Government bonds are debt instruments that governments issue to pay for government expenditures. Within the United States, federal government issues include savings bonds, treasury notes, treasury bonds, and TIPS Treasury inflation protected securities. Investors should carefully consider the risks that different countries’ governments possess before they invest in their bonds. Among these international government risks are political risk, country risk, interest rate risk, and inflation risk. Governments generally have less credit risk, though not always.
Savings bonds are a type of United States government bonds that the Treasury department sells. They are available in an electronic form. The Treasury offers them directly from their website, or individuals can buy them from the majority of financial institutions and banks. When savings bonds reach maturity, the investors get back the bond’s face value along with interest which accrued. These savings bonds may not be redeemed the first year of issue. Any investors who redeem them in their first five years of issue lose three months interest for cashing out too early.
The Treasury of the United States also issues intermediate time frame bonds known as Treasury notes or T-Notes. These notes provide interest payments semiannually at a coupon rate which is fixed. These notes typically are denominated in $1,000 face values. Those with three or two year maturity dates come in $5,000 denominations. Before 1984, T-Notes were callable and gave the Treasury the right to buy them back given specific conditions.
The U.S. government’s longest term bonds are Treasury Bonds, or T-Bonds. These have maturity dates ranging from ten to 30 years time. They also provide interest payments on a semiannual basis and come in $1,000 denominated values. These T-bonds are important because they pay for federal budget shortfalls, are a form of monetary policy, and ensure the country is able to regulate its money supply. As all bond issuers, the Treasury department looks at return and risk requirements on the market when it goes to raise capital so that it can be as efficient as possible. This helps to explain the different kinds of Treasury securities and government bonds they offer.
U.S. government bonds have generally been considered to be without risk, which is why they trade so easily in extremely large and liquid markets. The downside to this is that they offer considerably lower returns than do other bonds. TIPS do provide protection against inflation so that any inflation increases will not exceed the interest rate of the bond. The prices of government bonds are based on current interest rates. This means that the fixed rate bonds will decline in value as the interest rates rise, since there is lost opportunity to obtain newer bonds at higher interest rates. Similarly, if interest rates fall, the bond’s values will rise.
The federal government is able to control the money supply in part by its issue of the government bonds. If they wish to increase the money supply, they can simply buy back their own bonds. These funds then find their way to a bank and expand the money supply as banks keep small reserves and loan the rest out (in the money multiplier effect). The government is also able to lower the money supply by selling additional bonds which takes money out of circulation. If the government were to retire the funds received from the sale of these bonds, it would reduce the available money supply. More often than not, the U.S. government spends the money.