Treasury bonds are financial securities issued by governments when they need to borrow money, either directly from the public and corporations, or by selling these instruments through banks and other financial markets options, such as the stock exchange and brokers. The treasury bonds issued by the US government are considered to be amongst the most secure of these financial securities.
Types of bond
US Treasury securities come in a range of formats. These are determined firstly by the duration of the bond and, secondly, by their link to inflation and other factors. The government uses this money to pay for the country’s infrastructure, covering the gap between income and expenditure.
In terms of timescale, Treasury notes are securities offered for the short-term. These can have a maturity date of anything ranging from a few days to twenty-six weeks. Treasury bills are purchased at a discount with the full face value being repaid at maturity. The difference between the purchase price and redemption value is effectively the interest that is paid to the note holder.
Treasury bills are a medium-term investment, ranging between two and ten years to maturity. These bills are purchased by a bidding process, which can either be competitive, where the buyer determines the yield they wish to achieve, or non- competitive, in which case you accept the auctioned yield and are guaranteed the amount requested. In the former case the US Treasury can reject the bid or offer an alternative yield.
Treasury bonds, in their various elements, are investments for the longer term. For example, the standard bond is issued for a thirty-year period. This does not mean that the buyer has to hold the bond for that length of time, just that this is the period between issue and maturity. One can always sell it in less time than this and will then make a profit or loss on the deal, depending upon the performance of interest rates, an issue that will be explained in more depth later.
The Treasury also offers special bonds for specific purposes, such as the I-bond and EE-bond range. These bonds are more cost flexible and can be used for a special purpose. For example the I-bond has a fixed rate of return and the EE bond can be used as a mode of saving for retirement or as part of a children’s educational savings program.
There are three main advantages that attach to the purchase of US treasury bonds.
1) Low risk
Probably the most important of these is the low risk factor. As the US government issues these bonds there is considered to be a miniscule, if not impossible, risk of the borrower defaulting on maturity. This, together with the guaranteed income from interest, makes them the safest form of investment.
2) Tax advantages
Treasury bonds have tax advantages. These apply at state level, where they are exempt from income calculations. Thus, although in many cases the interest paid on the bond may be lower than prevailing market rates, because they are exempt from tax in these areas the net income, after tax has been applied, can in fact be higher
3) Face value
Treasury bonds will always be redeemed at face value, no matter how the market is acting at the time of maturity. In this respect the initial investment value is maintained, although of course one has to balance this against the rate of inflation increase that has occurred during the period this investment has been held. However, the face dollar value will always be returned to the bond holder.
Treasury notes, bills and bonds can only be purchased in blocks of $1,000 or at a discounted rate on that price. For example a Treasury $1,000 note may be sold for $980. The special treasury bonds, for example I and EE bonds, can be bought in much lower denominations, 50 units in terms of the former and 25 for the latter.
One of disadvantages of investing in Treasury bonds can be the movement of external interest rates. If the market interest rates increases beyond the level set of the bond, this depreciates their value as a buyer needs to take into account that there is an income deficit compared to open market rates.
Treasury securities can be purchased either direct from the US treasury or through brokers. The former option only applies to individuals at present. Therefore, there is no brokerage fee charged by the seller. If you purchase these bonds other than direct from the treasury, you may be liable to a brokerage charge.
US Treasury bonds and securities are a sound investment, particularly when used as a means of offsetting the risks associated with other financial market holdings. They have tax and security advantages, but they will not necessarily perform as well as ordinary stocks.