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Treasury Bonds

Treasury Bonds

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1. What is it?

A government or treasury bond is a bond issued by a national government, which can be either pre or post-rated, and intends to raise funds required for cover government’s debts. Also, it is an important tool for a country’s monetary policy, used by the Central Bank to control the volume of currency available in the market.

Any government has its debts. In order to finance those public debts, they issue these so-called treasury bonds. When you buy one of these notes, you are actually “lending” some money to the government, an in exchange, it commits to pay it back plus interests. Treasury bonds also finance several national government’s activities, such as education, health and infrastructural expenses, and are an option of investment for the people, backed by the country’s debts.

In the past, only rich people could afford investing in treasury bonds. Otherwise, such operation was only possible through a third-party investment fund. Currently, however, it is possible to a regular and small investor to be buying treasury notes, through a mechanism named Tesouro Direto.

Treasury bonds can be either negotiated in the primary and the secondary market. In the primary market, it happens when the government issues the bonds, trading them through two different methods:

i. Public offerings (auctions) – they happen in a weekly basis, held by the National Treasury and coordinated by the Central Bank. Just the financial mediators (like banks and brokers) can access this first batch.

ii. Tesouro Direto – the system was created in 2002, and allows the regular investor (only individuals) to acquire bonds directly from the National Treasury, after making a registration in any of the authorised financial institutions.

In the secondary market, the investor buys the bonds from other investors, rather them buy them from the issuer. Treasury notes are locally traded in Brazil following indexes, contrary to the usually observed in the international market, and because of that, deals are closed at predefined prices.

Nowadays, the main online platforms to deal with treasury bonds in the secondary market are the Sisbex, managed by the local central bank, and CetipNet, managed by CETIP. However, deals are mostly closed in the OTC market. Currently, there is no place that centralizes deals and pricing floats for all treasury bonds negotiations.

If you sell the bonds before the expiration date, the National Treasury pays you back the current value for deals in the secondary market.

When you buy a treasury bond, liquidation happens in the first day, but the note is only transfered to your name (under your CPF number) by the second day. That means if you purchase a bond today, the money will be leaving your banking account tomorrow, and the note will be just transfered to your name the day after tomorrow. Interests, however, are effective from the day 1.

Minimal investment sum

The minimal quantity of bonds allowed to be purchased are equivalent to 0,1 of one note, meaning a person can invest the equivalent of 10% of a bond. For instance, if a bond is valued at BRL1,000.00, the minimal investment will be fixed at BRL 100.00. In the Tesouro Direto, bonds are traded in multiples of 0,1. You can buy 0,1 or 0,2 treasury bonds and so on.

The maximum monthly investment, on the other hand, is fixed at BRL 1 M for the first month, but grows in the subsequential months, as it is cumulative and considers eventual interests.

Scheduled Purchases

A new Tesouro Direto’s feature allows one to schedule new bond purchases by using the interests paid for his current investment position. The paid interests can be partially or totally re-invested, in the same date they are paid. The feature can also be used when the bond expires, and the redeem value re-invested.

How does the government control currency using treasury bonds?

When the Central Bank decides to increase the interest tax rate, it makes people more likely to spend less and invest more. As the benchmark interest rate is higher, bonds become more attractive, paying better. That increases the amount of money invested and reduces the currency circulating, which tends to lower inflation rates in the medium term. When the Central Bank lowers interest rates instead, people tend to grab their investments and spend more, which usually results in a momentarily market growth, but hikes the inflation indexes up as time goes by.


2. Profitability

Treasury bonds are frequently considered a safe investment, with moderate paying rates. They pay better than savings accounts or certificates of deposits in general. Lately, the operation became more frequent in Brazil, and the invested amount saw a 40% hike from 2010 to 2011. Paying rates for a treasury bond can be based in pre or post fixed interest rates, depending on the note type and characteristics, and they can be linked to:

  • Selic interest tax rate;
  • IPCA + a fixed interest rate;
  • IGP-M + a fixed interest rate;
  • Any predetermined interest rate.

To calculate the raw profit margin of bonds that pay no coupon (those that can be just redeemed by the expiration date) we can use the formula:

Profitability = Selling Price – 1 /  Buying Price

We cannot forget, though, that income taxes cut the profits down. Thus, when making the calculations to find out which investment or bond pays better, do not forget to include income taxes incident over profits.


3. Risks

Risks of holding treasury bonds are generally related to the possibility of countries to not honor their debts. If public debts of a country are really high, the better is to put aside the bonds as an option, as chances to not receive them are high. That happened in the European crisis, between 2011 and 2012.

Governments in countries like Greece, for instance, have been issuing bonds that haven’t been honored. So, how much a bond that nobody wants is worth? And when a government declares it won’t be paying it back? Besides, the task of updating values and interests turns harder, with inflation or deflation moves, currency adjustments, and more.

