The Handbook of Financial Instruments

Chapter 7 U.S. Treasury Securities

Frank J. Fabozzi, Ph.D., CFA

Adjunct Professor of Finance School of Management Yale University

Michael J. Fleming, Ph.D.*

Senior Economist Federal Reserve Bank of New York

United States Treasury securities are direct obligations of the U.S. government issued by the Department of the Treasury. They are backed by the full faith and credit of the U.S. government and are therefore considered to be free of credit risk. Issuance to pay off maturing debt and raise needed cash has created a stock of marketable Treasuries that totaled $2.8 trillion on June 30, 2001.¹ Treasuries trade in a highly liquid round-the-clock secondary market with high levels of trading activity and narrow bid-ask spreads. Despite the absence of credit risk and the high level of liquidity, an investor in a Treasury security is still subject to interest rate risk and non-U.S. investors who seek to convert payments from U.S. dollars to their local currency are exposed to currency risk. As will be explained, there are Treasury securities that are available that eliminate inflation risk and reinvestment risk.

Treasury securities serve several important purposes in financial markets. Due to their liquidity and well-developed derivatives markets, Treasuries are used extensively to price, as well as hedge positions in, other fixed-income securities. Exemption of interest income from state and local taxes also helps make Treasuries a popular investment asset to institutions and individuals. ...