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accurately predict the direction of the interest rates and act on their predictions quickly, the rewards can be very handsome. This will become more clear as we continue our discussion.

The Government Securities

Have you ever wondered how the United States government raises money to pay for its day-to-day activities? Taxation is certainly one way, but the tax revenues are sometimes not enough to meet the expenses incurred by the government. In order to raise money, the government engages in the sale of certain instruments known as the government securities. Government securities come in many shapes and forms to suit almost every taste. They are bearer instruments allowing their owners to collect their original payment (principal) plus a certain amount of money (as determined by a fixed interest rate) over a period of time until a certain date known as the maturity date is reached when the principal is paid back. In effect the government borrows money from the public with a promise to pay it back at a certain interest rate. The amount of money that the government borrows is known as public debt, and there is an assigned bureau within the Treasury Department in charge of administering this program, appropriately named the Bureau of the Public Debt.

Actually the government sells securities through pre-announced auctions (handled by the federal reserve banks) and while the auctions are open to everyone, the securities are mostly snapped up in large quantities by financial institutions such as banks and brokerage firms. In turn these firms sell some of the securities in smaller quantities to the public with an added commission. The interest is paid in two ways: either in installments (coupon payments) until the maturity date is reached, or in a lump sum at maturity. Remember that the government …