Treasury security

Categories: Bonds

Treasury securities are government bonds issued by the United States Department of the Treasury, through their agency the Bureau of the Public Debt. They are the debt financing instruments of the U.S. Federal government, and are often referred to simply as Treasuries. There are four types of treasury securities: Treasury bills, Treasury notes, Treasury bonds, and Savings bonds. All of the Treasury securities besides Savings bonds are very liquid. They are heavily traded on the secondary market.

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Treasury bill

Treasury bills (a.k.a. T-bills) mature in one year or less. They are like zero coupon bonds in that they do not pay interest prior to maturity. Instead they are sold at an discount of the par value to create a positive yield to maturity. Treasury bills are considered by many the most risk free investment. Treasury Bills are commonly issued with maturity dates of 4 weeks, 91 days (~13 weeks), and 182 days (~26 weeks). Treasury Bills are sold weekly at an auction held on Mondays. Banks and financial institutions are the largest purchasers of T-Bills. T-Bills are quoted for purchase and sale in the secondary market on an annualized percentage yield to maturity or 'basis'.

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Treasury note

Treasury notes (a.k.a. T-Note) mature between one and ten years. They have a coupon payment every six months. Treasury notes are commonly issued with maturities dates of 2, 3, 5 or 7 years, and for denominations from $1,000 to $1,000,000. T-Notes and T-Bonds are quoted on the secondary market at percentage of par in thirty-seconds of a point. So a quote of 95.7 on a note indicates that it is trading at a discount: $952.19 for a $1,000 bond.

The 10-year Treasury note has become the security most frequently quoted when discussing the performance of the U.S. government-bond market and is used to convey the market's take on longer-term macroeconomic expectations. It is also important to the U.S. mortgage market which uses the yield on the 10-year Treasury note as a basis for setting mortgage interest rates.

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Treasury bond

Treasury bonds (a.k.a. T-Bonds) mature in more than ten years. They have coupon payment every six months like T-Notes. Treasury bonds are commonly issued with maturity dates of ten and thirty years. The secondary market is highly liquid, so the yield on the most recent T-Bond offering was commonly used as a proxy for long-term interest rates in general. This role has largely been taken over by the 10-year note, as the size and frequency of long-term bond issues declined significantly in the 1990s and early 2000s.

The U.S. Federal government stopped issuing the well-known 30-year Treasury bonds (often called long-bonds) on October 31, 2001. As the U.S. government used its budget surpluses to pay down the Federal debt in the late 1990s, the 10-year Treasury note began to replace the 30-year Treasury bond as the general, most-followed metric of the U.S. bond market. However, the U.S. Treasury announced in August 2005 that due to a flattening of the yield curve (the difference between short-term bond yields and long-term bond yields is narrowing) and due to demand from pension funds and large, long-term institutional investors, the 30-year Treasury bond will be re-introduced in February 2006. This will bring the U.S. in line with Japan and other European governments issuing longer-dated maturities amid growing global demand from pension funds (France and the United Kingdom are even offering a 50-year bond).

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TIPS

Treasury Inflation-Protected Securities (TIPS) are the inflation-indexed bonds issued by the U.S. Treasury. The principal is adjusted to the Consumer Price Index, the commonly used measure of inflation. The coupon rate is constant, but generates a different amount of interest when multiplied by the inflation-adjusted principal, thus protecting the holder against inflation.

Federal Income Tax Treatment: The interest payments from these securities are taxed for federal income tax purposes in the year payments are received (payments are semi-annual - every six months) as one would expect. The inflation adjustment credited to the bonds is also taxable each year, which might not be expected. This tax treatment causes an interesting effect: Even though these bonds are intended to protect the holder from inflation, the cash flows generated by the bonds are actually inversely related to inflation until the bond matures. For example, during a period of no inflation, the cash flows will be exactly the same as for a normal bond, and the holder will receive the coupon payment minus the taxes on the coupon payment. During a period of high inflation, the holder will receive the same cash flow, but will also have to pay additional taxes on the inflation adjusted principal.

The details of this tax treatment can have unexpected repercussions. An investor should seek advice from a tax advisor prior to purchasing these bonds.

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STRIPS

T-Notes, T-Bonds and TIPS may be "stripped", separating the interest and principal portions of the security; these may then be sold separately (in units of $1000 face value) in the secondary market. Such securities are known as STRIPS ("Separate Trading of Registered Interest and Principal Securities" being a backronym); the name derives from the notional practice of literally tearing the interest coupons off of (paper) securities

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Savings bond

Savings bonds are nontransferable treasury securities. Although they cannot be traded on the secondary market, they can be cashed before their maturity date after a required holding period, which is currently twelve months. They are also registered securities so they can be replaced if lost or destroyed. Savings bonds do not have coupons. Interest is accrued, being paid out only upon the bond's redemption.

The treasury first offered the predecessor to savings bonds, called "baby bonds," in March, 1935. The bonds were issued in denominations from $25 to $1,000. They were sold at 75 percent of face value, and accrued interest at the rate of 2.9% per year, compounded semiannually when held for their ten-year maturity period.

Series A bonds were sold in March, 1935. Series B bonds were offered in 1936. Series C bonds were offered in 1937 and 1938. Series D bonds were sold from 1939 through April, 1941. The series E bonds started in May, 1941 and played a major role in financing World War II. Series E bonds sold for almost forty years before they were withdrawn from sale on June 30, 1980.

Series EE savings bonds were introduced in 1980 to replace the series E bond. They are sold at a discount to their face value. The interest on series EE bonds purchased since 1989 is exempt from federal and state taxes if it is used for education expenses. Since December 11, 2001, series EE bonds have been incribed with the words "Patriot Bonds."

Series HH savings bonds originally sold in denominations from $500 to $10,000. Series E and EE savings bonds were able to be exchanged for them. The Series HH bonds pay interest semianually and mature in ten years. Federal income tax on these bonds can be deferred until the bonds are sold or mature. These bonds have not been available for purchase from the treasury, or via exchange of other bonds since September 1, 2004. See Here for Beurau of Public Debt FAQ on the HH and H Bonds

Series I Bonds are sold at face value and grow in value with inflation-indexed earnings for up to 30 years. I Bonds gain interest once a month, with interest being compounded twice per year. The composite interest rate has two components (multiplied, not added): a guaranteed fixed rate, which does not change over the 30 year period; and a semiannual inflation rate, which is adjusted twice per year. Even in times of deflation, the composite interest rate is guaranteed never to go below zero, meaning an I Bond's redemption value can never go down.

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Zero-Percent Certificate of Indebtedness

Funds that are deposited in a TreasuryDirect account, are automatically used to purchase a Zero-Percent Certificate of Indebtedness (Zero-Percent C of I or simply, C of I). The C of I is a Treasury security that does not earn any interest. It is intended to be used as a source of funds for Series EE and Series I bonds.

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Source

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See also

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External links

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References

  • "Series A, B, C, D, E, F, G, H, J, and K Savings Bonds and Savings Notes". Bureau of the Public Debt. Retrieved Sep. 9, 2005.