DEBT 

MANAGEMENT

Floating Rate Notes 

Can Help Treasury 

Meet Borrowing 

Goals, but Additional 

Actions Are Needed 

to Help Manage Risk

Report to the Chairman, Committee on 

Ways and Means, House of 

Representatives

June 2014

GAO-14-535

United States Government Accountability Office
United States Government Accountability Office

Highlights of GAO-14-535, a report to the 

Chairman, Committee on Ways and Means, 

House of Representatives

June 2014

DEBT MANAGEMENT

Floating Rate Notes Can Help Treasury Meet 

Borrowing Goals, but Additional Actions Are Needed 

to Help Manage Risk

Why GAO Did This Study

To continue meeting its goal of 

financing the federal government’s 

borrowing needs at the lowest cost 

over time, Treasury began issuing a 

new type of security—a 2-year floating 

rate note (FRN)—in January 2014. The 

FRN pays interest at a rate that resets 

periodically based on changes in the 

rate of the 13-week Treasury bill (to 

which the FRN is indexed). GAO was 

asked to review Treasury debt 

management, including this product 

and other debt management issues. 

This report (1) evaluates Treasury's 

rationale for introducing FRNs and (2) 

identifies the demand for Treasury 

securities from a broad range of 

investors to assess whether changes 

would help Treasury meet its goals. To 

address these objectives, GAO used 

Treasury auction data from 1980 - 

2014 to simulate the costs of Treasury 

FRNs, reviewed Treasury documents, 

surveyed a non-generalizable sample 

of 82 large domestic institutional 

investors across sectors, and 

interviewed market participants and 

academic experts. (For the survey and 

results, see GAO-14-562SP.) 

What GAO Recommends

GAO recommends that Treasury (1) 

track and report a measure of interest 

rate risk in its debt portfolio, (2) 

analyze the price effects of the 

difference between the term of the 

index rate and the reset period, (3) 

examine opportunities for additional 

new types of securities, such as FRNs 

of other maturities, and (4) expand 

outreach to certain market participants.

Treasury agreed with the 

recommendations and said that they 

had already taken steps to begin 

implementing them.

What GAO Found

Issuing floating rate notes (FRN) is likely to help the Department of the Treasury 

(Treasury) meet its goals to borrow at the lowest cost over time, extend the 

average maturity of the debt portfolio, and increase demand for Treasury 

securities, but it also presents risks related to changes in interest rates. 

GAO simulated the costs of 2-year Treasury FRNs using historical Treasury 

auction data and found that interest costs of the FRNs were generally less than 

costs of fixed-rate 2-year notes, but could be either more or less than costs of 13-

week bills, depending on assumptions about how investors price the FRNs. GAO

also found that in rising interest rate environments, the FRNs may be more costly 

than these alternatives. 

Multiple components contribute to achieving lowest cost financing over time: 

issuing FRNs is part of Treasury’s approach to achieving this goal. GAO analysis 

identified a number of design elements that may affect how FRNs contribute to 

that goal. Treasury officials believe it is prudent for Treasury to extend the 

average maturity of its debt portfolio because the debt level is already high and is 

expected to grow. Relative to issuing shorter-term debt, 2-year FRNs will help 

Treasury extend the average maturity of the debt portfolio and thereby reduce 

the risk inherent in going to market. Because the interest rate on a FRN can 

change during the life of the security, FRNs expose Treasury to the risk of rising 

interest rates whereas fixed-rate securities of the same maturity do not. These 

shifts in risk are likely to be small because currently FRNs are expected to 

constitute a small proportion of Treasury debt. Although managing interest rate 

risk is an important aspect of Treasury’s goal to borrow at the lowest cost over 

time, Treasury does not track and report a measure of the average maturity of 

the portfolio that captures the additional interest rate risk of FRNs. 

One element of the design of the 2-year FRN—the difference between the term 

of its index rate (13 weeks) and the length of its effective reset period (one 

week)—is not typical for floating rate notes and creates tradeoffs in interest rate 

risks but also may result in additional demand for the product. The risks could

affect the pricing of FRNs and raise Treasury’s borrowing costs in environments 

of high and volatile interest rates. Treasury officials told us they examined design 

elements, including this difference, before issuing the 2-year FRN. However, 

Treasury had not analyzed how the difference may affect FRN pricing.

FRNs give Treasury debt managers additional flexibility by increasing demand for 

Treasury securities and by adding a new security that meets the high demand for 

short-term securities. Results from GAO’s survey of a broad range of investors 

and interviews with market participants found that market participants likely will 

purchase Treasury FRNs primarily as a substitute for other Treasury securities, 

but they will also purchase the FRNs as a substitute for non-Treasury securities, 

bringing new and potentially growing demand to Treasury. To provide the lowest 

cost of financing the government over time, Treasury must consider investor 

demand for new and existing products. Survey respondents indicated an interest 

in FRNs of additional maturities and in other new Treasury products. Treasury 

currently offers many ways for market participants to provide input, but GAO’s 

survey identified opportunities for Treasury to enhance input from some 

sectors—including state and local government retirement fund managers. 

View GAO-14-535. To view the e-supplement, 

click on GAO-14-562SP. For more 

information, contact Susan J. Irving at (202) 

512-6806 or irvings@gao.gov.
Page i GAO-14-535 Debt Management

Letter 1

Background 3

Floating Rate Notes Are Likely to Help Treasury Borrow at the 

Lowest Cost over Time, Extend the Average Maturity, and 

Increase Demand, but They Also Present Certain Risks 10

Market Participants Identified Opportunities for Treasury to 

Enhance Investor Input and Expand Product Offerings 25

Conclusions 31

Recommendations for Executive Action 32

Agency Comments and Our Evaluation 33

Appendix I Simulations of Floating Rate Note Costs 34

Appendix II Survey Scope and Methodology 40

Appendix III GAO Contacts and Staff Acknowledgments 42

Tables

Table 1: Effect of Floating Rate Note Design Features on 

Attractiveness to Investors 19

Table 2: Definitions of Interest Rate Environments 36

Table 3: Survey Responses by Recipient Type 40

Figures

Figure 1: Marketable Securities Offered By Treasury 5

Figure 2: Design Elements of the Treasury 2-Year Floating Rate 

Note 7

Figure 3: Marketable Interest-Bearing Securities by Year of 

Maturity, as of December 31, 2013 (Total Outstanding: 

$11.9 trillion) 8

Figure 4: Actual and Projected Net Interest Outlays and Implied 

Average Treasury Interest Rates, 2004-2024 9

Figure 5: Three Different Approaches to Investing in Treasury 

Securities over 2 Years 11

Contents
Page ii GAO-14-535 Debt Management

Figure 6: Interest Savings or Added Costs from 2-year Floating 

Rate Notes Compared to 2-Year Notes and 13-Week 

Bills, by Rate Environment 13

Figure 7: Percent of Cases Where 2-Year Floating Rate Notes 

(FRN) Save or Add to Interest Costs Compared to 13-

Week Bills and 2-Year Notes, by Rate Environment 14

Figure 8: Weighted Average Maturity of Treasury’s Marketable 

Debt Outstanding 21

Figure 9: Extent to Which Treasury Floating Rate Note Purchases 

Will Substitute for Other Investments, According to 

Survey Respondents 23

Figure 10: Extent to Which Market Participants Said They Have 

Opportunities to Provide Input to Treasury 26

Figure 11: Market Participants’ Reported Estimated Purchases of 

Floating Rate Notes with Different Maturities 28

Figure 12: Treasury Products that Could Enhance Investor 

Demand, According to Survey Respondents 29

Figure 13: Treasury Debt Management Practices That Could 

Enhance Investor Demand, According to Survey 

Respondents 30

Figure 14: Interest Savings or Added Costs from 2-year Floating 

Rate Notes Compared to 13-Week Bills and 2-Year 

Notes, by Volatility in Rates 38

Figure 15: Percent of Cases Where 2-Year Floating Rate Notes 

Save or Add to Interest Costs Compared to 13-Week Bills 

and 2-Year Notes, by Volatility in Rates 39
Page iii GAO-14-535 Debt Management

Abbreviations

CMT Constant Maturity Treasuries

FRBNY Federal Reserve Bank of New York

FRN floating rate note

GSE government-sponsored enterprise

RMSE root mean square error 

TBAC Treasury Borrowing Advisory Committee 

TIPS Treasury Inflation-Protected Securities

Treasury Department of the Treasury

WAM weighted average maturity

This is a work of the U.S. government and is not subject to copyright protection in the 

United States. The published product may be reproduced and distributed in its entirety 

without further permission from GAO. However, because this work may contain 

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necessary if you wish to reproduce this material separately.
Page 1 GAO-14-535 Debt Management

441 G St. N.W.

Washington, DC 20548

June 16, 2014

The Honorable Dave Camp

Chairman, Committee on Ways and Means

House of Representatives

Dear Mr. Chairman:

The U.S. Treasury market is the deepest and most liquid government 

debt market in the world, and throughout history the Department of the 

Treasury (Treasury) has been able to borrow the money it needs to 

finance the federal government. In recent years federal debt held by the 

public has risen dramatically, more than tripling in 10 years, from $3.9 

trillion at the end of fiscal year 2003 to $12 trillion at the end of fiscal year 

2013.1

To continue to meet its goal of financing the federal government’s 

borrowing needs at the lowest cost over time, in 2013 Treasury 

announced that for the first time in more than 15 years, it would begin 

issuing a new type of security—a Treasury floating rate note (FRN). FRNs 

differ from Treasury’s traditional fixed-rate notes in that the FRNs pay 

interest at a rate that can rise and fall during the life of the security. 

