Rookie Cash Question (3-Year Notes)

[dualstow]

It isn't terribly important, but I don't understand why some 3-Year notes that I bought (CUSIP 912828TP5) are up in value. Let me show you how confused I am:

The coupon is 0.25%. I bought them at auction and they happen to pay exactly 0.25% (this is never the case with long bonds bought at auction where interest doesn't match the coupon), just $12.50 in interest divided by a cost of $4987.50.

In general, the yields of treasuries have of course been falling. (Not always the case with shorter-term notes, though. The 5-Year yield, ^FVX at yahoo has been all over the place. Flattening yield curve, blah blah blah...) But, I don't understandy why the value of these notes is currently up $20 (cost of 4987.5, but holdings value of $5007).

The reason I don't understand, is because there is an auction for new 3-YR notes right now with an indicative yield of more than 1%. The indicative yield is certainly no guarantee and the yield will probably end up being lower, but if it's that high, shouldn't the value of the notes I own be way down?

Again, this is small money and tiny interest. I just ladder these 3-Year notes for cash for the pp. But I'm curious. Any thoughts?

[rickb]

The bonds you bought mature in Sept 2015, less than a year from now.  You should completely ignore their coupon yield, and instead compare their yield to maturity to the current coupon yield of one year notes, not 3 year notes. The coupon rate your notes are paying (0.25%) is 2 1/2 times what current 1 year bonds are paying (0.1%) - so they're priced at a premium making their yield to maturity about 0.1%.

The wonderful/terrible thing about treasury bonds is that their current price adjusts so that their yield to maturity pretty much always exactly matches the current yield available on bonds of the same maturity date (this makes sense, because if this was not true somebody could make money by arbitraging the difference).  A 30-year bond that matures in 2015 will have essentially the same yield to maturity as a 1 year note you buy at auction today, even though the 1-year note will have a coupon rate of 0.1% and the 30 year bond might have a coupon rate of 7% or more.

The treasury market is big enough, and there are enough players, that I'd be surprised if you could find a bond whose yield to maturity differs by more than a few cents than any other bond with the same maturity date.

[dualstow]

Thanks, Rick. I knew you would be the one with the answer. Makes good sense.

[sophie]

Actually I did manage to find a small difference in yield in the secondary bond market, the last time I went to buy 30 year bonds:  bonds with low coupons selling at a discount showed a slightly higher yield than bonds of similar age (within 1-2 years) with high coupons selling at a markup.  I guess psychology drives people toward the bonds with higher coupon rates, and that makes more of an impression than the markup.  I bought the low coupons.

Other than that though, I do expect the bond market is very highly efficient especially when it comes to treasuries.  I was quite surprised to find this difference.  Forget how much it was, maybe 0.2%.