Every individual needs to put some part of his income into something which would benefit him in the long run. Investment is essential as unavoidable circumstances can arise anytime and anywhere. Managing your wealth well is like tending a beautiful formal garden – you need to start with good soil and a good set of tools.
Just as good soil has the proper fertility to nourish a plant, having the right foundation in financial literacy should empower you to potentially cultivate a successful investment portfolio. Cultivating and understanding of bonds and treasury bills will help educate you on the fundamentals of investing as you tend your very own financial garden.
THINGS TO CONSIDER BEFORE MAKING INVESTMENT DECISION
Considering recent market events, you may be wondering whether you should make changes to your investment portfolio. Some investors are making rapid investment decisions without considering their long-term financial goals. Though one is at liberty to manage his or her investment portfolio during a volatile market, this investor alert is issued to serve as tools to make an informed decision.
Before an investor makes any investment decision, the investor must have the following key considerations in mind:-
- Draw a Personal Financial Roadmap
Before you make any investing decision, take an honest look at your entire financial situation – especially if you have never made a financial plan. The first step is to figure out your goals and risk tolerance – either on your own or with the help of a financial professional. There is no guarantee that you will make money from investments. However, if you get the facts about saving and investing and follow through with an intelligent plan, you should be able to gain financial security over the years and enjoy the benefit of managing your money.
- Evaluate Your Comfort Zone in Taking on Risk
All investments involve some degree of risk. If you intend to purchase securities – such as stocks, bond or mutual funds. It is important that you understand before you invest that you could lose some or all of your money. Since the money you invest in securities is not insured, you could lose the principal, which is the amount invested. That is true even if you purchase your investment through a bank.
The reward for taking on risk is the potential for a greater investment return. If you have a financial goal with a long-time horizon, you are likely to make more money by carefully investing in asset categories with greater risk, like stocks or bonds, rather than restricting your investments to assets with less risk, like cash equivalent.
On the other hand, investing sole in cash investments may be appropriate for short-term financial goals. The principal concern for individuals investing in cash equivalents is inflation risk which is the risk that inflation will outpace and erode returns over time.
- Consider an Appropriate Mix of Investment
By including asset categories with investment returns that move up and down under different market conditions within a portfolio, an investor can help protect against significant losses. Historically, the returns of the three major asset categories – stocks, bonds and cash – have not moved up and down at the same time. Market conditions that cause one asset category to do well often cause another asset category to have average or poor returns. By investing in more than one asset category, you will reduce the risk that you will lose money and your portfolio’s overall investment returns will have a smoother ride.
If one asset category’s investment return falls you will be in a position to counteract your losses in that asset category with better investment in another asset category. In addition, asset allocation is important because it has major impact on whether you will meet your financial goal. If you don’t include enough return risk in your portfolio, your investments may not earn a large enough return to meet your goal.
- Be careful if investing heavily in shares of employer’s stock or any individual stock.
One of the most important ways to lessen the risks of investing is to diversify your investments. It is common sense: don’t put all your eggs in one basket. By picking the right group of investments within an asset category, you may be able to limit your losses and reduce the fluctuations of investment returns without sacrificing too much potential gain. You will be exposed to significant investment risk if you invest heavily in shares of your employer’s stock or any individual stock. If that stock does poorly or the company goes bankrupt, you will probably lose a lot of money (and perhaps your job).
- Create and Maintain an Emergency Fund
Most smart investors put enough money in a savings product to cover an emergency, like sudden unemployment. Some make sure they have up to six months of their income in savings so that they know it will absolutely be there for them when they need it.
- Consider Dollar Cost Averaging
Through the investment strategy known as “dollar cost averaging” you can protect yourself from the risk of investing all of your money at the wrong time by following a consistent pattern of adding new money to your investment over a long period of time. By making regular investments with the same amount of money each time, you will buy more of an investment when its price is low and less of the investment when its price is high.
- Take Advantage of “free money” From Employer
In many employer-sponsored retirement plans, the employer will match some or all of your contributions. If your employer offers a retirement plan and you do not contribute enough to get your employer’s maximum match you are passing up “free money” for your retirement strategy.
