Basic understanding of U.S. Treasury bonds: investment yields and the real meaning of interest rates

Recently, as uncertainties in the global financial markets increase, more investors are seeking stable asset allocations. In particular, there is a growing movement to accurately understand the meaning of government bonds and invest in U.S. Treasury bonds. As a safe asset backed by the U.S. government’s repayment credibility, U.S. Treasury bonds offer high liquidity despite low nominal interest rates, providing investors with principal preservation and regular cash flows. This article systematically explores the meaning of government bonds, the relationship between interest rates and yields, investment risk factors, and practical purchasing methods. It especially focuses on hedging strategies and portfolio optimization methods that Korean investors should consider.

Bonds and Government Bonds: Starting from the Basics

To understand the meaning of government bonds, you first need to grasp the concept of bonds. A bond is a financial contract where the debtor borrows funds from investors for a certain period, repays the principal at maturity, and pays periodic interest. Bonds issued by the government are called government bonds. When a country issues government bonds to raise necessary funds, investors purchase them to earn stable interest income.

The most actively traded product in the international bond market is the 10-year U.S. Treasury bond. This instrument not only serves as a simple investment product but also functions as a benchmark for global interest rates and is used as an indicator of the health of the global economy.

Classification of U.S. Treasury Bonds and the Meaning of Yields

U.S. Treasury bonds are divided into three categories based on maturity:

T-bill(Short-term Treasury) are ultra-short-term bonds with maturities of less than one year, characterized by the lowest credit risk and high liquidity. T-note(Medium-term Treasury) are medium-term bonds with maturities of 1 to 10 years, and T-Bond(Long-term Treasury) are long-term bonds with maturities over 10 up to 30 years, offering fixed interest rates.

During economic instability, investors tend to shift assets into government bonds. An important concept here is the interest rate and yield. The expected return when purchasing a bond divided by its purchase price is called the yield(yield), which fluctuates in real-time according to market supply and demand.

A commonly overlooked aspect is the inverse relationship between interest rates and bond prices. When demand for government bonds increases, bond prices rise, but interest rates fall. Conversely, if selling demand increases, prices fall and interest rates rise. Therefore, yield is considered the most honest indicator reflecting market sentiment and conditions.

Four Key Advantages of Investing in U.S. Treasury Bonds

(# 1. Top Creditworthiness and Safety U.S. Treasury bonds are guaranteed by the most trusted government in the world. This is why investors prefer them first during economic downturns.

)# 2. Fixed Interest Income The fixed interest rate set at issuance is typically paid semiannually. This makes them ideal for retirees or conservative investors who need stable cash flows.

3. Excellent Market Liquidity

U.S. Treasury bonds are the most actively traded assets in the bond market. You can hold them until maturity or quickly liquidate them if needed, enhancing portfolio flexibility.

4. Tax Advantages

Interest income from government bonds is subject to federal tax but exempt from state and local taxes, making the after-tax yield relatively favorable.

Four Major Risks of Investing in U.S. Treasury Bonds

1. Interest Rate Rise Risk

When interest rates rise, the yields on newly issued bonds increase, causing the market value of existing low-yield bonds to decline. Selling before maturity may result in losses.

2. Inflation Erosion

Returns from fixed interest rate bonds may not keep pace with rising prices. If inflation exceeds the bond interest rate, real returns decrease. Treasury Inflation-Protected Securities (TIPS) are designed to address this.

(# 3. Exchange Rate Risk For foreign investors, exchange rate fluctuations are critical. A weakening dollar can reduce the value of interest and principal when converted to local currency.

)# 4. Credit Risk While theoretically there is a possibility of U.S. government default, it maintains the highest credit rating globally, making the actual risk extremely low.

How to Purchase U.S. Treasury Bonds: Three Options

1. Direct Purchase of Bonds

You can buy U.S. Treasury bonds directly from the U.S. Treasury via the TreasuryDirect website. The maximum purchase amount per transaction is $10,000.

Advantages: No management fees, regular interest payments until maturity, full control over investments

Disadvantages: Limited purchase amount per individual, need to buy multiple bonds for diversification, potential losses if sold before maturity

Suitable Investors: Conservative investors aiming for long-term holding, retirees needing stable income

2. Bond Fund Investment

Managed by professional fund managers, bond funds include a diversified portfolio of various government bonds.

Advantages: Exposure to multiple bonds reduces individual bond risk, active management by professional fund managers, allows for small-scale diversification

Disadvantages: Management fees reduce net returns, no direct control over individual bonds

Suitable Investors: Investors seeking professional management, risk-averse investors pursuing long-term gains through diversification

(# 3. Bond Index Funds)ETF### Exchange-traded funds that track government bond indices, traded on stock exchanges like stocks.

Advantages: Lower fees than active funds, tradable like stocks, high transparency and liquidity

Disadvantages: Market volatility exposure, slight tracking error from the index, inability to actively manage based on market changes

Suitable Investors: Cost-conscious investors, passive investors preferring index tracking

Hybrid Strategies for Korean Investors

The value of combining Korean and U.S. government bonds

Combining Korean and U.S. government bonds allows for true diversification across regions and currencies. Economic downturns in one country can be offset by growth in the other, and currency fluctuations between KRW and USD can serve as natural hedges. Utilizing the interest rate curves of both countries can also optimize yields.

Practical Strategies for Korean Investors

1. Currency Risk Management

During periods of USD weakness, holding dollar-denominated assets without hedging can increase returns in KRW terms. Conversely, when the dollar is strong, using forward contracts to lock in exchange rates provides partial hedging.

2. Duration Strategy

Constructing a portfolio considering the duration( (average maturity) of bonds is crucial. For principal preservation, include long-term bonds; to reduce sensitivity to interest rate changes, mix in short-term bonds.

)# 3. Tax Optimization Interest from U.S. government bonds is subject to U.S. federal tax but can avoid double taxation through the Korea-U.S. Double Taxation Agreement###DTA###. Consulting a tax professional is recommended.

Real Portfolio Example

Suppose a balanced portfolio consists of 50% Korean government bonds and 50% U.S. Treasury bonds. This setup achieves both principal preservation and income generation. Hedging 50% of U.S. bonds against currency risk absorbs exchange rate volatility, while the unhedged remaining 50% can benefit from dollar strength, increasing KRW returns.

Conclusion: Starting Systematic Government Bond Investment

U.S. Treasury bonds are a proven safe asset for both individual and institutional investors. Understanding interest rates, inflation, and exchange rate risks accurately and developing appropriate strategies are key to success. For Korean investors, combining U.S. Treasury bonds with domestic bonds offers genuine diversification benefits. Choose the method that aligns with your investment goals and risk appetite—whether direct purchase, funds, or ETFs—and begin systematic asset allocation.