A T-bill or Treasury Bill has a maturity of less than one year and is issued by U. S. Department of the Treasury.
Characteristics of T-bills are as follows:
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They are issued by auction in units with a face value of $1,000.
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They are redeemed for $1,000. The Treasury pays $1,000 per unit at the maturity date of the T-bill.
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The Treasury bills bear no interest. Instead, they are sold in an issue at a discount, which means that each unit with a face value of $1,000 is sold for less than $1,000. In effect, the interest rate is included in the discount on purchases of T-bills.
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Treasury bills are liquid securities, meaning that they are actively traded in markets like many other securities. Their market prices are below $1,000, since there would be no reason to buy them if there were no discount. This discount is the only way investors profit from holding T-bills.
Example:
A person buying one unit for $800 at the beginning of the year who receives $1,000 on the maturity date at the end of the year earns $200 on their $800 investment, i.e., 25%. This profit is called the annualized yield of the T-bill (comparable to interest).
The size of the discount on the issue date, which is determined by supply and demand, is affected by the interest that an investor can earn on their money elsewhere (from a banks savings plan, for example).
In general, the higher the interest rate in the economy, then the larger the discount will be. An investor who buys a T-bill on the stock exchange and holds it until the maturity date earns the difference between the purchase price and $1,000 (the sum that is received on the maturity date).
Every day, the stock exchange and various financial websites publish the annualized yield of every T-bill. If a given T-bill is due to mature in six months, and the financial website reports that its annualized yield is 18%, then the owner of the T-bill will earn only 9% at the maturity date.
The U.S. Treasury Department issues T-bills every week for periods of one year, 6 months and 3 months. T-bills are therefore traded between individual investors for maturity periods ranging from less than one week to one year.
The Price List on “The Wall Street Journal” Website
Click here for an example of T-bills as the listing that appears on “The Wall Street Journal” website in order to understand this concept better.
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Column 1 states the most recent maturity date of the T-Bill.
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Columns 2 and 3 are bid and ask prices, i.e., these columns list the buying and selling price of the bond in terms of a discount on the redemption price as determined at the end of trading on the preceding day.
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Column 4 lists the change in the discount since the previous day.
- Column 5 lists the yields in annual terms according to the sale price of the T-bill.
The Reasons for Fluctuations in T-Bill Prices
As with any other product, the fluctuations in T-bill prices are related to changes in supply and demand. One of the important factors affecting supply and demand is the yield that the banks are willing to grant to their customers on their deposits. For example, if an investor holds a T-bill with a 5% annualized yield, and the bank offers them the opportunity to put the money into a deposit that generates a 7% annualized yield, then it is obviously advantageous to sell the T-bill and deposit the money into a bank.
That is what holders of T-bills normally do in these cases, and the price naturally falls as a result. When the price falls, then the profit that the T-bill generates until maturity rises: In other words, the yield increases.
Investors will continue selling T-bills, thereby causing a further drop in the price, until the yield on the T-bills rises to the level of the yield that the banks offer on deposits, which is usually affected by the Federal Funds Rate established by the Federal Reserve Board. This interest rate is set eight times each year, but it does not necessarily change each time.
