Question: Please can you explain what Treasury Bills upfront interest is and how it works?
Upfront interest is the interest paid at the commencement of the investment, rather than at maturity as is usually the case.
In Nigeria, interest in Treasury Bill’s investment is paid upfront by the broker. Brokers are banks, finance/investment houses, etc.). Usually, brokers make interest payments at the maturity of the investment. With treasury bills, it is the opposite.
Let’s assume you invest N1,000,000 for 91 days at 10% per annum on April 1. As shown in the article – How are interest in Treasury Bills calculated, the interest earned is N25,000 (assuming deductions for commissions, etc.). Your investment matures July 1.
With investment in fixed deposits and other money market instruments, the broker credits your account with N25,000 plus the principal (N1,000,000) on July 1.
With investment in Treasury Bills and Commercial Papers, the broker credits your account with N25,000 on April 1, which is the commencement date of the investment. Your principal (N1,000,000) is returned to you at maturity on July 1.
So in effect, you are getting the interest at the commencement of the investment and your principal at maturity.
That is the simplified version of how upfront interest works. That is all you need to know for now.
The reality is that there is nothing like upfront interest. You are simply buying a discounted instrument.
What you are doing is buying N1,000,000 worth of Treasury Bills (or commercial papers) at a 10% discount (per annum). So instead of paying the full value of N1,000,000, you pay N975,000 for N1,000,000 worth of 91-day treasury bills.
You deposit the full amount N1,000,000 in your investment account with the broker. The broker remits N975,000 to the Central Bank and returns N25,000 to you, or retains it in your investment account based on your instructions. The Central Bank pays you the full face value of N1,000000 at the maturity of your bills on July 1.
You are simply growing your money from N975,000 to N1,000,000 in 91 days. The broker returns your N25,000 (discount), which makes it look like you are getting paid interest upfront.
