Subject: Bonds - Treasury Debt Instruments

Last-Revised: 1 Jan 2002
Contributed-By: Art Kamlet (artkamlet at aol.com), Dave Barrett, Rich Carreiro (rlcarr at animato.arlington.ma.us)

The US Treasury Department periodically borrows money and issues IOUs in the form of bills, notes, or bonds ("Treasuries"). The differences are in their maturities and denominations:

BillNoteBond
Maturityup to 1 year1--10 years10--30/40 years
Denomination $1,000$1,000$1,000
Minimum purchase $1,000$1,000$1,000

Treasuries are auctioned. Short term T-bills are auctioned every Monday. The 4-week bill is auctioned every Tuesday. Longer term bills, notes, and bonds are auctioned at other intervals.

T-Notes and Bonds pay a stated interest rate semi-annually, and are redeemed at face value at maturity. Exception: Some 30 year and longer bonds may be called (redeemed) at 25 years.

T-bills work a bit differently. They are sold on a "discounted basis." This means you pay, say, $9,700 for a 1-year T-bill. At maturity the Treasury will pay you (via electronic transfer to your designated bank checking account) $10,000. The $300 discount is the "interest." In this example, you receive a return of $300 on a $9,700 investment, which is a simple rate of slightly more than 3%.

The best way for an individual to buy or sell Treasury instruments is via the US Treasury's "TreasuryDirect" program, which provides for no-fee/low-fee transactions. Please see the article elsewhere in this FAQ for more information about using the TreasuryDirect program. Of course treasuries can also be bought and sold through a bank or broker, but you will usually have to pay a fee or commission to do this, not to mention maintain an account.

Treasuries are negotiable. If you own Treasuries you can sell them at any time and there is a ready market. The sale price depends on market interest rates. Since they are fully negotiable, you may also pledge them as collateral for loans. (Note that if the securities are held by the Treasury as part of their TreasuryDirect service, then they cannot be used as collateral.)

Treasury bills, notes, and bonds are the standard for safety. By definition, everything is relative to Treasuries; there is no safer investment in the U.S. They are backed by the "Full Faith and Credit" of the United States.

Interest on Treasuries is taxable by the Federal Government in the year paid. States and local municipalities do not tax Treasury interest income. T-bill interest is recognized at maturity, so they offer a way to move income from one year to the next.

The US Treasury also issues Zero Coupon Bonds. The ``Separate Trading of Registered Interest and Principal of Securities'' (a.k.a. STRIPS) program was introduced in February 1986. All new T-Bonds and T-notes with maturities greater than 10 years are eligible. As of 1987, the securities clear through the Federal Reserve's books entry system. As of December 1988, 65% of the ZERO-COUPON Treasury market consisted of those created under the STRIPS program.

However, the US Treasury did not always issue Zero Coupon Bonds. Between 1982 and 1986, a number of enterprising companies and funds purchased Treasuries, stripped off the ``coupon'' (an anachronism from the days when new bonds had coupons attached to them) and sold the coupons for income and the non-coupon portion (TIGeRs or Strips) as zeroes. Merrill Lynch was the first when it introduced TIGR's and Solomon introduced the CATS. Once the US Treasury started its program, the origination of trademarks and generics ended. There are still TIGRs out there, but no new ones are being issued.

Other US Debt obligations that may be worth considering are US Savings Bonds (Series E/EE and H/HH) and bonds from various US Government agencies, including the ones that are known by cutesy names like Freddie Mac, as well as the Mae sisters, Fannie, Ginnie and Sallie.

Historically, Treasuries have paid higher interest rates than EE Savings Bonds. Savings Bonds held 5 years pay 85% of 5 year Treasuries. However, in the past few years, the floor on savings bonds (4% under current law) is higher than short-term Treasuries. So for the short term, EE Savings Bonds actually pay higher than treasuries, but are non-negotiable and purchases are limited to $15,000 ($30,000 face) per year.

US Government Agency Bonds, in general, pay slightly more interest but are somewhat less predictible than Treasuries. For example, mortgage-backed-bond returns will vary if mortgages are redeemed early. Some agency bonds, technically, are not general obligations of the United States, so may not be purchased by certain institutions and local governments. The "common sense" of many people, however, is that the Congress will never allow any of those bonds to default.

In October 2001, the Treasury Department announced that it was suspending issuance of the 30-year bond and had no plans to issue that security ever again.

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