Basics of Treasury Bonds & Securities Explained

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Between the various bailouts, rescues, and spending packages, the United States Treasury has been working overtime issuing debt. If you’re like me, you’re probably wondering how this is even possible and how the government goes about doing it. During the First World War and World War Two, we went through a similar period where the government needed to borrow a lot of money to help fund the war effort. That gave rise to the patriotic posters that called for ordinary Americans to buy war bonds to support our soldiers fighting the enemy on foreign soil. That same mechanism, public debt, is what we use today to help fund many of our programs. This makes it a prime topic for the third installment of the Foundation Series.

Relative Safety of Treasury Bonds

Before I get into the various instruments, the basic idea behind government bonds is that they are the safest investments in the world and that they are “backed by the full faith and credit of the United States Government.” When you buy stock in a company, there is a chance the company goes bankrupt and your shares are worthless. When you buy a corporate bond, there is a chance that the company goes bankrupt and your bonds are worthless. When you put your savings into a bank account, there is a chance that the bank fails, an almost impossible chance that FDIC insurance fails, and your money is worthless. When you put your money into a government bond, the government will collapse before you will lose your money. Being backed by the full faith and credit of the United States Government is an ironclad guarantee that your money is safe.

That guarantee, while comforting, is a bit illusory because we use a fiat currency that has no inherent or intrinsic value. Our dollars, or federal reserve notes, are themselves given value by government order (fiat) rather than an inherent value. However, despite this minor technical note, government bonds are still safer, from a capital preservation perspective, than every other investment.

Types of Treasury Bonds

When it comes to debt instruments, the name “bond” only appears in four of the seven debt instruments the Treasury issues because only three are truly bonds. A Bond is a very general term, it typically refers to a debt security where the issuer of the bond owes the holder of the bonds a debt. The bond itself has a coupon or interest rate at a certain interval and return the principal at a future date. Companies issue bonds, municipal government issue bonds, and the government issues bonds.

The other four debt instruments are called “securities” or marketable securities because they can be traded on the secondary market. Here is the list of products and a brief discussion of each:

  • Treasury Bills (T-Bills) – T-Bills mature in one year or less and do not pay interest. Instead, they are sold at a discount of the par value (face value) paid out at maturity. T-Bills are sold at auction every week in increments of $100 and an individual can purchase up to $5 million per auction.
  • Treasury Notes (T-Notes) – T-Notes mature in two to ten years and offer a coupon or interest payment every six months. The 10 year T-Note is the Treasury most often quoted in discussions about the bond market. T-Notes are sold at auction every week in increments of $100 and an individual can purchase up to $5 million per auction.
  • Treasury Bonds (T-Bonds) – T-Bonds mature in ten to thirty years, have a coupon payment every six months and are issued quarterly. T-Bonds are sold at auction every week in increments of $100 and an individual can purchase up to $5 million per auction.
  • Treasury Inflation-Protected Securities (TIPS) – TIPS were introduced in 1997 and are inflation-indexed bonds, pegged to the Consumer Price Index, in maturities of 5-year, 10-year, and 20-year. The coupon rate rate remains constant by the principal is adjusted for inflation (and deflation) every six months, but you the principal will never adjust below the principal you paid. TIPS are sold at auction every week in increments of $100 and an individual can purchase up to $5 million per auction.
  • I Bonds – Series I bonds are very popular now, I just bought Series I bonds for the first time this year, because they are sold at face value but have an interest rate that adjusts with inflation. Each bond has a fixed interest rate, that stays for the life of the bond, and a variable interest rate, which is indexed to the rate of inflation. The equation used is a little tricky to look at but easy to compute (here’s a Series I rate calculator). Here’s a comparison between Series I Bonds and TIPS, the two inflation indexed offerings from the Treasury.
  • EE/E Bonds – Series EE bonds are issued at 50% of their face value and mature in 30 years, though as it accues interest semi-annually, it is designed to reach face value in only 17 years.
  • HH/H Bonds – Series HH bonds are no longer offered as of August 31st, 2004, but they were similar to EE/E bonds in that they were sold at a discount and mature in 20 years at face value.

