Treasury bill",

A Treasury bill (T-bill) is a short-term fixed-income securities instrument issued by the U.S. Department of the Treasury to finance the government's operations. These highly liquid debt obligations mature in one year or less from their issue date, typically ranging from four to 52 weeks. Unlike bonds, Treasury bills do not pay periodic interest payments; instead, they are sold at a discount rate to their face value, with the investor earning the difference between the purchase price and the face value received at maturity date.

History and Origin

The introduction of Treasury bills marked a significant evolution in U.S. government finance. Prior to their existence, the Treasury relied on fixed-price subscription offerings of coupon-bearing debt instruments. However, these methods had drawbacks, including underpricing of new securities and an infrequent issuance schedule that led to inefficient cash management. To address these issues, Treasury bills were introduced, with President Herbert Hoover signing the enabling legislation on June 17, 1929.²²

The first regular issues of 13-week bills began in December 1929.²¹ This new approach allowed the Treasury to auction the bills, leading to pricing more consistent with market rates, and enabled borrowing as needed rather than on a rigid quarterly basis, thereby improving federal cash management.²⁰ The use of T-bill auction became a regular practice in the early 1930s, especially as the government sought funding for relief and recovery programs during the Great Depression. Over the decades, the maturity terms expanded, with 26-week and one-year bills becoming regular issues by 1959.¹⁹

Key Takeaways

Treasury bills are short-term debt obligations of the U.S. government, maturing in one year or less.
They are zero-coupon bonds, meaning they are sold at a discount and mature at face value, with the gain representing the investor's return.
T-bills are considered among the safest investments due to the backing of the U.S. government.
Interest earned on Treasury bills is exempt from state and local income taxes but is subject to federal income tax.
They are highly liquid and can be easily bought and sold on the secondary market.

Formula and Calculation

The return on a Treasury bill is calculated based on its discount yield. This yield is the difference between the face value and the purchase price, annualized, and expressed as a percentage of the face value.

The formula for the discount yield ($Y_D$) of a Treasury bill is:

Y_D = \frac{\text{Face Value} - \text{Purchase Price}}{\text{Face Value}} \times \frac{360}{\text{Days to Maturity}}

Where:

Face Value: The par value of the Treasury bill, typically $100.
Purchase Price: The price at which the investor buys the Treasury bill, which is less than the face value.
Days to Maturity: The number of days remaining until the Treasury bill matures.

This formula expresses the yield as a discount rate, which is a common convention for short-term money market instruments.

Interpreting the Treasury Bill

Treasury bills are often interpreted as a benchmark for the short-term risk-free rate in the economy. Their yields are closely watched as indicators of short-term interest rates and serve as a foundation for pricing other financial instruments. The yield on a Treasury bill reflects market expectations for short-term rates over its life. For instance, a rising T-bill yield might suggest that the market anticipates higher interest rates in the near future. Conversely, falling T-bill yields could indicate expectations of lower rates or increased demand for safe-haven assets.

Because of their short maturities and minimal default risk, Treasury bills are favored by investors seeking capital preservation and liquidity. They are a common component of money market funds and are often used by corporations and financial institutions to manage short-term cash flows.

Hypothetical Example

Imagine an investor purchases a 26-week (182-day) Treasury bill with a face value of $1,000 for a purchase price of $985.

To calculate the discount yield:

Y_D = \frac{\$1,000 - \$985}{\$1,000} \times \frac{360}{182}

Y_D = \frac{\$15}{\$1,000} \times 1.978

Y_D = 0.015 \times 1.978

Y_D \approx 0.02967 \text{ or } 2.967\%

In this example, the discount yield on the Treasury bill is approximately 2.967%. When the bill matures in 182 days, the investor will receive the full face value of $1,000, having earned $15 on their $985 investment. This simple scenario highlights the direct relationship between the purchase discount and the return earned by holding the Treasury bill to its maturity date.

