Treasury Bills

Definition

Treasury bills, commonly known as T-bills, are short-term government securities issued by the U.S. Department of the Treasury to finance national debt. They are sold at a discount to their face value and do not pay interest; instead, the return on investment is the difference between the purchase price and the amount paid at maturity. T-bills are considered a benchmark for the risk-free rate because they are backed by the full faith and credit of the U.S. government.

5 Must Know Facts For Your Next Test

1. Treasury bills are issued with maturities of 4, 8, 13, 26, and 52 weeks, making them one of the shortest-term debt instruments available.
2. Investors do not receive periodic interest payments from T-bills; instead, they buy them at a lower price and receive their full face value at maturity.
3. The yield on Treasury bills is often used as a proxy for the risk-free rate in financial models and investment analyses.
4. Because T-bills are backed by the U.S. government, they are considered virtually free of credit risk, making them attractive to conservative investors.
5. T-bills can be purchased directly from the government through auctions or indirectly through banks and brokers.

Review Questions

• How do Treasury bills contribute to determining the risk-free rate in financial models?
  • Treasury bills are viewed as the benchmark for the risk-free rate because they carry minimal risk due to being backed by the U.S. government. Investors use the yield on T-bills to gauge the baseline return expected from any investment, as it reflects what one could earn without taking on significant risk. This makes T-bills a critical component in calculating required rates of return for various investment opportunities.
• Evaluate how T-bills' unique features influence their attractiveness to different types of investors.
  • T-bills appeal primarily to conservative investors seeking safe and liquid investments due to their short maturities and low credit risk. They do not provide periodic interest payments but rather offer returns through their discount pricing mechanism. This simplicity and reliability make them an ideal choice for risk-averse individuals or institutions looking to preserve capital while earning a modest return.
• Analyze how changes in economic conditions might affect Treasury bill yields and their role in financial markets.
  • Economic conditions such as inflation rates, monetary policy changes by the Federal Reserve, or shifts in investor sentiment can significantly impact Treasury bill yields. In times of economic uncertainty or market volatility, demand for T-bills typically increases, driving their prices up and yields down as investors flock to safer assets. Conversely, in a strong economic environment with rising interest rates, yields may increase as investors seek better returns elsewhere. These fluctuations affect how T-bills are perceived as a risk-free benchmark and influence broader investment strategies in financial markets.

Related terms

Risk-free Rate: The theoretical return on an investment with zero risk, often represented by the yield on Treasury bills, reflecting the minimum return investors expect for any investment.

Discount Rate:

The difference between the face value of a Treasury bill and its purchase price, which determines the investor's return upon maturity.

Maturity: The date on which a financial instrument, such as a Treasury bill, becomes due and the issuer is obligated to pay back the principal amount to the investor.