Risk and Return

The treasury market is generally considered a low-risk investment, and as a result, the potential returns are also relatively low. Here’s why:

Risk:

Interest rate risk: Treasury bonds are susceptible to fluctuations in interest rates. If interest rates rise, the value of existing bonds will fall, leading to a capital loss for investors who wish to sell before maturity.

Inflation risk: Inflation erodes the purchasing power of fixed-income securities, including Treasury bonds. If the rate of inflation is higher than the yield on a bond, the investor’s real rate of return will be negative.

Default risk: The likelihood of the U.S. government defaulting on its obligations is low, but it is not zero. If the government were to default on its debt, investors in Treasury bonds could lose their principal and interest payments.

Return:

Yield: The return on Treasury bonds is primarily in the form of yield, which is the interest rate paid to bondholders. Treasury bonds typically offer a lower yield than other types of fixed-income securities, such as corporate bonds, to reflect their lower risk.

Capital appreciation: Although the potential for capital appreciation in the Treasury market is limited, it can occur if interest rates fall, leading to an increase in the value of existing bonds.

Return

Investors always wish to earn a return on the funds invested in assets. The return from an investment may be available in terms of revenue (divided or interest) and/or in terms of capital gain (capital appreciation).

The return from an investment can then be classified as under:

Expected Return: The expected return refers to the anticipated return for some future period. It may be noted that all investment decisions are made in the light of expected return. The expected return is estimated on the basic of actual returns in the past periods. The returns in the past periods provide goods basis for estimation of prospective behavior. However, in case of fixed interest investments (g., fixed deposits, bonds etc.), the expected return is equal to fixed interest plus capital change, if any, during the holding period.
Realized Returns: It is the net actual return earned by the investor over the holding period. It refers to the actual return over some past period. The actual return or realized return may be more or less than expected return. The difference between the expected and the realized return give rise to the risk attached with the return.

Risk

The risk of an investment is related to the uncertainly associated with the outcomes form an investment. All investors, in general, would prefer investments with highest possible return but for getting this higher return, he has to pay the price in terms of accepting higher risk too. Investors are rational and prefer less risky investments to riskier investments. Invertors are risk-averse in the sense that they do not assume risk for its own sake but they will not incur any level of risk unless there is an expectation of adequate compensation for undertaking that risk.