Government Bonds and Securities

Bond Basics

• A bond is a debt instrument where an investor lends money to an entity (like a company or government) for a defined period at a fixed interest rate.
• Government securities are investment products offered by a governmental body, such as US Treasury bonds, bills, and notes.

Who Can Issue Bonds?

• Companies can issue corporate bonds.
• Governments can issue government bonds.

Bond Features

• Face value: the amount written on the bond certificate.
• Maturity date: when the bond will be redeemed.
• Coupon rate: the interest rate paid periodically.

Government Bond Basics

• The US government is the largest single borrower in the world, with a gross public debt of over $5 trillion in 2007.
• The US Treasury finances government debt by issuing marketable and non-marketable securities.
• Municipal government debt is a large debt market, with over 85,000 state and local governments contributing to about $2 trillion of outstanding debt.

Types of Government Bonds

• Marketable securities: can be traded among investors; include T-bills, T-notes, and T-bonds.
• Non-marketable securities: must be redeemed by the issuer; include US Savings Bonds, Government Account Series, and State and Local Government Series.

Key Points

• Government securities come with a promise of full repayment of invested principal at maturity.
• Government securities often pay periodic coupon or interest payments.
• Government securities are considered conservative investments with low-risk since they have the backing of the government that issued them.
• However, these securities may pay a lower rate of interest than corporate bonds.

Why are Government Securities Issued?

• To raise funds for government expenditures.
• To control the supply of money in an economy.

Who Buys Government Securities?

• Institutional investors buy government securities through auctions.
• Retail investors can purchase government securities directly from the Treasury Department's website, banks, or through brokers.

Pros and Cons of Government Securities

• Pros:*
• Steady stream of interest income.
• Low default risk.
• Some securities are exempt from state and local taxes.
• Can be bought and sold easily.
• Available through mutual funds and exchange-traded funds.
• Cons:*
• Low rates of return relative to other securities.
• Interest rates may not keep up with inflation.
• Foreign government securities can be risky.
• May pay a lower rate in a rising-rate market.

Treasury Bills (T-Bills)

• Typical maturities: 4, 8, 13, 26, and 52 weeks.
• Pay a higher interest rate return as the maturity terms lengthen.

Treasury Notes (T-Notes)

• Maturities: 2, 3, 5, or 10 years.
• Pay a fixed-rate coupon or interest payment semi-annually.
• Face values: 1,000(exceptfor2−and3−yearnotes,whichhave1,000 (except for 2- and 3-year notes, which have 1,000(exceptfor2−and3−yearnotes,whichhave5,000 face values).

Treasury Bonds (T-Bonds)

• Maturities: 10 to 30 years.
• Face values: $1,000.
• Pay semi-annual interest returns.
• Used to fund deficits in the federal budget.
• The Fed controls the money supply and interest rates through the buying and selling of T-Bonds.

U.S. Treasury STRIPS

• Separate Trading of Registered Interest and Principal of Securities.
• Derived from 10-year T-notes and 30-year T-bonds.
• Effectively zero-coupon bonds.
• STRIPS price is calculated as the present value of a single cash flow.

Credit Ratings

• Ratings agencies: Moody's, Standard & Poor's, Fitch Ratings.
• Ratings range from Aaa (highest quality) to C (poor quality).
• Investment grade ratings: Aaa to BBB.
• Non-investment grade ratings: BB to C.