Treasuries

What Are Treasuries?

Treasuries are debt securities issued by the U.S. Department of the Treasury to finance the federal government's spending and operations. As a category of Fixed Income investments, they represent a loan made by an investor to the U.S. government. Due to being backed by the "full faith and credit" of the U.S. government, Treasuries are considered to have virtually no Default Risk and are among the safest and most liquid securities globally. Investors purchase Treasuries for various reasons, including capital preservation, generating stable income, and their role in a diversified portfolio.

History and Origin

The foundation for U.S. Treasuries was laid shortly after the American Revolutionary War, when the fledgling nation faced significant debt. Alexander Hamilton, as the first Secretary of the Treasury, played a pivotal role in establishing the country's financial system and public credit. His "Report on Public Credit," submitted in January 1790, proposed that the federal government assume the war debts of both the federal government and individual states, and then retire these obligations by issuing new securities¹⁷,¹⁶. This controversial but ultimately successful plan aimed to stabilize the nation's creditworthiness and ensure that government securities were regarded as reliable investments, thereby promoting economic growth¹⁵,¹⁴. The shift from fixed-price subscriptions to an auction system for issuing Treasury bills began in 1929, allowing the market to set prices.

Key Takeaways

• Treasuries are debt obligations issued by the U.S. Department of the Treasury to fund government operations.
• They are considered among the safest investments globally due to the backing of the U.S. government.
• Treasuries come in various forms, including Treasury Bills (T-Bills), Treasury Notes (T-Notes), Treasury Bonds (T-Bonds), and Treasury Inflation-Protected Securities (TIPS), differing primarily by their Maturity periods.
• Investors can purchase Treasuries directly from the U.S. government or through the Secondary Market.
• Their yields are influenced by economic conditions, Monetary Policy, and the balance of supply and demand in the Bond Market.

Formula and Calculation

Treasuries are debt instruments that pay interest based on their Coupon Rate and Par Value. The interest payment an investor receives from a coupon-bearing Treasury (Notes and Bonds) can be calculated simply:

This formula calculates the semi-annual interest payment, as most Treasuries pay interest twice a year. For example, a Treasury Bond with a $1,000 par value and a 3% coupon rate would pay $15 every six months. Treasury Bills, being short-term instruments, are sold at a discount to their par value and do not pay coupons; the return comes from the difference between the purchase price and the par value received at maturity.

Interpreting Treasuries

The yield of Treasuries is a critical indicator for investors and economists. It reflects the return an investor can expect to receive and provides insights into market expectations for future economic growth, Inflation, and interest rates. A rising Treasury yield often suggests expectations of stronger economic growth or higher inflation, while a falling yield might indicate concerns about economic slowdowns or a flight to safety. The relationship between the yields of Treasuries with different maturities is depicted by the Yield Curve. A normal yield curve slopes upward, reflecting higher yields for longer maturities, while an inverted yield curve, where short-term yields are higher than long-term yields, can sometimes signal an impending economic recession.

Hypothetical Example

Consider an investor, Sarah, who wishes to purchase a U.S. Treasury Note. She decides to buy a 2-year Treasury Note with a par value of $1,000 and a 4% coupon rate.

Here's how her investment would work:

1. Purchase: Sarah purchases the Treasury Note at auction or on the secondary market. For simplicity, assume she buys it at par.
2. Semi-Annual Interest Payments: Since the coupon rate is 4% annually, Sarah receives interest payments twice a year. Each payment would be: $$\text{Interest Payment} = \$1,000 \times \frac{0.04}{2} = \$20$$ So, Sarah receives $20 every six months. Over the two-year maturity, she would receive four such payments, totaling $80.
3. Maturity: At the end of the two-year term, the Treasury Note matures. Sarah receives her original principal of $1,000 back.

This example illustrates the predictable income stream and principal return associated with owning coupon-bearing Treasuries.

