U.s. treasury bill

A U.S. Treasury Bill (T-bill) is a short-term debt obligation issued by the U.S. Department of the Treasury that matures in one year or less. These financial instruments are part of the broader category of Money Market instruments and are considered among the safest investments available globally due to being backed by the full faith and credit of the U.S. government. They are sold at a discount rate from their face value, and the investor's return comes from the difference between the purchase price and the face value received at the maturity date. Treasury Bills are a key component of the nation's fixed income market.

History and Origin

The U.S. Treasury's initial approach to managing its cash and debt in the 1920s involved fixed-price subscription offerings of various coupon-bearing securities. This system had several drawbacks, including the underpricing of new securities, the need to borrow in advance due to infrequent issuance, and potential volatility in overnight interest rates caused by short-term loans from Federal Reserve Banks to finance maturing issues. To address these issues and improve cash management, President Herbert Hoover signed legislation on June 17, 1929, authorizing the Treasury to begin offering Treasury Bills.²⁰

The first regular issues of 13-week Treasury Bills were introduced in December 1929.¹⁹ Instead of fixed prices, T-bills were, and continue to be, sold through an auction process, which allows for pricing more consistent with prevailing market rates.¹⁸ This innovation enabled the Treasury to borrow funds precisely when needed and to time maturities to coincide with anticipated cash availability, significantly enhancing governmental financial operations.¹⁷ Over the decades, new maturities like 4-week, 8-week, 17-week, and 52-week bills have been introduced to meet varying market demands.¹⁶,¹⁵

Key Takeaways

• U.S. Treasury Bills are short-term government debt securities with maturities of one year or less.
• They are sold at a discount to their face value, with the investment return being the difference received at maturity.
• T-bills are considered virtually free of default risk due to the backing of the U.S. government.
• They are a highly liquid investment, easily traded in the secondary market.
• T-bill interest income is subject to federal income tax but is exempt from state and local income taxes.

Formula and Calculation

The return on a U.S. Treasury Bill is typically quoted as a discount yield, which reflects the gain an investor receives relative to the face value, annualized based on the number of days in the year. The formula for calculating the discount yield (or bank discount yield) is:

Where:

• Face Value (FV): The value of the T-bill at maturity.
• Purchase Price (PP): The price paid for the T-bill at auction.
• Days to Maturity (DTM): The number of days remaining until the T-bill matures.
• 360: The number of days conventionally used in the money market year for discount yield calculations.

To calculate the equivalent investment yield (sometimes called bond equivalent yield or coupon equivalent yield), which allows for comparison with coupon-bearing instruments, a different formula is used:

This formula provides a more accurate annualized return, reflecting the actual capital invested.

Interpreting the U.S. Treasury Bill

The yield on a U.S. Treasury Bill is a critical indicator of short-term interest rates in the broader financial market. Because T-bills are considered to have virtually no default risk, their yields are often used as a proxy for the risk-free rate in financial models. A lower yield indicates higher demand for these safe assets, often during periods of economic uncertainty when investors prioritize capital preservation. Conversely, higher yields can suggest less demand for safe-haven assets or expectations of rising inflation or higher future interest rates.

The relationship between yields on different maturities of Treasury securities (bills, notes, and bonds) forms the yield curve. The shape of this curve provides insights into market expectations for future interest rates and economic growth. An inverted yield curve, where short-term T-bill yields are higher than longer-term Treasury yields, can sometimes signal an impending economic slowdown.¹⁴

Hypothetical Example

Suppose an investor purchases a 13-week U.S. Treasury Bill with a face value of $10,000 at an auction for a price of $9,900.

