Introduction to Finance

Treasury Notes 
Treasury notes
are issued at specifi ed interest rates for maturities ran-
ging from two to 10 years. The Treasury currently issues 2-year, 3-year, 5-year, 7-year, and 
10-year notes. These intermediate-term government securities are also held largely by com-
mercial banks.
Treasury Bonds 
Treasury bonds
have original maturities ranging from 11 to 30 years, 
with the current focus being on issuing bonds with 30-year maturities. These bonds bear 
interest at stated rates. Many issues of these bonds are callable, or paid off , by the govern-
ment several years before their maturity. For example, a 30-year bond issued in 2015 may be 
described as having a maturity of 2040–2045. This issue may be called for redemption at 
par as early as 2040 but in no event later than 2045. Dealers maintain active markets for the 
purchase and sale of Treasury bonds and the other marketable securities of the government.
All marketable obligations of the federal government, with the exception of Treasury 
bills, are off ered to the public through the Federal Reserve banks at prices and yields set 
Treasury bills 
government 
securities issued with maturities up 
to one year
Treasury notes 
government 
securities issued with maturities 
ranging from two to 10 years
Treasury bonds 
government 
securities issued with maturities 
ranging from 11 to 30 years

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C H A PT E R 8 Interest Rates
in advance. Investors place their orders for new issues, and these orders are fi lled from the 
available supply of the new issue. If orders are larger than available supply, investors may be 
allotted only a part of the amount they requested.
Treasury bonds, because of at least initial long-term maturities, are subject to maturity 
or interest rate risk. Treasury notes with shorter maturities are aff ected to a lesser extent. For 
illustrative purposes, let’s assume that the market interest rate on 30-year Treasury bonds is 
currently 4 percent and, given their marketability, there is no liquidity premium. Let’s further 
assume that investors expect the infl ation rate will average 2 percent over the next 30 years and 
they expect a real rate of return of 1 percent annually. By applying equation 8.3 we can fi nd 
the maturity risk premium to be,
4% = RR + IP + DRP + MRP + LP
4% = 1% + 2% + 0% + MRP + 0%
MRP = 4% – 1% – 2% – 0% – 0% = 1%
Our interpretation is that the holders, or investors, require a 1 percent maturity risk 
premium to compensate them for the possibility of volatility in the price of their Treasury 
bonds over the next 30 years. If market-determined interest rates rise and investors are forced 
to sell before maturity, the bonds will be sold at a loss. Furthermore, even if these investors 
hold their bonds to maturity and redeem them with the government at the original purchase 
price, the investors would have lost the opportunity of the higher interest rates being paid in 
the marketplace. This is what is meant by interest rate risk. Of course, if market-determined 
interest rates decline after the bonds are purchased, bond prices will rise above the original 
purchase price.
Dealer System
The