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Trading and Capital-Markets Activities Manual

Instrument Profiles: U.S. Treasury Bills, Notes, and Bonds
Source: Federal Reserve System 
(The complete Activities Manual (pdf format) can be downloaded from the Federal Reserve's web site)


U.S. Treasury bills, notes, and bonds (collectively known as Treasuries) are issued by the Treasury Department and represent direct obligations of the U.S. government. Treasuries have very little credit risk and are backed by the full faith and credit of the U.S. government. Treasuries are issued in various maturities up to 30 years. 


Treasury Bills Treasury bills or T-bills are negotiable, non-interest-bearing securities with original maturities of three months, six months, and one year. T-bills are offered by the Treasury in minimum denominations of $10,000, with multiples of $5,000 thereafter, and are offered only in book-entry form. T-bills are issued at a discount from face value and are redeemed at par value. The difference between the discounted purchase price and the face value of the T-bill is the interest income which the purchaser receives. The yield on a T-bill is a function of this interest income and the maturity of the T-bill. The returns are treated as ordinary income for federal tax purposes and are exempt from state and local taxes. 

Treasury Notes and Bonds 

Treasury notes are currently issued in maturities of two, three, five, and 10 years on a regular schedule. Treasury bonds are currently issued in 30-year maturities. Treasury notes are not callable. Notes and bonds pay interest semi-annually when coupon rates are set at the time of issuance based on market interest rates and demand for the issue. Notes and bonds are issued monthly or quarterly, depending on the maturity of the issue. Notes and bonds settle regular way, which is one day after the trade date (T+1). Interest is calculated using an actual/365 day-count convention. 


Banks use Treasuries for investment, hedging, and speculative purposes. The lack of credit risk and deep liquidity encourages the use of Treasuries as investment vehicles, and they are often held in a bank's investment portfolio as a source of liquidity. Since it is the deepest and most efficient financial market available, many fixed-income and derivative instruments are priced relative to Treasuries. Speculators often use Treasuries to take positions on changes in the level and term structure of interest rates. 


Issuing Practices 

T-bills are issued at regular intervals on a yield-auction basis. The three-month and six-month T-bills are auctioned every Monday. The one-year T-bills are auctioned in the third week of every month. The amount of T-bills to be auctioned is released on the preceding Tuesday, with settlement occurring on the Thursday following the auction. The auction of T-bills is done on a competitive-bid basis (the lowest-yield bids are chosen because they will cost the Treasury less money). Non-competitive bids may also be placed on purchases of up to $1 million. The price paid by these bids (if allocated a portion of the issue) is an average of the price resulting from the competitive bids. 

Two-year and five-year notes are issued once a month. The notes are generally announced near the middle of each month and auctioned one week later. They are usually issued on the last day of each month. Three-year and 10-year note auctions are usually announced on the first Wednesday of February, May, August, and November. The notes are generally auctioned during the second week of those months and issued on the 15th day of the month. Thirty-year bond auctions are usually announced on the first Wednesday of February and August. Treasury bonds are generally auctioned during the second week of those months and issued on the 15th day of the month. 

Primary Market 

Treasury notes and bonds are issued through yield auctions of new issues for cash. Bids are separated into competitive bids and non-competitive bids. Competitive bids are made by primary government dealers, while non-competitive bids are made by individual investors and small institutions. Competitive bidders bid yields to three decimal places for specific quantities of the new issue. Two types of auctions are currently used to sell securities: 

    Multiple-price auction. Competitive bids are ranked by the yield bid, from lowest to highest. The lowest price (highest yield) needed to place the allotted securities auction is determined. Treasuries are then allocated to non-competitive bidders at the average yield for the accepted competitive bids. After all Treasuries are allocated to non-competitive bidders, the remaining securities are allocated to competitive bidders, with the bidder bidding the highest price (lowest yield) being awarded first. This procedure continues until the entire allocation of securities remaining to be sold is filled. Regional dealers who are not primary government dealers often get their allotment of Treasury notes and bonds through primary dealers, who may submit bids for the accounts of their customers as well as for their own accounts. This type of auction is used for auctions of the three-year and 10-year notes and for the 30-year bond. 
    Single-price auction. In this type of auction, each successful competitive bidder and each non-competitive bidder is awarded securities at the price equivalent to the highest accepted rate or yield. This type of auction is used for the two-year and five-year note auctions. 

During the one- to two-week period between the time a new Treasury note or bond issue is auctioned and the time the securities sold are actually issued, securities that have been auctioned but not yet issued trade actively on a when-issued basis. They also trade when-issued during the announcement to the auction period. 

