Lesson 5

Treasury Bills
After reading this lesson, you will be conversant with: Features of Treasury Bills Types of Treasury Bills Issuing Procedure of Treasury Bills Primary Market and Settlement Procedures Treasury Bills in International Markets

Financial Markets and Instruments

Introduction
Corporate short-term requirements are met through raising short-term funds with various instruments like CPs, Bill Finance, CDs, etc., and long-term needs through equity and long-term debt. Similarly, government issues Treasury bills (T-bills) and dated securities as a means to raise funds, in short-term and long-term markets respectively. T-Bills constitute a major portion of short-term borrowings by the Government of India.

FEATURES OF TREASURY BILLS

Treasury Bills are short-term, rupee denominated issued by the Reserve Bank of India (RBI) on behalf of the Government of India. T-bills are issued in the form of promissory notes or finance bills (a bill which does not arise from any genuine transaction in goods is called a finance bill) by the government to tide over short-term liquidity shortfalls. These short-term instruments are highly liquid and virtually risk-free. They are the most liquid instrument after cash and call money, as the repayment guarantee is given by the central government. Treasury bills do not require any grading or further endorsement like ordinary bills, as they are claims against the Government. These instruments have distinct features like zero default risk, assured yield, low transactions cost, negligible capital depreciation and eligible for inclusion in Statutory Liquidity Ratio (SLR) and easy availability, etc., apart from high liquidity.

Issuer
The Reserve Bank of India acts as a banker to the Government of India. It issues T-bills and other government securities to raise funds on behalf of the Government of India, by acting as an issuing agent.

Investors
Though various groups of investors including individuals are eligible to invest, the main investors found in treasury bills are mostly banks to meet their Statutory Liquidity Ratio (SLR) requirements. Other large investors include: Primary Dealers Financial Institutions (for primary cash management) Insurance Companies Provident Funds (PFs)(as per investment guidelines) Non-banking Finance Companies (NBFCs) Foreign Institutional Investors (FIIs), and State Governments. Non-Resident Indians (NRIs) and Overseas Corporate Bodies (OCBs) are also allowed to invest but only on non-repatriable basis. The RBI issues both bids on competitive and non-competitive basis. Eligible Provident Funds (i.e., the nongovernment provident funds governed by the Provident Fund Act, 1925 and employees PFs and Miscellaneous Provisions Act, 1952 whose investment pattern is decided by Government of India), State governments, and the Nepal Rastra Bank can participate in the auctions on non-competitive basis. The scheme of non-competitive bidding to encourage mid-segment investors like individuals, Hindu Undivided Families (HUFs), PFS, Urban Co-operative Banks (UCBs), NBFCs, Trusts, etc., to participate in the primary market of government securities, were operationalized in January 2002. All other participants excepting above mentioned investor classes participate in competitive bidding. 273

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Purpose
Treasury bills are raised to meet the short-term requirements of Government of India. As the Governments revenue collections are bunched and expenses are dispersed, these bills enable the Government to manage cash position in a better way. T-bills also enable the RBI to perform Open Market Operations (OMO) which indirectly regulate money supply in the economy. Investors prefer treasury bills because of high liquidity, assured returns, no default risk, no capital depreciation and eligibility for statutory requirements. Form T-bills are issued either in the form of promissory note (or scrip) or credited to investors SGL account. For every class, a standardized format is used. T-Bills are issued at a discount and are redeemed at par. Size The treasury bills are issued for a minimum denomination of 91 day T-Bills is Rs.25,000 while that of the 364-day T-Bills is Rs.1,00,000. The 91-day T-Bills auction has a notified amount, while there are no notified amounts for 364 day T-bills auction.

TYPES OF TREASURY BILLS

Treasury bills are issued at various maturities, generally up to one year. Thus, they are useful in managing short-term liquidity. At present, the GOI (Government of India) issues 3 types of T-bills viz., 91-day, 182-day and 364-day. In 1997, in order to enhance the depth of the money market in India, the RBI decided to introduce 14-day and 28-day T-bills. However, so far, only 14-day T-bills have seen the light. Latter, the RBI had withdrawn the 14-day and 182-day T-bills with effect from May 14, 2001. With effect from April, 2005, the Government reintroduced 182-day T-bills. Yield T-bills do not carry a coupon rate, but they are issued at a discount. Though the yields on T-bills are less when compared to other money market instruments, the risk averse investors and banks prefer to invest in these securities. Yields on T-bills are considered as benchmark yields. It is considered as a representative of interest rates in the economy in general, while arriving at an interest rate or yield on any short-term instrument. Considering the risk-free nature of T-bills all other instruments in money market will have to provide for higher yields. Illustration 1 The yield is calculated on the basis of 365 days a year. If the face value of a 364-day T-bill is Rs.100, and if the purchase price is Rs.96 for a Treasury Bill, then the yield is calculated as below:

Days x Yield 365

Yield =

1 x

Face Value Price 365 = 0.04178 = 4.178% 364

100 1 96

The T-bills can be categorized into three types based on the nature of issue.

