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Treasury Bond (T-Bond)

Step-by-Step Guide to Understanding Treasury Bonds (T-Bonds)

Last Updated February 20, 2024

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Treasury Bond (T-Bond)

Treasury Bond: Definition and Market Overview

Treasury bonds (T-bonds) are long-term debt securities issued by the U.S. Treasury Department with maturities of either 20 or 30 years.

The appeal of T-bonds to investors is that these debt obligations are as close to being “risk-free” as possible.

In the unlikely event that the U.S. government does default on its debt obligations, the government could hypothetically print more money, which coincides with the federal government’s ability to adjust the tax rate as deemed necessary and the perceived strength of the U.S. economy.

Therefore, Treasuries such as the T-bond are perceived as low credit risk, “safe haven” securities, since the issuances are backed by the U.S. government.

The downside, however, is that the lower credit risk and chance of default results in lower yields on Treasury bonds relative to other comparable bonds in the market, such as corporate bonds.

The trade-off in risk and return can still be worth it for many investors, however, since not all market participants possess the same investment objectives and appetite for risk.

U.S. Treasury Bond (T-Bond): Characteristics

The list below briefly describes the most notable characteristics of Treasury bonds:

  • High Credit Quality: T-bonds are considered “risk-free” debt securities with a low risk of default because the issuances are backed by the full faith and credit of the U.S. government.
  • Fixed Interest Rate: T-bonds offer a predictable, stable source of income, with interest paid to bondholders on a semi-annual basis.
  • High Liquidity: T-bonds are traded actively in the secondary markets among retail investors, institutional investors, foreign governments, and more. Thus, a bondholder attempting to sell their T-bond holdings could close (i.e. liquidate) their positions easily without incurring a steep monetary loss due to the broad marketability of the securities.
  • Tax Benefits: The interest income earned on T-bonds is exempt from state and local income taxes, however, the interest is still subject to federal income taxes.
  • Portfolio Diversification: T-bonds tend to be viewed as a safe haven amid periods of high market volatility and recessionary fears, which can de-risk and stabilize an investor’s portfolio.

U.S. Treasury Bonds Rates

Treasury Bonds at a Glance (Source: TreasuryDirect)

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Treasury Bond: Interest Rates and Maturities

Like most fixed-income securities, T-bonds periodically issue interest payments to the bondholder until the bond reaches maturity.

  • Maturity: 20 or 30 Years
  • Interest Rate Structure: Fixed Rate Pricing
  • Periodicity: Semi-Annual Basis (2x per Year)

Since the interest rate pricing is fixed rather than floating, i.e. variable pricing, the interest payments do not fluctuate over the course of the bond’s tenor.

Learn More → Treasury Securities Market (Source: Federal Reserve)

U.S. Treasury Bond Yield: 30-Year T-Bond Returns (3-Year Chart)

The following chart shows the historical 3-year yield on a 30-year Treasury bond from 2020 to 2022.

The plummet in yield is evident around the initial outbreak of the COVID-19 pandemic, followed by the gradual rise in rates as the Fed started to implement policies to fight rising inflation.

U.S. 30 Year Treasury Bond Yield

30-Year Treasury Bond Yield (Source: Wall Street Journal)

U.S. Treasury Securities: T-Bills vs. T-Notes vs. T-Bonds

Other than T-bonds, two other closely related Treasury offerings are treasury notes (T-notes) and treasury bills (T-bills), which are each differentiated by their maturities.

Out of the three, T-bonds carry the longest maturities and offer the highest interest rate, since the longer borrowing term coincides with more uncertainty (and risk).

Treasuries Maturities
Treasury Bills (T-Bills)
  • Short-Term Borrowing (<52 Week Maturities)
Treasury Notes (T-Notes)
  • Medium-Term Borrowing (2 to 10 Year Maturities)
Treasury Bonds (T-Bonds)
  • Long-Term Borrowing (20 or 30 Year Maturity)

For all of these offerings, the backing by the U.S. government (and thus the low credit risk) is the key factor that appeals to retail and institutional investors.

Treasuries generally become less attractive if interest rates are very low and during periods of high inflation (or if the market is worried about an inflationary spike).

In addition, all three Treasuries are traded in a highly liquid secondary market, i.e. there is significant trading volume with active buyers and sellers.

However, the 10-year T-note tends to garner the most attention, as its yield is most often used as the risk-free rate assumption in valuation models, such as for the discounted cash flow model (DCF).

How to Buy Treasury Bonds: TreasuryDirect Auction Process

Treasury bonds can be purchased directly from the U.S. Treasury or indirectly from financial institutions, such as banks and brokerages.

T-bonds can be bid on at regularly held auctions via the TreasuryDirect site, which occur 4x per year, on the first Wednesday of February, May, August, and November.

  1. Non-Competitive Bidding: The stated interest rate at the auction is the fixed rate that the investor receives post-purchase. Since the terms are agreed to without any negotiation, the bid is essentially guaranteed to be accepted and the investor is paid interest calculated from the face value of the bond, which is held until the maturity date.
  2. Competitive Bidding: The interest rate received is negotiated, rather than investors simply accepting the rate offered at the auction. However, in order for the bid to be accepted, the specified rate must be less than the standard rate.

The tentative schedule with the dates of upcoming auctions can be viewed on the TreasuryDirect site.

Treasury securities like T-bonds can also be purchased through a bank or brokerage, with the drawback of additional charged fees.

Otherwise, an investor can also gain exposure to Treasury bonds through mutual funds and exchange-traded funds (ETFs) with portfolios containing T-bonds.

U.S. Treasury Bonds: Guidelines on Taxes

Only the federal tax rate is applied to the interest income earned on T-bonds, as the income is exempt from taxation at the state and local level.

The price at which the Treasury bond was sold is also another consideration.

  • Discount: The purchase price was below the par value of the bond.
  • Par: The purchase price was the same as the par value of the bond.
  • Premium: The purchase price was above the par value of the bond.

Given the purchase price, an investor must consider that the net gain earned in excess of the original principal can be treated as taxable income.

For instance, if a T-bond is purchased at a discounted price relative to the market price in the secondary markets, the profit earned on the date of maturity is subject to taxation (and can be treated as a capital gain). Or in the case of an original issue discount (OID), the gain on the OID can be treated as a different type of income, which is specific to different jurisdictions.

That said, it is recommended that investors consult with a certified tax accountant before investing in Treasuries, as various individual factors could influence the amount of taxes owed.

Risks of Treasury Bonds: Inflation and Interest Rate Risk

While Treasury bonds carry minimal risk in terms of credit quality and the chance of default by the issuer, there is still some exposure to external risks that can affect investor returns.

  • Inflation Risk: To start, the inflation risk must be considered, as the interest rate might not keep pace with the rate of inflation. If the inflation rate outpaces the interest rate on the T-bond, there is actually a net loss on the investment, i.e. inflation erodes the monetary gain due to the reduction in purchasing power.
  • Interest Rate Risk: Another risk in the markets to be mindful of is interest rate risk. If the prevailing interest rates in the market rise, the value of T-bonds declines from a relative perspective. In other words, new issuances with higher interest rates, such as corporate bonds issued by corporations with high credit ratings during periods of more favorable economic conditions, can cause an existing T-bond to decline in relative value, i.e. due to the opportunity cost of capital.

In particular, inflation risk and interest rate risk pertain more to treasury bonds—compared to T-bills and T-notes—because of the longer maturities of T-bonds, as so much can change in the global economy and financial markets across a 20 to 30 year time horizon.

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