Hello, YieldAlley readers! In this issue:

🤖 Musk’s xAI sues OpenAI, alleging theft of trade secrets (Sherwood)

🙏 Five Pearls of Wisdom From a Legend of Financial Writing (NYT)

🚫 High Earners Age 50 and Older Are About to Lose a 401k Tax Break (WSJ)

💸 The Hidden Costs of Passive Investing Index funds (Larry Swedroe)

🛍️ The Tech Fashion Darling Accused of Swindling Investors Out of $300 Million (Bloomberg)

When investing in Treasury notes and bonds, one of the most common sources of confusion for new investors is the difference between two key metrics: the high yield and the interest rate. While both numbers appear prominently in auction results, they tell very different stories about your potential returns.

To understand these concepts, let's begin with a familiar scenario that illustrates the basic mechanics of bond investing. Consider purchasing a two-year Treasury bond with a par value of $100 for exactly $100 in month zero. In this straightforward example, you're buying the bond "at par" or "at face value," meaning your purchase price equals the bond's stated value.

This par-value purchase creates a clean baseline: when the bond reaches maturity in two years, you'll receive back exactly what you initially invested—no more, no less. The bond will repay its full $100 face value, matching your original purchase price perfectly.

However, real-world bond purchases rarely occur at exactly par value. In Treasury auctions, bonds frequently sell above or below their par value, creating additional layers of complexity that affect your overall returns.

The interest rate, also known as the coupon rate or simply the coupon, represents the annual percentage of a bond's par value that gets paid to you as interest. This rate remains fixed throughout the bond's life and provides the foundation of your returns.

Using our two-year bond example, if the bond carries a 4.25% interest rate, you'll receive $4.25 annually in interest payments. This calculation is straightforward: 4.25% multiplied by the $100 par value equals $4.25 per year. Over the two-year life of the bond, you'll collect a total of $8.50 in interest payments.

The key characteristic of the interest rate is its consistency. Regardless of what you actually paid for the bond, whether above, below, or at par value, the dollar amount of your interest payments remains the same. The bond issuer calculates these payments based solely on the par value, not your purchase price.

The high yield provides a more comprehensive view of your investment returns by incorporating two critical components that the interest rate overlooks.

Unlike the interest rate, the high yield accounts for your complete investment return, including both your annual interest payments and any additional gain or loss you'll experience at maturity. This additional gain or loss stems from the difference between what the bond repays at maturity (always the par value) and what you actually paid to purchase the bond.

Let's examine a real auction example. Suppose you purchased a two-year Treasury note at auction for $99.78 per $100 of par value. When this bond matures, you'll receive the full $100 par value, creating an additional gain of $0.22 beyond your regular interest payments.

Your total return picture looks like this: $4.25 in annual interest payments for two years, plus the $0.22 gain at maturity from buying below par value. The high yield calculation captures this complete return scenario, while the interest rate only reflects the annual interest component.

The second crucial difference lies in how each metric calculates percentage returns. The interest rate always uses the $100 par value as its denominator, regardless of your actual purchase price. The high yield, however, uses your actual purchase price as the basis for its calculations.

This distinction creates significant practical differences. Consider the same $4.25 annual interest payment under different purchase scenarios:

If you bought the bond for $95, your yield would be 4.47% ($4.25 ÷ $95). The same $4.25 interest payment represents a higher percentage return on your smaller investment.

If you bought the bond for $105, your yield would be 4.05% ($4.25 ÷ $105). Here, the identical interest payment represents a lower percentage return on your larger investment.

This mathematical relationship reveals why purchase price matters so significantly in bond investing.

Understanding how the purchase price affects the relationship between high yield and interest rate is crucial for bond investors. Three scenarios demonstrate this relationship:

When you buy a bond below its par value, the high yield will exceed the interest rate. This occurs because you're earning the same dollar amount of interest on a smaller investment, and you'll receive an additional gain when the bond matures and repays its full par value.

In our earlier example, the two-year note purchased for $99.78 demonstrates this scenario. The purchase price fell below the $100 par value, resulting in the high yield exceeding the interest rate.

When your purchase price equals the bond's par value, the high yield and interest rate will be identical. Since there's no difference between what you paid and what you'll receive at maturity, no additional gain or loss affects your return calculation.

