A Beginner’s Guide to Treasury Bills: Definition, Benefits and Risks

Introduction

If you are planning a vacation one year from now and have already calculated the total cost, but you need to accumulate a specific sum within the next year, you may consider investing in a risk-free instrument to ensure capital protection. Bank Fixed Deposits (FDs) are not suitable due to potential withdrawal charges in uncertain circumstances. The ideal option that meets all your requirements is in the money market. The money market is a segment of the Indian financial markets that primarily deals with short-term instruments. Financial institutions, including mutual funds, insurance companies, NBFCs, banks often tap the money market to meet their short-term financing needs. The money market includes instruments such as treasury bills, cash management bills, commercial papers and certificates of deposits. By investing in the money market, you can secure your funds and achieve your financial goal for the upcoming vacation. Treasury bills stand as one of the most popular and secure options in the money market segment. These short-term debt instruments issued by the Indian government hold a special place in the hearts of risk-averse investors. T-Bills offer an attractive combination of low risk and reasonable returns, making them an excellent choice for those looking to preserve capital while earning modest interest income. Welcome to the beginner’s guide to treasury bills, where we will explore the fundamentals of investing in these short-term debt instruments.

What are Treasury Bills?

Treasury Bills, commonly referred to as T-Bills, are short-term debt instruments issued by the central government to meet its short-term financing requirements. It is crucial to note that the state government lacks authorization to issue treasury bills, as this prerogative rests solely with the central government. These instruments come with maturities ranging from 91 days, 182 days and 364 days. T-Bills are essentially zero-coupon securities i.e. they are issued at a discount to their face value and investors earn the difference between the issue price and face value as income. The 91-days T-bill is issued weekly, while the 182-days and 364-days T-bills are issued fortnightly. As of May 2023, the total outstanding amount of T-Bills in India stands at Rs 9.4 trillion, according to CCIL India.

Why Does the Government Issue Treasury Bills?

When the government needs funds for short-term expenses, it auctions treasury bills through the Reserve Bank of India (RBI). The auction process determines the cut-off yield, which becomes the discount rate for all successful bidders. Successful bidders pay the discounted price upfront to the RBI and receive the face value of the T-Bill upon maturity. The investor’s return is determined by the difference between the face value of the Treasury Bill and its discounted price.

For example, if a 91-day T-Bill with a face value of Rs. 100 is issued at a discount price of Rs. 98, the investor will receive Rs. 2 at the end of the 91-day maturity period. The Rs. 2 difference is the interest earned.

Types of Treasury Bills

Warren Buffett’s strategic choice to invest in T-Bills has piqued curiosity. Treasury Bills are short-term, zero-coupon instruments crafted by central governments to fund immediate financial requisites. Available in three primary durations—91, 182, and 364 days—each serves a unique purpose. The weekly issuance of the 91-day T-Bill offers consistent entry points for investors, whereas the 182-day and 364-day varieties appear on the financial horizon bi-weekly. Purchased at a price below their nominal value, T-Bills promise a return calculated as the difference between the reduced purchase price and the full value returned upon maturity. This financial arrangement positions T-Bills as a secure harbor for investors charting a course through the choppy waters of short-term investment options, ensuring a predictable yield.

Yield Rate on Treasury Bills

For investors, the yield rate of Treasury Bills serves as a critical indicator, illustrating the returns they can expect from these brief-term government-issued securities. Distinct from typical bonds, T-Bills don’t yield regular coupon payments but are instead traded at a discount. The actual yield is the gap between what investors pay initially and the face value they receive at the maturity of the T-Bill. This metric not only captures the time value of money but also mirrors the government’s credit reliability. A lower buying price for a T-Bill correlates with a higher yield, attracting those in search of short-term, minimal-risk investment avenues. Typically, a shorter maturity of a T-Bill corresponds with a lower yield, minimizing time-associated risks. Market dynamics, economic signals, and policy decisions from the Reserve Bank of India shape these yield rates. In times of economic flux, T-Bills become particularly sought-after, providing a more stable return than many other investment choices that are prone to fluctuations.

How to Invest in Treasury Bills?

T-Bills are made available through auctions conducted by the RBI, which are announced beforehand. These auctions allow for both competitive and non-competitive bids. Competitive bids are submitted by participants willing to purchase securities at a specified price. Non-competitive bidding, on the other hand, allows individuals to invest in T-Bills at the weighted average yield of the auction. Investors can place bids for T-Bills through RBI’s E-Kuber platform and this method is particularly beneficial for retail investors who prefer a straightforward approach. T-Bills are readily tradable on the secondary market, accessible through exchanges, various online bond trading platforms, or even RBI retail direct. In case of online bond platforms, all you need is a demat account, along with completing the necessary KYC verification and fulfilling the required formalities. Additionally, for RBI retail direct, you will be required to open a Subsidiary General Ledger (SGL) account with RBI. Once these steps are completed, you can choose any of the abovementioned routes to invest in T-Bills. The minimum investment order value for Treasury Bills is ₹10,000 and investors can invest in multiples of ₹10,000 thereafter. Profits earned through T-Bills are subject to short-term capital gains (STCG) tax at rates applicable according to the income tax slab.

