Discount yield of a Treasury bill

What is a Treasury Bill ?

Treasury bill is a short term money market instrument issued by the government. It is issued at a discount to the face value and is redeemed at face value. Funds raised by the government through their issue is used to meet short term fund obligations.

Treasury bills do not pay any interest and hence are considered as zero coupon investments. Since, Treasury bills are redeemed at face value, the investor receives the face value of the bill on maturity. The return on investment for an investor is the difference between the Face value at the maturity date and the purchase price.

Treasury bills are considered low risk and secure investment as they are government issued securities. Repayment of the face value of the Treasury bill is assured.

 

What is the maturity period of Treasury bills ?

Maturity period of a Treasury bill varies based on the rules and regulations of the issuing authority of the country. In case of the United states the maturity period ranges from any where from a few days to a few weeks. The most commonly issued Treasury bills have a maturity period of 4 weeks to a maximum period of 52 weeks.

In case of India, the tenure of Treasury bills issued may be 14-days, 91-days, 182-days, or 364-days.

The longer the maturity period of a treasury bill, the higher the interest rate the Investor of the Treasury Bill will receive.

 

What are the advantages of investing in Treasury bills ?

   *  Since it is a security issued and regulated by the Government, the risk of non repayment of  face value on redemption is very less.

   *   They can be sold and purchased in the secondary market easily.

  *   Most Treasury bills issued have a face value as low as 1,000, hence high amount of initial investment is not mandatory.

 

What are the disadvantages of investing in Treasury bills ?

   *  There is no periodic interest payment on these bills. Interest payment is received only at  maturity of the bill.

   *  The return on Treasury bills is much less when compared to the returns received on similar debt instruments in the market.

   *   It is not a suitable investment for investors looking for a long term investment opportunity.

 

How do you calculate the discount yield of Treasury Bill ?

The formula for calculating the discount yield of a Treasury Bill is

= [ ( Face value – Purchase Price ) / Face value ] * ( 360 / Number of days to maturity )

 

Example :

A Treasury bill with purchase price of $ 945 has a face value of $ 1,000. The bill matures in 90 days. Assuming a year has 360 days, calculate the discount yield of Treasury bill.

Solution :

The formula for calculating the discount yield of a Treasury Bill is

= [ (Face value – Purchase Price) / Face value ] * ( 360 / Number of days to maturity )

 

As per the Information given in the question we have

Face Value = $ 1,000   ;  Purchase Price = $ 945   ;  Number of days to maturity = 90  ;

 

Applying the above values in the formula we have

= [ ( 1000 – 945 ) / 1000 ] * ( 360/90 )

= ( 55 / 1000) * 4

= 0.0055 * 4

= 0.22 = 22 %

Thus the discount yield of a Treasury bill is = 22 %

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