TREASURY BILLS (T-BILLS)

Definition

Treasury Bills are short-term government debt securities issued at a discount to face value and redeemed at par at maturity. They are used by governments (most notably the U.S. Treasury) to finance short-term funding needs and are considered risk-free investments due to their sovereign backing.

In essence: T-Bills are short-term, zero-coupon government-backed securities.

Origins

T-Bills were first issued by the U.S. government in 1929 and have since become a benchmark risk-free instrument worldwide. Their structure and use have been adopted by sovereign governments globally, serving as foundational instruments for monetary policy, liquidity management, and capital markets.

Usage

Industry Applications:

• Government Financing – Manage short-term cash needs or cover budget gaps.

• Cash Management – Corporates and banks use T-Bills for short-term, safe returns.

• Portfolio Allocation – Core component of money market funds and liquidity reserves.

• Benchmarking – Used to derive the risk-free rate in financial models (e.g., CAPM).

• Collateral – Commonly pledged in repos and derivatives transactions.

How Treasury Bills Works

T-Bills are:

• Issued at a discount (e.g., buy at $9,800, receive $10,000 at maturity).

• Matured at par – no coupon payments.

• Traded in money markets, with high liquidity.

• Issued with maturities of:

  • 4 weeks

  • 8 weeks

  • 13 weeks (91 days)

  • 26 weeks (182 days)

  • 52 weeks (1 year)

T-Bill Auction Process:

• Non-competitive bids (retail investors): accept the yield set at auction.

• Competitive bids (institutional): specify yield; risk not being allocated any T-Bills if bid is too low.

Key Takeaway

• T-Bills are ultra-safe, liquid, and short-term instruments.

• They do not pay interest—returns come via discounted purchase price.

• Used widely for risk-free benchmarking, liquidity management, and policy tools.

• Interest income is exempt from state and local taxes in many jurisdictions (e.g., U.S.).

Types of Treasury Bills

Context in Financial Modeling

In modeling:

• Used as the "risk-free rate" in CAPM and DCF models:

  $$r_f = \text{T-Bill Yield}$$

• Portfolio allocation: Represent safe, low-volatility assets.

• Discount factor calculation: Important for present value estimates in short-term cash flows.

• Liquidity yield: Serve as benchmark for money market yields.

Nuances & Complexities

• Zero-Coupon Structure: Similar to zero-coupon bonds, but much shorter in duration.

• Price Sensitivity: Minimal price fluctuation due to short duration and credit safety.

• Yield Calculation: Quoted using discount yield, which differs from bond equivalent yield (BEY).

• Taxation:

  • Interest income taxed federally.

  • Typically exempt from state and local taxes in the U.S.

Mathematical Formulas

1. Discount Yield (DY):

$$DY = \frac{F - P}{F} \times \frac{360}{n}$$

2. Bond Equivalent Yield (BEY):

$$BEY = \frac{F - P}{P} \times \frac{365}{n}$$

Where:

• $F$ = Face value

• $P$ = Purchase price

• $n$ = Days to maturity

3. Present Value of T-Bill:

$$P = \frac{F}{(1 + r \cdot \frac{t}{365})}$$

Related Terms

• Zero-Coupon Bond

• Money Market Instrument

• Discount Yield

• Risk-Free Rate

• Treasury Notes & Bonds

• Repo

• Liquidity Management

Real-World Applications

1. Institutional Treasury Management

A corporation allocates excess cash to 13-week T-Bills for a risk-free return while preserving liquidity.

2. Monetary Policy

Central banks use T-Bill auctions to manage short-term interest rates and control money supply.

3. Startup Cash Reserves

A VC-backed firm invests its idle cash in T-Bills to earn income with minimal risk and easy redemption.

4. Derivative Margining

Clearing houses accept T-Bills as collateral for margin accounts due to their safety and liquidity.

References & Sources

• Investing Brokers – Treasury Bills