How Treasury Bills Make Money For You. All treasury bills are short-term investment instruments and tend to mature within a year from the date of issue. The Governments of USA, UK, Canada, Nigeria and Kenya issues 91-day, 182-day and 364-day Treasury bills…
With rates so low, investors of U.S Treasury bills (T-bills), Treasury notes (T-notes), and Treasury bonds (T-bonds) barely get any yield at all. While the value of T-bills, T-notes, and T-bonds has
When an investor buys a Treasury Bill, they are lending money to the government. The US Government uses the money to fund its debt and pay ongoing expenses Fixed and Variable Costs Cost is something that can be classified in several ways depending on its nature.
What is Treasury Bills (TB) ?
This is a type of government securities issued on behalf of the Federal Government by CBN to control money supply in the economy. But unlike other government securities such as FGN Bonds, Federal Government Development stocks, which are long term in nature, TBs are short term securities issued at a discount for a tenor ranging from 91 to 364 days, which yields no interest.
How does the discount work?
If you buy T-bills worth of N500,000 at 10 per cent discount rate, CBN will debit your account with N450,000, leaving a balance of N50,000.
“This means that your interest of N50,000 has been paid to you upfront.When your investment matures, you are still paid your N500,000.This shows that you were actually paid N550,000 for your investment of N500,000”, says praticalbusinessideas.com.
Tenor of Treasury bills
Tenor is the duration of the investment.It is how long you are willing to let your funds stay with the Federal Government.Tenor is usually in 91 days(3months), 182 days(6 months) and 364 days (one year).Your investment matures after the expiration of the tenor.
How do I buy T-bills?
According to CBN, T-bills can be purchased both at the primary and secondary markets. The following steps are the procedures laid down by the apex bank
This is where new issues of securities are available for sale. The market for new issues in all government securities is the Issues Office, Central Bank of Nigeria. Secondary market is a market for the trading of previously issued securities. Hence, tenors of the securities traded are shorter than the original tenors. In the case of treasury bills, the market is within and outside the Central Bank of Nigeria. The market in the CBN is located at the Securities Dealing Office and Settlement and Control Office, while the outside markets include Banks and Discount Houses.
Primary market procedure for investing in TBs
All investments are by auction. Subscriptions at this market are for 91,182 and 365 days. “An advertisement, inviting bids for the securities is placed in selected national dailies in advance of the auction. The amount of securities being applied for ordinarily should have a minimum value of N10,000 and in multiples of N1,000 thereafter. Interested investors should obtain and complete application forms through authorized dealers (Banks and Discount Houses and Stock brokers). Interested Authorized dealers may submit tender on their own account or on behalf of their customers. Therefore, subscription is open to banks, discount houses, corporate bodies, institutions and individuals. Tenders for the Bills or Certificates are submitted on Mondays, Tuesdays and Wednesdays before 1.30p.m on the prescribed printed forms and in sealed envelope marked “TENDER FOR BILLS OR CERTIFICATES”.
Pricing and Allotment
Successful subscribers at the auction are allotted applying the Dutch, Multiple price auction system. Under the system, successful applicants pay for their allotment at the price quoted by them.
The result of the tender is announced before the close of business on Wednesdays. Allotment letters are issued to successful tenders on Thursday while payment in full for the amount of the successful tender must be made to the CBN not later than 1.30 p.m on the issue date – Thursdays. The accounts of the authorized dealers which must be funded are debited with the cost.
Secondary market procedure for investing in T-bills through Open Market Operation(OMO)
All investments are through auctions Notice, inviting bids is forwarded to licensed Discount houses and banks a day preceding the auction. Subscriptions are open to the general public, that is, banks/discount houses, government agencies, corporate bodies institutions and individuals. All applications must, however be routed through licensed discount houses. The amount of securities being purchased must have a minimum value of N10,000 and in multiples of N1,000 thereafter. Each applicant must state the discount rate and the amount of securities being applied for.