Advantages of Government Treasury Bills

Safety and Security: Treasury bills benefits the investors as they are considered one of the safest investment options available since they are backed by the Indian government’s creditworthiness. The risk of default is negligible, making them ideal for risk-averse investors.

Liquidity: T-Bills are highly liquid instruments. Investors can sell them on the secondary market before maturity to realize their investments. Moreover, banks and financial institutions are willing to buy back T-Bills, providing ease of exit.

Short-Term Investment Horizon: T-Bills are particularly suitable for those with short-term financial goals, such as saving for a holiday or building an emergency fund.

Diversification: Including T-Bills in an investment portfolio can enhance diversification, reducing the overall risk exposure.

Limitations of Treasury Bills

Treasury bill risks are as mentioned below:

Interest Rate Risk: Although T-Bills are short-term instruments, they are not entirely immune to interest rate fluctuations. If an investor needs to sell T-Bills before maturity, they may face the risk of receiving a price lower than the purchase price due to changes in interest rates.

Inflation Risk: T-Bills offer a fixed return and if the rate of inflation surpasses the return, the investor’s purchasing power may erode.

Reinvestment Risk: For investors who rely on the income from T-Bills, reinvesting the proceeds at prevailing interest rates at the time of maturity could be a challenge, especially if rates have fallen.

Who Should Consider Investing in Treasury Bills?

Treasury Bills are a prime choice for investors who focus on safeguarding their capital and prefer short-term investments. They typically attract risk-averse individuals, like retirees who wish to protect their capital while securing consistent, though modest, returns. Additionally, T-Bills are favored by corporations and mutual funds for managing liquidity due to their predictable outcomes and solid government backing, which virtually eliminates credit risk. Beginner investors also find T-Bills advantageous as a way to get familiar with market dynamics without the risk tied to volatile securities. With their brief maturities and government support, T-Bills are an excellent resource for managing immediate cash needs, appealing to a broad range of investors from large financial institutions to individual savers seeking a safe place to park their funds with returns that generally outperform those of traditional savings accounts.

Conclusion

Treasury bills are a cornerstone of the fixed-income asset class in the Indian financial market. Issued by the Indian government, T-bills are short-term and low-risk debt instruments. They serve as an excellent avenue for the government to meet their short-term needs, while also providing investors with safety, liquidity and reasonable returns. By understanding the benefits and risks associated with T-Bills, investors can make informed decisions and potentially include them in their investment portfolios to achieve their financial goals.

FAQs

Q. What is the meaning of treasury bills?

A. Treasury bills meaning refers to short-term debt instruments issued by the government, offering an avenue for investors to invest securely and earn returns based on the difference between the discounted price and the face value upon maturity.

Q. What returns can I expect from treasury bills?

A. Treasury bills offer competitive returns compared to traditional savings accounts and fixed deposits. The returns vary based on the auction yield, prevailing interest rates and the chosen maturity period. Before investing, it is essential to understand the treasury bills definition, which refers to short-term debt instruments issued by the government with maturities of 91 days, 182 days and 364 days.

Q. Is it possible to sell treasury bills before their maturity date?

A. Yes, T-Bills are highly liquid instruments. Investors can sell them on the secondary market before maturity to realize their investments. Banks and financial institutions are also willing to buy back T-Bills, providing ease of exit.

Q. What risks are associated with investing in treasury bills?

A. While treasury bills are considered low-risk, they are not entirely immune to interest rate fluctuations. If an investor needs to sell T-Bills before maturity, they may face the risk of receiving a price lower than the purchase price due to an increase in interest rates. Investors must carefully assess treasury bills risk before making investment decisions.

Q. What role do treasury bills play in financial planning?

A. Treasury bills can serve various financial planning purposes, such as building emergency funds, achieving short-term financial goals, preserving capital and mitigating risks in an investment portfolio. Understanding the treasury bills benefits can help investors make informed decisions for their financial goals.

Q. Can foreign investors buy treasury bills in India?

A. Yes, foreign investors can participate in the T-Bill auctions under the Reserve Bank of India’s (RBI) specified guidelines and through eligible channels like the Foreign Portfolio Investment (FPI) route.

Disclaimer: Investments in debt securities/ municipal debt securities/ securitised debt instruments are subject to risks including delay and/ or default in payment. Read all the offer related documents carefully.