"Government security" can mean two very different promises. Some are backed by the taxing power of the United States. Others are backed only by a shareholder-owned company with a congressional charter. Before you recommend either one, you need to know which promise the customer is buying, how it is priced and how it is taxed.
The U.S. Treasury finances the federal government by selling marketable securities. These are debts that investors buy at auction and can resell later. The shortest are Treasury bills (T-bills), which never run longer than one year. Treasury sells them in 4-, 6-, 8-, 13-, 17-, 26- and 52-week terms. The 52-week bill is auctioned every four weeks, and the others are auctioned weekly. Older material often leaves out the 6-week bill, so treat the seven-term list as the current one.
A bill pays no coupon. It is a discount security: you pay less than face value (or exactly par, depending on the auction) and collect the full face value at maturity.
Common mistakes
- Reading 32nds as decimals: 99-16 is $995.00 per $1,000 bond, not $991.60.
- Flipping bill quotes: In a 4.32 bid, 4.28 ask quote, the buying customer gets 4.28 and the higher price. Picking 4.32 because "the ask should be higher" reverses the market.
- Treating U.S. backing as a tax exemption: Ginnie Mae has full faith and credit backing yet is taxable at every level. Treasury obligations escape state and local income tax. Ginnie Mae, Fannie Mae, Freddie Mac and Sallie Mae securities do not (Federal Home Loan Bank debt, by contrast, is also state-exempt).
Bottom line
- Bills are discount securities sold in 4-, 6-, 8-, 13-, 17-, 26- and 52-week terms, quoted on a 360-day discount yield, with interest equal to face minus price.
- Notes run 2, 3, 5, 7 and 10 years and bonds 20 and 30 years; both pay fixed interest semiannually and are quoted in 32nds (99-16 = $995).
- Every Treasury has a $100 minimum, is book-entry, settles T+1 by market convention and is federally taxable but exempt from state and local income tax, except corporate franchise and estate or inheritance taxes.
- STRIPS are zero-coupon pieces stripped from notes, bonds and TIPS, bought at a deep discount, with yearly accretion taxed; they remove reinvestment risk and carry maximum rate risk.
Exam shortcut
When a stem names an issuer, ask "who pays if it defaults?" before anything else. "Full faith and credit" fits Treasuries and Ginnie Mae only, so any answer calling Fannie Mae, Freddie Mac or Sallie Mae government-guaranteed is wrong. Then ask "who taxes it?" Treasury obligations, including STRIPS and TIPS, skip state income tax, and so does Federal Home Loan Bank debt.
The full lesson (about 4,573 words, 30 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- C23
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