U.S. Treasury and Government Securities Explained for the SIE Exam

U.S. Treasury securities are debt issued by the federal government and backed by its full faith and credit, which is why they’re treated as the market’s risk-free benchmark. The three you must know cold: T-bills mature in one year or less and pay no coupon (you buy at a discount), T-notes run 2 to 10 years with semiannual interest, and T-bonds run 20 or 30 years with semiannual interest. On the SIE — 75 scored questions in 105 minutes, passing score 70 — government securities sit in “Understanding Products and Their Risks,” the largest section at 44% of the exam.

Why Treasuries are the benchmark

Treasuries are backed by the full faith and credit of the U.S. government, meaning the government pledges its taxing power and economic strength behind repayment. Practically, that means essentially no default risk — and because investors accept less return for that safety, Treasury yields are generally lower than corporate yields.

Here’s the nuance the exam loves: “no credit risk” is not “no risk.” Treasuries still carry:

• Interest-rate risk. When market rates rise, existing Treasury prices fall — and the longer the maturity, the harder the swing. A 30-year bond’s price moves far more than a 2-year note’s for the same rate change.
• Purchasing-power (inflation) risk. Treasuries pay fixed nominal dollars, so inflation erodes what those payments actually buy.
• Reinvestment risk on longer bonds, if rates fall and coupons must be reinvested at lower yields. (Short bills have minimal reinvestment risk since they mature quickly.)

What they don’t really carry is liquidity risk — Treasuries are among the most liquid securities in the world, trading with tight spreads in enormous size.

The mechanics of why prices and yields move in opposite directions matter throughout this post — a rising-rate environment hits a 30-year T-bond harder than a 2-year note for exactly that reason.

Treasury bills

T-bills are short-term: maturities of one year or less. Regularly issued terms are 4, 6, 8, 13, 17, 26, and 52 weeks. (Cash management bills are issued in variable terms as the Treasury’s cash needs require.)

Bills pay no periodic interest. Instead, they’re sold at a discount from face value and redeemed at face value — and the difference is your interest. Buy a $10,000 bill for $9,850 and you collect $10,000 at maturity; that $150 is the interest. This is why bills are quoted on a discount basis rather than as a coupon.

Treasury notes and bonds

T-notes are the intermediate rung: maturities of 2, 3, 5, 7, and 10 years. They pay a fixed coupon every six months and return principal at maturity.

T-bonds are the long end: 20- and 30-year maturities, also paying fixed semiannual interest. Because they lock in payments for decades, they generally carry higher coupons than notes — and much greater interest-rate sensitivity.

Both notes and bonds are quoted as a percentage of par in 32nds — a Treasury quote of 98:16 means 98 and 16/32, or 98.5% of par. (Corporate bonds, by contrast, are conventionally taught in eighths.)

TIPS

Treasury Inflation-Protected Securities are the government’s answer to inflation risk. Issued in 5-, 10-, and 30-year maturities, TIPS work like this: the principal adjusts with the Consumer Price Index. The coupon rate is fixed, but because it’s applied to an inflation-adjusted principal, the actual dollar interest payment rises and falls with inflation.

At maturity, the investor receives the greater of the inflation-adjusted principal or the original principal — so deflation can’t push you below where you started.

Floating Rate Notes (FRNs) are a related cousin: two-year securities paying quarterly interest that floats with the 13-week bill rate.

STRIPS

STRIPS — Separate Trading of Registered Interest and Principal of Securities — are zero-coupon Treasuries. A dealer takes a Treasury note or bond and separates each coupon payment and the principal into individually tradable pieces. Each piece is bought at a discount and matures at face value, paying no periodic interest.

The exam point is phantom income: even though a STRIPS holder receives no cash until maturity, the annual accretion (the imputed interest that builds toward par) is taxable each year. Investors often hold STRIPS in tax-deferred accounts for exactly this reason.

At a glance

Security	Maturity	How it pays interest	Key feature
T-bill	1 year or less (4–52 weeks)	None — bought at a discount, matures at face	Discount is the interest
T-note	2, 3, 5, 7, 10 years	Semiannual coupon	Quoted in 32nds
T-bond	20 or 30 years	Semiannual coupon	Longest maturity, most rate-sensitive
TIPS	5, 10, 30 years	Semiannual, on CPI-adjusted principal	Principal indexes to inflation
STRIPS	Varies	None — zero coupon	Phantom income taxed annually

Taxation: the mirror image of munis

Interest on Treasury securities is subject to federal income tax but exempt from state and local income tax. Capital gains from selling a Treasury at a profit are still taxable.

