Treasury Bill

Published Sep 8, 2024

Definition of Treasury Bill

A Treasury bill, often abbreviated as T-bill, is a short-term government debt security with a maturity of one year or less. It is issued by the U.S. Department of the Treasury to help finance the operations of the federal government. Treasury bills are sold at a discount from their face value, and the difference between the purchase price and the face value at maturity represents the interest income to the investor.

Example

To understand how Treasury bills work, imagine you decide to purchase a T-bill with a face value of $1,000. The U.S. Treasury auctions this bill and you manage to buy it at a discount price of $950. Upon maturity in one year, the Treasury redeems the bill at its face value of $1,000. The $50 difference between what you paid ($950) and what you receive at maturity ($1,000) is your interest income.

Since T-bills have short maturities, they are often considered one of the safest investments because they are backed by the full faith and credit of the U.S. government. Investors including individuals, financial institutions, and foreign governments frequently buy T-bills as part of their investment portfolio for their safety and liquidity.

Why Treasury Bills Matter

Treasury bills are important for several reasons:

• Safety: T-bills are backed by the full faith and credit of the U.S. government, making them virtually risk-free investments in terms of default risk.
• Liquidity: T-bills are highly liquid, which means they can be easily bought and sold in the secondary market without significantly affecting their price.
• Simplicity: T-bills are straightforward and easy to understand compared to other fixed-income securities with complex features.
• Investment Diversification: Including T-bills in an investment portfolio can help manage risk by balancing more volatile investment options.

Frequently Asked Questions (FAQ)

How do Treasury bills differ from Treasury bonds and Treasury notes?

Treasury bills, Treasury bonds, and Treasury notes are all types of U.S. government securities, but they differ primarily in their maturity periods:

• Treasury Bills (T-bills): These have the shortest maturities, ranging from a few days to one year, and are sold at a discount.
• Treasury Notes (T-notes): These have maturities ranging from two to ten years and pay interest every six months.
• Treasury Bonds (T-bonds): These are long-term securities with maturities of 20 to 30 years and also pay interest semiannually.

All three types of securities are considered safe investments, but they cater to different investment strategies based on the investor’s time horizon and income needs.

What are the tax implications of investing in Treasury bills?

Interest income earned from Treasury bills is exempt from state and local taxes, but it is subject to federal income tax. The interest income is recognized as the difference between the purchase price and the face value upon maturity. Investors will receive a Form 1099-INT from the U.S. Treasury, reporting the interest income for tax purposes.

Can individual investors purchase Treasury bills directly from the government?

Yes, individual investors can purchase Treasury bills directly from the U.S. government through the TreasuryDirect website. This platform allows investors to participate in the regular auctions conducted by the Treasury. Investors can also buy T-bills in the secondary market through brokers, banks, or other financial institutions.

How are the interest rates on Treasury bills determined?

The interest rates or yields on Treasury bills are determined through an auction process. During these auctions, investors submit bids that specify the discount rate they are willing to accept. The Treasury accepts the competitive and non-competitive bids starting with the lowest yield and moving up until they have issued the required amount of securities. The highest accepted yield is referred to as the “stop-out” rate. Investors who submit non-competitive bids agree to accept the yield determined by the auction.

Are Treasury bills suitable for all types of investors?

Treasury bills can be suitable for a wide range of investors, particularly those looking for low-risk, short-term investment options. They are ideal for conservative investors, retirees, or those who need to preserve capital while earning a small return. However, they may not be the best fit for investors seeking higher returns or those willing to assume more risk for potential higher rewards. Investors should consider their financial goals, risk tolerance, and investment horizon when deciding if T-bills are suitable for their portfolio.