U.S. Treasury Securities

Treasury securities are debt instruments issued by the U.S. Department of the Treasury to finance government operations. They represent the highest credit quality available in the market; all other bonds are measured against them.

Treasury Bills (T-Bills)

T-bills are the shortest-maturity Treasury security and function as zero-coupon instruments.

• Because T-bills pay no periodic interest, they are effectively zero-coupon instruments
• T-bills are considered the most liquid and lowest-risk marketable securities in the world
• The discount yield on T-bills is the benchmark for money market rates

Think of it this way: You buy a T-bill for $980 and receive $1,000 at maturity. That $20 difference is your return. No interest checks arrive in the mail; you simply pay less up front and get face value back later.

Exam Tip: Gotchas

T-bills do NOT pay semiannual interest. The investor's return is the discount (difference between purchase price and $1,000 face value). The exam may describe a T-bill paying "interest" to test whether you know it is a discount instrument.

Treasury Notes (T-Notes)

T-notes occupy the intermediate maturity range and pay a fixed coupon semiannually.

• The 10-year Treasury note yield is the most widely watched benchmark for long-term interest rates
• Mortgage rates, corporate bond spreads, and other fixed-income yields are typically quoted as a spread above the 10-year note

Exam Tip: Gotchas

T-notes and T-bonds are quoted in 32nds of par, not in decimals. A quote of 99-16 means 99 and 16/32 = 99.50% of par. The exam may show a price like "101-08" and expect you to convert it to 101.25% of par (8/32 = 0.25).

Treasury Bonds (T-Bonds)

T-bonds carry the longest maturities of any Treasury security and therefore have the greatest interest rate risk.

• T-bonds have the greatest price sensitivity to interest rate changes due to their long duration
• Some older T-bonds may be callable at par 5 years before maturity, but the Treasury no longer issues callable bonds

Exam Tip: Gotchas

Longer maturity = greater interest rate risk. If the exam asks which Treasury has the most price volatility, the answer is T-bonds (20-30 years), not T-notes or T-bills. Also, while some older T-bonds are callable, the Treasury stopped issuing callable bonds in 1985.

Common Features of All Marketable Treasuries

All Treasury bills, notes, and bonds share these characteristics:

• Credit quality: Backed by the full faith and credit of the U.S. government (the highest credit quality available)
• Default risk: Considered to have zero default (credit) risk
• Other risks still apply: Interest rate risk, inflation risk, and opportunity cost risk
• Auction process: Sold at auction by the U.S. Treasury through competitive and noncompetitive bids
• Primary dealers: Designated by the Federal Reserve Bank of New York, primary dealers are required to bid at Treasury auctions and make markets
• Secondary market: Trade over-the-counter (OTC), not on exchanges
• Day-count basis: Interest accrues on an actual/actual basis (actual days elapsed / actual days in the coupon period)
• Form: All issued in book-entry form only (electronic records, no physical certificates)

Exam Tip: Gotchas

Treasury securities are exempt from state and local income tax, but NOT from federal income tax. The exam frequently tests this distinction. Also, all Treasury securities carry a $100 minimum purchase (not $1,000 as some older materials state).

Quick Comparison

Think of it this way: Treasury securities sit on a spectrum. T-bills are the shortest and safest (weeks to a year, no coupon payments). T-notes are in the middle (2-10 years, semiannual coupons). T-bonds are the longest (20-30 years, semiannual coupons). The longer the maturity, the more the price swings when interest rates change.