T-Bill Yields - Why is the Treasury Bill Yield Less Than the Commercial Bill Yield?
Treasury bills or T-bills are debt obligations backed by the credit and faith of the U.
S.
Treasury.
These obligations have maturities of one, three or six months and are sold in varying denominations of $1000 up to $5 million.
When you buy a T-bill, you are buying the debt at a discounted value and you get back the appreciated amount at maturity.
So, unlike conventional bonds you dont receive interest payments but one final payment.
A commercial bill is a short-term debt obligation of a company that offers to pay back the debt at a fixed date and interest rate in the future.
So what determines the yield of a debt instrument? There are a few factors.
The most imnportant one is the credit rating of the entity issuing the bill.
The risk of the investor not getting back the money on maturity determines the yield the investor expects to take on to finance that debt.
So, in the case of the US Treasury the risk of not getting the money back is the same as the Treasury running out of money - not very likely.
The Treasury has the ability to raise money through taxes.
While in the case of companies, their cash flow between the period of issuing the debt and the maturity has more uncertainty associated with it.
This uncertainty or higher risk is compensated for with a higher yield.
Lets take a look at an example.
Consider the case where you have the option of choosing from two six month bills.
The first is a US government treasury bill and the other is a nanotechnology firm.
Which bill would you choose to buy if both have the same yield of 4%? Most investors would choose the t-bill since it has a better credit rating and there is less risk of default.
But, what if the bill issued by the nanotech firm yields 8%? Now, the decision is not as clearcut as before.
As an investor you would have to evaluate the credit rating of the company, the risk of default and your own investment objectives before making a decision.
All else being equal, whenever comparing the yield of two bills, the bill that has the higher credit rating will offer a lower yield due to less risk or uncertainty than the one with higher risk or uncertainty.
S.
Treasury.
These obligations have maturities of one, three or six months and are sold in varying denominations of $1000 up to $5 million.
When you buy a T-bill, you are buying the debt at a discounted value and you get back the appreciated amount at maturity.
So, unlike conventional bonds you dont receive interest payments but one final payment.
A commercial bill is a short-term debt obligation of a company that offers to pay back the debt at a fixed date and interest rate in the future.
So what determines the yield of a debt instrument? There are a few factors.
The most imnportant one is the credit rating of the entity issuing the bill.
The risk of the investor not getting back the money on maturity determines the yield the investor expects to take on to finance that debt.
So, in the case of the US Treasury the risk of not getting the money back is the same as the Treasury running out of money - not very likely.
The Treasury has the ability to raise money through taxes.
While in the case of companies, their cash flow between the period of issuing the debt and the maturity has more uncertainty associated with it.
This uncertainty or higher risk is compensated for with a higher yield.
Lets take a look at an example.
Consider the case where you have the option of choosing from two six month bills.
The first is a US government treasury bill and the other is a nanotechnology firm.
Which bill would you choose to buy if both have the same yield of 4%? Most investors would choose the t-bill since it has a better credit rating and there is less risk of default.
But, what if the bill issued by the nanotech firm yields 8%? Now, the decision is not as clearcut as before.
As an investor you would have to evaluate the credit rating of the company, the risk of default and your own investment objectives before making a decision.
All else being equal, whenever comparing the yield of two bills, the bill that has the higher credit rating will offer a lower yield due to less risk or uncertainty than the one with higher risk or uncertainty.