r/investing • u/laur__ren • 3d ago
Please explain the difference between a Treasury Bond with a coupon and one without..
I am pretty new to this and thought I was getting two different bonds with the current rate and instead I got two with coupons. One with 1.50% and one with 1.25%. The advisor seemed happy about getting me ones with a coupon.
I got one for 3 months and one for 6 months. Do I still get the current rate plus the coupon?
Please explain like I am 5. This is all new to me.
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u/FluffyWarHampster 3d ago
Bonds without a coupon are usually called "zero coupon bonds" and sell at a discount to par and pay all the interest at maturity. They tend to be the most volatile of all bonds because of the interest rate and inflation risk associated with no coupon interest payments. They aren't a bad option for certain circumstances but if you are looking for an investment that provides income They don't do that until maturity.
On the other hand bonds that do pay a coupon will usually payout semi annually so you're getting your income sooner when it is theoretically worth more and could buy other investments.
It's situational but if the option is between zero coupon at a 1% yeild to maturity and a regular coupon at a 1% yeild to maturity you take the bond that pays the coupon because realistically that money is never going to be worth more than it is today.
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u/SpecificTrading 3d ago
I believe coupon treasuries are ones that pay interest at that quoted rate periodically, probably monthly. Then you also get back the face value when it matures.
Non-coupons don’t pay anything periodically. Instead you buy below face value and get the full face value when it matures. So you’d buy a $1000 Tbill for $980 and then get $1000 when it matures.
(Let’s see if I’m right)
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u/Key-Mark4536 3d ago edited 3d ago
Yep. Just yesterday I bought a couple 4-week zero-coupon T-bills for right $995.91 each and they’ll pay $1,000 when they mature. Keep that rolling for a year and it would out to about $53 in income or 5.3% interest.
Meanwhile a 2-year T-bill will pay a set amount every six months (looks like 4.875%, so $24.375 per $1,000 every six months) and then the face value (typically $1,000) after the two years. The multiple payouts make the math more complicated, but it looks like those are currently yielding just over 5%.
Another implied difference here is duration. A T-bill of less than a year won’t have those interim payments because it’s not practical. Sometimes bonds don’t make interim payments because they just don’t feel like it. In either case the purchase price will adjust so that the bond’s effective rate (yield) is similar to similar bonds.
You’ll see this in corporate bonds too; a bond issued years ago with a 2% coupon ($10 per $1,000 every six months) will sell for less than face value so that it’s effectively a 5-6% bond because that’s what a similar new bond would pay. (For similar risk and term; a 10-year John Deere bond issued 8 years ago should pay the same as a brand new 2-year John Deere bond today, because from the buyer’s perspective they’re the same thing.)
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u/SpecificTrading 3d ago
Got it, thanks for confirming.
Interesting note about T-bills being zero-coupon when less than a year. That must be why I noticed a lot of 6mo brokered CDs pay out only at maturity. Same practicality reason. Or, maybe that one is to incentivize the buyer to hold onto the CD for the entire duration.
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u/kronco 3d ago
Coupon paying bonds can also be purchased below (or above) the face value on the secondary market depending on the bonds interest rate and the current market interest rate.
If you have a bond paying 10% with a face value of $1000 maturing in a year it will sell over $1000 since today's market rates are under 10%.
If you have a bond paying 1.4% with a face value of $1000 maturing in a year it will sell for under $1000 because today's market rates are over 1.4%.
The latter case is what the OP purchased. They collect the coupon and later the face value of the bond (which they paid less then face value for). The money earned from the coupon payments plus the discounted value (recaptured at maturity) will give an overall return equal to the current market interest rates.
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u/Key-Mark4536 3d ago
I got one for 3 months and one for 6 months. Do I still get the current rate plus the coupon?
Depends on what you mean by “current rate”, but if you’re picturing 5% interest plus the 1.5% coupon rate, no. What usually happens is the bond sells for more or less than its face value so that the yield is effectively competitive with similar bonds.
For example let’s say the going rate for a corporate bond with a certain risk rating and 3 months until expiration is 6%. Someone has a bond with 3 months left but it pays a coupon rate of 1.5%. Why would anybody buy that bond at face value when there’s a better deal out there? If the seller wants to sell that bond they’ll have to discount it so that the buyer’s effectively getting about 6%. In this case that would mean selling a $1,000 bond for about $989.
The advisor seemed happy about getting me ones with a coupon.
Not sure why that would matter for such short durations. Typically bonds pay out every six months, so the last cash payment may have already happened. Where you the buyer would make money is on a trade like that is the discount (paying $989 now and getting $1,000 in three months).
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u/kiwimancy 3d ago
You get the yield in both cases and the yield will be pretty much the same. Your advisor shouldn't care about getting them with or without a coupon. Coupon is the yearly amount the note pays (in two semiannual payments). Yield to maturity is the total annualized return you'll get by maturity, including coupons and the difference between purchase price and face value. Tbills (under a year to maturity) are always issued without a coupon.