What Are Treasury Bills, Notes and Bonds?

How Do They Work?

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U.S. Treasury Building with statue of Alexander Hamilton, First Treasury Secretary. Photo: Hisham Ibrahim/Getty Images

Definition: Treasury bills, notes, and bonds are fixed-income investments issued by the U.S. Treasury Department. They are the safest investments in the world since the U.S. government guarantees them. This low risk means they have the lowest interest rates of any fixed-income security. Treasury bills, notes, and bonds are also called "Treasuries" or "Treasury bonds" for short. 

How Do They Work?

The Treasury Department sells all bills, notes, and bonds at auction with a fixed interest rate.

When demand is high, bidders will pay more than the face value to receive the interest rate. When demand is low, they pay less.

The interest rate is paid every six months and does not change throughout the term of the product. If you hold onto Treasuries until term, you will get back the face value plus the interest that was paid over the life of the bond. You get the face value no matter what you paid for the Treasury at auction. The minimum investment amount is $100. That places them well within reach for many individual investors.

Don't confuse the interest rate with the Treasury yield. The yield is the total return over the life of the bond. Since Treasuries are sold at auction, Treasury yields change every week. Here's how it works: If demand is low, notes are sold below face value, which is similar to getting them on sale. Therefore, the yield is high because buyers get more for their money.

When demand is high, they are sold at auction above face value, and the yield is low. The buyers had to pay more for the same interest rate, so they get less return for their money.

Since Treasuries are safe, investors demand them when there is uncertainty. That's been the case since the 2008 financial crisis.

In fact, Treasuries reached record-high demand levels on June 1, 2012. That's when the 10-year Treasury note yield dropped to 1.442 percent, the lowest level in more than 200 years. Investors fled to ultra-safe Treasuries in response to the eurozone debt crisis. The yield fell even lower on July 25. Then, they reached the lowest level in U.S. history on July 1, 2016.  For more, see Treasury Yield Curve.

The Difference Between Treasury Bills, Notes, and Bonds

The difference between bills, notes and bonds are the lengths until maturity:

  • Treasury bills are issued for terms less than a year.
  • Treasury notes are issued for terms of 2, 3, 5, and 10 years.
  • Treasury bonds are issued for terms of 30 years. They were reintroduced in February 2006.

How to Buy Treasuries

There are three ways to purchase Treasuries. The first is called a non-competitive bid auction. That's for investors who know they want the note and are willing to accept any yield. That's the method most individual investors use. They can just go online to TreasuryDirect to complete their purchase. An individual can only buy $5 million in Treasuries with this method.

The second is a competitive bidding auction. That's for those who are only willing to buy a Treasury if they get the desired yield.

They must go through a bank or broker. The investor can buy as much as 35% of the Treasury Department's initial offering amount with this method.

The third is through the secondary market.  That's where Treasury owners sell the securities before maturity. The bank or broker acts as a middleman.

You can profit from the safety of Treasuries without actually owning any. Most fixed-income mutual funds own Treasuries. You can also purchase a mutual fund that only owns Treasuries. There are also exchange-traded funds (ETFs) that track Treasuries without owning them.

How Do They Affect the Economy?

Treasuries affect the economy in two important ways.

First, they fund the U.S. debt. The Treasury Department issues enough securities to pay ongoing expenses that aren't covered by incoming tax revenue. If the U.S. defaulted on its debt, then these expenses would not be paid. That means military and government employees wouldn't receive their salaries. Recipient of Social Security, Medicare, and Medicaid would go without their benefits. It almost happened in the summer of 2011 during the U.S. debt ceiling crisis.

Second, they affect interest rates. Since Treasury notes are the safest investment, they offer the lowest rate of return or yield.  Most investors are willing to take on a little more risk to receive a little more return. If that investor is a bank, they will issue loans to businesses or homeowners. If it's an individual investor, they will buy securities backed by the business loans or mortgage. If Treasury yields increase, then the interest paid on these riskier investments must increase in lock-step. Otherwise, no one would take on the added risk if they didn't get a higher return. For more, see Relationship Between Treasury Notes and Mortgage Interest Rates

Different Types of Bonds