Introduction to Government Securities
In the investment world, ‘government security’ covers a wide range of investment vehicles offered by governmental authorities. The most familiar types are those issued by the U.S. Treasury, which come in the form of Treasury bonds, bills, and notes. Governments globally issue similar debt instruments to fund necessary and ongoing operations.
Government securities come with a pledge of full repayment of the invested principal upon reaching maturity. Some may pay periodic interest or coupon payments. These instruments are generally considered low-risk investments because they are backed by the government that issued them.
Key Takeaways
- Government securities fund governmental operations and special projects, such as infrastructure and military initiatives.
- They guarantee the return of the principal amount at maturity and often pay periodic interest.
- Considered conservative investments with minimal risk due to government backing.
- Generally offer lower interest rates compared to corporate bonds.
- Can be sold on the secondary market if necessary.
Delving Deeper into Government Securities
Government securities are sovereign debt instruments sold to finance day-to-day operations and special projects. Similar to corporate debt issues, these investments enable governments to avoid increasing taxes or reducing other budgetary expenditures every time additional funds are needed.
After issuance, both individual and institutional investors purchase these securities either to hold unto maturity or to sell in the secondary bond market. Investors typically look for interest income from coupon payments or to balance their portfolios with conservative assets. These risks-free investments are considered reliable because the government can print more money to meet repayment needs.
Types of U.S. Treasury Securities:
1. Treasury Bonds (T-Bonds): Typically mature between 10 and 30 years, offering semiannual interest payments with $1,000 face values used to manage budget deficits.
2. Treasury Bills (T-Bills): Short-term securities with maturities of 4, 8, 13, 26, and 52 weeks, offering higher returns with longer maturity terms.
3. Treasury Notes (T-Notes): Intermediate-term bonds with maturities of 2, 3, 5, or 10 years, offering fixed-rate semiannual coupon payments usually at $1,000 face values.
Comparing U.S. and Foreign Government Securities
While the U.S. Treasury’s offerings are deemed risk-free due to American government backing, other countries also issue government bonds such as Italy, France, Germany, and Japan. However, foreign government securities may bear default risks due to potential economic, political, or country-specific instability.
For instance, in 1998, Russia defaulted on its debt amidst a financial crisis, highlighting possible default risks. Yet, despite their risk-free nature, U.S. government securities generally provide lower interest rates compared to corporate bonds, leading to considerations of interest rate risk and purchasing power erosion due to inflation.
Acquiring Government Securities
The U.S. Treasury Department conducts auctions for institutional purchase, while retail investors can buy directly via the Treasury Department’s website, banks, or brokers. Due to government backing, defaults on U.S. government securities are considered unlikely.
Buying foreign government bonds, such as Yankee bonds, usually requires intermediaries knowledgeable in global markets. These investments might incur heightened political, currency, and default risks and may need offshore accounts or high investment minimums.
Impact on Money Supply
The Federal Reserve (the Fed) influences money flow through policies like the buying and selling of government bonds. Selling bonds can reduce the money supply and push interest rates upward, while purchasing bonds can increase the money supply and push interest rates downward, known as open market operations (OMO). By manipulating these elements, the Fed significantly impacts interest rates and bond yields over time, energizing economic activity as banks gain additional funds to lend or as investors spend their cash elsewhere in the economy.
BENEFITS AND DRAWBACKS:
Pros:
- Steady interest income
- Low default risk, deemed safe
- Some are exempt from state and local taxes
- High liquidity
- Available via mutual and exchange-traded funds
Cons:
- Generally lower rates of return compared to other securities
- Interest rates often don’t match inflation
- Potential default risks with foreign government securities
- Lower returns in rising-rate markets
Common Examples of Government Securities
Below are some of the most commonly issued government securities:
Savings Bonds
These offer fixed interest rates over their term. Holding a savings bond to maturity yields the face value plus accrued interest. Bonds can’t be redeemed within the first 12 months, and redeeming within the first five years results in forfeiting monthly interest.
T-Bills
Short-term securities with typical maturities of 4, 8, 13, 26, and 52 weeks, offering higher interest returns with longer maturation.
Treasury Notes
Intermediate-term bonds with 2, 3, 5, or 10-year maturities, providing semiannual fixed-rate coupon payments.
Treasury Bonds
Long-term investments with 10-30 years maturity, $1,000 face values, and semiannual interest payments, predominantly funding federal budget deficits and monetary control.
Related Terms: Treasury bonds, T-Bills, T-Notes, Yankee bonds, open market operations.
References
- Institute of Modern Russia. “20 Years of Russian Default, A Plan to Seize Superprofits, What Russia Is Doing in Africa”.
- U.S. Department of the Treasury. “Daily Treasury Bill Rates Data”.
- U.S. Department of the Treasury. “Daily Treasury Yield Curve Rates”.
