Government Securities Primer

By JR Maniego, RFP

This primer provides a comprehensive overview on investing in government securities (commonly known as “GS”). It describes what they are, where they come from and how they function as financial instruments for investment among individuals and institutions. Hence, this primer describes many of the fundamental and most common features of government securities to get you started in understanding GS investing.

1. What are government securities?

   According to the Bureau of Treasury, government securities are unconditional bond obligations of the Republic of the Philippines. Hence, government securities are a type of financial instrument issued by the country to the public in order to fund its expenditures over a certain period of time usually long-term in nature. It is backed by the full taxing power of the country, so for a local investor, government securities are practically a default free investment.

   The Philippine government issues two types of GS, Treasury Bills and Treasury Bonds. These securities are offered to the investing public through a network of banks or authorized dealers or better known as Government Securities Eligible Dealers (GSED). Government securities are no longer certificated and just like other countries these securities are issued “scrip less” which are then safe kept by a registry or in some cases by a third party custodian. The third party custodian or registry handles maintenance of the GS and distribution of interest payments to the investor

2. What are Treasury Bills and Bonds?

   Treasury Bills (T-Bills) are government securities which mature within a year. These securities are issued with tenors of 91, 182, 364 days. By convention, T-Bills are quoted and traded via its yield which also acts as a discount rate. So, if a foreign or insurance company needs to purchase T-Bills to comply with their corporate requirements, they will have to purchase T-Bills at a discount or at an amount below the face value of the security. The usual investors of T-Bills are institution and corporate investors.

   Treasury Bonds is another type of government security which matures in more than 1 year. At present, investors can purchase treasury bonds with maturities ranging from 2, 5, 7, 10, 20 and 25 years. Unlike T-Bills, which are discounted, bonds pay-out interest payments semi-annually. Another type of Treasury bond which pays-out interest payments quarterly is the Retail Treasury Bond (RTB), which is more suitable to investors. And just last October 2011, the government issued 10 and 15 year RTBs worth over P100 billion. RTBs give the investor better cash flow streams as compared to any other outstanding bonds in the market, hence the suitability of RTBs to individual investors bearing the right risk profile.

3. How much do I need to invest in a government security? What are the requirements?

   For investors who really want to invest in GS instruments, there are banks that require only a minimum amount of about P100, 000. In some government-owned banks, they only require a minimum of P10, 000. For individual investors, it would be advisable open a settlement account with your respective bank in order to have ease in the settlement of purchase/sale and crediting of coupon payments.

   Investing in government securities is as easy as opening a bank account. Usually GSEDs or banks only require the client or investor to accomplish minimal but very important documentary requirements which range from the standard “KYC” documents, risk disclosure and client suitability documents. After which, the investor needs to only update documents annually for the simple reason that your bank needs to check on the suitability of your investments versus your changing financial and personal objectives.

4. Do government securities offer a tax advantage for its investors?

   In a sense, GS offers investors a tax advantage most especially corporate and institutional investors simply because interest payments earned are only subjected to a 20% withholding tax as compared to corporate tax of 30% if the funds are reinvested back into the company. So it would be advisable for companies to invest their long-term excess cash holdings in GS to do away with the opportunity cost of holding cash and high corporate taxes.

5. How to compute for the value of a bond?

   The value of a bond is computed using the standard present value formula with the quoted yield as that discount rate. Computing for the value of a bond is quiet tedious so I suggest that you use a spread sheet or just call your friendly neighbourhood banker and ask him to make the computation for you.

6. Mechanics for investing in GS

   In the Philippines, GS are quoted by convention in yields or interest rates unlike in the other countries like the US where US treasuries are quoted and traded by its price. Hence, in order to effectively trade GS, the investor must buy GS when interest rates are going down and sell when interest rates are rising. Nevertheless, unlike stocks, the investor has room for safety when he is not able to sell his GS holdings when interest rates suddenly rise because he has the comfort of interest payments when held to maturity.

   Investing in GS has never been more exciting. With the ongoing uncertainty in global growth, interest rates in the Philippines many be set to go down by about half percent in the early part of 2012, thus investors have room to position themselves for profits by investing in government securities.