Currently in Brazil, treasury notes are taken as a low-risk investment, thanks to favorable macroeconomic conditions that make a good deal investing in treasury bonds. But be careful, sometimes it is hard to notice when a crisis is to take place.

Another risk commonly related to treasury bonds are changes in interest rates. By purchasing a pre-rated bond that pays 12% if the Central Bank decides to increase the benchmark to 12.5%, you are not receiving the complementary percentage. You must buy a new bond to be exposed to any change that may occur in the rates – as its name suggests, the rate is predetermined. Be always in the loop with trends that influence the benchmark rates.

If the benchmark interest rates are hiking up, it is preferable to buy post-rated bonds. This way, the higher the benchmark gets, the more the bonds will be paying back. If the banchmark is falling down, pre-rated bonds are recommended, as they keep profit margins unchanged, in spite of any market floats.

Also, remember that treasury bonds are not backed by the local guaranty fund – FGC.


4. Taxation

When investing in treasury bonds, one must income taxes after the bonds redemption. The selling institution (mediator) is actually the responsible for paying the tax, deducting the value afterwards.

The income tax rate can change depending on expiration dates for the bond:

  • Expiration date within 180 days or less: 22,5% (just over profits)
  • Expiration date within 181 to 360 days: 20% (just over profits)
  • Expiration date within 361 to 720 days: 17,5% (just over profits)
  • Expiration date within 720 days: 15% (just over profits)

They are also subject to IOF tax, but only if the redemption happens BEFORE 30 days of investment. There is a table that shows IOF rates, according to a redemption happening during the first 30 days of investment:

Days passed from the investment date Taxable stake of profits (%)
1 96
2 93
3 90
4 86
5 83
6 80
7 76
8 73
9 70
10 66
11 63
12 60
13 56
14 53
15 50
16 46
17 43
18 40
19 36
20 33
21 30
22 26
23 23
24 20
25 16
26 13
27 10
28 6
29 3
30 0

In addition to the income tax and the IOF (if applicable), there are other 3 charges and fees to be considered:

1. Negotiation fees of 0.10% over the total investment amount. No matter what bond you are choosing to invest, the fees are to be charged by Tesouro Direto anyway. For scheduled purchases, fees drop to 0.05% of the amount from the third deal on. If an automatic re-investment is scheduled for the redemption date, fees are not charged at all. This charge is no longer effective since January 2013, though.

2. Another charge that affect treasury bonds’ profitability corresponds to the custody fees charged by CBLC to hold the notes and give information on operations. It charges an annual fee equivalent to 0.3% of the bonds value, and must be paid every first bank day in January and July, when every time a custody happens, whatever comes first. This charge incides depending on the period of time the investor holds the note, calculated to a limit of BRL1.5m. If during a semester the fees do not exceed BRL10.00, the amount accumulates to the next exercise and so on. As of the second day after the purchase, fees are daily cumulative over the par value. That continues to be daily updated, until the investor sells the bond or reaches the redemption date. That makes difficult to forecast how much CBLC is to charge.

For instance, in a LFT bond, to which prices vary in a daily basis, CBLC fees are equivalent to 0.3% per year but calculations are also daily. Thus, one can only forecast how much is to be charged if he knows the value of the bond for every single day of investment. Otherwise, only projections are possible.

3. To invest in any government note it is necessary to have an account opened in a broker, or custodian. They usually charge a small service fee, previously agreed when the account is opened. The percentage hugely changes from agent to agent. Make a research to find a best option and if the fees exceed 1% of investment, it’s probably not worth. After the first year of custody, fees are daily updated based on the par value. In other words, for the very first year, a single amount is charged over the invested value. Thereafter, fees are just charged for the days of investment, just like CBLC does. Again, only projections are possible.

These three charges are relatively low, but they can steal the bond profitability if put altogether.


5. How it works

The most common and known to invest in treasury bonds is by using Tesouro Direto system. For such, having a broker account is mandatory. However, it is also possible to purchase these bonds in the OTC market.

In Tesouro Direto website, it is possible to invest any value higher than BRL30.00 safely. Once bought, the investor can wait for the redemption date, when the amount and profits are to be credited back, or he can also try to sell it before. However, treasury notes can only be sold in Wednesdays. From 11/03/2015, the purchase and sale of Treasury Bonds is daily.

The bonds’ redemption occurs in a predetermined date, for a predefined value, updated or not by market indexes. In Tesouro Direto there is also the option of selling them in the weekly rebuying rounds.


6. Types

Financial Treasury Bills – FTB (Treasury Selic)

FTBs are post-rated bonds, and its profitability follows the daily SELIC benchmark. The change is daily calculated, from the moment that the note is purchased, until its sale. The investor earns the profits just once, and only by the redemption date, together with the original invested amount.

The National Treasury settled by July 2000 the one FTB is worth BRL1,000.00. Hence, FTB prices before the redemption date are calculated in accordance to interest rates agreed and the time of investment.