Tax Considerations

One of the benefits of these products is that interest is exempt from income tax on the State and local level (but not Federal level). Some of the bonds, such as the Series EE/E and Series I Savings Bond, offer education tax savings. If you use the interest from an Series EE/E or a Series I Savings Bond to pay for eligible education expenses, it is tax free! Couple that with the Lifetime Learning or Hope Credits and you can get some serious tax savings.


There are risks to buying Treasury Bonds and similar debt instruments. The two major risks are inflation risk and currency risk.

Inflation risk: Inflation risk refers to the risk that your purchasing power will fall as inflation increases. If you have a coffee can stuffed with a thousand dollars buried in your back yard, you can be pretty sure that the $1,000 will still be there when you dig it out of the ground in five years. However, the $1,000 is worth less in five years because the value of a dollar will have fallen due to inflation. The same is true for money saved in bank accounts, CDs, or anything else not pegged to inflation. If inflation is 5% a year, you lose five dollars out of every hundred dollars each and every year. This risk is dangerous because it’s difficult to see with your eyes. You still see your thousand dollars sitting there, but you forget that the jar of peanut butter you buy each month or the gallon of milk you buy each week has gotten a little more expensive (or they shrank the jar!).

Currency risk: Another risk you face is that the dollar loses its value against other currencies. This is important because you’ll probably be buying products manufacturer or produced overseas and so your purchasing power will once against be tested. If you lock up your funds in a bond or CD, the risk that the dollar’s value goes down will have an impact on your savings.

Are these two reasons enough to preclude you from putting your money into a bond (or CD or savings account)? I don’t think so, but you need to be aware of them.

Where & How To Buy

You can buy some of the bonds at your local bank but the best and easiest place to do it is through the government’s TreasuryDirect website. Setting up an account is fairly straightforward but be sure you get all the details right the first time. Making a change to your account will require a stamp from a bank official, which may be a pain to get if you’re working regular 9-to-5 hours at your job.

Also, you can buy paper bonds and convert them into electronic bonds, but having done that myself I have to say it was a little confusing. You have to create a Conversion Account that’s separate, but accessible, from your regular TreasuryDirect account. Then you have to create a manifest and mail in the paper bond with the manifest. It’s not impossible, but avoid the headache if you can.

Where & How To Sell or Redeem

So you have some savings bonds and you want to sell or redeem them, you have a few options based on what kind of certificates you have. Selling and redeeming a bond are two different things, though both result in the security or bond being taken away and replaced with money. Some of these investments, like TIPS, cannot be closed before they mature, so the only way for you to recover your money is to sell your TIPS. Some of these investments, like Series EE bonds, cannot be sold or transfered to another person, so the only way to recover your money is for you to redeem them. Now that we have that cleared up, here’s how you do either.

Electronic certificate: If you have an electronic bond you bought through TreasuryDirect, just log into your account and sell or redeem your bond through the website. In fact, if it’s a security, you don’t have to do anything because they will close the security and transfer the funds to your account. This is by far the easiest.

Paper certificate: If you have a bond, such as an I or EE bond, you can cash in your bond at most local financial institutions, call beforehand to confirm. You’ll need to bring some ID to prove its yours. You can only redeem up to $1,000 in bonds at one time without having to subjecting yourself to further identification (beyond a driver’s license). Don’t sign the bond until you’re in the presence of a certifying officer at the bank and they should take care of the rest.

If you have a security, such as a TIPS, you’ll have to sell it. To sell it, you’ll need to get your hands on a copy of the form “Sell Direct® REQUEST” (PD F 5179-1, it’s the second to last form on the page) from this page of Treasury forms. Sign the form in the presence of an “authorized certifying officer,” usually at a bank, and mail to:
Federal Reserve Bank of Chicago
Investment Division for Sell Direct
230 S. LaSalle St.
Chicago, IL 60604

At Chicago, the Federal Reserve Bank will sell your security to the highest bidder, deduct a $45 fee, and transfer the rest to your bank account.

Have you purchased any savings bonds or other Treasury securities?

{ 26 comments, please add your thoughts now! }

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26 Responses to “Basics of Treasury Bonds & Securities Explained”

  1. One of the minor risks is default risk. T-bills can be considered a risk free rate because what are the odds the federal government will go bankrupt in the next 3 months or so?

