Treasury Bills (T-Bills) - Meaning, Examples, Calculations (2024)

Treasury Bills (T-Bills) Meaning

Treasury Bills (T-Bills) are investment vehicles that allow investors to lend money to the government. In return the investors get a steady interest income. The maturity period for a treasury bill is less than one year.

These short-term debt instruments are issued at a discounted price, but while redeeming, investors get at par value. This yields marginal interest to the holders. Treasury Bills are considered a safe investment as the sum collected is not invested in the stock market. The government uses these funds for welfare schemes, capital project financing, operating expenses, and other financial obligations.

• Treasury bills are a type of zero-coupon security where the central government borrows funds from the individual for a period of 364 days or less. In return, the investors receive interest.
• These money market instruments provide a return on investment at once, and there is no provision for periodic returns. Also, the income so generated is the difference between the at par value (redeemable price) and the discounted price of the T-Bill.
• The Treasury Department is responsible for issuing T-Bills in the US, and the Federal government guarantees repayment.
• The government imposes a federal income tax on the yields from the T-Bills.

How do Treasury Bills Work?

By buying treasury bills, the investors loan money to the US government. In exchange, they get a definedrate of returnknown as the yield. The maturity period is less than 364 days. Holders purchase government-backed securities with a maturity period below one year. The face value of a T-Bill is higher than its discounted value. Therefore, the face value becomes the at par rate or redemption value upon maturity. Also, the discounted price is the amount at which this security is offered for purchase.

The government utilizes the funds to finance its spending requirements. For example, the US Treasury's job is to raise money for government expenses and pay the nation's bills. While levying taxes is one of the ways to raise funds, another route is through the issue of T-Bills and other bonds in the open market. As for the investors, the government's backing makes T-Bills a relatively safer investment. This is unlike stocks that are highly prone to market fluctuations. Usually, the investment comes with low risks and low but steady gains.

T-Bills are for investors with a low risk appetite who prefer to invest funds for a short period. While the minimum purchase is just $100, up to $5 million non-competitive T-Bills can be purchased in a single auction. Competitive ones can be purchased up to 35% of the offering amount. According to US Treasury Department, the treasury bills rates on 3^rd September 2021 were as follows:

One of the most common ways of buying T-Bills in the US is through the online platform. "TreasuryDirect" is authorized by the US Treasury Department. The investors need to create an online "TreasuryDirect" account and initiate the electronic transaction via this account. In addition, many brokers and dealers offer primary T-Bills to the public. These debt instruments are available for reselling and purchasing through secondary market trading, banks, and other financial organizations.

Features of Treasury Bills

The features of T-Bills are as follows:

1. Debt Instruments: Treasury bills belong to the category of debt instrument. It is an obligation through which the issuing party can raise funds with a promise to repay a fixed amount to the lender on a specified date or as per the contract terms.
2. Short Term: T-Bills have a period of less than one year or a maximum of 52 weeks; therefore, these are considered to be short-term debt instruments.
3. Maturity Periods: Generally, these are introduced with a maturity period of 4, 8, 13, 26, and 52 weeks.
4. Safety: T bills are issued by the government of a country hence categorized as the safest debt instruments. It has the lowest possible risk.
5. Interest Rates: Although it doesn't pay regular interest but is issued at a discount and redeemed at its par value on maturity.
6. Returns: The investor will receive the excess amount of the maturity price (at par value) over its issuance price. With an extended period to maturity, the return rises.
7. Purchase: Fresh or primary issues by the government can be bought through online auctions (primary market purchase). While already issued T-Bills can be acquired from the existing holders via secondary market platforms.
8. Issuance: In the US, T bills are issued in denominations of $1000. However, a purchase can even reach a maximum of $5 million.
9. Taxation: Though the local and state governments don't levy any taxes on the interest earned on T-Bills, it is chargeable under the federal income tax.

Treasury Bills Example & Calculations

T-Bills don't pay regular interest but are issued at a discount (i.e., a reduced value) and redeemed at their par value on maturity. Thus, an investor can purchase T-Bills at a price below the actual face value, and the interest is reflected in the final amount received by the investor. In addition, due to shorter due dates, it becomes convenient to avoid remitting regular interest payments, and the discounted value serves as the final return to the investor.

For example, The US Federal Treasury Department issued 52week T-Bills at a discounted rate of $97 per bill at face value of $100. An investor purchases 10 T-Bills at a competitive bid price of $97 per bill and invests a total of $970.

After 52 weeks, the T bills matured. Upon maturity, the Federal Treasury paid a total amount of $1000 to the investor, i.e., $100 for every bill held. The investor did not receive any payment in the form of interest during this period of 52 weeks. However, the final yield or profit amounted to $30, computed as follows:

Advantages

Treasury bills are the most secure form of debt instruments as they hold the government's assurance of repayment. Even in periods of economic slowdown or instability, T-Bills assure the promised returns to the investors. As these securities mature within a year, it provides liquidity to the investors. Further, these investment products can be purchased in the primary and secondary markets, ensuring easy exchange.

Since T-Bills facilitate government borrowings to serve the short-term capital requirement of the nation, their benefits also extend to the citizens and the society indirectly. Moreover, in the US, T-Bills can be purchased for as low as $100, making it an affordable money market instrument. Retail investors and institutional investors can also buy these securities.

Disadvantages

The risk-free feature of the T-Bills comes at the cost of low returns; moreover, it doesn't provide a regular return, and the interest is received in the form of a margin above its discounted value.

The investors have to pay the Federal income tax over the interest earned on such securities. It even has an opportunity cost since the investors miss the chance of making a higher return from investing in the equity or stock market during the same period.

Frequently Asked Questions (FAQs)

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This has been a guide to Guide to what Treasury Bills (T-bills) are and their definition. Here we discuss their features, advantages, disadvantages, and examples. You can learn more about financing from the following articles –

• Bill of Sale
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• Treasury Bills vs. Bonds
• Non-Marketable Securities