Treasury Bill

A Treasury bill is a marketable debt security issued by the United States Treasury with a maturity of one year or less. It is a discount instrument, meaning it makes no periodic interest payment: TreasuryDirect states that "bills are sold at a discount or at par (face value)" and that "when the bill matures, you are paid its face value." The return is therefore the difference between the purchase price and the face amount, and TreasuryDirect says so directly, defining interest on a bill as "the difference between what you paid and the face value you get when the bill matures."

The qualifier "or at par" matters and is often dropped. A bill is not always sold below face value; where the auction clears at a rate of zero, the price equals par. The common description of a bill as "sold at a discount and repaid at full face value" is therefore slightly overstated, though a discount is the ordinary case.

Bills are offered in terms of 4, 6, 8, 13, 17, 26 and 52 weeks, with a minimum purchase of $100 and in increments of $100. They can be bought directly at auction through TreasuryDirect or through a bank or broker, and because they are marketable they can also be bought and sold before maturity in the secondary market rather than being held to the end.

Treasury publishes two rates for the same bill and they are not the same number, which is the single most useful thing to understand here. An auction result for a bill reports a high rate, which is a discount rate, and an investment rate, which Treasury's own auction result footnotes define as the "equivalent coupon-issue yield." Two separate conventions produce the difference, and both of them push in the same direction.

The discount rate is calculated against face value and on a 360-day year. TreasuryDirect gives the price formula outright: "Price = Face value (1 − (discount rate × time)/360)." So the rate is applied to the amount you will receive rather than to the amount you pay, and it is annualized over a year that is five days short.

The investment rate is calculated against the price actually paid and on a 365-day year. Because the price paid is smaller than the face value, dividing by it produces a larger figure; and because 365 is larger than 360, annualizing over it also produces a larger figure. The two adjustments compound rather than offsetting, which is why the investment rate on a bill bought at a discount is above its discount rate. On the rare bill that prices at par there is no discount and no interest, so nothing separates the two. Neither number is wrong. The discount rate is the auction convention and the investment rate is the figure that compares with a yield quoted on any other investment, which is what makes it the one to use when setting a bill beside a CD or a savings account.

Not insured, and the reason it does not need to be is different in kind. A bill carries no FDIC deposit insurance, because it is not a deposit at a bank. Deposit insurance exists to protect a depositor against the failure of the intermediary holding the money. A Treasury bill is a direct obligation of the United States, so there is no intermediary between the holder and the issuer to fail. Describing a bill as insured, or as guaranteed by the FDIC, gets the structure backwards. Where a bill is held in a brokerage account, the securities investor protection regime covers the custody of the security rather than its value, which is a different question again.

A bill has no inflation protection, and grouping it with instruments that do is a common error. Bills, certificates of deposit and savings accounts sit next to each other in every list of cash alternatives, so whatever is said about the group gets applied to all of them. Two distinctions are worth keeping. A bill's return is fixed in nominal terms at purchase, so if inflation runs above that return the real value of the money falls, exactly as with a CD. That is different from a Series I savings bond, whose rate includes a component that resets with measured inflation and which is therefore built to track it rather than be eroded by it. It is also different from a savings account, whose rate is variable and can rise during an inflationary period while a bill's cannot. What a bill does offer that a CD does not is a functioning secondary market, so the money can be reached before maturity by selling rather than by paying a penalty, at whatever price the market gives.

The state and local tax exemption is federal law rather than Treasury's choice. TreasuryDirect states the outcome for bills as "federal tax due on interest earned. No state or local taxes." The source is 31 USC 3124(a), which provides that obligations of the United States government are exempt from taxation by a state or a political subdivision of a state, with narrow carve-outs including a nondiscriminatory franchise tax on a corporation and estate or inheritance taxes. That is a uniform federal rule rather than fifty state policies, and it is the one structural advantage a bill has over a CD paying the same yield: for a holder in a state with an income tax, the same nominal yield is worth more after tax. Interest is reported on Form 1099-INT, and for an individual on the cash method it is recognized when the bill matures or is sold rather than accruing along the way; IRC 1281 requires current accrual only for specified holders such as accrual-method taxpayers, dealers and banks.

You buy at auction or in the secondary market, pay the price, and receive the face value at maturity. Nothing arrives in between. At TreasuryDirect a noncompetitive bid accepts whatever rate the auction sets, which is how almost all individual purchases are made, and the minimum is $100 in $100 increments.

A hypothetical example using TreasuryDirect's own price formula, with a rate chosen purely to illustrate. A 26-week bill has 182 days to maturity. On a $10,000 face amount at a discount rate of 4.000%, the price is:

$10,000 × (1 − (0.04 × 182) ÷ 360) = $10,000 × (1 − 0.020222) = $9,797.78

So you pay $9,797.78 and receive $10,000 at maturity, and the interest is $202.22.

Now the second rate on the same bill. The investment rate divides that $202.22 by the price paid rather than the face value, and annualizes over 365 days rather than 360:

($202.22 ÷ $9,797.78) × (365 ÷ 182) ≈ 4.14%

Two published rates, 4.000% and roughly 4.14%, describing one security on one day. The second is the number to set beside a savings account or a CD, because those are quoted on the money you actually commit.

A shorter example for scale. A 4-week bill, 28 days, with $1,000 of face value at the same illustrative 4.000% discount rate prices at $996.89 ($1,000 × (1 − (0.04 × 28) ÷ 360)), for $3.11 of interest. Short bills produce small absolute amounts, which is worth knowing before rolling a small balance every month for the yield.

These rates are illustrative and not current. Bill rates move at every auction, so the figure to act on is the one on Treasury's own auction results for the term you are buying.

Pros

• A direct obligation of the United States, so there is no intermediary whose failure could cost you the principal.
• Interest is exempt from state and local income tax under 31 USC 3124(a), which raises the after-tax return for a holder in a state that taxes income.
• Terms from 4 to 52 weeks let a maturity be matched to a known date, and the $100 minimum makes that practical at small sizes.
• Marketable, so it can be sold before maturity rather than surrendered for a contractual penalty as a bank CD would be.
• No credit analysis is needed and no rate negotiation is possible, so the auction price is the same for a small buyer as for a large one.

Cons

• It pays nothing until maturity, so it does not suit money that has to produce income along the way.
• The return is fixed in nominal terms at purchase, so it offers no protection if inflation runs above the yield.
• Selling before maturity means accepting the market price, which can be below what you paid if rates have risen since.
• The two published rates invite confusion, and the lower one is the headline figure on an auction result.
• Rolling short bills repeatedly means repeated reinvestment at whatever rate then prevails, and on small balances the absolute interest is modest.
• It is not FDIC-insured, which is a correct statement about the structure rather than a comment on the risk.