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Treasury Securities—3 Ways to Lend to Uncle Sam

Did you know Uncle Sam is one of the world's biggest borrowers? To help finance its operations, the U.S. government borrows money by selling investors a variety of debt securities known collectively as Treasury securities, or simply, Treasuries. These securities have a special place in the investment world, since they are the benchmark by which most other debt securities are measured.

When you invest in
a Treasury security,
you lend money to
the U.S. Treasury.

Here's how Treasuries work: When you invest in a Treasury security, you lend money to the U.S. Treasury. The amount of the loan, the principal, is also called the security's face value or par value. The Treasury pays you interest for the use of your money throughout the term of the debt security, typically twice a year. The interest rate is sometimes called the coupon, from days past when you had to tear a paper coupon off the bond certificate and present it to a bank or other agent to receive your interest payment. These days, interest is credited electronically to your account. When the term ends, the bond matures—and investors get back their principal.

3 Ways to Lend

When investors talk about Treasuries, they usually mean those government securities that are transferable or marketable—in other words, financial instruments that can change ownership. This means you don't need to be the original purchaser of the security to collect the interest and principal, and you can sell your investment if you choose. 

There are three major classes of marketable Treasuries: bills, notes and bonds, also known as T-bills, T-notes and T-bonds. The face value for a single Treasury security is $100, which is the least amount you can invest. You can invest more, in increments of $100 each—for example, $200, $300 and so forth. In fact, if you want, you can buy up to $5 million of any of these securities at one time.

T-bills, T-notes and T-bonds essentially differ in the length of time they take to mature, from several weeks to many years, making each of them suitable for a different investing purpose. Here's what you need to know about each type.

Treasury Bills

Treasury bills are extremely short-term debt investments that are sold with 4-week, 13-week, 26-week and 52-week maturities. With T-bills, you don't receive regular interest payments, as you normally would with debt securities. Instead, you receive the interest only once, at the end of the term. Interest income on T-bills is exempt from state and local income taxes but subject to federal income tax.

T-bills are also priced differently from other debt securities at the time they are issued. Typically, an investor lends the issuer an amount called the face value, or par value, which is paid back at maturity. With T-bills, however, your initial investment is less than par. This is known as buying at a discount. At maturity, you're paid the face value, so the interest you've received is equivalent to the discount you got when you first bought the bill. For example, if you bought $5,000 worth of T-bills at the discounted price of $4,800, you would earn $200 in interest when you receive the full $5,000 face value at maturity.

Because T-bills have short maturities, they have limited exposure to inflation and interest rate risks. As a result, T-bills serve as a benchmark against which the risk of other investments is measured. They typically pay rates comparable to those on bank CDs or money market mutual funds. In fact, when you assign Treasuries to an asset class, T-bills are generally considered cash equivalents.

T-bills may be appropriate for financial goals that call for extremely liquid, low-risk investments. So you might use T-bills in an emergency fund, as a place to hold money while you choose what to invest in next, or as a place to save for short-term goals, such as buying a car.

Treasury Notes

Treasury notes come in a range of medium-length terms: 2, 3, 5, 7 and 10 years. They pay interest twice a year at rates that are fixed at the time they're issued. At maturity, you get the full face value of the note back. T-notes can be useful sources of income and their maturity can be timed to correspond to certain mid-term financial goals, such as buying a home. Or you can buy and sell notes to take advantage of changes in interest rates. In a period of changing interest rates, investors often prefer notes to longer-term bonds, since their investment isn't tied up for such a long period of time. Like T-bills, interest income on T-notes is exempt from state and local income taxes but subject to federal income tax.

The 10-year T-note has a special place in the economy because analysts and financial journalists use it as the benchmark to measure the performance of other debt securities, such as corporate or municipal bonds, and the state of the debt market as a whole.

Treasury Bonds

The long-distance runners of the debt securities universe, sometimes called "long bonds," Treasury bonds have a 30-year term. Like T-notes, T-bonds pay interest on a semiannual schedule, at a fixed rate, and return the full face value of the bond at maturity. After a five-year break from 2001 to 2006, during which no T-bonds were issued, the U.S. Treasury is once again issuing them on a regular schedule.

T-bonds often appeal to buy-and-hold investors because they provide a source of regular income over an extended period of time without risk of default. The interest they pay tends to be higher than on shorter-term bonds, though that isn't always the case. In periods when interest rates are rising, investors may be reluctant to tie up their money for many years if they think that by waiting a bit longer to buy they might lock in a more favorable return. Like T-bills and T-notes, interest income on T-bonds is exempt from state and local income taxes but subject to federal income tax.

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