What is a Government Security
A government security is a bond issued by a government authority with a promise of repayment upon maturity. Government securities such as savings bonds, treasury bills and notes also promise periodic coupon or interest payments. These securities are considered low-risk, since they are backed by the taxing power of the government.
BREAKING DOWN Government Security
The Treasury Department issues government securities through auctions to institutional investors for buying and selling. Retail investors buy government securities directly from the Treasury Department’s website, banks or brokers. Since most government securities are backed by the full faith and credit of the U.S. government, default is unlikely.
Rates on government bonds affect the entire U.S. economy. The government’s sale or repurchase of its bonds affect the money supply and influence interest rates. For example, when the Federal Reserve repurchases Treasuries, sellers deposit proceeds in banks, which lend money to customers, who deposit the loan proceeds in bank accounts, and use the money for various purposes. Therefore, every dollar of repurchased Treasuries increases the money supply by several dollars.
Examples of Government Securities
Savings bonds offer a fixed interest rate over a certain period of time. When an investor buys and holds a savings bond until maturity, he receives the bond’s face value plus accrued interest. Savings bonds are not redeemable for the first 12 months that they are outstanding. Redeeming a bond in the first five years means forfeiting the last three months of interest.
Treasury notes (T-notes) are intermediate-term bonds maturing in two, three, five or 10 years. They provide semiannual interest payments at fixed coupon rates. T-Notes typically have a $1,000 face value; those with two- or three-year maturities have a $5,000 face value.
Treasury bonds (T-Bonds) are long-term bonds maturing in 10 to 30 years. T-Bonds provide semiannual interest payments and have $1,000 face values. The bonds fund shortfalls in the federal budget, regulate the nation’s money supply, and execute U.S. monetary policy.
Pros and Cons of Government Securities
Government securities are exempt from state and local taxes, making government bonds advantageous for investors in high tax brackets. The bonds are very liquid, but have low rates of return. The securities rarely protect against inflation and have little or no capital gains opportunity.
Many investors hold government securities through mutual funds. The funds offer diversification among all types and maturities of bonds, which is difficult for retail investors to achieve without investing more cash than mutual funds require. However, fund-management fees lower investors’ overall returns.
Although government securities carry little risk of default, they carry interest rate risk. When interest rates rise or fall, bond prices react inversely. Fortunately, when interest rates rise, T-Note prices typically fall less than with other bonds. With their steady income streams, government securities are a conservative choice in a fluctuating market.