Treasury Bill

Treasury bills are best described as...

1. A.Securities exempt from federal income taxTreasury interest is federally taxable; only munis are federally exempt.
2. B.Inflation-adjusted securities maturing in 30 yearsThat describes long-dated TIPS, not T-bills.
3. C.Short-term securities sold at a discount with no stated couponCorrect — T-bills mature in a year or less and pay no coupon.
4. D.Long-term securities paying a semiannual couponThat describes T-bonds, not T-bills.

Why: T-bills are short-term Treasuries maturing in one year or less, sold at a discount and paying no stated coupon.

Kaito Nakamura buys a 26-week Treasury bill with a $10,000 face amount and pays $9,835. He asks when the interest payments will arrive. His adviser should explain that:

1. A.Interest is paid semiannually, as it is on all marketable Treasury securitiesNotes and bonds pay semiannually, which is why this generalizes so easily, but bills do not.
2. B.There are no interest payments; the entire $165 return is the difference between the discounted purchase price and the $10,000 received at maturityCorrect. A bill is issued at a discount, and the accretion to face value at maturity is the whole return.
3. C.Interest accrues monthly and is credited to his account, with the principal returned at maturityNo cash interest is credited at any interval on a bill.
4. D.Interest is paid in a single payment at maturity in addition to the $10,000 face amountHe receives exactly $10,000 at maturity, not $10,000 plus a separate interest payment.

Why: Treasury bills are original issue discount instruments. They pay no periodic coupon; the investor buys at a price below face value and receives the full face amount at maturity, so the entire return is the $165 difference between the $9,835 purchase price and the $10,000 received. The clue is that the purchase price is below face value with no coupon rate stated. Treasury notes and bonds, by contrast, pay semiannual interest. Review the characteristics of Treasury securities.

A corporate treasurer must park 2 million dollars of operating cash for about four months in the safest instrument available with a matching maturity. The most appropriate Treasury security is a...

1. A.Treasury noteNotes start at 2 years. Selling one after four months exposes the cash to interest-rate risk that the bill avoids.
2. B.Treasury billCorrect. Bills are issued in maturities of one year or less, so a 13-week or 17-week bill matches the horizon.
3. C.Treasury STRIP maturing in 10 yearsA long zero-coupon instrument has the highest duration of all, making it the most price-volatile choice for short-term cash.
4. D.Treasury bondA 20- to 30-year maturity is grossly mismatched to a four-month need, even though the credit quality is identical.

Why: Treasury bills are auctioned in maturities of one year or less, including 4-week, 8-week, 13-week, 17-week, 26-week, and 52-week terms. A 13-week or 17-week bill matches the four-month horizon with essentially no credit risk and minimal price risk.

Which investment carries the greatest liquidity risk?

1. A.A listed large-cap common stockExchange-listed shares sell readily at posted prices.
2. B.A money market mutual fundMoney market funds are designed for immediate redemption.
3. C.An interest in a non-traded direct participation programCorrect. There is no active secondary market, so exiting promptly at fair value is difficult.
4. D.A Treasury billTreasury bills trade in the deepest, most liquid market there is.

Why: A direct participation program interest has no active secondary market, so an investor may be unable to sell promptly at a fair price. Listed stocks, Treasury bills, and money market funds are all readily converted to cash.