Commercial Paper: A Primer
February 12, 2025
In the previous article, we became aware that the value of a stock can be split into two parts. One part is the horizon period i.e. the period chosen by the analyst for which they believe they can accurately forecast the financials of the company and therefore its dividends. This part remains the same when […]
When we think about investment banks, as well as the activities that they undertake, we tend to think about initial public offerings, debt syndication, and other such activities that are very visible to the public eye. However, the reality is that a lot of investments that are routed via investment banks are actually private placements. […]
In the previous articles, we have already seen how the use of securitization has grown in sports. We also know that the increasing use of securitization is because of certain benefits that are provided by this method of raising capital. However, it is important to note that securitization is a part of structured finance. Structured […]
What is the Fed Wire System? The Fed Wire system is a service that is offered by the Federal Reserve, which is the central bank of the United States. This service is provided by the main Federal Reserve bank as well as its twelve regional offices. Since this service is offered by the central banking […]
The profession of investment banking has evolved over the years. Earlier, they were only used when companies wanted to issue securities and raise capital. Over the years, companies have realized that investment bankers know how to make securities more palatable to the investor community. Hence, they also know how to run the process in reverse, […]
In the previous articles, we have studied various money market instruments as well as how they are traded in the market. In this article, we will have a closer look at treasury bills.
It needs to be understood that treasury bills are the most widely sold instruments in the global money markets. They are the most famous type of instrument and are synonymous with the money market. They generally have the largest trading volume in any money market worldwide. Hence, it is important for investors to know what treasury bills are as well as how they are traded in the money market.
Treasury bills are short-term debt-based promissory notes which are issued by the government. All governments worldwide have their own version of treasury notes. However, when the term treasury bills or “t-bills” is used, it is commonly done to refer to the short-term debt issued by the United States government.
The treasury bills can have several maturities from a few days to a year. Treasury bills with three months maturity are the ones which are the most commonly issued by the United States government.
The United States government undertakes periodic auctions to sell treasury bills. This is done for various reasons. One of the most common reasons is that the tax revenue of the government does not follow a consistent pattern.
There are a few months in which the government generates a lot of tax revenue. However, there are other months where the tax revenue is not enough. Hence, in order to balance their budget, governments issue short-term debt which they pay back when they receive tax revenues.
If the tax revenues are lower than expected, then the government issues some more short-term debt in order to roll over the old debt.
The announcement regarding the issuance of treasury bills is first made by the government. Around ten days after the announcement, the actual treasury bills are issued in the market. In these ten days, there is an active treasury market called the “when-issued” market.
In this market, dealers interact with their customers and then aggregate their own orders which they then further place with the government.
The “when-issued” market is useful for understanding the underlying demand for treasury bills. It is also important to note that the rules prohibit a single dealer from purchasing more than 35% of any issue. This is done to ensure that no dealer can corner the treasury bills and cause a squeeze in the market.
Treasury bills are very famous as money market instruments because they have the following characteristics:
Hence, in the short term, the United States government almost has zero risk. Unless a catastrophic event takes place which jeopardizes the entire financial system, the United States government should be able to repay its debt in the short run.
Since treasury bills are basically risk-free, a wide variety of organizations are allowed to hold them. For instance, pension funds and insurance funds can also hold a large number of treasury bills. Often, they have separate money market funds which they use in order to hold these assets.
Hence, a lot of investors are always looking to hold them in their portfolios. The end result is that treasury bills can be bought and sold instantaneously without any loss of value. This is what makes them the most preferred instrument in the money market.
When investors buy other securities, they have to pay state, federal as well as local taxes on the interest earned. However, treasury bills are exempted from most of these taxes. Hence, even though they provide a lower nominal rate of return, they provide a higher effective rate of return.
The smaller denominations mean that a large number of investors directly purchase treasury bills apart from a very large number of investors who indirectly hold these denominations via money market mutual funds. It is estimated that treasury bills contribute about one-sixth of the total assets which are under the management of money market funds.
Hence, it can be said that treasury bills form the backbone of the money market. It provides the required volume as well as the required liquidity which encourages more investors to invest in money market instruments.
Your email address will not be published. Required fields are marked *