Practical Applications

Treasuries serve multiple crucial roles in finance and the broader economy. For individual investors, they are often a cornerstone for portfolio Diversification, offering a safe haven during periods of market volatility. Their high Liquidity means they can be easily bought and sold without significantly impacting their price.

The U.S. Treasury issues these securities through a public auction process conducted by the Federal Reserve¹³,¹²,¹¹. Individual investors can purchase Treasuries directly from the government via the TreasuryDirect website.

Beyond individual investment, Treasuries are integral to the global financial system. Central banks, like the Federal Reserve, use them extensively in open market operations to implement Monetary Policy¹⁰,. By buying or selling Treasuries, the Federal Reserve can influence the money supply and short-term interest rates, thereby impacting economic activity⁹. Furthermore, Treasuries are a benchmark for pricing other debt instruments worldwide and play a key role in managing government debt and implementing Fiscal Policy.

Limitations and Criticisms

While Treasuries are celebrated for their safety, they are not without limitations. The primary risk associated with Treasuries is Interest Rate Risk. If interest rates rise after an investor purchases a Treasury, the market value of their existing Treasury will fall, as newly issued Treasuries will offer higher yields. This risk is more pronounced for longer-maturity bonds.

Another significant concern is Inflation risk. Although Treasuries are considered credit-risk-free, unexpected inflation can erode the purchasing power of their fixed interest payments and the principal received at maturity. This means the "real" return (return after accounting for inflation) could be negative. Federal Reserve officials regularly monitor inflation and its potential impact on the economy, acknowledging the dual risks to both inflation and employment goals when making policy decisions⁸,⁷. This balancing act highlights the ongoing challenge of maintaining stable prices while supporting economic growth, which directly impacts the real value of Treasury investments.

Treasuries vs. T-Bonds

The terms "Treasuries" and "T-Bonds" are often used interchangeably, but it's important to understand their relationship. "Treasuries" is a broad term that refers to all marketable debt securities issued by the U.S. Department of the Treasury. This umbrella includes:

• Treasury Bills (T-Bills): Short-term securities with maturities ranging from a few days to 52 weeks⁶,⁵. They are sold at a discount and do not pay coupon interest.
• Treasury Notes (T-Notes): Intermediate-term securities with maturities of 2, 3, 5, 7, or 10 years⁴. They pay semi-annual coupon interest.
• Treasury Bonds (T-Bonds): Long-term securities with maturities of 20 or 30 years³. They also pay semi-annual coupon interest.
• Treasury Inflation-Protected Securities (TIPS): Available in 5, 10, or 30-year maturities, their principal value adjusts with inflation,².
• Floating Rate Notes (FRNs): Two-year maturity, with interest payments that adjust based on a benchmark rate¹.

Therefore, a T-Bond is a specific type of Treasury, distinguished by its long maturity period. While all T-Bonds are Treasuries, not all Treasuries are T-Bonds. The distinction is crucial for investors considering their investment horizon and sensitivity to interest rate fluctuations.

FAQs

What types of Treasuries are there?

There are several types of Treasuries, differentiated primarily by their maturity: Treasury Bills (short-term, up to 52 weeks), Treasury Notes (intermediate-term, 2-10 years), Treasury Bonds (long-term, 20 or 30 years), Treasury Inflation-Protected Securities (TIPS), and Floating Rate Notes (FRNs). Each serves different investment objectives based on its structure and payment schedule.

How do I buy Treasuries?

Individual investors can purchase Treasuries directly from the U.S. government through the TreasuryDirect website, often at auction. Alternatively, they can be purchased through a bank, broker, or dealer on the Secondary Market.

Are Treasuries a safe investment?

Yes, Treasuries are widely considered one of the safest investments because they are backed by the "full faith and credit" of the U.S. government, implying an extremely low Default Risk. However, like all investments, they are subject to Interest Rate Risk and Inflation risk, which can affect their market value or purchasing power.