What Does a Treasury Bill & How Does It Benefits to an Investor?
May 23 2022 7 Min Read
For most countries, the monarchy came to an end aeons ago and ended the supreme authority of the monarchs to own the whole kingdom. Now, we have governments.
A government is an organised community that functions for the people and does not own everything in the country. They have their share of assets and obligations.
So, when the government requires funds, it tours the financial market for fundraising.
The government has been raising money with the help of two debt instruments – treasury bills and government bonds.
When the government requires quick money for a short period, they issue treasury bills.
But the main question is, what are treasury bills and who buys them?
Read on to find the answers to all your questions in detail.
So, what is a treasury bill?
The central government issues treasury bills when they need funds to clear their short-term obligations.
They are not interest-generating securities, and they are sold at a discounted rate, but the government pays in total face value during maturity. Hence, treasury bills are a powerful financial instrument for booking capital gains.
These bills are short-term financing instruments marketed by the government to increase liquidity. It is a money market instrument and can be easily converted into cash.
Because the treasury bill is a money market instrument, it is usually traded over the counters and cannot be done by an investor alone; one needs a certified broker to do so.
However, this is some random information about the treasury bill. The exact definition of a treasury bill is as follows:
Treasury bills definition
In India, Treasury Bills were first issued in 1917. T-Bill or Treasury Bill, in simple words, refers to the government bonds or government debt securities, the maturity period of which is less than a year.
Also, Treasury bills are financial tools issued by the Reserve Bank of India for short-term borrowings on behalf of the government. They are a type of promissory note because they promise full payment at a later date. The maximum tenure of treasury bills is 364 days.
Properties of treasury bills
Treasury bills have some caveats that an individual should know before deciding to make an investment choice.
The features of treasury bills are as follows:
- If an individual wants to purchase a treasury bill, they need to invest a minimum amount of INR 25,000 to secure a short-term treasury bill.
- One cannot buy treasury bills with a random value. The amount you plan to invest in a treasury bill should be in multiples of INR 25,000.
- Treasury bills are zero-coupon securities, and these government securities do not give any interest on the bills. So, investors should book capital gains from these investments.
- Treasury bills are sold at a discounted rate. But, during the repayment, investors are paid the total face value of the treasury bills.
- The Reserve Bank of India auctions the treasury bills on behalf of the Central government in the market. Every Wednesday, the auctions occur depending on the total bids placed on significant stock exchanges.
- The process behind investing in treasury bills is the most integral part of the investing procedure. Investors buy these securities through registered primary dealers (PDs), brokers, depository participant commercial banks or brokers, where the bill transfer follows T+1 settlement.
P.S. – T+1 settlement means that one must meet all the trade-related settlements within a day after completing the transaction.
How do treasury bills work?
To understand how exactly the treasury bill works, let us know by taking the help of an example.
A treasury bill is available in the market at INR 95. But, the face value of that bill is declared to be INR 100 on the maturity date. The issue date is 1st March 2022, and it is a 91-day treasury bill.
Hence, after 91 days from 1st March 2022, the value of this treasury bill will increase to INR 100.
The treasury bills are issued at a discount, and the redemption happens at total face value, and the investors receive the full value at the maturity date.
The returns from treasury bills can be higher if they are issued during a liquidity crisis in the country.
Similarly, the returns are lower if the treasury bills are issued when the country has strong liquidity.
Types of treasury bills meaning
The treasury bills are classified into four types depending on their tenure. These four types of treasury bills are as follows:
14-day treasury bill
The Reserve Bank of India announced the 14-day treasury bills as substitutes for the on-tap treasury bills. After 14 days from the issue date, treasury bills are either repaid or renewed.
The minimum value for buying 14-day treasury bills is INR 1 lakh, and these bills are sold only at 1 lakh or multiple.
The 14-day treasury bills have been designed to be sold only to state governments, foreign Central banks, and some particular structures. They are non-transferable and are available for re-discounting. One can re-discount these bills at 50 basis points higher than the initial discount rate.
These treasury bills are auctioned every week, possibly on Wednesday. The payment for these bills is made on the following Friday.
91-day treasury bill
The 91-day treasury bills are repaid or renewed 91 days after the issue. This treasury bill matures within 91 days and is auctioned weekly, possibly every Friday.
The minimum amount for investment in a 91-day treasury bill is INR 25 thousand and its multiples thereof. These bills are issued at a discounted rate, and the final price is determined through auctions.
182-day treasury bill
The 182-day treasury bills are bills that mature within 182 days from their date of issue. The minimum amount to purchase 182-day treasury bills is INR 25 thousand, and its multiples.
Like 91-day treasury bills, these bills are also issued at a discounted rate, and the final price is determined through auctions.
However, the auction takes place on a fortnightly basis, unlike 91-day treasury bills.
364-day treasury bill
The 364-day treasury bills are bills that mature within 364 days from the issue date. The minimum amount to purchase these bills is INR 25 thousand and multiples thereof.
These bills are issued at a discounted rate, and the final price is determined through auctions—the auction state place on a fortnightly basis, possibly every alternate Wednesday.
How to calculate the yield rate of treasury bills?
The formula used for the calculation of the percentage of yield generated from treasury bills is as follows:
Y = (100-P)/P X 365/D X 100
where,
Y = yield per cent or return per cent.
P = Discounted price of the bill or purchase price of the securities.
D = tenure of the bill.
Let us understand the above formula with an example for crystal clear understanding.
The Reserve Bank of India decides to issue a 182-day treasury bill.
The discounted value of the bill, or the value at which investors can purchase this security is INR 98, and the face value of the treasury bill is 100.
We have to determine the yield of this government security.
