Treasury security

Treasury Securities are bonds issued by the U.S. Treasury. They are the debt finance instruments of the Federal government, and are often referred to 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.

Contents

Treasury bill

Treasury bills (a.k.a. T-bill) mature in one year or less. They are zero-coupon bonds. 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, 6 months, or 1 year.

Treasury note

Treasury notes (a.k.a. T-Note) mature between one and ten years. They have coupon payment every six months. There are two kinds of Treasury Notes. They are fixed principal and inflation-indexed Treasury notes. Inflation Indexed Notes adjust the principal for inflation. Treasury notes are commonly issued with maturities dates of 2, 3, 5 or 7 years.

The U.S. 10-year Treasury note has become the security most frequently quoted when discussing the performance of the 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.

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. T-Bonds 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. The secondary market for both STRIPS and unstripped bonds 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 May 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 might be re-introduced in early 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 is even offering a 50-year bond) A final decision by the U.S. Treasury will be announced in August 2005.

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 treatments cause 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.

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.

See also

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