- Consider Rebalancing Portfolio Occasionally
Rebalancing is bringing your portfolio back to your original asset allocation mix. By rebalancing, you will ensure that your portfolio does not overemphasize one or more asset categories, and you will return your portfolio to a comfortable level of risk.
You can rebalance your portfolio based on the calendar or on your investments. Many financial experts recommend that investors rebalance their portfolios on a regular time interval, such as every six or twelve months. The advantage on this method is that the calendar is a reminder of when you should consider rebalancing. Others recommend rebalancing only when the relative weight of an asset class increases or decreases more than a certain percentage that you have identified in advance. In either case, rebalancing tends to work best when done on a relatively infrequent basis.
- Avoid Circumstances That Can Lead to Fraud
Scam artists read the headlines, too often, they will use a highly publicized news item to lure potential investors and make their “opportunity” sound more legitimate. It is prudent to ask questions and check out the answers with an unbiased source before you invest. Always take your time and talk to trusted friends and family members before investing.
WHAT ARE BONDS
A bond is a debt security where the bond issuer (the borrower) issues the bond for purchase by the bondholder (the lender). It is also known as fixed income security, as a bond usually gives the investor a regular fixed return.
When you invest in a bond, you are essentially lending a sum of money to the bond issuer. In return, you are usually entitled to receive interest payment (coupon) at scheduled intervals; and capital repayment of your initial capital amount at an agreed date in the future (maturity date).
In other words, a bond is a loan from an investor (lender) to a borrower such as a company or government. The borrower pays investors a fixed rate of return over a specific time frame. It is a fixed income instrument whereby a contract is established between the investor and the borrower, and the borrower uses the money to fund its operation (Source: Bajai Finserv).
BOND RATINGS
Bond ratings are grades given to bonds on the basis of the creditworthiness of the government, municipality, or corporation issuing them. The ratings are assigned by independent rating agencies (in the United States the largest are Standard & Poor’s (S & P) and Moody’s Investors Service).
Ratings run from Aaa (Moody’s) or AAA (S & P) through D (for default), based on the rater’s appraisal of the issuer’s creditworthiness. Aaa (Moody’s) and AAA (S & P) are highest credit ratings.
Ratings better than BBB (S & P) and Baa (Moody’s) are considered to be “investment grade.” Bonds that are rated below investment grade (i.e. BB or lower by S & P, Ba or lower by Moody’s) are sometimes called “junk” bonds. They may be appropriate for investors who can withstand higher price volatility and default risk while seeking increased investment cash flow potential. (Source: MERRILL & Encylopedia Britannica).
CHARACTERISTICS OF BOND
Most bonds share some basic characteristics including:-
- Face Value
Face value is the amount that the bond will be worth at maturity. Bond issuers use the face value of the bond to calculate the interest payments.
- Coupon Rate
The interest rate at which a bond is issued, which the company is liable to pay to the investor is referred to as the coupon rate.
- Coupon Date
Coupon dates are the dates on which interest payments will be made. Interest payments can be made at different intervals, but the standard is semi-annual payments.
- Maturity Date
It is the date on which the issuer pays back the bonds’ face value to the investor.
- Issue Price
The issue price is the price that the bond was originally sold for.
- Issue Date
It is the date from which the interest starts accruing.
- Taxation
Certain bonds provide tax benefits, while there are few corporate bonds that levy tax on their bonds.
TYPES OF BONDS
Bonds are differentiated by their varying payment features as detailed below:-
- Fixed Rate Bond
The interest or coupon rate of the bond is fixed for the entire term (tenor) of the bond. If the bond comes with an embedded issuer call option, the bond issuer may prepay the bond at certain predetermined dates.
- Floating-Rate Bond
Unlike fixed-rate bonds, the coupon or interest rate of a floating-rate bond is variable. The interest rate is reset at each coupon payment date, in accordance with pre-determined interest rate index. As in the case for fixed-rate bonds, issuer call options may also be embedded.
- Subordinated Bond
This type of bond has a lower repayment priority than other bonds issued by the same issuer in the event of the liquidation or bankruptcy of the issuer. A subordinated bond has a lower credit rating because it carries higher risks but pays higher returns than other non-subordinated bonds of the same issuer. These bonds are usually issued by banks.