FTBs can be traded with premium, discounted values or par value.

Premium: if bonds pay extras, the investor receives the SELIC rates, less the premium amount. A 0.02% over SELIC rates means that the investor will be actually paid with a 0.02% discount.

Discounted prices: with discounted prices, the opposite actually happens, and the investor is entitled to receive the SELIC plus the discount.

Par value: that means FTB are being traded by its actual value.

To find out in which situation FTBs are being traded, it is just looking at prices and rates for bonds on Tesouro Direto’s web page.

http://www.tesouro.fazenda.gov.br/tesouro_direto/consulta_titulos/consultatitulos.asp

National Treasury Letters – NTL (Treasury Fixed)

NTL are pre-rated bonds. All of the bond’s characteristics like the pricing, rates and periods of redemption, as well as the profit margins, are known by the moment of purchase. They have a basic par value of BRL 1,000.00, and the investor gets paid just once, by the redemption date.

That means the FTB prices are always to reach BRL 1,000.00 for redemption – and the longer the period of investment, the higher are the interests to be paid. For instance, if an investor buys a FTB today for BRL914.36, will be necessarily redeeming it for BRL 1,000.00. The interest rates and profits over time depend on the period and ways of negotiation.

NTLs are easy to understand. While buying them, one will be immediately aware of its prices, dealing taxes and the period for redemption. From all information provided, that is quite easy to find how much profits the notes will pay. Well, and being told about how much you can redeem by the expiration date, it is up to you to decide whether investing in NTLs is worth or not.

A quick advice – NTLs are usually recommended when SELIC rates are going down.

Treasury Notes – series B (Treasury IPCA with semiannual interest)

Series B treasury notes are bonds whose profits evolve in pararel with the IPCA inflation index, plus interests agreed by the notes’ purchase. If you are looking for protect the money from inflation, the bonds TN- B are the  most recommended.                                                          .

TN-B will be subject to two interest rates at the same time:

  • 1. IPCA changes (monthly)
  • 2. Interest rates defined in the moment of purchase

IPCA is monthly calculated by IBGE (Brazilian Institute of Geography and Statistics) and reflects ups and downs in prices for basic items that comprise an average mid-family consumes. The index changes monthly. As pricing research for calculating the IPCA inflation rate happens between the 15th day of the previous month and the 15th of the current, an IPCA forecast is used in order to get nominal TN-B prices.

The component between IPCA + a fixed interest rate (agreed during the purchase) is the actual margin of the investment. However, you can’t simply sum all taxes together. As calculation are made in composite interest rate, so if you just sum the numbers, that would result in standard interest rates. So, for an IPCA rate of 4.5% and an interest rate of 6%, we would have:

(1+0,045)*(1+0,06) -1 x 100 = 10,77% (gross earnings).

For TN-B, you will be receiving payments from the bond profits each six months, in predefined dates. The original amount, though, will be redeemed together with the last profits payment, in the note expiration date.

The nominal profitability for this kind of bond is reasonably uncertain, as it is tied to IPCA rates and also exposed to floats within the secondary market.

National Treasury Bonds – series F (Treasury Fixed with semiannual interest)

Series F Treasury bonds have pre-rated interests, just like NTLs. In fact, NTB-F are quite similar to NTLs, but interests are paid each six months.

NTB-F will always be valued at BRL1,000.00 on its redemption date. For instance, if you purchase a series F note for BRL 900.00, and six months later it reaches BRL 950.00, you earned BRL 50.00 in interests. The original value, though, is also growing – apart from interests – until it reaches BRL 1,000.00, by the redemption.

Dates for withdrawing interests are defined retrospectively each six month, counting from the redemption date.

The last interests payment happens together with the redemption itself – in other words, by the end you are paid a last installment and get your investment back.

Treasury Notes– series B Principal(Main) (Treasury IPCA)

TN-B Main Series is pretty much the same note than the standard TN-B, that means it is also linked to IPCA, plus interest rates to be dealt in the moment of the purchase. However, it essentially differs when it comes to the redemption rules – contrary to the standard TN-B, it can be only redeemed on the redemption date, and that include all interest coupons as well.

It is a post-rated bond, and its par value is also fixed at BRL 1,000.00. It is generally recommended as a hedge against inflation upside downs, and usually a long term investment option.


7. Advantages

  • Profits flot depending on SELIC, providing a considerably good ROI.
  • Tesouro Nacional assures the liquidity;
  • Low risk;
  • By investing, you can help small entrepreneurs ;
  • Transactions allowed for any value above BRL30.00.

8. Disadvantages

  • Pays income taxes, depreciating the profitability;
  • You need to carefully find a broker that charges less than 1%;
  • Purchasing and managing fees from CBLC;
  • Notes not backed by guaranty fund – FGC;
  • Any redeem before 30 days will be paying IOF tax.

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