Sun | Sep 19, 2021
ADVISORY COLUMN: PERSONAL FINANCIAL ADVISER

Oran Hall | More on repos, T-bills and math

Published:Sunday | February 28, 2021 | 12:08 AM

QUESTION: I am very poor at doing math, so I need your help. If I put $1 million in repos at 4 per cent for 30 days, how much would I get in interest payment at maturity? Also, what are the different terms of repos? Can I just go to a financial...

QUESTION: I am very poor at doing math, so I need your help. If I put $1 million in repos at 4 per cent for 30 days, how much would I get in interest payment at maturity? Also, what are the different terms of repos? Can I just go to a financial institution and purchase these instruments or do I need a broker? Is there a minimum investment? Can these instruments be used as collateral if you need to get a loan?

– Colin

FINANCIAL ADVISER: Repurchase agreements, more so known as repos, are short-term financial instruments with maturities varying from 30 days to 365 days, which makes them money market securities. They stand out from other securities in that they are contracts by which the holder of debt instruments sell them to another party with an undertaking to buy them back at a set date in the future and to pay interest at an agreed rate at the end of the contract.

They are generally sourced through investment houses, which act as middlemen between buyers and sellers, but not all such companies participate in that market today. This is quite different from what obtained in the past and much has changed in that market following changes made by the regulators.

Generally, the minimum size of such a transaction is $1 million and the rate varies, depending on the size of the transaction and the term of the investment. Usually, the longer the term and the larger the transaction, the higher the rate.

It does not seem that using this type of instrument as collateral for a loan is as straightforward as using other types of instruments but, ultimately, its acceptance as collateral depends on the policy and practice of the lending institution.

So, how much interest would you earn if you invested $1million for one year at 4% per annum? You would first multiply $1 million by 4 and then divide by 100. The answer – $40,000 is the interest you would earn for a full year. Next, you would multiply the $40,000 by 30, then divide by 365 – alternatively, you could do the calculations, this was: $1,000,000 x 0.04 x 30 ÷ 365. The answer, $3,287.67 is the gross interest you would earn for 30 days.

If you want to, you will be able to stop describing yourself as being poor at mathematics. Calculations such as this are not complicated but are necessary in everyday life, so begin to practise making such calculations and develop the confidence you need to function effectively. One big bonus is that you will become more independent in the management of your affairs.

With these benefits in mind, I strongly suggest you ask a friend or relative to help you to learn how to do basic arithmetic and then to advance to more complex matters. You owe that to yourself.

On a general note, numeracy is absolutely essential to financial literacy, personal financial management and survival in a world that is becoming more and more complicated in financial matters. Financial instruments, for example, are becoming more complex, and they are increasing as time progresses.

Let us now go beyond repos. Prospective investors lacking the resources to participate in the repo market do not have to be left out of the money market, the market for financial instruments with a term of up to one year. Treasury bills are another option as their maturities range from 30 to 365 days.

Treasury bills trade at a discount and mature at face value, the difference between the two being income to the investor and is not interest in the traditional sense but is taxable, as is the interest earned on repos.

The public can submit bids for Treasury bills to Bank of Jamaica at its auctions, but it is quite common for the public to submit their bids through their stockbrokers. The minimum bid amount in a Treasury bill auction is $5,000.

Being an auction, there is no guarantee a bid will be successful. Oftentimes, the auction is oversubscribed and it is the bids with the highest price, or lowest yield, which are satisfied first. Other bids may be partially filled, but others may be rejected, so it is important to be able to understand what is happening in the market when submitting a bid for Treasury bills.

Repos – for which Bank of Jamaica and Government of Jamaica instruments are generally the underlying instruments – and Treasury bills tend to give better returns than can be obtained from instruments offered by the commercial financial institutions.

Depending on market conditions, it is generally possible to liquidate them prior to their maturity date, but at the risk of a lower rate of return than that contracted at the time the investment was made.

Oran A. Hall, author of ‘Understanding Investments’ and principal author of ‘The Handbook of Personal Financial Planning’, offers personal financial planning advice and counsel. finviser.jm@gmail.com