What is Treasury Bond?
A Treasury Bond (or T-bond) is a government debt security with a fixed rate of return and relatively low risk, as it is issued by the US government. You can buy treasury bonds directly from the US Treasury or through a bank, broker, or mutual fund company.
Since T-bonds are one of the safest investment vehicles, they are purchased by investors to finance their education, supplement their retirement income, and to ensure a steady return, even in times of financial turbulence.
- Treasury bonds are debt instrumentsDebt InstrumentsDebt instruments provide finance for the company's growth, investments, and future planning and agree to repay the same within the stipulated time. Long-term instruments include debentures, bonds, GDRs from foreign investors. Short-term instruments include working capital loans, short-term loans. issued by the US government, making them a great investment for those prioritizing safety and a fixed rate of interest.
- These bonds usually have long maturity periods, ranging between 20 to 30 years.
- T-bond holders receive semi-annual interest payments until maturity when the T-bonds’ initial investment amount (face value) is repaid to the investor.
- T-bonds can be purchased directly from the US Treasury. They can also be bought from banks, brokers or as a collection of securities in a mutual fundMutual FundA mutual fund is a professionally managed investment product in which a pool of money from a group of investors is invested across assets such as equities, bonds, etc/ETF. They’re often used to diversify portfoliosDiversify PortfoliosPortfolio diversification refers to the practice of investing in a different assets in order to maximize returns while minimizing risk. This way, the risk is kept to a minimal while the investor accumulates many assets. Investment diversification leads to a healthy portfolio. and offset the risk of equity investmentsEquity InvestmentsEquity investment is the amount pooled in by the investors in the shares of the companies listed on the stock exchange for trading. The shareholders make gain from such holdings in the form of returns or increase in stock value..
How Do Treasury Bonds (T-Bonds) Work?
The US government issues various treasury securities in order to fund development projects, military undertakings, and day-to-day administrative activities. These government debt issuances can be divided into three categories: treasury bills, notes, and bonds. In this article, we will be talking at some length about treasury bonds, one of the three types of treasury securities.
- The US Treasury organizes auctions to facilitate the sale of treasury bonds. At these auctions, the prices and interest rates of individual bonds are determined. The price set at the auction can be lower, higher, or equal to the bond’s face value.
- The two factors that influence the price of fixed-rate securities like T-bonds are the interest rate and the yield to maturityYield To MaturityYield to Maturity refers to the expected returns an investor anticipates after keeping the bond intact till the maturity date. In other words, a bond's expected returns after making all the payments on time throughout the life of a bond. (YTM). The YTM of a T-bond is simply the total returnTotal ReturnThe term “Total Return” refers to the sum of the difference between the opening and closing value of all the assets over a particular period of time and the returns thereon. To put it simply, the changes in opening and closing values of assets plus the number of returns earned thereof is the Total Return of the entity over a period of time. that the owner can expect to get if the bond is held until maturity.
- As mentioned above, investors can purchase treasury bonds through brokers, banks, ETFsETFsAn exchange-traded fund (ETF) is a security that contains many types of securities such as bonds, stocks, commodities, and so on, and that trades on the exchange like a stock, with the price fluctuating many times throughout the day when the exchange-traded fund is bought and sold on the exchange., and mutual funds. They can also buy these bonds directly from the website of the US Treasury, which we will discuss in greater detail later in the article.
- T-bonds are now issued only in electronic form. The last paper-format T-bonds reached maturity in 2016.
- T-bonds usually have a maturity period of 20 to 30 years and are issued with a minimum denomination of USD 100. The highest possible bid amount is $5 million for non-competitive bids.
- Bonds pay a fixed rate of interest to the holder every six months.
- In addition to the interests, after maturity, the holder of the T-bond will also get back the face value of the bond, which is the amount of money that was originally invested.
- As T-bonds are a virtually risk-free form of investment, they are preferred when the stock marketStock MarketStock Market works on the basic principle of matching supply and demand through an auction process where investors are willing to pay a certain amount for an asset, and they are willing to sell off something they have at a specific price. is volatile, and investors are looking for a safe place to park their savings.
- However, the safety of the T-bonds also means that they offer lower interest rates than shares, stocks, or even other fixed-income securities.
