Treasury Bills Final.odt

Treasury Bills 

Treasury bills represent short-term borrowings of the Government.

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Treasury bill market refers to the market where treasury bills are brought and sold.

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Treasury bills are very popular and enjoy higher degree of liquidity since they are issued by the government.

What is Treasury bill? 

a treasury bill is nothing but a promissory note issued by the Government under discount for a specified period stated there in.

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The Government promises to pay the specified amount mentioned there in to the bearer of the instrument on the due date.

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The period does not exceed a period of one year

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It is purely a finance bill since it does not arise out of any trade transaction

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Treasury bills are issued only by the RBI on behalf of the Government.

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Treasury bills are issued for meeting temporary Government deficits.

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The Treasury bill rate of discount is fixed by the RBI from time-to-time.

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It is the lowest one in the entire structure of interest rate in the country because of short term maturity and degree of liquidity and security.

Types of Treasury bill: 1. Ordinary and Regular

2. AD-HOCS Ordinary TB:

Ordinary treasury bills are issued to the public and other financial institutions for meeting the short –term financial requirements of the Central Government.

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These bills are freely marketable and they can be brought and sold at any time and they have secondary market also.

AD-HOCS:

Ad-hocs are always issued in favor of the RBI only. They are not sold through tender or auction. They are purchased by the RBI and the RBI is authorized to issue currency notes against them.

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Ad hocs serve the Government in the following ways:

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They replenish cash balances of the central Government .Just like state Government get advance (ways and means advances) from the RBI, the central Government can raise finance through these ad hocs.

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They also provide an investment medium for investing the temporary surpluses of State Government , semi-government departments and foreign central banks.

On basis of periodicity:

91 Days TB

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184 Days TB

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364 Days TB

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Ninety one days treasury bills are issued at a fixed discount rate of 4% as well as through auctions.

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364 days bills do not carry any fixed rate. The discount rate on these bills are quoted in auction by the participants and accepted by the authorities .Such a rate is called cut off rate .In the same way, the rate is fixed for 91 days treasury bills sold through auction.91 days treasury bills (top basis) can be rediscounted with the RBI at any time after 14 days of their purchase .Before 14 days a penal rate is charged.

Participants:

RBI and SBI

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Commercial Banks

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State Government

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DFHI

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STCI

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Financial Institutions like LIC, GIC, UTI, TDBI, ICICI, IFIC, NABARD etc.

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Corporate customers

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Public

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Through any participants are there, in actual practice, this market is in the hands at the banking sector. It accounts for nearly 90% of the annual sale of TBs.

Process of treasury bills When an investor purchases a T-Bill, the U.S. government effectively writes investors an IOU; they do not receive regular interest payments as with a coupon bond, but a T-Bill does include interest, reflected in the amount it pays when it matures.

The pricing of T-Bills is unique among government debt issues; rather than providing interest payments like Treasury Bondsor Notes do, T-Bills are sold at a discount and the entire return is realized upon maturity. The interest rate earned on T-Bills is equal to the difference between the purchase price and maturity value, divided by the maturity value. New issues of T-Bills can be purchased at auctions held by the government; previously issued ones can be bought on the secondary market. T-Bills purchased at auctions are priced through a bidding process. Bids are referred to as "competitive" or "non-competitive." A competitive bid sets a price at a discount from the T-Bill's par value, letting you specify the yieldyou wish to get from the T-Bill. Non-competitive bid auctions allow investors to submit a bid to purchase a set dollar amount of the Bills. The yield they receive is based upon the average auction price from all bidders. Importance Of TB:Safety: Investments in TBs are highly safe since the payment of interest and repayment of principal are assured by the Government. They carry zero default risk since they are issued by the RBI for and on behalf of the central bank.

Liquidity: Investments in TBs are also highly liquid because they can be converted into cash at any time at the option of the inverts. The DFHI announces daily buying and selling rates for TBs. They can be discounted with the RBI and further refinance facility is available from the RBI against TBs. Hence there is market of TBs. Factors that affect Treasury bills T-Bill prices fluctuate in a similar fashion to other debt securities. Many factors can influence TBill prices, including macroeconomic conditions, monetary policy and the overall supply and demand for Treasuries.