The economic slowdown and global financial crisis that contributed 

to this recent, rapid run-up in debt also brought about regulatory changes 

and a “flight to quality”: this increased the demand for Treasury securities 

and helped keep the interest rates that Treasury paid to its investors near 

historic lows. Low rates meant that, while the debt more than tripled, the 

interest expense on Federal debt held by the public increased by only 58 

percent from fiscal year 2003 through 2013 to $248 billion. But with debt 

projected to continue to grow and interest rates expected to rise, this cost 

will increase.

 1

Total federal debt consists of two components: debt held by the public and debt held by 

government accounts. Debt held by the public is the value of all federal securities held by

the public, i.e., investors outside of the federal government. Debt held by government 

accounts represents balances in the federal government's accounts—primarily trust funds, 

including the Social Security and Medicare trust funds—that accumulate surpluses. See 

GAO, “Fiscal Outlook: Understanding the Federal Debt,” Key Issues, (Washington, D.C.: 

2014), accessed Apr. 22, 2014, 

http://www.gao.gov/fiscal_outlook/understanding_federal_debt/overview and GAO, 

Financial Audit: Bureau of the Fiscal Service’s Fiscal Years 2013 and 2012 Schedules of 

Federal Debt, GAO-14-173 (Washington, D.C.: Dec.12, 2013). 
Page 2 GAO-14-535 Debt Management

According to Treasury officials, FRNs will help Treasury to (1) borrow at 

the lowest cost over time, (2) increase the maturity profile of the debt 

portfolio, and (3) expand Treasury’s investor base by attracting new 

buyers. 

You asked us to review Treasury debt management in the context of its 

growing debt portfolio, including the introduction of FRNs. The objectives 

of this report are to (1) evaluate Treasury’s rationale for introducing FRNs 

and (2) identify the demand for Treasury securities from a broad range of 

investors to determine whether changes would help Treasury meet its 

goals. To address these objectives, we did the following:

• Simulated the costs of 2-year FRNs, based on Treasury auction data 

from 1980 to 2014 using two models, each with different assumptions 

about the interest rates that Treasury would pay on the FRNs. We 

compared those costs to Treasury’s actual costs of funding with 13-

week bills and 2-year notes. We also analyzed how those costs varied 

over different interest rate environments. For more information on our 

cost simulations, see appendix I.

• Reviewed the analysis Treasury conducted in developing the 2-year 

FRN and the input Treasury received from market participants.

• Administered an online survey to 82 (62 completed the survey) of the 

largest domestic institutional holders of Treasury securities in the 

following sectors: money market mutual fund managers, mutual and 

exchange-traded fund managers, state and local government 

retirement fund managers, retail and commercial banks, life insurance 

providers, property-casualty insurance providers, and securities 

broker-dealers. Respondents were selected to achieve 50 percent of 

the total amount of Treasury holdings for each sector. The survey 

results are not generalizable to all investors in Treasury securities. For 

more information on our survey methodology, see appendix II. For 

aggregate survey results reproduced as an e-supplement, see 

GAO-14-562SP.

• Interviewed market participants—including six primary dealers and 

four asset managers—regarding the market for FRNs, the structure of 

FRNs, other actions Treasury could consider to expand demand for 

Treasury securities, and opportunities for investors to provide input to 

Floating Rate Note (FRN)

An FRN pays interest at a rate that is indexed 

to another rate, which can rise and fall during 

the life of the FRN. Treasury’s 2-year FRN is 

indexed to the rate from Treasury’s mostrecent 13-week bill auction.
Page 3 GAO-14-535 Debt Management

Treasury.2

To assess the reliability of the data used in this study, including Treasury 

auction data and information on the largest holders of Treasury securities, 

we reviewed related documentation, conducted testing for missing data, 

outliers, obvious errors, and traced data from source documents, where 

possible and appropriate. To the extent possible, we also corroborated 

the results of our data analyses and interviews with other sources. Based 

on our assessment we believe that the data are reliable for the purposes 

of this report.

We selected primary dealers and asset managers based 

on their holdings of Treasury securities and their public comments on 

Treasury’s FRN proposals. The views expressed in these interviews 

are not generalizable to all market participants. Finally, we also 

interviewed five academics recognized as having expertise in the 

Treasury market, regarding the market for FRNs, the structure of the 

FRN, and models for pricing the FRN.

We conducted this performance audit from April 2013 to June 2014 in 

accordance with generally accepted government auditing standards. 

Those standards require that we plan and perform the audit to obtain 

sufficient, appropriate evidence to provide a reasonable basis for our 

findings and conclusions based on our audit objectives. We believe that 

the evidence obtained provides a reasonable basis for our findings and 

conclusions based on our audit objectives.

To achieve its primary debt management objective of financing the 

federal government’s borrowing needs at the lowest cost over time, 

Treasury issues debt through a regular and predictable schedule of 

auctions across a wide range of securities. Most of the securities that are 

issued to the public are marketable, meaning that once the government 

 2

Twenty-two banks and securities broker-dealers are currently designated by the Federal 

Reserve Bank of New York (FRBNY) as primary dealers and are expected to participate 

meaningfully in every Treasury auction by bidding for, at a minimum, an amount of 

securities representing their share of the offered amount (based on the number of primary 

dealers at the time of the auction). Primary dealers also have a role in making a 

secondary market for Treasury securities. (The secondary market is the market in which 

previously issued Treasury marketable securities are bought and sold among investors.)

Background
Page 4 GAO-14-535 Debt Management

issues them they can be resold by whoever owns them.3

 3

In addition to marketable securities, Treasury issues nonmarketable securities that 

cannot be resold, such as U.S. savings bonds and special securities for state and local 

governments.

Marketable debt 

consists of bills, notes, bonds, Treasury Inflation-Protected Securities 

(TIPS), and, since January 2014, FRNs (see figure 1). Currently, 

Treasury issues bills with maturities ranging from a few days to 52 weeks; 

notes with maturities of 2, 3, 5, 7, and 10 years; bonds that mature in 30 

years; TIPS with maturities of 5, 10, and 30 years; and FRNs that mature 

in 2 years.
Page 5 GAO-14-535 Debt Management

Figure 1: Marketable Securities Offered By Treasury

Treasury issues securities in a wide range of maturities to diversify its 

portfolio and to appeal to the broadest range of investors. Issuing at 

multiple points across a wide range of maturity lengths both ensures high 

demand for Treasury securities and improves the general functioning of 

the financial markets by providing price transparency. Investors in 

Treasury securities include

• domestic private investors, such as individuals, banks, and pension 

funds;

• investment funds and asset managers;
Page 6 GAO-14-535 Debt Management

• state and local governments; and

• foreign investors, including both private investors and foreign official 

institutions, such as central banks and national government-owned 

investment funds.

Treasury auctions securities on a regular and predictable schedule to 

reduce market uncertainty, facilitate investor planning, and enhance the 

liquidity of Treasury securities, thereby helping Treasury to borrow at the 

lowest cost over time.4

At least in the near term, FRNs will constitute a small proportion of 

Treasury’s debt portfolio. Treasury held its first FRN auction on Jan. 29, 

2014, and it plans to issue the 2-year FRN every 3 months with a 

reopening auction in each of the 2 intervening months.

Regular and predictable issuance means that 

Treasury debt managers choose the times and maturities of series of 

securities—rather than of individual issues—as part of their strategy for 

debt management. While this means that Treasury does not “time the 

market,” issuing on a regular and predictable schedule does not preclude 

Treasury debt managers from considering fiscal conditions and the 

contemporaneous costs and benefits of shorter-term versus longer-term 

financing. Treasury also announces significant changes long before they 

are implemented and facilitates investor planning by giving market 

participants advance notice of its issuance plans through regular quarterly 

refunding statements. For example, Treasury published a notice and 

request for comments on its potential issuance of FRNs in March 2012, 

almost two years before the first Treasury FRN auction.

5

 4

In a liquid market, trading can be completed at will and the offer and purchase prices 

differ only slightly. Liquidity is important to Treasury because investors are willing to pay 

more for liquid securities that can be easily traded, resulting in lower borrowing costs for 

Treasury.

Treasury 

auctioned $15 billion at the first FRN auction in January 2014 and $13 

billion at each of the reopening auctions in February and March. 

Assuming Treasury FRN issuance amounts remain constant, at the end 

of calendar year 2015 outstanding Treasury FRNs will total $328 billion, 

which is less than 3 percent of the current amount of debt held by the 

5

In a reopening, Treasury auctions additional amounts of a previously issued security. 

Reopened securities have the same maturity date and coupon interest rate or spread as 

the original securities, but have a different issue date and usually a different purchase 

price. 

Total Federal Debt

Total federal debt consists of two 

components: debt held by the public and debt 

held by government accounts.

1. Debt held by the public

Debt held by the public represents federal 

debt issued by Treasury and held by 

investors outside of the federal 

government, including individuals, 

corporations, state or local governments, 

the Federal Reserve, and foreign 

governments. 

