The low-risk characteristic, ease of being converted to cash, and certainty of repayment upon maturity make treasury bills a worthy investment option for many people in Nigeria. Although treasury bills offer low returns compared to other short-term securities, like government-backed bonds, many Nigerians see it as a suitable avenue to stash money for a brief period. If you don’t mind the low yield of treasury bills and want to go ahead and invest your idle funds, keep on reading to find out how to calculate interest rates on treasury bills in Nigeria.
How to calculate interest rates on treasury bills in Nigeria would be discussed below:
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What are Treasury Bills and How Do They Work?
Treasury bills, sometimes called t-bills, are government-backed short-term securities that are sold to the public through a bi-weekly auction conducted by the Central Bank of Nigeria. Treasury bills are usually issued when the Federal Government wants to borrow funds from the public for independent operations and special projects and the maturity period ranges from 91 days to 364 days (that is 91 days, 182 days, and 364 days).
When the Central Bank of Nigeria is about to auction treasury bills to the public, advertisement is published in national dailies to inform the public so interested investors can bid for available t-bills. It is pertinent that we disclose that N50,000,000.00 is the least amount an investor can buy treasury bills during such auctions conducted by the CBN.
If you don’t have up to that amount, you could either go through banks or licensed brokers to purchase t-bills. However, in such cases where you using a bank or broker, several investors like yourself would have to contribute funds to meet or exceed the N50 million required which the bank or broker would invest into a portfolio on behalf of everyone who contributed.
During the auction of t-bills in Nigeria, investors are allowed to submit quotes on the discount rate that they are willing to pay for each tenor of treasury bills. After all the bids have been received, CBN will accept the lowest bids, climbing higher until it has reached the total amount it seeks to raise for the issued treasury bills.
The bid rate at which the total amount the apex bank seeks to raise for the issued t-bills is achieved is selected as the maximum discount price (also known as the stop rate). All investors with quotes lower or equal to the stop rate will be able to purchase t-bills from CBN, while those with quotes above the maximum discount rate are rejected. Consequently, CBN offers all successful bidders the highest accepted bid rate as the discount margin of the t-bills.
With the highest accepted quote of the auction selected as the discount margin of the treasury bills, successful investors (that is, those whose bids were equal to or below the highest accepted bid rate) can proceed to purchase t-bills at a price lower than the face value of the issued treasury bill. For example, if an investor purchases treasury bills worth N200,000.00 with a maturity period of 364 days at the discount rate of 10 percent, CBN will only debit his account with N180,000, leaving N20,000, which is the interest the investor earns. At the expiration of the 364 days, the investor will be paid the full price of the t-bill, which is N200,000.00. (The formula to arrive at these figures would be provided later on in this article).
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How is the Interest Rate on Treasury Bills Calculated in Nigeria?
We’ve been able to establish how CBN selects the discount rate for each tenor of treasury bills during the bi-weekly auctions through which t-bills are sold to the public. The selected discount rate implies that successful investors will buy treasury bills from CBN at a lower price (lower than the face value).
To explain this better, let’s maintain the example we used earlier. Assuming an investor purchase t-bills worth N200,000.00 with a maturity period of 364 days at the discount rate of 10 percent, what would be the price he pays for the t-bills?
Solution
Before we can determine what the investor will pay as the discounted price for 364-day tenor treasury bills worth N200,000.00 at a 10% discount rate, we need to first determine the amount discounted. Here’s the formula to use:
(Tenor/364 days) × face value of treasury bill × discount rate
where Tenor = duration of maturity (could be 91 days, 182 days, or 364 days, depending on the tenor or the treasury bill)
Face value of treasury bill = the value of the security as stated by its issue (i.e. the full price)
Now let’s find what the discounted portion of the N200,000.00 is using the above formula.
= (364/364) × 200,000.00 × 10%
= 1 × 200,000.00 × 0.1
= 20,000
From the calculation above, the investor enjoys a discount of N20,000 on the N200,000-worth t-bills. This implies, that CBN will only N180,000 from his account, leaving his N20,000.
After the expiration of the tenor of which the treasury bills are expected to last, investors will eventually be paid the full price of the face value of the issued t-bills. In the case of our fictitious investor, he will be paid N200,000.00 after 364 days.
The interest earned from the difference between the price paid at purchase and the bill’s face value which is the final amount received at maturity is the profit the investor makes from t-bills. In the case of our fictitious investor, he made a profit of N20,000 on the 364-day treasury bill of N200,000.00 at the discount rate of 10 percent, that is, N200,000 – N180,000.
To answer the question, which is the title of this article, the interest on treasury bills in Nigeria is calculated with the formula below:
Tenor/364 days) × face value of treasury bill × discount rate
where Tenor = duration of maturity (could be 91 days, 182 days, or 364 days, depending on the tenor or the treasury bill)
Face value of treasury bill = the value of the security as stated by its issue (i.e. the full price)