What are treasury bills, and how do they work

Companies raise money from the market to fund their working capital requirements. Likewise, governments also go to the financial market to raise funds. Governments issue treasury bills when they need money for a short period. Market forces determine the interest on T-bills. This blog post will fill you in on everything related to treasury bills— how they work, the returns they fetch, and the risks involved.

Understanding treasury bills

The treasury bills issued by governments are a type of money market instrument. They are similar to a promissory note that guarantees repayment at a future date. Governments incur huge expenditures to function. Hence, to meet short-term requirements, governments will issue treasury bills. They also help to reduce the fiscal deficit.

T-bills are good instruments to invest in as they carry very low risks though you will get low returns on your investments. The bills are sold in specific denominations. The debt instrument allows its investors to earn money. So if you want a high-interest rate, you must choose a more extended maturity date. If you are an investor who wants to take risks at the time of maturity, then you can choose to invest in a treasury bill.

What are treasury bills?

The government of India issues two types of debt instruments: Treasury bills and government bonds. The central bank of a country issues these bills. The government decides the interest rates based on market forces. The T-bills were first launched in India in 1917, and they have three types of maturity in India. For instance, 91, 182, and 364 days. Thus, the T- bill with a maturity date of one year will have higher interest rates.

Governments issue T- bills through auctions regulated under the guidelines and supervision of the country’s central bank. The auctions for T- bills are done through competitive and non-competitive bids. By adopting the non-competitive bids, the central bank retains the power as the investors will accept the discount rate. Investors will be paid guaranteed amounts.

The competitive bids give power to the investors. The investors need to bid high to get a high discount rate. Competitive bids give you a higher return as you purchase at a lower price. You need to provide a high bid, or else the order gets rejected. In a competitive bid, you must take help from brokers or banks. Like non-competitive ones, they are not sold directly to investors.

Mostly, financial institutions buy them, although they are also open to individuals and trusts. The banks purchase such investments to maintain their repo rates and requirements related to SLR (Statutory Liquid Ratios).

How do treasury bills work?

The central bank issues the treasury bill to the Reserve Bank of India. Governments issue T- bills at discounted rates, which helps the investor to get a higher rate at maturity. So, the buyers will receive the original values at the maturity date. For instance, you will buy the treasury bill at ₹98, which has a face value of ₹100. On completion of the maturity date, you will get the value at ₹100 per T-bill. However, returns on T-bill will depend on the economy’s liquidity position. If a liquidity crisis prevails within the economy, then you can expect a very high return.

In India, RBI issues T-bills only on Wednesdays based on bids made on stock exchanges. One can purchase T-bills through commercial banks or certified and approved primary dealers.

In India, RBI uses non-competitive bidding, thus, giving lesser control to the investor. Also, if you purchase T- bills, you will also receive tax benefits.

Risks and returns of treasury bills

To understand the risks and returns of T- bills, you need a complete understanding of how the process works.

T-bills are one of the safest investments in the money market. The central bank issues them, and the RBI vouches for their security. Even if you buy from a broker, you will get the guaranteed amount on maturity as the central bank is the country’s leading financial institution. T-bills are zero-risk investments. The risks are also low as the longer maturity dates are one year at maximum. Other financial instruments offer a high interest only if you keep your investment locked for more than two years.

The returns on T-bills are highly reliant on liquidity position. In a recession or economic downturn scenario, the central bank will issue a treasury bill at a meager rate to collect funds for financing activities. Thus, you will get a higher amount at maturity as it will be rounded off on the face or original values. The investment is very good for people who want speedy returns on low-risk investments.

The return value will also be high when you trade this bill in the secondary market. The government allows reselling T-bills, so investors can realize cash when required. Secondary markets are very active, so that you can trade them further anytime.

How to invest in treasury bills?

Before investing in treasury bills, you must know how they work.

First, understand the return mechanism. The central bank does not give you any additional interest. It is unlike other investments where the issuer promises a specific rate of interest. In this investment, you buy at a discounted rate but get funds on original values. Thus, you are getting more returns than you paid.

Secondly, the maturity period is concise, ranging from 91 days to one year. If you lock your money for one year, you will procure the bill at a meager rate and receive high returns. Short maturity periods make investments highly liquid.

Retail investors can buy T-bills by opening a Retail Direct Scheme Account with the RBI. Investors can also purchase them from stock exchanges and primary and secondary markets.

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