A government bond is a type of security that is sold by the government or one of its agencies. These bonds are called fixed-income securities because they earn a fixed amount of interest per year, every year, for the entire duration of the bond.
A treasury bond or T-bond is a government debt security that is used by the Federal Government with maturity dates of 10 years or more. These bonds earn interest periodically until maturity, and at that point, the owner is also paid an amount equal to the principal amount.
How are government/treasury bonds issued?
When a new bond is born, a legal document must be created to outline the conditions under which the bond issue can be undertaken. Government officials in charge of the bond must also decide how the bond will be sold. Oftentimes, auctions are held for multiple underwriters to attend and participate in the bidding process.
In the beginning stages of the marketing phase, a preliminary official statement or disclosure document is created to deliver to potential purchasers. These investors may examine the price, risks, and expected return of each bond offering before deciding which to bid on. As a legal requirement, a public meeting must be held after a reasonable marketing period of potential purchasers thoroughly reviewing and evaluating the disclosure document. When the auction is held, each group submits its purchase bid on the day of the public meeting. This auction continues until all bonds are distributed.
Once a government bond is successfully auctioned off, the underwriter will wire the purchase price of the bond to the paying agent. The paying agent acts as a middle man for bond purchasing and ensures that funds are distributed appropriately in relation to the intended purpose of the bond. After the funds are distributed, closing documents will be prepared for signing and filing.
What are the types of government bonds?
There are four main types of government bonds, including:
- Treasury Bills – bonds that mature in less than one year
- Treasury Notes – mature between one and 10 years
- Treasury Bonds – longer-term bonds with a maturity date of more than 10 years
- Treasury Inflation Protection Security (TIPS) – a slightly different form of government bond and has its interest rate adjusted semiannually in line with inflation
Municipal bonds are similar to government bonds in that their purchase covers government-run entities, such as parks, highways, and public schools. However, municipal bonds are exempt from all income taxes – federal, state, and local.
More About Municipal Bonds
Can you trade government bonds?
Government bonds can be freely traded in the market, and the price they trade at is related to the interest rate of the particular bond, its remaining life, and the current rate of interest for new bonds. These types of bonds are sold through a broker in the secondary market, also called the bond market. There are many reasons why someone would decide to sell an immature government bond, but the most common are:
- Anticipation of changing interest rates
- To hedge against interest rate increases on existing bonds
- To hedge against high inflation on existing fixed-income investments
What are the risks of government bonds?
Government bonds are issued by the U.S. Treasury and are therefore backed by the full faith and credit of the U.S. government. If you keep a bond through the maturity date, there is virtually no risk involved besides the chance that its return may not keep pace with inflation. However, there are risks involved with selling a government bond prior to maturity.
How do taxes work for government bonds?
The interest earned by government bonds is taxed only at the federal level and is exempt from taxes at the state and local levels. How you claim your earned interest depends on the type of government bond you own. For example, Treasury Bills are paid at maturity and therefore are tax-reportable in the year the money is received.
Contact Carty & Co.
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