What Are Treasury Bills (T-Bills) and How Do They Work?

What Is a Treasury Bill (T-Bill)?

A Treasury Bill (T-Bill) is a short-term U.S. government debt obligation backed by the Treasury Department with a maturity of one year or less. Treasury bills are usually sold in denominations of $1,000. However, some can reach a maximum denomination of $5 million in non-competitive bids. These securities are widely regarded as low-risk and secure investments.

The Treasury Department sells T-Bills during auctions using a competitive and non-competitive bidding process. Noncompetitive bids—also known as non-competitive tenders—have a price based on the average of all the competitive bids received. T-Bills tend to have a high tangible net worth.

Key Takeaways

  • A Treasury Bill (T-Bill) is a short-term debt obligation backed by the U.S. Treasury Department with a maturity of one year or less.
  • Treasury bills are usually sold in denominations of $1,000 while some can reach a maximum denomination of $5 million.
  • The longer the maturity date, the higher the interest rate that the T-Bill will pay to the investor.
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Treasury Bills

Understanding Treasury Bills (T-Bills)

The U.S. government issues T-bills to fund various public projects, such as the construction of schools and highways. When an investor purchases a T-Bill, the U.S. government is effectively writing an IOU to the investor. T-bills are considered a safe and conservative investment since the U.S. government backs them.

T-Bills are normally held until the maturity date. However, some holders may wish to cash out before maturity and realize the short-term interest gains by reselling the investment in the secondary market.

T-Bill Maturities

T-bills can have maturities of just a few days or up to a maximum of 52 weeks, but common maturities are four, eight, 13, 26, and 52 weeks. On average, the longer the maturity date, the higher the interest rate that the T-Bill will pay to the investor.

Need help differentiating between T-Bills, T-Notes, and T-Bonds? T-Bills are short-term, so you can use the mnemonic that the "bill needs to be paid soon".

T-Bill Redemptions and Interest Earned

T-bills are issued at a discount from the par value (also known as the face value) of the bill, meaning the purchase price is less than the face value of the bill. For example, a $1,000 bill might cost the investor $950 to buy the product.

When the bill matures, the investor is paid the face value—par value—of the bill they bought. If the face value amount is greater than the purchase price, the difference is the interest earned for the investor. T-bills do not pay regular interest payments as with a coupon bond, but a T-Bill does include interest, reflected in the amount it pays when it matures.

T-Bill Tax Considerations

The interest income from T-bills is exempt from state and local income taxes. However, the interest income is subject to federal income tax. Investors can access the research division of the TreasuryDirect website for more tax information.

Purchasing T-Bills

There are two ways to buy T-bills. You can buy them directly from the government, or on the secondary market through a broker.

Buying T-Bills from TreasuryDirect

New issues of T-Bills can be purchased at auctions held by the government on the TreasuryDirect site. These are priced through a bidding process, with bidders ranging from individual investors to hedge funds, banks, and primary dealers. These purchasers may then sell the bills to other customers in the secondary market.

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. Noncompetitive bids auctions allow investors to submit a bid to purchase a set dollar amount of bills. The yield investors receive is based upon the average auction price from all bidders.

Buying T-Bills on the Secondary Market

You can also buy Treasury bills through a bank or a licensed broker. Once completed, the purchase of the T-Bill serves as a statement from the government that says you are owed the money you invested, according to the terms of the bid.

Treasury Bonds vs. Treasury Notes vs. Treasury Bills

Treasury bills are one of several types of debt issued by the U.S. Department of the Treasury. In addition to T-bills, there are also Treasury bonds and Treasury notes, each referring to different debt products. All three represent fixed-term debt over a period of time.

The main difference between these types of debt is the time to maturity. Treasury bills represent short-term obligations that mature anywhere between a few days to 52 weeks. Treasury notes are medium-term securities that take between two and 10 years to mature. Treasury bonds have the longest lifetime and mature in 30 years.

Advantages and Disadvantages of T-Bills

Treasury Bills are one of the safest investments available to the investor. But this safety can come at a cost. T-bills pay a fixed rate of interest, which can provide a stable income. However, if interest rates are rising, existing T-bills fall out of favor since their rates are less attractive compared to the overall market. As a result, T-bills have interest rate risk meaning there is a risk that existing bondholders might lose out on higher rates in the future.

Although T-bills have zero default risk, their returns are typically lower than corporate bonds and some certificates of deposit. Since Treasury bills don't pay periodic interest payments, they're sold at a discounted price to the face value of the bond. The gain is realized when the bond matures, which is the difference between the purchase price and the face value.

However, if they're sold early, there could be a gain or loss depending on where bond prices are trading at the time of the sale. In other words, if sold early, the sale price of the T-bill could be lower than the original purchase price.

Pros and Cons of T-Bills

Pros
  • Zero default risk since T-bills have a U.S. government guarantee.

  • T-bills offer a low minimum investment requirement of $100.

  • Interest income is exempt from state and local income taxes but subject to federal income taxes.

  • Investors can buy and sell T-bills with ease in the secondary bond market.

Cons
  • T-Bills offer low returns compared with other debt instruments as well as when compared to certificates of deposits (CDs).

  • The T-Bill pays no coupon—interest payments—leading up to its maturity.

  • T-bills can inhibit cash flow for investors who require steady income.

  • T-bills have interest rate risk, so, their rate could become less attractive in a rising-rate environment.

What Influences T-Bill Prices?

