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When a government or corporation, needs to raise money, they have the option of issuing bonds. As the need for flexibility has increased over the years, so has the variety of bonds found in the marketplace. They can vary in length of issue, payment terms, tax implications, as well as risk.
In this publication, we'll be discussing the various types of bonds issued by the United States government. That discussion will include Bills, Notes, Bonds, Inflation-Protected Securities, as well as Savings Bonds issued by the Treasury Department. As part of that discussion, we will talk about the maturities of these securities, their features, and the process for obtaining these bonds.
Issuers of Bonds
Generally, bonds are issued by two entities: governments as well as corporations. Within the former category we can have federal, state, and local governments. Corporate bonds offer investors greater returns, but carry a higher risk of default. Government bonds offer investors lower returns, lower risk of default, and often provide the benefit of tax-free returns.
Federal Bonds
Also referred to as U.S. Government bonds, these are bonds issued by the U.S. Department of the Treasury. The bonds offered by the federal government include:
Treasury Bills
Also known as T-bills, these are short term government securities that mature in as little as a few days to as long as one year. Treasury bills are sold at a discount to their face value. For example, if a Treasury bill with a par value of $1,000 sells for $950, the holder of this bond will be paid $1,000 when the security matures. The purchasing process involves placing either a competitive or noncompetitive bid on the bill (discussed later). Treasury bills are sold in increments of $100, with a minimum purchase of $100.
Treasury Notes
Also known as T-notes, these bonds earn a fixed rate of interest, which is paid every six months. In addition to receiving interest payments, the holder will receive the par value of the note at maturity. Treasury notes are sold with maturities of 2, 3, 5, 7, and ten years. T-notes can be purchased through TreasuryDirect, a broker, or a banker. The purchasing process involves placing either a competitive or noncompetitive bid on the note. T-notes are sold in increments of $100, with a minimum purchase of $100.
Treasury Bonds
As was the case with T-notes, Treasury bonds pay a fixed rate of interest every six months. They also pay the bondholder its face value at maturity. Treasury bonds are issued with a 30 year term. The price and yield of Treasury bonds is determined through an auction process. Noncompetitive bids can be placed through TreasuryDirect, while competitive bids require the use of a banker or broker. Treasury bonds are sold in increments of $100, with a minimum purchase of $100.
Treasury Inflation-Protected Securities
Also referred to as TIPS, Treasury Inflation-Protected Securities provide holders of these bonds with protection against inflation. TIPS pay a fixed rate of interest every six months. They also pay the bondholder its face value at maturity. TIPS are issued with maturities of 5, 10, and 30 years. TIPS offer protection against inflation by adjusting principal with changes in inflation. As inflation increases, the principal on TIPS will increase. A decrease in the rate of inflation results in a decrease in the TIPS principal value.
The measure of inflation used by these securities is the Consumer Price Index. The principal on Treasury Inflation-Protected Securities is adjusted every six months. Since the rate of interest is fixed, and based on the principal of the security, it takes six months for the next interest payment to adjust to the new principal value.
The price paid for TIPS is determined through an auction process. Noncompetitive bids can be placed through TreasuryDirect, while competitive bids require the use of a banker or broker. TIPS are sold in increments of $100, with a minimum purchase of $100.
I Savings Bonds
At one time, I Savings Bonds were only available as a paper investment; these bonds are now available in electronic form too. It's also possible to convert Series E and EE paper bonds to electronic form. Like the TIPS mentioned above, the interest rate on these bonds adjust with inflation, thereby offering the investor this protection. I Savings Bonds will be assigned an annual interest rate, which reflects a fixed rate of interest plus an adder for a semiannual measure of inflation.
I Savings Bonds pay interest when redeemed. To receive interest payments, these bonds must be held a minimum of one year and a maximum of 30 years. Redemption of these bonds before a five year term results in the forfeiting of three months' of interest. I Savings Bonds are sold at face value, and the electronic version can be purchased in denominations of $50, $75, $100, $200, $500, $1,000, and $5,000. In addition, paper securities can be purchased for as little as $25. Individuals are limited to a maximum of $5,000 in any calendar year.
EE Savings Bonds and E Savings Bonds
E Savings Bonds have now been replaced with EE Savings Bonds. The features, denominations, and rules that apply to Series EE Savings Bonds are exactly the same as those described above for the I Savings Bond, with one very important difference. Unlike I Savings Bonds, EE Savings Bonds pay a fixed rate of interest, which is known when purchased. EE Savings Bonds are not indexed for inflation.
Electronic versions of both EE Savings Bonds and I Savings Bonds may be purchased through TreasuryDirect, while paper versions of these securities can be purchased through financial institutions or through the mail by filling out a form on TreasuryDirect.
Competitive and Non Competitive Bids Explained
As mentioned above, Treasury Bills, Notes, Bonds, and Inflation-Protected Securities are purchased through an auction process. That auction accepts two types of bids: competitive and noncompetitive.
Competitive Bids
All competitive bids must be placed through a broker or bank. When placing a competitive bid, you are specifying the yield you are willing to accept for a given security. There are three possible outcomes when placing a competitive bid:
- Accepted in Full: if your yield bid is less than the yield determined during the auction, then you will receive the full value of the bonds you wanted to purchase.
- Partial Acceptance: if your yield bid is equal to the yield determined during the auction, you may only receive a portion of the bonds you wanted to purchase.
- Rejected in Full: if your yield bid is higher than the yield determined during the auction, then you will not receive any of the bonds you wanted to purchase.
Noncompetitive Bids
When you place a noncompetitive bid, you are agreeing to accept the interest rate yield determined during the auction. As such, you are guaranteed to receive the full amount of the bonds you wish to purchase. Noncompetitive bids can be placed using a broker, bank, or TreasuryDirect.
About the Author - Understanding US Bonds
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