2. Debt held by government accounts

Debt held by government accounts 

represents balances in the federal 

government’s accounts (primarily trust 

funds, including the Social Security and 

Medicare trust funds) that accumulate 

surpluses.
Page 7 GAO-14-535 Debt Management

public.6 The first FRNs have a 2-year maturity. Although Treasury 

regulations allow it to issue FRNs with maturities ranging from 1 to 10 

years, Treasury has not announced plans to issue FRNs with other 

maturities.7 The interest rate on Treasury’s 2-year FRN is indexed to the 

13-week Treasury bill and resets daily. Although the interest rate resets 

daily, in practice it will change only weekly because the 13-week bill is 

currently auctioned weekly. The 2-year FRN pays interest quarterly and 

accrues interest daily at a rate that equals the index rate from the most 

recent 13-week Treasury bill auction plus the FRN spread, which is 

determined competitively at the FRN auction (see figure 2).8

Figure 2: Design Elements of the Treasury 2-Year Floating Rate Note

Note: Although the interest rate on the FRN is reset daily, the interest rate paid on the FRN will only 

change weekly because its index rate, the 13-week bill rate, is currently auctioned weekly.

 6

Consistent with its practice for other securities, Treasury does not announce specific 

FRN offering amounts until shortly before each auction.

7

31 C.F.R. § 356.5(b)(3).

8

The FRN index rate is the high rate from the 13-week Treasury bill auction converted to a 

simple-interest money market yield on an actual/360 basis.
Page 8 GAO-14-535 Debt Management

The mix of outstanding Treasury securities can significantly influence both 

rollover risk and the federal government’s borrowing cost. Rollover risk 

includes two types of risk: (1) interest rate risk—the risk that Treasury will 

have to refinance its debt at less favorable interest rates, and (2) market 

access risk—the risks inherent in coming back to the market to refinance 

the debt.9

Figure 3: Marketable Interest-Bearing Securities by Year of Maturity, as of 

December 31, 2013 (Total Outstanding: $11.9 trillion)

As shown in figure 3, as of December 31, 2013, $7.9 trillion (or 

67 percent) of outstanding marketable Treasury securities mature by 

2019 and will need to be rolled over (i.e., refinanced)—potentially at 

higher interest rates.

Note: This includes only debt outstanding as of December 31, 2013. As Treasury refinances maturing 

debt, the dollar amount that will mature in subsequent times will increase. Included in this data is a 

 9

In times of federal budget deficits, all maturing debt must be rolled over into new 

issuances. Rollover risk also includes operational risk, such as the risk that a Treasury 

auction cannot be held due to technical problems with the auction systems.
Page 9 GAO-14-535 Debt Management

small amount of marketable debt held by government accounts. This data does not include $15 billion 

of long-term marketable securities issued by the Federal Financing Bank and held by government 

accounts that are not currently traded in the market.

One measure Treasury uses to manage rollover risk is the weighted 

average maturity (WAM) of outstanding marketable Treasury securities.10

Figure 4: Actual and Projected Net Interest Outlays and Implied Average Treasury Interest Rates, 2004-2024

A high WAM could indicate that Treasury is paying higher rates on its 

debt because longer-term securities generally have interest rates higher 

than shorter-term securities. On the other hand, when they need to be 

refinanced, shorter-term securities expose Treasury to the risk of rising 

interest rates and market access risk. The introduction of the new 

Treasury FRN comes at a time when both interest rates and interest costs 

are expected to rise (see figure 4).

 10The weighted average maturity of outstanding marketable Treasury securities is 

calculated by averaging the remaining maturity of all outstanding marketable Treasury 

securities, weighted by the dollar value of the securities. 
Page 10 GAO-14-535 Debt Management

Note: Actual values through the end of fiscal year 2013; projected values 2014-2024. Net interest 

outlays are interest expenses on Treasury debt held by the public and exclude other interest costs, 

including interest received by other federal entities, such as trust funds, and interest on debt issued 

by agencies other than Treasury (primarily the Tennessee Valley Authority).

We analyzed the potential cost to Treasury of issuing 2-year FRNs and 

found they are likely to have interest costs lower than 2-year fixed-rate 

notes and not substantially different than 13-week bills. As a result, FRNs 

will likely result in savings over the long run, helping Treasury achieve its 

goal of borrowing at the lowest cost over time. Our simulations found 

interest costs and savings varied depending on the security to which the 

FRN is compared, how the FRN is treated by investors, and the interest 

rate environment. We found that the cost of 2-year FRNs was generally 

less than that of fixed-rate 2-year notes, but that it could be either more or 

less than the cost of 13-week bills depending on assumptions regarding 

investor treatment of the FRN. In addition, in all cases and in all 

environments, savings tended to be greater—or added costs lower—

under a model that sets the FRN spread based on its weekly reset than 

under an alternative model where the FRN spread is influenced by its 

final maturity of 2 years. We also found that, while issuing 2-year FRNs 

generally results in cost savings, they may be more costly than other 

alternatives in certain rate environments, such as rising rate 

environments.

Prior to issuance of the first FRN, Treasury conducted its own analysis of 

the potential cost of FRNs. Treasury’s analysis found that from 1982 to 

2010, issuance of 2-year FRNs would have led to cost savings compared 

to fixed-rate notes. Treasury’s analysis, however: (1) compared the cost 

Floating Rate Notes 

Are Likely to Help 

Treasury Borrow at 

the Lowest Cost over 

Time, Extend the 

Average Maturity, and 

Increase Demand, 

but They Also Present 

Certain Risks

2-Year FRNs Are Likely to 

Cost Less than 2-Year 

Fixed-Rate Notes but 

Could Cost More or Less 

Than Bills, and the Cost 

Will Vary by the Interest 

Rate Environment

Floating Rate Note (FRN) Spread

The difference (i.e., spread) between the 

index rate and the interest rate for the FRN. 

The FRN spread is determined at the FRN 

auction and is fixed over the life of the FRN.
Page 11 GAO-14-535 Debt Management

of 2-year FRNs only to 2-year notes and not to other alternatives, and (2) 

assumed a fixed spread of 15 basis points (or 0.15 percentage points).

To estimate the potential cost of FRNs to Treasury, we compared the cost 

of hypothetical 2-year FRNs both to the cost of 2-year fixed-rate notes 

and to series of rolling 13-week bills, using historical auction data from 

January 1980 to March 2014 (see figure 5 below). We made these 

comparisons using two models, each with different assumptions about the 

spread over the index rate that Treasury would pay. We also compared 

the cost of FRNs in the various interest rate environments. 

Although it is uncertain what Treasury would issue in the absence of 

FRNs, Treasury has indicated that, at least initially, the FRNs would be a 

substitute for Treasury bill issuance. Both in interviews and in our survey 

of large holders of Treasury securities, market participants also indicated 

that they see the FRNs as a substitute for bills. However, Treasury has 

also indicated that it intends to reduce the share of debt funded by bills in 

order to increase its WAM. Without the 2-year FRN, Treasury might have 

increased the WAM by the same amount by instead increasing its 

issuance of 2-year fixed-rate notes, making them an appropriate 

benchmark with which to compare the costs of the FRNs.

Figure 5: Three Different Approaches to Investing in Treasury Securities over 2 Years

Note: Although the interest rate on the FRN is reset daily, the interest rate paid on the FRN will likely 

only change weekly because its index rate, the 13-week bill rate, is currently auctioned weekly.

Our analysis used two models for how the FRN spread—the spread 

between the index rate and the interest rate for the FRN—may vary over 

time. The FRN spread is set at auction and is expected to vary in 

response to changes in the level and volatility of interest rates. Because 

there is uncertainty about how market participants will price the FRN 

Floating Rate Note (FRN) Index Rate

The rate to which the interest rate of an FRN 

is indexed. Treasury’s 2-year FRN is indexed 

to the rate from Treasury’s most-recent 13-

week bill auction.
Page 12 GAO-14-535 Debt Management

relative to other products, we considered two different models of the 

response of spreads to changes in different interest rates:

• A “maturity-based” model, where the spread estimate is influenced by 

the 2-year term of the FRN.

• A “reset-based” model, where the spread estimate is derived from the 

weekly reset term, which determines the nature of the interest rate 

risk faced by investors in FRNs.

These two models are designed to approximate the range of potential 

spreads at which the 2-year FRN would have been expected to have 

been auctioned in historical interest rate environments. For more details 

on our models for FRN cost, including other models we considered, see 

appendix I.

Because interest rate environments vary substantially over time, we also 

compared how the cost of FRNs may vary based on changes in the level 

and volatility of interest rates.11 Although these views are not 

generalizable, market participants and experts we interviewed expect the 

demand for FRNs to vary based on the interest rate environment. In 

addition, 58 of 62 respondents to our survey indicated that FRNs would 

be more attractive when interest rates are expected to rise; 49 of 62 

indicated that FRNs would be less attractive when interest rates are 

expected to fall.

 11Definitions of the interest rate environments we used can be found in appendix I.
Page 13 GAO-14-535 Debt Management

We found that compared to 2-year fixed-rate notes, FRNs are likely to 

result in interest savings to Treasury regardless of how the FRN is treated 

by market participants; however, compared to 13-week bills, they could 

result in either savings or additional costs (see figure 6). Compared to 2-

year fixed-rate notes, 2-year FRNs historically would have saved between 

$8.1 million in interest costs annually per billion in issuance under our 

maturity-based model, and $13.6 million under our reset-based model. 

Compared to 13-week bills, the FRN would have resulted in annual 

savings of $2.4 million per billion of issuance under our reset-based 

model but additional annual costs of $3.1 million per billion of issuance 

under our maturity-based model.