Successful applicants at the OMO auctions are allotted using the Dutch, multiple pricing system. Under this system, securities are allotted to applicants at the rate quoted by them. The accounts of the successful applicants are debited with the cost through the discount houses. Results of the OMO auction are announced through the discount houses and banks; and on the following day through the media. Authorised Dealer Banks and Discount Houses and other institutions that maintain accounts with the CBN have direct access to the CBN and they can also give mandate for automatic investment of idle funds on their accounts. Other investors would communicate their intention through the authorized dealers. Trading can be undertaken any day of the week during approved banking hours. Rates at this market are administratively fixed and as such are lower than rates obtained through auctions.
True Yield of Treasury Bills
A true yield is calculated as the actual return on your investment. According to practicalbusinessideas.com, the initial yiels for N500,000 at 10 per cent is N50,000.”However, because your interest is paid upfront, your actual yield is the N50,000 divided by the N450,000 deducted from your account, multiplied by 100.That is 11.11 per cent, which is higher than the 10 per cent. You can only enjoy true yield when you hold your investment to maturity.”
Can I sell my T-bills before it matures?
If you are in urgent needs of funds, you may sell your T-bills before it matures, using the OTC market. Whether you will sell for more or less of your face value depends on the forces of demand and supply. Here is an instance; a N505,000 (higher value) provided your face value is trading at a higher price. However you may have to sell at a loss (N545,000) if your face value is trading at a lower price.
Benefits of T-bills
Yield / Income on investment is realizable upfront and can be automatically reinvested for a higher income. Yield / Income on investment is competitive with returns on other money market instruments of similar maturities. The securities have zero-default risk. Yield/Income on investment is tax-free. The securities can be used as collateral for short-term borrowing from banks.
What are Treasury Bills?
Treasury bills are short-term, government-backed debt instruments that the government issues through its treasury department to raise funds for governmental projects. The Treasury bill serves as an IOU (I owe you) where the government acknowledges its indebtedness to the holder of the Treasury bill for the amount stated on the bill.
For example, the government can issue a six months treasury bill of $1,000. The six months is the maturity period. The $1,000 is the par value of the bill. If Investor A pays $950 to purchase the bill, the $950 is the discount value, and the $50 is the discount and the discount rate is 5% ($50/$1000 * 100).
A treasury bill is a zero-coupon bond, which means rather than receiving regular interest on the bill, the interest is paid as a discounting factor on the par value. Therefore, instead of paying $1,000, you pay $950 for a $1,000 bill, but when the government pays back at the maturity date, they pay you $1,000. Rather than a bond where you get two interest payments in a year, with a bill you get the interest payment at once- at maturity.
The maturity date for treasury bills is usually one year or lesser. They are issued in denominations ranging from a thousand dollars (or naira or pounds) to five million dollars (or naira or pounds). Treasury bills are sold through auctions in competitive or non-competitive bids.
In a competitive bid, every investor bids a specific discount rate (3%, 5%, 10%, etc.) they are willing to accept for the bill. The treasury department starts allocating the bills according to the bids, starting from the lowest discount rate until they sell the total number of bills they plan to issue.
In a non-competitive bid, the government finds the average discount rate from all the bids placed, and that figure becomes the discount rate that everyone accepts.
How to make money with Treasury Bills (TB)
There are two ways to make money from treasury bills:
- Earn interest at the maturity date: You can decide to hold the bill to maturity where you receive the par value of the bill and earn the difference between the par value (that you receive) and the discount value (that you pay).
- Sell in the secondary market: On the other hand, you can decide not to hold the bill to maturity. In this case, you can sell the bill at a secondary market (at the prevailing interest rate) and (hopefully) earn a profit. Your ability to make a profit depends on the current price of the Treasury bill.
You can buy treasury bills through your broker during the initial auction or in the secondary market. You can also sell your bills in the secondary market through your broker.
Factors that affect the prices of Treasury Bills
The prices of treasury bills vary depending on certain factors:
When inflation is high, the discount rate on treasury bills must be higher than the prevailing inflation rate to be profitable. For example, if the inflation rate is 10%, the discount rate on treasury bills must be higher than 10% to make them valuable in real terms. High inflation will make treasury bills less desirable, causing lower demand and fall in prices and vice versa.
