How to Calculate Interest Rate on a Treasury Bill

For centuries, debt was considered a crime against society, punishable by imprisonment. Not until the mid-19th century were debtor prisons abolished in the United States. Fast-forward to the 21st century and debt, albeit properly managed, is an important component of the modern economy.

According to the Federal Reserve Bank of New York, American families have well over $15 trillion in financial obligations. Their government leads the way with a national debt of over $30 trillion as of March 2022. It should be no surprise, then, that debt is a safe, conservative vehicle for investors. Among the lowest risks are Treasury bills.

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Treasury bills, or T-Bills, are government bonds with a unique feature. They offer no stated interest rate. Instead, they are sold below their face value, called par value, and then redeemed at face value, thereby earning a profit for the investor.

In general, they mature in ​one year or less​, and they are usually bought and sold in denominations of ​$100.​ In some cases, that figure has reached into the millions.

Investors bid for T-Bills at auctions, where the price is determined by averaging all the bids received. These bids are either competitive or non-competitive. Overall, Treasury bills are among the easiest securities to convert into cash. The important point to note is that profit is made at the time of purchase and is determined by the size of the discount.

In fact, direct investment in the bond market in general has declined since the dawn of the 21st century. There are reasons for this. For one thing, it can be cost-prohibitive since many bonds, in $100 denominations like T-Bills, are bought in bundles, not individually. Therefore, bond investment is more likely performed by brokers through exchange-traded funds (ETFs).

Nevertheless, the U.S. Treasury Department provides an outlet for those wishing to buy and sell on their own. TreasuryDirect is an online platform through which investors can acquire Treasury bills.

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As a sole means for wealth creation, Treasury bills will likely not promote an individual from rags to riches. As described above, T-Bills are conservative investments. In other words, their relative safety is balanced by modest returns.

Should an investor buy a $1,000 T-Bill for $929, there is a $71 profit, for example. While this does not represent a mountain of gold, there is a high level of confidence that you can pocket $71 when the bill matures. So, T-Bills best serve as complements to a larger investment portfolio.

While a T-Bill lacks a published interest rate, the fact that its purchase very nearly guarantees that you will walk away with some financial gain indicates that the profit is measurable in terms of a T-Bill discount rate. The very dollar difference between the acquisition price and the redemption price gives you all you need to determine what that rate will be. That is the T-Bill discount formula.

The way to calculate the "interest rate" for a Treasury bill is simple. Subtracting the purchase price from the par value yields the gain in dollars. Dividing that difference by the purchase price then conveys the rate.

Using the example above, $71 is the difference between the buy price and face value. Since the bond is purchased at $929 (quite low), dividing the profit by the purchase price gives a quotient representing the discount rate. In this instance, it's an extremely optimistic and unusual 7.64 percent.

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