U.S. Treasury bills or "T-bills" are a class of government debt securities that mature in one year or less (one-month, three-month, six-month and 12-month terms). Unlike other securities with longer terms, T-bills don't have coupon payments, which are guaranteed payments in addition to interest during the life of the security. Rather, T-bills are sold at a discount of what they will be worth at maturity. For example, a six-month T-bill that can be redeemed for $1,000 at maturity will be sold by the U.S. Treasury to an investor for $970 at the beginning of the term.
A debt security's "yield-to-maturity (YTM)" refers to how much of a return it will provide if held to maturity. However, YTM is usually calculated by the year. To calculate YTM for a security maturing in less than a year, you need to calculate the "Bond Yield Equivalent (BYE)."
Subtract the asking price of the T-bill from its par value, the dollar amount that the T-bill will be redeemable for at maturity.
Divide the answer from Step 1 by the par value.
Divide 182 days (the term of the T-bill) by 364 days (the number of days in the financial calendar year).
Divide the result from Step 2 by 0.5 (the result from Step 3).
Multiply by 100 percent to convert the BYE to a percentage. By substituting this value for YTM, you can better compare the attractiveness of a six-month T-bill compared to securities with multi-year terms.
Warnings
While accurate over the term of the T-bill, this technique is not necessarily accurate over the course of the year. This model assumes that you are able to purchase a second six-month T-bill for the exact same price after the first one reaches maturity. However, this may not be the case.
Once the first T-bill reaches maturity, you need to calculate the BYE for the current asking price. Depending on this new price, the BYE may no longer be more attractive than other securities.
References
- NYU: Calculating YTM For Treasury Bills
- TreasuryDirect. "Purchase Limits." Accessed Aug. 1, 2020
- TreasuryDirect. "How Treasury Auctions Work." Accessed Aug. 1, 2020.
- TreasuryDirect. "Treasury Bills: Rates & Terms." Accessed Aug. 1, 2020.
- U.S. Department of the Treasury. "Daily Treasury Bill Rates Data." Accessed Aug. 1, 2020.
- TreasuryDirect. "Treasury Bills." Accessed Aug. 1, 2020.
- TreasuryDirect. "Auctions." Accessed Aug. 1, 2020.
- Corporate Finance Institute. "Treasury Bills (T-Bills)." Accessed Aug. 1, 2020.
- The New York Times. "The Fed Goes All In With Unlimited Bond-Buying Plan." Accessed Aug. 1, 2020.
- Federal Reserve Bank of San Francisco. "What makes Treasury bill rates rise and fall? What effect does the economy have on T-Bill rates?" Accessed Aug. 1, 2020.
Warnings
- While accurate over the term of the T-bill, this technique is not necessarily accurate over the course of the year. This model assumes that you are able to purchase a second six-month T-bill for the exact same price after the first one reaches maturity. However, this may not be the case.
- Once the first T-bill reaches maturity, you need to calculate the BYE for the current asking price. Depending on this new price, the BYE may no longer be more attractive than other securities.
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