Ad hoc Treasury Bills

Ad hoc T-bills are issued in favor of the RBI when the Government needs cash. They are neither issued nor available to the public. These bills are purchased by RBI at discount and are held in its Issue Department and the RBI issues currency notes against these bills to the Government if required, and bills are renewed at maturity. 274

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Ad hoc T-bills are issued to serve two purposes. Firstly, to replenish cash balances of the Central Government and secondly, to provide a medium of investment for temporary surpluses to State Governments, semi-government departments and foreign central banks. The RBI acts as a banker to the Central Government, hence, the Government needs to maintain a minimum balance of Rs.50 crore on Fridays and Rs.4 crore on other days free of obligation to pay interest thereon and further whenever the balance in the account of the Government falls below the minimum agreed amount, the account will be replenished by the creation of ad hoc Treasury Bills in favor of Bank. Ad hocs have maturity period of 91-day and carry a discount rate of 4.6 percent. These bills can be extinguished before maturity. The maximum incremental outstanding limit of T-bills at the end of the year should be Rs.5,000 crore and within the year, the incremental ad hoc T-bills cannot exceed Rs.9,000 crore for a period greater than ten consecutive days. In case this is not adhered to, the RBI would automatically reduce the level of ad hoc T-bills by auctioning them or selling fresh Government of India dated securities in the market thereby, bringing down the level of ad hocs to the maximum level permitted. This is essentially an arrangement between Central Government and RBI and the actual operational aspects may vary from time to time. It is adequate to state that this is essentially a mechanism through which the Central Bank (RBI) funds the government. T-bills have to be repaid by the government when it has adequate cash flows. However, there was no compulsion that they have to be repaid. When they were outstanding for more than 90 days, the RBI used to convert them into dated securities. As the expenditure of the government always exceeded its income, some amount of T-bills remain unpaid at the end of the year thus becoming a permanent source to finance the budget deficit, which can lead to fiscal indiscipline resulting in serious imbalances in the economy. As there was no limit on the amount that can be raised by the government on its own, the government itself decided to put a cap on it. Consequently, the Union Budget 1994-95 stated that automatic monetization of budget deficit through creation of ad hoc T-Bills would be phased out completely over three years period with an objective to reduce inflation. Subsequently, a limit on the issue of ad hocs was imposed under an agreement between the Union Government and the RBI. The Union Government and the RBI have, therefore, entered into an agreement to change the way the budget deficit is financed. The agreement was signed in March 1997, bringing into existence the new system of Ways and Means Advances (WMA) replacing the system of ad hoc treasury bills. WAYS AND MEANS ADVANCES (WMA) WMA is not a permanent source of financing government deficit. But, this is likely to provide greater autonomy to the RBI in conducting monetary policy. According to the agreement, the RBI will no longer monetize the fiscal deficit and the government should borrow from the market to finance the fiscal deficit. But, the RBI will extend the advances to the Central and State governments to tide over temporary or short-term finance requirements which needs to be repaid in three months. Drawals in excess of the WMA limit will be allowed for a maximum of ten consecutive days. The RBI allows for three types of ways and means advances: the clean WMAs (unsecured), the secured WMAs (which are secured against central government securities) and the special WMAs which are allowed in exceptional circumstances against the pledge of government securities. The system of WMA broadly works as follows: The limit of WMA is decided in terms of mutual consultations between the RBI and the central government. The interest charged up to the WMA limit would be three percent less than the average implicit yield at the cut-off prices of 91-day T-bills in the previous quarter and for the amount in excess of WMA limit, it is two percent more than the normal rate. 275