- Convertible Bond
These bonds allow the bondholder and/ or issuer to convert them into shares of common stocks/shares in the issuing corporation at a pre-determined price in the future when certain conversion criteria are fulfilled. Such bonds are usually issued by companies and tend to pay lower coupon rates than ordinary bonds of the issuer due to the attractiveness of the conversion feature.
- TIPS ( Treasury Inflation Protected Securities )
These bonds peg their principal amount to the inflation index, therefore protecting the bondholder against inflation. Such bonds are issue by governments.
- Zero-Coupon Bond
Also known as a discount or deep discount bond, this bond is bought at a price lower than its face value, with the face value repaid at the time of maturity. It does not make periodic interest or coupon payments, hence the term zero-coupon bond.
- Callable Bonds
This is where the bond issuer calls out his right to redeem the bond even before it reaches its maturity. This option is exercise by the bond issuer. An issuer can convert a high debt bond into a low debt bond.
- Puttable Bonds
These are bonds where an investor sells his/her bonds and get the money back before the maturity date.
WHO ARE ISSUERS OF BONDS
Bond issuers are entities that raise and borrow money from the people who purchase the bonds (Bondholders), with the promise of paying periodic interest and repayment of the principal amount upon maturity of the bonds.
Most bond issuers are:-
- Governments
A nation’s government issues bonds for funding its various welfare measures or other investment purposes. They usually payout interest on bonds and repay the principal from their revenue, such as taxes. Government bonds are generally considered relatively less risky than corporate issues.
- Corporations
Corporations are one of the largest categories of bond issuers. Corporations include financial institutions, public sector undertakings, and other private companies. Both private and public corporations issue bonds to raise money for various reasons. These may range from funding their day- to -day operations to expanding their existing businesses.
- Supranational and Multilateral Entities
These are entities that are not based in a particular nation. It includes entities like World Bank, International Monetary Fund (IMF) etc. These issuers are also highly rated and less risky because of their global stand.
MAIN PURPOSE OF ISSUING BONDS
Below are the main reasons for issuing bonds:-
- Governments have no choice but to borrow when they are unable to meet their expenses from current revenue. In other words, governments issue bonds to raise funds needed to pay off maturing debt and finance their operating and development expenditures that cannot be fully met from tax revenues.
- Corporations, on the other hand, have a wider choice in the matter of financing their operations e.g. retained earnings, new equity issues etc. However, they still prefer to go in for borrowing for the following reasons:-
- To reduce the cost of capital
- To gain the benefit of leverage
- To effect tax saving
- To widen the source of funding
- To preserve control
WHY PEOPLE INVEST IN BONDS
People are motivated to invest in bonds due to the following considerations:-
- Higher Returns than Bank Deposit
Bonds typically pay a higher yield (return) than bank deposits of a similar term (tenor).
- Regular Income
Bond issuers are bound by the terms of the bond to pay out regular coupon income to bondholders (Subject to credit risk of the issuer). Investors who are risk averse (ie. reluctant to take risk) and looking for fixed returns on investment, mostly consider bonds.
- Hedge Against Inflation
With proper bond selection you may potentially earn an investment return which keeps pace with or even exceed the inflation rate.
- Capital Appreciation
Like all instruments traded in the secondary market; the price of bond can appreciate (or depreciate) over and above (or below) the initial purchase price, and allow you to realize capital gain (or capital losses).
HOW BONDS WORK
Bonds are commonly referred to as fixed income securities and are also one of the main asset classes that individual investors are usually familiar with along with stocks (equities) and cash equivalents. When companies or other entities need to raise money to free new projects, maintain ongoing operations or refinance existing debts, they may issue bonds directly to investors.
- The borrower (issuer) issues a bond that includes the term of the loan, interest payments that will be made, and the time at which the loaned funds (bond principal) must be paid back (maturity date).
- The interest payment (the coupon) is part of the return that bondholders earn for loaning their funds to the issuer. The interest rate that determines the payment is called the coupon rate.
- The initial price of most bonds is typically set at par, or GHS 1,000.00 face value per individual bond. The actual market price of a bond depends on the following:-
- Credit quality of the issuer
- The length of time until expiration
- The coupon rate compared to the general interest rate environment at the time.
