No one likes bills. They are usually a harsh reminder that you are an adult and therefore have responsibilities and obligations to meet. If you are the issuer of the bill, you are supposed to be the happiest of the stakeholders, except when you are not certain of being paid. In this case, you must avoid any form of fraternizing with the debtor (e.g accepting offered food) to reduce compromise before the eventual receipt of payment……just so there is no story (I recently got this insight from my furniture guy!!). If I were to look at a bill in government, it is still a proposal which is yet to be passed into law. We can infer from this that every bill must reach a logical conclusion before it can be considered valuable.
In the case of a Treasury Bill (which is actually the bride of this occasion), a logical conclusion is the expiration of the tenor. Don’t worry, this will make sense as soon as I elucidate on what a Treasury bill is. By definition, a Treasury Bill a.k.a tbill is an investment instrument issued by the Federal Government of any country at no interestrate. Rather, it is issued at a discount on its redemption price or face value. This simply means that if you buy a 91-day treasury bill whose face value is NGN500,000.00 and the discount rate is 10% for instance , then you will only pay NGN487,534.25 for it (Hopefully, you were at the Investment 101 class on simple interest in the last edition!). It works exactly like getting a phone on sale on Black Friday – you get to pay NGN85,000.00 for a phone valued at NGN100,000.00 because it was at a 15% discount. The difference with a treasury bill is that the discount rate is annualizedand so you only get the fraction of the 10% discount that is commensurate with the fraction of the year for which you invested.
Now, here’s the thing – When you buy a tangible object like a phone or a dress at a discount, the original value becomes yours immediately. You get to go away with a phone valued at NGN100,000 for which you only paid NGN85,000.00. As a matter of fact, if you are entrepreneurial (or ‘sharp’ as we say it here in Naija), you could resell it at NGN100,00.00 and enjoy the NGN15,000.00 profit without fear or favour.Unfortunately, the full value (or face value as we like to call it in Finance) of a treasury bill is not yours until the expiration of the tenor (or maturity date). What I am trying to say, using our example above, is that when you buy a NGN500,000 face value of a 91-day treasury bill at a 10.00% discount, thereby paying NGN487,534.25 for it, the NGNG500,000.00 does not become yours until the entire 91 days have elapsed. If you happen to resell the treasury bill after only 50 days, you will only be entitled to that discount for those 50 days. The buyer ( or the dealer) will only give you the 50-day value of the tbill, which using our example above, only comes to NGN494,383.57 assuming all terms and conditions remain constant.
There is however, a catch.The terms and conditions of a treasury bill can hardly remain constant because it is a tradeable financial instrument which makes it susceptible to price fluctuation. Simply put, the discount rate on any given treasury bill could change due to economic, social or political factors. The effect of the possible change in the discount rate is that if you sell any time before maturity, you will be paid based on the prevailing discount rate in the financial market. The interesting thing is that if the discount rate increases, your value decreases. If the rate decreases, your value increases. Let me attempt to explain this conundrum.
Ever heard the term ‘upfront interest’? What about ‘yield’? These two concepts are synonymous with treasury bills and form the basis of the inverse relationship I just described. When you pay a discounted value for a tbill, you have collected the interest due after 91 days (for instance) on day 1, up front. That discount you enjoyed at the onset represents the return on the investment whichis usually received at the expiration of the tenor (or the back-end). Trying to resell the tbillany time before maturity means that you literally have to vomit (excuse my morbidity) the upfront discount you got initially, only this time, it will be at whatever rate is obtainable in the market currently. The plus is that you get to keep the discount for the days you have earned and only return the balance of the discount for the remaining days left in the tenor. Peep this – You got a 10% discount on a tbill, but now you have to return the balance of the discount to someone else (the buyer, that is) at 12%, just because the discount rates on tbills are on an upward trend. Your value has automatically dropped and I think it is easy to see why. Similarly, if you only had to return an 8% discount to the buyer because rates are heading south, you are definitely in the money. A yield by definition, is the real return derivable from an investment. It is better known as a ‘yield-to-maturity’ because the advantage lies in holding your treasury bill till its maturity date.The discount rate becomes a yield if the investor actually utilizes his entire cashflow, such that there is no idle cash left in his account. Again, going by our example above, if the investor had NGN500,000.00 available for the tbill investment, he could decide to re-invest the NGN12,465.75 upfront interest he got in that same tbill, thereby increasing his face value from NGN500,000 to NGN512,465.75. This will invariably increase the real return on his treasury bill investment from 10% to 10.26%. A yield formula (which I will not bug you with) will compute this real return quite accurately.
The Central Bank auctions 91-day, 182-day and 364-day Treasury bills fortnightly for a variety of reasons. The primary reason is to raise short-term financing to meet short term obligations. Another is to control the amount of cash in circulation to check inflation. This is the reason why they are classified as risk-free investments – because they are guaranteed by the government. As I keep telling you, when you invest your funds in any financial instrument, more notably government securities, you are actually nation building.
Are you a nation builder? That case is still open……