Treasury Bond (T-Bond)

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Last Updated:December 1, 2023

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What Is a Treasury Bond (T-Bond)?

Treasury bonds, also known as T-bonds, refer to government-issued fixed-income securities with a maturity of more than 20 years. The US Federal Government always issues these financial instruments.

Interest is earned on such bonds until it reaches maturity. At maturity, the bond owner is paid the accumulated interest over the years, a par amount generally equivalent to the bond's principal amount.

These bonds comprise the US Sovereign Debt, also known as treasuries. All these securities are considered risk-free as they are backed by the credit rating of the US Federal Government.

Treasury notes, along with treasury bills, notes, and inflation-protected securities (TIPS), comprise the four risk-free assets offered by the US Government. Interest on these securities is generally accumulated on a semi-annual basis.

The government generally issues these securities to raise money to help the government fund its commercial expenditure. All treasury securities are fixed-income assets, typically risk-free and backed by the government's credit rating.

These bonds first come into the primary market through an online auction conducted by the US Treasury every month. The price and yield of these securities are determined during the auction, and from there, these bonds are traded in the secondary market.

Individual investors tend to purchase these securities to bring diversification and safe financial instruments to their portfolios. In addition, income from T-bonds can be used to fund retirement expenses or set aside for a major expense such as child education.

Types of Treasury Securities

Treasury securities are considered one of the safest forms of investments as they are backed by the credit rating of the US Government.

The different types of treasury securities being traded on the market are as follows:

1. Treasury Bills (T-Bills)

Treasury bills are considered government-issued fixed-income securities with the shortest maturity duration ranging from 30 days to 1 year.

Before entering the secondary market, these bills are sold through an auction regularly. As a result, they are generally issued on a variable basis, and it only takes a few days for the government to issue one T-Bill.

These securities are generally issued at a discount and mature at par value. The difference between the two values, i.e., purchase and sales price, represents the interest earned on the treasury bill.

T-bills are the only government-issued securities traded on both capital and money markets.

2. Treasury Notes (T-Notes)

Treasury notes are the securities issued by the government with a higher maturity duration than T-bills but a lower maturity duration than T-bonds.

These securities are generally issued with a maturity duration of 2-10 years. The notes up to the maturity of 7 years are regularly auctioned every month, and the ones with 10-year maturities are auctioned at specific periods.

In most cases, T-notes are issued at a par value of $100, and these securities only mature at that value. Accordingly, interest paid on such securities is paid on a semi-annual basis.

3. Treasury Inflation Protected Securities (TIPS)

TIPS refers to government-issued fixed-income securities adjusted according to the prevailing inflation rate to protect investors from incurring a loss.

As inflation increases, the yield for these securities does not increase. Instead, it adjusts the price according to the inflation rate to maintain the investment's real value.

Advantages of Treasury Bonds

The advantages of owning these bonds are as follows:

1. Secure Forms of Investments

One of the biggest advantages of owning T-bonds is the low risk that these securities bear with them. In addition, T-Bonds are considered one of the safest forms of investment due to the credit backing of the US government.

Bonds are safe investment security as the US Treasury cannot call most bonds, implying that the investor will not be expected to sell the bond before it reaches maturity.

Moreover, it is unlikely for the investor to face default risk as the bond is issued by the US Federal Government, which guarantees strong credit backing.

2. Highly Liquid Market

The market for treasury bonds is highly liquid, which implies that buyers and sellers can trade the bonds easily at any given time.

Moreover, bonds are electronic securities, so the transfer process is even quicker as there is no need to exchange papers or certificates. The availability of information about the bonds makes it easier for buyers and sellers to value these securities.

The feature of market liquidity and availability of information makes it easy for every player in the market to avail themself of equal opportunities with confidence, as everyone in the market knows the true and fair value of these bonds.

3. Tax Benefits

Unlike most bonds, where the investor has to pay a state or a federal tax on the interest received, investors are exempt from paying tax on the income generated from holding a government-issued bond.

Some of the US savings bonds are also exempt from paying federal tax. For example, a holder of a government-issued bond who has earned $1,000 from interest income can save the tax amount of $300 (assuming the tax rate is 30%).

4. Portfolio Diversification

Since government-issued bonds are considered one of the safest forms of investment in the financial markets, including these securities in the asset portfolio helps diversify the portfolio.

Ownership of government-issued bonds amid stocks and other risky assets helps diversify the portfolio risk, thereby minimizing risk and maximizing the return for the investors.

