As with all bonds, when interest rates go up, the value of the bond goes down. When interest rates drop, the value of the bond rises. After a bond is issued, the price of the bond reflects current interest rates. If the bond did not change price, an investor would not be able to sell the bond once interest rates changed, because the buyer could get a better rate by buying a newly issued bond. It is important to understand this principle before reading any further.
Bonds change value with interest rate changes.
T-bills are sold at a discount and bought by individual investors on a noncompetitive bid. This means that once the institutional investors, including mutual fund and pension managers, make their purchase through the auction process, an average interest rate is calculated. This average rate becomes the rate offered to noncompetitive bidders. The discount is based on the interest rate and is an immediate return of the interest earned over the term of the purchased T-bill. The interest rate actually earned is not the same as the discount received, because the interest rate is based on the amount actually invested.