Treasury Securities

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Treasury Securities

What It Means

The United States Department of the Treasury is the department in the U.S. federal government that manages the country’s revenue (funds). The Treasury sells financial assets called securities to individuals, institutions (both inside and outside of the United States), and foreign governments. To be more precise, by selling Treasury securities to people or institutions, the government is borrowing money from them. This borrowed money, which is used to fund various government programs and services, is part of the country’s national debt. In exchange for lending their money, purchasers of Treasury securities get to collect a fee (called interest) after a specified period of time.

In the world of investing, there are various kinds of securities (stocks, for instance); the kind that the U.S. Treasury sells are called bonds. Bonds require the issuer (in this case the federal government) to pay the holder of the bond the face value of the bond plus interest (an additional fee added to the loan) at a specific time in the future. The day the original amount must be repaid is referred to as the day the bond matures. There are five types of Treasury securities: Treasury bills (T-bills), Treasury notes (T-notes), Treasury bonds (T-bonds), Treasury Inflation-Protected Securities (TIPS), and savings bonds.

In effect, a person who buys a Treasury security is loaning the government money for a specific period of time and in exchange for a specific fee. For example, if an individual purchased a $970 T-bill that matured in six months, that person would be lending the federal government $970 for six months. Suppose that the agreed-upon interest rate for this bond was 3.09 percent. If the person bought it in January, the government would repay the investor $1,000 in June, when the bond matured. The additional $30 would be the interest (also called the coupon) on the loan (because 3.09 percent of $970 is $30).

When Did It Begin

During World War I (1914–18) the United States began loaning large sums of money to the Allied forces (Great Britain, France, and Russia) to help them fund the war. To raise money for the loans, the U.S. government borrowed money from U.S. citizens by issuing Liberty Bonds, which were the first Treasury securities. The country lost money on these bonds because after the war the European nations were either unable to repay the loans or could only repay them at drastically reduced rates of interest. Meanwhile, the Liberty Bonds were maturing, and U.S. citizens were owed money on the loans they had made to the government. The government repaid U.S. citizens at the initially promised rates of interest. Liberty Bonds were, however, discontinued after World War I.

The government made no similar offerings to the public until 1935, when it began selling “baby bonds,” so called because they were issued in small denominations. From 1935 to 1941 the government issued $3.5 billion worth of these bonds at 2.9 percent interest. During World War II (1939–45) the Treasury Department took baby bonds off the market and started issuing Defense Savings Bonds at the same interest rates. After the Korean War (1950–53) these bonds were renamed “savings bonds.”

More Detailed Information

Each of the different types of Treasury security is issued on different terms. The shortest-term securities are Treasury bills (T-bills). These are issued in denominations of $1,000 up to a maximum of $5 million and with maturity dates of 4 weeks (one month), 13 weeks (three months), or 26 weeks (six months). The Bureau of the Public Debt (an agency in the Department of the Treasury) holds weekly auctions for T-bills at more than 40,000 locations throughout the United States. There are two ways for an investor to bid on a T-bill: noncompetitive bids and competitive bids. In a noncompetitive bid the investor agrees to an interest rate established by the Bureau of Public Debt at the auction. Investors making noncompetitive bids are guaranteed to receive the bill they request (a T-bill in the desired amount that matures at the desired time). With a competitive bid the investor requests a higher interest rate. These bids may be accepted, rejected, or accepted in part (for less than the desired amount, less than the desired interest rate, or both). Noncompetitive bids can be made directly to the government or through a bank or broker. Competitive bids must be made through a bank or broker.

Although T-bills are issued in denominations of $1,000, the terms of the transaction are slightly more complicated. T-bills are actually issued at a discount, the amount of which is determined by the interest rate. For example, a 13-week $10,000 T-bill with an interest rate of 2.04 percent would be issued at the discount rate of $9,800. At the end of the 13 weeks, the investor receives $10,000; this is the original amount plus the interest fee, which is 2.04 percent of the original amount, or $200.

Treasury notes, or T-notes, are longer-term securities. Issued in denominations of $1,000 up to a maximum of $1 million, they have maturities of 2, 3, 5, or 10 years. The Treasury pays the investor interest on T-notes every six months. When the bond matures, the investor receives face value, meaning that if a two-year bond was issued for $10,000, the investor will be paid $10,000 at the end of two years. During this time the investor will have received four interest payments. T-notes are auctioned less frequently than T-bills (monthly or a few times a year, depending on the kind of note). As with T-bills, investors can make either competitive or noncompetitive bids for T-notes.

T-bonds are issued for even longer; they mature in 10 to 30 years, and, like T-notes, they pay interest every six months. T-bonds tend to have the highest interest rates, as a way to persuade people to loan their money for such a long time.

In 1997 the U.S. Treasury began issuing another kind of security, called Treasury Inflation-Protected Securities (TIPS). Inflation, the general rising of prices, decreases the value of the dollar, and many investors are worried about their money losing value this way. TIPS were designed to address this concern. These securities have 5-, 10-, and 25-year maturities and pay interest every six months. With TIPS the principal (the face value of the security) increases with inflation and decreases with deflation (a general decline in prices). This means that if an investor purchased a five-year TIPS for $10,000 (the principal), and the economy subsequently experienced significant inflation, the face value of the security would be adjusted (in this case increased) to reflect the general rise in prices.

Finally, savings bonds are Treasury securities for individual investors only. These securities must be held for at least one year and can be redeemed anytime thereafter. Unlike the other Treasury securities, savings bonds cannot be traded among investors, because they are registered to the original purchaser.

Recent Trends

The U.S. Treasury market is considered the safest market in the world. This means that investors are more likely to earn a profit on their investment if they purchase U.S. Treasury securities than if they invest in any other market. Because of this reliability, the central banks of other countries often buy U.S. Treasury securities. Starting in 2000 there was an increase in foreign demand for such securities; foreign investors wanted to make safe investments to balance out their more risky investments in developing nations (which are not industrialized and tend to have unstable economies). At the end of 2003, nearly 38 percent of the money the U.S. government owed on Treasury securities was owed to foreign investors.

While foreign investors in the international market at this time were financially cushioned by the modest profits they earned from Treasury securities, investors within the United States were not drawing as much profit from these securities as they had in the past. This was because, with so many international lenders eager to invest in the United States, the U.S. Treasury was able to charge more for its securities while offering lower interest rates.

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