Bills

What Are Bills?

Bills, most commonly referring to Treasury Bills (T-Bills), are short-term debt instruments issued by governments. They are a core component of the money market, representing a foundational category within fixed income securities. Unlike traditional bonds, Bills do not pay periodic interest payments. Instead, they are sold at a discount rate to their face value, and the investor earns the difference when the Bill reaches its maturity date. Bills are considered among the safest investments due to the backing of the issuing government.

History and Origin

The concept of short-term government debt has existed for centuries, but modern Treasury Bills, particularly in the United States, gained prominence in the 20th century. The U.S. Treasury Department officially introduced Treasury Bills as a regular financing tool in 1929. This shift was largely in response to the need for a more efficient and flexible way to manage government borrowing, especially during periods of high fiscal demands like the Great Depression. The first auction of U.S. Treasury Bills took place on December 10, 1929, marking a significant evolution from the previous fixed-price subscription system to a market-driven auction process. This change allowed market forces to determine the actual price and yield, making the debt issuance more responsive to prevailing interest rates and investor demand.

Key Takeaways

• Bills, particularly Treasury Bills, are short-term government debt obligations maturing in one year or less.
• They are sold at a discount to their face value, with the return being the difference between the purchase price and the face value received at maturity.
• Bills are considered highly liquid and nearly risk-free investments due to government backing.
• They serve as a crucial tool for governments to manage short-term cash flow and for central banks to implement monetary policy.
• While offering safety, Bills typically provide lower returns compared to longer-term or higher-risk investments.

Formula and Calculation

The yield on a Bill is typically quoted as a "discount yield" or "bond equivalent yield." The discount yield is calculated as follows:

Where:

• Face Value = The value of the Bill at maturity.
• Purchase Price = The price at which the Bill was bought (at a discount).
• Days to Maturity = The number of days remaining until the Bill matures.

For example, a Bill with a face value of $1,000 purchased for $980 with 90 days to maturity date would have a discount yield of:

It is often more helpful for investors to convert the discount yield to a "bond equivalent yield" to compare it with other investment opportunities that quote annual percentage yields.

Interpreting the Bills

The yield of a Bill reflects the market's assessment of short-term interest rates and the perceived risk-free rate for the issuing government. A higher yield indicates that investors are demanding more compensation for lending their money for a short period, possibly due to expectations of rising interest rates or higher inflation. Conversely, a lower yield suggests less demand for compensation, often in an environment of low interest rates or economic uncertainty where capital preservation is prioritized. Bills are often seen as a benchmark for short-term borrowing costs and a key indicator within the yield curve.

Hypothetical Example

Consider an investor who wishes to temporarily store $10,000 for three months. Instead of leaving the money in a checking account, they decide to purchase a 13-week (approximately 91-day) Treasury Bill.

Assume the Bill has a face value of $10,000 and is sold at a discounted price of $9,900.

1. Purchase: The investor pays $9,900 today for the Bill.
2. Holding Period: The investor holds the Bill for 13 weeks (91 days).
3. Maturity: At the end of 91 days, the Bill matures, and the investor receives its full face value of $10,000.

The profit from this investment is $10,000 (face value) - $9,900 (purchase price) = $100. This $100 represents the interest earned over the 91-day period. This simple example highlights the Bills' role in short-term cash management and capital preservation.

Practical Applications

Bills serve multiple critical functions in the financial system. For individuals and corporations, they offer a highly liquid and secure place to park short-term cash, often used for managing working capital or as a safe haven during market volatility. Their high liquidity means they can be easily bought and sold in the secondary market before maturity.

Governments utilize Bills as a flexible instrument for short-term financing needs, such as bridging gaps between tax receipts and expenditures. Central banks, like the Federal Reserve, extensively use the buying and selling of Treasury securities, including Bills, as a primary tool for conducting open market operations.⁴ By purchasing Bills, the central bank injects money into the financial system, increasing bank reserves and putting downward pressure on interest rates. Conversely, selling Bills removes money, tightening credit conditions and raising interest rates. This mechanism allows central banks to influence the overall money supply and credit conditions in the economy, impacting everything from consumer lending rates to investment in capital markets.

Limitations and Criticisms

While Bills are lauded for their safety and liquidity, they come with certain limitations. A primary criticism is their relatively low rate of return compared to other investment vehicles such as corporate bonds or equities. This lower yield means that in periods of high inflation, the real return (adjusted for inflation) on Bills can be minimal or even negative, eroding the purchasing power of the invested capital over time.³

Another drawback is the opportunity cost of holding Bills, particularly when other assets like stocks or longer-term bonds are experiencing significant gains.² Investors who allocate heavily to Bills might miss out on potentially higher returns elsewhere in the market, although this trade-off is often accepted for the sake of capital preservation and reduced risk. Additionally, while the default risk of government-issued Bills is minimal, sustained reliance on short-term Bill auctions by a government can expose it to risks if market appetite diminishes, potentially leading to higher financing costs.¹ Investors should also note that Bills do not provide regular cash flow, as the entire return is received at maturity.

Bills vs. Bonds

The terms "Bills" and "Bonds" are often confused, but they primarily differ in their maturity periods and interest payment structures.

The fundamental distinction lies in their investment horizon and the way they provide returns. Bills are ideal for very short-term financial needs and managing liquidity, whereas notes and bonds are suited for longer-term investment strategies focused on income or capital appreciation over extended periods.

FAQs

Q: Are Bills a good investment for everyone?
A: Bills are excellent for investors seeking safety and liquidity for their short-term cash. However, due to their typically lower returns, they may not be suitable for long-term growth objectives or for investors with a higher tolerance for risk seeking greater returns.

Q: Do I pay taxes on the interest from Bills?
A: In the United States, the interest earned on Treasury Bills is exempt from state and local income taxes but is subject to federal income tax. This tax treatment can make them more attractive than other short-term investments for residents of high-tax states.

Q: Where can I buy Bills?
A: Individual investors can buy new issue Treasury Bills directly from the U.S. Treasury through its TreasuryDirect website. They can also be purchased through banks, brokers, or financial institutions, often with a small fee, and traded on the secondary market.

Q: What is the minimum investment for a Treasury Bill?
A: In the U.S., Treasury Bills are typically sold in denominations of $100. This low minimum investment makes them accessible to a wide range of investors.

Q: Can I lose money investing in Bills?
A: While the default risk of government Bills is virtually zero, you could incur a loss if you sell a Bill in the secondary market before its maturity date and prevailing interest rates have risen significantly since your purchase, causing the price to fall below your original purchase price. However, if held to maturity, you are guaranteed to receive the face value.