A United States Treasury security is government debt issued by the United States Department of the Treasury through the Bureau of the Public Debt. Treasury securities are the debt financing instruments of the United States Federal government, and they are often referred to simply as Treasuries. There are four types of marketable treasury securities: Treasury bills, Treasury notes, Treasury bonds, and Treasury Inflation Protected Securities (TIPS). There are several types of non-marketable treasury securities including State and Local Government Series (SLGS), Government Account Series debt issued to government-managed trust funds, and savings bonds. All of the marketable Treasury securities are very liquid and are heavily traded on the secondary market. The non-marketable securities (such as savings bonds) are issued to subscribers and cannot be transferred through market sales.
The U.S. government knew that the costs of World War I would be great, and the question of how to pay for the war was matter of intense debate. The resulting decision was to pay for the war with a balance between higher taxes (see the War Tax Act) and government debt. Traditionally, the government borrowed from other countries, but there were no other countries from which to borrow in 1917: U.S. citizens would have to fully finance the war through both higher taxes and purchases of war bonds.
The Treasury raised funding throughout the war by floating $21.5 billion in 'Liberty bonds.' These bonds were sold at subscription where officials created coupon price and then sold it at Par value. At this price, subscriptions could be filled in as little as one day, but usually remained open for several weeks, depending on demand for the bond.
After the war, the Liberty Bonds were reaching maturity, but the Treasury was unable to pay each down fully with only limited budget surpluses. The resolution to this problem was to refinance the debt with variable short and medium-term maturities. Again the Treasury issued debt through fixed-price subscription, where both the coupon and the price of the debt were dictated by the treasury.
The problems with debt issuance became apparent in the late-1920's. The system suffered from chronic oversubscription, where interest rates were so attractive that there were more purchasers of debt than supplied by the government. This indicated that the government was paying too much for debt. As government debt was undervalued, debt purchasers could buy from the government and immediately sell to another market participant at a higher price.
In 1929, the U.S. Treasury shifted from the fixed-price subscription system to a system of auctioning where 'Treasury Bills' would be sold to the highest bidder. Securities were then issued on a pro rata system where securities would be allocated to the highest bidder until their demand was full. If more treasuries were supplied by the government, they would then be allocated to the next highest bidder. This system allowed the market to set the price rather than the government. On December 10, 1929, the Treasury issued its first auction. The result was the issuing of $224 million three-month bills. The highest bid was at 99.310 with the lowest bid accepted at 99.152.
Foreign countries later started to buy U.S. debt as an investment of their surplus U.S. Dollars. There is fear that foreign countries hold so many bonds that if they stopped buying them, the U.S. economy would collapse; however, the reality is that more bonds are transferred in a single day by the Treasury than are held by any single sovereign state. The perception of this dependence furthers belief that the U.S. and China economies are so tightly linked that both fear the consequences of a potential slow down in China's purchase of those bonds. In her visit to China, U.S. State Secretary Hillary Clinton called on authorities in Beijing to continue buying U.S. Treasuries, saying it would help jumpstart the flagging U.S. economy and stimulate imports of Chinese goods.
As the economic recession continues, more doubts arise over the real value of U.S. treasury securities. Though carefully worded, Chinese premier Wen Jia Bao's warning about possible devaluation of Chinese held U.S. bonds was taken very seriously by Washington:
"Of course we are concerned about the safety of our assets. To be honest, I'm a little bit worried" ... "I would like to call on the United States to honor its words, stay a credible nation and ensure the safety of Chinese assets." - Chinese premier, Wen Jiabao, said at a news conference after the closing of China's 2009 legislative session.
However, it is important to note that such comments, while critical, were very likely indicative of Chinese "gesturing" ahead of the April 1st G-20 Economic Summit. As of April 2009, the U.S. dollar had rallied YTD against all other major world currencies. On March 18, 2009, the Federal Reserve used quantitative easing "to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months."
Treasury bills (or T-Bills) mature in one year or less. Like zero-coupon bonds, they do not pay interest prior to maturity; instead they are sold at a discount of the par value to create a positive yield to maturity. Many regard Treasury bills as the least risky investment available to U.S. investors.
