Government security: Meaning, Criticisms & Real-World Uses

What Is Government Security?

A government security is a debt instrument issued by a national government to finance its expenditures. These instruments are considered a cornerstone of fixed-income investments due to their perceived low risk of default, as they are typically backed by the full faith and credit of the issuing government. Governments issue various types of securities, including Treasury bills, Treasury notes, and Treasury bonds, each with different maturities and payment structures. The issuance of government securities is a critical component of a nation's fiscal and monetary policy, allowing governments to borrow money from investors to fund public services, infrastructure projects, and other government operations.

History and Origin

The concept of government debt and securities dates back centuries, but modern government securities, particularly in the United States, have a more defined origin. The U.S. has maintained public debt since its inception, with significant borrowing occurring to finance the American Revolutionary War. Early forms of debt included loans from domestic investors and the French government.¹⁴

The widespread issuance of various types of marketable government securities, such as Treasury bills, notes, and bonds, largely began in the 1920s to help fund World War I.¹³ Prior to this, methods like the sale of "Liberty Bonds" during World War I were used, where officials set a coupon price and sold them at par value. A significant shift occurred in 1929 when the U.S. Treasury transitioned from a fixed-price subscription system to an auction system for selling Treasury bills, allowing market forces to determine the price. Furthermore, the conversion of Treasury securities to book-entry, or nonphysical, form began in 1966, enhancing market efficiency and reducing operational costs and risks.¹²

Key Takeaways

Government securities are debt instruments issued by national governments to raise capital for public spending.
They are generally considered among the safest investments due to the backing of the issuing government's full faith and credit.
Common types include Treasury bills (short-term), Treasury notes (intermediate-term), and Treasury bonds (long-term).
These securities play a crucial role in governmental finance and are a key tool for central banks in implementing monetary policy.
The yield on government securities often serves as a benchmark for other interest rates in the economy.

Formula and Calculation

The pricing and yield calculation for government securities, particularly fixed-coupon bonds like Treasury notes and bonds, involves the concept of present value. The price of a bond is the present value of all its future cash flows (coupon payments and the face value at maturity), discounted at the bond's yield to maturity.

The formula for the present value of a bond is:

P = \sum_{t=1}^{N} \frac{C}{(1+r)^t} + \frac{F}{(1+r)^N}

Where:

(P) = Current market price of the bond
(C) = Annual coupon payment (Face Value × Coupon Rate)
(r) = Yield to maturity (discount rate), expressed as a decimal
(N) = Number of periods until maturity
(F) = Face value (par value) of the bond

For Treasury bills, which are zero-coupon securities, the calculation is simpler as they are sold at a discount and mature at face value. The return is the difference between the purchase price and the face value.

Interpreting the Government Security

Interpreting a government security involves understanding its key characteristics and how they reflect economic conditions and investor sentiment. The yield on a government security is a primary indicator, representing the return an investor can expect. A higher yield might suggest increased perceived risk or a general rise in prevailing interest rates in the market, while a lower yield indicates strong demand for the security, often seen during periods of economic uncertainty when investors seek safety.

The maturity of a government security also provides crucial context. Short-term securities like Treasury bills are highly liquid and sensitive to immediate monetary policy actions by the central bank. Long-term bonds, conversely, reflect long-term inflation expectations and economic growth projections. Changes in the yield curve, which plots yields against different maturities, can signal future economic shifts, such as impending recessions or expansions.

Hypothetical Example

Suppose an investor, Sarah, is looking for a low-risk investment for a portion of her portfolio. She decides to purchase a¹ ² ³ ⁴ ⁵ ⁶ ⁷ ⁸ ⁹ ¹⁰ ¹¹