Question

Which of the following is the best expression for the yield on a government T-Bill?

A) YTM = kr

B) YTM = kr + INF

C) YTM = kr + INF + MRP

D) YTM = kr + INF + MRP + LRP

E) YTM = kr + INF + MRP + LRP + DRP

Please explain with detail. Thanks in advance.

Answer 1

The best expression for the yield on T bill is :

YTM = kr + INF,

T bills are the safest investment and is backed by the full and faith and credit of the Government. These T bills are default free, so there is no default risk premium, there is no lack of liquidity in T bills, so there is no Liquidity risk premium . It is virtually risk free,  In fact, holding treasuries poses some very specific risks like inflation risk, interest rate risk, and opportunity cost. A Treasury Bill (T-Bill) is a short-term debt obligation backed by the U.S. Treasury Department with a maturity of one year or less, so there is no maturity risk premium as well.

SO, we are only compensated for the INFLATION RISK.

So, the correct expression is option B. The yield on the T-Bills only compensate us for the inflation risk.