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

Maturity Dates

T-Bills with longer maturity dates tend to have higher returns than those with shorter maturities. In other words, short-term T-bills are discounted less than longer-dated T-bills. Longer-dated maturities pay higher returns than short-dated bills because there's more risk priced into the instruments meaning there's a greater chance that interest rates could rise. Rising market interest rates make the fixed-rate T-bills less attractive.

Market Risk

Investors' risk tolerance affects prices. T-Bill prices tend to drop when other investments such as equities appear less risky, and the U.S. economy is in an expansion. Conversely, during recessions, investors tend to invest in T-Bills as a safe place for their money spiking the demand for these safe products.

The Federal Reserve

The monetary policy set by the Federal Reserve through the federal funds rate has a strong impact on T-Bill prices as well. The federal funds rate refers to the interest rate that banks charge other banks for lending them money from their reserve balances on an overnight basis. The Fed will increase or decrease the fed funds rate in an effort to contract or expand the monetary policy and the availability of money in the economy. A lower rate allows banks to have more money to lend while a higher fed funds rate decreases money in the system for banks to lend.

As a result, the Fed's actions impact short-term rates including those for T-bill. A rising federal funds rate tends to draw money away from Treasuries and into higher-yielding investments. Since the T-bill rate is fixed, investors tend to sell T-bills when the Fed is hiking rates because the T-bill rates are less attractive. Conversely, if the Fed is cutting interest rates, money flows into existing T-bills driving up prices as investors buy up the higher-yielding T-bills.

The Federal Reserve is also one of the largest purchasers of government debt securities. When the Federal Reserve purchases U.S. government bonds, bond prices rise while the money supply increases throughout the economy as sellers receive funds to spend or invest. Funds deposited into banks are used by financial institutions to lend to companies and individuals, boosting economic activity.

T-Bill prices tend to rise when the Fed performs expansionary monetary policy by buying Treasuries. Conversely, T-bill prices fall when the Fed sells its debt securities.

Inflation

Treasuries also have to compete with inflation, which measures the pace of rising prices in the economy. Even if T-Bills are the most liquid and safest debt security in the market, fewer investors tend to buy them in times when the inflation rate is higher than the T-bill return.

For example, if an investor bought a T-Bill with a 2% yield while inflation was at 3%, the investor would have a net loss on the investment when measured in real terms. As a result, T-bill prices tend to fall during inflationary periods as investors sell them and opt for higher-yielding investments.

Example of a Treasury Bill Purchase

As an example, let's say an investor purchases a par value of $1,000 T-Bill with a competitive bid of $950. When the T-Bill matures, the investor is paid $1,000, thereby earning $50 in interest on the investment. The investor is guaranteed to at least recoup the purchase price, but since the U.S. Treasury backs T-bills, the interest amount should be earned as well.

As stated earlier, the Treasury Department auctions new T-bills throughout the year. On March 28, 2019, the Treasury issued a 52-week T-bill at a discounted price of $97.613778 to a $100 face value. In other words, it would cost approximately $970 for a $1,000 T-bill.

What Are the Maturity Terms for Treasury Bills?

U.S. Treasury bills are short-term government bonds and are issued with five terms. These consist of four, eight, 13, 26, and 52 weeks.

What Kind of Interest Payments Will I Receive If I Own a Treasury Bill?

The only interest paid will be when the bill matures. At that time, you are given the full face value. T-bills are zero-coupon bonds that are usually sold at a discount and the difference between the purchase price and the par amount is your accrued interest.

How Can I Buy a Treasury Bill?

U.S. Treasury bills are auctioned on a regular schedule. Individuals can buy T-bills from the government using the TreasuryDirect website. It is free to register, and it will function like a brokerage account that holds your bonds. In addition to bidding on new issues, You also can set up reinvestments into securities of the same type and term. For instance, you can use the proceeds from a maturing 52-week bill to buy another 52-week bill. Certain brokerage firms may also allow trading in U.S. Treasuries.

Where Is My Paper Hard Copy of the T-Bill I Bought?

T-bills and other government bonds are no longer issued on paper and are only available in digital form through TreasuryDirect or your broker.

How Are T-Bills Different From Treasury Notes and Bonds?

T-bills are short-term government debt instruments with maturities of one year or less, and they are sold at a discount without paying a coupon. T-Notes represent the medium-term maturities of 2, 3, 5, 7, and 10 years. These are issued at par ($100) and pay semi-annual interest. T-Bonds are otherwise identical to T-notes but have maturities of 30 years (or longer in some cases).

The Bottom Line

Treasury Bills, or T-Bills, represent short-term debt obligations by the Treasury. Because they are backed by the U.S. government, they are considered extremely low-risk, although they also have relatively low returns.

Article Sources
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  1. TreasuryDirect. "Treasury Bills: Rates & Terms."

  2. TreasuryDirect. "Treasury Bills: FAQs."

  3. TreasuryDirect. "Treasury Bills in Depth."

  4. TreasuryDirect. "Treasury Bills."

  5. TreasuryDirect. "How Treasury Auctions Work."

  6. TreasuryDirect. "Auctions."

  7. Federal Reserve Bank of San Francisco. "What Is the Fed: Monetary Policy."

  8. Federal Reserve Bank of San Francisco. "What Makes Treasury Bill Rates Rise and Fall? What Effect Does the Economy Have on T-Bill Rates?"

  9. TreasuryDirect. "Auction Query."

  10. TreasuryDirect. "Treasury Securities & Programs."

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