United States Treasury security: Difference between revisions

Treasury securities are government bonds issued by the United States Department of the Treasury through 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 and are heavily traded on the secondary market.

Treasury bill

Treasury bills (or 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 a 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 91 days (~3 months), and 182 days (~6 months). Treasury Bills are sold weekly at an auction held on Mondays. Banks and financial institutions, especially primary dealers, are the largest purchasers of T-Bills. They are quoted for purchase and sale in the secondary market on an annualized percentage yield to maturity, or 'basis'.

Treasury note

Treasury notes (or T-Notes) mature in one to ten years. They have a coupon payment every six months, and are commonly issued with maturities dates of 2, 3, 5 or 10 years, 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. Thus, for example, 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 benchmark for setting mortgage interest rates.

Treasury bond

Treasury bonds (or T-Bonds) mature in ten years or longer. They have coupon payment every six months like T-Notes, and 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, due to demand from pension funds and large, long-term institutional investors, along with a need to diversify the Treasury's liabilities - and also because the flatter yield curve meant that the opportunity cost of selling long-dated debt had dropped - the 30-year Treasury bond was 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. Some countries, including France and the United Kingdom have begun offering a 50-year bond, known as a Methuselah.

TIPS

Treasury Inflation-Protected Securities (or 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. TIPS are currently offered in 5-year, 10-year and 20-year maturities. 30-year TIPS are no longer offered.

The interest payments from these securities are taxed for federal income tax purposes in the year payments are received (payments are semi-annual, or 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.

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.

Savings bond

Savings bonds are treasury securities for individual investors. About one in six Americans - more than 50 million individuals - have together invested more than $200 billion in savings bonds. However, all savings bond investments together cover only a minor portion - less than 3% - of the U.S. public debt.

Savings bonds have traditionally been issued as paper, or definitive, bonds. In October 2002 the treasury also began to offer electronic, or book, savings bonds through its online service TreasuryDirect. About a fourth of new savings bond investments are now made electronically.

Savings Bonds cannot be traded on the secondary market, but after a one-year holding period they can be redeemed at any time, making them very liquid. Since they are registered securities, possession of a savings bond is of no legal consequence; ownership is determined by the names in the treasury's records, which are also printed on paper savings bonds. Consequently, savings bonds can be replaced if lost or destroyed.

Savings bonds do not have coupons. Interest payments are compounded or accrued, which means they are added to the value of the bond and paid out only upon the bond's redemption. Unlike other treasury securities, income from these interest payments does not have to be reported to the IRS as income until the bonds are cashed, which makes savings bonds tax-deferred investments.

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. Paper EE bonds are sold at a 50 percent discount to their face value (from $50 to $10,000), and are guaranteed to be worth at least face value at "original maturity", which varies from 8 years to (presently) 20 years depending on issue date. Electronic EE bonds sold thru TreasuryDirect are sold at face value ($25 and up); however, they are guaranteed to be worth at least double their face value at original maturity, so the difference is nominal. EE Bond interest rates vary depending on issue date, and for older bonds, yields on other Treasury securities; the rate on bonds issued between May 2005 and April 2006 is fixed at 3.2% per annum. Series EE bonds issued in May 1997 or later earn interest every month, compounded twice per year, until they reach "final maturity" after 30 years; earlier EE bonds vary in interest accrual, but have the same 30-year final maturity. The interest on series EE bonds purchased since 1989 is exempt from federal and state taxes if it is used for education expenses, so long as the expenses are incurred in the same year as the bonds are redeemed. Since December 11, 2001, series EE bonds purchased thru financial institutions have been inscribed 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. [1]

Series I Bonds, which are similar to TIPS, were introduced in September 1998. They are sold at face value ($50 to $10,000 for paper bonds, $25 and up for electronic bonds) 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: 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. The significant differences between series I bonds and TIPS are that I bonds are tax-deferred and are protected from loss of value, while TIPS generally have a higher fixed rate.

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 for use as a source of funds for traditional Treasury security purchases. It is commonly used to accumulate funds from other sources (such as payroll deductions) until reaching the minimum amount for a traditional security purchase.

See also

• Government debt
• Interest
• Risk

External links

• TreasuryDirect (new) One Stop Shopping for Treasury Securities Electronically on the Internet
• Legacy TreasuryDirect:
• [http://www.treasurydirect.gov/indiv/myaccount/sectdes.htm Legacy Treasury Direct®:

Electronic Services for Treasury Bills, Notes, and Bonds]

• Bureau of the Public Debt : US Savings Bonds Online
• Major Foreign Holders of Treasury Bonds
• Bureau of the Public Debt: Series A, B, C, D, E, F, G, H, J, and K Savings Bonds and Savings Notes.
• Savings-Bond-Advisor.com