- The face value is what will be paid back to the lender once the bond matures.
- Most bonds can be sold by the initial bondholder to other investor after they have been issued. In other words, a bond investor does not have to hold a bond all the way through to its maturity date.
- It is also common for bonds to be repurchased by the borrower if interest rates decline, or if the borrower’s credit has improved and it can reissue new bonds at a lower cost.
ADVANTAGES OF BONDS
Everyone needs money for survival and for a better future they must invest money to attain huge profits during bad times. Various platforms are available to invest in, such as saving money in a bank account, fixed deposit, assets, gold, trading, mutual funds, stocks and bonds.
However, everything has some advantages and disadvantages. In most ways investing in bonds benefits everyone due to the following factors:-
- Easy to Buy or Sell
Bonds are easy to buy. However, investors must be aware of their terms, conditions, return policies, and how profitable the bond is. An investor can buy a bond directly through a broker or indirectly through bond mutual funds.
- A Good Financial Investment
Bonds are considered less risky investments because they promise their investors to return the face value of the bond. Bonds yield a meaningful increase in investment and provide investors with an opportunity to earn a decent income. Bonds also offer attractive capital gains.
- A Safe Investment Compared to Others
Generally, bonds are considered as a safe investment than stocks because the volatility of bonds, especially short or medium-dated bonds, is lower than stocks (equities). It is an ideal investment for retirees as bonds serve a source of income for them, provides for their living expenses and preserves their savings.
- Bonds are Better than Banks
Few bonds are better than banks’ investments (Savings accounts and other scheme investments). The interest rates given by banks on deposits (Savings) are less than interest on bonds.
- A Good Form of Fixed Income
Interest payments of bonds are more than the general dividend payment as bonds are liquidity for a company or individual because they can easily sell many bonds without affecting the price, which is quite difficult in equities. Rather than less day-to-day volatility, bonds are highly beneficial as they provide a fixed income payment twice a year and a fixed lump sum at maturity. Government bonds are a good source of fixed income since interest earnings on government bonds are disbursed every six months, providing a greater opportunity for investors to earn regular income by investing their idle funds.
- Stability
Bonds are tradeable at low risk and are long-term investment tools that give assured returns compared to other investment options. Bonds are inelastic compared to cyclical market fluctuation even when equities dividend income is traditionally more than coupon returns.
- Portfolio Diversification
User diversification means that an investor is investing in a mix of different types of investment. It reduces the risk of losing money by spreading money across different platforms or asset classes like stocks, bonds, and cash. This could help in the reduction of volatility and overall portfolio risk. As we know, bonds are less volatile than other assets, so many investors include them in their portfolio as a source of diversification.
RISKS ASSOCIATED WITH BONDS
The risks associated with bonds include the following:-
- Market Volatility
The market is responsible for increasing and decreasing the bond market value, which is affected by two factors, i.e. Market volatility and macroeconomics. Bond price are also influenced by the rating allocated by credit agencies which can either upgrade or downgrade a bond issuer based on its financial health. However, these external factors do not, impact the bond’s interest or coupon interest payment but only affect the market price of bonds.
- Fluctuation of Interest Rate (Interest Rate Risk)
Interest rate and bond price are inversely related. Should interest rates rise, the price of your bond will tend to fall (and vice versa). The longer the time to maturity of a bond, the greater the interest rate risk. Due to this, the total value of a bond may suffer from rising interest.
This fluctuation or change in bond price impacts the institutional and mutual funds investors with exposure to bonds. This affects professional investors like insurance companies, banks and pension funds.
- Change in the Issuer’s Financial Stability
In the bond market, due to bankruptcy or liquidation case, bondholders have to face a capital risk. When an issuer faces a liquidity issue, it can hamper the bondholder’s interest or principal repayment schedule. It also affects the issuer’s financial stability, directly impacting bondholders.
- Foreign Exchange Risk
Some bonds are denominated (and the issuer’s payments made) in a foreign currency, which may fluctuate against your home currency. The impact of such foreign exchange movements may offset any interest or capital returns you may receive from the bond investment.
- Not Best for Short-Term Investment
Bonds are not meant for a one year investment because, in the year, the issuer should not receive the maturity amount instead, the investor has to pay the penalty (equal to three months of interest). This condition arises when the investor cashes out at any time over five years of buying the bond.