Figure 6: Interest Savings or Added Costs from 2-Year Floating Rate Notes Compared to 2-Year Notes and 13-Week Bills, by 

Rate Environment

Costs of 2-Year FRNs Vary 

Based on What Treasury 

Would Have Issued Instead, 

Investor Treatment of FRNs, 

and Interest Rate Environment
Page 14 GAO-14-535 Debt Management

In addition to examining estimates of the relative savings and costs from 

issuing 2-year FRNs, we also analyzed the share of cases in our 

simulations where FRNs save or add to interest costs across different 

interest rate environments (see figure 7). We found that compared to 2-

year fixed-rate notes, the 2-year FRN would have resulted in savings in 

82 percent of cases under our reset-based model and in 72 percent of 

cases under our maturity-based model. Compared to 13-week bills, 2-

year FRNs would have resulted in savings in 85 percent of cases under 

our reset-based model but added to costs in 81 percent of cases under 

our maturity-based model.

Figure 7: Percent of Cases Where 2-Year Floating Rate Notes (FRN) Save or Add to Interest Costs Compared to 13-Week Bills 

and 2-Year Notes, by Rate Environment

We also found that the interest savings or added costs from 2-year FRNs 

varied with the interest rate environment regardless of how the FRN is 

treated or whether it is being compared to 2-year fixed-rate notes or 13-
Page 15 GAO-14-535 Debt Management

week bills. Relative to 2-year fixed-rate notes, FRNs tended to be more 

costly in rising rate environments compared to other environments. 

Compared to 13-week bills, FRNs tended to be more costly (in the case 

of our maturity-based model) or to produce less savings (in the case of 

our reset-based model). The extra cost or reduced savings in rising rate 

environments, however, tended to be less than the savings in steady and 

falling rate environments. As shown in figures 6 and 7 above, under our 

maturity-based model

• in rising rate environments, 2-year FRNs were less costly than 2-year 

fixed-rate notes in only 24 percent of cases and, on average, 

increased Treasury interest costs by 0.48 percentage points, resulting 

in $4.8 million in annual interest costs per billion in issuance; and

• in falling rate environments, 2-year FRNs were less costly than 2-year 

fixed-rate notes in all cases and, on average, reduced interest costs 

by 2.07 percentage points, resulting in $20.7 million in annual interest 

savings per billion in issuance.

We also analyzed the potential costs and savings from FRNs in 

environments with different levels of rate volatility and found that, at all 

levels of volatility, there was little variation between our two models. In 

periods of low, moderate, and high volatility, 2-year FRNs tended to 

produce savings compared to 2-year fixed-rate notes, but compared to 

13-week bills, could produce either costs or savings, depending on which 

model is used. In periods of extreme (i.e., higher than “high”) volatility, 

FRNs produced savings under both models. For more information on the 

results of this analysis, see appendix I.

Factors other than interest rates may affect demand for FRNs, and 

Treasury could realize additional savings from FRNs due to these 

elements of technical demand. Both of the models we used to estimate 

the cost of FRNs assume the FRN spread is based solely on the relative 

value of FRNs compared to other Treasury securities. However, both our 

interviews with market participants and our survey responses indicate that 

demand for FRNs is also likely to be affected by technical factors, such as 

investment guidelines or regulatory requirements to hold certain types of 

investments. For example, Treasury officials and market participants told 

us that Treasury structured the FRNs in a way that makes them 

Technical Demand May 

Increase Savings to Treasury, 

While a Liquidity Premium 

May Increase Costs
Page 16 GAO-14-535 Debt Management

especially attractive to money market investors.12 To meet investment 

guidelines and regulatory requirements, these funds tend to hold mostly 

short-term securities like Treasury bills and, because their interest rate 

resets frequently, FRNs.13

Our survey results confirm that technical factors affect the attractiveness 

of FRNs for at least some investors. Twenty-seven of the sixty-two survey 

respondents said that FRNs’ consistency with client or fund investment 

guidelines make them attractive to a great or very great extent. Results of 

our survey also show that 2-year FRNs are more attractive because they 

conform to regulatory requirements for certain sectors. Six of the seven 

money market mutual fund managers that responded to our survey 

indicated that conformance with limits on their holdings make the FRNs 

attractive to a great or very great extent. Similarly, five of the nine retail 

and commercial banks that responded to our survey indicated that 

conformance with new capital requirements made the FRNs attractive to 

a great or very great extent.

These factors would create some technical 

demand for Treasury FRNs that is less sensitive to the relative value of 

the FRN. This generally would lower Treasury’s costs since some 

investors would be willing to accept a lower interest rate at auction.

Treasury’s costs could be increased if Treasury FRNs have a higher 

liquidity premium than other Treasury securities. Debt issuers, including 

Treasury, generally have to pay a liquidity premium on less liquid 

products—products that cannot be easily bought and sold in large 

volumes without meaningfully affecting the price—to compensate 

investors for the possibility that they might not be able to sell the security 

as readily as a more liquid product. A liquidity premium on FRNs that is 

greater than the premium on other Treasury securities could increase 

costs compared to our estimates. Although Treasury securities are 

generally considered very liquid and have very low liquidity premiums, 

market participants we interviewed said that FRNs might be less liquid 

than bills—Treasury’s most liquid product—but more liquid than TIPS—its 

 12A money market fund is a type of investment fund that is required by law to invest in lowrisk securities. These funds have relatively low risks compared to other mutual funds and 

pay dividends that generally reflect short-term interest rates. Money market funds typically 

invest in government securities (including Treasury bills and notes), certificates of deposit, 

commercial paper of companies, or other highly liquid and low-risk securities.

1317 C.F.R. § 270.2a-7(c)(2).

Technical Demand

Technical demand is driven by factors such as 

investment guidelines or regulatory 

requirements and is less sensitive to the 

relative value of the security.
Page 17 GAO-14-535 Debt Management

least liquid product.14

The results of Treasury’s first three FRN auctions were within the range 

estimated by our models. At the first FRN auction in January 2014, FRNs 

were auctioned with an FRN spread of 0.045 percentage points. At the 

February and March 2014 auctions, FRNs were auctioned with discount 

margins of 0.064 and 0.069 percentage points, respectively.

FRNs are expected to be less liquid than bills 

because (1) investors are more likely to buy and hold rather than to trade 

FRNs, and (2) FRNs are expected to have a smaller relative market size. 

Several market participants said that liquidity is likely to be lower initially 

and to improve as Treasury issues more FRNs.

15 The actual 

auction results appear linked to the spreads predicted by our reset-based 

model. In each of the three auctions, the actual auction results equaled 

the spread predicted by our reset-based model plus a small and 

consistent premium.

One element of the design of the Treasury 2-year FRN is that it is what 

the market refers to as a “mismatched floater.” The difference (i.e., the 

mismatch) between the term of its index rate (13 weeks) and the length of 

its reset period (stated as daily, but effectively weekly) may introduce the 

risk of price instability on the reset date that is not typical of most floating 

rate securities. This is particularly the case if market participants treat the 

FRNs more like series of rolling 1-week bills. This might affect demand for 

the product in certain interest rate environments and, if so, could raise 

Treasury’s borrowing costs.

For most floating rate securities, the maturity of the index rate and the 

frequency of the interest rate reset match. For example, a floating rate 

note indexed to the 3-month LIBOR—an interbank lending rate that is the 

 14Previously, we recommended that Treasury take actions to increase TIPS liquidity;

Treasury has implemented each of our recommendations. See GAO, Debt Management: 

Treasury Inflation Protected Securities Should Play a Heightened Role in Addressing Debt 

Management Challenges, GAO-09-932 (Washington, D.C.: Sept. 29, 2009).

15In a Treasury FRN auction, bids are made in terms of a desired discount margin. The 

highest accepted discount margin in the initial auction for a given FRN (which we refer to 

as the FRN spread) becomes the spread for that FRN, and bidders pay the full value of 

the FRN. At subsequent reopening auctions of the FRN, the spread is fixed based on the 

results of the initial auction. Bidders at the auction still bid on a discount margin basis and 

may pay more, less, or the same as the full value, depending on whether the discount 

margin is less, more, or the same as the initial auction.

Results of Initial FRN Auctions 

Were Within the Range 

Estimated by Our Models

Mismatch Between the 

FRN’s Index Rate Maturity 

and Reset Frequency 

Poses Risk That Treasury 

Has Not Fully Analyzed
Page 18 GAO-14-535 Debt Management

most common index for non-Treasury floating rate notes—would typically 

reset every 3 months. Absent a change in the credit risk of an issuer, the 

value of a typical floating rate security returns to par—the value at 

maturity—at each reset. This leads to a higher level of price stability in 

floating rate securities compared to fixed-rate securities of the same 

maturity. This price stability is highly desirable to some investors.

The Treasury 2-year FRN is different from a typical floating rate security 

in that it will reset every week to a 13-week rate. This mismatch 

introduces a tradeoff between yield curve risk and interest rate risk. 

