Treasury bills",

What Is Treasury Bills?

Treasury bills, often referred to as T-bills, are short-term debt obligations issued by the U.S. government that mature in one year or less. They are a fundamental component of the fixed income market and are considered among the safest investments globally due to being backed by the full faith and credit of the U.S. government. Unlike coupon-bearing bonds, Treasury bills do not pay periodic interest rate payments; instead, they are sold at a discount rate to their face value and mature at par, with the investor's return being the difference between the purchase price and the face value received at the maturity date. This structure makes them a type of zero-coupon bond.²⁸

History and Origin

The U.S. Treasury began auctioning Treasury bills in 1929 to address inefficiencies in its debt management practices, replacing older fixed-price offerings of short-term securities. This shift allowed the Treasury to better manage its cash flow and align borrowing costs with prevailing market rates.²⁷ The introduction of regular T-bill auction processes marked a significant evolution in how the U.S. government financed its operations and managed its debt, especially as government funding needs increased during periods like the Great Depression and World War II.²⁶ Initially, regular issues of 13-week bills began in December 1929, with 26-week and 52-week bills becoming regular by 1959 and 1972, respectively.²⁴, ²⁵ These securities are primarily issued in the primary market through a competitive bidding process managed by the U.S. Department of the Treasury.

Key Takeaways

• Treasury bills are short-term U.S. government debt securities maturing in one year or less.
• They are sold at a discount to their face value, with the investor earning the difference between the purchase price and the face value upon maturity.²³
• Considered among the lowest-risk investments, they are backed by the full faith and credit of the U.S. government.²²
• T-bills are highly liquid and a key tool for short-term cash management for both investors and the U.S. government.²¹

Formula and Calculation

The yield on a Treasury bill is typically expressed as a discount yield or a bond-equivalent yield. The discount yield (often called the bank discount basis) is calculated as follows:

Where:

• Face Value is the par value of the Treasury bill, usually $1,000 or multiples thereof.
• Purchase Price is the price at which the investor bought the Treasury bill at auction or in the secondary market.
• Days to Maturity is the number of days remaining until the Treasury bill matures.

This formula expresses the return as an annualized percentage of the face value based on a 360-day year. To convert this to a bond-equivalent yield for comparison with other fixed-income instruments that use a 365-day year, a different calculation is used.

Interpreting Treasury Bills

Treasury bills are widely regarded as the closest approximation to a risk-free rate in financial markets due to the minimal default risk associated with the U.S. government. Their yields serve as a benchmark for short-term interest rates across various financial instruments.²⁰ The yield on a T-bill reflects current market expectations for short-term interest rates and the overall economic outlook. When T-bill yields are low, it often indicates market expectations of stable or declining interest rates, or a strong demand for safe assets. Conversely, higher yields suggest expectations of rising rates or lesser demand for safety. The relationship between T-bill yields and longer-term Treasury securities (like notes and bonds) helps shape the yield curve, which is a key indicator of economic health.

Hypothetical Example

Suppose an investor purchases a 26-week (182-day) Treasury bill with a face value of $10,000 at a discount rate auction. The auction results indicate a purchase price of $9,800.

To calculate the dollar return:
Dollar Return = Face Value - Purchase Price = $10,000 - $9,800 = $200

To calculate the approximate annualized discount yield:
( Discount,Yield = \frac{$10,000 - $9,800}{$10,000} \times \frac{360}{182} = \frac{$200}{$10,000} \times 1.978 \approx 0.02 \times 1.978 \approx 0.03956 )

So, the approximate annualized discount yield for this Treasury bill would be about 3.96%.

Practical Applications

Treasury bills are essential instruments in various financial applications:

• Cash Management: Investors, corporations, and financial institutions use T-bills to park excess cash for short periods, earning a return while maintaining high liquidity.¹⁹
• Monetary Policy: The Federal Reserve actively uses Treasury securities, including T-bills, in its open market operations to manage the money supply and influence short-term interest rates. By buying or selling these securities in the secondary market, the Fed can inject or withdraw reserves from the banking system, affecting economic activity.¹⁶, ¹⁷, ¹⁸
• Safe-Haven Investment: During times of economic uncertainty or market volatility, investors often flock to Treasury bills as a safe haven, preserving capital even if yields are low.
• Benchmark for Short-Term Rates: T-bill yields serve as a benchmark for other short-term interest rates in the economy, influencing the pricing of commercial paper, certificates of deposit, and other money market instruments.

The U.S. Department of the Treasury regularly issues new Treasury bills and provides auction results and data, offering transparency and enabling investors to track market conditions.¹⁵ The Securities and Exchange Commission (SEC) also provides educational resources for investors interested in U.S. Treasury securities.¹⁴

Limitations and Criticisms

While Treasury bills are highly regarded for their safety, they are not without limitations:

• Low Returns: Historically, T-bill yields are often lower compared to other investment classes, particularly during periods of low interest rates. This can make them less attractive for investors seeking higher capital appreciation or substantial income.
• Inflation Risk: The biggest criticism of Treasury bills stems from their susceptibility to inflation. If inflation rises unexpectedly during the holding period, the real return (adjusted for inflation) on a T-bill can be significantly eroded, potentially leading to a negative real return. This means the purchasing power of the money returned at maturity could be less than the original purchasing power of the investment.
• Opportunity Cost: Investing solely in Treasury bills might mean missing out on potentially higher returns available from other asset classes, such as stocks or longer-term bonds, particularly during economic expansions.
• Interest Rate Reinvestment Risk: For investors who regularly roll over T-bills, there's a risk that future auctions will offer lower interest rates, leading to diminished returns over time. While short-term interest rate fluctuations are inherent, their impact can be particularly noticeable for frequent investors. The Federal Reserve Bank of San Francisco (FRBSF) highlights the importance of managing interest rate risk within financial institutions, a concept that also applies to individual investors holding fixed-income instruments.¹¹, ¹², ¹³

Treasury Bills vs. Treasury Notes

Treasury bills and Treasury notes are both government securities issued by the U.S. Department of the Treasury, but they differ primarily in their maturity periods and how they pay interest.

The main point of confusion often arises from both being debt instruments issued by the U.S. Treasury. However, their distinct maturity profiles and interest payment structures make them suitable for different investor needs and market conditions. Treasury bills are favored for short-term liquidity management, while Treasury notes are preferred by investors seeking regular income over a medium-term horizon.

FAQs

Are Treasury bills taxable?

Yes, the income earned from Treasury bills is generally subject to federal income tax, but it is exempt from state and local income taxes.² This tax treatment makes them particularly attractive to investors in states with high income taxes.

How do you buy Treasury bills?

Investors can purchase Treasury bills directly from the U.S. Department of the Treasury through its TreasuryDirect website. Alternatively, they can buy T-bills through brokerage firms or banks, though these avenues may involve additional fees. Both competitive and non-competitive bids are accepted in the auction process.

What is the minimum investment for a Treasury bill?

The minimum investment for a Treasury bill is typically $100. They are often sold in increments of $100, making them accessible to a wide range of investors.

What happens when a Treasury bill matures?

When a Treasury bill reaches its maturity date, the investor receives the full face value of the bill. For example, if you bought a $1,000 face value T-bill, you would receive $1,000. If purchased through TreasuryDirect, the funds are automatically deposited into your linked bank account unless you choose to reinvest.

Are Treasury bills liquid?

Yes, Treasury bills are considered highly liquid investments.¹ Beyond purchasing them at auction, investors can sell them in the secondary market before their maturity date, often with minimal impact on price, due to the active trading environment for U.S. government securities.