In Part 1 of this series, the importance of U.S. Treasury securities was discussed, along with their advantages and disadvantages for investors. Today we’ll examine the four kinds of Treasuries that are available:
Treasury bills - Treasury bills, or T-bills, are short-term U.S. Government discount notes. They’re sold at a discount from their face value, and when they mature the government pays the investor the note’s full face value. The difference between the discounted price at which the note is sold and the face value at which it is redeemed represents the investor’s return. The government issues T-bills with three different maturates: three-month, six-month, and one-year. Their actual maturity is 13, 26, and 52 weeks, respectively.
Treasury notes and bonds - A treasury with a maturity of longer than one year is known as either a Treasury note (T-note) or Treasury bond (T-bond). T-notes have maturates of between one and ten years. T-bonds have a maturity of more than ten years. Instead of being sold at a discount, T-notes and T-bonds pay interest on a semi-annual basis.
Notes and bonds with specific maturity dates are auctioned off on a predetermined schedule based on the government’s need for financing. The most recently auctioned issue of each maturity of Treasury note and bond is referred to as the “on the run” issue. For example, the most recently auctioned five-year note is known as the “on the run five-year”. It will remain the on the run issue until the government auctions off the next five-year note, which will become the new on the run five year issue. The on the run issues are notable in that they’re more liquid than the other Treasury issues and, therefore, offer lower yields.
Treasury strips - The treasury strip, also known as a strip, Treasury zero, or zero coupon bond (ZCB), is very similar to the T-bill in that it’s sold at a discount and when it matures, it pays the investor its face value. In essence, a strip is simply a long-term discount note. Its name is derived from the way in which the security is created -- by stripping the individual cash flow away from the interest-bearing T-note or bond.
ZCBs are extremely sensitive to interest rates. As rates change, the price of a ZCB will change more than that of any other bond with similar maturity. This makes them highly attractive vehicles for speculating on the direction of interest rate moves.
Treasury inflation protection securities - TIPS are the most recent innovation in the Treasury securities market. They do not pay a fixed rate of interest; instead, the rate that they pay is a fixed percentage over the rate of inflation. For example, if the TIPS pays a rate of “inflation plus 2 percent” and the inflation rate is 3 percent, then the TIPS would pay 5 percent. The rate is adjusted semi-annually as inflation changes. Because the interest rate that TIPS pay fluctuates along with inflation, their market value should generally remain constant over time, thereby making them a very low-risk Treasury security.
