What Is a 10-Year Treasury Note and How Does It Work?

Should you invest in a U.S. 10-year Treasury note?

Some astute observers might look at the size of the federal deficit and wonder to themselves: When the United States borrows trillions of dollars, who is doing the lending? Who has that much money laying around and why would they be willing to lend it to the U.S.?

The answer is that it’s actually a combination of almost everyone. When any country borrows money, it does so by selling bonds — clearly defined loans that are backed by the tax revenues of that nation. In the U.S., those take the form of Treasuries — very commonly, the 10-year Treasury note — which play an essential, if often overlooked, role in the basic functioning of the government and the economy.

So you can better understand the federal deficit and economy, here’s a deeper dive into the U.S. 10-year Treasury note.

What Is a 10-Year Treasury Note?

When the U.S. government needs to raise more money than it has on hand from tax revenues, it does so by selling bonds. Bonds are a type of loan in which the repayment terms are clearly defined ahead of time, making it easier for the government to understand and plan around the cost of interest on these loans.

These Treasuries have three different categories based on how long they last. Treasuries that mature in a year or less are known as T-bills, and Treasuries that mature after a decade are called T-bonds. Treasuries that mature in five to 10 years are known as T-notes.

Read: The Best Investment Brokers

How Do 10-Year Treasury Notes Work?

The basics of a 10-year T-note involves paying the government a single, lump sum at the beginning to purchase the bond — $1,000 apiece. After that point, the government pays interest in the form of payments that come twice a year until they mature, at which point the entire sum you borrowed will be returned. The interest rate, known as the “yield,” expresses the annual return on the money you’ve lent.

So, if you purchase one 10-year T-note with a 3 percent yield, that would mean that you would pay the federal government $1,000 up front. Then, you would get a payment of $15 every six months until, when the bond matures at the end of 10 years, you would get back your $1,000.

Treasuries are sold at auction, with banks and investors the world over competing over bond prices on U.S. debt. This competition helps keep borrowing costs low for the United States as the people willing to accept the lowest yields are the ones who will ultimately be able to get their hands on the T-notes. For most people who aren’t major investment bankers, though, you’ll purchase your T-notes through a broker or on the secondary market.

See: The Best Robo-Advisors

Why Do 10-Year T-Notes Matter So Much?

Although 10-year T-notes are simple bonds, they play a very important role in the global economy. Because T-notes are so safe, banks the world over will hold them as capital reserves to insulate them against economic shocks. Likewise, many different consumer interest rates are set using the yield on the 10-year T-note as a guide.

T-notes can also be a solid bellwether for the economy as a whole. As one of the most basic types of investment, watching the way yields change over time can give a strong sense of how optimistic or pessimistic investors are about the direction of the economy.

Take the “yield curve” for example. Normally, yields on longer term T-notes and T-bonds are higher to reflect the increased risk of the longer maturity date. However, when the near-term prospects of the economy seem bleak, it will often drive more investors into T-notes before interest rates fall — as they usually do during hard times — and drive down those yields, “flattening” or even “inverting” the yield curve.

A flat or inverted yield curve has preceded every recession in the last 60 years, so it can be a powerful signal to prepare for hard times to come.

Click to see the best online stock brokers for beginners.

More on Investing