- Liquidity Risk
While there is almost always a ready market for government bonds, corporate bonds are sometimes entirely different animals. There is a risk an investor might not be able to sell their corporate bonds quickly due to a thin market with few buyers and sellers for the bond.
- Sovereign Risk
Payment of the bond may be affected by the political and economic events in the country of the issuer of the bond. For example, the issuer may be forced to make payments in the local currency of the issuer’s country instead of the original currency of the bond.
- Event Risk
Events such as leveraged buyouts, mergers, or regulatory changes may adversely affect both (i) the bond issuer’s ability to make payments on the bond, and (ii) the price of the bond.
HOW TO MEASURE GOVERNMENT BOND RISK
The key ways in which risk in government bonds can be measured include:-
- Credit Risk – The risk that a country will default on its debt.
- Inflation Risk – Your returns could be wiped out by inflation, especially if you are holding a bond to maturity where your interest rate is fixed and doesn’t adjust for inflation throughout the life of your bond. You can’t sustain yourself on a 4% coupon if the inflation is 8%.
- Interest Rate Risk – Interest rates move up and down over time, and when they do, so does the value of bonds. Bonds that pay a lower rate than your group may go up in value as rates decline (eg. when investors are worried about economic slowdowns), but as rates start to rise again, those same bonds may go down in value as investors realize they are not getting paid enough interest relative to other results offered elsewhere in the market place.
- Liquidity Risk – Can you sell your bond in case of an emergency (ie. you need cash) without losing value? There were very few buyers of Greek sovereign bonds during the global financial crisis. Thus, their prices dropped gradually.
HOW TO MANAGE RISK IN BONDS
Each of the risks is managed in its own way, through the evaluation of both qualitative and quantitative parameters:-
- Credit Risk – Check for the credit rating of the issuer AAA – rated bonds are the best, while anything below BBB – is bad.
- Liquidity Risk – If you are planning not to hold the bond until maturity, prefer investing in bonds with more buyers.
- Inflation Risk – If the coupon on your country’s sovereign bond does not meet the inflation numbers, try diversifying in international markets. Developing markets often give higher coupons since they are hungry for capital.
- Interest Rate Risk – You must decide whether the potential gains from coupons outweigh the opportunity loss before investing in a particular bond or portfolio of bonds.
HOW SAFE ARE INVESTMENTS IN BONDS
Bonds when used strategically alongside stocks and other assets, can be a great addition to your investment portfolio, many financial advisors say. Unlike stocks, which are purchased shares of ownership in a company or public entity’s debt obligation.
Stocks earn more income, but they carry more risk, so the more time you have to ride out market fluctuations, the higher your concentration in stocks can be. However, as you are near retirement and has less time to ride out rough patches that might erode your nest egg you will want more bonds in your portfolio. If you are in your 20s, 10% of your portfolio might be in bonds; by the time you are 65, that percentage is likely to be closer to 40% or 50%.
Though bonds are much safer investment than stocks, they somehow carry some risks, like the possibility that the borrower will go bankrupt before paying off the debt. “It is important to understand that bonds are generally secure, but not necessarily safe” as a series of interest rate hikes can erode the value of bonds.
WHAT IS A TREASURY BILL
A treasury bill is a paperless short-term borrowing instrument issued by the government through the Central Bank (as a fiscal agent) to raise money on short term basis for a period of one (1) year. Treasury bills are issued in maturities of 91, 182 and 364 days. Treasury bills are sold at a discounted price to reflect investor’s return and redeemed at face (par) value (Source: Gok Securities).
In other words, treasury bills are money market instruments issued by the government as a promissory note with guaranteed repayment at a later date. Funds collected through such tools are typically used to meet short term requirements of the government; hence, to reduce the overall fiscal deficit of a country.
Example: A 91 day treasury bill with a face value of GHS 120.00 can be bought at a discounted price of GHS 118.40. Upon maturity, individuals are eligible to receive the entire nominal value of GHS 120.00 which allows them to realize a profit of GHS 1.60.
