Question

What is the difference between the yield on a discount basis and the yield to maturity for a T-bill?

How might a firm use the commercial paper market to deal with seasonal fluctuations in sales?

Answer 1

T bill

Treasury bill or T bills refers to short term securities issued by the government that mature with in a period of one year or less.

*Yeild at discount basis

Bank discount yeild is calculated as the annualized discount as a percentage of the face value of the treasury bill based on the 360 day period

Discount yeild (DY),rBD =(D/F)(360/t)

rBD= the annualized yeild on a discount basis

D=the dollar discount

F=Face value of the treasury bill

t= actual number of days remaining to maturity.

*Yeild at maturity

The yeild of a treasure bill at maturity can be calculated using the following formula

Y=(100-P/P)*(365/D)*100

Note: it's 100-P whole divided by P

Y=Yyeild to maturity

P=Purchase price of the treasury bill

D= Days to maturity

Yeild to maturity represents the true yeild of the treasury bill.In the case of discount yeild, treasury bill is issued at discount from parvalue ( face value) along with many forms of commercial paper other short-term securities.when it's sold before the maturity date,the rate of return earned is different as the new return depends on the sale price of the security.

* Use of commercial paper by the firm

Commercial paper is a short term debt instrument issued by the companies to raise funds generally for a period up to one year.

Commercial paper is not backed by collateral.Only firms with high credit rating will be able to sell their commercial paper at a reasonable price.

When firm face issues related to sales or other financial requirements,it issues commercial paper.lt helps the firm in the following ways

* It is a cheaper source of fund for the firm

* It helps to meet funding requirements quickly .Procedural requirements for securing bank facilities and charge creation on assets is as also not required.

*Commercial paper issuance also serves as a preamble to any future bond offering by the firm . Balance sheet efficiency creates great potential funding capacity for the issuer.

*It enables the firm to complement it's sources of working capital, while diversifying it's funding sources to include non-bank investors.

*Ultimately it also enables the firm to acquire investments that are tradable with out a penalty.