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The interest rate is decided on, and can be altered by mutual agreement between the RBI and the government. The outstanding balance of WMA at the end of the year should be repaid by the central government (it should be brought down to zero). If the balance remains unpaid for more than two weeks after the end of year, the RBI converts the amount into dated securities at the market rate of interest. If 75 percent of limit is utilized, the RBI should initiate a fresh flotation of central government securities. Box 1: Ways and Means Advances to the Government of India for the Financial Year 2005-2006 The Ways and Means Advances (WMA) to the Government of India have been reviewed in consultation with the Government of India and the following arrangements will be in force for the fiscal 2005-06: i. The limit for WMA will be Rs.10,000 crore for the first half of the year (April to September) and Rs.6,000 crore for the second half of the year (October to March). When 75 percent of the limit of WMA is utilized by Government, the Reserve Bank may trigger fresh floatation of market loans depending on market conditions. ii. The interest rate on WMA will be as under: a. Ways and Means Advances : Bank Rate (6.0%) b. Overdraft : Two percent above the Bank Rate. iii. The minimum balance required to be maintained by the Government of India with the Reserve Bank of India will not be less than Rs.100 crore on Fridays, on the date of closure of Government of Indias financial year and on June 30, i.e., closure of the annual accounts of the Reserve Bank of India and not less than Rs.10 crore on other days. iv. As per the provisions of the Agreement dated March 26, 1997 between the Government of India and Reserve Bank of India, overdrafts beyond ten consecutive working days will not be allowed. Source www.rbi.org.in / press release 2004-05/1024

On Tap Treasury Bills (Discounted Treasury Bills)

The RBI issues discounted T-bills to investors on any working day. There is no limit to the amount of investment in these types of securities. These types of T-bills have a maturity of 91 days. The discount rate is around 4.6 percent and they are redeemable at face value on maturity. These bills can also be rediscounted after a minimum period of 14 days with the RBI. Generally the state governments, banks and provident funds use these T-bills as a liquidity management tool as the RBI is willing to rediscount at any point of time for any amount. These treasury bills are discontinued with effect from 1st April, 1997 along with the ad hoc T-bills.

Auctioned Treasury Bills

The Government of India has decided to move towards a weekly auction system for 91-day T-Bills from January, 1993. Auctions in respect of 14-day and 91-day treasury bills are held on Fridays and payments in respect of allotments made on Saturdays. In October, 2000, considering the request from the market participants, the day of payment has been changed from Saturday to the next working day in respect of both 14-day and 91-day Treasury Bills. However, this will be reviewed after six months. On the other hand, 182-day and 364-day T-bills are auctioned every alternative week on Wednesdays. The RBI issues a calendar of T-bill auctions. Further, the RBI, by issuing press releases prior to every auction, also announces the exact dates of auction, the auction amount and dates of payment. The bids are tendered and accepted at the auction. As the participants in the 276

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auction are the players in the market, the market perceptions about an acceptable yield get reflected in this process. Then the yield on T-bills becomes more a market determined one rather than a regulated one. The unsubscribed portion is subscribed by the RBI at a cut-off rate, that is evolved in the process of auction. The issuing procedure of auctioned T-bills are discussed below.

ISSUING PROCEDURE OF TREASURY BILLS

As discussed above, the RBI on behalf of central government, announces the auctioning of T-bills by tender notification through the press. The bills are sold by the RBI, Public Accounts Department (PAD), Mumbai, on an auction basis. The date of auction and notified amount are announced by the RBI from time to time. Though the tender is invited for competitive bids, bids will be allotted to both competitive and non-competitive bids. Under Non-competitive bidding, bidders such as State Governments, PFs would be able to participate in the auctions of dated government securities without having to quote the yield or price in the bid. They will not have to worry about whether this bid will be on or off-the-mark; as long as they bids in accordance with the scheme, they will be allotted securities fully or partially. A non-competitive bidder will submit only one bid. There is no need for bidding in case of non-competitive bids. These bids are accepted at the weighted average of the successful bids if the notified amount is not fully subscribed to. Non-competitive bidders will Telex\Facsimile the amount of tender before the day of auction or on the day of the auction before the close of banking hours to the Manager, RBI, Mumbai. Eligible investors intending to procure the instruments need to submit their tender for the issue of bills in the form as prescribed for the purpose, which can be obtained from RBI, PAD, Mumbai. An investor can submit multiple tenders filling separate forms stating different prices. Successful competitive bids will be accepted up to the minimum discounted price called cut-off price determined at the auction. Partial pro rata allotments are common for bids submitted at cut-off price. The bids above the cut-off price are accepted completely and other bids at offer prices lower than cut-off price are rejected. Result of the auction is displayed at RBI, PAD, Mumbai. Reserve Bank has the full discretion to accept or reject any or all the bids, both competitive and non-competitive bids either wholly or partially if deemed fit without assigning any reason. The tenderer needs to check for himself the result of the auction and if successful, should collect the letter of acceptance of the tender from the RBI. The bidders will be allotted the Treasury Bills at the respective prices at which the bids have been made. For 91-day T-bills, the successful bidders at the auction have to make the payment on the next working day following the Friday auction; and for 364-day T-bills, the payment has to be made by successful bidders on Thursday following the Wednesday auction. Successful bidders at the auction are required to make the payment by cash/cheque drawn in favor of the Reserve Bank of India or by Bankers Pay Order. Payments by competitive bidders are effected by debiting their current account with PAD, Mumbai, if RBI is authorized to that effect. If the day of payment falls on any public holiday, the payment is made on the day after the holiday. Otherwise, the required amount shall be deposited with RBI, PAD, on the following working day of the announcement either in cash or through crossed Bankers cheque. In case of State Governments, the payment would be effected by debiting their account with the CAS, RBI, Nagpur. Payment On expiry of the tenure, the bills are presented at RBI, PAD, Mumbai for payment.

