Treasury Bills

T-Bills

Most investors' prime goal is to maximize returens on a given level of risk. i.e holding efficient portfolios. Most investors who want to make sure that they get their invested with certainty usually invest in treasury bills. Treasury bills are debt instruments issued by the U.S federal government in order to raise money and pay off its maturing debts. Treasury bills are the safest and most secure type of investment wit a minimal level of risk. Its low risk is due to the credit of the U.S government insuring that all investments and interest would be paid on time. They are also easily converted to cash so its very liquid.

This paper explains everything one needs to know about Treasury bills and the treasury bills market. The paper begins by giving the characteristics of a Treasury bills, its lack of default risk, its liquidity, its tax status and its denomination. The second part of the paper gives the quotes on the T Bills, it gives how it is quoted, the bid quotes and the submission of the bids, and the ask quotes. It also gives the yield and the calculation of yields on the T Bills. The third part of the paper gives the primary market for the T Bills. It gives how it is initially issued, the investors, ie the buyers and sellers, the dealers, the brokers, the auctioning and the auctioning procedures. The fourth part of the paper deals with the secondary market, this is the over the counter market and will discuss the the differ over the counter markets that T bills are traded which includes the wi market, the Repo market, government purchases and the buybacks. The final part of the report will gives the regulatory agencies that run these markets.

Section 1

Characteristics of Treasury Bills

The investment characteristics of T Bills differentiate them from many other Treasury securities. Treasury bills are the most liquid asset in the money market. They could be converted to cash with most ease than any other security. They are the least risky asset because the U.S government will always pay their debts. Anyone who owns them will be certain that it will not default. It also has a favorable tax status and a low minimum denomination.

High Liquidity

One of the most important characteristic of T Bills are their high level of liquidity. They can be transformed to cash fairly quickly with little or no transaction cost. "Investors in Treasury bills have this ability because bills are a homogeneous instrument and the bill market is highly organized and efficient. A measure of the liquidity of a financial asset is the spread between the price at which securities dealers buy it (the bid price) and the price at which they sell it (the asked price). In recent years the bid-asked spread on actively traded bills has been 2 basis points or less, which is lower than for any other money market instrument" (Cook 80). A basis point is equivalent to 1/100 of a percent.

Default Risk

Due to the fact that the T Bills are issue by the federal government, the default rate is non existent. T Bills has the highest grade of risk free asset in all the money markets. It even has a higher grade than certificate of deposits and/or commercial which is perceived to have some level of risk. Due to this fact, its yield is less than most money market instruments. The yields on T bills tend to rise when the nation is in weak economic conditions.

"Because Treasury bills are free of default risk, various regulations and institutional practices permit them to be used for purposes that often cannot be served by other money market instruments. For example, banks use bills to make repurchase agreements free of reserve requirements with businesses and state and local governments, and banks use bills to satisfy pledging requirements on state and local and federal deposits. Treasury bills are widely accepted as collateral for selling short various financial securities and can be used instead of cash to satisfy initial margin requirements against futures market positions. And Treasury bills are always a permissible investment for state and local governments, while many other types of money market instruments frequently are not" (Cook 80).

T Bills serve the most important purposes that cannot be match by any other instrument making it one of the most important instruments offered on the money market.

Tax Status

Unlike any other security on the money market, T Bills are exempt from any local, state income taxes. "For this reason, Treasury Bills may have a slightly lower interest than other money market instruments subject to taxes" (Livingston 352). This way an investor must multiply their return on other asset by (1-tax) and compare it to the return on the T Bill to make a decision on which one pays more. For example, on a commercial paper the calculation will be:

Return on Commercial * (1-Tax rate) = Return on T Bill

If the return on the T bill is higher then the investor would choose the T bill over the commercial paper because it pays more. Even if the two happen to be the same, the investor will be more likely to go with the T bill because there is less risky. This advantage depends on some factors including the current interest rate and the investor's state and local tax rate. Some investors like state and local governments are not subject to state income taxes, however others still may be liable for state income taxes like commercial banks which might not make it profitable for them to buy T Bills.

Minimum Denomination

Before 1970, the minimum denomination for a T Bill was $1,000. In 1970, the department of Treasury raised the minimum to $10,000 to discourage small investors from making noncompetitive bids and to "reduce the costs of processing many small subscriptions yielding only a small volume of funds, and discourage the exodus of funds from financial intermediaries and the mortgage market" (Cook 81). This $10,000 is much smaller than the denomination required to purchase other short term securities apart from government securities. CDs and commercial paper usually carry a minimum denomination of about $100,000.

Section 2

Quotes on T Bills

Treasury bills are quoted as a discount rate.