Care to give a numeric example for me to understand what you
have said better ?
T-bills work by buying at a lower face value .
eg. $100 USD T bill is bought at a discount say 90 USD .
They can choose to sell at a lower discount from the face value eg
. 95 USD . That is what I mean at lower discount .
Anyone care to share and verify else I am going to buy T bills
to try out ... haha ... Actually I have a colleague ( pretty smart
) ... swap from shares to T bills last year ..
let me try.
firstly i want to clarify that i am talking about fixed income
instruments with coupons, ie treasury notes and bonds. treasury
bills have tenures less than 1 year and therefore usually do not
pay a coupon. it is this coupon payments that will affect the value
of the bond.
a bond is valued by 1) the present value of the future maturity
amount + 2) the present value of the coupons.
lets take a 10 year $1000000 bond yielding 5% when interest
rates are 5% ( this means the bond is selling at par). this bond
pays interest annually.
the present value of the bond when interest rates are 5% is
=
5000 (1- (1.05)^
-10)
100000
________________ +
________
(divided by)
.05
(1.05)^10
= 38608.675 ( present value of future coupons) + 61391.325
(present value of maturity amount)
= $100000
Now lets take this same 10 year $100000 bond yielding 5% when
interest rates are 1%. this bond also pays interest annually.
the present value of the bond when interest rates are 1% is
=
5000 ( 1 - ( 1.01)^-10) 100000
________________ +
______
(divided by)
.01
(1.01)^10
= 47356.523 (present value of future coupons) + 90528.695
(present value of maturity amount)
= $137885.219
So we can see from this simple exercise that when interest rates
are lower, bonds that have a higher interest rate than that of the
current interest rates would sell at a premium, rather than a
discount.
of course there are other issues that come into the pricing,
including but not limited to, the duration, convexity, effect of
time on a bond's price, as well as market supply and demand. what i
am trying to show you is purely the academic way of
calculation.