Treasury Bills, Notes, and Bonds

How it works

The Treasury raises money on a published auction calendar. Bills are issued at four, eight, thirteen, seventeen, twenty-six and fifty-two weeks; notes at two, three, five, seven and ten years; bonds at twenty and thirty years. Each is a direct loan to the federal government, and each auction sets the price or yield the market is willing to accept that day.

Bills are zero-coupon instruments: you pay less than the $100 face value up front and receive the full face value at maturity, with the difference standing in for interest. Notes and bonds instead pay a fixed coupon every six months and return the principal in one lump sum at maturity.

At auction, competitive bidders name a yield and risk not being filled if it is too aggressive; non-competitive bidders — the route most individuals use through TreasuryDirect or a brokerage — simply accept whatever yield the auction produces and are guaranteed an allocation. Everything settles in book-entry form, in $100 increments, and then trades in the largest, most liquid secondary bond market that exists.

The same machinery supports several variants. TIPS adjust their principal for changes in the consumer price index. Floating-rate notes reset their coupon off the thirteen-week bill rate. STRIPS take the coupon and principal payments of a note or bond and sell each piece separately as its own zero-coupon security.

What it pays

Bills are quoted in two ways: a discount rate calculated off face value, and an investment (bond-equivalent) yield that is the number comparable to a bank CD's APY. Notes and bonds are quoted as a yield to maturity, a single figure that blends the stated coupon with whatever premium or discount was paid relative to par.

Across the whole curve, that yield reflects two things: where short-term policy rates are expected to go, and a term premium — extra compensation demanded for tying up money over a longer stretch. Because Treasuries are the reference risk-free rate in dollars, nearly every other yield in fixed income is quoted as a spread over the matching-maturity Treasury.

Prices and yields move opposite each other, and the size of that swing scales with duration: a thirty-year bond's price moves far more per unit of yield change than a two-year note's does. TIPS are the exception in how the payment arrives — they quote a real yield, and the inflation component shows up as an adjustment to principal rather than as a bigger coupon check.

Costs and taxes

Buying directly at auction — through TreasuryDirect or most large brokers — carries no commission. Buying in the secondary market instead means crossing a bid-ask spread, and sometimes paying a dealer markup on top.

Interest is fully taxable at the federal level and reported on Form 1099-INT, but it is exempt from state and local income tax, which improves the after-tax return relative to a bank deposit for residents of high-tax states. On a bill, the entire discount-to-face gain counts as interest income, not a capital gain, and is recognized in the year the bill matures or is sold.

Buying a note or bond between coupon dates means paying the seller the accrued interest since the last payment; that amount is later subtracted from your taxable interest for the year, so it is not taxed twice.

TIPS carry a quirk: the annual inflation adjustment to principal is taxable federal income in the year it accrues, even though the cash itself is not paid out until the bond matures — a mismatch commonly called phantom income.

Liquidity and time commitment

Because the secondary market is enormous and trades continuously, a Treasury can be sold on any business day at a tight spread. That sale happens at the prevailing market price, though, which can be below the purchase price if yields have risen since.

Holding to maturity sidesteps that entirely: the government redeems the security at face value on the stated date no matter what happened to rates in between. TreasuryDirect holdings can also be moved into a brokerage account for sale, a transfer that involves paperwork and takes time; Treasuries already held in a brokerage account can be sold immediately.

Auction settlement typically lands a few business days after the auction, and coupon payments arrive automatically on a fixed semiannual schedule. Once bought, effort required is close to zero — a bill ladder or an auto-reinvestment instruction can roll maturing securities into new ones without any further action.

How it goes wrong

Interest-rate risk is the central hazard for anything beyond a bill. A long bond purchased when yields were low can lose a large share of its market value once yields rise — long-duration Treasury holders learned this directly in 2022.

That loss is only realized on a sale, but institutions that must mark positions to market, or that face sudden withdrawal demands, are forced to sell anyway. That dynamic was central to the failure of Silicon Valley Bank in 2023, whose held Treasuries had lost value on paper long before the bank was forced to sell them at a loss.

A nominal Treasury also carries inflation risk: it repays a fixed number of dollars, and unexpected inflation over a ten- or thirty-year holding period erodes what those dollars will buy. Short bills avoid duration risk but introduce reinvestment risk instead — each bill in a ladder matures and must be rolled at whatever yield the market happens to offer next.

Debt-ceiling standoffs have occasionally caused bills maturing near a projected default date to trade at a yield concession — a technical dislocation tied to political timing rather than a change in credit quality. TIPS holders face their own version of the problem: in a year of sharp unexpected inflation, the tax bill on the accrued principal adjustment can exceed the actual cash the security paid out that year.