The risks and profitability of investing in US treasuries

Perhaps many investors would argue that US Treasury bonds offer relatively low returns compared to assets like stocks and options, making them seem unappealing. Indeed, if one solely focuses on potential future returns, bonds may not seem as attractive. However, from a long-term asset allocation and risk management perspective, US Treasury bonds possess three unique advantages:

1. Low Investment Threshold: Unlike many other bond products that require substantial initial investments, the threshold for purchasing bonds is extremely low on most stock trading platforms. Taking US Treasury bonds as an example, an investment as little as $1,000 may suffice. Furthermore, the transaction process for buying Treasury bonds is straightforward, akin to purchasing stocks.
2. Lower Risk: Bonds, in general, pose a lower risk compared to assets like stocks and options. If you invest in sovereign-backed bonds like US Treasury bonds, you essentially eliminate credit risk. After all, to date, there has never been a credit default on US Treasury bonds.
3. Stable Returns: Bonds offer fixed coupon payments, ensuring that investors receive periodic interest payments regardless of market fluctuations, providing relatively stable returns. Upon maturity, investors also receive their principal back, making bonds an ideal choice for those averse to high risks.

Despite their low threshold, low risk, and stable returns, US Treasury bonds are not without potential risks. Apart from currency exchange rate factors, bond investments primarily face two types of risks: credit risk and interest rate risk.

1. Credit Risk: Credit risk refers to the possibility that a bond issuer may fail to repay the principal or interest payments on time. This risk significantly impacts bond prices and investment returns. Generally, bonds with higher credit quality offer lower returns, while those with lower credit quality offer higher returns. Institutional investors such as pension funds and insurance companies tend to favor high-credit bonds due to their emphasis on principal preservation and stable interest payments. On the other hand, some institutional investors, like high-yield bond funds, may seek higher returns by accepting higher credit risks.
2. Interest Rate Risk: Interest rate risk refers to the potential for bond prices to fluctuate due to changes in market interest rates.Interest rate risk is one of the most prominent risks in the bond market. Suppose you purchased a $1,000 face value, 5% coupon rate 10-year fixed-rate bond, which means that the bond will pay you $50 in interest annually (1000 * 5%) and mature in 10 years, at which point you will be repaid the $1,000 principal. However, if market interest rates rise from 5% to 6% after you purchase this bond, the attractiveness of your 5% coupon rate diminishes as newly issued bonds offer higher coupon rates. If you decide to sell your bond, its price may decline as investors prefer bonds with higher interest rates. Consequently, you may have to sell your bond at a discount, incurring a capital loss.

It's worth noting that US Treasury bonds typically only face interest rate risk, while corporate bonds and a minority of municipal bonds are exposed to both interest rate risk and credit risk. For instance, in some jurisdictions with lenient penalties for financial fraud and no obligation to compensate investors upon delisting, some companies deliberately engage in fraudulent accounting practices and seek delisting, posing significant credit risks to their bonds.

Now, let's delve deeper into how one can profit from US Treasury bonds:

1. Income from Coupon Payments: Upon purchasing a bond, investors typically receive periodic coupon payments based on the bond's face value and coupon rate, usually paid semi-annually or annually.
2. Capital Gains from Price Differences: Bond prices fluctuate with market conditions. As mentioned earlier, bonds purchased at lower prices offer higher yields to maturity. Thus, buying bonds at a discount can result in higher returns upon maturity.
3. Trading Gains from Buying Low and Selling High: Similar to stocks, bonds can be bought and sold in the market. This means investors can profit by buying bonds at low prices and selling them at higher prices. However, bond price volatility is relatively low compared to assets like stocks, so short-term price differences may not be substantial.