5-Year Note Auction
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Definition
Treasury notes are sold at regularly scheduled public auctions. The competitive bids at these auctions determine the interest rate paid on each Treasury note issue. Twenty primary dealers (as of November 30, 2007) are authorized and obligated to submit competitive tenders at Treasury auctions. Dealers can hold, resell, or trade the securities with other firms. The Treasury announces the amount, date and time of the 5-year note auction monthly. The 5-year notes are announced around the third week of the month (usually on Thursday) and then auctioned the following week (usually Thursday). The 5-year notes are issued (settled) on the last day of the month, unless it falls on a weekend or holiday, and then they are issued on the next business day.
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Why Do Investors Care?
Individual investors can participate in Treasury auctions through a securities dealer or via the Treasury Direct program. The Treasury Direct program saves on brokerage commissions, but the commission is nominal and eliminates a lot of paper work and administrative hassle. Brokers facilitate the purchases and sales of Treasuries in the secondary market, which is handy for buying Treasuries at times other than scheduled auctions or with maturities other than those offered by standard new issues.
Interest rates on Treasury securities are determined in the market; the Federal Reserve does not set them. However, bond investors are sensitive to Federal Reserve policy and thus market rates will mirror policy expectations. Usually, bond market players are forward-looking and this means that interest rates on Treasury securities will move in the direction of Fed policy with a lead. As a result, one is more likely to see rising interest rates on Treasury yields during an expansion (and falling yields during economic slowdowns) in advance of policy changes by the Federal Reserve.
Primer on Treasuries
Treasury securities, Treasuries, and Govies all refer to the same type of security, and are debt obligations of the United States. Maturity refers to the length of your loan to the government. Treasury notes have maturities of 2 to 10 years (2-, 3-, 5- and 10-year notes are the most common). Since 1998, the Treasury ruled that all securities it issues now have minimum denominations of $1,000 and must be purchased in increments of $1,000.
How notes work
You pay $1,000 for a note. You receive interest payments every six months based on the coupon rate. If the rate is 6%, you get $30 every six months for a total of $60/year. When the note matures in five years, you get back the original investment of $1,000, called the principal.
Investment Profile
Treasuries offer a measure of security unmatched by other investments - the U.S. government guarantees the initial investment (the principal) and the interest payments. When Treasuries are resold in the secondary market, their price could be substantially more or less than face value. Price fluctuations in the secondary market are based on the economic environment, inflation expectations, Federal Reserve policy, and simple forces of supply and demand. If a Treasury is held to maturity, inflation and opportunity risks remain. Inflation erodes the value of both the principal and interest payments. Opportunity risk refers to what could have been earned had the money been invested elsewhere.
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