A $1,000 T-bill typically costs less than its face value, as these short-term government securities are sold at a discount. For example, a one-year T-bill with a $1,000 face value and an annual yield of 5% would cost approximately $950 upfront.
Understanding T-Bill Pricing
Treasury Bills (T-bills) are debt instruments issued by the U.S. Treasury, known for their safety and liquidity. Unlike traditional bonds that pay periodic interest payments, T-bills are discount instruments. This means you purchase them for less than their face value (also known as par value), and the return on your investment comes from the difference between the lower purchase price and the higher face value you receive at maturity.
- Face Value: This is the amount you receive when the T-bill matures (e.g., $1,000).
- Purchase Price: This is the amount you pay upfront, which is always less than the face value.
- Yield: The effective annual return on your investment, which dictates how much of a discount the T-bill is sold at. A higher yield means a lower purchase price for the investor.
The cost of a T-bill is inversely related to its yield. The higher the yield offered, the lower the initial purchase price you will pay, and consequently, the greater the profit you earn when the bill matures at its full face value.
Example Cost Breakdown
Let's illustrate the concept with a practical example:
| Face Value | Annual Yield | Approximate Purchase Cost |
|---|---|---|
| $1,000 | 5% | $950 |
In this scenario, by paying $950 for a T-bill that will pay you $1,000 at maturity, you effectively earn a return of $50 over the one-year term. This translates to an approximate 5% annual yield on your investment. While the precise price involves a specific discount rate formula, $950 serves as a close approximation for a $1,000 T-bill with a 5% yield.
Why T-Bills Are Popular Investments
T-bills are a favored choice for many investors due to several key advantages:
- Exceptional Safety: Backed by the full faith and credit of the U.S. government, T-bills are considered one of the safest investment options available, carrying minimal default risk.
- Short-Term Horizon: They come with maturities ranging from just a few days up to 52 weeks (one year), making them ideal for short-term cash management or preserving capital.
- High Liquidity: T-bills are highly liquid assets, meaning they can be easily sold on the secondary market before their maturity date if you need access to your funds.
- Tax Advantages: The interest earned from T-bills is exempt from state and local income taxes, although it is subject to federal income tax.
You can purchase T-bills directly from the U.S. Treasury through the official TreasuryDirect website.
