Introduction
The Central government issues several types of financial instruments to raise funds for their financial obligations. The general public can purchase these instruments such as debt securities, bonds, money market instruments. A treasury bill is a money market instrument used to raise funds for the government’s short-term requirements.
Treasury bills meaning
Treasury bills are issued as promissory notes with the guarantee of repayment on a later date. Since these T bills are used to meet short-term requirements, they help the government reduce the country’s fiscal deficit. Holders of treasury bills do not earn any interest on them since these financial instruments carry zero-coupon rates. These money market instruments are issued at a discounted value compared to the nominal value. Upon maturity, treasury bills can be redeemed at their nominal value. This way, the holders of these bills can earn a profit on the amount initially invested by them.
Why are they issued?
Treasury bills, which are short-term financial instruments, are issued to meet the government’s obligations that exceed its annual revenue generation. The idea is to bring down the total fiscal deficit and regulate the circulation of currency. T bills are issued by the Reserve Bank of India (RBI) as part of their open market operations. Here’s why –
- When inflation rates are high, especially during an economic boom, issuing treasury bills reduces the supply of money in the economy. This reduces demand rates and, as a result, the high prices.
- During a recession or times of economic slowdown, the circulation of T bills and the discount value can both be reduced. This way, investors choose to invest in other securities instead such as stocks, giving a fillip to productivity for most companies, thereby raising the GDP and demand.
How treasury bills work
T bills can be bought at a discounted price than the nominal price, and redeem them at the nominal price to earn the difference. Here’s a closer look at how treasury bills work—
- As mentioned earlier, treasury bills are zero-coupon securities which means that holders of such bills do not earn any interest on the deposits. The profits earned after redemption are treated as capital gains.
- The minimum investment on T bills, as per the RBI’s guidelines, is Rs 25,000. Other investments can all be made in multiples of Rs 25,000.
- These bills are issued in the dematerialised form and credited to the holder’s subsidiary ledger account (SGL), or in the physical form.
- On behalf of the Centre, the RBI auctions securities like T bills each week based on the total bids placed on stock exchanges.
- Depository participants, commercial banks, primary dealers or even open-ended mutual fund schemes can offer these bills to investors.
- It takes T+1 days to settle the process of transferring treasury bills.
- T bills with a 91-day maturity period are auctioned in the uniform auction method and the 364-day bills follow the multiple auction method.
Yield
The annual yield percentage from a treasury bill is calculated using this formula-
Y= (100-P)/Px[(365/D)x100].
Y is the yield or return per cent
P is the discounted price of the bill
D is the tenure of the bill.
Types of treasury bills
T bills are distinguished based on the length of their tenure. While the holding period for every type of treasury bills is the same, the discount rates and face value continue to change depending on the monetary policy, number of bids, and requirements for funding.
14 days
Auctioned every Wednesday, 14-day treasury bills mature 14 days after the date they have been issued. The minimum investment amount for these bills is Rs 1 lakh, and those looking to invest more can buy these T bills in multiples of Rs 1 lakh. The payments for these treasury bills are made on Fridays.
91 days
One type of treasury bills matures after 91 days of being issued. With a minimum investment of Rs 25,000, these T bills can be bought in multiples of the same amount. These bills are also auctioned on Wednesday and their payments are made on Friday.
182 days
Auctioned on Wednesday every alternate week, the 182-day treasury bills are sold in multiples of Rs 25,000 with the minimum investment of Rs 25,000.
364 days
These bills, which mature after 364 days from their date of issue, are auctioned on Wednesdays and their payments are made on a Friday when the term gets over. These bills are also sold in multiples of Rs 25,000, with the minimum amount being Rs 25,000.
Advantages
No risk
Treasury bills are short-term financial instruments payable by the Central government, making them completely risk-free. Issued by the RBI, T bills are a liability to the Centre and are required to be repaid on a predetermined date. These bills, therefore, make for extremely secure investments and are paid despite the state of the economy.
Non-competitive bidding
Auctioning for treasury bills is weekly and not competitive, and allows small-scale and retail investors to participate in the bids. They need not quote the price or yield rate during the auction. With smaller investors gaining access to the government security market, the overall cash flow in the capital market gets higher.
High liquidity
Treasury bills have a maximum maturity period of 364 days, making it easy for investors to make gains in the short term when compared to other securities. Investors who need cash during an emergency can sell their treasury bills in the security market and meet their liquidity needs.
Disadvantages
T bills generate lower returns when compared to other stock market investments as they are zero-coupon securities and issued at a discount. As a result, the returns remain the same throughout the tenure no matter what the economic conditions and the changes in the business cycle. As against investments in the stock market that are influenced by the market conditions and other factors, the yield from treasury bills is significantly lower.
A short-term capital gains (STCG) tax is applicable on the gains made from treasury bills in accordance with the income tax slab under which the investor falls.
Conclusion
A treasury bill is a safe and secure type of investment ideally suited for investors who refrain from taking any risks. For investors who have various types of investments, including those in the stock market, a T bill is a tool to diversify their portfolio and reduce their risk.
Due to the non-competitive process of bidding, more investors can get access to the capital market. Moreover, investment in treasury bills is more transparent due to the fact that par value and discount rates are made available in advance.