Investors' risk tolerance affects prices. T-Bill prices tend to drop when other investments seem less risky and the U.S. Economy is in expansion. During recessions, in contrast, investors may decide that T-Bills are the safest place for their money, and demand could spike. T-bills are seen as extremely secure, as they are backed by the full faith and credit of the U.S. government. This makes them the closest thing to a risk-free return in the market, unless they are resold on the secondary market, in which case they become exposed to market risk. Yield curves can even become inverted during times of real uncertainty. The monetary policy set by the federal reserve has a strong impact on T-Bill prices as well. Tbills compete with other short-term returns, including the federal fund rate. According to economic theory, interest rates tend to change across the market and move closer to each other, which is exactly what happens with T-Bills and interest rates set by the Fed. A rising federal

funds rate tends to draw money away from Treasuries, causing the price to drop. The drop in prices tends to continue until the return on T-Bills is no longer lower than the federal funds rate. The Federal Reserve is often one of the largest purchasers of government debt securities. T-Bill prices tend to rise when the Fed performs expansionary monetary policy by buying Treasuries. The opposite is also true when the Fed sells its securities. Treasuries also have to compete with inflation. Even if T-Bills are the most liquid and safest debt security in the market, fewer people want to invest in them if the rate of inflation is higher than the return they offer. If someone purchases a T-Bill when it is yielding 2% and inflation is at 3%, then the investment actually loses money in real terms. Thus, prices tend to drop during inflationary periods. Advantages of TB  With a minimum investment requirement of just $1,000, they are accessible by a wide range of investors.  Their interest income is exempt from state and local income taxes. (It is, however, subject to federal income taxes, and some components of the return may be taxable at sale/maturity.)  They are highly liquid. Investors can keep funds in these treasuries if they believe that they may have some need of cash within the next year. Treasuries are also very easy to buy and sell, and they tend to carry lower spreads than other securities on the secondary market.  They do not have any call provisions. In times of declining interest rates, when municipal or corporate bonds are often being called in by their issuers, T-Bill investors have the peace of mind of knowing exactly how long they can hold their securities.

Disadvantages of TB  Because they are generally considered one of the safest short-term investments, T-Bills offer relatively low returns compared to other debt instruments. In fact, rates on T-Bills can be less than most money market funds or certificates of deposit (CD's). Remember the finance world mantra: less risk, less reward.  The returns from T-Bills are only realized when they mature, making them a somewhat less attractive income vehicle – especially for investors seeking a steady cash flow. Calculation of the price To calculate the price, you need to know the number of days until maturity and the prevailing interest rate. Take the number of days until the Treasury bill matures, and multiply it by the interest rate in percent. Take the result and divide it by 360, as the Treasury uses interest-rate assumptions using the common accounting standard of 360-day years. Then, subtract the resulting number from 100. That will give you the price of a Treasury bill with a face value of $100. If you want to invest more, then you can adjust the figure accordingly. As a simple example, say you want to buy a $1,000 Treasury bill with 180 days to maturity, yielding 1.5%. To calculate the price, take 180 days and multiply by 1.5 to get 270. Then, divide by 360 to get 0.75, and subtract 100 minus 0.75. The answer is 99.25. Because you're buying a $1,000 Treasury bill instead of one for $100, multiply 99.25 by 10 to get the final price of $992.50. Keep in mind that the Treasury doesn't make separate interest payments on Treasury bills. Instead, the discounted price accounts for the interest that you'll earn. For instance, in the

preceding example, you'll receive $1,000 at the end of the 180-day period. Because you only paid $992.50, the remaining $7.50 represents the interest on your investment over that time frame. HOW IT WORKS: 

T-Bills are issued at a discount to the maturity value. Rather than paying a coupon rate of interest, the appreciation between issuance price and maturity price provides the investment return.

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For example, a 26-week T-bill is priced at $9,800 on issuance to pay $10,000 in six months. No interest payments are made. The investment return comes from the difference between the discounted value originally paid and the amount received back at maturity, or $200 ($10,000 - $9,800). In this case, the T-bill pays a 2.04% interest rate ($200 / $9,800 = 2.04%) for the six-month period.

WHY IT MATTERS: 

T-bills are considered the safest possible investment and provide what is referred to as a ,"risk free rate of return" based on the credit worthiness of the United States of America. This risk-free rate of return is used as somewhat of a benchmark for rates on municipal bonds, corporate bonds and bank interest.

