Corporate Treasury: T-Bill, TFC or Money Market Fund
A Pakistani corporate treasurer must place PKR 500m of surplus cash for exactly 12 months and is comparing three instruments. A 12-month T-bill is available at a cut-off yield of 11.85%. A listed bank is offering a 3-year term finance certificate with a quarterly floating coupon of 3-month KIBOR plus 175bp; KIBOR is currently 11.50%, the TFC is rated AA and is callable at par after 12 months. A money market fund reports a net yield of 11.20% after its expense ratio and offers redemption in two business days. The company pays tax at 29%. T-bill discount income is taxed at the normal rate with full set-off; TFC coupon carries 10% withholding tax as minimum tax that is adjustable against final liability; fund distributions are taxed at 15% as dividend income. The treasury mandate permits no mark-to-market losses in the portfolio and requires liquidity within five business days. The treasurer asks which instrument wins on an after-tax, mandate-compliant basis.
1. Compute the after-tax yield of each instrument over the 12-month horizon and rank them. State the assumptions that can flip the ranking.
Read the worked answer
T-bill. 11.85% x (1 - 0.29) = 8.41%. Rate locked for the full 12 months.
TFC. Coupon = 11.50% + 1.75% = 13.25%. The 10% withholding is adjustable, so for a profitable company the effective rate is 29%: 13.25 x 0.71 = 9.41%.
Money market fund. 11.20% x (1 - 0.15) = 9.52%.
Ranking: fund 9.52%, TFC 9.41%, T-bill 8.41% - a spread of 111bp between first and last, which is meaningful on PKR 500m (about PKR 5.6m a year).
Assumptions that flip it:
- Tax position. If the company has tax losses, only 10% minimum tax applies to the TFC: 13.25 x 0.90 = 11.93%, far ahead of everything. The ranking is entirely a function of the company's tax shield, so check the tax computation before choosing.
- The fund's yield is a trailing number. It embeds past higher rates; the forward yield is lower if the SBP is easing.
- The 11bp gap between fund and TFC is inside the estimation error of a 29% versus 10% tax treatment. Do not present the TFC as the winner on a difference that small.
Mandate note. Two of the three instruments carry NAV variability; see the next task.
2. Which instruments satisfy the 'no mark-to-market losses' and 'five business day liquidity' clauses, and how would you advise the treasurer to interpret the mandate?
Read the worked answer
T-bill. Sovereign credit, deep two-way bank market, and if held to maturity there is no mark-to-market event at all. Sale before maturity can be done through a bank or repo'd. Satisfies both clauses if held to maturity.
TFC. A quarterly floating reset gives a very short duration (roughly 0.25 years), so a 100bp move in KIBOR moves the price only about 0.25% - the interest-rate MTM risk is small. The risks that are not small are (a) credit spread widening, which on a 2-year residual with a 100bp spread move is worth about 2%, and (b) liquidity: PKR corporate TFCs trade thinly, so a five-business-day exit at a fair price is not assured for a 500m position in a single AA bank. The call after 12 months belongs to the issuer, not to the investor - negative convexity.
Money market fund. Two-day redemption meets the liquidity test comfortably. But NAV can fall: a 100bp rise with a 0.3-year duration is a 0.3% loss. Small, but it is a mark-to-market loss.
Advice. The clause is ambiguous and the treasurer should get it defined in writing. If it means 'no realised losses', all three qualify and the ranking above holds. If it means 'no decline in NAV at any month-end', only the held-to-maturity T-bill qualifies, and the mandate is effectively a sovereign-only mandate - in which case the treasurer should ask the board to amend the policy rather than silently breach it.
Practical answer. Split the 500m: T-bills for the portion that must be MTM-free, the fund for the balance, and ask the bank for a 12-month deposit at a competitive rate as a fourth option.
3. How does a 300bp easing over the year change the ranking, and what does it reveal about the TFC's floating coupon?
Read the worked answer
T-bill. Unchanged at 8.41% after tax. The 11.85% is locked in; a 12-month bill has zero reinvestment risk over a 12-month horizon. That is the whole point of matching instrument tenor to horizon.
TFC. Average KIBOR over the year is roughly 10.0%, so the average coupon is about 13.25% falling to 10.25%, i.e. 11.75%. After tax: 11.75 x 0.71 = 8.34% - now last. Worse, the issuer calls at par at the 12-month point precisely because refinancing is cheaper, so the 175bp spread is stripped away exactly when it is most valuable, and the treasurer faces reinvestment at roughly 8.5% KIBOR.
Fund. Yield reprices within weeks. Blended net yield of around 9.7% gives about 8.25% after tax, plus a small duration gain of perhaps 0.5-0.9%, so roughly 8.8-9.0% all-in.
The lesson. A floating coupon protects price, not income. The treasurer who bought the TFC for its 13.25% headline captured 175bp of spread for at most one quarter and then wore the full downside of the easing cycle. In a falling-rate world the fixed-rate T-bill wins on certainty, and any floating instrument whose call sits at the investor's horizon is structurally the wrong choice.
Recommendation. Buy the 12-month T-bill, or ladder 3/6/12-month bills if the cash profile is uncertain, and revisit the TFC only if the spread compensates for the call.