Government Securities

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The U.S. government is a huge issuer of securities that it sells to investors all over America - and also investors from overseas. The securities it issues are essentially various types of bonds, and because of the tremendous financial strength and stability of the U.S. government, the bonds it issues are probably the safest investment you can make. Like any other bond issuer, the government issues securities to raise money and to provide a way for all investors - institutional investors and individuals - to invest money with little risk of default. However, because the investment is so secure, government securities do not usually pay the highest coupon rates. They don't need to: investors are willing to sacrifice higher returns for stability and safety. ( Savings bonds are also a type of government security, but are primarily intended for individual savers. Savings bonds cannot normally be traded like other government securities and can usually only be redeemed [cashed in] by the holder of the savings bond whose name appears on the bond.) The government issues three main types of bonds, distinguished by when they mature. (See Maturity Date [Bonds].) First are the treasury bonds, sometimes known as T-bonds or treasuries. The T-bond has historically been the most important government security, issued in amounts (known as denominations) of between $1,000 and $1,000,000 and offering maturities of between ten and thirty years. (In April 2008 the Treasury Department reduced the minimum denomination to $100.) In 2001 the government stopped issuing new treasury bonds; however, there are many T-bonds still in circulation and paying interest twice a year. You can buy these bonds in the secondary market. Most of these bonds can be bought and sold until they mature, but some bonds issued before 1985 have a callable feature, so investors looking to buy T-bonds from before 1985 should be aware of that. Because of the length of their maturity these bonds are a form of long-term debt. (After a five-year gap, the federal government began reissuing thirtyyear treasury bonds in February 2006.) Second are treasury bills, or T-bills, which are also a type of bond but with much shorter maturity periods of no more than a year. These T-bills are sold by the government at regular auctions where investors bid on them at a discount to their face value. This means that a 26-week $10,000 bill might sell for $9,500; there are no coupon payments, but at maturity (in this case, after 26 weeks) the investor receives back the full face value of the bill, so the effective interest earned would be $500. This makes T-bills a kind of zero coupon bond. These T-bill auctions are closely watched, as the demand for the bills and the ultimate prices paid give an indication of interest rate trends. T-bills are short-term debt and the minimum purchase before April 2008 was $1,000, at which time the minimum was reduced to $100. In between long-term T-bonds and short-term T-bills are treasury notes, issued with maturities of between two and ten years; T-notes are intermediate-term debt. Like T-bonds, T-notes pay interest every six months and can be bought and sold before they mature. Like T-bills, new issues are sold at auction by the government, and like all treasury securities, since April 2008 the minimum denomination has been $100. The interest income from all these three types of government bonds is typically exempt from state taxes, but still subject to federal income tax. There is another type of government security, which offers investors protection against the threat of inflation causing an effective reduction in the value of the investment. These are called treasury inflation-protected securities (TIPS). The value of the principal will rise with inflation (and fall with deflation) based on the consumer price index (CPI). These securities pay interest twice a year, and to calculate the payment the coupon rate is applied to the increased (or decreased) principal. Protection against inflation sounds like an attractive proposition; however, the coupon rate for TIPS is set significantly lower than for other government securities. This means that for TIPS to be appealing, the inflation rate has to be high enough to make up the difference. For example, compare a "regular" government security paying a coupon rate of 5.2% with a TIPS that pays 2.1%. For investors, the breakeven point is the difference between the two rates, which is 3.1%. Therefore, unless inflation as measured by the CPI increases to over 3.1% and the TIPS rises accordingly so that the total yield is greater than the 5.2% of the other security, investors are probably better off buying regular government securities. In recent years (2007 and earlier) inflation has been low, so investors have tended to do just that and have avoided TIPS. Note that there are tax implications involved in buying any government security.