Unlike a typical FRN, the price of the Treasury 2-year FRN will not reliably 

return precisely to par at each reset date before its 2 year maturity. This is 

because investors factor in changes between the 1-week bill rate and the 

13-week bill rate. However, the price of the Treasury 2-year FRN should 

return close to par weekly, which is more frequent than if it had a 13-week 

reset. Treasury officials told us they believe that the frequent resets 

provide increased price stability for the FRN. They said that they expect 

investors to price the 2-year FRN in a way that reflects the expectation 

that the yield curve risk for Treasury’s 2-year FRN is likely to be small 

relative to its reduced interest rate risk. However, if the difference 

between the 1-week rate and the 13-week rate changes substantially over 

the two year term, either in fact or in expectations, then the yield curve 

risk that the investor faces would be more substantial. It is possible that in 

higher and changing interest rate environments, the tradeoff between 

yield curve risk and interest rate risk may not be favorable to investors. 

This could be reflected in the spread, as investors bid for FRNs at auction 

in a way that compensates them for this additional risk, which could raise 

Treasury’s borrowing costs.

The mismatch between the index rate maturity and the frequency of the 

interest rate reset could have adverse effects on the costs of FRNs to 

Treasury. Treasury officials told us they discussed the design of the 2-

year FRN both internally and with market participants and structured the 

2-year FRN in this way for two reasons. First, as both those who 

commented on Treasury’s proposal and Treasury have noted, the 13-

week bill market is a large, liquid, and transparent market. Second, 

Treasury designed the 2-year FRN to meet high demand for short-term 

securities, and both Treasury officials and the market participants we 

spoke with cited the 2-year FRN’s frequent reset as a reason for greater 

demand from money market funds. These funds face constraints on the 

average maturity of their holdings, which the weekly reset of the Treasury 

2-year FRN helps address. This additional demand would likely result in 

lower costs and helps establish the new product for Treasury, which may 

Yield Curve Risk

The risk that interest rates at different maturity 

points—for example the rates for a one-week 

bill and a 13-week bill—will change relative to 

one another.

Money Market Fund

A money market fund is a type of investment 

fund that is required by law to invest in lowrisk securities. These funds have relatively 

low risks compared to other mutual funds and 

pay dividends that generally reflect short-term 

interest rates. Money market funds typically 

invest in government securities (including 

Treasury bills and notes), certificates of 

deposit, commercial paper of companies, or 

other highly liquid and low-risk securities.
Page 19 GAO-14-535 Debt Management

outweigh the potential cost of the mismatch. Results of our survey show 

that overall, the FRN’s index rate and the frequency of its interest rate 

reset chosen by Treasury—as well as the difference between the two—

made the FRN more attractive to investors (see table 1).

Table 1: Effect of Floating Rate Note Design Features on Attractiveness to Investors

Effect on attractiveness of FRN

Feature More attractive

Neither more 

nor less attractive Less attractive

No basis to judge/

no opinion

Index rate maturity 24 28 6 4

Interest rate reset frequency 34 12 12 4

Difference between index rate 

maturity and interest rate reset period

16 34 7 5

Source: GAO analysis of survey data.

Although Treasury officials told us they discussed the potential benefits 

and risks of the mismatch, Treasury had not analyzed how the mismatch 

could affect pricing. After we briefed Treasury officials on the issue in 

April 2014, Treasury began taking steps to study the mismatch to more 

fully understand its potential pricing risks. While its practice of regular and 

predicable issuance means Treasury issues all products in all 

environments, it is important that the risks of different securities are 

considered when making decisions about the mix of securities to issue. 

Treasury did analyze and consider how other design elements would 

affect pricing of the 2-year FRN and incorporated the results of that 

analysis into their final design. For example, Treasury analyzed how 

setting a minimum spread for the FRN would affect pricing. This analysis

led Treasury officials to conclude that a minimum spread would 

unnecessarily complicate pricing, and it was excluded from the final 

structure of the FRN.

Consistent with its goal of borrowing at the lowest cost over time, 

Treasury tracks and manages the average maturity of the debt portfolio. 

Relative to issuing bills, 2-year FRNs will help Treasury extend the 

average maturity of the debt portfolio, but only slightly. The effect that the 

FRNs will have on the average maturity is likely to be small because at 

least at the onset, FRNs are expected to constitute a small proportion of 

overall Treasury debt. Even so, Treasury officials said it is prudent to 

reduce Treasury’s rollover risk by extending the average maturity. 

Treasury officials told us that FRNs will help Treasury continue to 

FRNs Can Help to Extend 

the Maturity of the Debt 

Portfolio, but They Make 

Treasury’s Weighted 

Average Maturity an 

Incomplete Measure of 

Rollover Risk
Page 20 GAO-14-535 Debt Management

increase the maturity profile of the debt portfolio while meeting high 

demand for high-quality, short-term securities. Treasury could extend the 

average maturity of the portfolio by replacing issuance of shorter term 

notes and bills with longer term fixed-rate notes and bonds, rather than 

issue FRNs. In deciding what to issue, however, Treasury is confronted 

with making prudent decisions about investor demand by product. If 

Treasury issues the wrong mix of products, its overall cost of funding 

would increase, as investors would express their preferences in prices bid 

at auction.

Treasury tracks the WAM of outstanding marketable securities and 

publicly releases WAM data quarterly. Treasury debt managers do not 

have a WAM target, but over the past 30 years they have generally kept 

the WAM between 50 and 70 months (see figure 8). As of February 28, 

2014, the WAM of the Treasury’s outstanding marketable debt was 67 

months, well above the historical average of 58.6 months. As of January 

2014, Treasury continued to increase the WAM in a way that Treasury 

officials stated is consistent with their long-term objectives of financing the 

government at the lowest cost over time and ensuring regular and 

predictable management of the debt portfolio. 

Weighted Average Maturity (WAM)

The WAM of outstanding marketable Treasury 

securities is calculated by averaging the 

remaining maturity of all outstanding 

marketable Treasury securities, weighted by 

the dollar value of the securities.

Rollover Risk

Rollover risk includes two types of risk:

1. Interest rate risk

For a borrower, such as Treasury, interest 

rate risk is the risk of having to refinance 

its debt at less favorable interest rates 

and, for floating rate debt, of interest rates 

rising during the life of the security.

2. Market access risk

The risk associated with coming back to 

the market to refinance the debt. In times 

of federal budget deficits, maturing federal 

debt must be rolled over into new 

issuance.

Marketable Debt

Marketable securities can be resold by 

whoever owns them. In addition to marketable 

securities, Treasury issues nonmarketable 

securities that cannot be resold, such as U.S. 

savings bonds and special securities for state 

and local governments.
Page 21 GAO-14-535 Debt Management

Figure 8: Weighted Average Maturity of Treasury’s Marketable Debt Outstanding

Before Treasury began issuing FRNs, its WAM metric captured both 

components of rollover risk—interest rate risk and market access risk. 

Increasing the WAM by issuing 2-year FRNs instead of bills does not 

have the same effect on Treasury’s risk profile that issuing 2-year fixedrate notes would have. Since both 2-year securities have the same final 

maturity, they carry the same market access risk. The FRNs, however, 

carry a larger interest rate risk. The weekly reset means the interest risk 

on the FRN is similar to that of a 1-week bill, making it the shortest term 

product in Treasury’s regularly issued portfolio from an interest rate risk 

perspective.16

 16Treasury issues 4-week, 13-week, 26-week, and 52-week bills on a regular schedule. 

Treasury issues cash management bills of varying maturities only as Treasury financing 

needs require.

As noted above, it is uncertain what Treasury would issue 

in the absence of FRNs and whether 2-year FRNs will substitute primarily 
Page 22 GAO-14-535 Debt Management

for 2-year fixed-rate notes, other fixed-rate notes, or bills. Relative to 

issuance of regularly issued bills, 2-year FRNs reduce Treasury’s market 

access risk by locking in that funding for a longer period but increase 

interest rate risk due to the weekly reset.

As FRN issuance grows, Treasury’s single WAM metric will remain a 

meaningful measure of market access risk; however it will no longer be 

an accurate measure of interest rate risk because floating rate securities 

carry higher interest rate risk than fixed-rate securities of the same term. 

Treasury debt management officials said that because Treasury issues in 

all interest rate environments and does not time the market, they primarily 

use the WAM metric as a proxy for market access risk in the portfolio. 

However, because market access risk and interest rate risk are related, 

Treasury understands the importance of both parts of the measure. 

Managing interest rate risk is an important aspect of Treasury’s goal to 

borrow at the lowest cost over time; guidelines for sovereign debt 

management also emphasize the importance of managing the exposure 

of the debt portfolio to interest rate risk, as well as to market access risk.17

Market participants that hold both floating rate and fixed rate debt use 

more than one measure to assess the length of their portfolios. For 

example, certain money market mutual funds are required to measure the 

average term of the fund in two ways—one based on the final maturity 

dates of the securities in the fund and the other based on the interest rate 

reset dates of the securities in the fund.18 When we raised this issue with 

them, Treasury officials told us that they could easily publish another 

measure of interest rate risk.

FRNs provide Treasury with additional flexibility in its debt issuance by 

adding a new type of security to Treasury’s debt portfolio and by 

increasing overall demand for Treasury securities. If a new security brings 

incremental demand for Treasury securities, Treasury can grow its debt 

portfolio without increasing by as much as it might otherwise have had to 

the amount needed to finance the debt through existing securities. Our 

interviews and survey results found that although market participants will 

likely primarily purchase Treasury FRNs as a substitute for other Treasury 

 17International Monetary Fund and the World Bank, Guidelines for Public Debt 

Management, as amended Dec. 9, 2003. 

