Treasury bills

What Is Treasury Bills?

Treasury bills, often referred to as T-bills, are short-term debt instruments issued by the U.S. Department of the Treasury. They represent a fundamental component of the broader money market, designed to help the U.S. government finance its operations and manage its public debt. Treasury bills are distinguished by their short maturities, typically ranging from a few days to 52 weeks. Unlike other bonds, T-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 when the bill matures. This characteristic makes them popular short-term investments for individuals and institutions seeking capital preservation and high liquidity.

History and Origin

The introduction of Treasury bills marked a significant evolution in U.S. government finance, addressing inefficiencies in earlier debt management practices. Before their inception, the U.S. Treasury relied on fixed-price subscription offerings of coupon-bearing certificates of indebtedness, which often led to underpricing and required borrowing in advance of needs. These challenges prompted the need for a more flexible and market-responsive financing instrument. On June 17, 1929, President Herbert Hoover signed legislation allowing the Treasury to begin offering these new securities. The first T-bill auctions were held shortly thereafter, with regular issues of 13-week bills commencing in December 1929²⁴, ²⁵. This shift allowed the Treasury to auction bills, resulting in pricing more consistent with market rates and enabling more effective cash management by selling bills when funds were needed and timing maturities to coincide with cash availability²³. Over the decades, the maturity offerings expanded, with 26-week and 1-year bills introduced in 1959, and various shorter maturities, such as 4-week and 8-week bills, added in the 21st century²². The shift from paper to book-entry form and the conversion of bidding to a bank discount yield basis further streamlined the process²¹.

Key Takeaways

• Treasury bills are short-term U.S. government debt obligations with maturities of one year or less.
• They are sold at a discount to their face value, with the investor's return being the difference between the purchase price and the face value received at maturity.
• Considered among the safest investments, Treasury bills are backed by the full faith and credit of the U.S. government, implying minimal default risk.
• T-bills play a crucial role in the Federal Reserve's implementation of monetary policy through open market operations.
• Their highly liquid nature allows for easy buying and selling in the secondary market before maturity.

Formula and Calculation

The return on a Treasury bill is typically expressed as a discount yield or bond equivalent yield. The discount yield, also known as the bank discount yield, is calculated using the following formula:

Where:

• Face Value: The value of the Treasury bill at maturity.
• Purchase Price: The price at which the investor buys the Treasury bill.
• Days to Maturity: The number of days remaining until the Treasury bill matures.

For example, if a 90-day Treasury bill with a face value of $10,000 is purchased for $9,900, the calculation would determine the yield on a discount basis.

Interpreting the Treasury bills

Treasury bills are typically interpreted through their yield, which reflects the return an investor can expect for holding the security until maturity. A lower yield on Treasury bills indicates a higher demand for these government securities, often driven by investors seeking safety or capital preservation. Conversely, a higher yield suggests either less demand or an expectation of rising interest rates in the broader economy. The yield on T-bills is often seen as a benchmark for short-term interest rates and can provide insights into market expectations for future economic conditions and monetary policy direction²⁰. For instance, a rise in T-bill yields can signal an anticipation of tighter monetary policy by the central bank.

Hypothetical Example

Imagine an investor, Sarah, is looking for a safe place to park $9,900 for three months. She decides to purchase a 91-day Treasury bill with a face value of $10,000. Sarah participates in the weekly auction where new T-bills are issued.

At the auction, her bid is accepted, and she pays $9,900 for the T-bill. For the next 91 days, her money is held by the U.S. Treasury. When the 91 days are up, the Treasury bill matures, and Sarah receives the full face value of $10,000. Her profit from this investment is $100 ($10,000 - $9,900). This simple example illustrates how the return is realized through the difference between the discounted purchase price and the full face value at maturity.

Practical Applications

Treasury bills serve several critical functions in the financial world. For individual investors, they are a primary choice for short-term cash management and as a component of a diversified portfolio due to their safety and liquidity. Corporations often use T-bills to manage their short-term cash surpluses, ensuring funds are secure and accessible.

More broadly, Treasury bills are indispensable to central banks, such as the Federal Reserve, in executing monetary policy. Through open market operations—the buying and selling of government securities like T-bills—central banks influence the money supply and short-term interest rates in the economy. Fo¹⁸, ¹⁹r instance, when the central bank buys T-bills from commercial banks, it injects money into the banking system, increasing liquidity and potentially lowering interest rates to stimulate economic activity. Co¹⁷nversely, selling T-bills withdraws money, reducing liquidity, and potentially raising rates to curb inflation. This mechanism allows central banks to manage economic stability and achieve goals like controlling inflation and promoting employment. Th¹⁶e International Monetary Fund (IMF) describes how central banks utilize monetary policy to stabilize prices and output, often using short-term government debt like Treasury bills as a key tool in these operations.

#¹⁵# Limitations and Criticisms
While Treasury bills are renowned for their safety, they are not entirely without limitations or criticisms. Often referred to as "risk-free" due to the near-zero default risk of the U.S. government, this term can be misleading as T-bills are subject to other financial risks.

O¹³, ¹⁴ne significant concern is inflation risk. If the rate of inflation exceeds the yield on a Treasury bill, the investor's real purchasing power diminishes, meaning their investment loses value in real terms over time. An¹¹, ¹²other key drawback is reinvestment risk. When a T-bill matures, the investor might face lower prevailing interest rates if they decide to reinvest the principal. Th¹⁰is can erode overall returns, particularly for investors with a longer investment horizon who repeatedly roll over short-term bills.

F⁹urthermore, while T-bills offer exceptional liquidity, their returns are typically lower compared to other investment vehicles such as corporate bonds or equities, reflecting the inverse relationship between risk and potential return. This can present an opportunity cost for investors who might forgo potentially higher returns from riskier assets. Th⁸e perceived safety of T-bills, while a major advantage, also limits their upside potential, making them less suitable for aggressive growth strategies.

Treasury bills vs. Treasury Notes

Treasury bills and Treasury Notes are both types of marketable government securities issued by the U.S. Department of the Treasury, but they differ primarily in their maturity periods and how interest is paid.