What is a Treasury Bond?

A Treasury bond is like a long-term IOU…

If you lend some money to your friend, they might give you a signed paper, an IOU, promising to pay you back at some date in the future. A Treasury bond is like an IOU from the government. The government promises to return your money to you 10 to 30 years from now, but also to provide interest payments in the interim.

A Treasury bond is a type of fixed-income security issued by the United States government. Individuals and large organizations such as banks can purchase the bonds directly from the Treasury. The Treasury allows purchases in $100 increments from a minimum of $100 to a maximum of $5 million at a time.

Treasury bonds are long-term bonds. Currently, the Treasury offers bonds with maturities of 20 or 30 years. The government also offers shorter-term securities called T-bills or T-notes. These can have maturities as short as a few weeks or as long as a few years.

Many investors treat U.S. government bonds as risk-free assets. The government backs its promise to pay with the strength of the American economy and its power to tax Americans. That makes the risk of default (a failure to make interest payments) exceedingly low. In reality, all investments have risk, but most investors treat U.S. government bonds as one of the closest to having no risk among all securities.

Because Treasury bonds serve as an essentially risk-free asset, the going rate for the bonds is important for many investors. Riskier investments, such as bonds from less stable countries or businesses, or stocks, must offer a higher return to justify the increased risk.

Both individual investors and institutions like banks can purchase Treasury bonds from the government. Individuals can place orders directly through the government’s TreasuryDirect website, while institutional investors buy bonds at auction. The auctions usually occur online, and individuals can only participate through a broker. Investors can also purchase bonds through other means.

The Treasury starts the process by announcing an auction date and the bonds it plans to sell at the auction. Large investors can submit competitive bids at the auction to purchase bonds. These bids include the amount they wish to buy and the interest rate they’re willing to accept from the government. The Treasury fills competitive bids, starting with the lowest rate bids until it meets its borrowing needs.

Individual investors who wish to buy a Treasury bond receive bonds at the highest rate that the government accepted at the auction. Large investors can also submit noncompetitive bids, including just the amount of bonds they’re willing to purchase. They also receive bonds with the rates determined at the auction.

When an investor buys a Treasury bond, they receive interest payments based on the face value of the bond (how much the original purchaser paid to the government) and the interest rate agreed to at the time the bond was issued. The government makes the payments twice per year. Once the bond matures, the government repays the bond’s face value and stops making interest payments.

You can hold a Treasury bond until it matures, or you can sell it to other investors. If you sell the bond, the buyer will receive future interest payments and the face value of the security when the government redeems it. Typically, if yields (the ratio of its interest payment divided by its current market value) have increased since the government issued a bond, the bond will lose value. If rates have decreased, the bond gains value. When the bond matures, the holder receives the face value from the government.

There are two significant differences between Treasury bonds and Treasury bills.

Treasury bonds are long-term securities that investors purchase at their face value. Most mature 20 or 30 years from the date of issue and make interest payments twice per year. The size of the payment is based on the interest rate of the bond and its face value.

Treasury bills are short-term securities that mature no more than 52 weeks from the date of issue. Instead of buying a T-bill at its face value, investors purchase them at a discount to their face value.

Unlike T-bonds, T-bills do not offer interest payments. Instead, the holder of the bill receives the face value of the bond when it matures. Because you buy a bill at a lower cost than its face value, the return you receive is equal to the difference between the face value and the purchase price. For example, say ou buy a $100 T-bill for $95 — When it matures, you’ll get $100, $5 more than you paid.

Like a Treasury bond, you can hold a T-bill until it matures or you can sell it to another investor on the open market. Also, like bonds, the value of bills changes as market rates change. Bills gain value when rates drop and lose value as rates increase.

The interest you earn from both Treasury bonds and bills is exempt from state income taxes, but you do have to pay federal income tax on the interest you earn.

Treasury bonds and Treasury notes are very similar, with the primary difference being the terms available.

Treasury bonds are long-term securities that have maturities of up to 30 years. Investors receive interest payments twice per year based on the face value and the interest rate. When the bond matures, the government returns the face value to the investor.

Treasury notes are medium-term securities, with maturities ranging from two to 10 years. A similarity between T-bonds and T-notes is that investors purchase them at their face values and receive semiannual interest payments. Also, like T-bonds, investors can hold the notes to maturity, when they receive the face value of the note from the government or sell them to other investors before maturity.

Treasury bonds pay interest based on the interest rate when the government issued the bond and the face value of the bond. The government makes interest payments twice per year. Your first payment comes six months after the bond is issued. The next payment comes six months after that. The pattern continues until the bond matures.

For example, if you purchased a 30-year T-bond with a face value of $1,000 and an interest rate of 5% in July of 2020, you’d get your first payment of $25 in January 2021, your second payment of $25 in July 2021, and additional $25 payments every January and July. When the bond matures in July 2050, the holder of the bond receives the $1,000 face value of the bond.

Whether Treasury bonds are a good investment depends on the investor’s individual goals.

T-bonds, like most fixed-income securities, offer lower potential returns than investments like stocks. However, they also reduce the risk in the investor’s portfolio. Many people advise holding a combination of stocks and bonds based on your risk tolerance and goals.

If you’re young and saving for retirement, some advisors argue that you can hold more stocks than bonds. If you’re nearing retirement age, increasing the number of bonds you hold can reduce your investment risk. The interest payments can also provide a source of income that you can use to pay for retirement expenses.

The rate that Treasury bonds pay changes daily. On February 9th, 2021, the average rate for Treasury bonds was 1.19%. Throughout 2020, rates varied from a high of 2.28% to a low of 0.97%.

Once the government sells a bond, it continues to pay the same interest rate for the life of the bond. Interest rate changes only affect the interest payments on newly issued bonds. However, the value of a bond on the secondary market is partially determined by its interest rate and the market rate for similar bonds. As yields (the ratio of a bond’s interest payment divided by its current market value) increase, existing bonds tend to lose value. When interest rates drop, existing bonds tend to gain value.

Investors can purchase Treasury bonds in a few different ways.

One method is purchasing the bonds directly from the Treasury through the TreasuryDirect website. Individuals purchasing bonds through TreasuryDirect receive bonds with interest rates based on the rates determined at the auction for institutional investors. You can purchase T-bonds in $100 increments up to a maximum of $5 million.

You can also purchase bonds from a broker or dealer. With this method, you can submit a bid to buy bonds at auction, specifying the interest rate that you’re willing to accept for the bond.

Investors can sell bonds on the open market after they purchase them, so you can also purchase T-bonds directly from other investors. Bear in mind there is usually a cost involved in this type of transaction called a mark-up.