Treasury Bill
A Treasury Bill (T-Bill) is a short-term U.S. government debt obligation with a maturity of one year or less, issued at a discount to face value and redeemed at par, with the difference representing the investor's return. T-Bills are backed by the full faith and credit of the U.S. government and are considered the closest approximation to a risk-free asset in financial theory.
Key takeaways
- T-Bills are issued in maturities of 4 weeks (1 month), 8 weeks (2 months), 13 weeks (3 months), 26 weeks (6 months), and 52 weeks (1 year) through weekly competitive and non-competitive auctions.
- T-Bills are zero-coupon instruments—they pay no periodic interest but are purchased at a discount and redeemed at $1,000 face value per bill.
- The 3-month T-Bill yield serves as the standard proxy for the risk-free rate in financial models including CAPM, Sharpe Ratio, and Black-Scholes.
- T-Bills are among the most liquid instruments in global fixed income markets, with secondary market trading dominated by primary dealers and facilitated by the Federal Reserve.
- The TED Spread (T-Bill rate vs. 3-month LIBOR/SOFR) is a key indicator of financial system stress and credit risk in the banking system.
Explanation
Treasury Bills represent the shortest-duration segment of the U.S. government securities market and serve as a fundamental building block for monetary policy implementation, liquidity management, and risk-free rate benchmarking. They were first issued during World War I to finance war expenditures and have evolved into one of the world's most liquid and widely held financial instruments, with outstanding volume exceeding $5 trillion.
T-Bills are sold through weekly auctions conducted by the U.S. Treasury in partnership with the Federal Reserve's fiscal agency function. Competitive bidders (typically primary dealers, hedge funds, and institutional investors) specify both the discount rate and the quantity they wish to purchase; non-competitive bidders agree to purchase at the stop-out rate (the highest yield at which the Treasury fills the auction) without specifying a price. The Treasury accepts all non-competitive bids first, then fills competitive bids from the lowest yield (highest price) upward until the auction is fully subscribed. The auction mechanism ensures that T-Bills are issued at market-clearing rates reflective of current short-term interest rate expectations.
The pricing of T-Bills uses a bank discount yield convention rather than the bond equivalent yield (BEY) or money market yield. The bank discount yield is calculated as: d = ((Face Value - Price) / Face Value) × (360 / Days to Maturity). This convention understates the true return relative to BEY because it uses face value (rather than purchase price) as the denominator and a 360-day year. Converting to BEY: BEY = (Face Value - Price) / Price × (365 / Days to Maturity). For comparison with other fixed-income instruments, investors should use BEY.
T-Bills play a central role in monetary policy transmission. The Federal Open Market Committee (FOMC) influences short-term interest rates by targeting the federal funds rate—the rate at which banks lend reserves to each other overnight. Changes in the federal funds rate rapidly transmit to T-Bill yields through arbitrage relationships and expectations of future short-term rates. When the Fed raises rates, T-Bill yields rise quickly, making cash management instruments more attractive. Conversely, during monetary easing cycles, T-Bill yields fall toward zero, compressing returns for investors using T-Bills for cash management or portfolio hedging.
In portfolio management, T-Bills serve multiple functions. As cash equivalents, they provide a return on uninvested capital during portfolio construction or after redemptions. As margin collateral, T-Bills are accepted at full face value by most clearinghouses and prime brokers as margin for futures and derivatives positions, allowing investors to earn the risk-free rate on capital committed as margin. In performance measurement, the T-Bill rate is the standard deduction in calculating the Sharpe Ratio, representing the opportunity cost of risk-taking. In options pricing, the risk-free rate in Black-Scholes is operationalized as the T-Bill rate matched to the option's time to expiration.
Formula
Bank Discount Yield = ((Face Value - Price) / Face Value) × (360 / Days to Maturity); Bond Equivalent Yield = ((Face Value - Price) / Price) × (365 / Days to Maturity)
Example
An investor purchases a 26-week T-Bill with $1,000 face value at auction for $988.50, representing a bank discount yield of approximately 2.32% (($1,000 - $988.50) / $1,000 × 360 / 182 = 2.27%). The bond equivalent yield, which compares more directly to semiannual coupon bonds, is approximately 2.38% (($1,000 - $988.50) / $988.50 × 365 / 182). At maturity in 26 weeks, the investor receives $1,000 face value. A hedge fund holding $50 million in 3-month T-Bills as variation margin collateral for its equity derivatives positions earns approximately $312,500 over the quarter at a 2.5% annualized yield—a meaningful contribution to the fund's carry while maintaining the full cash-equivalent liquidity of the collateral.
Related terms
Arbitrage Bond Clearing Corporate Bond Discount Rate Duration Equity Face Value Federal Funds Rate Flat Yield Curve Hedge Fund Hedging