Treasuries

U.S. Treasuries are issued by the U.S. Department of the Treasury on behalf of the federal government.

They carry the full faith and credit of the U.S. government, making them a safe and popular investment.

Because they are considered to have low credit or default risk, they generally offer lower yields relative to other bonds.

Types of U.S. Treasury debt include:

• Treasury Bills (T-bills) are short-term securities maturing in a few days to 52 weeks.
• Treasury Notes (T-notes)are longer-term securities maturing within ten years.
• Treasury Bond (T-bones) are long-term securities that typically mature in 30 years and pay interest every six months.
• TIPS (Treasury Inflation-Protected Securities) are notes and bonds whose principal is adjusted based on changes in the Consumer Price Index. TIPS pays interest every six months and is issued with maturities of five, ten, and 30 years.

Types of Treasuries

Newly issued Treasuries can be purchased at auctions held by the government, while previously issued bonds can be purchased on the secondary market.

Benefits of Treasuries

Credit quality

Treasury securities are considered to be of high credit quality and are backed by the full faith and credit of the U.S. government.

That backing carries weight due to the federal government’s taxing power and the relative size and strength of the U.S. economy.

However, in August 2011 the long-term sovereign credit rating on the United States of America was downgraded to AA+ from AAA by the Standard & Poor’s rating agency, reflecting increasing concerns about the U.S. budget deficit and its future trajectory.

Tax advantages

Interest income from Treasury bonds is exempt from state and local income taxes but is subject to federal income taxes.

Other components of your return, however, may be taxable when the bonds are sold or mature.

If you buy a bond for less than face value on the secondary market (known as a market discount) and you either hold it until maturity or sell it at a profit, that gain will be subject to federal and state taxes.

Buying a bond at a market discount is different than buying a bond at an Original Issue Discount (OID).

When a bond is sold or matures, gains resulting from purchasing a bond at a market discount are treated as capital gains while OID gains are treated as a type of income.

Liquidity

Large volumes of Treasuries are bought and sold throughout the day by a wide range of institutions, foreign governments, and individual investors so they are considered to be highly liquid.

Investors considering Treasury securities have opportunities to buy bonds both at regularly scheduled auctions (see Auction Schedule) and in the secondary market, which is one of the world’s most actively traded markets. Investors can find Treasury bills, notes, and bonds posted with active bids and offers.

Spreads (the difference in price between the bid and offer) are among the most narrow available in the bond market. Investors should, however, be aware that at certain times, such as when important economic data is released, Treasury securities can be at their most volatile.

Choice

Treasuries come in maturities of 4 weeks to 30 years, with longer maturities usually offering higher coupons.

Treasuries also come in various structures, like Treasuries with coupons, zero-coupon Treasuries, and Treasury inflation-protected securities (TIPS), whose principal and returns adjust to reflect changes in the consumer price index.

Risks of Buying Treasuries

Lower yields
Treasury securities typically pay less interest than other securities in exchange for lower default or credit risk.

Interest rate risk
Treasuries are susceptible to fluctuations in interest rates, with the degree of volatility increasing with the amount of time until maturity. As rates rise, prices will typically decline.

Inflation risk
With relatively low yields, income produced by Treasuries may be lower than the rate of inflation. This does not apply to Treasury inflation-protected securities (TIPS).

Credit or default risk
Investors need to be aware that all bonds have the risk of default. Investors should monitor current events, as well as the ratio of national debt to gross domestic product, Treasury yields, credit ratings, and the weaknesses of the dollar for signs that default risk may be rising.

Coupon or No Coupon

Buyers of Treasury notes (which have shorter-term maturities, from 1 to 10 years) and Treasury bonds (which have maturities of up to 30 years) receive interest payments, known as coupons, on their investment.

The coupon rate is fixed at the time of issuance and is paid every six months.

Other Treasury securities, such as Treasury bills (which have maturities of one year or less) or zero-coupon bonds, do not pay a regular coupon.

Instead, they are sold at a discount to their face (or par) value.

Investors receive the full face value at maturity. These securities are known as Original Issue Discount (OID) bonds since the difference between the discounted price at issuance and the face value at maturity represents the total interest paid in one lump sum.