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Interest on U.S. Treasury bills is computed using which of the following calculations?

a. Actual days on the basis of a 360-day year
b. Actual days on the basis of a 365-day year
c. 30-day months on the basis of a 360-day year
d. 30-day months on the basis of a 365-day year

1 Answer

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Final answer:

The correct answer is option a. Actual days on the basis of a 360-day year.

Step-by-step explanation:

Interest on U.S. Treasury bills is computed using the calculation of actual days on the basis of a 360-day year. This convention simplifies the interest calculation for these short-term securities. To further illustrate financial calculations, let’s consider a simple two-year bond. When issued for $3,000 at an interest rate of 8%, this bond will pay $240 in interest each year (calculated as $3,000 × 8%). Calculating the present worth of this bond requires discounting future payments to their present value using the present value formula.

Under a discount rate of 8%, the present value of the first year's interest payment ($240) would be $240 / (1 + 0.08), and the second year's combined payment of interest and principal ($3,240) would be $3,240 / (1 + 0.08)². If the discount rate rises to 11%, the first year's interest payment's present value becomes $240 / (1 + 0.11), and the second year's combined payment's present value is $3,240 / (1 + 0.11)².

The stream of payments being received from the bond in the future are worth less in today's money when a higher discount rate is applied, indicating that bond prices and interest rates have an inverse relationship.

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