This short tutorial will take you through the basics of Treasury bills, or T-bills, which are sold by the United States Treasury. Treasury bills are considered money market instruments because of their short durations: three to twelve months. Because they are backed by the federal government and have low volatility, they are considered the safest of all securities. We will cover three topics:
HOW ARE T-BILL RATES ARE COMPUTED?
Treasury bills do not pay periodic interest. Instead, they are sold at a discount from their face value. Upon maturity, the investor receives the face value. The difference between the face value and the price at which it was sold is treated as interest. For example, a $10,000 T-bill issued by the Treasury could be sold at a discount for only $9,300. The $700 difference is the "interest," which the investor would receive once the bill matured.
To calculate the return, divide the "interest" by the amount paid for the bill. In this case, you would figure the return this way:
T-bills mature in either 90, 180, or 360 days. They are often referred to by their maturity dates; for example, there are 180-day bills, 13-week bills (90 days) and 12-month bills (360 days).
Treasury bills are sold at auctions, as are stocks.
Read below to find out more about how T-Bills are sold.
HOW T-BILLS ARE SOLD
Treasury bills are sold in face amounts beginning at $10,000 and increasing by $5,000.
The Treasury department sells T-bills at weekly auctions every Monday at New York City's Federal Reserve Bank. The Federal Reserve Board (URL?) acts as the fiscal agent and conducts the auction, called a yield auction. The bills are sold at discounts. The investors in attendance bid on how much the bills are worth to them today. In other words, they bid on how much less they want to pay for the bills. The winning bidders pay on the following Thursday. The Federal Reserve System, participating banks and the Treasury Department record their ownership of the T-bills in book-entry form.
Bids over $1 million are called competitive bids; those less than $1 million are non-competitive bids. T-Bills are sold at competitive bids first. The remaining T-Bills are then sold non-competitively for the average price of the winning competitive bids.
Both institutional and private investors may bid on Treasury bills. Institutional investors include banks, governments, mutual funds, etc. Broker-dealers also buy T-bills for resale in the secondary market. A prospective investor must demonstrate to the Fed that it is in good financial shape.
HOW T-BILLS ARE QUOTED
Treasury bills are quoted differently from other debt securities. They use annualized discount yield. This shows for how much less than face value they are selling. The annualized discount yield is the rate of return on the purchase price based upon a one-year holding period.
The bid is the rate that the bidder wants the T-bill discounted. The ask is the rate that the seller offers to discount the bill. The financial press quotes this as follows:
Here, the customer is bidding for a 9% discount, and the seller is offering an 8.5% discount. Thus, for a T-bill with a face value of $10,000 with a one-year maturity, the customer bids $9,100 (or 9% less than $10,000), whereas the seller offers to sell the bill for $9,150, which is 8.5% less than the $10,000 face amount.
You can also see that the higher the bid, the lower the price of the bill.
Treasury bills can be bought at Federal Reserve Banks and sometimes through the mail.
This concludes the tutorial on T-Bills.
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