Regular weekly T-Bills are commonly issued with maturity dates of 28 days (or 4 weeks, about a month), 91 days (or 13 weeks, about 3 months), 182 days (or 26 weeks, about 6 months), and 364 days (or 52 weeks, about 1 year). Treasury bills are sold by single price auctions held weekly. Offering amounts for 13-week and 26-week bills are announced each Thursday for auction, usually at 11:30 am, on the following Monday and settlement, or issuance, on Thursday. Offering amounts for 4-week bills are announced on Monday for auction the next day, Tuesday, usually at 11:30 am, and issuance on Thursday. Offering amounts for 52-week bills are announced every fourth Thursday for auction the next Tuesday, usually at 11:30 am, and issuance on Thursday. Purchase orders at TreasuryDirect must be entered before 11:00 on the Monday of the auction. The minimum purchase - effective April 7, 2008 - is $100. (This amount formerly had been $1,000.) Mature T-bills are also redeemed on each Thursday. Banks and financial institutions, especially primary dealers, are the largest purchasers of T-bills.
Like other securities, individual issues of T-bills are identified with a unique CUSIP number. The 13-week bill issued three months after a 26-week bill is considered a re-opening of the 26-week bill and is given the same CUSIP number. The 4-week bill issued two months after that and maturing on the same day is also considered a re-opening of the 26-week bill and shares the same CUSIP number. For example, the 26-week bill issued on March 22, 2007, and maturing on September 20, 2007, has the same CUSIP number (912795A27) as the 13-week bill issued on June 21, 2007, and maturing on September 20, 2007, and as the 4-week bill issued on August 23, 2007 that matures on September 20, 2007.
During periods when Treasury cash balances are particularly low, the Treasury may sell cash management bills (or CMBs). These are sold at a discount and by auction just like weekly Treasury bills. They differ in that they are irregular in amount, term (often less than 21 days), and day of the week for auction, issuance, and maturity. When CMBs mature on the same day as a regular weekly bill, usually Thursday, they are said to be on-cycle. The CMB is considered another reopening of the bill and has the same CUSIP. When CMBs mature on any other day, they are off-cycle and have a different CUSIP number.
Treasury bills are quoted for purchase and sale in the secondary market on an annualized discount percentage, or basis.
With the advent of TreasuryDirect, individuals can now purchase T-Bills online and have funds withdrawn from and deposited directly to their personal bank account and earn higher interest rates on their savings.
General calculation for the discount yield for Treasury bills is
Treasury notes (or T-Notes) mature in two to ten years. They have a coupon payment every six months, and are commonly issued with maturities dates of 2, 3, 5, 7 or 10 years, for denominations from $100 to $1,000,000.
T-Notes and T-Bonds are quoted on the secondary market at percentage of par in thirty-seconds of a point. Thus, for example, a quote of 95:07 on a note indicates that it is trading at a discount: $952.19 (i.e., 95 + 7/32%) for a $1,000 bond. (Several different notations may be used for bond price quotes. The example of 95 and 7/32 points may be written as 95:07, or 95-07, or 95'07, or decimalized as 95.21875.) Other notation includes a +, which indicates 1/64 points and a third digit may be specified to represent 1/256 points. Examples include 95:07+ which equates to (95 + 7/32 + 1/64) and 95:073 which equates to (95 + 7/32 + 3/256). Notation such as 95:073+ is unusual and not typically used.
The 10-year Treasury note has become the security most frequently quoted when discussing the performance of the U.S. government bond market and is used to convey the market's take on longer-term macroeconomic expectations.
Treasury bonds (T-Bonds, or the long bond) have the longest maturity, from twenty years to thirty years. They have a coupon payment every six months like T-Notes, and are commonly issued with maturity of thirty years. The secondary market is highly liquid, so the yield on the most recent T-Bond offering was commonly used as a proxy for long-term interest rates in general. This role has largely been taken over by the 10-year note, as the size and frequency of long-term bond issues declined significantly in the 1990s and early 2000s.
The U.S. Federal government suspended issuing the well-known 30-year Treasury bonds (often called long-bonds) for a four and a half year period starting October 31, 2001 and concluding February 2006. As the U.S. government used its budget surpluses to pay down the Federal debt in the late 1990s, the 10-year Treasury note began to replace the 30-year Treasury bond as the general, most-followed metric of the U.S. bond market. However, because of demand from pension funds and large, long-term institutional investors, along with a need to diversify the Treasury's liabilities - and also because the flatter yield curve meant that the opportunity cost of selling long-dated debt had dropped - the 30-year Treasury bond was re-introduced in February 2006 and is now issued quarterly. This brought the U.S. in line with Japan and European governments issuing longer-dated maturities amid growing global demand from pension funds.
