on the 10 Year Treasury.
Below is an example of the calculation:
In cell E15 above, the cost of debt is equal to the yield on the 10-year treasury.
Learn more in CFI’s financial modeling and valuation courses.
The 10-year US Treasury Note is used to show investor confidence in the state of the economy. When the investors have high confidence in the performance of the economy, they look for investments with a higher return than the 10-year treasury note. This triggers a drop in the price of this T-note since investors are interested in earning higher returns more than the safety of their investments.
On the contrary, when investors have low confidence in the state of the economy, the demand for safer government-backed 10-year T-notes increases, resulting in a price increase. The prices of the less secure investments will decline because of their high risk of default.
The 10-year US T-note is one of the most tracked treasury yields in the United States. Investors can assess the performance of the economy by looking at the Treasury yield curve. The yield curve is a graphic representation of all yields starting from the one-month T-bill to 30-year T-bond.
The 10-year T-note is located in the middle of the curve, and it indicates the amount of returns that investors need to tie their money to for 10 years. If they predict an expansion in the next 10 years, investors will require a high return on their money. However, if they anticipate that a recession will occur in the next decade, they don’t require a high return to keep their money safe.
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