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PRIMARY MARKET AND SETTLEMENT PROCEDURES Development of the Market

Until 1950s, T-Bills were issued by both the Central and State Governments and from 1950s, it is only the Central Government that is issuing Treasury bills. Up to 1965, the mode of issue of T-bills to the public were through bi-weekly auctions or tenders. In 1965, the concept of intermediate T-bills were introduced and were sold for few years. According to this mode, T-bills had a maturity of 91 days and the rates were fixed by the RBI. The day succeeding the day of the usual weekly auction till the day preceding the next auction, was fixed for receiving the tenders for the next auction. The mode of issuing T-bills has changed from 12th July, 1965. Instead of inviting tenders, the T-bills were made available throughout the week at specified rates from time to time. This change in issuance has facilitated an increase in selling of T-bills (as the commercial banks were investing their short-term surpluses in these instruments). As the government raised its finances by issuing ad hoc T-bills to RBI, which is technically a short-term source, but, in practice, it is long-term in nature. In the sense, the ad hoc treasury bills are notionally discharged and renewed on maturity. Therefore, finance raised by the government in this form is technically short-term finance, but in reality ends as a long-term finance. Primary Market in India In India, till April, 1992, T-bills of 182 days maturity were issued along with 91-day T-bills. These have since been phased out in favor of 364-day T-Bills. There are five types of treasury bills based on maturity dates but the 28-day bills have not yet been launched as stated below and the development of each maturity dated T-bill is as follows: 91-Day T-Bills Starting from July, 1965, 91-day T-bills were issued at a discount rate ranging from 2.5-4.6 percent per annum. Till July, 1974, the discount rate was 4.6 percent. Even later, the discount rate hovered around the same. The extremely low yield on these bills was totally out of alignment with the other interest rates in the system. Moreover, the Central Bank readily rediscounted these bills due to which the yield for these bills remained more or less artificial. The banks used these instruments to park their funds for a very short period of 1-2 days. This resulted in violent fluctuations of volumes of outstanding T-bills. The RBI had introduced two measures in order to cope with the situation. Firstly, to recycle the T-bills (from October, 1986) under which the bills are rediscounted by the RBI and are resold to the banks. Secondly, an additional early rediscounting fee was imposed, if the banks rediscounted the T-bills within 14 days of purchase. Although this resulted in a decline in weekly fluctuations, the T-bills market did not become an integral part of the money market and the interest rates did not rise considerably as the bulk of T-bills continued to be held by the RBI. The weekly auctions of 91-day T-bills were started in January 1993, which in due course resulted in gradual decline of the T-bills outstanding with the RBI. 182-Day T-Bills Following the Sukhamoy Chakravarty Committee recommendations, in November, 1986, 182-day T-bills were introduced in order to develop the short-term money market and also to provide an additional avenue for the Government to raise financial resources for its budgetary expenditure. Initially, these were the first type of treasury bills to be auctioned on monthly basis without any rediscounting from the RBI. Thus, the first step of market oriented discount rate has come into existence. The state governments and provident funds were not allowed to participate in these auctions. To impart an element of flexibility, the Central Bank was not announcing the amount in advance. The market participants were allowed to bid the amount and price of their choice. The authorities would determine the cut-off discount rate and the amount of T-bills sold in an auction. They were 278

