Treasury Bills - Meaning and its Characteristics
In the previous articles, we have studied various money market instruments as well as how they are traded in the market. In this article, we will have a closer look at treasury bills.
It needs to be understood that treasury bills are the most widely sold instruments in the global money markets. They are the most famous type of instrument and are synonymous with the money market. They generally have the largest trading volume in any money market worldwide. Hence, it is important for investors to know what treasury bills are as well as how they are traded in the money market.
What are Treasury Bills?
Treasury bills are short-term debt-based promissory notes which are issued by the government. All governments worldwide have their own version of treasury notes. However, when the term treasury bills or “t-bills” is used, it is commonly done to refer to the short-term debt issued by the United States government.
The treasury bills can have several maturities from a few days to a year. Treasury bills with three months maturity are the ones which are the most commonly issued by the United States government.
How are Treasury Bills Issued?
The United States government undertakes periodic auctions to sell treasury bills. This is done for various reasons. One of the most common reasons is that the tax revenue of the government does not follow a consistent pattern.
There are a few months in which the government generates a lot of tax revenue. However, there are other months where the tax revenue is not enough. Hence, in order to balance their budget, governments issue short-term debt which they pay back when they receive tax revenues.
If the tax revenues are lower than expected, then the government issues some more short-term debt in order to roll over the old debt.
The announcement regarding the issuance of treasury bills is first made by the government. Around ten days after the announcement, the actual treasury bills are issued in the market. In these ten days, there is an active treasury market called the “when-issued” market.
In this market, dealers interact with their customers and then aggregate their own orders which they then further place with the government.
The “when-issued” market is useful for understanding the underlying demand for treasury bills. It is also important to note that the rules prohibit a single dealer from purchasing more than 35% of any issue. This is done to ensure that no dealer can corner the treasury bills and cause a squeeze in the market.
Characteristics of Treasury Bills
Treasury bills are very famous as money market instruments because they have the following characteristics:
- Default Risk: Treasury bills almost have zero default risk. This is because they are issued by the United States government. The United States government also controls the issue of the United States dollar which is the reserve currency of the world.
Hence, in the short term, the United States government almost has zero risk. Unless a catastrophic event takes place which jeopardizes the entire financial system, the United States government should be able to repay its debt in the short run.
Since treasury bills are basically risk-free, a wide variety of organizations are allowed to hold them. For instance, pension funds and insurance funds can also hold a large number of treasury bills. Often, they have separate money market funds which they use in order to hold these assets.
- Liquidity: Treasury bills are traded through a well-organized and sophisticated market. Hence, the transaction costs for buying or selling these securities are very low. Also, treasury bills are largely homogenous in nature.
Hence, a lot of investors are always looking to hold them in their portfolios. The end result is that treasury bills can be bought and sold instantaneously without any loss of value. This is what makes them the most preferred instrument in the money market.
- No Taxes: Treasury bills are able to provide a higher effective yield on the investment because of the favorable taxation rules which apply to them.
When investors buy other securities, they have to pay state, federal as well as local taxes on the interest earned. However, treasury bills are exempted from most of these taxes. Hence, even though they provide a lower nominal rate of return, they provide a higher effective rate of return.
- Lower Denominations: Another unique factor that works in the favor of treasury bills is the fact these bills are sold in very low denominations. Therefore, investors who only have $1000 can also invest in treasury bills. This is opposed to other market instruments such as commercial paper where the minimum denominations are often greater than $100,000.
The smaller denominations mean that a large number of investors directly purchase treasury bills apart from a very large number of investors who indirectly hold these denominations via money market mutual funds. It is estimated that treasury bills contribute about one-sixth of the total assets which are under the management of money market funds.
Hence, it can be said that treasury bills form the backbone of the money market. It provides the required volume as well as the required liquidity which encourages more investors to invest in money market instruments.
Authorship/Referencing - About the Author(s)
The article is Written By “Prachi Juneja” and Reviewed By Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.
- Money Market - Introduction
- Pros and Cons of Money Markets
- Characteristics of Money Market
- Functions of the Money Market
- Commercial Paper: A Primer
- Asset-Backed Commercial Paper
- Pros and Cons of Asset-Backed Commercial Papers
- Euro Commercial Paper
- Banker’s Acceptance
- Treasury Bills
- Interbank Market
- Repo Market
- How Triparty Repo Works?
- Money Market Mutual Funds
- Variable Rate Demand Obligations
- Government Sponsored Entities
- Forward Rate Agreement
- Money Market Futures
- Volatility in Money Markets
- Risks in Money Market Investing
- How Money Market Impacts Other Markets?
- Money Market Reforms
- Stress Testing in Money Market Funds