Market Fluctuations Establish Interest Rates For Treasury Bonds

How are the interest rates for Treasury bonds set?

By the market, of course, like those for virtually every other financial instrument.

The Treasury Department sells 30-year bonds only twice a year, at competitive auctions in February and August. Each auction is intended to raise a certain amount of money, say $10 billion, and the bonds are sold to the bidders that are asking for the lowest interest rates.

The coupon rate set at auction determines the amount of the actual interest payments the government will make every six months.

Those payments do not change over the life of the bond. This means that if market interest rates go up and you choose to sell your bond before its maturity, investors will pay less than the face value to buy your bond. That’s because they can get a new bond at the current higher rate. Conversely, if market rates go down and you decide to sell, investors will be willing to pay more for your fixed payments.

Thus, changing market interest rates - and the changes they cause in the current price of a bond - account for the daily fluctuations you noticed in bond yields. The yield is the interest rate as a percentage of the price.

For example: A 5 percent interest rate on a $1,000 bond equals a 5 percent yield. But a 5 percent interest rate on a bond that has dropped in price to $950 equals a 5.26 percent yield.

Mutual fund taxation explained

A lot of things can cloud the tax picture when it comes to mutual funds. For example, did you pay a sales charge (known as a “load”) when you bought or sold shares in your fund? Were any dividends involved, and were they reinvested?

Did you sell all your shares, or only some of them? Did the fund have any “undistributed” capital gains? Did it make any non-taxable distributions to you?

All these issues carry tax consequences.

To learn more, take a look at Internal Revenue Service Publication 564, “Mutual Fund Distributions,” and Publication 551, “Basis of Assets.”

For your free copies, visit your local IRS office, call the IRS at (800) 829-3676, or complete the form at the end of your Form 1040 package.

There’s also the 19-page booklet, “Tax Dos & Don’ts for Mutual Fund Investors,” from the Investment Company Institute.

It explains mutual fund tax matters in plain language, and includes tables, tax tips and real-life examples.

For your free copy, write: Investment Company Institute, P.O. Box 27850, Washington, D.C. 20038-7850.

Remember to ask for the booklet by name, and be sure to include your name and address. Your request won’t result in any follow-up calls or mailings, said institute spokesman John Collins.

More companies offer DRIPs

Five more companies have recently joined the movement toward offering investors the ability to buy shares directly instead of going through a broker.

The companies, and their telephone numbers, are: Amoco, (800) 821-8100;C.R. Bard, (800) 828-1639; Reader’s Digest, (800) 242-4653; York International, (800) 437-6726; Central & South West, (800) 527-5797.

For a prospectus and enrollment information, investors may call the numbers above, which may connect with the company or its transfer agent. Minimum investment requirements may be waived in some cases if investor agrees to make automatic monthly investments from checking account.

Money fund assets drop

Assets of the nation’s 672 retail money market mutual funds fell by $8.79 billion in the latest week to $559.74 billion, the Investment Company Institute said Thursday.

Assets of the 412 taxable money market funds in the retail category fell by $5.77 billion to $454.53 billion for the week ended Wednesday, the Washington-based mutual fund trade group said. The 260 tax-exempt fund assets fell by $3.02 billion to $105.21 billion.