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issued with a minimum lot size of Rs.1 lakh and multiples thereof. These auctions were monthly in the beginning but later in 1988, they were made fortnightly. These bills were eligible securities for Statutory Liquidity Ratio purpose and for borrowing under standby refinance facility of the RBI. The 182-day T-bills had an interest rate that was relatively market determined and this made it possible for the development of a secondary market for it. Nevertheless, till 1987, 182-day T-bills market could not emerge as an integral part of the money market. These bills were discontinued and in place of which 364-day T-bills emerged. In April, 1998, these bills were reintroduced in order to obtain a continuous yield curve for a period of one year. These bills were again discontinued from May, 2001 up to March, 2005. These bills were reintroduced with effect from April, 2005. 364-Day T-Bills The Government considered that it is important to develop government securities market for monetary control. It also had an intention to ensure that governments credit needs are met more and more directly from the market instead of pre-emption of deposit resources. With this view, treasury bill was developed as a monetary instrument with market related rates. As a part of the overall development of Government securities market, the Government of India proposes to float treasury bills of varying maturities up to 364 days on auction basis. The Government, with an intention to stabilize the money market in the country, introduced the 364-day T-bills on 28th April, 1992. The RBI neither discounted these bills nor participated in the auction. 364-day T-Bills are auctioned fortnightly, but the amount, however, is not notified in advance. These T-bills have become popular due to their higher yield coupled with liquidity and safety. The yield on 364-day T-bills is used as a benchmark by the financial institutions such as IDBI, ICICI, etc., for determining the rate of interest on floating bonds/notes. These bills widened the scope of money market and provided an innovative outlet for surplus funds. The introduction on treasury bills of varying maturities would offer investors a wider choice for investing in different instruments and thereby foster the development of Government securities market. 14-Day and 28-Day T-Bills The presence of 91-day, 182-day and 364-day T-bills provided an opportunity for investors to choose varying maturities either from the primary market or from the secondary market. However, an investor who is interested in a maturity less than 91 days had to necessarily look for secondary market. In order to enhance the breadth of the market, RBI decided to introduce 14-day, 28-day T-bills in 1997. However, till now RBI has introduced 14-day Treasury Bills only. In accordance with monetary and credit policy of April, 2001, the 14-day T-bill auctions has been discontinued and instead, the notified amount in the 91-day T-bill auctions has been increased with effect from May 14, 2001. Clearing and Settlement The Treasury Bills are available in physical form if an investor desires so. The market is mostly dominated by institutional players who have a facility to hold the T-bills in scripless form. For this purpose, the investor opens an Subsidiary General Ledger (SGL) Account with RBI who credits the accounts with T-bills subscribed. When a transaction of sale is undertaken between two institutional players, the seller issues an SGL transfer form specifying the details of the transaction. The SGL transfer form is then lodged by the buyer with the Public Accounts Department of RBI to credit its account by debiting the value of the securities to the sellers account. Usually, interbank trades are settled on the same business day, whereas trades with non-bank counterparties are settled either on the same day or one business day after trade date. Commercial Papers, Certificates of Deposits, short-term debentures and intercorporate deposits are alternatives to T-bills. In spite of the low returns, T-bills 279

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constitute a viable investment opportunity for cash rich PSUs and corporates due to their liquidity, eligibility for SLR, nominal risk weightage. The scope for capital erosion is almost insignificant. Hence, it is essential to develop treasury bill market as it would provide appropriate ancillary facilities to foster the development of money market instruments. Box 2: Retailing The Gilt-Edge The Advantages G-Secs and T-Bills enjoy a zero default risk since they are sovereign paper. There is no deduction of tax at source. Besides, there is a rebate of Rs.3,000 per annum on interest income derived from G-secs and T-Bills under Section 80L of the Income Tax Act. Both these instruments enjoy a high level of liquidity and can be sold in the market. Primary dealers offer quotes to buy T-bills and G-secs and could be sold to them easily before maturity. That apart, an investor can earn much better returns in the short run. An individual or a corporate enjoying a short-term float, even for four to five days, can earn decent returns. Moreover, with the increase in Bank Rate, yields on G-secs and T-bills are expected to improve from the current levels. But, as banks are surplus with deployable funds, deposit rates are unlikely to go up in the near future. This makes gilts more attractive compared to bonds or bank deposits. Once an investment in gilts or T-bills is made, there is no change in the YTM, even if there is change in the interest rate during the tenure of the instrument. It means, if a security is bought for a certain yield, it will remain the same if the security is held till maturity, even if interest rates go up or down during the intervening period. Thus, one is protected from price risk as well. However, if one trades in gilts, the downward risk in yields is limited to 100 to 200 (at the maximum) basis points while the opportunity for higher returns is quite good. Source: ICFAI Research Center. State Government Securities Like other government securities, the issues of state government securities are also managed and serviced by the RBI. In general, the tenure of state government securities is 10 years. These securities are available for a minimum amount of Rs.1,000 and in multiples thereof. State government securities are available at a fixed coupon rate. However, at present, some state governments have started auctioning their own securities. These securities can be brought through a wide network of offices of both, the RBI and the SBI and its associate banks.