Practical Applications

Treasury bills play several critical roles in the financial system. They are a primary tool for the U.S. government to manage its short-term funding needs. Investors, from individuals to large institutions, use T-bills for various purposes:

Cash Management: Corporations and financial institutions often park excess cash in Treasury bills for short periods, seeking a safe and liquid temporary holding.
Safe-Haven Investment: During periods of economic uncertainty or market volatility, investors often flock to T-bills as a "safe haven" due due to their minimal default risk.¹⁸
Monetary Policy Implementation: The Federal Reserve utilizes the Treasury market, which includes T-bills, as a channel for conducting monetary policy. While the Fed does not buy new Treasury securities directly from the U.S. Treasury, its open market operations involving the purchase and sale of existing Treasury securities in the secondary market influence short-term interest rates and the overall money supply.¹⁷,
Benchmark for Short-Term Rates: The yields on Treasury bills serve as fundamental benchmarks for short-term borrowing costs across the economy, influencing rates on commercial paper, certificates of deposit, and other short-term debt instruments.

Individuals can purchase Treasury bills directly from the U.S. government through the TreasuryDirect website, or through banks and brokerage firms.¹⁶,¹⁵

Limitations and Criticisms

While Treasury bills are widely lauded for their safety and liquidity, they do come with certain limitations and criticisms:

Lower Returns: T-bills typically offer lower returns compared to other debt instruments like corporate bonds, equities, or even longer-term Treasury securities. This lower yield is the trade-off for their extremely low risk.¹⁴
Inflation Risk: Because their returns are generally modest, especially in comparison to potentially higher-yielding investments, the purchasing power of the returns from T-bills can be eroded by inflation, particularly during periods of rising prices.¹³ This makes them less suitable for long-term growth-oriented investment strategies.
No Periodic Income: For investors seeking regular income streams, the zero-coupon nature of Treasury bills, where the return is realized only at maturity, can be a drawback compared to coupon-paying bonds or notes.¹²
Interest Rate Risk (for early sale): While holding a T-bill to maturity guarantees the face value, if an investor needs to sell before the maturity date in the secondary market, the price received could be lower than the original purchase price if prevailing interest rates have risen.¹¹

Treasury Bill vs. Treasury Bond

The primary distinguishing factor between a Treasury bill and a Treasury bond lies in their maturity periods and how interest is paid.

Feature	Treasury Bill	Treasury Bond
Maturity	Short-term, up to one year (e.g., 4, 8, 13, 17, 26, 52 weeks)¹⁰	Long-term, 20 or 30 years
Interest Payment	Zero-coupon; sold at a discount, mature at face value (interest is the difference)⁹	Pays fixed interest every six months⁸
Denomination	Typically $100 denominations, often up to $5 million for non-competitive bids	Typically $100 denominations⁷
Purpose	Short-term cash management, highly liquid⁶	Long-term government financing, income generation

Confusion often arises because both are debt instruments issued by the U.S. Treasury and are backed by the full faith and credit of the U.S. government, implying very low default risk.⁵ However, their vastly different maturities and payment structures mean they serve distinct purposes within an investment portfolio and are subject to different degrees of interest rates sensitivity and yield curve influences.

FAQs

Q: What is the minimum investment for a Treasury bill?

A: Treasury bills are typically sold in denominations of $100.

Q: Are Treasury bills taxable?

A: Yes, the interest earned on Treasury bills is subject to federal income tax. However, it is exempt from state and local income taxes.⁴

Q: How do I buy Treasury bills?

A: You can purchase Treasury bills directly from the U.S. government through the TreasuryDirect website, which is the official platform for buying federal government securities without a fee. Alternatively, you can buy them through a bank or brokerage firm, though they may charge a fee for their services.,³ Purchases are made through a competitive or non-competitive auction process.

Q: What is the risk associated with Treasury bills?

A: Treasury bills are considered one of the safest investments available, backed by the "full faith and credit" of the U.S. government, meaning virtually zero default risk.²,¹ While they have minimal default risk, they are still subject to interest rates fluctuations if sold before maturity date and may offer lower returns that struggle to keep pace with inflation over time.