Disadvantages of Treasury Bonds

Although treasury bonds are considered one of the safest forms of investments being traded on the financial markets, there are several downsides to holding these securities. The drawbacks of these bonds are as follows:

1. Low Yield

Treasury bonds are considered to be very secure investment instruments. However, the yield generated on these securities is extremely low. As a result, aggressive investors do not favor these securities due to lower returns.

These bonds offer a lower rate of return even if the bonds are held until maturity. This is due to the lower risk characteristics that these bonds carry with them, and it is known that the rate of return on investments increases along with an increase in risk.

Moreover, these bonds typically mature after ten years due to the longer maturity durations. However, even after ten years, the investors earn a bare minimum return, so these securities are most suitable for diversifying the portfolio.

2. Treasury Bonds are never risk-free

Although T-bonds are low-risk financial instruments, they can never be regarded as risk-free securities as the US government has to issue new debt to pay off the old debts that are in the form of maturing bonds.

Though it has never happened, Congress in the country can refuse to issue more debt, resulting in a possible default.

Moreover, bonds need to be adjusted according to inflation, so if the bonds are held for more than ten years, and inflation keeps on rising, it could be risky for the investors as he/she will have to sell the bond to avoid more losses.

3. Interest Rate Risk

Frequent changes in the interest rate can significantly affect the prices of the bonds. This implies that an increase in interest rates will lead to a fall in the security's market value, and investors will receive less interest than the market rate.

Moreover, during increasing interest rates, the investor is also expected to incur a loss if the bond is sold before the maturity date.

4. Tax Implications

The income generated from holding the bond is, at times, subject to certain federal or state taxes to be paid by the bondholder.

This means that the investor will have to bear some tax implications if the bond is purchased at a discount, held until maturity, or sold at a profit.

How to Buy Treasury Bonds?

There are two main ways to purchase a US Treasury Bond, directly from the US Treasury or from a private-financial services firm.

The ways to acquire the bonds can be explained as follows:

1. Directly from the US Treasury

The first and the most direct way of purchasing a treasury bond is to purchase it directly from the online website of the US Treasury. Then, a bid can be placed on the bonds sold through regular auctions.

The auctions for T-bonds generally happen four times a year, and the minimum buy value for the security is $100. The ways to place a bid for the securities are as follows:

Non-Competitive Bidding

This bidding happens when the investor agrees to accept all terms, such as the interest rate prevailing during the auction, just when he/she makes the bid.

This, as a result, guarantees the investor an accepted bid, and the investor will be paid the amount totaling the face value upon the bond's maturity.

Competitive Bidding

In a competitive bidding process, the investor can decide the interest rate the investor will be willing to receive for the security.

However, in this case, it is not confirmed for the investor that her bid will be accepted, and the bid is only satisfied if the demanded interest rate is less than or equal to the rate the auction committee decides.

2. Purchasing through a bank or broker

If not purchased through an auction, an investor can purchase treasury security from a financial services institution like a bank or brokerage firm.

However, different financial institutions offer different buy-in rates.

The two different options available to an investor while purchasing through a financial institution are as follows:

The intermediary purchases from the government website: In this process, the financial intermediary such as the bank purchases the security for the investor from the government website but charges a fee.
The intermediary purchases from the secondary market: In this case, the intermediary purchases the security from the secondary market and charges a certain fee for this purpose. This also opens the opportunity for the investor to invest in treasury bond mutual funds and other exchange-traded funds being traded on the market.

Treasury Bond Yield

Maturities of these bonds range from 20 to 30 years, and these bonds are generally issued at a face value of $100. In addition, investors receive coupon payments on these bonds semi-annually.

The primary market for these bonds is the auction organized by the US Treasury. The maximum purchase value in the case of non-competitive bidding is $5 million.

Moreover, after obtaining the bond from the auction, the investor always has the choice to sell the bond to another buyer in the secondary market depending on the investment preferences and strategy of the bondholder.

Treasury bonds play an important role in depicting the yield curve, which graphs all kinds of investment options the US Treasury offers. The yield curve diagrams draw out the maturities of different securities and, in most cases, is an upward-sloping curve.

The yield curve can only be inverted when the rates, in the long run, are lower than the rates in the shorter period, and this indicates the possibility of a recession in the economy.

Treasury bonds are an attractive investment source as a highly liquid secondary market is available for trading, making these securities a viable investment option.

Due to the low-risk and high liquidity characteristics, investors can use these treasury bonds to their advantage to reap the benefits of diversification in their portfolio.