Week2 - Bills and Gilts

[Pages:24]Treasury bills and Gilts

Week 2

CORPORATE FINANCE - 1 UNIVERSITY OF EXETER MARK FREEMAN, 2004

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Risk-free, tax free, projects

In today's class, we shall concentrate on the valuation of riskfree cashflows in the absence of taxation. The introduction of risk and tax will come later in the course.

While this may seem over simplistic, it will enable us to understand much of what occurs with government fixed income securities. So, by the end of today's class, we should be in a position to read and interpret bond market data.

Further, as most companies want to raise debt as well as equity, we need to be aware of the other types of debt finance against which our project is competing ? including government debt.

Therefore understanding fixed income securities will both help us with the fundamentals of project evaluation and debt financing.

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US fixed income securities Q2 2004

Treasuries Mortgage-backed Fed Agencies Municipal Corporate Money market Asset backed

Total value = USD 22,787,000,000,000 or USD 22.8tn.

Source: The bond market association

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UK T-bill auctions

T-bills, remember, are short-term Government borrowing. For institutional details of trading in UK Gilts and money market instruments, there is an excellent governmental website (.uk). The money is raised through auction. These happen each Friday:

92 Day TBill due 04/01/2005 Lowest Accepted Yield Average Yield Highest Accepted Yield Avg Rate of Discount (%)

Average price per ?100 nominal (?) Tail (In Yield Terms) Amount Tendered For (?) Amount On Offer (?) Cover Amount Allocated (?)

ISIN Code: GB00B024NB10 4.720000 4.734680

4.740000 (94.80% allotted) 4.678843

98.820675 0.005320

6,336,000,000.00 1,000,000,000.00

6.34 1,000,000,000.00

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US Treasury bills

Details of US T-bill auctions can be found at

Security Term

13-WEEK 13-WEEK 13-WEEK 13-WEEK 13-WEEK 13-WEEK

Auction Date

10-04-2004 09-27-2004 09-20-2004 09-13-2004 09-07-2004 08-30-2004

Issue Date

10-07-2004 09-30-2004 09-23-2004 09-16-2004 09-09-2004 09-02-2004

Maturity Date

01-06-2005 12-30-2004 12-23-2004 12-16-2004 12-09-2004 12-02-2004

Discount Rate %

0.000 1.710 1.685 1.640 1.635 1.580

Investment Yield %

0.000 1.741 1.716 1.671 1.663 1.607

Price Per $100 0.000000 99.567750 99.574069 99.585 99.587 99.601

CUSIP

912795RU7 912795RT0 912795RS2 912795RR4 912795RQ6 912795RP8

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The four T-bill yields

There are four ways in which the rate of return on T-bills are quoted

US markets

Discount Rate Investment Yield

UK markets

Average Rate of Discount Average Yield

CFA / My terms

Bank Discount Yield Money Market Yield CD Equivalent Yield Holding Period Yield Effective Annual Yield "True" Yield to Maturity

You need to be able to distinguish between these four yields.

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Yields on T-bills - 1

Consider the US data given above. A key number is the auction price of 99.567750 for the thirteen-week bill of 27-092004.

What this means is that, for every $99.567750 you lend to the government today, you will be paid $100 on Dec 30 2004. That is, you will receive $0.43225 more than you invested (the "discount") per $100 of face value. The Bank Discount Yield is then calculated as follows:

Discount rate = Discount x

360

$100

Days to maturity

= $0.43225 x 360

$100

91

= 1.710%

In the UK, the convention is to use the actual number of days in the year, rather than 360.

UK Discount rate= 4.678844%

?100 - ?98.820675 x

?100

92

365 =

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Yields on T-bills - 2

Much more important is the "coupon equivalent". First we calculate the Holding Period Yield to the t-bill:

Holding Period Yield = Selling price ? Buying price Buying price

= Discount Auction price

So, for the US and UK bonds

US bill =

$0.43225 = 0.4341% $99.567750

UK bill =

?1.179325 = 1.1934% ?98.820675

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