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OK, I have a (probably stupid) question. If the 3-month T-bond rate is say 2.32%, does that mean that I can buy such a 3-month security 4 times in a row in a gi
by haidut 8y ago
OK, I have a (probably stupid) question. If the 3-month T-bond rate is say 2.32%, does that mean that I can buy such a 3-month security 4 times in a row in a given year to get a total of 4 * 2.32 = 9.28% ROI on the money I am using to invest? Actually, the return would technically be higher than since the second, third and fourth times I am buying the T-bond I will use not only the original cash I had on hand but also the 2.32% return I received each time I bought the T-bond. So, assuming everything is re-invested in the 3-month T-bond the total ROI for a given year would be about 9.6% (assuming the rates stay the same of course).
A ROI of 9.6% is quite good and beats stock market return over most years, while also being virtually risk-free.
Am I missing something here? Why invest in a (risky) stock market unless you can reasonably expect a return in the double digits that can compensate for the extra risk, compared to a 9.6% risk-free ROI from T-bonds?
Please pardon my ignorance and thanks in advance.
- ttul 8y agoNah, those are annualized figures. Buying a three months four times will give you ~2.32.
- haidut 8y agoOK, thanks. Then what would buying a 3-month one once a year give me? Still 2.32%, or 2.32% / 4? Also, since right now the 3-year bond offers more than a 5-year one, why would anyone prefer to buy the 5-year bond? Doesn't the 3-year one offer the same (or better) return over a shorter period of time?
- cm2187 8y ago2.32% / 4. Technically the "/4" may not be exactly "/4" depending on the bond. It is called day count fraction and for some bonds the rules can be quite complex. But the basic idea is to prorate ("accrue") the interest rate to the time you held the bond.
- zaroth 8y ago2.32% / 4. And hopefully that answers your second question as well. The rate is annualized, meaning the profit if you held the bond for 1 year. So a 3 year bond at 2.32% pays a 2.32% annual interest rate. Interest payments are made twice a year. A 5 year bond at 2.32% pays the same rate of return — 2.32% interest per year, but in that case guaranteed to continue paying at the same rate for 5 years instead of 3. The rate is the annual rate. The term is for how long interest payments are made and how long until the bond “matures” — when the face value is paid back. If people think rates are going to go down in the future, then they will accept a slightly lower rate if it is locked in for a longer term, which is the idea behind the “inversion”.
- yzmtf2008 8y ago>Doesn't the 3-year one offer the same (or better) return over a shorter period of time? Later part of the OP's post was mostly focused on this question :)
- driverdan 8y agoAll rates are APY, not the time interval of the bond.
- deleted 8y ago[deleted]
- stuuuuuuuuu 8y agoIn addition to the comments about APY, this analysis also assumes that you'll get the same 2.32% rate when you buy another bond three months from now, six months from now, etc.--correct me if I'm wrong, but that rate isn't guaranteed to hold up through the year.
- haidut 8y agoYes, that's why I said in my post "assuming rates stay the same". But thanks for chiming in anyways.