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In addition, because T-bills are very short-term investments (as opposed to Treasury notes and Treasury bonds) there is very little interest rate risk. When interest rates rise, the price of fixed return securities falls as the relative value of their future income stream is discounted. However, short-term securities are much less affected than long-term securities because higher rates will have a very limited effect on future income streams.

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Treasury interest is also exempt from state and local taxes because of the law of reciprocal immunity, which stipulates that states cannot tax federal securities and vice versa.

Treasury bills, notes, and bonds are fixed income investments issued by the U.S. Treasury department. They are the safest investments in the world since the U.S. government guarantees them. This low risk means they have the lowest interest rates of any fixed-income security. Treasury bills, notes, and bonds are also called "Treasury’s" or "Treasury bonds" for short. How They Work The Treasury Department sells all bills, notes, and bonds at auction with a fixed interest rate. When demand is high, bidders will pay more than the face value to receive the fixed rate. When demand is low, they pay less. The Treasury Department pays the interest rate every six months. If you hold onto Treasury’s until term, you will get back the face value plus the interest that was paid over the life of the bond. You get the face value no matter what you paid for the Treasury at auction. The minimum investment amount is $100. That places them well within reach for many individual invsters. Don't confuse the interest rate with the treasury yield. The yield is the total return over the life of the bond. Since Treasury’s are sold at auction, their yields change every week. If demand is low, notes are sold below face value. The discount is like getting them on sale. As a result, the yield is high. Buyers pay less for the fixed interest rate, so they get more for their money. When demand is high, they are sold at auction above face value. As a result, the yield is low. The buyers had to pay more for the same interest rate, so they get less return for their money.

Since Treasury’s are safe, demand increases when risk rises. The uncertainty following the2008 financial crisis heightened their popularity. In fact, Treasury’s reached record-high demand levels on June 1, 2012. The10- year treasury note yield dropped to 1.442 percent, the lowest level in more than 200 years. This was because investors fled to ultra-safe Treasury’s in response to the Eurozone net crisis. On July 25, 2012, the yield hit 1.43, a new record low. On July 1, 2016, the yield fell to an intra-day low of 1.385. These lows had a flattening effect on the Treasury yield curve. The Difference Between Treasury Bills, Notes, and Bonds The difference between bills, notes, and bonds are the lengths until maturity: 

Treasury bills are issued for terms less than a year.

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Treasury notes are issued for terms of 2, 3, 5, and 10 years.

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Treasury bonds are issued for terms of 30 years. They were reintroduced in February 2006.

How to Buy Treasurers There are three ways to purchase Treasury’s. The first is called a non-competitive bid auction. That's for investors who know they want the note and are willing to accept any yield. That's the method most individual investors use. They can just go online to Treasury direct to complete their purchase. An individual can only buy $5 million in Treasury’s with this method. The second is a competitive bidding auction. That's for those who are only willing to buy a Treasury if they get the desired yield. They must go through a bank or broker. The investor can buy as much as 35 percent of the Treasury Department's initial offering amount with this method.

The third is through the secondary market. That's where Treasury owners sell the securities before maturity. The bank or broker acts as a middleman. You can profit from the safety of Treasurys without actually owning any. Most fixed income mutual funds own Treasurys. You can also purchase a mutual fund that only owns Treasurys. There are also exchange-traded funds that track Treasurys without owning them. If you have a diversed portfolio, you probably already own Treasurys. How They Affect the Economy Treasurys affects the economy in two important ways. First, they fund the U.S. debt. The Treasury Department issues enough securities to pay ongoing expenses that aren't covered by incoming tax revenue. If the United States defaulted on its debt, then these expenses would not be paid. As a result, military and government employees wouldn't receive their salaries. Recipients of Social Security, Medicare, and Medicaid would go without their benefits. It almost happened in the summer of 2011 during the U.S. Debt ceiling crisis. Second,Treasury notes affect mortgage interest rates. Since Treasury notes are the safest investment, they offer the lowest rate of return or yield. Most investors are willing to take on a little more risk to receive a little more return. If that investor is a bank, they will issue loans to businesses or homeowners. If it's an individual investor, they will buy securities backed by the business loans or mortgage. If Treasury yields increase, then the interest paid on these riskier investments must increase in lock-step. Otherwise, everyone would switch to Treasurys if added risk no longer offered a higher return.