1817 C.F.R. § 270.2a-7.

FRNs Provide Treasury 

with Additional Flexibility

in Its Debt Issuance
Page 23 GAO-14-535 Debt Management

securities (especially bills), market participants will also purchase 

Treasury FRNs as a substitute for other investment options, including 

FRNs from other issuers and repurchase agreements (see figure 9).

Figure 9: Extent to Which Treasury Floating Rate Note Purchases Will Substitute for Other Investments, According to Survey 

Respondents

The results of the early FRN auctions indicate high demand for the 

security. The bid-to-cover ratios at the first three FRN auctions were 

higher than bid-to-cover ratios for other Treasury securities auctioned 

around that time. The first auction on January 29, 2014 had a bid-to-cover 

ratio of 5.67 and the reopening auctions in February and March had bidto-cover ratios of 5.29 and 4.67, respectively. This compares to the bid-tocover ratios in 13-week bill and fixed-rate 2-year note auctions averaging 

4.53 and 3.37, respectively, over the same January to March period. 

According to Federal Reserve Bank of New York (FRBNY) officials, 

trading for the FRNs in the when-issued market was limited ahead of the 
Page 24 GAO-14-535 Debt Management

three FRN auctions; nevertheless, the rates quoted in the when-issued 

market were very close to the auction results, an indicator that the 

auctions came very close to market expectations. This suggests that the 

price discovery mechanism of the market was functioning well for FRNs 

and that the market embraces and understands the security, which in turn 

indicates strong current and continuing demand that helps Treasury 

borrow at lower cost over time.

Our survey results suggest demand for Treasury FRNs is likely to grow. 

Eighteen out of 61 survey respondents participated in the first Treasury 

FRN auction, but more said they plan to purchase Treasury FRNs this 

year. About half of all respondents (32 of 62) said their organizations 

definitely or probably will purchase Treasury FRNs in 2014.19

Although issuance of FRNs brings incremental demand for Treasury 

securities and demand in the initial auctions was high and is likely to 

Survey 

respondents anticipate that money market mutual funds, corporate 

treasuries, and foreign central banks are likely to have the most demand 

for 2-year FRNs. Survey respondents noted a number of reasons why 

Treasury FRNs are an attractive investment option, including the interest 

rate risk protection they provide the purchaser, their price stability, their 

use as a cash management tool, their consistency with investment 

guidelines and regulatory requirements, and the liquidity of the securities. 

The successful launch of a new type of security relies both on the 

readiness of investors and on Treasury’s own operational readiness. 

Overall, market participants felt prepared for the introduction of a new 

security. According to almost all of the market participants we surveyed, 

Treasury provided sufficient information regarding its plans to issue FRNs 

(53 out of 62 respondents noted that Treasury provided sufficient 

information and the remaining 9 noted that they had “no opinion or no 

basis to judge.”) In addition, of the 48 survey respondents that said that 

they would need to make systems changes to purchase FRNs, 36 said 

that Treasury or the Federal Reserve had provided adequate assistance 

or information to make the necessary changes. Some respondents noted 

that as of March 2014, they had not yet completed systems changes that 

will be needed to purchase FRNs. Demand for FRNs may increase as 

additional investors complete systems changes.

 19These planned purchases include purchases at Treasury auctions, in the secondary 

market, and in the when-issued market. 

Reopening Auction

An auction of additional amounts of a

previously issued security.

Bid-to-Cover Ratio

In a Treasury auction the bid-to-cover ratio is 

the dollar value of all bids received in the 

auction, divided by the dollar value of the 

securities auctioned.

When-Issued Market

When-issued trades are contracts for the 

purchase and sale of a new security before 

the security has been auctioned. When-issued 

trades settle on the issue date of the new 

security, when the security is first available for 

delivery.
Page 25 GAO-14-535 Debt Management

grow, one design feature of the 2-year FRN may constrain Treasury’s 

flexibility in the issuance of 13-week bills. Treasury officials and market 

participants both told us that because the FRN is indexed to the 13-week 

Treasury bill rate, Treasury will have to be more judicious in adjusting the 

size or timing of Treasury auctions of 13-week bills. As some comments 

on the proposed rule noted, there is some risk in indexing a floating rate 

note to a product from the same issuer. However, given that the 13-week 

bill is one of Treasury’s largest and most liquid markets, its selection as 

the index rate minimizes this risk.

As our prior work has found, communication with investors is essential as 

Treasury faces the need to finance historically large deficits expected in 

the medium and long term.20

 20GAO, Debt Management: Treasury Was Able to Fund Economic Stabilization and 

Recovery Expenditures in a Short Period of Time, but Debt Management Challenges 

Remain, 

Overall, survey respondents said that 

Treasury provides sufficient information to investors on its debt 

management plans. Forty-three out of the 62 survey respondents said 

communication from Treasury occurred to a great or very great extent; no 

respondents said communication occurred to little or no extent (one had 

no basis to judge). In addition, most survey respondents said that they 

were able to provide sufficient input to Treasury, but respondents from 

some sectors reported lower levels of opportunity to provide input. The 26 

respondents who reported opportunities existed to some or little to no 

extent included 10 state or local government retirement fund managers, 4 

money market mutual fund managers, and 3 life insurance providers (see 

figure 10 below).

GAO-10-498 (Washington, D.C.: May 18, 2010).

Market Participants 

Identified 

Opportunities for 

Treasury to Enhance 

Investor Input and 

Expand Product 

Offerings

Overall Treasury’s 

Communication with 

Investors Is Strong, but 

Certain Sectors Said It 

Could Be Improved
Page 26 GAO-14-535 Debt Management

Figure 10: Extent to Which Market Participants Said They Have Opportunities to Provide Input to Treasury

To manage risks associated with borrowing, Treasury monitors market 

activity and, if necessary, responds with appropriate changes in debt 

issuance based on analysis and consultation with market participants. 

Treasury offers a number of ways for market participants to give input,

such as providing comments on regulations solicited through the Federal 

Register and through the email box on the Treasury website. The 

Treasury Borrowing Advisory Committee (TBAC) is comprised of senior 

representatives from investment funds and banks and holds quarterly 

meetings to provide insights to Treasury on the overall strength of the 

U.S. economy and recommendations on debt management issues. In 

addition, FRBNY administers the network of primary dealers that also 

provide market information and analysis to Treasury. However, 

Treasury’s Office of Debt Management does not meet regularly with all 

sectors, such as state and local government retirement fund managers. 

Survey respondent suggestions for improving communication with 
Page 27 GAO-14-535 Debt Management

Treasury included administering surveys, holding regular meetings or 

calls with investors outside of the TBAC, polling investors on new product 

ideas, and providing a mechanism for submitting annual 

recommendations to Treasury from large investors. Without targeted 

outreach to all major sectors of investors in Treasury securities, Treasury 

could miss important insights to improve its debt management plans.

Responses from our survey of market participants indicate an interest in 

FRNs of both shorter- and medium-term maturities, but respondents 

expressed more limited interest in 7- and 10-year FRNs than in shorterterm FRNs (see figure 11). Survey respondents expressed the most 

interest in the introduction of a 1-year FRN. Interest in the 1-year FRN 

varied by sector, with mutual funds (including money market funds) 

expressing substantial interest in this maturity, while retail and 

commercial banks had little interest. Securities broker-dealers and state 

and local retirement fund managers expressed the most interest in FRNs 

with maturities other than 2 years, but other sectors—such as banks and 

property-casualty insurance providers—also showed some interest in 

these other securities. Treasury officials said they might consider issuing 

FRNs with longer maturities once both they and the market gain some 

experience with the 2-year Treasury FRN. Over the long run, Treasury 

FRNs with maturities other than 2 years are likely to provide a cost 

savings to Treasury relative to issuance of fixed-rate securities with the 

same maturity.

Survey Respondents 

Reported Interest Both

in FRNs with Different 

Maturities and Other

New Types of Treasury 

Securities
Page 28 GAO-14-535 Debt Management

Figure 11: Market Participants’ Reported Estimated Purchases of Floating Rate Notes with Different Maturities

Survey respondents expressed their views on certain design features of 

FRNs with maturities other than 2 years. For instance, if Treasury were to 

issue FRNs with different maturities, almost all survey respondents (57 

out of 62) thought those FRNs should also be indexed to the 13-week 

Treasury bill. More respondents said they would prefer daily interest rate 

resets to any other reset period for FRNs with maturities other than 2 

years. Of the respondents who wanted new FRNs to be indexed to the 

13-week Treasury bill rate, 13 would also prefer daily resets for all 

hypothetical maturities, including 4 state and local government retirement 

fund managers and 5 securities broker-dealers. Although this suggests 

that these respondents would prefer a “mismatched floater,” as discussed 

earlier in this report, the mismatch feature may raise risks that result in 

higher costs to Treasury in certain interest rate environments. 

