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Types of Bonds

Other U.S. Treasury Securities

Three other forms of U.S. Treasury securities available to individual investors are, TIPS, STRIPS, and U.S. Savings Bonds.

Treasury Inflation-Protected Securities ("TIPS").

In 1997, the U.S. Treasury introduced notes and bonds in a new form designed to protect the investor from the effects of inflation. These inflation-indexed securities are known as Treasury Inflation-Protected Securities, or "TIPS". Using the Consumer Price Index (CPI) as a guide, the value of the principal is adjusted to reflect the effects of inflation. A fixed rate of interest is paid semi-annually on this adjusted principal. At maturity, if inflation has increased the value of the principal, the investor receives the higher, adjusted value back. If deflation has decreased the value, the investor nevertheless receives the original face amount of the security.

Here’s an example of how inflation-indexed securities work. Let’s say you invested $1,000 in January in a new 10-year inflation-indexed note. The note pays 3% annualized interest semi-annually. At mid-year, the Consumer Price Index indicates that inflation has been 1% during the first six months. Your principal is adjusted upward to $1,010 ($1,000 times $101%) and your resulting interest payment would be $15.15 ($1,010 times 3% divided by 2, as interest payments are made semi-annually). At the end of the year, the index indicates that inflation was 3%, which brings the value of your principal to $1,030. Your second interest payment is $15.45 ($1,030 times 3% divided by 2).

Because of the built-in inflation protection, these securities usually offer lower interest rates than U.S. Treasuries of similar maturities without the protection feature.

The U.S. Treasury suspended issuance of the 30-year TIPS in 2001, but reinstated this offering in 2009. However, they had also issued five- and 20-year TIPS during those years in addition to the 10-year offering.

Separate Trading of Registered Interest and Principal Securities ("STRIPS").

For many years, securities firms have offered special products to investors by separating the principal and interest components of U.S. Treasury securities, a process called “coupon stripping.” Initially, stripped securities were available only through proprietary programs of a few firms. Since 1985, the process has been facilitated through a program created by the U.S. Treasury Department—Separate Trading of Registered Interest and Principal Securities (“STRIPS”). STRIPS components, also called “zero-coupon” securities or “zeros,” are traded as individual securities. Stripping a bond with 20 years to maturity, for example, generates 40 coupon STRIPS (one for each semiannual coupon payment) plus one principal STRIP. Once a bond is stripped, investors can buy any or all of the available components.

U.S. Savings Bonds.

U.S. Savings Bonds are available in either a Series EE or Series I. An investor may buy as much as $5,000 per year, and may redeem the bonds anytime after 12 months (there is a 3-month penalty loss of interest if redeemed prior to five years).

Popular gifts, the familiar Series EE savings bonds are sold electronically at face value in any amount between $25 and $5,000, and are sold in paper at one half the face value in standard denominations.

Series EE bonds issued in May 2005 or later earn a fixed interest rate based on 10-year U.S. Treasury note market yields, which are adjusted twice a year. Series EE bonds that were issued from May 1997 through April of 2005 accrue interest according to a floating rate–90% of the average market yields on 5-year Treasuries–that is also adjusted twice a year. The holder doesn’t receive the interest until the bonds are cashed in. If the bonds are redeemed less than five years from the time they are purchased, the holder must sacrifice three-months worth of interest. The U.S. Treasury guarantees that Series EE bonds will mature at full face value in no more than 17 years. If you want to hold them longer, they will continue to accrue interest for 30 years.

Series I savings bonds have a built-in inflation adjustment. They are sold electronically at face value in any amount between $25 and $5,000, and are sold in paper at full value in standard denominations. While issued in the same denominations as Series EE bonds, Series I savings bonds pay interest according to an earning rate that is partly a fixed rate of return and partly adjusted for inflation. Other rules are similar, but not identical, to Series EE bonds.

Unlike most investments, Series EE and I bondholders are allowed to defer paying income taxes on the interest earned until they redeem the bonds. Under certain circumstances, the interest may be tax-deductible when it is applied against expenses for higher education.

 

All information and opinions contained in this publication were produced by the Securities Industry and Financial Markets Association from our membership and other sources believed by the Association to be accurate and reliable. By providing this general information, the Securities Industry and Financial Markets Association makes neither a recommendation as to the appropriateness of investing in fixed-income securities nor is it providing any specific investment advice for any particular investor. Due to rapidly changing market conditions and the complexity of investment decisions, supplemental information and sources may be required to make informed investment decisions.