U.S. Treasury Securities

U.S. Treasury securities are debt obligations issued by the federal government. They are considered the safest investments in the world because they are backed by the "full faith and credit" of the U.S. government. Understanding the different types of Treasuries is essential for the SIE exam.

Why Treasuries Are Safe

• No credit risk - The U.S. government has never defaulted on its debt
• Highly liquid - Largest and most active bond market in the world
• Benchmark rates - Other bonds are priced relative to Treasury yields

Key Point: While Treasuries have virtually no credit risk, they are still subject to interest rate risk. When rates rise, Treasury prices fall.

Overview of Treasury Securities

Treasury Bills (T-Bills)

T-Bills are short-term securities that mature in one year or less. They are the most common money market instrument.

Key Characteristics

• Maturities: 4, 8, 13, 26, and 52 weeks
• Minimum investment: $100
• Interest: None—sold at discount, mature at par
• Quoted: On a discount yield basis

Example: You buy a 26-week T-bill for $9,800. At maturity, you receive $10,000. Your return is the $200 discount.

T-Bill Taxation

• Interest is exempt from state and local taxes
• Interest is subject to federal income tax
• Interest is recognized in the year of maturity

Treasury Notes (T-Notes)

T-Notes are intermediate-term securities, the most popular Treasury for individual investors.

Key Characteristics

• Maturities: 2, 3, 5, 7, and 10 years
• Interest: Pays semi-annual interest at a fixed rate
• Issued: At par (face value)
• Minimum: $100

The 10-year Treasury note yield is closely watched as a benchmark for mortgage rates and other long-term interest rates.

Treasury Bonds (T-Bonds)

T-Bonds are long-term securities for investors seeking steady income over decades.

Key Characteristics

• Maturities: 20 and 30 years
• Interest: Pays semi-annual interest at a fixed rate
• Issued: At par
• Risk: Highest interest rate risk among Treasuries (due to long maturity)

Interest Rate Sensitivity: Because T-bonds have the longest maturities, their prices are most sensitive to interest rate changes. A 30-year bond will move much more than a 2-year note when rates change.

TIPS (Treasury Inflation-Protected Securities)

TIPS protect investors from inflation by adjusting the principal based on the Consumer Price Index (CPI).

How TIPS Work

1. Principal adjusts with inflation (CPI)
2. Interest rate is fixed, but payment varies with principal
3. At maturity, receive the greater of adjusted principal or original par

Example of TIPS Adjustment

TIPS Risk Protection

• Protects against: Purchasing power (inflation) risk
• Still subject to: Interest rate risk
• Taxation: Must pay taxes on principal adjustments annually ("phantom income")

Best For: Investors concerned about inflation eroding their purchasing power over time.

STRIPS (Separate Trading of Registered Interest and Principal)

STRIPS are zero-coupon Treasury securities created by separating the interest and principal components of Treasury notes and bonds.

How STRIPS Are Created

1. A broker buys a Treasury note or bond
2. Each interest payment and the principal become separate securities
3. Each "strip" is a zero-coupon security sold at a discount

Key Characteristics

• Maturity: Up to 30 years
• Interest: None—sold at deep discount
• Issued by: Securities dealers (not the Treasury directly)
• Backed by: Full faith and credit of U.S. government

STRIPS Risks

Phantom Income Tax Issue

STRIPS holders must pay taxes annually on imputed interest (the discount accreting toward par), even though no cash is received until maturity. This is called "phantom income."

Suitability: STRIPS are ideal for tax-advantaged accounts (IRAs, 401(k)s) where phantom income tax is deferred.

Tax Treatment Summary

This state tax exemption makes Treasuries particularly attractive for investors in high-tax states.

Key Takeaways

• T-Bills are short-term (≤1 year), sold at discount, no interest payments
• T-Notes are intermediate (2-10 years), semi-annual interest
• T-Bonds are long-term (20-30 years), highest interest rate risk
• TIPS adjust for inflation using CPI, protecting purchasing power
• STRIPS are zero-coupon, have highest interest rate risk but no reinvestment risk
• All Treasuries are exempt from state and local taxes