CHARACTERISTICS OF TREASURY BILL
The following are the key features of a treasury bill:-
- Zero Coupon Securities: Treasury bills don’t yield any interest on total deposits. Instead, investors stand to realize capital gains from such investments as such securities are sold at a discount rate in the market. Upon redemption, the entire par value of the bill is paid to investors, thereby allowing them to realize substantial profits on total investment.
- Eligibility: Individuals, firms, companies, trust, banks, insurance companies, provident funds, state government and financial institutions are eligible to invest in treasury bills.
- Minimum Investment: As per the regulations put forward by the Central Bank, a minimum amount has to be invested by individuals willing to procure a short term treasury bill. Furthermore, any higher investment has to be made in multiples of the minimum amount required for the investment.
- Issue price: T-bills are issued at a discount, but redeemed at par.
- Repayment: The repayment of the bill is made at par on the maturity of the term.
- Availability: Treasury bills are highly liquid negotiable instruments that are available in both financial markets, i.e. primary and secondary.
- Method of the auction: Uniform price auction method for 91 days T-bills, whereas multiple price auction method for 364 days T-bill.
- Day count: The day count is 364 days, in a year, for treasury bills.
Besides this, other characteristics of treasury bills include market-driven discount rate, selling through auction, issued to meet short-term mismatches in cash flows, assured yield, low transaction cost, etc.
- Trading: The method of investment forms an integral part of essential Treasury bill details. The retail banks on behalf of the Central Bank auctions such securities every week in the market, depending upon the total bids placed on the stock exchange.
- Yield Rate on Treasury Bills: The percentage of yield generated from a treasury bill can be calculated through the following: –
Y = (100 – P) /P X 365/D X 100
Where Y = Return per cent
P = Discounted price at which a security is purchased, and
D = Tenure of a bill
For example, if a 91-day treasury bill at a discounted value of GHC 98.00 while the face value of the bill is GHC 100.00, the yield on such investment can be determine as follows: –
Yield = (100 – 98) / 98 x365/91 x 100
= 8.19%
FACTORS THAT MOVE TREASURY BILL INTEREST RATES UP AND DOWN
Many factors may affect treasury bills interest rates in general, as well as rates for specific issues of treasury securities, in particular. The following are the factors that usually trigger the movement of Treasury bill prices:-
- Macroeconomic conditions
- Investor risk tolerance
- Inflation
- Monetary policy
- Specific supply and demand conditions
TYPES OF TREASURY BILL
The distinction between different Treasury bill types is made based on their tenure, as enumerated below:
- 14-day treasury bill
- 91-day treasury bill
- 182-day treasury bill
- 364-day treasury bill
While the holding period remains constant for all types of treasury bills issued (as per the categories mentioned above), face values and discount rates of such bonds change periodically, depending upon the funding requirements and monetary policy of the Central Bank, along with total bids placed.
WHY GOVERNMENTS ISSUE TREASURY BILL
A short-term treasury bill helps the government raise funds to meet its current obligations, which are in excess of its annual revenue generation. Its issue is aimed at reducing total fiscal deficit in an economy, and also in regulating the total currency in circulation at any given point of time.
The Central Bank also issues such treasury bills under its Open Market Operations (OMO) strategy to regulate its inflation level and spending/borrowing habits of individuals. During times of economic boom leading to high and persistent inflation rates in the country, high-value treasury bills are issued to the public, which, thereby, reduces aggregate money supply in an economy. It effectively curbs the surging demand rates, and in turn, high prices hurting the poorer sections of the society.
Alternatively, a contractionary OMO regime is undertaken by the Central Bank during times of recession and economic slowdown through a reduction in Treasury bill circulation and reduced discounted value of the respective bonds. It disincentives individuals into channeling their resources in this sector, thereby boosting cash flows to the stock markets instead, ensuring a boost in the productivity of most companies. Such a rise in productivity has a positive impact on the GDP and aggregate demand levels in an economy.
Hence, a treasury bill is an integral monetary tool used by the Central Bank to regulate the total money supply in an economy, along with its fundraising usage.
ADVANTAGES OF TREASURY BILL
- Risk-Free
Treasury bills are one of the most popular short-term government schemes issued. Such tools act as a liability to the government as they need to be repaid within the stipulated date. Hence, individuals enjoy comprehensive security on the total funds invested as they are backed by the highest authority in the country, and have to be paid even during an economic crisis.