Additionally, respondents generally preferred quarterly interest payments 

for FRNs with other maturities and monthly auctions for 1-year and 3-year 

FRNs and quarterly auctions for FRNs with other maturities.
Page 29 GAO-14-535 Debt Management

Survey respondents also expressed an interest in possible new Treasury 

securities. Suggestions were ultra-long bonds, callable securities, FRNs 

indexed to inflation, and zero-coupon notes or bonds (see figure 12).21

Figure 12: Treasury Products that Could Enhance Investor Demand, According to Survey Respondents

In addition, respondents suggested that certain debt management 

practices, specifically buybacks and reverse inquiry window, would 

 21Ultra-long bonds are issued with a maturity greater than Treasury’s current offerings, 

such as 40-, 50- or 100-years. Callable bonds are bonds that can be redeemed or paid off 

by the issuer prior to the bond’s maturity date. FRNs indexed to inflation are floating rate 

notes that adjust the coupon rate for inflation while the principal is held constant. Zerocoupon bonds are bonds that do not pay interest during the life of the bonds. Zero-coupon 

bonds pay a lump sum, equal to the initial investment plus imputed interest, at maturity.
Page 30 GAO-14-535 Debt Management

enhance demand for Treasury securities.22

Figure 13: Treasury Debt Management Practices That Could Enhance Investor Demand, According to Survey Respondents

However, respondents said 

that in general, changes to Treasury’s current debt management 

practices—such as frequency of initial and reopening auctions, issuance 

sizes, and non-competitive award limits—would not enhance demand

(see figure 13).

 22Buybacks are the redemption of marketable securities prior to their maturity dates. We 

previously recommended that Treasury build the capacity for a buyback program that 

could be used to respond to potential changes in market conditions during times of deficit. 

This recommendation has not been implemented to date. See GAO, Debt Management: 

Buybacks Can Enhance Treasury’s Capacity to Manage under Changing Market 

Conditions, GAO-12-314 (Washington, D.C.: Mar. 7, 2012). A reverse inquiry window is a 

method of purchasing securities where an investor consults with a broker-dealer who 

proposes to an issuer that a specific security be issued to meet the investor’s needs. 
Page 31 GAO-14-535 Debt Management

To achieve the lowest cost of financing the government over time, it is 

important that Treasury spread debt across maturities and take into 

account investor demand for new and existing products. The medium and 

long term fiscal outlook make evaluating the demand for Treasury 

securities, including new securities, increasingly important. Currently, 

Treasury feels unable to conduct a broad survey of market participants. 

For this reason, the insights on potential demand for new products from 

our survey can provide Treasury with a starting point so that it does not 

miss opportunities.

The U.S. Treasury market is the deepest and most liquid government 

debt market in the world. Nevertheless, Treasury faces challenges in 

managing the debt at a time when debt levels are high and projected to 

increase and when interest rates are also expected to rise. Given the 

market uncertainties and the federal government’s fiscal challenges, 

increasing Treasury’s flexibility to respond to changing market conditions 

in ways that minimize costs is prudent. FRNs are a tool that can help

meet these goals. Over the long term, FRNs can reduce Treasury interest 

costs relative to fixed-rate securities that lock in funding for the same 

term. FRNs can also help enhance Treasury flexibility by marginally 

increasing demand for Treasury securities.

The design and implementation of FRNs has implications for Treasury’s 

ability to minimize borrowing costs over time and for the balance of risks 

in Treasury’s debt portfolio. Our cost analysis finds that in comparison to 

issuance of 2-year fixed-rate notes, Treasury is taking on additional 

interest rate risk but is likely to achieve interest cost savings while not 

increasing market access risk. The mismatch feature of Treasury’s first 

FRN presents a tradeoff between different risks for both investors and 

Treasury that could raise Treasury’s borrowing costs when interest rates 

are high and the yield curve is volatile. However, the mismatch also helps 

Treasury tap into the current high demand for high-quality short-term 

securities. Without analyzing how the mismatch between the frequency of 

the reset period and the maturity of the index could affect pricing, 

however, Treasury is unable to judge either (1) the risks (and therefore 

the ultimate cost) of FRNs in a different interest environment, or (2) 

whether the additional demand from money market funds due to the 

mismatch feature outweighs the potential costs it creates. A better 

understanding of these tradeoffs will be important when Treasury 

considers issuing FRNs with maturities other than 2 years. Furthermore, 

with the addition of FRNs to Treasury’s debt portfolio, the weighted 

average maturity length of securities in the portfolio (i.e., the WAM) is now 

Conclusions
Page 32 GAO-14-535 Debt Management

an incomplete measure of rollover risk because it does not accurately 

measure interest rate risk. Tracking and reporting an additional measure 

of the length of the debt portfolio that captures interest rate risk could help 

Treasury debt managers understand and weigh risks in the portfolio, and 

publicly reporting that measure would facilitate transparency and market 

understanding of Treasury debt management decisions.

Introducing FRNs at this time—when demand is high—can help Treasury 

and market participants become more familiar with the new security so 

that Treasury can expand to FRNs with different maturities if Treasury 

determines that doing so would enhance its flexibility and advance its 

debt management goals. It will also be important for Treasury to gauge 

market demand for FRNs and other products by soliciting input from all 

sectors of Treasury investors, specifically state and local government 

retirement fund managers. Such input can help inform Treasury decisions 

about changes to Treasury issuance or debt management practices that 

could enhance overall demand for Treasury securities. When deciding 

what to issue, Treasury must make prudent decisions about investor 

demand by product. If Treasury issues the wrong mix of products, its 

overall cost of funding will increase, as investors express their 

preferences in prices bid at auction.

To help minimize Treasury borrowing costs over time by better 

understanding and managing the risks posed by Treasury floating rate 

notes and by enhancing demand for Treasury securities, we recommend 

that the Secretary of the Treasury take the following four actions:

1. Analyze the price effects of the mismatch between the term of the 

index rate and the reset period;

2. Track and report an additional measure of the length of the portfolio 

that captures the interest rate reset frequency of securities in the 

portfolio;

3. Expand outreach to state and local government retirement fund 

managers; and

4. Examine opportunities for additional new security types, such as 

FRNs with maturities other than 2 years or ultra-long bonds.

Recommendations for 

Executive Action
Page 33 GAO-14-535 Debt Management

We provided a draft of this product and the accompanying e-supplement 

(GAO-14-562SP) to Treasury for comment. On May 23, 2014 the 

Assistant Secretary for Financial Markets told us that Treasury thought it 

was an excellent report, that they agreed with the recommendations, and 

that they had already taken steps to begin implementing them. For 

example, he told us that Treasury’s new Office of State and Local 

Finance will bolster outreach to investors in the state and local sectors. 

Treasury also provided technical comments that were incorporated as 

appropriate. Further, Treasury told us they had no comments on the esupplement.

As agreed with your office, unless you publicly announce the contents of 

this report earlier, we plan no further distribution until 7 days from the 

report date. At that time, we will send copies to the Secretary of the 

Treasury, the appropriate congressional committees, and other interested 

parties. In addition, the report will be available at no charge on the GAO 

website at http://www.gao.gov.

Should you or your staff have any questions about this report, please 

contact me at (202) 512-6806 or irvings@gao.gov. Contact points for our 

Offices of Congressional Relations and Public Affairs may be found on 

the last page of this report. GAO staff who made major contributions to 

this report are listed in appendix III.

Sincerely yours,

Susan J. Irving

Director for Federal Budget Analysis

Strategic Issues

Agency Comments 

and Our Evaluation
Appendix I: Simulations of Floating Rate Note 

Costs

Page 34 GAO-14-535 Debt Management

To estimate the potential cost of floating rate notes (FRN) to Treasury, we 

simulated the costs of 2-year FRNs based on Department of the Treasury 

(Treasury) auction data from January 1980 to March 2014 using two 

models, each with different assumptions about the spread over the index 

rate that Treasury would pay. We compared those costs to Treasury’s 

actual costs of funding with 13-week bills and 2-year notes. We also 

analyzed how those costs varied over different interest rate environments.

To estimate the range of potential costs from FRNs, we used two models 

of the costs of FRNs to Treasury:

1. A “maturity-based” model where the spread estimate is influenced by 

the 2-year term of the FRN.

In the maturity-based model, the FRN spread—the difference 

between the index rate and the interest rate on the FRN—split the 

difference between the 13-week bill and 2-year note yields on the date 

of the FRN auction:

SpreadFRN = 1

2 �Yield2y fixed − YieldIndex�

This model was suggested to us by a market participant as one way 

to estimate the likely spread for the Treasury FRN, and we found it to 

be reasonable.

2. A “reset-based” model where the spread estimate is derived from the 

weekly reset term, which determines the nature of most of the interest 

rate risk faced by investors in FRNs.

In the reset-based model, the FRN spread adjusted the yield of the 

FRN from the 13-week index rate to a yield equivalent to what a 1-

week bill would provide. We imputed a 1-week bill rate based on a 

straight-line extension of the 13-week bill and 26-week bill rates on 

the date of the FRN auction. Where possible, we used the Constant 

Maturity Treasuries (CMT) series issued by the Board of Governors of 

the Federal Reserve System, which calculates rates for 13- and 26-

week bills on a daily basis using secondary market data. However, the 

CMT series only begins in 1982, so for our simulations in 1980 and 

1981, we used the weekly Treasury auction data. Once we imputed 

the 1-week bill rate, we subtracted the current index rate to compute 

the predicted spread:

SpreadFRN = − 12

13 (Yield26w − Yield13w) + Yield13w − YieldIndex

Appendix I: Simulations of Floating Rate 

Note Costs

Estimating Spreads
Appendix I: Simulations of Floating Rate Note 

Costs

Page 35 GAO-14-535 Debt Management

This frequently results in a negative FRN spread, meaning that, under 

this model, the FRN generally has a yield lower than a 13-week bill. 

We allowed for negative spreads under this model because Treasury 

regulations allow the FRN to auction with a negative spread and, in 

very low interest rate environments, short term bills on the secondary 

market have sometimes traded with a negative yield.

