The U.S. Treasury Bond market has arguably the greatest impact of any market on the general economy and is watched by the world over. As bond prices fall, interest rates rise taking with them rates charged on credit cards, business loans and mortgages. Meanwhile, as rates rise, general economic activity slows and unemployment rises. What happens in the Treasury Bond market touches the lives in one way or another of almost every resident.

Treasury Bonds have always attracted trading interest both because their prices are volatile enough to provide trading opportunities and because the market is liquid enough to absorb orders of any size - from one contract to 100 contracts or more. Treasury Bonds and, more generally, U.S. government debt securities are held by private and public organizations, hedge funds, pension plans, insurance companies and even domestic and international governments. This wide investor base provides liquidity virtually around the clock and creates a fair and level playing field for all participants. Regular sales of bonds by the U.S. government to fund operations keeps this market liquid and viable.

Understanding Bonds
A bond represents nothing more than a stream of income: regular coupon payments and then the principal payment at bond maturity. For example, a $100,000 30-year bond having coupon 6% would pay to the holder interest income of $6,000 every year and then $100,000 at maturity in 30 years. Treasury Bonds are backed by the financial credibility of the U.S. government who guarantees that payments will be made.

Bonds are quoted in terms of $100 of face value. In the example above, if this bond were trading exactly at 100, then a buyer would receive 6% annually for 30 years. However, it is often the case that buyers demand a different rate of return. If investors desire a higher rate of return, then the price of this bond will trade at a price below 100, for example, at 97. This has the effect of driving up the implied rate of return, also called the yield to maturity, to a value of say, 6.20% The bond's price will continue to fall, and the yield to maturity will continue to rise, until investors are content to buy the bond. On the other hand, if the bond's coupon seems very attractive, then investors may bid up the price of the bond say to 103. This will lower the yield to maturity to say, 5.80% and subsequently reduce the demand for the bond.

In practice, it is rare that a bond trade exactly at par, that is, exactly at 100. This is because the rate of return that investors demand often changes especially in response to new information on the economy. Falling bond prices mean that interest rates corresponding to that bond are rising while rising bond prices mean that interest rates are falling. In other words, bond prices and interest rates move in opposite directions.

Trading Treasury Bonds
While Treasury Bonds and shorter-dated Treasury Notes for that matter do trade in a cash secondary market, it is the futures market that provides access to these assets for most investors. CME Group (which includes the former CBOT) is the futures exchange on which futures contracts on Treasury Bonds and other U.S. Government securities are listed. Trading bonds means buying and selling Treasury Bond futures. If you expect long-term interest rates to rise (fall), then you might consider a strategy of selling (buying) Treasury Bond futures.

Treasury Bond prices are influenced by economic data such as employment, income growth, and overall consumer and industrial prices. Any data which supports expectations of rising inflation tends to weaken Treasury Bond prices because inflation erodes the present value of the stream of income that the bond provides. You will almost always see the bond market drop during a time of heightened inflationary concerns.

Treasury Bonds are also viewed as a safe-haven investment. Consequently, they often rally during times of international financial crises. Investors, both domestically and internationally, value the credit guarantee of the U.S. government and this gives Treasury Bonds great appeal when the credit quality of other borrowers - including other governments - falters. This has been the predominant reason for the incredible rally in bond prices in the last half of 2008.