T-BILLS IN INTERNATIONAL MARKETS Primary Market

T-bills are important money market instruments in the US. In US, the minimum denomination of T-bills is $10,000 and thereafter in multiples of $5,000. They are debt obligations of the US government and constitute almost 20% of the marketable debt of the country. In UK, the treasury bills are called gilts and they are issued in the market by the government through the debt Management Office. The gilts are marketable and fall into three types viz., conventional, index-linked and rump stocks. The bank of England holds the gilts on its behalf and on behalf of its clients. The bank also acts as a registrar for gilts and started postal buying and selling of the securities in 1998. 280

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Box 3: T-Bills: The Specs Like G-Secs, T-Bills are also issued by the RBI on behalf of the Central Government to finance its borrowing program. The difference is that T-Bills are issued to meet the short-term borrowing program of the government. They do not carry a coupon rate but are issued at a discount and redeemed at par. T-Bills are issued for a period of less than one year. Currently, there are T-Bills of 91 days, 364 days maturity. Minimum investment required in cast of T-Bills is Rs.25,000. Source: ICFAI Research Center. Types of T-Bills In the US markets, though there are many types of T-bills, they can be broadly classified into two types regular-series bills and irregular-series bills. Regular-series bills are issued routinely by competitive auctions, either on a weekly or on a monthly basis. These bills are issued in regular series. They are issued by Federal Reserve district banks and their branches with different maturities of 3 months (13 weeks), 6 months (26 weeks) or 12 months (52 weeks). New issues of three or six month bills are auctioned weekly; whereas, new issues of one year bills are normally sold once in each month. Irregular-series bills are issued when a special cash need arises for the Treasury. These T-bills are of two types strip bills and cash management bills. Strip bills are nothing but a package of bills requiring investors to bid for an entire series of bills with different maturities. Investors who bid successfully must accept bills at their bid price each week for several weeks running. Cash management bills, on the other hand, consist simply of reopened issues of bills that were sold in prior weeks. The reopening of a bill issue normally occurs when there is an unusual or unexpected treasury need for more cash. Issuing Procedure Treasury bills are sold using the auction procedure. The Treasury entertains both competitive and non-competitive tenders for T-Bills. Government securities firms, individuals, financial and non-financial companies usually participate in the bidding. In competitive bids, the quantity of desired T-bills are specified with lowest interest rates which the buyer is willing to accept. (However, treasury rules prohibit any single bidder from obtaining more than 35 percent of any new issue.) The competitive tenders are typically submitted by large investors, banks and securities dealers. The non-competitive bids are submitted by small investors and their bidding amount is limited to $1 million or less. A non-competitive bidder accepts the weighted average interest rate of the competitive bids and these bids state only the quantity of bills desired. In UK, all new issues are scheduled and are made through auctions with the details being announced in advance. Private investors may bid for gilts at auctions on a non-competitive basis and receive the gilt at the weighted average of the price paid by successful competitive bidders. The minimum for this type of application is 1000 nominal of the gilt and the maximum is 500,000. Investors making non-competitive bids at the auction are asked to enclose a cheque for a specified amount per 100 nominal bid for. If the eventual price is less, the difference is refunded if greater, a further payment will be asked for. Discount Pricing The T-bills are issued at a discount to face value and hence have no coupon. Commission rates on round lots generally range from $12.50 to $25.00 per $1 million of T-Bills, depending on the maturity of indebtedness is issued with the T -Bill and there is no engraved matter on the T-Bill specifying the terms. The purchase is simply recorded by a book-entry system by the Federal Reserve Bank. Interest earned is the difference between the price paid to purchase the instrument and the amount received upon maturity. The value of T-bill price is face value less discount at a given interest rate. The discount is based on a 360-day year and the number of days between date of purchase and maturity date and is quoted per $100 of face value. 281

