The Abcs of us Treasury Bonds

The U.S. Government is the largest borrower in the world; its debt load is well over seven trillion dollars and this number keeps getting higher due to deficit trend rising in recent years. The Government has to borrow to finance the difference between the incoming of tax and the spending on cost of running the government and,ironically,to service its debts! Borrowing money is raised through issuing Bonds,Notes,and Bills.

Treasury Bills are short term securities,their maturity terms include four weeks,13 weeks,and 26 weeks,it does not fit the general definition of bonds so,it will be discussed in more details in another opportunity. This article will explore Treasury Notes and Treasury Bonds.

Treasury Notes or T-Notes are intermediate-term bonds issued by the U.S. Department of Treasury,their maturities range from over one to ten years.The Notes are non-callable (that is they will not be called to redemption before their maturity) and issued in multiples of $1,000 of par (notes can have par values of $1,000,$2,000,$3,000,etc).Interest will be paid every six months to holders’ accounts.

TIPs-Treasury Inflation Protection Securities- are bonds that have a special feature: principal is protected from inflation and deflation. That is,in time of inflation the principal is adjusted upward and in time of deflation it always can be redeemed at par value. TIPS are issued with fixed rate and the rates are usually slightly lower than other comparable bonds that do not have the inflation protection feature. Interest payments are paid every six months and Principal is increased by inflation,the amount added to principal is based on equal amount of CPI-Consumer Price Index. For example,every six months.

The Treasury calculates the difference between the CPI at the beginning and at the end of that period, then uses that result to find the amount of money to add to the beginning principal balance.So,during inflation periods,the interest rate of the TIPs is fixed but the interest payment increased due to the increasing principal.On the other hand,during the deflation period,principal will be adjusted downward but never below par value.

STRIPS-Separate Trading of Registered Interest and Principal of Securities.The name sounds long but,luckily,it can be grouped into an easy short form! STRIPS are actually zero coupon bonds or bonds that do not have stated interest rate when issued.So,how will STRIPS holders get paid? The structure of zero coupon debts in general is based on the idea of interest payments are paid upfront.check this example: the market interest rate is 5%,the par value of the bond is $1,000,maturity is 10 years. Instead of issuing a bond of $1,000 par,5% coupon,and maturing in 10 years the issuer offers the bond at $700 and repays $1,000 at maturity. That is, whatever way the market change in the next 10 years the bond holder has earned the total interest payment of $300 already-or as termed above “registered interest and principal”.

30-Year Treasury Bonds or T-Bonds are long term bonds issued in multiples of $1,000 with stated fixed interest rate and may be called at par, five years before maturity.

Ratings: all U.S. Government kinds of debts have the highest investment ratings,AAA.They have never defaulted.If they would the whole world economy certainly was in an unimaginable crisis.This does not mean trading U.S. securities is always giving profit because their prices change with market interest rate and condition.

Trading: U.S. Government securities market is the largest and most active market in the world.There is no exchange floor,trading takes place over the counter only. Participants include Federal Reserve, commonly called the Fed,large commercial banks,foreign banks.The largest ones consist of about 20 primary dealers,designated by the Fed (some well-known as Merrill Lynch,Citigroup,J.P. Morgan,etc). Smaller participants include small banks and brokerage firms who buy and sell securities through primary dealers. The Federal Reserve Bank’s activities through this market help to manage the interest rate and are termed as “open market operations”. Quotes are posted in percentage of par and changed in 1/32 of one point increments.For example, a bond quote is 99.16; that is, 99 16/32 % of $1,000 par value or 99.5% of $1,000 or $995.

Small traders or individuals can participate directly in initial offerings of U.S. Government securities through the website .The process is pretty simple: register and fund the account then enroll in the available auction of the next offering.All T-bonds,Notes,short term T-Bills are available for public participants. Because of the highest investment grade rating, U.S. government securities play an important part in a portfolio.They tame the portfolio against volatility,serve as a cushion in a down market or give a reliable stream of income.

Taxation: Interest income from all U.S. Government securities is exempt from State and Local income tax but subject to Federal Taxation. It may reduce return for individual with high tax bracket so the tax aspects should be put into consideration when investing in Treasuries.

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