An I reading this correctly, that these three otherwise nearly identical 2 YR Treasuries are rather divergent in price, and the third one is the obvious one to buy? In two years they all redeem at $100, correct?
There are divergent in price because of the coupon. The most expensive has the highest interest rate.
And yes, at maturity, you get the original $100 purchase price back.
intercst
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What matters is the “yield to worst” number. That number might be represented by the “yield” number in your chart. That number roughly corresponds to “what total return will you get if you bought at the current price and held until maturity or the first available call date?”
Standard bonds are priced based primarily on their likelihood of default and their remaining time until maturity. (Some other factors can also matter, but that’s a topic for another post.)
When interest rates go up, the prices on existing bonds tend to go down so that their yield to worst numbers come close to matching the same number for a newly issued bond with a similar risk profile and time until maturity (or allowable early call).
Mispricings can occur in the bond market, but they’re more likely to take place in the higher risk areas, rather than in treasuries.
Regards,
-Chuck
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That’s a remarkable difference in price.
Treasuries are not callable. If held to maturity they will all pay par.
Notice that they all have virtually identical yields. The price of the bonds with the lower coupons have lower prices to get the same yield.
This is why bond holders hate rising interest rates. The bonds they bought when interest rates were low (like 1.250% during the Fed’s QE) won’t sell in the market unless they drop to price to match the current yield (which is 4.33% in your example).
If you buy the cheapest bond you will get a lower coupon rate but you will have to pay tax on the capital gain at maturity at the same rate as ordinary income - it will count as interest, not as a lower-taxed capital gain.
These are notes so they are probably 5 to 10 year maturity (not shown in your example). The price drop would be even more extreme for bonds (30 year maturity).
Wendy
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I’m not sure your questions were really answered, though intersct and wendy did touch on it.
Here’s my understanding, fwiw.
Total yield = (yield from coupon) + (yield from discount)
The total yield is nearly the same across the three bonds, but they have different coupons.
The higher coupon bonds will provide more of the yield via the coupon (interest) payments, which occur semi-annually.
The lower coupon bond provides less of the yield via the coupon because of the lower semi-annual coupon (interest) payments.
So to have the same yield as the higher coupon bonds, the lower coupon bond sells at a greater discount to par value (value at maturity) and you get the remainder of the total yield from this discount.
As an aside, for Treasuries with the same maturity but different yield components (coupons vs discount), investors may value them differently.
| Factor | Yield from Coupon Payments | Yield from Discount to Principal |
|---|---|---|
| Cash Flow Profile | Regular, semi-annual cash distributions. | Single lump-sum payment at maturity. |
| Tax Efficiency | Taxed annually as ordinary income at the federal level. | Subject to specific rules like OID or the De Minimis Rule. |
| Reinvestment Risk | High. Investors must find places to reinvest the cash. | Zero. Locked-in compounding behavior until maturity. |
| Price Volatility | Lower volatility (shorter duration). | Higher volatility (longer duration). |
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Let’s say there are 2 bonds:
- Coupon 1%, face value $1000, matures in exactly 1/2 year, 1 year term, simple interest, all paid at maturity.
- Coupon 5%, face value $1000, matures in exactly 1/2 year, 1 year term, simple interest, all paid at maturity.
Would you pay the same for each of these bonds? No way! Bond #1 will pay you $1000 principal + $10 interest (1%) in half a year at maturity. And Bond #2 will pay you $1000 principal + $50 interest (5%) in half a year at maturity.
So you would pay different amounts for each of these bonds, hence they trade at different prices. The lower coupon ones are worth less than the higher coupon ones. There are tons of calculators out there to determine the actual yield, the yield to maturity to determine what you might think is a fair price to buy it.
This is correct, but they also pay interest every 6 months, and a final interest payment at maturity.
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