Treasury Bills Definition
Treasury Bill or a T-Bill is used to control temporary liquidity fluctuations and it is the Central Bank that is charged with the responsibility of issuing the same on behalf of the government and it is issued at its redemption price and at a discounted rate and is repaid as and when it reaches maturity.
Treasury bills were first introduced by the US Federal Government after the First World War in the form of Zero Coupon Bonds with a proposed maturity of one year. Due to their discounting structure and short period maturity, US Treasury coined them as Treasury Bills.
Structure of Treasury Bills
Identifying the structure of treasury bills from its basic definition (as stated above) step by step:
- Debt Instruments: A debt instrument is an obligation through which the issuing party can raise funds with a promise to repay a fixed amount back to the lender on a specified date or as per the terms of the contract.
- Short Term: Refers to the maturity period. T bills have a period of less than one year or a max of 52 weeks.
- Maturity Periods: Generally, T bills are introduced with a maturity period of 4, 8, 13, 26, and 52 weeks.
- Safety: T bills are issued by federal governments hence categorized as the safest debt instruments, or it has the lowest possible risk.
- Interest Rates: T bills do not pay regular interest but are issued at a discount (i.e., a reduced value) and redeemed at their par value on maturity.
- Returns: The investor will receive returns in the form of the difference in the values of issuance (issue price) and the value at maturity (par value). With a longer period to maturity, the return to investors rises.
- Purchase: Fresh or primary issues by the government can be bought through online auctions. T bills can also be purchased from existing holders through secondary market platforms.
- Issuance: In the US, generally, T bills are issued in denominations of $1000. However, denominations can reach a maximum of $5 million.
Purpose of Issuance of Treasury Bills
Every organization needs funds to carry out its operations. For governments, taxes are the single source of revenue, hence to carry out public welfare projects like constructions of schools and hospitals, roads, railways, and airports, etc., governments’ issues various debt instruments generally based on maturity periods like:
- Government Bonds with higher maturity period (5 years or more) and
- Treasury Bills with short term maturity
Calculation of Return on T Bills
T bills do not pay regular interest as the case with governmental bonds but are issued at a discount (i.e., a reduced value) and redeemed at their par value on maturity. I.e., an investor can purchase T bills at a lower price than its actual face value and the interests reflected in the final amount received by the investor. Due to shorter due dates, it becomes convenient to avoid remitting any regular interest payments, and the discounted value serves as the final return to the investor.
The US Federal Treasury Department issued 52 week T bills at a discounted rate of $97 per bill with a face value of $100. An investor purchased a 10 T bill at a competitive bid priceA Competitive Bid PriceBid Price is the highest amount that a buyer quotes against the “ask price” (quoted by a seller) to buy particular security, stock, or any financial instrument. of $97 per bill and invested a total of $970.
After 52 weeks, when the T bills get matured, Federal Treasury paid a total amount of $1000 to the investor, i.e., $100 for every bill held. The investor did not receive any payment in the form of interest during this period of 52 weeks. However, his final profit becomes $300, as reflected in the following calculation:
Taxation of T bill Earnings
Taxation rules get changed from country to country. However, interest incomes are generally taxed under federal income taxFederal Income TaxFederal income tax is the tax system in the United States and is levied and governed by Internal Revenue Services (IRS). It helps determine the tax charged on the income earned by individuals, corporations, and various other legal entities. forms. E.g., in US interest, incomeInterest, IncomeInterest Income is the amount of revenue generated by interest-yielding investments like certificates of deposit, savings accounts, or other investments & it is reported in the Company’s income statement. is exempt from state and local taxes but is fully taxable under the federal taxation system.
Similarly, in India, T bills are considered as taxable income, and the tax rates are applicable as per the tax slabs, including a surcharge of 10% with income more than Rs. 5 lakhs annually.
Advantages and Disadvantages of Investing in T-bills
Treasury bills are considered to be the safest investment tools because these are backed by national governments that can print currency and pays fixed interest rates. But with lower risks comes lower returns. As a result, the risk of inflationRisk Of InflationInflation Risk is a situation where the purchasing power drops drastically. It could also be explained as a situation where the prices of goods and services increase more than expected. Inflation Risk is also known as Purchasing Power Risk. arises; investors can make losses if inflation rates are higher than that of interest rates.
- T bills are backed by governments hence are considered as the safest investments with zero risk to default.
- The government utilizes these funds in public welfare projects. Hence an investment of $100 by an individual provides benefits of $1000 to the whole society.
- During periods of market instability or economic uncertainty, the T bill proves to be a stable and certain investment tool.
- Available for every sector of society, including individuals and organizations, at a very low minimum cost starting at $100 (in the USA).
- T bills are tradable at both primary and secondary platforms.
- With low risks, T bills provide lower returns.
- T bills avoid payments of any regular interests till maturity.
- Earnings on T bills are fully taxable.
- Investors may lose the capital invested if the rate of return (interest rates) gets lower than the inflation rate.
This has been a guide to what are Treasury Bills (T-bills) and its definition. Here we discuss how to calculate T-bill returns along with examples, advantages, and disadvantages. You can learn more about financing from the following articles –