- Liquidity
As stated above, government Treasury bill is issued as a short-term fundraising tool for the government and has the highest maturity period of 364 days. Individuals looking to generate short term gains through secure investments can choose to park their funds in such securities. Also such securities can be resold in the secondary market thereby allowing individuals to convert their holding into cash during emergencies.
- Non-competitive Bidding
Treasury bills are auctioned by banks every week through non-competitive bidding, thereby allowing retail and small-scale investors to partake in such bids without having to quote the yield rate or price. It increases the exposure of amateur investors to the government securities market, thereby creating higher cash flows to the capital market.
LIMITATIONS ASSOCIATED WITH TREASURY BILL
- Subject to interest rate risk
- Tend to yield lower returns in periods of high inflation
- Subject to inflation risk
While T-bills are low-risk, they do carry interest rate risk. Treasury Bills are fixed-income investments. Therefore, when interest rates go up unexpectedly, the value of T-bills decreases. T-bills with longer maturity periods tend to be most sensitive to interest rate risk.
Another limitation of these investments is simply that they tend to yield low returns relative to returns earned on other securities. In other words, anyone considering T-bills as an investment should weigh the advantage of the security’s low risk against the disadvantage of their lower rewards.
Finally, these bills are subject to inflation risk. If the rate of inflation is especially high, investors may find that their real returns are effectively lowered and that the return they receive from their T-bills has not even kept up with inflation. Investors should consider the rate of inflation alongside the return guaranteed on an individual T-bill purchase. If inflation rates are high, people considering buying T-bills should take this into consideration and understand the impact.
ARE TREASURY BILLS A GOOD INVESTMENT
Treasury bills are good investments for individuals looking to make a large purchase in a short timeline, as the money will only be tied-up for at most a year. Though Treasury bills don’t earn as high of returns as other investments, they also offer greater security. It is one of the safest places you can save your money despite the above-mentioned limitations associated with it.
MAJOR DIFFERENCES BETWEEN BONDS AND TREASURY BILLS
Treasury bills and bonds are both financial and debt instruments used in the market to earn additional income or gain. The major differences include:-
Treasury Bills
- They are money market instruments
- They are short-term money market instruments issued by governments to raise short-term funds.
- They are issued at a discounted price
- They mature in a year or less
- Price fluctuation very less since it matures in less time
- Return on investment is low due to shorter maturity period ahead
- Difference between the issue price and face value is treated as interest income
- Risk associated is low as compared to bond
Bonds
- They are capital market instruments
- They are long term capital market instrument
- Bonds pay interest (i.e. coupon) every six months to holders of bond
- They have a maturity greater than ten(10) years
- Return on investment is higher due to the longer maturity period
- Risk associated is high as compared to Treasury bill
- Price fluctuates more in bonds due to the longer maturity period
- It is an investment mechanism that allows businesses, banks and governments to fulfill large capital needs at a low cost
CONCLUSION
Whether to invest in Bonds or Treasury bills often depends on the investor’s time horizon and risk tolerance. If the money will be needed in the short term, a treasury bill with its short maturity might be the best. For investors with a longer time horizon, bonds with maturities up to ten (10) years and above might be better. Although bonds are long-term investments with variable interest rates that tend to be higher, it can fluctuate over time.
Typically, the longer the maturity, the higher the return on investment. Both Treasury bills and Bonds are generally safe ways to invest your money since they are backed by government. However, investors are eager to know which of the two investment instruments is riskier. The general guidance is for investors to maintain a balanced portfolio in keeping with their goals and to remain disciplined. An investor who is unsure which a better choice is or need help navigating the buying process, should consider seeking the advice of a financial advisor.
ABOUT THE AUTHOR
ROBERT is a Fellow of the Chartered Institute of Bankers (Ghana). A seasoned banker with wide experience in Retail Banking, Internal Auditing, Project Management, Electronic Banking with high specialty in Internet Banking. He is also a Consultant and a Supervisor of Chartered Institute of Bankers (Ghana) examination.
CONTACT
E-mail address: kwa [email protected]; Tel. 0240 821597 & 0546 907904
