Treasury bills (T-Bills) are short-term debt securities issued by the U.S. government to fund its operations and manage its debt. They are considered to be among the safest investments, as they are backed by the full faith and credit of the U.S. government. One important aspect of T-bill investment is understanding how to calculate their yield, as it allows investors to accurately determine their potential return on investment.

In this article, we will discuss how to calculate T-bill yield using three common methods: the discount yield, investment yield and bond equivalent yield.

1.Discount Yield

Discount yield is the most common method used to calculate T-bill yield, as it considers the discount from the face value at which the T-bill is purchased. This method assumes that an investor holds the T-bill until maturity and does not reinvest any interest received during the holding period.

To calculate discount yield, use this formula:

Discount Yield = [(Face Value – Purchase Price) / Face Value] x (360 / Days to Maturity)

Example:

Face Value = $10,000

Purchase Price = $9,800

Days to Maturity = 90

Discount Yield = [(10,000 – 9,800) / 10,000] x (360 / 90)

Discount Yield = 0.02 x 4 = 0.08 or 8%

2.Investment Yield

Investment yield takes into account both the income earned on a T-bill and any price appreciation during the holding period. This method provides a more accurate representation of an investor’s total return on investment.

To calculate investment yield, use this formula:

Investment Yield = [(Face Value – Purchase Price) / Purchase Price] x (365 / Days to Maturity)

Example:

Face Value = $10,000

Purchase Price = $9,800

Days to Maturity = 90

Investment Yield = [(10,000 – 9,800) / 9,800] x (365 / 90)

Investment Yield = 0.0204 x 4.056 = 0.0846 or 8.46%

3.Bond Equivalent Yield (BEY)

Bond equivalent yield is used to compare T-bill yields with bond yields quoted on a semi-annual basis. It provides a standardized way of assessing returns across various fixed-income securities.

To calculate bond equivalent yield, use this formula:

Bond Equivalent Yield = [(Face Value – Purchase Price) / Purchase Price] x (365 / Days to Maturity)

Example:

Face Value = $10,000

Purchase Price = $9,800

Days to Maturity = 90

Bond Equivalent Yield = [(10,000 – 9,800) / 9,800] x (365 / 90)

Bond Equivalent Yield = 0.0204 x 4.056 = 0.0846 or 8.46%

In conclusion, understanding how to calculate T-bill yield helps investors make informed decisions when considering investment in U.S. government debt securities. By using discount yield, investment yield and bond equivalent yield calculations, one can determine their potential return on investment based on the underlying factors influencing their investment strategy and market conditions.