What it means
Governments issue treasury bills to manage the mismatch between when tax revenue arrives and when spending happens. They are sold at auction in large denominations, then trade actively in a secondary market, which means an investor can usually sell before maturity at a fair price.
The pricing convention is what confuses newcomers. There is no coupon, so instead of quoting a rate the market quotes a discount: a bill with a face value of $1,000,000 might cost $985,000 today and repay $1,000,000 in six months, and the $15,000 difference is the entire return.
For a business, treasury bills matter as a cash management tool rather than an investment strategy. A company sitting on a large tax provision or an acquisition war chest can hold bills that mature exactly when the money is needed, earning a return without taking credit or price risk.
Two different yield conventions coexist and they give different answers. The bank discount yield uses the face value as the base and a 360 day year, while the investment or bond equivalent yield uses the price actually paid and a 365 day year, and the second is always the higher and more honest of the two.
The main risks are not about repayment. Reinvestment risk means a maturing bill may only be replaceable at a lower rate, and inflation risk means a 3% return can still lose purchasing power if prices rise faster, which is why bills preserve capital rather than build wealth.
In practice
Real-world examples
Example 1
A property developer receives $40,000,000 from a land sale and owes a large tax payment in four months. It buys treasury bills maturing one week before the tax deadline, so the cash is working rather than idle but is certain to be available on the day.
Example 2
A university endowment holds a rolling ladder of bills maturing every month to cover its operating drawdowns. When rates rise, each maturing bill is reinvested at the higher rate, so the portfolio reprices upward within a year without any trading decision.
Example 3
A finance director comparing two offers sees a treasury bill quoted at a 3.0% discount rate against a bank deposit paying 3.05%. Converting the bill to its investment yield of 3.09% reverses the ranking, and the treasury bill wins on both return and liquidity.
Think of it
Treasury bill is short-term US government debt-one year or less.
Formula
Calculation
Discount = face value - purchase price
Bank discount yield = (discount / face value) x (360 / days to maturity)
Investment yield = (discount / purchase price) x (365 / days to maturity)
A corporate treasurer buys a treasury bill with a face value of $1,000,000, maturing in 180 days, for $985,000. The discount is $1,000,000 - $985,000 = $15,000.
The bank discount yield = ($15,000 / $1,000,000) x (360 / 180) = 1.5% x 2 = 3.0%. The investment yield = ($15,000 / $985,000) x (365 / 180) = 1.5228% x 2.0278 = 3.09%, and it is this second figure that the treasurer should compare against a bank deposit rate.Case study
Seen in the real world
The following is an illustrative and entirely fictional case. Halden Marine Supplies, an invented distributor of ship chandlery, kept an average balance of $12,000,000 in a current account earning almost nothing, because its cash flow was lumpy and the finance director wanted every dollar instantly available.
A review of two years of bank statements showed the balance never fell below $7,000,000, and that the timing of the large outflows, quarterly tax and an annual insurance premium, was known months in advance. The fictional treasurer built a simple ladder of treasury bills against the predictable $7,000,000 core, with maturities matched to the known payment dates.
At an average investment yield of around 3%, the change produced roughly $210,000 of extra income a year with no new credit risk and no reduction in the company's ability to pay its bills. The only real cost was setting up a custody account and a monthly reinvestment routine.
Watch out
Common mistakes
- Comparing a quoted discount rate directly with a bank deposit rate, which understates the treasury bill return because the two are calculated on different bases.
- Assuming a treasury bill cannot lose money, when selling one before maturity after rates have risen produces a real capital loss.
- Buying longer dated bills than the cash forecast supports, which turns a cash management decision into an unintended bet on interest rates.
Questions
People also ask
Are treasury bills genuinely risk free?
They carry effectively no credit risk in a major currency, but they still expose the holder to inflation and to reinvestment risk when they mature.
Why do treasury bills pay no coupon?
The return is built into the discounted purchase price instead, which keeps the instrument simple and avoids the administration of interim payments on very short maturities.
How does a treasury bill differ from commercial paper?
Both are short term discount instruments, but commercial paper is issued by companies and carries credit risk, so it normally offers a higher yield.