    But who knows what 30 years from now will look like? The USA may not exist, and your bond is worthless. I’m not a fear monger, I do believe government bonds are one of the safest investments in the world. But like the bargainr says, all investments carry risk.

  2. Miranda says:

    I’m not sure that inflation is all that much of a concern for many right now. After all, quite a few people are actually buying bonds in order to preserve principal. It’s gotten that risk averse out there…

    • Lee says:

      Not now, but the worry is FUTURE inflation. Your present bond will lose value and must be sold at a discount if you need to sell it.

  3. Patrick says:

    I agree with the other commenter in that who knows how the US government is going to be in the next 30 years. I would rather invest in municipal bonds at this point as they are both federal and state tax exempt.

  4. I am actively involved in shorting long dated treasury bonds.

    I believe this is the latest bubble.

    This post would have been timely in September 07. I would point out to your readers that the treasury bond market is extremely overcrowded, and the risk/reward ratio in these securities isn’t in favor of the purchaser.


    • Jim says:

      I wasn’t so much recommending Treasuries as I am just trying to explain them so people understand what they are. I do agree that we are in a bubble (or at least frothy) as people turn to them for safety.

  5. T-Bonds are a great way to get in to low risk investing beyond the confines of CDs and Savings Accounts. I’m writing a piece for my site about them and plan to use some of this information.

  6. thomas says:

    Great summary of bonds & securities. I have several EE bonds from my Army days (Man I thought I was so cool saving $50 a month!). Always good to get a refresher on the different offerings.

  7. Eric N. says:

    I purchased my I Bonds when you did. 😀

    Though this post reminds me…are we technically in a period of deflation now? I admit I’m a bit clueless but does that affect the bonds that are pegged to the inflation rate?

    • Lee says:

      I guess the question is: Where does that “pegged” money come from. More borrowing from China???

  8. Hey Jim, you list where to buy but not where (or how) to sell them. You might not imagine that anyone wouldn’t know that but if you’re a college kid who’s got a bunch of bonds that your grandparents bought for you when you were a baby, you might not have a clue how to cash them in.

  9. Thanks Jim! Now I’ll forward this one to my son who will probably turn around and cash in all his bonds. Oh wait, maybe that wasn’t such a good addition after all!

  10. Ramoogur Akshay says:


  11. Herb O'Connor says:

    I am now 61. Should I buy a treasury bond that pays 4.5% or one that has an interest rate of 6.25%. We are interested in producing as much income as possible at this stage of our lives. Thanks

  12. Brodient says:

    Is it possible to hold TIPS or I Bonds in an IRA? I’m considering a Treasury Direct account, but would like to buy the bonds using cash already in my ROTH or regular IRA accounts. Is there a preferred process to do this?

  13. govenar says:

    Re: “You can only redeem up to $1,000 in bonds at one time without having to subjecting yourself to further identification (beyond a driver’s license).”

    I think if you have an account at the bank already, you don’t need any other identification.

  14. Sonia says:

    Isn’t there a $1,000 dollar minimum to open an account with treasurydirect. How can I purchase 3-month t-bills with treasurydirect at increments of $100 if there is a $1,000 minimum opening account requirement? Is there another investment firm that I can purchase a 3-month T-bill at the $100 minimum requirement?

  15. Ramiro Cabrera says:

    Hi ,

    Could you explain the fundamentals behind the decrease on the 10 year t-note rate from 3% to 2,5 after bernanke´s speech? Why prices rose and what is the explenation for rates decrease.


  16. JOE says:

    Is there any way to roll over mature E and/or EE Bonds I bought 30 years ago? I remember something about HH Bond but I understand they no longer exist.

  17. Marilyn says:

    Way back in Elementary school I remember starting to put money towards, U.S. Treasury Bonds. What ever became of that money that I would guess other students got involved with. I’m talking about the Mentor School System in Mentor, Ohio 44060 around 1955-57?

  18. Tammy says:

    Buy the T bills. If you buy 7 the government will give you 3 for free. My third cousin Wally told me so.

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