Learn something new every day
More Info... by email
A treasury lock is type of agreement between the issuer of a security and the investor who buys that security in regard to the rates that will apply to a treasury security. Essentially, the contract will fix or lock the price or the yield that is associated with that security. This approach makes it possible for the investor to enjoy some sort of guaranteed return from the purchase of the asset when the treasury lock has to do with the price. In the event of a lock on the yield, this means that the investor is able to create a hedge situation that can also be used to his or her best advantage.
The structure of a treasury lock calls for one of the two parties in the agreement to pay the difference between the prevailing market rate and the rate that is designated in the terms of the agreement. If the treasury lock is set at 6%, this establishes the benchmark that both parties agree to use as part of the investment agreement. In the event that the market interest rate exceeds that percentage during the life of the agreement, the investor must pay the seller the difference between the lock rate and the market rate. At the same time, if the market interest rate is below the percentage designated as the lock rate, then the seller must pay the difference between the two rates to the buyer or investor.
By establishing a treasury lock, the investor is in a position to project the type of returns he or she will receive, based on what is anticipated to happen with the market interest rate. This strategy calls for considering all relevant events that may occur and cause that rate to shift above or below the treasury lock rate, setting the rate at a level that is likely to require the seller to pay the difference to the investor. Failure to accurately project what will happen with the market interest rate will result in not receiving as much benefit from the arrangement, although the investor still receives a return based on the treasury lock rate itself.
While a treasury lock does carry a relatively low risk for the investor, there is always the chance that the market interest rate will increase over the lock rate, resulting in the need to tender the difference between the two rates to the seller. This is where accurately predicting the movement of the market interest rate is key for the success of the strategy. While it is rare, there is the chance of the market rate increasing enough to offset the lock rate, leaving the investor with no returns in interest, at least until that rate begins to fall once more.
One of our editors will review your suggestion and make changes if warranted. Note that depending on the number of suggestions we receive, this can take anywhere from a few hours to a few days. Thank you for helping to improve wiseGEEK!