Treasury bonds are issued by the government of
the United States in order to pay for government projects. The money paid
out for a Treasury bond is essentially a loan to the government. As with any
loan, repayment of principal is accompanied by a fixed interest rate. These
bonds are guaranteed by the 'full faith and credit' of the U.S. government,
meaning that they are extremely low risk (since the government can simply
print money to pay back the loan). Additionally, interest earned on Treasury
bonds is exempt from state and local taxes. Federal taxes, however, are
still due on the earned interest.
The government sells Treasury bonds by auction in the primary market, but
they can also be purchased through a broker in the secondary market. A
broker will charge a fee for such a transaction, but the government charges
no fee to participate in auctions. Treasury bonds are marketable securities,
meaning that they can be traded after the initial purchase. Additionally,
they are highly liquid because there is an active secondary market for them.
Prices on the secondary market and at auction are determined by interest
rates.
Treasury bonds issued today are not callable, so
they will continue to accrue interest until the maturity date. One possible
downside to Treasury bonds is that if interest rates increase during the
term of the bond, the money invested will be earning less interest than it
could earn elsewhere. Accordingly, the resale value of the bond will
decrease as well. Rising inflation can also eat into the interest earned on
Treasury bonds. Because there is almost no risk of default by the
government, the return on Treasury bonds is relatively low, and a high
inflation rate can erase most of the gains by reducing the value of the
principal and interest payments.
Investors who wish to participate in auctions and purchase Treasury
securities directly from the Federal Reserve Bank can open a Treasury Direct
Account. There are no fees associated with the account unless it contains
over $100,000, at which point a very small maintenance fee is incurred.
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