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What is a 'Treasury Bill - T-Bill'

A Treasury bill (T-Bill) is a short-term debt obligation backed by the Treasury Dept. of the U.S. government with a maturity of less than one year, sold in denominations of $1,000 up to a maximum purchase of $5 million. T-bills have various maturities and are issued at a discount from par.

When an investor purchases a T-Bill, the U.S. government effectively writes investors an IOU; they do not receive regular interest payments as with a coupon bond, but a T-Bill does include interest, reflected in the amount it pays when it matures.

BREAKING DOWN 'Treasury Bill - T-Bill'

The U.S. government uses the funds raised from selling Treasury bills (T-Bills) to fund various public projects, such as the construction of schools and highways. T-Bills can have maturities of just a few days up to the maximum of 52 weeks, but common maturities are one month, three months or six months. The longer the maturity date, the higher the interest rate that the T-Bill will pay to the investor.

Purchase Process

The pricing of T-Bills is unique among government debt issues; rather than providing interest payments like Treasury Bonds or Notes do, T-Bills are sold at a discount and the entire return is realized upon maturity. The interest rate earned on T-Bills is equal to the difference between the purchase price and maturity value, divided by the maturity value.

New issues of T-Bills can be purchased at auctions held by the government; previously issued ones can be bought on the secondary market.

T-Bills purchased at auctions are priced through a bidding process. Bids are referred to as "competitive" or "non-competitive." A competitive bid sets a price at a discount from the T-Bill's par value, letting you specify the yield you wish to get from the T-Bill. Non-competitive bid auctions allow investors to submit a bid to purchase a set dollar amount of the Bills. The yield they receive is based upon the average auction price from all bidders.

Example of Treasury Bill Purchase

For example, an investor purchases a par value $1,000 T-Bill with a competitive bid of $950. When this T-Bill matures, the investor is paid $1,000, thereby making $50 on the investment. The investor is guaranteed to at least recoup his purchase price, but – given the backing by the Treasury – invariably he recoups the interest too.

Competitive bids are made through your local bank or a licensed broker. Non-competitive bids can be done by individual investors via the Treasury Direct site. Once completed, the purchase of the T-Bill serves as a statement from the government that states you are owed the money you invest, according to the bid terms. T-Bills are issued by your lending institution or broker and are held until the maturity date when the money can be bid again for more T-Bills or simply cashed out with the short-term interest gains.

What Influences T-Bill Prices?

T-Bill prices fluctuate in a similar fashion to other debt securities. Many factors can influence T-Bill prices, including macroeconomic conditions, monetary policy and the overall supply and demand for Treasuries.

Longer T-Bills tend to have higher returns than shorter issues (something that is generally true of all debt securities and helps explain the shape of a normal yield curve). The reason for this is that the longer money is held in a security, the more delayed its use becomes and the more risk gets priced into the instrument. Generally speaking, a six-month T-Bill is priced lower than a three-month T-Bill.

Investors' risk tolerance affects prices. T-Bill prices tend to drop when other investments seem less risky and the U.S. economy is in expansion. During recessions, in contrast, investors may decide that T-Bills are the safest place for their money, and demand could spike. T-bills are seen as extremely secure, as they are backed by the full faith and credit of the U.S. government. This makes them the closest thing to a risk-free return in the market, unless they are resold on the secondary market, in which case they become exposed to market risk. Yield curves can even become inverted during times of real uncertainty.

The monetary policy set by the Federal Reserve has a strong impact on T-Bill prices as well. T-bills compete with other short-term returns, including the federal funds rate. According to economic theory, interest rates tend to change across the market and move closer to each other, which is exactly what happens with T-Bills and interest rates set by the Fed. A rising federal funds rate tends to draw money away from Treasuries, causing the price to drop. The drop in prices tends to continue until the return on T-Bills is no longer lower than the federal funds rate.

The Federal Reserve is often one of the largest purchasers of government debt securities. T-Bill prices tend to rise when the Fed performs expansionary monetary policy by buying Treasuries. The opposite is also true when the Fed sells its securities.

Treasuries also have to compete with inflation. Even if T-Bills are the most liquid and safest debt security in the market, fewer people want to invest in them if the rate of inflation is higher than the return they offer. If someone purchases a T-Bill when it is yielding 2% and inflation is at 3%, then the investment actually loses money in real terms. Thus, prices tend to drop during inflationary periods.

T-Bill Investment Pros and Cons

T-Bills carry a primary advantage over other types of investments: safety. We've said it before and we'll say it again: All T-Bills are fully guaranteed by the faith and credit of the U.S. government and the Department of the Treasury. They carry almost zero default risk. Even in times of great financial stress, the government has the power to tax and the power to print money to fund its debts.

In short, T-Bills offer a very low-risk way to earn a guaranteed return. But they offer other advantages as well:

  • With a minimum investment requirement of just $1,000, they are accessible by a wide range of investors.
  • Their interest income is exempt from state and local income taxes. (It is, however, subject to federal income taxes, and some components of the return may be taxable at sale/maturity.)
  • They are highly liquid. Investors can keep funds in these treasuries if they believe that they may have some need of cash within the next year. Treasuries are also very easy to buy and sell, and they tend to carry lower spreads than other securities on the secondary market.
  • They do not have any call provisions. In times of declining interest rates, when municipal or corporate bonds are often being called in by their issuers, T-Bill investors have the peace of mind of knowing exactly how long they can hold their securities.

On the down side:

  • Because they are generally considered one of the safest short-term investments, T-Bills offer relatively low returns compared to other debt instruments. In fact, rates on T-Bills can be less than most money market funds or certificates of deposit (CDs). Remember the finance world mantra: less risk, less reward.
  • The returns from T-Bills are only realized when they mature, making them a somewhat less attractive income vehicle – especially for investors seeking a steady cash flow.
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