3-month t-bill

Definition

A 3-month t-bill, or treasury bill, is a short-term government security issued by the U.S. Department of the Treasury that matures in three months. These instruments are sold at a discount to their face value and do not pay interest in the traditional sense; instead, the investor receives the face value upon maturity, with the difference being the earned interest. This makes them a popular choice for investors looking for a safe and liquid investment option, as they are backed by the U.S. government.

5 Must Know Facts For Your Next Test

1. 3-month t-bills are considered one of the safest investments because they are backed by the full faith and credit of the U.S. government.
2. The yield on 3-month t-bills is often used as a benchmark for the risk-free rate in financial models.
3. These t-bills are auctioned regularly, and their prices fluctuate based on market demand and prevailing interest rates.
4. Investors typically buy 3-month t-bills for cash management purposes or as a place to park cash temporarily while seeking higher returns elsewhere.
5. The liquidity of 3-month t-bills makes them a favored instrument for institutional investors and money market funds.

Review Questions

• How does the structure of a 3-month t-bill impact its attractiveness to investors compared to other investment vehicles?
  • The structure of a 3-month t-bill makes it attractive to investors primarily due to its safety and liquidity. Since it is backed by the U.S. government, it carries minimal risk, which appeals to risk-averse investors. Additionally, its short maturity period allows investors to access their funds quickly compared to longer-term securities. This combination of safety and quick access to capital positions t-bills favorably against other investment options.
• Discuss how changes in interest rates can affect the yield of 3-month t-bills and investor behavior.
  • When interest rates rise, the yields on newly issued 3-month t-bills typically increase as well. This leads to existing t-bills with lower yields becoming less attractive, potentially causing their prices to drop in secondary markets. Conversely, when interest rates fall, existing t-bills with higher yields become more valuable, increasing demand. Investor behavior shifts accordingly; during rising rates, investors may seek longer maturities or alternative investments offering better returns.
• Evaluate the role of 3-month t-bills in determining the risk-free rate and how this impacts broader financial markets.
  • The 3-month t-bill plays a critical role in determining the risk-free rate, serving as a benchmark for other investments and influencing various financial decisions. Because these bills are low-risk due to government backing, their yields reflect investor expectations about future economic conditions and interest rates. Changes in the risk-free rate can impact asset pricing across financial markets, affecting everything from corporate bond yields to equity valuations, thereby shaping overall investment strategies in the economy.

Related terms

Treasury Securities: Debt instruments issued by the U.S. Treasury to finance government spending, including t-bills, notes, and bonds.

Discount Rate: The difference between the purchase price of a t-bill and its face value at maturity, which reflects the interest earned by the investor.

Risk-Free Rate: The theoretical return on an investment with zero risk, often represented by the yield on short-term government securities like t-bills.