A U.S. T-bill is a short-term government bond issued for a period of no longer than one year.
These bonds have a number of unique characteristics:
They have a face value of $1,000 and are issued at auction.
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They are redeemed at $1,000, that is, the US Federal Reserve Bank pays $1,000 for each unit.
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They are always issued at a discount.
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They bear no interest, and their return is derived from the discount at which they are purchased.
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They are traded on the stock exchange. Their price never rises above $1,000 since there is no point in paying more for them.
Because of the purchase discount, investors always earn a profit on T-bills. An investor paying $800 for a $1,000 certificate at the beginning of the year recoups a $200 profit on an investment of $800 (a 25% profit) at the end of the year when the certificate is redeemed for $1,000. This profit is the T-bills’ annual yield.
The size of the discount is determined by supply and demand. It is also influenced by the interest that investors can obtain for their money from other investments. In general, the higher the available interest rate, then the greater the discount on T-bills.
If somebody buys short-term loans on the stock market and holds them until they mature, then he gains the difference between $1,000 and the price at which he bought them. Both the stock exchange and the newspapers regularly publish the annual yield on T-bills.
If the maturation period of a T-bill is six months and its annual yield is 18%, purchasers of T-bills will earn a 9% return. The Federal Reserve issues T-bills for periods of 52, 26 and 13 weeks. T-bills are traded on the stock exchange for periods varying from one week to one year.
