Treasury Note

The ten-year Treasury note yield in particular is the single most important interest rate benchmark in all of global finance — influencing mortgage rates, corporate bond pricing, equity valuations, currency exchange rates, and economic policy decisions by central banks and governments worldwide. 

Understanding the Treasury note's structure, auction mechanics, the critical significance of the ten-year yield as a benchmark, the on-the-run versus off-the-run distinction, and the note's tax treatment and STRIPS eligibility is directly tested on the Series 7 examination.

Structure and Basic Characteristics

Treasury notes are issued in electronic form only with a minimum denomination of one hundred dollars in one hundred dollar increments — identical to Treasury bonds in their basic structural parameters. The coupon rate is fixed at the original issue auction and never changes throughout the note's life — the interest rate is never less than zero point one two five percent as specified in TreasuryDirect's published note specifications. Semi-annual coupon payments are made every six months until maturity, at which point the full face value is returned to the holder along with the final coupon payment.

The two-year, three-year, five-year, and seven-year Treasury notes are auctioned monthly — providing a continuous and predictable supply of short-to-medium maturity government debt to the market. The ten-year Treasury note is auctioned at original issue in February, May, August, and November — four times per year — and reopened eight additional times per year in the remaining months, following the same reopening convention used for Treasury bonds in which new supply of an existing CUSIP is issued at the market-clearing yield of the reopening auction while retaining the original coupon rate of the initial offering.

All Treasury notes are non-callable — the Treasury cannot redeem them before their stated maturity date regardless of how interest rates change. Like Treasury bonds, the non-callable feature of Treasury notes provides investors with certainty of cash flow timing and eliminates the reinvestment risk that callable corporate or municipal bonds impose on investors who may have their bonds redeemed early in declining rate environments precisely when they would prefer to continue collecting the above-market coupon.

The maximum non-competitive purchase at any single auction is ten million dollars — the same limit applying to all Treasury marketable securities — and competitive bidders may not purchase more than thirty-five percent of the total offering amount. Individual investors purchase through TreasuryDirect at no fee by submitting non-competitive bids and accepting the auction clearing yield.

The Ten-Year Treasury Note — The Global Benchmark Rate

Among all Treasury maturities the ten-year Treasury note yield commands exceptional significance as a financial benchmark — a role that extends far beyond its importance as a government borrowing cost indicator into every corner of global financial markets and economic analysis.

The ten-year Treasury yield serves as the baseline risk-free rate against which corporate bond credit spreads are calculated — when analysts and investors discuss that a corporate bond trades at two hundred basis points over Treasuries they mean two hundred basis points above the ten-year Treasury yield, which serves as the reference for investment grade corporate bonds of comparable maturity. 

Investment grade corporate bond yields across the maturity spectrum reference the ten-year note yield as their primary benchmark — making the ten-year yield the most direct determinant of borrowing costs for the entire investment grade corporate sector.

Mortgage rates in the United States track the ten-year Treasury yield with remarkable consistency — the thirty-year fixed mortgage rate is typically one hundred and fifty to two hundred basis points above the ten-year Treasury yield, reflecting the credit spread and prepayment optionality premium that lenders charge above the risk-free rate. 

When the ten-year Treasury yield rises by one percentage point mortgage rates typically rise by a similar amount, increasing monthly payments on new mortgage originations and reducing housing affordability. The Federal Reserve's management of the ten-year Treasury yield through both conventional interest rate policy and unconventional quantitative easing is therefore directly connected to the housing market — one of the most interest-rate-sensitive sectors of the United States economy.

Equity market valuations are mathematically linked to the ten-year Treasury yield through the discount rate used to calculate the present value of future corporate earnings. When the ten-year yield rises the discount rate applied to future earnings increases, reducing the present value of those earnings and the justifiable current price of equities — particularly for growth companies whose earnings are weighted further into the future and therefore more sensitive to the discount rate in the present value calculation. 

The sustained decline in the ten-year Treasury yield from approximately fifteen percent in 1981 to below one percent in 2020 was a primary driver of the secular expansion in equity price-to-earnings multiples over that period — and the subsequent rise in the ten-year yield from under one percent in 2021 to above five percent in 2023 was a primary driver of the multiple compression that reduced equity valuations across the market.

