The U.S. Treasury Department issues debt to help finance the operations of the federal government. There are four types of Treasury debt instruments: short-term bills, medium-term notes, long-term bonds and inflation-protection bonds. Treasury debt is very liquid – it can be bought and sold in the secondary market without affecting its price -- and is considered default-risk-free, since the government can always print the cash necessary to redeem it.
The U.S. Treasury first issued debt in 1917 in the form of “Liberty Bonds” to help finance World War I. The Treasury subsequently issued fixed-price debt to redeem maturing Liberty Bonds. These initial bonds were vastly oversubscribed and led to the Treasury introducing its auction system in 1929. Initially, only short-term T-Bills were auctioned; the Treasury began auctioning longer-term debt in 1973. The worldwide popularity of Treasury debt grew sharply after WWII. In 2009, the Treasury issued $8.6 trillion in debt securities.
Ten-year Treasury notes (T-Notes) are denominated in $1,000 face-value units. The Treasury fixes the interest rate for each new issue of T-Notes. Interest is paid in semi-annual coupon payments. The convention for T-Notes is to quote prices as a percentage of par (100 percent) in 1/32nds of a point. Thus a price of 98-08 is translated as 98 8/32 percent of $1,000, or $980.25 per note. Debt is characterized as selling at discount, par or premium depending on whether its price is below, equal to or above its face value, respectively.
Treasury debt is free from state and local taxes.
Institutions and foreign governments are the largest consumers of the 10-year T-Note. Companies with medium- to long-term funding obligations, such as insurance providers and pension plans, buy large quantities of 10-year T-Notes. Institutions use T-Notes to park their long-term excess cash risk-free. Foreign governments hold Treasury debt to earn interest income from their excess dollar reserves. Banks and brokerage firms buy T-Notes and then strip apart the interest and principal portions for separate resale. This is how zero-coupon bonds arise. Ten-year T-Notes serve as an underlying security in futures markets. A futures contract on 10-year T-Notes is settled with the delivery of T-Notes to the buyer of the futures contract.
Individuals can buy debt directly from the Treasury through its web-based TreasuryDirect retail program. Smaller investors can submit non-competitive bids at a Treasury auction for up to $5 million face-value of coupon-bearing debt.
The Treasury auctions 10-year T-Notes monthly: four auctions are for new notes and coincide with the Treasury’s quarterly refunding schedule; the other eight are ones in which recent T-Note issues are reopened with new prices and issue dates. Preceding each auction, the Treasury publicly announces the face value of debt for sale. Competitive bids come mostly from primary bond dealers for their own inventory or on behalf of customers. Bids are made in terms of face-amount sought and yield; the yield figure, which is specified to three decimal places, implies a bid price. At most, only 35 percent of an issue can be awarded to a single bidder.
After subtracting out the non-competitive bids, the Treasury allocates the remainder to bidders starting with highest bid price and working downwards. The Treasury does not disclose bids to the public, but does publish auction statistics such as high, low and weighted average prices. The Treasury assigns the weighted average of successful bids as the price of non-competitive bids. Successful bidders take delivery of T-Notes on issue day, generally one week after the auction.
After the Treasury delivers debt to successful bidders, these debt-holders often resell their holdings in the secondary market. Exchanges like the New York Stock Exchange provide facilities for trading Treasury debt; it is also traded over-the-counter by broker-dealers. Capital markets rely upon efficient secondary markets to rationally allocate capital. The Treasury debt market is the largest, most liquid market in the world.
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