A Jamaican perspective by Lissant Mitchell, Manager, Treasury and Capital Markets, Knutsford Capital Merchant Bank. June 1999.

 (Note - Mr. Mitchell is now at Pan Caribbean Merchant Bank. Although the article is a bit old, the principles remain the same - Rohan Chambers 5/6/01) 

UNDERSTANDING FIXED INCOME SECURITIES

The Government of Jamaica is the main borrower of funds in our economy and offers a range of investment instruments to the public on an ongoing basis. The money raised is used to either fund certain budgetary requirements or used for varying development projects. The more popular types of these instruments are: Local Registered Stocks, Treasury Bills, Promissory Notes and Bonds denominated in both local currency or United States dollars.

Local Registered Stocks (LRS)

These are offered with varying frequency, but at least once per quarter. They are long term in nature with maturity dates in excess of three years. The interest rates on these offerings are always attractive as the structuring takes into consideration the current market sentiments. LRS have very little interest rate risk, as they typically have an initial interest period ranging from three months to one year during which time the interest rates are fixed, thereafter it varies on a quarterly or semi-annual basis. The change in the interest rate always reflects prevailing market conditions as the new rates for the subsequent interest period is pegged to the average yield of the Treasury Bills.

LRS are fully secured by the assets of the nation and are highly marketable. At any time these instruments can be sold providing liquidity when needed, and as with all products, the sale price is a reflection of current market condition. Investors wishing not to sell their instruments may also use them to secure short term financing, as there is a very active market in this area.

The government latest offer of LRSs, at the time of writing, saw two instruments being sold into the market, one maturing March 06, 2002 and the other March 07, 2004. The table below shows the essential structure of the offerings:

Granted the 2004C instrument have a much longer maturity date than the 2002M, it was more attractive for three reasons. Firstly, its initial rate was 23.50% in comparison to 23.00% for the 2002M. Secondly, interest rates are reset on a quarterly basis instead of semi-annually providing less interest rate risk, and thirdly, the interest reset formula is 0.50% greater (i.e. the re-pricing).

Treasury Bills

These are issued by the government at least once per month, by way of a auction held at the central bank. When there is an up-coming action notification is made in the local press, outlining the auction, issue, and maturity dates, along the amount of instruments being offered to the market.  

Bids are accepted at the central bank on the morning of the auction, with the result being made public by the end of the business day. All successful applicants are required to pay for these instruments by the issue date. This price is determined by a formula which takes into consideration the tenure of the instruments offered along with the desired interest rate.

Like Local Registered Stocks, these instruments are very attractive as they are also secured by the assets of the nation and are quite marketable. Unlike LRS however, they are shorter term in nature, having maturity dates up to one year, thus adding to their attractiveness.

The last Treasury Bill auction saw instruments with a tenure of 365 days averaging a rate of 21.67% and being over subscribed by some 400%, attesting to its attractiveness.

Government of Jamaica Promissory Notes and Bonds

These instruments are issued through agencies to raise short term funding for various projects. The borrower of the funds are not necessarily the government, as in the case of LRS and Treasury Bills, but can be other institutions undertaking the projects. However the government gives a full guarantee on the repayment of such funds. 

These investments instruments have varying tenure, and can be denominated in United States dollars, or our local currency.

All these instruments are taxable, with taxes being withheld at source unless the investor is tax-exempt. For individual investors, taxes of 25% is withheld on interest income. As a result, some investors shy away from these offerings and elect to purchase other instruments, that while still taxable, are free of withholding taxes at source.

Repurchase Agreements

Agreements in which the central bank or other financial institutions sells securities that are in their portfolio, with an agreement to repurchase the same security at a future date, at a price which is greater than which it was initially sold. The difference in the sale and repurchase price represents the yield accruing to the investor. These investment options have grown in popularity over the last four years to the point where there are now the most common type of investments in the money market.

Repurchase agreements or repos are very  secure, as the underlying risk is the same as Government of Jamaica instruments. It gives investors the opportunity to invest in risk free government instruments for much shorter periods than otherwise would be available.

The central bank in recent times offers these instruments to its retailers with yields and tenor as follows:

Other institutions offering these products peg the yields they offer on their repurchase agreements to that of the central bank.

Commercial Paper

Very popular among issuer and investors alike, for the issuer it allows them to raise short term financing in the money market at significantly lower interest rates than that of conventional bank loans. Lending rates at banks are relatively high and therefore large corporations tend to go to the money market to satisfy their short-term cash flow needs.

For the investor, the commercial paper market provides them with other short term investment opportunities with much higher yields than otherwise available. The investors, however, takes on the risk of the borrower in the case of an unsecured facility or the guarantor in the case of a guaranteed facility.