Wednesday, August 19, 2009

calculating the yield on treasury bills

Treasury bills do not carry a promised interest rate but instead are sold at a discount from par. Thus, their yield is based on their appreciation in price between the time the bills are issued and the time they mature or are sold by the investor. Any price gain actually realized by the investor is treaded, not as a capital gain, but as ordinary income for federal tax purposes. We will see in the next topic that the rate, or yield, on most debt instruments is calculated as a yield to maturity. However, bill yields are determined by the bank discount method, which ignores the compounding of interest rates and uses a 360-day year for simplicity.
The bank discount rate (DR) on bills is given by the following formula:
DR = (per value-purchase price ÷ par value ) × (360÷ number of days to maturity)

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