What it is:
A government bond isissued by the government.
How it works/Example:
The or through banks and website .
For example, savings bonds are also sold by the U.S. Treasury. Savings come in electronic form and can be purchased from most financial institutions or via the U.S. Treasury's website. When a savings matures, the investor receives the of the plus accrued interest. Savings are not redeemable for the first 12 months they’re outstanding, and investors who redeem within the first five years forfeit the last three months of interest as a penalty.
Treasury (T-Notes) are intermediate-term issued by the U.S. Treasury. They mature in two, three, five or 10 years. T-Notes make semiannual interest payments at fixed rates. T-Notes issued before 1984 are callable, meaning that the Treasury can repurchase the notes under certain circumstances. T-Notes usually have $1,000 face values, although those with two- or three-year maturities have $5,000 face values.
Treasury ("T-Bonds") are long-term issued by the U.S. Treasury. They mature in 10 to 30 years. T-Bonds make semiannual interest payments and have $1,000 face values. They help shortfalls in the federal budget, regulate the nation's supply, and execute U.S. monetary policy. Like any , the U.S. Treasury considers the ’s risk and return requirements in order to successfully and efficiently raise . This is why there are several types of Treasury securities ( , T-Notes, T-Bonds, and TIPS, for example).
Why it matters:
Most government are backed by the full faith and of the U.S. government, meaning that default is extremely unlikely and would really only occur if the U.S. government could not print additional to pay off its . For this reason, T-Notes, for example, are generally considered risk-free and benchmarks against which other investments are compared.
Rates on government affect the entire . This is partially because the government’s or repurchase of their own affects the supply and influences interest rates. For example, when the Federal Reserve repurchases , sellers the proceeds at their local banks, which in turn lend to customers, who their loan proceeds in their bank accounts, and so on. Thus, every dollar of Treasuries repurchased increases the supply by several dollars. The supply of for lending increases and the demand for borrowing increases, causing lending rates to fall.
Government are usually simple, low-risk investments. The state and local tax exemption, as well as the federal exemption for tuition payment, make some especially advantageous for investors in high tax brackets or those with children heading to college. Government are very . However, government usually have a very low rate of return, rarely protection, and have little or no opportunity.
Many investors hold government through mutual . The fund-management fees do cut into returns, but the funds among all the types and of , which is hard for the individual investor to achieve without significantly more than require.
Though government carry little risk of default, they do carry interest-rate risk, meaning that when interest rates rise, prices fall, and vice versa. Fortunately, in periods of rising interest rates, T-Note prices tend to fall less than other do. Thus, with their virtually guaranteed income stream, government make excellent defensive plays in an uncertain .
Inflation takes a bigger bite out of government returns than from riskier but higher-yielding . Thus, changes in inflation expectations or the degree of uncertainty about inflation can really affect government prices. For example, if the consumer price increases by 3% over the life of the T-Note, then 3% of the T-Note's return is eaten away, leaving a much lower "real" return.
Income from government is federally taxable but generally exempt from most state and local taxes. This means that for some investors, particularly those who live in states with high taxes, Treasuries may return slightly more than taxable securities with higher coupons. For example, if a resident of California and a resident of Nevada each purchase a $10,000 T-Note with a 3% , each have received interest payments of ($10,000 x .03) = $300 in one . If the California resident’s is 20%, he really only earns $240 from the T-Note ($300 x .80). However, the same T-Note has a higher return in the eyes of the Nevada resident, whose state is 0%, because he gets to keep the entire $300. (Keep in mind that Treasury income may be subject to Alternative Minimum Tax, so investors should seek tax advice before .)