What Is a Government Security? Types and How They Work

Government securities are a primary mechanism through which governments acquire funding. These financial instruments allow federal, state, and local entities to borrow money for various financial obligations and public initiatives. Investors who purchase these securities lend money to the government.

Understanding Government Securities

Government securities are debt instruments issued by a government to finance its expenditures. When an individual or entity buys a government security, they provide a loan to that governmental body. The government commits to repaying the principal by a specified maturity date, and most securities involve periodic interest payments.

Governments issue these securities to fund public projects, manage national debt, and cover operational costs, including infrastructure and social programs. U.S. federal government securities are backed by the “full faith and credit” of the U.S. government, which signifies a strong assurance of repayment. This backing contributes to their perception as low-risk investments.

Federal Government Securities

The U.S. federal government issues several types of marketable securities, each with distinct characteristics regarding maturity and interest payment structures. These include Treasury Bills, Treasury Notes, Treasury Bonds, and Treasury Inflation-Protected Securities (TIPS).

Treasury Bills (T-Bills)

T-Bills are short-term debt instruments with maturities of one year or less, commonly issued for 4, 8, 13, 17, 26, or 52 weeks. They are sold at a discount from their face (par) value. The investor’s return is the difference between the discounted purchase price and the full face value received at maturity.

Treasury Notes (T-Notes)

T-Notes represent intermediate-term debt, typically issued with maturities of 2, 3, 5, 7, or 10 years. These securities pay fixed interest every six months, known as coupon payments, until they reach maturity.

Treasury Bonds (T-Bonds)

T-Bonds are long-term debt instruments, generally issued for 20 or 30 years. Like T-Notes, they provide fixed interest payments semi-annually until the bond matures.

Treasury Inflation-Protected Securities (TIPS)

TIPS are designed to protect investors from inflation. The principal value of a TIPS adjusts with changes in the Consumer Price Index (CPI), a measure of inflation. While the interest rate remains fixed, the actual dollar amount of each semi-annual interest payment varies because it is paid on the inflation-adjusted principal. TIPS are offered with maturities of 5, 10, or 30 years.

U.S. Savings Bonds

U.S. Savings Bonds, such as Series EE and Series I bonds, represent another category of federal government securities, though they are non-marketable. Series EE bonds are sold at a discount from their face value and are guaranteed to double in value over 20 years, continuing to earn interest for up to 30 years. Series I bonds also earn interest, which adjusts based on inflation, providing a measure of protection against rising prices. Both types are typically held to maturity and cannot be traded in the secondary market.

State and Local Government Securities

State and local governments, including cities, counties, and public agencies, issue their own debt instruments, primarily known as municipal bonds, or “munis.” These bonds finance a wide array of public projects and services within communities. Common uses include funding the construction of schools, roads, bridges, and water systems.

Municipal bonds are generally classified into two main types: general obligation bonds and revenue bonds. General obligation (GO) bonds are backed by the full faith and credit of the issuing governmental entity, relying on its general taxing power to ensure repayment. This means the issuer can use any available tax revenue to meet its debt obligations. Revenue bonds, in contrast, are secured by the specific revenue generated from the project they finance, such as tolls from a highway or utility payments from a water system.

A distinguishing feature of municipal bonds for investors is their tax treatment. Interest earned on municipal bonds is often exempt from federal income tax. For investors residing in the state or locality where the bond is issued, the interest may also be exempt from state and local income taxes, offering a “double” or even “triple” tax exemption. This tax advantage can make municipal bonds particularly attractive to investors in higher tax brackets.

How Government Securities Function

Federal government securities are widely considered among the safest investments due to the backing of the U.S. government, implying a very low risk of default. While state and local government securities carry a slightly higher degree of credit risk compared to federal ones, they are still generally regarded as relatively low-risk investments.

Many government securities, especially federal ones, exhibit high liquidity, meaning they can be readily bought and sold in secondary markets before their maturity date. This liquidity provides investors with flexibility, allowing them to access their capital if needed. Returns from these securities typically come in the form of fixed interest payments, known as coupons, for notes and bonds, paid periodically like semi-annually. For T-Bills, the return is realized from the difference between the discounted purchase price and the face value at maturity.

Individual investors can acquire government securities through various methods. In the primary market, new issues of U.S. Treasury securities can be purchased directly from the U.S. Treasury via its online platform, TreasuryDirect. This involves participating in auctions where the securities are initially offered. Alternatively, investors can buy existing government securities in the secondary market through brokerage firms or banks. These securities often serve as conservative components within an investment portfolio, offering capital preservation and a source of regular income.