When you buy a bond above its par value, the high yield will be less than the interest rate. Although you'll still receive the same dollar amount in interest payments, you'll experience a loss at maturity since the bond only repays its par value, which is less than what you paid.

For instance, if you purchased a bond for $105 but only receive $100 at maturity, you'll have a $5 loss that reduces your overall investment return, pulling the high yield below the stated interest rate.

The third major distinction between high yield and interest rate calculations involves the time value of money, a fundamental financial concept that the high yield incorporates but the interest rate ignores.

The time value of money refers to the principle that a dollar received today holds more value than a dollar received in the future. This concept recognizes that money available now can be invested to earn returns, making present dollars more valuable than future dollars.

In bond investing, this principle means that interest payments received earlier in a bond's life are worth slightly more than payments received later. A $4.25 interest payment received in year one has more value than an identical $4.25 payment received in year two.

The high yield calculation employs sophisticated methods like discounted cash flow (DCF) analysis to account for this timing difference. These techniques calculate how much future dollars are worth in today's terms, providing a more accurate assessment of your bond's true value.

While the interest rate calculation simply adds up your cash flows without considering when you receive them, the high yield calculation weights earlier payments more heavily than later ones, reflecting their greater present value.

Understanding these differences has important practical implications for your investment strategy and decision-making process.

Always use the high yield when making investment decisions or comparing Treasury securities with other investment opportunities. The high yield provides the complete picture of your expected returns, making it the appropriate metric for meaningful comparisons.

The interest rate, while useful for understanding your basic income stream, doesn't capture the full value proposition of your investment. Relying solely on interest rates can lead to suboptimal investment choices, particularly when comparing bonds with different purchase prices or maturities.

When participating in Treasury auctions, remember that you won't know your exact purchase price or final yield until after the auction concludes. The competitive bidding process determines the final price, which may differ from your expectations.

This uncertainty creates a practical challenge: you might end up paying more than the par value, requiring a larger investment than initially planned. To manage this risk, maintain a financial cushion in your bank or brokerage account when bidding on Treasury securities.

For portfolio management purposes, the high yield provides the most accurate basis for calculating your expected returns and assessing how Treasury securities fit within your broader investment strategy. Use high yield figures when modeling portfolio performance or comparing the risk-adjusted returns of different asset classes.

To access the high yield and interest rate information for Treasury auctions, navigate to the Treasury's Announcements, Data and Results page. Scroll down to find the "T Notes" tab, which displays auction results including both the high yield and interest rate columns.

This official source provides the most current and accurate information about recent auctions, helping you understand market conditions and make informed investment decisions.

Understanding the distinction between high yield and interest rate represents just one component of successful Treasury investing. These concepts form the foundation for more advanced topics, including floating rate notes—Treasury securities that feature variable rather than fixed interest rates over their lifetimes.

Mastering these fundamental concepts prepares you for more sophisticated Treasury investment strategies. As you develop confidence with fixed-rate securities, you can explore other Treasury products that offer different risk and return profiles.

The relationship between purchase price and yields also highlights important risk management considerations. When you buy above par value, you're accepting a guaranteed loss at maturity in exchange for higher current income. When you buy below par value, you're positioning for additional gains while still receiving regular interest payments.

The differences between high yield and interest rate reflect three fundamental distinctions:

First, the high yield accounts for your complete return—both annual interest payments and any gain or loss at maturity based on the difference between the par value repayment and your purchase price. The interest rate only considers your annual interest payments.

Second, the high yield uses your actual purchase price as the calculation basis, while the interest rate always uses the $100 par value, regardless of what you actually paid.

Third, the high yield incorporates the time value of money through advanced calculation methods, while the interest rate treats all cash flows equally regardless of timing.

From a practical investment standpoint, always focus on the high yield for investment decisions and comparisons with other opportunities. When participating in auctions, maintain adequate account reserves since your final purchase price may exceed par value.

With this comprehensive understanding of high yield versus interest rate, you're better equipped to make informed Treasury investment decisions and accurately assess the true value of these important fixed-income securities. This knowledge forms the essential foundation for exploring more advanced Treasury products and developing a sophisticated bond investment strategy.

Government Money Market Funds (7-Day Yields)

Brokered CD Rates (6-Month Rate)

ETFs (30-Day Yields)

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