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T-Bill purchases are maintained electronically by the Treasury and the Federal Reserve System. As there is no physical delivery, transaction costs are significantly reduced, thereby, eliminating the need to handle, ship and store physical documents. Box 4: Non-competitive Bidding With a view to encourage wider participation and retail holding of government securities, a scheme for non-competitive bidding was introduced with the auction of a 15 year stock in January 2002. Under the scheme, the investors who do not maintain current account or SGL account with the RBI are eligible to bid; the minimum amount of bid is Rs.10,000 and thereafter in multiples of Rs.10,000 and the maximum amount of each bid is Rs.1 crore; bids are placed through a bank or PD; the total amount under the scheme does not exceed 5% of the notified amount; and allotment to non-competitive bidders are made at the weighted average rate of successful competitive bidders. Source: Debt market, www.nseindia.com

Secondary Market
The major participants in secondary market are banks, brokerage firms and bond houses. They buy and sell T-bills on behalf of customers and themselves. The customers include depository institutions, insurance companies, pension funds, non-financial firms, and state and local governments. Government dealers help to maintain an orderly market mechanism through trades of T-bills for their own accounts. They are the market makers for these instruments by providing Bid-Ask quotes. The US Treasury Bill market attracts both domestic and international investors because of the perceived strength of the US$ apart from the liquidity, maturity profile and the risk-free nature which are true for most of the sovereign securities. The Fed (Federal Reserve Bank) usually holds more than $100 billion worth of T-Bills at any given point of time and buys large quantities of bills from the dealers in the secondary market when it wants to inject more money in the economy. In UK, Gilts are traded in a very active market centered on a group of firms known as Gilt-Edged Market Makers (GEMM). The GEMMs deal continuously with major professional investors life pension funds and insurance companies, across the entire list of gilts. GEMMs, along with institutional investors and custodians who may hold stock on behalf of private investors, hold gilts in computerized form using the CREST settlement system (The CREST system is a computerized system to settle the registration and transfer of dematerialized securities including UK and Irish corporate securities, UK government securities and international securities). Some of the GEMMs make special provision for deals in small amounts.

SUMMARY
Treasury bills are issued by the government to raise short-term funds in the money market. They are a major portion of the borrowings of the Government of India. The RBI acts as the banker to the Government of India to issue the T-bills. The investors in T-bills include: Banks (to meet their SLR requirements), primary dealers, financial institutions (for primary cash management), insurance companies, provident funds (as per the investment guidelines), non-banking finance companies, corporations, FIIs, state governments and individuals (to a very minor extent). T-bills are issued in the form of promissory notes or credited to the SGL account. They are for a minimum of Rs.25,000 and multiples thereof, issued at a discount and redeemed at par and do not carry any yield. 282

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There are five types of T-bills: 14-day, 28-day, 91-day, 182-day and 364-day, out of which the 28-day T-bills have not yet been launched. 14-day T-bills were discontinued from May, 2001. 182-day T-bills were discontinued in May 2001, and reintroduced with effect from April 2005. The bills are available in paper as well as in scripless form. Ad hoc T-bills are issued in favor of the RBI when the government needs to replenish the cash balances and to provide temporary surpluses to state governments and foreign Central Banks. These are not available to the public. On tap T-bills were issued by the RBI to investors on any day and with no limit on investment. They were for a minimum of 91 days and the discount rate was around 4.6% redeemable at par. They were discontinued from April 1, 1997. 91-day T-bills are auctioned weekly on Fridays and payment in respect to the allotments is made on Saturdays. The auction for and 364-day is held weekly on Wednesdays and payment in respect to the allotments is made on Thursdays. T-bills are important market instruments in the US, where the minimum denomination is $10,000 and in multiples of $5,000 thereof. The American T-bills are mainly classified as regular-series T-bills and irregular-series T-bills. Regular-series of 13-week, 26-week and 52-week maturities are issued weekly or monthly while irregular-series are issued for a special cash need of the treasury. The US T-bills are sold in auctions and issued at a discount to face value.

