How to invest in multi-year treasury bonds

In this article we want to illustrate all the main features of the Long-Term Treasury Bonds (BTP), their use as a form of investment. Our goal is to provide you with the tools necessary to establish how to invest in multi-year treasury bonds (BTPs) and estimate their performance.

What are multi-year treasury bonds (BTPs) ? How do BTPs work? Is it possible to use BTPs to get a good return?

Surely the Multi-year Treasury Bonds (BTP) are one of the most popular financial instruments and it is therefore of fundamental importance to understand how they work and to know how to profit from the BTPs.

To better understand what the yield on multi-year treasury bonds (BTPs) may be, we must start from some basic concepts.

The bonds : they are cash loans that recognize a periodic interest to investors through coupons.

All the states issue bonds and in the case of the Italian State, these are called Government Securities or Treasury Bills (BTP). These loans recognize, through coupons, an interest at fixed intervals over time (which usually has a half-yearly frequency).

The BTPs ( Treasury Bonds ) have a maturity of 3, 5, 7.10, 15, 20, 30 and 50 years and guarantee a payment of the six-month returns.

The nominal value of the BTP is equal to 100 in conjunction with the issue and maturity. BTP taxation is 12.5 for the State (but increases to 26% for private individuals).

But what is the return on long -term Treasury Bonds (BTPs)?

But what is the return on long -term Treasury Bonds (BTPs)?

The yield on long -term treasury bonds (BTPs) derives from two components:

  • the coupon flow
  • the difference with the subscription price

Clarified that a Long Term Treasury Bonds (BTP) always has a nominal value of 100, we note that the price on the market of a BTP can vary, assuming lower quotations (for example 80) or higher quotations (for example 120).

To calculate the yield of net BTPs, regardless of their maturity, these parameters must be taken into account:

  • the BTP purchase price ;
  • the coupon, ie the interest that accrues on that BTP;
  • purchase costs, ie the commissions to be paid for the purchase of a BTP to the intermediary;
  • performance taxes, by law you have to pay taxes at 12.5% (for the State) and 26% for private individuals;
  • the tax on the issue spread, ie on the difference between the value of the BTP at the time of issue and the value at the time the investor takes possession of it.
  • the taxes on the capital gain, that is on the gain beyond the issue price.

From 2012 the BTP Italia is available from the Italian State, with a 4-year maturity. On BTP Italia you can invest a thousand euros or multiples of it. The investor can receive annual coupons paid every six months (for example, a 4% Italian BTP pays two half-yearly coupons of 2% each).

The yield of BTP Italia has a fixed rate, communicated at the end of the subscription period, and calculated on the revalued capital based on actual inflation in Italy.

At the expiry of the BTP, when the coupon is paid to the investor, two situations can occur:

Purchase BTP with price below 100

In this case, at the time of issue we purchased the BTP at lower value and therefore at maturity we realize a gain equal to the difference to 100, to which the 12.5% ​​tax must then be deducted.

Example:

  • Purchase: 90
  • Capital gain: 100-90 = 10
  • Tax on capital gain: 10 * 12.5% ​​= 1.25
  • Net repaid: 100 – 1.25 = 98.75

Purchase BTP with a price over 100

In this case, at the time of issue we purchased the BTP at higher value and therefore at maturity we realize a gain equal to the difference at 100 (capital gain) less the 12.5% ​​tax. In this case you will receive a net repayment that coincides with the nominal value.

Example:

  • Purchase: 110
  • Capital gain: 100-110 = -10
  • tax credit on capital gains: -10 * -12.5% ​​= 1.25
  • Net repaid: 100

What are the risks for those investing in multi-year treasury bonds (BTPs)

What are the risks for those investing in multi-year treasury bonds (BTPs)

If you purchase BTPs and intend to keep them until maturity, the only risk you run is the fact that you are a creditor and that, whoever issues the bonds, ie the Treasury, may not pay the coupons or repay the principal.

Another risk that you run is that of the market, that is, if you sell (for any reason) the BTPs before the expiry. In fact, if the market were to fluctuate and there was a rise in yields, the BTP price may fall, causing a capital loss.

Why invest in multi-year treasury bills (BTP)

Why invest in multi-year treasury bills (BTP)

Summing up we can say that investing in BTP is worthwhile for the following reasons:

  • BTPs are particularly suitable bonds for medium, long or very long term investments;
  • the BTPs guarantee fixed periodic coupons and therefore regular and predetermined collections;
  • BTPs have a medium / low risk, being issued by a sovereign state, if you keep them until maturity. First you could have capital losses if the market fluctuates upwards, especially with long-term maturities.

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