Treasury Bills and Bonds

Thursday, January 8, 2015

The most talked about story in the market last week was the depreciation of the Kwacha against the United States dollar. But that was not the only big story. There is one story that was overlooked – the Government raised K856.5 million in its first Treasury bill auction of 2015 on Thursday last week. The total value of treasury bills placed on offer on 8th January 2015 through the primary market was K900 million, unchanged from the preceding week's auction. In response to the tender invitations, investors submitted bids amounting to K856.5 million – this translated into a subscription rate of 95.2 percent compared to a subscription rate of 43.3 percent in the previous week. Except for the 273-day bills, all the other bills were oversubscribed. The Bank of Zambia sold K865.5 million ~$132 million) worth of treasury bills last week with yields on the 91-day, 182-day and 273-day papers higher than the previous auction, while the 364-day yields decreased slightly. The 364-day bills attracted the highest subscription, with investors bidding for a total of K446.9 million at a yield rate of 20.5 percent.

Results of Treasury Bills Auction, 8th January 2015

What are Treasury Bills?
It is not often that you hear one talking about investing in Treasury bills. We often think it is the preserve of the elite or the commercial banks, who are the most active players in the auctions. So, what exactly are treasury bills?

Treasury bills are investments that mature in one year or less and they are considered to be the baseline “risk free” investment. When you invest in Treasury bills, you are lending your money to the Government in exchange for interest payments. The Government uses Treasury bills to raise the money needed to pay off its bills. Here is where the Government is different from you and me, and different from firms. When the Government borrows money, it doesn't go to the bank and apply for a loan. It instead "issues debt” by selling tradable market securities such as Treasury bills and bonds. Over time, the Government gives that money, plus interest, back to the lenders as payment for using the borrowed money.

Treasury bills are offered with maturity dates of 91 days, 182 days, 273 days or 364 days. The maturity date tells you when you will get your principal back. Treasury bills do not pay any interest directly; instead, they are sold at a discount of their face value and thus “earn” by selling at face value upon maturity. For instance, if you have K20, 000 to invest in 91- day treasury bills now, you will buy those bills at a discounted rate of 12.8 percent, (i.e., you will pay K20, 000 less 12.8% = K17, 436). After 91 days, you will redeem K20, 000! That means you'd have made K2, 564 from your money in three months. Of course this is a simplistic example as you would have to incur withholding tax and other charges. So the effective yield rate averages 13.25 percent. But it will still be above the interest that any bank would give you for a fixed deposit account in 3 months?

What about bonds?
Another type of security worth investing in are government bonds, which are much more long-term (2-15 years) and more lucrative. A bond's face value, or price at issue, is known as its "par value." Its interest payment is known as its "coupon." The last time the Bank of Zambia auctioned bonds on behalf of the Central Government, the 3-year bond, for example, had a coupon rate of 10 percent and a yield rate of 16 percent [source: www.boz.zm ]. If you have just been given your K200, 000 gratuity by your employers and you invest in a 3-year bond with a 10 percent coupon, what the Government is saying is “In three years' time, I will owe you K200, 000. And every year until then, I will pay you K20, 000”. Actually, the money will arrive in two K10, 000 payments spaced 6 months apart. The yield rate takes care of the price fluctuations of the bond. If the market price fluctuates and values your bond at K125, 000, your yield would now be 16 percent (K20, 000/K125, 000), but the K10, 000 semi-annual coupon payments would not change. If you kept your investment up to maturity, in the three years' time, you would have earned K60, 000 on your investment.