- Those who own T-bonds do not have to pay local or state income taxes. The federal government will tax the interest earned from T-bonds. This is why T-bonds are preferred by those living in states with higher tax rates.
- Usually, the longer the maturity period of a treasury bond, the higher will be the returns. However, T-bonds can be sold in the secondary marketSecondary MarketA secondary market is where securities are offered to the general public after being offered in the primary market. Such securities are usually listed on the stock exchange. A significant portion of trading happens in such a market and are of two types – equities and debt markets. before maturity.
Let us take you through some recent events that had taken place in the world of T-bonds. They will help you understand the concept better. In March 2021, many factors had caused Treasury securities yields to rise dramatically from record lows in 2020. It allowed bondholders to earn higher-than-usual interest rates amidst the financial uncertainty brought on by the pandemic. The massive monetary stimulus packages approved by the US government and the news of Covid-19 vaccines stimulated investors’ hope, pushing the yields up.
In May 2021, the government auctioned a revamped 20-year Treasury bond, auctioning it for the first time since 1986. A day after the auction, the yield on the bond closed at 1.165%, which was less than the auction day yield of 1.22%. This was because the bond saw a price rise, which led to a fall in its yield. Whenever bond price rises, its yield falls.
Treasury Bond Yields
Treasury bond yields are essentially the return on investment that you can expect when you buy T-bonds. It is the interest paid by the government to borrow money for a particular period of time. There are some treasury bond calculators available online that can help in calculating the returns.
Source – scottgrannis.blogspot.com
Since T-bonds are almost risk-free, they offer a lower interest rate than many other similar, fixed-income investments. For instance, the 30-year bonds yield around 2.30% as of April 2021, a massive improvement from the Covid-19 hit fallen rates of around 1.65%. Although, it is nowhere close to 1981’s 15.21%. This report showcases their changing rates over the years, with the average rate since 2012 hovering between 2.5-3%.
As per many experts, chances of a massive rate revival is a distant dream. Also, investors earn higher returns when they commit their money for longer periods of time. Consequently, 30-year bonds are more lucrative than 20-year ones. However, locking your money for such long periods of time with low rates of interest may not be profitable to many.
Moreover, when market volatility causes the demand for T-bonds to rise, then the yield usually goes down. Conversely, the yield on T-bonds increases when the demand for them is relatively low. Also, treasury bond rates undergo inflation adjustment, causing them to fall further. As such, it works best for people who are willing to sacrifice high earnings in return for a safer, low-risked and guaranteed investment.
How to Buy Treasury Bonds?
You can buy Treasury bonds from a broker or a bank. Most mutual fund companies also offer treasury bond funds as part of a diversified portfolio. Investors often buy T-bonds in order to diversify their portfolios and offset the risk of stocks and shares.
You can buy T-bonds in the secondary market – known as the bond market – if you already have a brokerage account. Another way to buy these bonds indirectly is through exchange-traded funds or ETFs. This option offers greater liquidityLiquidityLiquidity shows the ease of converting the assets or the securities of the company into the cash. Liquidity is the ability of the firm to pay off the current liabilities with the current assets it possesses. than if you were to buy the T-bonds directly from the government.
If you want to buy T-bonds directly from the US government, you can do so through a website known as TreasuryDirect. Just make sure that the browser’s URL field says treasurydirect.gov so as to not spend money on any sham websites.
Source – treasurydirect.gov
First, you will need to open an account with TreasuryDirect, which involves a three-step setup process. You can apply to TreasuryDirect as an individual investor, a corporation, a limited liability companyLimited Liability CompanyLimited liability refers to that legal structure where the owners' or investors' personal assets are not at stake. Their accountability for business loss or debt doesn't exceed their capital investment in the company. It is applicable in partnership firms and limited liability companies. (LLC), or a partnership. You will then need to fill in an online form with all the relevant information, including your social security number and taxpayer identification number.
Once you’ve set up your account, you can click on the Buy Direct tab at the top of the website to start purchasing T-bonds directly from the US Treasury.
This has been a guide to Treasury Bonds & their Definition. Here we discuss how T-bonds work and how to buy them, along with an example. You can learn more about fixed income from the following articles –