From a brokerage house Shajar Capital, an education to investors and create market awareness about the fixed income securities and the opportunities they provide. In this regard they are launching a new series of product (published intermittently) titled ‘Treasury Notes’ that will primarily focus on Fixed Income segment. To recall, it has been reported that the government, the central bank and the capital market regulators have finalized the plan for a soft launch on Jan 31, 2014 for the first phase of trading of government papers on the three stock exchanges. The formal launch of the trading of various type of government securities is scheduled to begin tentatively on Feb 08 and Feb 11. Today is a rudimentary note attempting to create a basic understanding of various government securities, markets and their associated risks, particularly for retail investors.
What are treasury securities
A treasury security is a government debt issued by the Ministry of finance through its Debt Management Department. In other words, treasury securities are the debt financing instruments of the government, and are often simply referred as Treasuries or Government Paper. Increased requirement of the government to bridge its fiscal deficit and pay off its maturing debt have created a sizable stock of government securities worth approximately PkR8tn as per the last reported numbers of Nov’13. Furthermore, being backed by the government they are considered as a benchmark for risk free investment that has created a highly liquid secondary market with soaring level of trading activity.
Types of treasury securities
Though there are three basic types of treasury or government securities in Pakistan. These include two conventional securities i.e. Treasury bill (T‐Bill) and Pakistan Investment Bond (PIB), and one Islamic Government Ijarah Sukuk.
Brief descriptions of the following are as follow:
i) Treasury bills – short term instruments: The securities issued with maturities of one year or less are called Treasury bills (or T‐bills) and are often referred to as discount securities. Discount securities are so called because they are issued at a price below the face value, with return to the investors being the difference between the face value and the issue prices. Furthermore, there is no intervening interest payment. In Pakistan, the Tbills are issued with maturities of 3‐months, 6‐months and 1‐year as well as cash‐management bills with various maturities. As of last reported numbers, T‐bills account for approx. 77% (or PkR 5.8tn) of the total issued government securities.
ii) Pakistan Investment Bonds – over a year horizon maturities: Pakistan Investment Bonds (PIBs) are government securities with original maturities of more than 1‐year issued as coupon securities. The government issues bonds of 3‐years, 5‐years, 7‐years, 10‐years, 15‐years, 20‐ years and 30‐years maturity periods. However, bonds of maturity with 7‐years, 15‐years and 30‐years are not being currently issued by the government. Of the total outstanding government securities, PIBs accounts for 17% (or PkR1.3tn) These coupon bearing securities are issued with a stated rate of interest, pay interest biannually, and are redeemed at par or face value. Furthermore, they are issued at or close to par or face value while the return of the investors being the primarily the coupon payments received over the life of the securities.
iii) Government of Pakistan Ijarah Sukuk – a Sharia compliant instrument: Besides the conventional instruments debt market securities, the government has also launched Sharia compliant securities to cater the increased need of investors to avoid the conventional financing scheme. Ijara Sukuk is similar to PIBs but complies with Sharia laws (particularly is asset back). Ijara Sukuk sells an investor group the certificate, who then rents it back to the issuer for a predetermined rental fee. The issuer also makes a contractual promise to buy back the bonds at a future date at par value Currently, Ijara Sukuk accounts for 5% of the total government securities. Presently Ijarah Sukuk is offered for a period of three years.
Major segments of the fixed income securities
There are primarily two major segments of the fixed income securities i.e. Primary market and secondary market.
i) Primary market: The new issue is sold through an auction which forms the primary market for the government securities. These auctions are notified of several days in advance and are only allowed to be participated by the primary dealers.
ii) Secondary market: Subsequent to the issue, the securities are traded in an over‐the‐counter market comprising of various primary dealers, other organizations and inter‐bank dealers/brokers. This aftermarket reselling and purchasing activity forms the secondary market for the government securities.
In order to increase access of small investors to these securities the government with the help of other stakeholders is trying to start government securities trading through organized stock exchanges of the country. Through the envisioned trading system, individuals will be able to access these markets, allowing them to earn a higher return than other saving avenues currently being offered. However, the development of the ordeal is still in the infant stage and through our effort of Treasury Notes we shall strive to keep investors at pace with the developments in this regard.
Risk associated with fixed income securities
Being backed by the government, the said fixed income securities are generally immune to default risk and are thus called risk‐free. However, the investors need to be aware of potential risk to holding a government bond. The price of the bond has an inverse relationship with the prevalent interest rates in the market. This means as interest rates fall, the price of the bonds being traded in the marketplace generally rise. Conversely, when interest rates rise, the prices of the bonds tend to fall. This happens because when interest rates are declining, individual investors try to buy the highest rates they can for the longest maturity possible. To do this, they will buy existing bonds that pay a higher interest rate than the prevailing market rate. This increase in demand translates into a hike in bond price.
Similarly, when the interest rates are increasing, the investors offload their existing position to take exposure on the new high yielding securities, therefore the demand of the existing securities decline.
Besides, there are certain tax considerations a retail investor should be aware of. While trading in the secondary market the ouns of WHT fall on the investor holding the security at the time maturities. Though this is not an hinderance in trading for the institutions, it is likely to create a hassel for the small investors for claiming the WHT. Therefore, in developing the secondary market of the government securities the concern stakeholders should give due consideration to smooth out this issue.
