Why do U.S. Treasury bills have lower interest rates than large-denomination negotiable bank CDs

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Why do U.S. Treasury bills have lower interest rates than...

Key Concepts

Credit Risk

Credit risk refers to the potential for loss due to an issuer's failure to meet its financial obligations. U.S. Treasury bills are backed by the full faith and credit of the U.S. government, making them almost free of credit risk. In contrast, bank-issued certificates of deposit, even those issued in large denominations, carry some risk of default, which investors account for when demanding a higher interest rate.

Risk Premium

The risk premium is the additional return investors require for taking on extra risk. Because Treasury bills are considered extremely safe investments, they offer lower yields. Negotiable bank CDs, however, carry higher credit and liquidity risks, prompting investors to seek a risk premium in the form of higher interest rates.

Yield Determination

Yield determination in financial instruments is influenced by the perceived safety, liquidity, and credit quality of the issuer. U.S. Treasury bills, due to their low risk and high liquidity, command lower yields compared to bank CDs, which must offer higher returns to attract investors despite their comparatively higher risk profile.

Liquidity

Liquidity refers to the ease with which an asset can be bought or sold in the market without affecting its price. U.S. Treasury bills are highly liquid, meaning there is a large market for them and investors are confident in their ability to quickly convert them into cash. In contrast, negotiable CDs may be less liquid, which can contribute to the higher interest rates as investors demand compensation for the lower liquidity.

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