Treasury Inflation-Protected Securities (or TIPS) are the inflation-indexed bonds issued by the U.S. Treasury. The principal is adjusted to the Consumer Price Index, the commonly used measure of inflation. The coupon rate is constant, but generates a different amount of interest when multiplied by the inflation-adjusted principal, thus protecting the holder against inflation. TIPS are currently offered in 5-year, 10-year and 30-year maturities. The U.S. Treasury replaced the 20-year maturity with the new 30-year maturity in February 2010.
As of December 2009:
|Oil Exporters||$207.4 billion|
|United Kingdom||$178.0 billion|
|Hong Kong||$148.7 billion|
Separate Trading of Registered Interest and Principal Securities (or STRIPS) are T-Notes, T-Bonds and TIPS whose interest and principal portions of the security have been separated, or "stripped"; these may then be sold separately (in units of $1000 face value) in the secondary market. The name derives from the days before computerization, when paper bonds were physically traded; traders would literally tear the interest coupons off of paper securities for separate resale.
The government does not directly issue STRIPS; they are formed by investment banks or brokerage firms, but the government does register STRIPS in its book-entry system. They cannot be bought through TreasuryDirect, but only through a broker.
STRIPS are used by the Treasury and split into individual principal and interest payments, which get resold in the form of zero-coupon bonds. Because they then pay no interest, there isn't any interest to re-invest, and so there is no reinvestment risk with STRIPS.
The "Certificate of Indebtedness" is a Treasury security that does not earn any interest and has no fixed maturity. It can only be held in a TreasuryDirect account and bought or sold directly through the Treasury. It is intended to be used as a source of funds for traditional Treasury security purchases. Purchases and redemptions can be made at any time.
Government Account Series Treasuries are the principal form of intragovernmental debt holdings. Surpluses from the Social Security Trust Fund are invested in this type of security.
Savings bonds were created to finance World War I, and were originally called Liberty Bonds. In 2002, the Treasury Department started to gut the savings bond program by lowering interest and closing its marketing offices, although the program was very well known previously.
Series EE bonds are issued at 50% of their face value and reach final maturity 30 years from issuance. Interest is added to the bond monthly and paid when the holder cashes the bond. They are designed to reach face value in approximately 17 years, although an investor can hold them for up to 30 years and continue to accrue interest. For bonds issued before May 2005 the rate of interest is recomputed every six months at 90% of the average five-year Treasury yield for the preceding six months. Bonds issued in May 2005 or later pay a fixed interest rate for the life of the bond, although the Treasury does guarantee that the bond will reach face value after 20 years. In the space of a decade, interest dropped from well over 5% to 0.7% for new bonds in 2009.
Interest is taxable at the federal level only. Investors can elect to defer taxation until the bond ceases to pay interest (30 years after issuance) or until it is redeemed.
Series EE bonds are designed for individual investors, sold at a discount, and redeemed at an amount that includes the interest income. Hence, while interest is calculated monthly, the interest on a Series EE bond is not paid until redemption.
All Series I Savings Bonds and Series EE Savings Bonds issued in May 1997 or later increase in value monthly. All other Savings Bonds, including Series HH bonds issued after May 1997, pay interest on a six-month cycle. These bonds should be cashed near the beginning of their month of issue or of the month exactly six months later.
Series HH bonds are sold at a discount and mature at face value. Unlike T-Bonds (Treasury Bonds) and agency issues, Series HH bonds are nonmarketable. They also pay interest semi-annually, as do most bonds.
Series I bonds are issued at face value and have a variable yield based on inflation. The interest rate consists of two components: the first is a fixed rate which will remain constant over the life of the bond and the second is a variable rate reset every six months from the time the bond is purchased based on the current inflation rate. New rates go into effect on May 1 and November 1 of every year. The fixed rate is determined by the Treasury Department; the variable component is based on the Consumer Price Index from a six month period ending one month prior to the reset time. Like EE bonds, I bonds are issued to individuals with a limit of $5,000 per person (by Social Security number) per year. A person may purchase the limit of both paper and electronic bonds for a total of $10,000 per year. Redeeming the bonds before five years will incur a penalty of three months of interest. The Treasury Department announced in early November 2008 the return of a fixed rate component, which the Treasury removed in July. For newly purchased securities, the Series I will pay 0.7% fixed annual rate, in addition to the inflation adjustment. Combining the fixed rate and the inflation adjustment as of November 2008, new I-bonds will earn interest at a 5.64% annual percentage rate.