While we considered other models for determining the cost of FRNs, 

these two models are designed to approximate the range of potential 

spreads Treasury’s 2-year FRN would be expected to have been 

auctioned at in historical interest rate environments. We also considered 

models based on:

• FRNs from government-sponsored enterprises (GSEs). Several 

market participants we spoke with indicated that FRNs issued by 

Fannie Mae and Freddie Mac would be the closest comparison for 

Treasury FRNs. However, we determined that GSE FRNs were not 

sufficiently comparable for our purposes due to the issuance practices 

and FRN structures used by Fannie Mae and Freddie Mac.

• Swap prices. Several market participants also suggested interest rate 

and asset swaps could be used to estimate spreads on Treasury 

FRNs. We reviewed results of simulations of FRN spreads published 

by one market participant, and found the estimates from this model 

usually to be within our own estimates for the FRN spread.

• Theoretically derived formula. We explored modifying the formulas 

used in Don Smith’s “Negative Duration: The Odd Case of GMAC’s 

Floating-Rate Note” to derive a theoretically correct spread price.1

This approach predicted FRN spreads comparatively very close to 

zero and which generally lie within the costs predicted by the maturityand reset-based models. This pricing model did not incorporate the 

pricing consequences of the mismatch between the reset rate and the 

maturity of the index, and so does not fully capture the pricing risks 

faced by the FRN.

 1

D. J. Smith, "Negative Duration: The Odd Case of GMAC’s Floating-Rate Note," Journal 

of Applied Finance, vol. 16, no. 2 (2006).
Appendix I: Simulations of Floating Rate Note 

Costs

Page 36 GAO-14-535 Debt Management

Because interest rate environments vary substantially over time, we 

compared the relative costs of the FRNs in various interest rate 

environments. The different environments, as used in our analysis and 

discussed in our report, are described below (see table 2).

Table 2: Definitions of Interest Rate Environments

Change in Rates Rising

Cases where the trend of the 13-week bill rate increases by 1 percentage point or more over 2 

years.

Steady Cases where the trend of the 13-week bill rate changes by less than ±1 percentage point over 2 

years.

Falling Cases where the trend of the 13-week bill rate decreases by 1 percentage point or more over 2 

years.

Trough Cases where the trend in interest rates initially falls, but then rises, over 2 years and where the 

trend in interest rates changes at least 0.5 percentage points in each direction.

Peak Cases where the trend in interest rates initially rises, but then falls, over 2 years and where the 

trend in interest rates changes at least 0.5 percentage points in each direction.

Volatility in Rates Low Cases where the root mean square error (RMSE) of 13-week bill rates in the sample is less than 

0.112.

Moderate Cases where the RMSE of 13-week bill rates in the sample is between 0.112 and 0.219.

High Cases where the RMSE of 13-week bill rates in the sample is between 0.235 and 0.500.

Extreme Cases where the RMSE of 13-week bill rates in the sample is above 0.521.

Source: GAO definitions using Treasury auction data.

To determine the trend of 13-week yields over a two year period, we 

estimated a linear time trend on the first difference of weekly yields 

(where t is an index of the number of weeks since the start of the twoyear window):

Yieldt+1 − Yieldt = α + β ∗ t

This is essentially equivalent to fitting a second degree polynomial to the 

yields, allowing us to capture changes in direction of the interest rate 

trend (i.e., peaks and troughs) as well as the slope of a linear trend. The 

estimated curves were used in classifying the interest rate environments.

The cut-offs for assigning an interest rate trend to a category of rising or 

falling—versus steady—were based on our professional judgment. Other 

approaches—such as using traditional statistical significance tests—

conflate volatility with assessment of the presence of a trend and 

therefore are not appropriate for this determination.

Defining Interest Rate 

Environments
Appendix I: Simulations of Floating Rate Note 

Costs

Page 37 GAO-14-535 Debt Management

We were able to use a data-derived approach to assign 2-year periods to 

our volatility categories. We use the RMSE statistic as an aggregate 

measure of the weekly yields’ total deviation from the trend. We then 

used a k-mean cluster analysis to divide the sample into four volatility 

groups: low, moderate, high, and extreme.

Using the maturity- and reset-based models, we estimated what the 

spread would be for FRNs auctioned on the same day as actual 2-year 

fixed-rate notes from January 1980 to March 2012, resulting in 387 

simulated FRNs. We then applied these estimated spreads to the actual 

weekly 13-week bill auctions from January 1980 to March 2014, and 

calculated what the total interest cost would have been for each simulated 

FRN during this period. Like the actual 2-year FRN, we used a floor of 

zero for the daily interest accrual of our simulated FRNs.

To determine the relative interest cost of the FRN, we compared the 

estimated costs of the simulated FRNs to the costs of the actual 2-year 

fixed-rate notes and a rolling series of 13-week bills for each 2-year 

period. We estimated the average interest costs relative to 2-year notes 

and 13-week bills as well as the percent of cases where FRNs generate 

savings or additional costs compared to bills or notes.

In addition to the results presented in the body of our report, we estimated 

the cost of 2-year FRNs by volatility of the rate environment. As shown in 

figures 14 and 15 below, we found that, at all levels of volatility, there was 

little variation between our two models. In periods of low, moderate, and 

high volatility, 2-year FRNs tended to produce savings compared to 2-

year fixed-rate notes, but could produce either costs or savings compared 

to 13-week bills depending on which model is used. In periods of extreme 

volatility, FRNs produced savings under both models.

Estimating Interest 

Costs

Results of 

Simulations of

FRN Costs by 

Volatility in Rates
Appendix I: Simulations of Floating Rate Note 

Costs

Page 38 GAO-14-535 Debt Management

Figure 14: Interest Savings or Added Costs from 2-year Floating Rate Notes Compared to 13-Week Bills and 2-Year Notes, by 

Volatility in Rates
Appendix I: Simulations of Floating Rate Note 

Costs

Page 39 GAO-14-535 Debt Management

Figure 15: Percent of Cases Where 2-Year Floating Rate Notes Save or Add to Interest Costs Compared to 13-Week Bills and 

2-Year Notes, by Volatility in Rates
Appendix II: Survey Scope and Methodology

Page 40 GAO-14-535 Debt Management

To address both of our objectives, we surveyed and interviewed market 

participants regarding (1) the market for FRNs, (2) the structure of FRNs, 

(3) other actions Treasury may consider to expand demand for Treasury 

securities, and (4) communication between Treasury and investors. To 

gather information from a broader range of investors, we administered an 

online survey to 82 of the largest domestic institutional holders of 

Treasury securities in the following sectors: money market mutual fund 

managers, mutual and exchange-traded fund managers, state and local 

government retirement fund managers, retail and commercial banks, life 

insurance providers, property-casualty insurance providers, and securities 

broker-dealers (see table 3). Results of the survey are not generalizable. 

For aggregate survey results reproduced as an e-supplement, see 

GAO-14-562SP.

Table 3: Survey Responses by Recipient Type

Sector

Total recipients

of survey

Total completed 

surveys

Response rate 

(percent)

Money market mutual fund managers 9 7 78

Mutual fund and exchange-traded fund managers 10 8 80

State and local government retirement fund managers 26 19 73 a

Retail and commercial banks 10 9 90

Life insurance providers 8 5 63 b

Property-casualty insurance providers 12 7 58

Securities broker-dealers 7 7 100

Total 82 62 76

Source: GAO analysis of survey results.

a

Three state-local government retirement funds refused to answer the survey; two specifically told us 

they fell outside the scope of our review.

b

One life insurance provider refused to answer the survey.

To identify sectors for our sample, we reviewed data from the Federal 

Reserve’s Financial Accounts of the United States, (table L.209, third 

quarter 2013) to identify which sectors have at least $60 billion in 

Treasury holdings. We excluded some sectors due to challenges in 

contacting certain entities, such as foreign monetary authorities, other 

foreign investors, and the household sector.

To identify the organizations within each sector that would receive our 

web-based survey, we used rankings of the largest organizations in each 

sector based on total assets or an equivalent financial indicator, such as 

Appendix II: Survey Scope and Methodology
Appendix II: Survey Scope and Methodology

Page 41 GAO-14-535 Debt Management

assets under management or direct premiums written. From these ranked 

lists, we determined Treasury holdings for each organization and selected 

as many organizations as needed to represent at least 50 percent of the 

total amount of Treasury holdings for that sector (based on table L.209 of 

the Federal Reserve’s Financial Accounts of the United States) or in the 

case of mutual funds, exchange traded funds, and money market funds, 

based on information from the Investment Company Institute on total 

assets under management in Treasury- and government-focused funds.
Appendix III: GAO Contacts and Staff 

Acknowledgments

Page 42 GAO-14-535 Debt Management

Susan J. Irving, (202) 512-6806 or irvings@gao.gov

In addition to the contact named above, Tara Carter (Assistant Director), 

Susan E. Murphy, (Analyst-in-Charge), Abigail Brown, Emily Gruenwald, 

Daniel Ramsey, and Albert Sim made key contributions to this report. 

Amy Bowser, Dianne Guensberg, Stuart Kaufman, Risto Laboski, Donna 

Miller, Dawn Simpson, and Stewart W. Small provided subject matter 

assistance.

Appendix III: GAO Contacts and Staff 

Acknowledgments

GAO Contact

Staff 

Acknowledgments

(451040)
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