Bond Yield, 10 Year Treasury Bonds

Connections

Connections to Key Topics with Additional Resources

Topic Connections and Additional Resources
Scarcity, Choice, and Opportunity Cost

Since the U.S. government is considered a risk-free borrower, the Treasury bond yield serves as a benchmark risk-free interest rate. Investors in the stock market can consider the risk-free return offered on Treasury bonds as an opportunity cost when investing in stocks. Since the return on stocks (dividends plus capital gain) is subject to unforeseen fluctuations, the return on stock market investments must equal the risk-free interest rate plus a risk premium to compensate investors for accepting the higher-risk investment.

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Supply and Demand

The forces of supply and demand operate in the (resale) bond market to efficiently adjust bond prices so that bond yield equals the prevailing interest rate. For example, if a Treasury bond pays 5 percent interest, but prevailing interest rates rise to 10 percent, then the demand for the Treasury bond will decline, since it generates a substandard return on investment, causing the price of the bond to fall. The equilibrium price for the bond occurs when the bond yield equals the prevailing interest rate.

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Monetary Policy

The Federal Reserve System uses sales or buybacks of Treasury bonds as one of the ways in which it can control the money supply. For example, the Fed can expand the money supply by purchasing bonds, which places new money in the hands of those who sold the bonds to the Fed. Monetary policy determines prevailing interest rates in the money market by increasing or decreasing the supply of money, and thus the pace of economic growth.

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International Finance With the increasing globalization of finance, many foreign investors look to the U.S. as a safe haven for investment. U.S. Treasury Bonds are perceived to be one of the safest investments available anywhere in the world, and are therefore included in many foreign investment portfolios. The attractiveness of U.S. securities assures a steady demand for dollars in world currency markets, and an important source of funds for financing the national debt. IF US interest rates fall relative to those of other industrialized countries, it may become more difficult to attract foreign financial investment. The U.S.'s growing trade deficit with China results in China holding a large quantity of dollars. Were China to sell these dollars in the international currency market, the value of the dollar would fall, which would make Chinese imports more expensive. Since China wants to maintain its exports to the U.S., it buys U.S. Treasury bonds with these dollars, which maintains a stronger dollar but keeps Treasury bond yields lower than they would otherwise be. Low bond yields put downward pressure on other long-term interest rates, which in turn has fueled heated demand in real estate markets.

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