ethiozoo

What is T-bill anyway?

March 22, 2010 at 10:30 PM 4 comments

By Getachew Teklu 

 Do  you know what it means?
A short-term debt obligation backed by the U.S  government with maturity of less than one year. T-bills are sold in denominations of $1,000 up to a maximum purchase of $5 million and commonly have maturity of one month (four weeks), three months (13 weeks) or six months (26 weeks). 

T-bills are issued through a competitive bidding process at a discount from par, which means that rather than paying fixed interest payments like conventional bonds, the appreciation of the bond provides the return to the holder.  

The smallest face value for a T-Bill is $1,000 US Dollars (USD). The T-Bill is sold at a discount, which is determined by the Bureau of Public Debt, but the Treasury pays the full face value when it is redeemed. For example, an investor might purchase a 90-day T-Bill for $900 USD, and earn a $100 USD return on the investment when the T-Bill is redeemed. Unlike many other securities, a T-Bill does not bear interest, but the return on a T-Bill is highly predictable and very stable, barring complete financial collapse of the United States Treasury.  

Investors may choose to include T-Bills in their profiles because they are highly stable investments with a pre-set time to maturity and a dependable return. Unlike more risky investments, a T-Bill is unlikely to return a substantial sum, but when they are traded on large volume, they can represent a substantial return. Investors can potentially purchase millions of dollars worth of T-Bills, assuming that they possess the available capital. They are also extremely liquid assets making them a versatile and useful addition to a diverse investment portfolio.  

While private investors can and do purchase T-Bills, banks and other financial institutions are capable of purchasing them on a much larger scale, and thus make up the bulk of the trade in T-Bills on the day of the initial offering. Once purchased from the Treasury, a T-Bill can be sold or traded before it matures and is ready to be redeemed, and many individuals purchase T-Bills on the secondary market, from banks and institutions which purchased the bills from the Treasury. As compared with other Treasury securities, the T-Bill matures much more quickly, creating a rapid turnover investment, as opposed to the Treasury note, which matures in two to 10 years, or Treasury Bonds, which take 10-30 years to mature. 

T-bill  are backed by the full taxing power of the US government and therefore the risk of default is essentially zero. However they are subject to interest rate risk. As interest rates rise the value of the portfolio will go down and as interest rates fall the value of the portfolio goes up. If you hold the portfolio to maturity you eliminate the interest rate risk.  I have no idea how the Ethiopian T-bill is backed by in case of default. More info needed.

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