The mechanism is straightforward: an investor lends money to the government by purchasing the bill at a discount to its face value. This tax exemption can make them particularly appealing for investors in high-tax states.
How US Treasury Bills Generate Returns and Their Key Mechanism
Large financial institutions typically engage in competitive bidding, specifying the yield they are willing to accept, while smaller investors can usually submit non-competitive bids, guaranteeing they receive the bill but accepting the average yield determined at auction. The interest rate on these short-term bills, specifically the 13-week bill, acts as a benchmark for the "risk-free rate" used in financial models and corporate finance.
Comparison with Other Treasury Securities. They act as a counterbalance to more volatile assets like stocks and corporate bonds.
How US Treasury Bills Generate Returns and Manage Risk
The interest earned on federal Treasury bills is exempt from state and local income tax, although it is subject to federal income tax. The Auction Process and Primary Market New Treasury bills are introduced to the market through a regular auction process conducted by the Treasury Department.
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