How Government Bonds Work
The U.S. Department of the Treasury uses bonds as a long-term strategy to raise funds. When an investor purchases a government bond, he essentially provides the issuing government with a long-term loan of 20 or more years. Shorter investments are available, too, as Treasury bills and Treasury notes mature in less than a year to 10 years. With modern Treasury bonds, holders receive interest payments on their investment, and then may trade the bond in for its face value when it matures.
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Treasury Bond Basics
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Investors purchase Treasury bonds directly from the U.S. Treasury in blocks of $100. Treasury bonds mature over a period of 30 years, at which time the investor receives her full investment by cashing in the bond. In the interim, however, she receives interest payments every six months based upon the interest rate negotiated when the bond was purchased. When a bond reaches maturity, the Treasury stops making interest payments on the loan. For example, an investor purchases a $100 bond that pays a 2 percent annual interest rate. Each six months, she receives a $1 payment for interest. After the bond matures in 30 years, she has received $60 in interest payments and receives her $100 principal when she cashes it in.
Selling Treasury Bonds Before Maturity
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Investors who purchase a Treasury bond aren't locked into the investment for 30 years. Those who wish to prematurely sell their bond may contact the U.S. Treasury's customer service division and sell the bond using a "sell direct" form. The Treasury will then give other investors the opportunity to bid on your bond, and it's sold at the highest price the market will bear. You receive the proceeds from the bond's sale, and the investor who purchased it begins drawing interest revenue. He also can cash the bond in at maturity for its face value.
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Savings Bonds
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Savings bonds work a lot like traditional Treasury bonds. Investors may purchase paper bonds for half of their face value, then redeem the bond for its full value after it reaches maturity 30 years later. During the maturity phase, investors also receive a small interest payment every two years while the bond matures. Electronic savings bonds are also available and sell at face value. They pay the same rate as paper bonds but are easier to liquidate. Holders may redeem savings bonds prematurely, though if they do so in the first five years after the bond is issued, they forfeit the last three months' interest. After five years, savings bonds may be redeemed without incurring a penalty.
Investment Strategies
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Many investors use Treasury bonds to provide a stable investment in their portfolio. Although Treasury bonds don't offer the returns of more high-risk ventures such as corporate bonds, they're considered one of the safest investments available, with bond ratings receiving the highest rating -- AAA -- from the three major credit reporting agencies: Moody's, Standard and Poor and Fitch Ratings.
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References
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