How a Federal Bond Gets Issued

Global bond markets are larger than the collective stock markets, both in the monetary value of bonds outstanding and in dollar value of bonds traded daily. Yet, investors seem to know relatively little about bonds compared to stocks.

Even federal bonds, known as Treasury bonds (T-Bonds) in the U.S., are not free from obscurity. However, they compose a significant portion of the entire bond market. Treasury bonds are considered the safest fixed-income investment—the benchmark against which the risks of other bonds are measured.

Why Federal Bonds Are Issued

In the United States, the U.S. Treasury coordinates the federal bond issuing process. The first open-market Treasury bonds were war bonds, issued to raise funds for the military. As these matured, the Treasury issued new bonds to pay for older ones, thereby creating a sustainable market of short-, medium-, and long-term bonds that could be easily saved or resold on the open market.

Originally, the Treasury managed bond issuances by conducting informal surveys of market participants to determine the best offering price. In the 1970s, this system was replaced by an auction system, with each bond offering going to the highest bidder.

How a New Bond Is Born

Before the details of the new bond issue are decided, several important questions have to be answered. There must be a legal document that outlines the conditions under which the bond issue can be undertaken. Government officials must also decide how the bonds will be sold. The federal government often holds bond auctions and invites multiple underwriters to attend and participate in the bidding process.

How a New Bond Is Marketed

The first step of the marketing phase is to prepare a preliminary official statement or disclosure document to deliver to potential purchasers. Investors typically examine the price, risk, and expected returns of each bond offering before deciding to place a bid.

One of the most important legal requirements for a federal bond issue is that a public meeting must be held after a reasonable marketing period. During this marketing period, usually lasting about a week, potential purchasers thoroughly review and evaluate the disclosure document.

When the government holds a bond auction, each group submits its purchase bid on the day of the public meeting. The auction continues until all the bonds are duly distributed.

How a New Bond Is Bought and Paid For

In the last steps of the federal bond issue process, the underwriters wire the purchase price for the bonds to the paying agent. The paying agent then pays the costs of issuance, at the direction of the issuer. The paying agent plays an important practical role in the bond issue. The agent sees that funds are appropriately distributed according to the intended purpose of the bond issue. After the closing of the bond distribution, the bond counsel distributes a complete set of closing documents to each participant.

That brings us to the preparation of closing documents, which is the final step in the federal bond issuing process. As you might expect, these documents are highly technical in nature and written within a specific legal framework. Without going into extensive detail about their contents, suffice to say that closing documents reiterate the terms of the approved purchase proposal. Also, the documents lay out the procedure by which the bonds are paid for and distributed.

The Bottom Line

Why should you care about the federal bond issuing process? It is important because federal bond issues tend to be the safest fixed-income investments available. After all, they are backed by the taxation powers of the federal government. The particular nature of each bond issue should still be carefully analyzed.

An encyclopedic knowledge of the procedures surrounding the federal bond issuing process is not necessary to participate in retail bond purchases. An investor can buy government bond ETFs just as easily as stocks without knowing anything about the bond issuing process. However, it is still useful to have some understanding of the bond market.

The federal government has an obligation to purchasers to ensure that the issues are liquid, marketable, and of a size sufficient to guarantee a tradable market. Ultimately, all of these factors combine to improve the marketability of a particular bond issue and make it more attractive to potential purchasers.