Bills, Notes and Bonds…OH MY!

Here’s a joke. A bill, a note and a bond walk into a bar. Who leaves first?

At the end of this lesson, you will be able to answer that question.

Education:

In the last lesson, we introduced the U.S. Savings Bonds.  Today, we will discuss the other investment alternative offered by the United States Government – U.S. Treasury Securities.

U.S. Treasury Securities come in three different classes based on their length to maturity.

Class #1 – U.S. Treasury Bills (maturities range from a few days to 52 weeks)

Class #2 – U.S. Treasury Notes (maturities of 2, 3, 5, 7 and 10 years)

Class #3 – U.S. Treasury Bonds (matures in 30 years)

Treasury Bills

Treasury bills, or T-Bills mature in one year or less, they do not pay interest prior to maturity; instead, they are sold at a discount of the par value to create a positive yield to maturity or profit for the investor.

For instance, you might pay $990 for a $1,000 bill. When the bill matures, you would be paid $1,000. The difference between the purchase price and face value is profit.

Treasury Notes

Treasury Notes, or T-Notes mature in two to ten years, pays interest every six months, and have denominations of $1,000. In the basic transaction, one buys a “$1,000” T-Note for say, $950, collects interest over 10 years of say, 3% per year, which comes to $30 yearly, and at the end of the 10 years cashes it in for $1000. So, $950 over the course of 10 years becomes $1300.

Treasury Bonds

Treasury bonds mature more than ten years (up to 30 year).  Treasury bonds pay a fixed rate of interest every six months until they mature. When a bond matures, the owner is paid the face value of the bond. Bonds can be held until maturity or sold before maturity.

Let’s recap:

Type of Security

Maturity

Pays Interest
Treasury Bills (T-Bills) Less than 1 year No
Treasury Notes (T-Notes) 2 – 10 years Yes, every 6 months
Treasury Bonds More than 10 years Yes, every 6 months

Advantages of U.S. Treasury Bond

  1. Safe, risk-free investment
  2. Backed by the full faith and credit of the U.S. Government
  3. Purchased directly from the U.S. Treasury in $100 increments
  4. Pays a fixed amount of interest (based on the discount rate)
  5. Interest earned is exempt from state and local income tax
  6. Great for retirement
  7. T-bills and T-Notes are great short term investments
  8. Diversify your investment portfolio
  9. T-Bills can be purchased in virtually every type of investment account, including Coverdell ESA’s, UTMA/UGMA custodial accounts, and educational trusts. Additionally, many Section 529 plans offer a low-risk mutual fund option that is heavily invested in T-Bills.

Disadvantages of U.S. Savings Bonds

  1. Interest rate varies with maturity of security – still comparatively low based on other types of investments
  2. High purchase limit (up to $5 million)
  3. Interest earned is subject to federal income tax
  4. Opportunity Costs of money tied up especially in Notes and Bonds

 Resources:

Treasury Direct (www.treasurydirect.gov)  – TreasuryDirect is the first and only financial services website that lets you buy and redeem securities directly from the U.S. Department of the Treasury in paperless electronic form. The website offers product information and research across the entire line of Treasury securities, from Series EE Savings Bonds to Treasury Notes. Our TreasuryDirect accounts offer Treasury Bills, Notes, Bonds, Inflation-Protected Securities (TIPS), and Series I and EE Savings Bonds in electronic form in one convenient account.

Important terms from this lesson:

Term

Definition
Treasury Bills or T-Bills A bill is a short-term investment issued for a year or less.
Treasury Notes or T-Notes Are government securities that are issued with maturities of 2, 3, 5, 7, and 10 years and pay interest every six months.
Treasury Bonds Pay interest every six months and mature in 30 years.
Discount Means a purchase price that is less than the face value of the security.
Discount Rate Another name for the coupon or interest rate given to a security.
Opportunity Costs The cost of an alternative that must be forgone in order to pursue a certain action. Put another way, the benefits you could have received by taking an alternative action.

 Action Step:        Watch the short video to drive this lesson home.

Bonds, notes and bills