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What is a treasury bill? How does it work?

The Government of India needs money to meet its financial obligations. They approach the general public to raise funds. The funds can be raised by offering different financial instruments. Treasury bill is one such money market instrument that the government issues for the short term requirement of funds. These financial instruments can be money market instruments, debt securities, bonds, and many more.

treasury bills

What is a treasury bill?

Treasury bills, also known as T-bills, are short term money market instruments. The RBI on behalf of the government to curb liquidity shortfalls. It is a promissory note with a guarantee of payment at a later date. The funds collected are usually used for short term requirements of the government. It is also used to reduce the overall fiscal deficit of the country.

 Treasury bills or T-bills have zero-coupon rates, i.e. no interest is earned on them. Individuals can purchase T-bills at a discount to the face/value. Later, they are redeemed at a nominal value, thereby allowing the investors to earn the difference. For example, an individual purchase a 91-day T-bill which has a face value of Rs.100, which is discounted at Rs.95. At the time of maturity, the T-bill holder gets Rs.100, thus resulting in a profit of Rs.5 for the individual.

Therefore, it is an essential monetary instrument that the Reserve Bank of India uses. It helps RBI to regulate the total money supply in the economy as well as raising funds.

Types of Treasury Bills

Four types of treasury bills are auctioned. The primary distinction for these treasury bills tbills is their holding period.

 14-day Treasury bill

These bills complete their maturity on 14 days from the date of issue. They are auctioned on Wednesday, and the payment is made on the following Friday. The auction occurs every week. These bills are sold in the multiples of Rs.1lakh and the minimum amount to invest is also Rs.1 lakh.

 91-day Treasury bill

These bills complete their maturity on 91 days from the date of issue.  They are auctioned on Wednesday, and the payment is made on the following Friday. They are auctioned every week. These bills are sold in the multiples of Rs.25000 and the minimum amount to invest is also Rs.25000.

182-day Treasury bill

These bills complete their maturity on 182 days from the date of issue.  They are auctioned on Wednesday, and the payment is made on the following Friday when the term expires. They are auctioned every alternate week. These bills are sold in the multiples of Rs.25000 and the minimum amount to invest is also Rs.25000.

364-day Treasury bill

These bills complete their maturity  364 days from the date of issue. They are auctioned on Wednesday, and the payment is made on the following Friday when the term expires. They are auctioned every alternate week. These bills are sold in the multiples of Rs.25000 and the minimum amount to invest is also Rs.25000.

As mentioned above, the holding period for each bill remains constant. However, the face value and the discount rates of treasury bills can change periodically. This depends on the funding requirements and monetary policy of RBI along with total bids received.

Also, The Reserve Bank of India issues treasury bills calendar for auction. It announces the exact date of the auction, the amount to be auctioned and the maturity dates before every auction.

Features of Treasury Bills

Form

Treasury bills can be issued in a physical form as a promissory note or dematerialized form by crediting to SGL account (Subsidiary General Ledger Account).

Minimum Bid Amount

Treasury bills are issued at a minimum price of Rs.25000 and in the same multiples thereof.

Issue Price

Treasury bills are issued at a discounted price. However, they are redeemed at par value at the time of maturity.

Eligibility

Individuals, companies, firms, banks, trust, insurance companies, provident fund, state government and financial institutions are eligible to purchase T-bills.  

Highly Liquid

Treasury bills are highly liquid negotiable instruments. They are available in both financial markets, i.e. primary and secondary market.

Auction Method

The 91 day T-bill follows a uniform auction method, whereas, 364 day T-bill follows a multiple auction method.

Zero Risk

The yields are assured. Hence, they have zero risks of default.

Day Count

For treasury bills, the day count is 364 days in a year.

Besides this, it also have other characteristics like market-driven discount rate, selling through auction, issued to meet short term cash flow mismatch, assured yield, low transaction cost, etc.

How to calculate the yield on Treasury bills?

To calculate the yield, the comparison of par value to its face value is the first step. Additionally, investment returns are more useful when expressed on an annualized basis. The next step is to use the maturity period to convert the return to an annual percentage.

You can calculate the yield of treasury bills through the following formula –

Y= (100-P)/P * [(365/D)*100], where

Y – Yield/ return percentage of T-bill

P – The discounted price of the T-bill purchased

D – Tenure of T-bill

Let’s understand this with an illustration. If RBI issues a 91- Day treasury bill at the discounted price of Rs.97 while the face value of the bill is Rs.100, the yield of the security can be determined as follows –

Yield = [(100-97)/97] *(365/91*100)

         = 12.40%

By annualizing the returns, a shorter Treasury bill can be compared with the following:

  • Long-dated Treasury bill
  • Government bond
  • Corporate bond
  • Treasury bond
  • Any other type of fixed income investment instrument.

 Advantages and limitations of treasury bills

Treasury bills investments come with many advantages as it provides safety and security to its investors.

Risk-Free

Treasury bills is a popular short term government security. The Central government backs them. They act as a liability to the Indian government as they need to be paid within a stipulated time.

Therefore, investors have total security on their funds invested as they are backed by the government of India, I.e. the highest authority in the country. The amount has to be paid to the investors even during the crisis.

Highly Liquid

Treasury bill has a highest maturity period of 364 days. They help in raising money for short term requirements for the economy. Individuals who are looking for short term investments can park their funds here. Also, T-bills can be sold in the secondary market. This allows investors to convert their holding into cash during any emergency.

Bidding

Treasury bills are usually auctioned by RBI every week. This allows the retail investors to place their noncompetitive bids. This increases the exposure of investors to the government bond market, which creates higher cash flows to the capital market.

Limitations of Treasury Bills

Compared to other stock market investment tools, treasury bills yield lower returns as they are government-backed debt securities. Treasury bills are zero-coupon bonds, i.e. no interest is paid on them to investors. They are issued at a discount and redeemed at face value. Therefore, the returns earned by investors in T-bills remains fixed throughout the bond tenure irrespective of the economic condition of the country.

Stock market variations influence the returns generated by equity, equity fund, debt fund and debt instruments. Subsequently, when the stock market moves upwards, the yield generated by equity, equity fund, debt fund or debt instruments is also higher. However, the returns generated by T-bills remain fixed irrespective of the financial market movements.

Who should invest in treasury bills?

The government of India issues Treasury bills which are ideal for investors who are looking for secure investment and reasonable returns. RBI facilitates the noncompetitive bids to be placed by the investors. The bidding process of T-bills allows investors to take part in the same by placing their bid. The details regarding the discount value and par value are published beforehand. Investors can get full transparency of the investment process. Also, it helps for wealth creation for individuals.

It is suitable for any investors irrespective of their knowledge and risk tolerance levels. Over and above, it can also add as a secure investment for investors looking for portfolio diversification. This can dilute the risk of overall portfolio allocation.

Even companies, firms, banks, trust, insurance companies, provident fund, state government and financial institutions are eligible to invest in treasury bills.

Treasury bills are the safest fixed income investment instrument in its category as the risk of default is negligible. The yield is also predetermined as the date of issue, the maturity dates and the amount is also fixed. They play a crucial role in regulating the total money supply in the economy. 

Published on September 10, 2020