I just want confirm that I am thinking about this correctly, or a slap to get me to think about it correctly.

Currently, I put my short term savings money (future car, home improvements, etc.) in Vanguard's Short-Term Treasury index. My thought on doing this is since it is short term money, I don't want to risk the principal too much, but I am okay with some risk.

Anyway, my thinking is that the risk that the price of the fund drops significantly is relatively minimal as the fund holds only short term obligations that are generally held to maturity (so they aren't selling a bunch at a loss when rates rise).

The High and Low of the fund since January 1, 2009 has a spread of $0.28 ($10.67 low and $10.95 high), which is approximately 2.5% had I bought on the high and sold on the low, and if that can be used as a rough indicator or my potential risk, then I am satisfied.

Is my think correct?

Your thinking is correct.

To quantify the risk though, that fund (VFISX) has a "duration" of 2.2 years. That means that if interest rates rise by 1% your principal value will decline by 2.2%. For every $1000 you have invested you will lose $22 if interest rates rise 1%. Given that it invests only in US government instruments your default risk is negligible.

I suspect that most of the price variation is related to dividend/interest accumulation in the fund and timing. In other words, if the fund is prices at $10.67 and pays a $0.20 dividend and drops to $10.47 on it's ex-dividend date you have not actually lost anything or seen a decline. It is also completely predictable. It's not a random variation in teh normal sense.

I never thought of that, but it appears to be pretty accurate. I checked the prices on dates around distributions and it seems to drop in accordance with the amount of the distribution.

One must be very careful to consider that when evaluating the "risk" of any fund. If you calculate the standard deviation based only on daily prices you will almost always get the wrong answer. You will calculate a higher risk than what it truly is. That's not so important in a stock fund but it is critical with any bond fund.