For years, investors who wanted to preserve their capital have consistently turned to one instrument: Treasury Securities (or ‘Treasuries’). Treasury instruments such as T-bills, bonds, notes, and bond funds have been offering investors not just the stability they are looking for from their investments but also the handsome returns to keep them afloat over inflation. To understand them better, just remember that the difference between bills, notes, and bonds is the length until they mature.
- Treasury bills will mature in less than 12 months.
- Treasury notes carry terms of 2, 3, 5, and 10 years.
- Treasury bonds take the longest to mature at 30 years.
What is a Treasury Bond or a T- Bond?By definition, Treasury Bonds (or T-Bonds) are long-term bonds that the U.S. Treasury Department issues. They typically mature in 10 to 30 years and have a $1,000 face value. The holder of T-Bonds can expect to receive interest payments semi-annually. Their purpose is to help fill the gaps in the federal budget, regulate the nation’s money supply, and administer the country’s monetary policy. As the custodian of the country’s coffers, the U.S. Treasury studies the market’s risk and return conditions to effectively and efficiently raise capital and funds. T-Bonds carry with them the backing of the full faith and credit of the U.S. government. This gives T-bonds a generally risk-free status in the investment market. However, due to the absence of default risk and the presence of high liquidity, Treasuries can get away with offering the lowest yields among bonds their peer. T-Bonds are the benchmarks of the fixed income asset class. If you study the profile of Treasuries investors, you will notice that institutional investors account for the majority of the market. This does not mean, however, that individual investors can not invest in T-Bonds – they can easily purchase them if they want. Income from Treasuries is subject to federal taxes but they are normally exempt from most state and local taxes. This is a welcome relief for some investors, especially those who live in states with higher taxes. Overall, Treasuries may provide slightly higher returns than other securities with higher coupons but are not federally tax-exempt.
How You Can Buy Treasury Bonds?Any time you talk about buying a Treasury Bond, you will always come across the term ‘bidding’ because essentially, that is how an investor can acquire a T-Bond after its issuance. The system of bidding on Treasury Bonds started around 1963 when banks and securities firms bought them competitively. Nowadays, the Department of Treasury puts up 30-years bonds for auctions for four months of the year: February, May, August and November. If you don’t want to go through the bidding process, you may still purchase Treasury bonds through a broker, dealer, bank, investment house, or thru TreasuryDirect. The advantages of buying via TreasuryDirect is that you can do most of your bond transactions online, such as buying bonds, reinvesting them, and managing your account. The cool thing is that you don’t have to pay any maintenance fees on these bonds so you preserve your income as well. If you’re the patient type of investor who can really wait for your investment to grow but also want a respectable rate of return, a T-Bond will suit you to a ‘T’ (no pun intended). It’s also one of the rare instruments that suffers no value loss over the years. But if 30 years is a long time even for you and you don’t want to pay penalties if you redeem early, there are other short-term investments you can consider. This is how the selling goes. Initially, the buyer will participate in an auction for the bond issues. The maximum purchase amount is $5 million if the bid is noncompetitive. If the bid is competitive, it’s set at 35% of the offering. A competitive bid will indicate the interest rate that the bidder is willing to accept in relation to how it compares to the specified rate of the bond issue. For a non-competitive bid, the bidder gets the bond but he has to accept the set rate of the bond. After the auction, they can already sell the bonds in the secondary market. There is a very robust secondary market for Treasury Bonds that makes the investment extraordinarily liquid. It is also the secondary market that causes the price of Treasury Bonds to fluctuate considerably each trading day. Because of this, the current auction and yield rates of T-Bonds dictate how their prices will behave in the secondary market. Similar to other types of bonds, the price of a Treasury Bond on the secondary market goes down when the auction rates increase because bidders discount the value of the bond’s future cash flow at the higher rate. Inversely, when prices increase, auction rate yields go down.
The Treasury Bond FormulaThe Treasury Bond formula is much like the T-bill formula except that a T-bond has interest payment or coupons. You can calculate the Treasury Bond rates, current price, coupons, as well as the face value by using these formulas:
Example Of Treasury BondLet’s say Baruch buys a 10-year, $2,000 T-Bond with a current YTM of 3%. The bond will mature in 8 years and pays a 5% coupon annually. Compute for the current price of the bond. Using the formula above, this is how it will go:
The Pros and Cons of Treasury Bond InvestmentInvesting in treasury bonds can have a great option. Like any other investment tool, it can fit for some types of investors profile, depends on their goals, level of risk and expected yield in the current market situation.
|High Credit Quality||Low Yield|
|Tax Advantages||Missing Alternatives|
|Liquidity||Interest Rate Risk|