Hold that next to municipal bonds, which are generally exempt from federal tax (and from state and local tax too, for in-state residents). The two are mirror images, and the exam tests exactly that contrast: Treasuries dodge state and local tax; munis dodge federal.

Agency and GSE securities

This is the single biggest trap in the topic, and it comes down to one word: sponsored.

• GNMA (Ginnie Mae) is a government-owned corporation. Its securities are backed by the full faith and credit of the U.S. government.
• FNMA (Fannie Mae) and FHLMC (Freddie Mac) are government-sponsored enterprises (GSEs). Their securities are not backed by the full faith and credit of the U.S. government. They carry an implied association with the government, not a guarantee.

Ginnie, Fannie, and Freddie all issue mortgage-backed pass-through securities: pools of home mortgages where the monthly payments homeowners make — both interest and principal — pass through to investors. That monthly return of principal creates two risks:

• Prepayment risk. When rates fall, homeowners refinance and pay off their mortgages early, so investors get principal back sooner and must reinvest it at lower rates.
• Extension risk. When rates rise, homeowners hold onto their cheap mortgages, so principal comes back more slowly than expected — leaving investors stuck at below-market rates for longer.

The auction, briefly

Treasuries are sold at regularly scheduled auctions. Bidders come in two flavors. Competitive bidders specify the yield they’ll accept and may or may not be filled. Noncompetitive bidders agree to accept whatever yield is determined at auction — and in exchange, they’re guaranteed to receive the security in the full amount they wanted. Noncompetitive bids are filled first, which is why small investors use them.

Exam traps to avoid

• “Risk-free” means credit risk only. Treasuries still carry interest-rate risk and inflation risk. A 30-year T-bond is very much exposed to rate moves.
• T-bills pay no coupon. The discount from face value is the interest. Don’t look for a semiannual payment.
• Treasury taxation is the opposite of muni taxation. Treasuries: federally taxable, state/local exempt. Munis: federally exempt.
• Ginnie Mae is full faith and credit; Fannie and Freddie are not. “Sponsored” is not “guaranteed.”
• STRIPS generate phantom income. You owe tax on accretion every year despite receiving no cash.
• TIPS adjust principal, not the coupon rate. The rate is fixed; the payment changes because the principal changed.

Once bills-vs-notes-vs-bonds, the muni tax mirror, and Ginnie-vs-Fannie-Freddie feel automatic, test yourself with the free SIE diagnostic to see how the SIE actually frames government-securities questions.

Frequently asked questions

What’s the difference between T-bills, T-notes, and T-bonds?

Maturity and how they pay. T-bills mature in one year or less and pay no coupon — they’re sold at a discount and mature at face value. T-notes mature in 2 to 10 years and pay semiannual interest. T-bonds mature in 20 or 30 years and also pay semiannual interest, with the most interest-rate sensitivity.

Are Treasury bonds taxable?

Partly. Interest on Treasuries is subject to federal income tax but exempt from state and local income taxes. Capital gains from selling a Treasury above your cost are taxable. This is the mirror image of municipal bonds, whose interest is generally exempt from federal tax.

Do T-bills pay interest?

Not as periodic coupons. You buy a T-bill at a discount to its face value and receive the full face value at maturity — the difference is your interest. Buy a $10,000 bill for $9,850 and the $150 you gain at maturity is the interest.

What are TIPS and how do they work?

Treasury Inflation-Protected Securities adjust their principal with the Consumer Price Index. The coupon rate stays fixed, but since it’s applied to the adjusted principal, the actual interest payment rises with inflation. At maturity you receive the greater of the adjusted principal or the original principal.

Are Fannie Mae and Freddie Mac backed by the U.S. government?

No. Fannie Mae (FNMA) and Freddie Mac (FHLMC) are government-sponsored enterprises, and their securities are not backed by the full faith and credit of the U.S. government. Ginnie Mae (GNMA), by contrast, is a government-owned corporation, and its securities are backed by the full faith and credit of the government.

What is phantom income on STRIPS?

STRIPS are zero-coupon Treasuries that pay no cash until maturity, but the annual accretion toward par is still taxable each year. That taxable-but-uncollected interest is called phantom income, which is why investors often hold STRIPS in tax-deferred accounts.

One hook to carry in: bills discount, notes and bonds coupon, TIPS index, STRIPS accrete — and Treasuries dodge state tax while munis dodge federal. Add “Ginnie is guaranteed, Fannie and Freddie are only sponsored,” and you’ve got most of the government-securities questions on the SIE.