Main points

• A Treasury bill is a U.S. government debt security with a fixed interest rate and a maturity of two to ten years.
• Treasury bills may be acquired through competitive bidding (investors specify a rate of return) or noncompetitive bidding (investors accept a determined rate of return).
• Treasury bills are similar to Treasury bonds, the only difference is that they have a different maturity date - Treasury bonds have a maturity of 20 to 30 years.

Understanding Treasury Bills

Treasury bills have maturities of two, three, five, seven and ten years, making them a popular investment, and the secondary market is huge, increasing their liquidity.

Interest payments on Treasury bills are made every six months until maturity. Interest income is not taxed at the local or state level, but is still taxable at the federal level, similar to Treasury bonds or Treasury notes.

Treasury bills, Treasury bonds, and Treasury notes are debt investments issued by the U.S. Department of the Treasury. The main difference between them is the expiration time. Taking Treasury bonds as an example, they have a maturity time of more than 10 years and can reach up to 30 years, making them the longest sovereign fixed-income security.

Treasury Bills and Interest Rate Risk

The longer a Treasury bill has to maturity, the greater its exposure to interest rate risk. In addition to its credit strength, the value of a Treasury bill or bond is affected by its sensitivity to changes in interest rates. Interest rate changes are usually under the control of central banks or manifested as changes in the shape of the yield curve.

Additionally, these fixed-income instruments have different sensitivities to changes in interest rates, which means prices can fall by varying degrees. Sensitivity to changes in interest rates is measured as duration and expressed in years. Factors used to calculate duration include coupon, yield, present value, ultimate maturity and call characteristics.

An absolute example of an interest rate change occurred in December 2015, when the Federal Reserve (Fed) raised the federal funds rate by 25 basis points. At that time, the interest rate was between 0% and 0.25%, and was subsequently adjusted to 0.25% to 0%. A rise in benchmark interest rates causes the prices of all existing U.S. Treasury bills and bonds to fall.

Special Considerations

In addition to benchmark interest rates, changes in investor expectations can also cause fluctuations in the yield curve, known as yield curve risk. This risk is related to how steep or flat the yield curve is, reflecting changes in yields among similar bonds with different maturities.

For example, in the case of a steep yield curve, the gap between short-term and long-term rates widens, with long-term rates rising more than short-term rates. If short-term interest rates are higher than any long-term interest rates, a condition known as an inverted yield curve develops.

As a result, the price of longer-term Treasury bills declines relative to that of shorter-term Treasury bills. And with a flattening yield curve, the gap narrows and the price of short-term Treasury bills falls relative to long-term Treasury bills.

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