1. Calculate the Discount: The discount is the difference between the face value and the purchase price:
   $10,000 (Face Value) - $9,900 (Purchase Price) = $100

2. Calculate Days to Maturity: A 13-week T-bill has 13 weeks * 7 days/week = 91 days to maturity.

3. Calculate the Discount Yield:

   $$\text{Discount Yield} = \frac{\$100}{\$10,000} \times \frac{360}{91} = 0.01 \times 3.956 = 0.03956 \text{ or } 3.956\%$$

4. Calculate the Investment Yield (Bond Equivalent Yield):

   $$\text{Investment Yield} = \frac{\$100}{\$9,900} \times \frac{365}{91} = 0.0101 \times 4.011 = 0.04051 \text{ or } 4.051\%$$

At maturity, the investor would receive $10,000, earning a $100 return on their $9,900 investment over 91 days. This example illustrates how the discount rate translates into an actual return.

Practical Applications

U.S. Treasury Bills serve several vital roles in the financial system:

• Monetary Policy: The Federal Reserve uses open market operations, primarily involving the buying and selling of government securities like Treasury Bills, to influence the money supply and short-term interest rates.¹³,¹² When the Fed buys T-bills, it injects money into the banking system, increasing reserves and typically lowering interest rates.¹¹ Conversely, selling T-bills removes money from the system, raising rates. These operations are crucial for implementing monetary policy decisions made by the Federal Open Market Committee (FOMC).¹⁰
• Cash Management: Corporations, financial institutions, and even individuals use T-bills for short-term cash management due to their high liquidity and safety. They provide a secure place to hold excess cash while earning a modest return.
• Risk-Free Benchmark: T-bill yields are a fundamental benchmark for pricing other financial assets, particularly those with short maturities. They represent the theoretical "risk-free" rate against which riskier investments are measured.
• Diversification: While offering relatively low returns compared to other asset classes, T-bills can provide portfolio stability and act as a safe-haven asset, especially during periods of market volatility.

Limitations and Criticisms

Despite their reputation for safety, U.S. Treasury Bills do have certain limitations:

• Low Yield: In environments with low interest rates, the returns on T-bills can be very modest, sometimes barely keeping pace with or even falling below the rate of inflation.,⁹ This can lead to a negative real return, meaning the purchasing power of the investment diminishes over time.⁸
• Inflation Risk: As fixed-income securities, T-bills are susceptible to inflation risk. If unexpected inflation rises significantly during the holding period, the real return (adjusted for inflation) can be eroded. While T-bills are nominal securities, their returns can be critically assessed against real returns to understand their true purchasing power.⁷
• Opportunity Cost: Investing heavily in U.S. Treasury Bills, especially during periods of economic growth, might lead to an opportunity cost, as other asset classes like equities or longer-term bonds could offer higher potential returns.
• Debt Ceiling Debates: Although considered virtually free of default risk, political impasses over the U.S. debt ceiling can occasionally introduce uncertainty into the Treasury market, potentially causing short-term price fluctuations, even for T-bills.

U.S. Treasury Bill vs. U.S. Treasury Note

While both are government securities issued by the U.S. Treasury, the primary distinction between a U.S. Treasury Bill and a U.S. Treasury Note lies in their maturity periods and how interest is paid.

The key source of confusion often arises from both being debt instruments of the U.S. government. However, their differing maturities and interest payment structures dictate their use by investors and their sensitivity to changes in interest rates (with notes generally being more sensitive due to their longer duration).

FAQs

What is the minimum investment for a U.S. Treasury Bill?

The minimum purchase for a U.S. Treasury Bill is typically $100, and they are sold in increments of $100.⁶,⁵ This makes them accessible to a wide range of investors.

How do I buy U.S. Treasury Bills?

You can buy U.S. Treasury Bills directly from the U.S. Treasury through its TreasuryDirect website in the primary market auctions, or you can purchase them through banks or brokerage firms in both the primary and secondary market.⁴,³

Are U.S. Treasury Bills taxed?

Yes, the interest earned on U.S. Treasury Bills is subject to federal income tax. However, it is exempt from state and local income taxes.²,¹

Why are U.S. Treasury Bills considered risk-free?

U.S. Treasury Bills are considered virtually risk-free because they are backed by the full faith and credit of the U.S. government. This implies an extremely high probability that the government will honor its debt obligations. Therefore, the default risk associated with T-bills is considered negligible.