Treasury bills are the shortest-maturity instruments issued by the U.S. Department of the Treasury to fund federal government operations. They are issued at a discount to face value and mature at par — the difference represents the investor's return. Standard maturities are 4, 8, 13, 17, 26, and 52 weeks. Because T-bills pay no periodic interest, they have no reinvestment risk during their term.
T-bills are considered the risk-free rate benchmark in finance and serve as the baseline against which other investments are measured. They are backed by the full faith and credit of the U.S. government, making credit risk negligible. They are sold via competitive and non-competitive bids at weekly Treasury auctions.
Discount yield (bank discount yield) is the standard quotation method for T-bills: [(Face − Price) / Face] × (360 / Days). The bond equivalent yield (BEY) restates the return on a 365-day basis for comparison to coupon-bearing securities. The BEY is always higher than the discount yield.
Interest income from T-bills is subject to federal income tax but exempt from state and local income taxes — a key advantage over comparable corporate instruments for investors in high-tax states.
> Exam tip: On the Series 7 and Series 65/66, know the discount yield vs. BEY distinction. T-bill interest is taxable federally but state/local exempt — the same rule applies to all Treasury securities. Remember that T-bills are the closest proxy to the risk-free rate used in CAPM and the Sharpe ratio formula.