Investing in T-bills (Part 13)

Last time, I discussed how I invest in zero-coupon T-bills and presented a sample calculation of annual yield. For educational purposes, I will begin today’s post with a similar calculation for a T-bill with coupon.

I have previously invested in couponed T-bills but will no longer be doing so. I recently spoke with a fixed-income representative at my brokerage who told me YTM is calculated a bit differently and for more complexity because coupon payment(s) and accrued interest need to be factored in, the payout ends up being slightly less for numerous couponed T-bills versus zero-coupon T-bills she has compared.

As a sample calculation, consider a T-bill purchased for $99.079 (10X multiplier applies) on Mar 19, 2024, to mature on Aug 31, 2024 (165 days). This was stated to have a 5.357% YTM with $1.766 accrued interest (first coupon Feb 28, 2023) and 3.25% coupon. The 3.25% coupon is semi-annual with each coupon payment half that amount. This bond, therefore, issued coupon payments on Feb 28 and Aug 28, 2023 (or the first business day thereafter if on a weekend), along with Feb 28, 2024. Accrued interest—which gets subtracted since owed to previous bond owner—is from the latter date, and a final coupon payment (Aug 28, 2024) will be issued at [first business day after if on a weekend] maturity:

100% * ((1000.00 – (99.079 * 10)) + (1000 * (3.25 / 100 / 2)) – 1.766) / (1000 * (165 / 365)) = 5.241%

As with the zero-coupon T-bill calculation, this is not an exact match (to 5.357%) but in the ballpark. As a partial explanation, the fixed-income representative told me something about the YTM calculation for couponed T-bills not accounting for accrued interest that must be repaid and is not actually part of the calculation.

I always maintain a cash buffer when investing in T-bills. I hinted at this in the second-to-last paragraph of Part 4 as well as Part 12 where I mention the 90% number. If the market moves against me and a short option need to be bought back for a loss, then my cash balance will go down. If I am consistently buying long options that don’t pay out then cash balance can be depleted as well. As stated in the third paragraphs of Part 2 and Part 3, the last thing I want is for my cash balance to go negative and be forced to borrow brokerage funds because the margin interest rate is over double what I receive on T-bills.

Were I primarily investing in long stock, a cash buffer would be less important. Losing $5,000 on a $20,000 stock position would likely be followed with investment of the remaining $15,000 in a different stock; only if I turned around and invested another $20,000 would I deplete the cash balance. Besides, as mentioned in the fourth paragraph of Part 2, a [predominantly] stock investor will use most free cash for equity investments thereby leaving little left over for T-bills anyway.

I will continue next time.