What is a bond?
A bond is a promise to pay. It’s an agreement between two parties, the lender and the borrower. The lender is the one giving money and the borrower is the one getting money. Essentially a bond is a debt obligation, or an IOU. Bonds are issued in order to raise money. The U.S. government has different types of bonds (and other debt obligations like “notes” and “T-bills”) that can be purchased by nearly anyone and are known to be “very low risk”. Treasury notes, bonds and T-bills are some types of U.S. government debt obligations that have different durations (length of time until the debt matures).
What is the 10-year Treasury and 3-month T-Bill?
Imagine you have some money that you want to keep safe, so you put it in a special vault. Now, there are two kinds of vaults we’ll talk about to explain this: the 10-year vault and the 3-month vault.
The 10-year vault is like a long-term vault. When you put your money in there, you have to wait for 10 years before you can take it out in order to make the amount of money stated by the vault. You can try to take the money out of the vault before 10 years but you may end up making less money (the risk).
The 3-month vault is like a short-term vault. You only have to wait for 3 months before you can take your money out in order to make the amount of money stated by the vault (the risk).
Now, the “spread” is like the difference between these two vaults. It tells us how much more money you can get if you save in the 10-year vault compared to the 3-month vault. It’s like knowing if you will get a lot of extra money or just a little extra money when you wait longer before accessing your money.
When the “spread” is positive, it means you can make more money by saving in the 10-year vault. But when the “spread” becomes negative, it means you will actually make less money by saving in the 10-year vault than just putting your money into the 3 month vault. Now this is NOT the normal occurrence and generally only happens when investors have fear (such as if they think an economic downturn may be coming in the future).
So, when we talk about the “10-year Treasury minus the 3-month T-bill spread,” we’re looking at how much extra money you can get by waiting longer to take your money out of the vault. It helps people understand if it’s a good time to save for a long time or if it’s better to save for a shorter time with bonds.
I hope this helps you understand a little bit about the 10-year Treasury minus the 3-month T-bill spread!
Disclaimer: I am not a financial adviser. This is for educational purposes only. Full disclaimer here.