We already know that,
Discounted Price of the treasury bill (P) = 98
Tenure of the bill (D) = 182
Hence, yield rate (Y) = (100-98)/98 X 365/182 X 100
Yield rate (Y) = 2/98 X 365/182 x 100
Yield rate (Y) = 4.09 %
Hence, the yield rate of the given 182-day treasury bill is 4.09 per cent.
Merits of treasury bills
Some merits of treasury bills are as follows:
- Treasury bills are risk-free money market securities, and it is a tool of obligation to the Indian government that they will repay within the decided date.
The Reserve Bank of India issues the bills on behalf of the central government, which is the supreme authority in the country.
As the government backs the bills, it gives investors a sense of complete security.
- Treasury bills have high liquidity, and the government uses these bills to raise funds for a short period. The maximum maturity period of a treasury bill can last up to 364 days.
Investors looking for short-term and secure investments should invest their funds in treasury bills.
If the investor wants to encash them, this standard security can also be sold to others in the secondary market. This quality of immediate encashment and less maturity period makes treasury bills highly liquid and desirable for investors.
- The auction for treasury bills happens every week through non-competitive bidding, and this allows small-scale and retail investors to take part in the bidding without worrying about quoting the yield price.
This unbiased allotment approach attracts potential investors to the government securities market, thereby bringing higher cash inflows to the capital market.
Demerits of treasury bills
A few demerits of the treasury bill are as follows:
- Treasury bills are zero-coupon securities, and they do not generate any interest and remain constant until maturity, irrespective of economic growth or seasonal fluctuations.
- Treasury bills are known to deliver a lower rate of return than other securities. Other securities of the same category promise higher returns than treasury bills with the same conditions.
- A change in the market conditions affects the yield rate of other securities. However, there seems to be no upswing or downswing in the treasury bill because of market rumours or expectations.
Why are treasury bills crucial for the government?
Primarily, treasury bills are short term money market securities generated by the Reserve bank of India on behalf of the central government. The primary purpose of the government behind issuing treasury bills is to raise short-term funds to meet its short-term obligations that are more than the annual revenue generated by the government.
The primary purpose of issuing treasury bills is to lessen the fiscal deficit and regulate the currency circulating in the market.
The open market operations (OMO) methodology of the Reserve Bank of India includes issuing treasury bills. The reason behind giving treasury bills is to regulate citizens’ borrowing and spending habits to keep inflation in control. During an economic boom, there is a lot of money available in the market, and issuing Treasury bills help reduce the currency circulating in the market. This reduction, in turn, creates a healthy balance between demand and supply and prevents the upsurge of inflation.
On the contrary, a reverse OMO strategy is used when there is less currency circulating in the market. The government repays the treasury bills, leading to an inflow of money in the market, leading to increased demand, supply, and economic growth. The repayment of treasury bills also boosts cash inflow in the stock market as the investors try to channelise their money to alternative sources.
Overall, Treasury bills are of substantial importance. With the help of treasury bills, the government can generate short-term funds during a liquidity crisis in the company. The government also uses treasury bills for the open market operations strategies to regulate the currency circulating in the market.
What type of investors should invest in treasury bills?
Any investor looking for a safe investment and decent returns should invest in treasury bills issued by the government.
To provide an equal platform to all the investors, the Reserve Bank of India facilitates non-competitive bidding.
This non-competitive bidding process helps small investors participate in the bidding process and place bids alongside pioneer investors without hesitation.
The government also releases the details of the discounted value and face value before publishing these treasury bills. This process of disclosing information beforehand helps an individual identify the transparency of the process. If someone is planning for wealth accumulation robustly, this is the go-to tool.
In most countries, the treasury bill is the safest money market security. Investors who have been tired of losing their money in the risky stocks in the stock market can safely put their money into treasury bills.
Experienced investors always have a part of treasury bills in their financial portfolio for diversification purposes. The presence of a treasury bill helps an investor dilute the overall portfolio risk.
So, investors looking for a safe investment with a low risk can invest in treasury bills with a blindfold.
Frequently Asked Questions
Treasury bills have less than a year of maturity, i.e., up to 52 weeks. Typical maturities are 4, 8, 13, 26, and 52 weeks.
During the redemption of Treasury bills, the investors are paid at face value or par value – of the bill, bought at or issued at a discount.
The Treasury bill does not include regular interest payments, unlike coupon bonds.
The interest payment is reflected through the amount paid at maturity, which is the face value more significant than the purchase price.
In India, the treasury bills were issued in 1917 for the first time. The delivery of treasury bills happened through auctions that the Reserve Bank of India conducted.
Everyone from individuals to institutions and banks and trusts is allowed to purchase treasury bills. But, a large chunk of treasury bills is usually taken by Financial institutions.
These bills are crucial for the financial market as they can immediately change the liquidity status of the market.
Banks are known to provide treasury bills to the Reserve Bank of India to get money. The banks can keep treasury bills to clear their statutory liquid ratio (SLR) requirements.
Treasury bills are money market instruments used by the government to raise funds for a short period, and they are the safest securities besides government bonds.
These financial instruments are backed by the government and have a constant return, irrespective of the economic fluctuations. They have zero risk because they are the obligation of significant authority in India, thereby having high credibility.
The secondary market for treasury bills is also very active because they are highly liquid.
Amateur investors afraid of taking risks find treasury bills to be very favourable.
Interest income from treasury bills is taxed under federal income tax. Short term capital gains from Treasury Bills are subject to tax at rates applicable as per the income tax slab of the investors.
So, all investors are supposed to pay tax on the gains obtained from treasury bills and their income.
The profits from treasury bills will only enjoy a basic exemption under the capital gain head, and however, it is exempted from all state and local income taxes.
