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U.S. Treasury securities are debt obligations of the U.S. government, the largest debt issuer in the world. Since these debt obligations are backed by the “full faith and credit” of the US government, and thus by its ability to raise tax revenues and print currency, U.S. Treasury securities are considered the safest of all investments. They are viewed in the market as having no “credit risk,” meaning that it is virtually certain your interest and principal will be paid on time.
Due to the unique degree of safety provided in the US Treasury as a credit, the interest offered by US Treasuries is ordinarily lower than for other widely traded debt with similar length of maturity, such as corporate bonds.
Treasury bonds can have certain positive tax attributes - US Treasury interest is not taxable at the state or local level.
US Treasury securities are divided into Treasury bills
(auctioned in 3 month, 6 month and 1 year maturities),
Treasury notes (2 year, 5 year, 10 year and 30 year)
and Series I Bonds and 10 year TIPS. Series I Bonds
must be purchased directly from the U.S.
Treasury. All other US Treasury securities may be
purchased at auction directly from the U.S. Treasury
or through primary deals (a series of investment banks).
There is also a very vibrant secondary market for all
US Treasuries, which ensures liquidity (although the
price will fall dramatically if yields rise).
The US Treasury Bond Yield curve lists the current yields on primary and secondary offerings of US Treasury securities.
Long duration Treasuries are not cash equivalent securities as they may lose value quickly if interest rates rise. Moreover, they are not recommended at this time because long-term interest rates remain near all-time lows, and there is little opportunity for them to fall further (and bonds to appreciate) as interest rates rise. Moreover, since the yield curve lacks any slope, purchasers are not offered any time premium for lending over longer periods.
However, as short term rates have started to rise, short duration Treasuries, have emerged as competitive with fully-taxible short term Certificates of Deposit, especially for those in higher state and local tax areas. In order to determine the fully taxible equivalent to a US Treasury, divide the Treasury rate by the reciprocal of your cumulative state and local tax obligations.
(Treasury rate) / (1 - Your state and local tax rate)
The purchase of longer duration Treasury bonds near maturity at a premium in secondary markets can provide tax losses on maturity - a positive tax attribute that can offset gains that you may have.
Series I Treasury Bonds and TIPS:
Series I Treasury Bonds may protects
your principal from losing value and provides you with
a competitive return, although the return is lessened
by a three month interest penalty where you redeem the
bond in fewer than five years from the issue date (and
the bond absolutely cannot be redeemed within one year
of issue).
TIPS
may
also protect against a loss of value of your principal
due to inflation, but ordinarily bear greater risk of
decline in value of principal (unless you are purchasing
TIPS on the secondary market that are near maturity).
Both TIPS and I Bonds are US Treasury instruments with
the same perfect credit that are tied to the Consumer
Price Index for Urban Consumers (CPI-U) and therefore
provide better protection that ordinary US Treasuries
in a rising interest rate environment. I Bonds adjust
to the rising interest rate environment through semi-annually
adjusted changes in the interest rate; TIPS through
adjustments in the value of the principal.
Series EE bonds, which until recently were reset according
to the prevailing 5-year Treasury rate, have recently
been restructured so that the rate is set at purchase
for the life of the bond. These bonds, therefore, no
longer provide additional interest rate protection that
ordinary US Treasury instruments do not provide.
Avoiding the Pitfalls
of Treasury Bonds:
Please note that
if you are purchasing TIPS or ordinary Treasuries through
a bank, virtually all banks charge a commission. Find
out what commission your bank is charging before entering
into any Treasury transactions. I Bonds must be purchased
directly from the U.S.
Treasury.
