How does the price of a long term treasury bond effect the value of your investment?

Question

The most important thing to point out about bonds is their interest rate and face value fluctuate like a see-saw, when interest rates are high the face value is lower, when the face value is high the interest rate is lower.

So since you make your money with treasury bonds by the treasury compounding your interest every six months, is it then just a terrible idea to buy them during times when the fed charges low interest rates (like during the last recesssion)? How does the face value of a treasury bond get factored into the interest calculation?

Answer 1

It is not always a bad idea to buy treasury bonds when interest rates are low. Interest rates might go lower. In some parts of the world, interest rates have been negative.

The semi-annual coupons for a treasury bond you own are: coupon_rate*face_value_you_purchased/2.

Also note that there are treasury floating rate notes. For these, the amount of interest can go up or down depending on the results of treasury bill auctions.

Answer 2

The face value of a bond is the amount of money that you will be owed when the bond matures. The coupon rate is part of the bond contract: it's the amount of interest that the issuer promises to pay each year, and it's listed as a percentage of the face value. It determines the amount of the regular interest payments that the bond issuer is obligated to make, typically every six months. Multiply the coupon rate by the face value of the bond to get the amount of annual interest; if it's paid every six months, divide by two to get the amount of each payment; if it's paid quarterly, divide by four; et cetera.

The price of a bond is whatever someone is willing to pay to buy that bond. The higher the face value, the higher the price, of course. But as interest rates change, the price also changes. Suppose interest rates are currently 10%. That is, you can buy a new issue bond for $1000, and that bond will pay you interest of $100 each year. How much would you pay for a bond with a 5% interest rate? If you want to get $100 each year, you'd have to buy a bond with a face value of $2000; at 5% interest, that gets you $100 per year. But you could get that same return for an investment of $1000 in that 10% bond, so it would be silly to pay $2000 for a $100 annual payment. That $2000 bond is worth less than its face value because its interest rate is lower than the current interest rate. Its price will be a bit more than $1000, because in addition to that $100 per year you also will get $2000 when the bond matures, while the $1000 bond will only pay you $1000. The closer you are to the maturity of the bond the more its face value affects its price. The price of a bond that will mature tomorrow will be its face value; the price of a bond that will mature in 99 years will be determined entirely by its coupon rate and the current interest rate.