The U.S. government is a financial pig. It borrows money alllll the time. Snort snort.
Somebody's gotta buy vibrating back massagers for all those senators' mistresses, right? T-Bills are just one way in which the government raises cash for itself to, uh…buy things.
How does they work? Investors write a check to the U.S. government, taking their hard-earned cash and giving it to Uncle Sam, who in return gives them a piece of paper promising to pay them back in a short period of time. So yeah...Treasury Bills are typically short in duration. And they sell at a discount to par, like a zero coupon bond. Meaning that an investor might pay $982 for a thousand dollar par bond which comes due in 6 months. The investor, for loaning the government her $982 in cash for 6 months, gets paid 18 dollars in rent on that money. There are no interest payments made along the way, as there would be in a traditional bond investment, which typically pays interest twice a year. In this case, the investor is just buying a grand at a discount. Simple.
And note that, in this case, the return is 18 bucks on a grand for 6 months. That implies an annualized interest rate on the money, i.e. over 12 months of…what? Well, our investor makes 18 bucks in 6 months, which is half a year, so double that is 36 bucks for a full year. Notionally, had the government rented that grand for a year, it would have paid 36 dollars for the privilege…or 3.6% annualized interest. That's 36 over a grand. But it's not quite accurate, because the investor didn’t put in a full grand...they put in less.
In this example, they invested 982 and got back 18 bucks for 6 months of doing a whole lot of nothing, other than watching the clock and hoping the U.S. government wouldn’t go bankrupt during that time period. So the interest rate of return to the investor? You take 18 bucks and divide it by 982, and you get about 1.83%. Annualize it, and you get a skosh more than 3.6%, i.e. something more like 3.66%.
Small change, but big numbers. And now, with investor money, the government is free to do all its pork spending. Maybe a nice, new sty for the Speaker of the House. Oink.
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Finance: What are T-Notes, T-Bonds and T...17 Views
Finance allah shmoop what are t notes t bills and
tips All right we'll see that tea in there Well
it stands for treasury and all of these air one
flavor or another of government debt that is the u
s government raises cash for itself teo fix roads build
bridges and erect statues of lebron james dunking on the
statue of liberty or you know whatever else he thinks
the public wants or needs it does that by auctioning
off these debt securities with the promise of its full
faith and credit to pay back the money is the
paper specifies well t notes are quote mid range unquote
paper in that they generally have maturity ease of two
three five seven and ten years that's a teen note
t notes carry a stated interest rate and look a
lot like a normal corporate bond paying interest twice a
year T bills on the other hand are generally very
short term paper usually coming due within a few days
all the way up to a year they're sold or
auctioned at a discount meaning that the t bill might
promise to pay a thousand bucks if it comes due
In six weeks you might pay nine hundred ninety six
dollars for it and you get a whopping fee Four
bucks an interest for your six weeks hard work of
owning that t bill and just you know sitting there
kind of looks like a zero coupon bond Okay so
now we have tips that's tips treasury inflation protected securities
tips as in show us your tips getting Why do
we have such a thing Well the problem with super
duper safe bonds like those of the u s government
is that investors holding them a long time often do
worse after taxes than inflation meaning that if inflation is
growing at three percent a year in their bonds are
only returning one percent a year after tax while then
the investors actually losing two percent a year in buying
power and that's a problem in nineteen nineties when investors
started to realize this issue well they began Tio you
know stop buying u s government bonds and that's a
huge problem for a country that desperately needs to borrow
cash all the time So rather than risk a liquid
marketplace where there's just no buyers buying government paper uncle
Sam created tips which basically adjust the end value of
the principle that investors get based on the c p
i or consumer price index which is a measure of
the average selling prices of a carton of milk a
gallon of fuel a dozen eggs and a grand slam
breakfast at denny's Basically what happens is that the price
of the principal the investor gets back goes up with
inflation over time So they're not losing buying power and
that's a big deal That's it go Enjoy your grand 00:02:33.995 --> [endTime] slam It'll be fourteen thousand dollars in fifty years
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