All About Treasury Bills

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 on noncompetitive bids. Known as noncompetitive tenders, noncompetitive bids have a price based on the average of all competitive bids received.

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 investment since the U.S. government backs them.

T-Bill Maturities

T-bills can have maturities of just a few days up to the maximum of 52 weeks, but common maturities are 4, 8, 13, 26, and 52 weeks. The longer the maturity date, the higher the interest rate that the T-Bill will pay to the investor.

T-Bill Redemptions and Interest Earned

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

Previously issued T-bills can be bought on the secondary market through a broker. New issues of T-Bills can be purchased at auctions held by the government on the TreasuryDirect site. T-bills purchased at auctions are priced through a bidding process. Bids are referred to as "competitive" or "noncompetitive."

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.

Competitive bids are made through a local bank or a licensed broker. Individual investors can make noncompetitive bids via the TreasuryDirect website. 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. T-Bills are issued by lending institutions or brokers and are held until the maturity date. The T-bill can be held to maturity or cashed out before maturity if the investor wants to realize the short-term interest gains.

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. Since T-bills are backed by the full faith and credit of the U.S. government, they're seen as the closest thing to a risk-free return in the market.

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 increase or decrease the fed funds rate in an effort to contract or expand monetary policy. 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 T-bill rates. A rising federal funds rate tends to draw money away from Treasuries and into higher-yielding investments. Since T-bill rates 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.

In short, 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 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.

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, the sale price of the T-bill could be lower than the original purchase price.

As an example, let's say an investor purchases a par value $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.