SIE Ready💵 Debt Securities · Lesson 4 of 7 · 6 min
Bills, Notes, Bonds, TIPS and STRIPS
🇺🇸 The safest borrower in the market sells five kinds of IOUs. The exam loves to swap their maturities.
💡 Key idea
Bills ≤ 52 weeks at a discount; notes 2–10 years; bonds 20–30 years. Federal tax yes, state and local tax no.
🧠 Why it matters
T-BILLS mature in 4, 6, 8, 13, 17, 26 or 52 weeks; they pay no coupon and are sold at a discount, so interest is the gap between price and face value. T-NOTES run 2, 3, 5, 7 or 10 years and T-BONDS 20 or 30 years; both pay fixed interest every six months. TIPS (5, 10 or 30 years) have principal that rises and falls with the CPI; the fixed rate is paid on the adjusted principal, and at maturity you get the adjusted or original principal, whichever is greater. STRIPS are Treasury interest and principal payments sold separately as zero-coupon securities, bought only through banks or brokers. Treasuries are sold at auction. Interest is federally taxable but exempt from state and local tax.
📈 In the real world
🏦 Ms. Ruiz lives in a high-tax state and parks cash in 26-week bills. At maturity she receives $10,000 after paying $9,800. The $200 is interest: taxed on her federal return, but her state return ignores it. Her colleague's bank CD paying a similar rate is taxed by both.
📌 Takeaways
- Bills: no coupon, discount, terms from 4 to 52 weeks
- TIPS principal tracks CPI; inflation adjustments are taxable each year
- STRIPS are zeros: no cash until maturity, but tax on accreting interest yearly
📖 Terms in this lesson
Treasury bill (T-bill): A Treasury security maturing in one year or less, sold at a discount and repaid at face value.
Treasury note: A Treasury security with a 2- to 10-year maturity that pays interest every six months.
Treasury bond: A Treasury security with a 20- or 30-year maturity that pays interest every six months.
TIPS: Treasury Inflation-Protected Securities: Treasuries whose principal adjusts with the CPI, with interest paid on the adjusted principal.
STRIPS: Treasury interest and principal payments separated and traded as individual zero-coupon securities.
EACH LEVEL SPARES THE OTHER (interest taxes): Treasury interest is federally taxed but state-tax free; municipal bond interest is generally federal-tax free and may be state taxed.
✅ Test yourself
Which Treasury security pays no periodic interest and is issued at a discount with a maturity of one year or less?
- Treasury bill
- Treasury bond
- TIPS
- Treasury note
Answer: A · Treasury bill
Bills (4 to 52 weeks) are sold below face value and pay face value at maturity. Notes, bonds and TIPS all pay interest every six months.
Interest from Treasury notes is:
- Taxable federally, state and locally
- Taxable federally, exempt from state and local tax
- Exempt from all income taxes
- Taxable only by the investor's state
Answer: B · Taxable federally, exempt from state and local tax
Treasury interest is subject to federal income tax but exempt from state and local income tax. It is municipal bond interest that is generally exempt from federal tax.
What happens to the principal of a TIPS when the Consumer Price Index rises?
- It increases
- It converts to cash
- It stays the same
- It decreases
Answer: A · It increases
TIPS principal is adjusted upward with inflation (and down with deflation). Interest is paid on the adjusted principal, so payments grow too.
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