Federal Funds Rate
When the Central Bank or Federal Reserve increases the federal funds rate or the monetary policy rate, investments in other debt securities increase, making treasury bills less desirable. Consequently, the prices fall. If the Central Bank or Federal Reserve reduces the federal funds rate or MPR, investments in other debts securities reduce, making treasury bills more desirable. Consequently, prices increase.
The longer the maturity date, the higher the return, vice versa. Treasury bills have a maximum of a one-year maturity.
The current level of risk associated with high returns investment like stocks, mutual funds, and corporate bonds will also affect the price of treasury bills. When there is a higher risk associated with them, treasury bills become more desirable (since they come with no risk), and prices increase, vice versa.
When the interest rate is growing, the value of fixed-income securities decreases. Since people can buy the same type of investment at a higher rate, they will pay less for fixed income securities with rates below the current interest rate. If the prevailing interest rate exceeds the discount rate on the bill, the price falls, vice versa.
The above factors will determine the price of a treasury bill at a particular period. The price will determine if you will make a profit when you decide to sell in a secondary market.
Pros of Investing in Treasury Bills
What are some of the benefits of treasury bills in comparison to other investment channels?
A treasury bill is backed by the financial power of the Federal Government. Therefore, you can be sure there will not be a default when it is time for repayment. Only treasury bonds offer the same kind of security.
Safe and Stable Income
Treasury bills allow you to earn a safe and stable income from your investment. When you buy a bill, you know when you will be paid, and you have the assurance that there will not be a default. It makes it easy to make financial plans.
Ease of investment
If you cannot participate in the auction, you can easily buy treasury bills in the secondary market through any broker. Also, the minimum investment requirement is usually low, which makes it more accessible to many investors.
Cons of Investing in Treasury Bills (TB)
The returns on treasury bills are small when compared to corporate bonds, stocks, mutual funds, or even certificates of deposits. The return follows the truism, “the lower the risk, the lower the returns.”
Vacillating Interest Rates
The prices of treasury bills move with interest rates. In cases where the prevailing interest rate is higher than the discount rate on a bill you purchased, the value of your bill falls, ceteris paribus.
Though they are short-term investments, when you buy treasury bills, you lock in your cash for the period before maturity. Selling at the secondary market is undesirable most of the time. When you lock your money in this way, there is an opportunity cost.
Below are some recommendations for Treasury bill investors:
- Invest more in treasury bills when the market risk (of other high yielding investments) is high and not when the market risk is low.
- Don’t buy treasury bills at a discount rate below inflation, ceteris paribus
- Don’t be too invested in treasury bills. Diversify your portfolio with other high yielding assets
- Consider using the bond ladder system for treasury bills to minimize idle cash.
Difference between T-Bills, T-Notes, and T-Bonds
T-bills, T-notes, and T-bonds are fixed-income investments issued by the US Department of the Treasury when the government needs to borrow money. They are all commonly referred to as “Treasuries.”
Treasury bills have a maturity of one year or less and they do not pay interest before the expiry of the maturity period. They are sold in auctions at a discount from the par value of the bill. They are offered with maturities of 28 days (one month), 91 days (3 months), 182 days (6 months), and 364 days (one year).
Treasury notes have a maturity period of two to ten years. They come in denominations of $1,000 and offer coupon payments every six months. The 10-year T-note is the most frequently quoted Treasury when assessing the performance of the bond market. It is also used to show the market’s take on macroeconomic expectations.
Treasury bonds have the longest maturity among the three Treasuries. They have a maturity period of between 20 years and 30 years, with coupon payments every six months. T-bond offerings were suspended for four years between February 2002 and February 2006. T-bond offerings resumed due to demand from pension funds and other long-term institutional investors.
A good investment portfolio should have some treasury bills to minimize overall portfolio risk, especially when market risk is high.
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