The fixed-income market includes Treasury securities. Treasury securities refer to the debt obligations of the United States bought and sold to maintain the functioning of the government. The Department of the Treasury has apportioned different securities to perform these activities, which range from short-term bills, which are all under one year in maturity, and long-term securities, which include notes and bonds maturing anywhere from two to thirty years from the time they are sold.

Until 2001, three-month bills were the shortest-maturing securities offered. But in July 2001, the Treasury introduced 4-week bills in a weekly auction setting in order to smooth out seasonal fluctuations in cash flows. These securities, along with three and six month bills are now sold at weekly auctions with a face value minimum of $100, where investors can either participate directly in the auctions electronically or buy through securities brokers.   Officially, three-month bills are 13-week bills and six-month bills are 26-week bills (length of months vary while that of weeks does not).

Price vs. Yield to Maturity

These securities are bought at a face value and sold at a discount.  For example, if a $1,000 26-week bill sells at auction for a 3.80% discount rate, the purchase price would be $980.79, a discount of $19.21. The purchase price can be determined from the following formula:

One-year, or 52-week bills, are offered every four weeks at public auctions.  

Treasury notes are interest-bearing securities that have a fixed maturity of not less than 1 year and not more than 10 years from date of issue.   The Treasury currently issues notes in 2, 3, 5, 7, and 10-year maturities.   Treasury notes pay interest on a semi-annual basis.   When a note matures, the investor receives the face value.

The price of a fixed-rate security depends on the relationship between its yield to maturity and the interest rate. If the yield to maturity (YTM) is greater than the interest rate, the price will be less than par value; if the YTM is equal to the interest rate, the price will be equal to par; if the YTM is less than the interest rate, the price will be greater than par.

When purchasing a Treasury note, any interest accrued since the last interest payment is added to the note purchase price. At the next interest payment date the investor receives the full interest payment.

Use the following formula to figure accrued interest:

Example: A 5% 10-year note ($1,000 principal) is purchased 91 days after the last coupon payment. The current coupon period contains 182 days.

A = 1000 x .05 (( 91 / 182 )/2) , solving

A = $12.50

Two-year notes are intermediate Treasury securities sold at regularly scheduled monthly public auctions. Notes are not sold at a discount to the face value like bills. Instead, investors buy notes totaling $1,000, and receive interest payments every six months based on the coupon rate. When the note matures, the original investment of $1,000, called the principal, is returned.   Three-year, five-year, seven-year, and ten-year notes are purchased in the same fashion as 2-year notes: investors buy a note in $100 increments, and receive interest payments every six months based on the coupon rate.

As the maturity period lengthens, the risk element of Treasury securities increases. The longer a security is held, the more it is subject to inflation risk and opportunity risk. Inflation risk refers to the erosion of the value of interest payments and the principal paid at the end of the security's maturity cycle. Opportunity risk refers to what would have been earned had an investor invested the money elsewhere.

Helping to mitigate inflation risk, at least for the 2-year maturity, is the Treasury's floating rate note. When inflation rises, interest rates typically rise in anticipation of Federal Reserve action to slow inflation (or following actual Federal Reserve action to slow inflation). Payment here changes over time, moving higher when rates are up over the note's 2-year maturity and lower when rates are down.

Ten-year notes are the longest-termed intermediate security. They have gained a reputation as the benchmark security for the fixed-income market as the supply of thirty-year bonds had dwindled until recently. Treasury securities are considered risk-free because they are free from default risk. They are not free from inflation risk or opportunity risk.

Since the late 1970s, the thirty-year bond was the U.S. Treasury's longest-term security. From 1993 to 2001, it had been sold at auction two to three times per year depending on the Treasury's borrowing needs. In 2000, the Treasury began to reduce the quantity of thirty-year bonds sold to the public and in October 2001, the Treasury suspended indefinitely 30-year bond auctions. Thirty-year bonds were not eliminated entirely, although most bonds in circulation had fewer than 30-years to expiration. In 2005, the Treasury announced that it would once again offer 30-year bonds and the first auction took place in February 2006.

In addition to these securities, the Treasury also offers TIPS, Treasury Inflation-Protected Securities. These securities protect investors against inflation. The principal of a TIPS increases with inflation and decreases with deflation as measured by the Consumer Price Index. The U.S. Treasury pays the greater amount of the adjusted principal or the original principal. Just like other Treasury notes and bonds, TIPS pay interest twice a year based on a coupon rate. This rate is applied to the principal, so that interest rates are also adjusted for inflation. For a given maturity, the coupon rate on TIPS is lower than for the equivalent note. For instance, the coupon rate of a 5-year TIPS will be lower than the coupon rate of a 5-year note. If inflation is rapidly accelerating, an investor might be better off with the TIP than the regular note. However, it does depend on the coupon rate and the rate of inflation.

The size and quantity of the TIPS auctions can be changed at any time, just as it is for other Treasury securities.