U.S. Treasury bills (also called T-Bills) are securities representing financial obligations of the U.S. government. They have the unique feature of being issued at a discount from their stated value at maturity. In other words, a sum of money is paid today for a greater fixed dollar amount in the future at maturity; usually the payment at maturity is $100,000 (no coupon payments are made). For example, Treasury bills may sell for $98,000 when issued and have a maturity value of $100,000 in sex months. Thus, the return to the investor is $2,000. During this six month period, the investor earns interest, although the interest is not paid in cash but is merely accrued.

    Treasury bills have maturities of less than 1 year. T-bills are issued on an auction basis. The U.S. Treasury accepts competitive bids and allocates bills to those offering the highest prices. Noncompetitive bids are also accepted. A noncompetitive bid is an offer to purchase the bills at a price that equals the average of the competitive bids. By the end of 1996, the Treasury bill market exceeded $775 billion. The market for T-Bills is one of the most active in the world.

    The first column gives the coupon rate, followed by the maturity date. Next, the bid and asked discount rates are given, followed by the change from the previous day. The discount rate is a method of quoting interest rates for T-bills. The bid rate is the discount rate at which you, the investor, can sell a T-bill. The asked rate is the discount rate at which you can buy it from a dealer. The higher the discount rate, the lower the price. The bid discount rates exceed asked discount rates, because dealers are willing to sell only at prices higher than they are willing to buy. The final column gives the internal rate of return of the asked discount rate of the T-bill. It is calculated using a different approach than the discount rate, and it measures the yields so they are comparable to yields on Treasury and corporate bonds.

    Another type of money market security is commercial paper, which is a vehicle of short-term borrowing by large corporations. Large, well-established corporations have found that borrowing directly from investors via commercial paper is cheaper than relying solely on bank loans.

        Commercial paper is unsecured notes of corporations, usually issued at a discount. Unsecured means that these loans are not backed by specific assets. That is, the only thing backing the loans is the “full faith and credit” of the firm. Commercial paper is issued either directly from the firm to the investor or through an intermediary

        Issuers of commercial paper are typically corporations that have a high credit rating. However, other firms can use the commercial paper market if they “enhance” the credit quality of the commercial paper. Firms can enhance their credit by purchasing a guarantee from another, more well-established firm or by pledging collateral of quality assets with the issue.

        Commercial paper is riskier than Treasury bills, because there is a greater risk of default by a corporation. (There is virtually zero probability of default by the federal government.) Also, commercial paper is not easily bought and sold after it is issued, because most investors in commercial paper hold it until maturity. The majority of investors in this market are institutions like money market mutual funds and pension funds. By the end of 1996, the commercial paper market in the United States exceeded $475 billion.

        Bankers’ acceptances are short-term obligations that are based on a customer’s request to pay a supplier at a future date. Bankers’ acceptances arise from the financial needs of corporations engaged in international commerce. The supplier desires immediate payment. And the customer desires to pay once the goods are delivered and inspected. A bankers’ acceptance allows both the supplier’s and the customer’s desires to be achieved, but not without cost.

        To demonstrate how a firm and its customer use bankers’ acceptances, suppose a U.S. firm ships a 3-ton engine to a Swiss firm, and delivery takes two months. The U.S. firm would like payment from the sale today, and the Swiss firm wants to wait until the engine is delivered. Neither the U.S. firm’s bank nor the Swiss firm’s bank wants to provide the capital for this loan. The Swiss firm’s bank could pay the U.S. firm a discounted amount now. The Swiss bank could then sell this short-term loan contract to an outside party, recouping its initial outlay. This short-term loan contract will typically have a higher interest rate than similar money market securities, making it attractive to investors. Because of its complexity, the market for bankers’ acceptances does not have active trading of its securities. Its market, which is much smaller than that for commercial paper, was only about $12 billion in October 1996.