Secondary Market 

Secondary trading in Treasuries occurs in the over-the-counter (OTC) market. In the secondary market, the most recently auctioned Treasury issue is considered current or on-the-run. Issues auctioned before current issues are typically referred to as off-the-run securities. In general, current issues are much more actively traded and have much more liquidity than off-the-run securities. This often results in off-the-run securities trading at a higher yield than similar-maturity current issues. 

Market Participants 

Sell Side 

All U.S. government securities are traded OTC, with the primary government securities dealers being the largest and most important market participants. A small group of inter-dealer brokers disseminates quotes and broker trades on a blind basis between primary dealers and users of the Government Securities Clearing Corporation (GSCC), the private clearinghouse created in 1986 to settle trades for the market. 

Buy Side 

A wide range of investors use Treasuries for investing, hedging, and speculation. This includes commercial and investment banks, insurance companies, pension funds, and mutual fund and retail investors. 

Market Transparency 

Price transparency is relatively high for Treasury securities since several information vendors disseminate prices to the investing public. Govpx, an industry-sponsored corporation, disseminates price and trading information via inter-dealer broker screens. Prices of Treasuries are active and visible. 


Treasury Bills 

Treasury bills are traded on a discount basis. The yield on a discount basis is computed using the following formula: 

Annualized Yield = [(Face Value / Price) / Face Value] x (360 / Days Remaining to Maturity) 

Treasury Notes and Bonds 

Treasury note and bond prices are quoted on a percentage basis in 32nds. For instance, a price of 98:16 means that the price of the note or bond will be 98.5 percent of par (that is, 98 16/32). Notes and bonds can be refined to 64ths through the use of a plus tick. A 98:16+ bid means that the bid is 98 and 1612 32nds (that is, 98 16.5/32), which is equivalent to 98.515625 percent of par. When the note or bond is traded, the buyer pays the dollar price plus accrued interest as of the settlement date. Yields are also quoted on an actual/365 day-count convention. 


Treasuries are typically hedged in the futures or options markets or by taking a contra position in another Treasury security. Also, if a position in notes or bonds is hedged using an OTC option, the relative illiquidity of the option may diminish the effectiveness of the hedge. 


Market Risk 

The risks of trading Treasury securities arise primarily from the interest-rate risk associated with holding positions and the type of trading conducted by the institution. Treasury securities are subject to price fluctuations because of changes in interest rates. Longer-term issues have more price volatility than shorter-term instruments. A large concentration of long-term maturities may subject a bank's investment portfolio to increased interest-rate risk. For instance, an institution which does arbitrage trading by buying an issue that is relatively cheap (that is, off-the-run securities) in comparison to historical relationships and selling one that is relatively expensive (that is, current securities) may expose itself to large losses if the spread between the two securities does not follow its historical alignments. In addition, dealers may take positions based on their expectations of interest-rate changes, which can be risky given the size of positions and the impact that small changes in rates have on the value of longer-duration instruments. If this type of trading is occurring, the institution's risk-management system should be sufficiently sophisticated to handle the magnitude of risk to which the dealer is exposed. 

Liquidity Risk 

Due to lower liquidity, off-the-run securities generally have a higher yield than current securities. Many institutions attempt to arbitrage these pricing anomalies between current and off-the-run securities. 


The accounting treatment for investments in Treasuries is determined by the Financial Accounting Standards Board's Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities, as amended by SFAS 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. SFAS 125 has been replaced by SFAS 140, which has the same title. Accounting treatment for derivatives used as investments or for hedging purposes is determined by SFAS 133, Accounting for Derivatives and Hedging Activities. (See section 2120.1, Accounting, for further discussion.) 


U.S. Treasury bills, notes, and bonds have a 0 percent risk weighting. For specific risk weights for qualified trading accounts, see section 2110.1, Capital Adequacy. 


U.S. Treasury bills, notes, and bonds are type I securities with no legal limitations on a bank's investment. 


Fabozzi, Frank J., and T. Dessa Fabozzi, ed. The Handbook of Fixed Income Securities. 4th ed. U.S. Treasury Bills, Notes, and Bonds 4020.1 Trading and Capital-Markets Activities Manual April 2001 Page 3 Chicago: Irwin Professional Publishing, 1995. Stigum, Marcia L. The Money Market. 3d ed. Homewood, Ill.: Dow Jones-Irwin, 1990. U.S. Department of the Treasury. Buying Treasury Securities. Washington, D.C.: The Bureau of the Public Debt, 1995. 


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