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Appendix* Auction Procedure

Let us consider an example to understand the process of bidding in treasury bills. Say on 2nd November, RBI issued a tender notification for 91-day T-bill for Rs.500 crore. There were 4 competitive bidders namely, A, B, C and D who responded to the notification of T-bills, and submitted sealed tenders to the RBI. The overall amount quoted through the tender is Rs.1,900 crore. A General Manager from Public Debt Office (Mumbai) opened the tenders, and compiled the following information to determine the cut-off point. Sl. No. Name of the Bidder 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 B A A C B C C A B A B C D D D D Price (Rs.) 98.95 98.90 98.80 98.80 98.75 98.65 98.50 98.50 98.50 98.45 98.40 98.35 98.45 98.35 98.30 98.25 Amount (Rs. in cr.) 50 40 60 80 50 120 200 100 100 200 120 280 70 120 150 160 Cumulative Amount (Rs. in cr.) 50 90 150 230 280 400 600 700 800 1000 1120 1400 1470 1590 1740 1900

Based on the above information, the GM needs to decide the cut-off price and allocate the T-bills to bidders at respective rates. The GM decides an optimal cut-off price as Rs.98.50. Below this point, amount of bids is short by Rs.100 crore and at this point, it has a surplus of Rs.300 crore. The first six bids given by A, B and C are accepted completely, and the next quote given by the three bidders being the same, RBI allots T-bills proportionately. The fully accepted bids are: Name of the Bidder A A B B C C Price Quoted 98.90 98.80 98.95 98.75 98.80 98.65 Total 284 Approved Amount 40 60 50 50 80 120 400

Financial Markets and Instruments

The RBI allots the three bidders proportionately in the following manner: Name of the Bidder A B C Price 98.50 98.50 98.50 Amount 100 100 200 400 Proportionate Amount Allotted (cr.) 25 25 50 100

100 x 100 = 25. Thus, a proportionate allotment is made to the three bidders. 400

The yield is calculated as Yield =

Face Value Price

1 x

365 Days to Maturity

Weighted Average Yield for the Issue Name of the Bidder A Price (i) 98.90 98.80 98.50 B 98.95 98.75 98.50 C 98.80 98.65 98.50 Amount (ii) 40 60 25 50 50 25 80 120 50 Proportion Wt. Price (iii) (i x iii = iv) 0.08 0.12 0.05 0.10 0.10 0.05 0.16 0.24 0.10 1.00 7.912 11.856 4.925 9.895 9.875 4.925 15.808 23.676 9.850 98.722 Yield (v) 0.0446 0.0487 0.0610 0.0425 0.0507 0.0610 0.0487 0.0548 0.0610 Wt.Yield (vi) 0.00356 0.00584 0.00305 0.00425 0.00507 0.00305 0.00779 0.00131 0.00610 0.04002

The non-competitive bidders would have to pay weighted average cut-off price which is obtained by taking the average of prices, which works out to be 98.72 in this particular issue. The non-competitive bidders would get an yield of 4 percent. Let us calculate the yield based on the above inputs for each of the bidders: a. Average Yield for A: (98.90 x 40/125 + 98.80 x 60/125 + 98.50 x 25/125) = 98.77 Yield =

100 98.77

1 x
or

365 = 4.99% 91

(0.0446 x 40/125 + 0.0487 x 60/125 + 0.0610 x 25/125) = 4.984% b. Average Yield for B: (98.95 x 50/125 + 98.75 x 50/125 + 98.50 x 25/125) = 98.78 Yield =

100 98.78

1 x

365 = 4.95% 91

(0.0425 x 50/125 + 0.0507 x 50/125 + 0.0610 x 25/125) = 4.948% 285

Treasury Management: Theory and Practice

c.

Average Yield for C: (98.80 x 80/250 + 98.65 x 120/250 + 98.50 x 50/250) = 98.668 Yield =

100 98.668

1 x

365 = 5.414% 91

Or (0.0487 x 80/250 + 0.0548 x 120/250 + 0.0610 x 50/250) = 5.41% As per the RBI guidelines issued on November 6, 1998 the 91-day T-bills only would follow uniform price auction method, instead of multiple price auction method. In uniform price auction method, all successful bidders would pay a uniform cut-off price that would emerge in the course of auction. In this example, all the bidders would be paying a price of Rs.98.72 uniformly. This would avoid price discrimination among the successful competitive bidders. * Source: ICFAI Research Center.

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