Currency exchange rates respond to movements in the ten-year Treasury yield relative to the equivalent sovereign bond yields of other countries — a rise in the ten-year United States Treasury yield relative to the German Bund yield or the Japanese Government Bond yield makes dollar-denominated assets more attractive to global investors, increasing demand for dollars and strengthening the dollar exchange rate. 

The interconnection between the ten-year Treasury yield and currency markets makes the note a central variable in international capital flows and the global investment allocation decisions of sovereign wealth funds, central banks, and institutional investors worldwide.

On-the-Run Versus Off-the-Run Treasury Notes

The distinction between on-the-run and off-the-run Treasury notes is among the most directly examination-tested concepts in the Treasury market curriculum and is essential for understanding Treasury market liquidity, yield spreads, and the arbitrage strategies that exploit the pricing differential between the two categories.

An on-the-run Treasury note is the most recently issued Treasury note of a specific maturity — the newest ten-year note, the newest five-year note, and so on. On-the-run notes are the most liquid Treasury securities — they are the benchmark issues that primary dealers use to hedge their inventories, that index funds track as their reference points, that traders use to establish duration exposure, and that institutional investors prefer when they need maximum liquidity and tight bid-ask spreads. The on-the-run note commands a liquidity premium — it trades at a slightly higher price and therefore slightly lower yield than otherwise identical older notes — because its superior liquidity makes it more valuable to investors who may need to sell quickly.

An off-the-run Treasury note is any previously issued note of the same maturity that has been superseded by a newer on-the-run issue. When the Treasury auctions a new ten-year note in February, the note issued in November of the prior year becomes off-the-run — it is now a nine-year-and-three-month note rather than a current ten-year note, it is less liquid than the on-the-run ten-year, and it typically trades at a slightly higher yield than the on-the-run note despite having nearly identical cash flows and credit quality. This yield difference — the on-the-run versus off-the-run spread — represents the pure liquidity premium that investors pay for the superior trading liquidity of the on-the-run security.

The on-the-run versus off-the-run spread has been the basis for fixed income arbitrage strategies — most famously at Long-Term Capital Management — in which investors buy the cheaper off-the-run notes and sell the more expensive on-the-run notes, expecting the spread to narrow as the on-the-run note eventually becomes off-the-run after the next auction and the two notes become more equivalent in liquidity. The risk of this strategy — illustrated catastrophically at LTCM in 1998 — is that the liquidity premium can widen substantially during periods of market stress when investors flee to the most liquid instruments, widening the on-the-run versus off-the-run spread rather than narrowing it and generating severe mark-to-market losses for the arbitrageur.

The Yield Curve and Treasury Notes

Treasury notes of different maturities — two-year, three-year, five-year, seven-year, and ten-year — provide the data points that define the middle section of the United States Treasury yield curve — the graphical representation of Treasury yields across the maturity spectrum from the short-term T-bill through the long-term T-bond.

The relationship between short-term and long-term Treasury note yields — the yield spread between the two-year note and the ten-year note — is among the most widely followed economic indicators in finance. The two-year to ten-year spread — commonly called the two-ten spread — is positive in a normal upward-sloping yield curve when long-term yields exceed short-term yields, reflecting expectations of future economic growth and the term premium investors require for locking in a fixed rate for a longer period. The two-ten spread inverts — becomes negative — when short-term yields exceed long-term yields, creating an inverted yield curve that has historically preceded most United States recessions by six to eighteen months and is therefore one of the most closely watched recession indicators in economics.

The mechanism through which an inverted yield curve signals recession is related to the Federal Reserve's monetary policy stance — short-term Treasury yields are heavily influenced by the Federal Reserve's federal funds rate target, which rises when the Fed is tightening monetary policy to combat inflation. When the Fed raises short-term rates aggressively the two-year yield rises rapidly while the ten-year yield — which reflects longer-term growth and inflation expectations — may rise less or even fall if the market believes the Fed's tightening will eventually slow the economy and reduce future inflation. When the two-year yield rises above the ten-year yield the yield curve inverts — signalling that the market expects lower short-term rates in the future as the economy weakens and the Fed eventually cuts rates. The comprehensive treatment of yield curve shapes and their economic significance is provided in the Yield Curve entry in Letter Y of this dictionary.

Tax Treatment and STRIPS Eligibility

Treasury note interest income is subject to federal income tax and exempt from state and local income taxes under 31 U.S.C. 3124 — identical to the tax treatment of Treasury bonds and bills. The federal-only taxation makes Treasury notes more attractive than comparable corporate bonds for investors in high-income-tax states on an after-tax yield comparison basis — the same state tax adjustment calculation described in the Treasury Bond entry applies equally to Treasury notes.

