Understanding Treasury Bill Pricing and Yields
Treasury Bills (T-Bills) are short-term government debt obligations backed by the United States Treasury with a maturity of one year or less. Unlike traditional bonds that pay regular interest coupons, T-Bills are sold at a discount to their face value. The "interest" earned by the investor is the difference between the purchase price and the face value paid at maturity.
How to Use This Calculator
This calculator helps investors determine the annualized rates of return for T-Bills. To get an accurate result, enter the following:
- Face Value: The amount the Treasury will pay you when the bill matures (typically $1,000 increments).
- Purchase Price: The actual dollar amount you pay to buy the bill today.
- Days to Maturity: The number of days remaining until the bill expires and the face value is paid.
Formulas Used in T-Bill Calculations
There are two primary ways to express the rate of return on a T-Bill: the Bank Discount Rate and the Bond Equivalent Yield (also known as the Coupon Equivalent Yield). It is crucial to distinguish between them because they use different day-count conventions.
1. Bank Discount Rate (BDR)
This is the rate typically quoted when buying T-Bills at auction. It uses a 360-day year and calculates the return as a percentage of the Face Value, not the invested amount.
2. Bond Equivalent Yield (BEY)
The BEY (or Investment Rate) allows you to compare T-Bills with other investments like savings accounts or coupon-bearing bonds. It uses a 365-day year and calculates return based on the Purchase Price.
Why is the Investment Rate Higher?
You will notice that the Bond Equivalent Yield (Investment Rate) is almost always higher than the Discount Rate. This happens for two reasons:
- Denominator Difference: The Discount Rate divides your profit by the higher Face Value, while the Investment Rate divides profit by the lower Purchase Price (your actual investment).
- Calendar Basis: The Investment Rate accounts for a full 365-day year, whereas the Discount Rate assumes a 360-day year.
When comparing T-Bills to CDs or Corporate Bonds, always use the Bond Equivalent Yield to ensure an apples-to-apples comparison.