On-the-Run Treasury

• The Bottom Line: The on-the-run Treasury is the most recently issued U.S. government bond for a specific maturity, serving as the definitive benchmark for the “risk-free” interest rate that underpins all investment valuation.
• Key Takeaways:
• What it is: The newest, most actively traded, and most liquid U.S. Treasury security (bill, note, or bond) of a particular tenor.
• Why it matters: Its yield is used as the global risk-free_rate of return, a crucial baseline for valuing stocks and assessing the opportunity_cost of every investment.
• How to use it: A value investor uses its yield as the non-negotiable starting point for calculating discount rates in valuation models like discounted_cash_flow.

Imagine a car dealership that only sells one model: the “U.S. Government Reliability.” Every few months, a brand-new, updated version of this car rolls onto the showroom floor. This latest model is the “on-the-run” Treasury. Everyone—from big banks to foreign governments to individual investors—wants this specific new model. It's the most talked about, the most traded, and its price is watched by the entire financial world. The moment a newer model is released, the one that was just on the showroom floor gets moved to the back lot. It's still a perfectly good car—it's just not the benchmark anymore. It has become an “off-the-run” Treasury. In finance, the U.S. Department of the Treasury is constantly issuing new debt to fund the government. It does this through regular auctions for different time frames (maturities), such as:

• Treasury Bills (T-Bills): Short-term debt, up to one year.
• Treasury Notes (T-Notes): Medium-term debt, typically 2, 3, 5, 7, or 10 years.
• Treasury Bonds (T-Bonds): Long-term debt, typically 20 or 30 years.

The on-the-run security is simply the most recent one issued for each of these maturities. For example, the “on-the-run 10-year note” is the 10-year note sold at the Treasury's most recent auction. Because it's the newest, it is the most liquid (easiest to buy and sell without affecting the price) and its yield is considered the purest reflection of the market's current interest rate expectations for that time horizon.

“The risk-free rate is to finance what the meter is to physics. It is the fundamental unit of measure.” ¹⁾

For a value investor, the on-the-run Treasury isn't something you necessarily buy; it's a tool you use to make rational decisions about everything else. It is the North Star of valuation. Here's why it's indispensable:

• It Defines Your Opportunity Cost: As an investor, you have a choice. You can lend your money to the U.S. government—an entity with the power to tax and print money, making default virtually impossible—and earn a specific rate of return. This is the yield on an on-the-run Treasury. Every other investment, from a blue-chip stock to a speculative startup, must offer a potential return significantly higher than this rate to compensate you for the added risk. The on-the-run Treasury yield clearly and constantly tells you the baseline return you can get for taking almost no risk.
• The Bedrock of Intrinsic Value Calculation: The core of value investing is calculating a business's intrinsic_value. The most common method is a discounted_cash_flow (DCF) analysis, which estimates all of a company's future profits and translates them into today's dollars. To do that translation, you need a “discount rate.” This rate always starts with the risk-free_rate. The yield on the on-the-run 10-year Treasury note is the universal standard for this. A higher Treasury yield means a higher discount rate, which directly leads to a lower calculated intrinsic value for a stock, all else being equal.
• It Enforces a Margin of Safety: Benjamin Graham's principle of a margin of safety is about demanding a buffer between the price you pay and the value you get. The on-the-run Treasury helps quantify this buffer. If the 10-year Treasury offers a 4% return, is an expected 6% return from a volatile stock enough of a premium? A value investor would say no. The risk premium (the extra return you demand) must be substantial to create a true margin of safety. The Treasury yield sets the floor from which this safety buffer is built.
• A Rational Anchor in an Irrational Market: Market sentiment can swing wildly, but the yield on the on-the-run Treasury is a cold, hard number. It reflects the collective, real-money consensus on inflation and economic growth. By anchoring your valuations to this objective rate, you protect yourself from getting swept up in market euphoria or panic.

A value investor doesn't trade on-the-run Treasuries; they use their yield as a critical input for decision-making.

1. Step 1: Identify the Correct Benchmark. For valuing long-term assets like stocks, the on-the-run 10-year U.S. Treasury note is the industry standard. Its decade-long maturity aligns well with the long-term nature of a business's earning power.
2. Step 2: Find the Current Yield. You don't need a fancy terminal. This information is published in real-time on major, free financial websites like The Wall Street Journal, Bloomberg, or even Google Finance. Search for “US 10-Year Treasury Yield” (Symbol: ^TNX).
3. Step 3: Anchor Your Valuation. Use this yield as the Risk-Free Rate (Rf) in your valuation. This is the first building block of your discount rate. For example, a simple discount rate might be calculated as: `Discount Rate = Risk-Free Rate + Equity Risk Premium`. If the 10-year yield is 4.5%, your discount rate for an average-risk company might be 4.5% + 5% = 9.5%.
4. Step 4: Constantly Compare. Before buying any stock, ask the crucial question: “Is the potential long-term return from this business, with all its operational, financial, and market risks, compellingly superior to the guaranteed return I can get from the U.S. government right now?”

The level of the yield is what you use in your formulas, but its direction provides context about the investment landscape.

• A High or Rising Yield: This suggests the market expects higher inflation and/or stronger economic growth. For a value investor, this is a headwind. It raises the “hurdle rate” for all other investments. The risk-free alternative is more attractive, and the higher discount rate puts downward pressure on stock valuations.
• A Low or Falling Yield: This often signals expectations of a weaker economy or lower inflation. This is a tailwind for stock valuations, as it lowers the discount rate. However, it may also indicate a poor economic environment that could hurt corporate profits.
• The Value Investor's Stance: Do not try to predict where interest rates will go. That is speculation, not investing. Your job is to use the current on-the-run yield as the most rational and up-to-date expression of the risk-free rate available today. Anchor your analysis in present reality, not in a forecast.

Let's follow an investor named Susan analyzing a fictional, stable company, “Reliable Utilities Inc.”

The Insight: The business of Reliable Utilities didn't change at all between Year 1 and Year 2. Its factories, customers, and management are all the same. However, because the risk-free alternative became much more attractive (rising from 1.5% to 4.5%), the price Susan is willing to pay for the company's future earnings dropped significantly. The on-the-run Treasury yield forced her to be more disciplined and demand a higher return from her stock investment, which directly lowered her calculation of its intrinsic_value.

• The Gold Standard Benchmark: Its yield is the universally accepted proxy for the risk-free_rate. Using it brings objectivity and consistency to your valuation process.
• Ultimate Liquidity and Transparency: As one of the most heavily traded securities in the world, its yield is an efficient and accurate reflection of the market's collective wisdom. There is no ambiguity.
• Economic Barometer: The yield provides a real-time signal of the market's expectations for inflation and economic growth, grounding your investment analysis in the broader macroeconomic reality.

• Not Entirely “Risk-Free”: While free of default risk, Treasury bonds carry other risks. interest_rate_risk means if rates rise after you buy a bond, the market price of your bond will fall. inflation risk means that a high inflation rate can erode the real (after-inflation) return you receive.
• The Trap of Forecasting: A critical error is to use a predicted future Treasury yield in your valuation instead of the current one. This replaces investing with speculating. A value investor's edge comes from analyzing businesses, not from forecasting interest rates.
• Short-Term Noise: While a long-term anchor, the on-the-run yield can be volatile day-to-day. Resist the urge to change your long-term business valuations based on minor daily fluctuations. Focus on the general level of rates as an input, not the noise.

• risk-free_rate
• discounted_cash_flow
• intrinsic_value
• opportunity_cost
• yield_curve
• interest_rate_risk
• margin_of_safety