Treasury notes are eligible for the STRIPS programme — the coupon and principal components of any Treasury note can be separated and traded as individual zero-coupon securities. Ten-year Treasury note STRIPS are particularly widely used for liability-driven investing by pension funds and insurance companies that need zero-coupon instruments maturing at specific dates within the ten-year horizon to immunise specific liability payment obligations. The same phantom income tax treatment applicable to Treasury bond STRIPS applies to Treasury note STRIPS — annual imputed interest is taxable as ordinary income in the year it accrues despite no cash receipt — making STRIPS generally appropriate only for tax-deferred accounts.

Treasury Notes in Portfolio Management

Treasury notes serve multiple distinct portfolio management functions that investment advisers must understand under the fiduciary duty of the Investment Advisers Act of 1940 and the care obligation of Regulation Best Interest at 17 CFR 240.15l-1.

Duration management uses Treasury notes to adjust the interest rate sensitivity of a fixed income portfolio. An investment adviser who wants to increase a portfolio's duration — to benefit from expected falling interest rates — can shift allocation from shorter to longer Treasury notes. An adviser who wants to reduce duration — to protect against expected rising rates — can shift from longer to shorter notes. This duration management capability is one of the primary uses of Treasury notes in institutional portfolio construction.

Flight to quality positioning uses Treasury notes as the primary safe-haven instrument during periods of market stress — when equity markets decline sharply and credit spreads widen, investors typically move capital from risky assets into Treasury notes, driving note prices higher and yields lower. This negative correlation between Treasury notes and equity markets in risk-off environments makes Treasury notes valuable portfolio diversifiers — they tend to gain value precisely when equity holdings are losing value, reducing total portfolio volatility.

Core fixed income allocation uses Treasury notes as the foundational low-risk fixed income component of balanced portfolios — providing stable income, capital preservation, and the interest rate exposure that diversifies equity risk within a multi-asset portfolio.

Examination Relevance and Key Takeaways

Treasury notes are tested on the Series 7 examination in the context of government securities, the distinction from Treasury bills and bonds, the significance of the ten-year yield as a global benchmark, the on-the-run versus off-the-run distinction, and the yield curve.

The key points to retain are these.

A Treasury note is a medium-term United States government debt obligation with original maturity of two, three, five, seven, or ten years — issued at or near face value with a fixed coupon rate paying semi-annual interest throughout its life and face value at maturity. The minimum purchase is one hundred dollars. Two-year, three-year, five-year, and seven-year notes are auctioned monthly. Ten-year notes are auctioned at original issue in February, May, August, and November and reopened eight additional times per year. All Treasury notes are non-callable — the Treasury cannot redeem them before maturity.

The ten-year Treasury note yield is the single most important interest rate benchmark in global finance — it determines the baseline for corporate bond credit spreads, directly influences thirty-year fixed mortgage rates which typically track at one hundred and fifty to two hundred basis points above the ten-year yield, links mathematically to equity valuations through the discount rate applied to future earnings, and drives currency exchange rates through interest rate differentials with other sovereign bond markets. The on-the-run Treasury note is the most recently issued note of a specific maturity — the most liquid benchmark issue trading at the lowest yield. Off-the-run notes are older previously issued notes of the same maturity — less liquid and therefore trading at slightly higher yields than otherwise equivalent on-the-run notes. The on-the-run versus off-the-run spread represents the pure liquidity premium of the benchmark issue.

The two-year to ten-year Treasury yield spread — the two-ten spread — is one of the most widely followed recession indicators — a positive spread indicates a normal upward-sloping yield curve reflecting growth expectations — a negative or inverted spread in which the two-year yield exceeds the ten-year has historically preceded most United States recessions. Treasury note interest is subject to federal income tax and exempt from state and local income taxes under 31 U.S.C. 3124. Treasury notes are STRIPS eligible — individual coupon and principal cash flows can be separated and traded as zero-coupon securities — with phantom income tax treatment requiring annual recognition of imputed interest despite no cash receipt. The critical examination distinction from Treasury bonds is maturity — notes mature in two through ten years, bonds mature in twenty or thirty years — both pay semi-annual coupons and face value at maturity. The critical distinction from Treasury bills is the payment structure — notes pay semi-annual coupons while bills are zero-coupon discount instruments.