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27.06.2005 Business & Finance

An Exciting And Safe Investment Alternative Available In Ghana

Kufuor, Kojo

Repos To The Rescue – If you know the interest rate you earn on your savings or current account, then you are certainly in a very small minority. It is a sad truth that most people in Ghana today either do not know or simply do not care how much they earn on their bank balances.

One major reason for this indifference is the notion that the interest paid on current or savings accounts is either insignificant or, worse still, almost completely swallowed up by operating fees and other charges deducted by the friendly bank manager.

It is known fact that one sure way to lose money is to place it in a savings account or investment vehicle that pays a return lower than the prevailing rate of inflation (reported as c.14.0% - Feb.2005). By definition, if you leave your money in such a vehicle long enough, then over time your savings will be worthless since the interest you will receive during this period shall not adequately compensate you enough for the eroding effect of inflation.

It is for this reason, among several others, that everyone should always be on the search for savings accounts and investments that at least compensate them for the effect of inflation (or comes as close as possible to doing so). If this means constantly moving your money around from bank to bank, then so be it.

The authors of this article have been around long enough to know that some unscrupulous operators in our midst have used the legitimate demand for higher interest rates to peddle all manner of get-rich tricks – basically fraudulent and criminal schemes which promise astronomical interest rates and which, surprisingly, never fail to attract the less savvy and/or greedy ones amongst us.

Of course, these promises have often been nothing more than illegal pyramid schemes, which are not recognized by the regulators, and which have always eventually collapsed in a spectacular manner taking their sorry victims along with them.

For the purpose of this discussion we shall assume that the search for higher interest rates is confined to mainstream financial institutions - those that carry out honest and legally recognized business and, most importantly, are regulated by the appropriate regulatory agencies - Bank of Ghana, SEC etc.

We shall also exclude from this discussion investments in stocks listed on Ghana stock exchange and, by extension, the mutual funds that invest in these stocks. As a form of savings, stocks generally offer phenomenal returns over the long term but in the short to medium term can be extremely volatile and unpredictable. Again, companies that issue these stocks never indicate what rate of return its investors will receive, since this is ultimately determined by supply-demand dynamics of the open market. In contrast issuers of bonds (and other fixed income instruments) are required to indicate upfront the interest payments due investors during the life of the instrument.

Having clearly established the need to earn a return as close as possible, if not more than, inflation, and agreeing to restrict our search to fixed income products offered by legitimate and regulated financial institutions, we can now consider the options available to the average saver seeking the best possible rate for his ¢1mm end of year bonus.

The available options that immediately come to mind are the following:

1. Current Account: The typical current account pays an interest rate of between 0% and 1%, well below the prevailing inflation rate. In addition, most banks will charge fees for the privilege of operating the very useful cheque book facility, possibly the only acceptable reason why anyone should ever operate a current account. In contrast to a fixed term deposit, the current account always offers instant access to cleared funds.

2. Savings Account: The typical savings account pays interest rates between 1.5% and 8%, again well below the all- important inflation rate. There is no cheque book facility on a savings account, which generally implies a trip to the bank whenever you need to access your money. Savings accounts can either be instant access or term deposit, the latter requiring that you leave your funds with the bank for a pre-determined period or pay a penalty for taking it our earlier.

3. Treasury Bills: By their very nature, these instruments are designed to compensate investors for inflation. A 91-day T-Bill currently pays 17.27%, well above the headline inflation rate. T-Bills are issued for fixed term: 28 days, 56 days, 91 days, and 182 days. However, only 91 and 182-day T-Bills are available to the general public. Investors or savers who know exactly how long they wish to tie up their funds for would be well advised to always consider this option – if nothing else to protect their money from inflation!

It is essential that investors in T-Bills be prepared to wait till the instrument matures before attempting to access their funds since trying to redeem the Bills before maturity will attract a rediscount penalty. This deduction could seriously eat into any interest which would have accrued to the investor for the period the T-bill would have been held.

Therein lies the fundamental problem with Treasury Bills – the fixed maturity. Few amongst us can confidently tie up a reasonable amount of money for 91 days, with the absolute certainty that it will not be needed. Emergencies do happen (sometimes too often!) and with that the unanticipated need to immediately access what was supposed to be tied-up term savings.

From the foregoing, it should by now be clear to the reader that the ideal savings instrument must offer a rate as close as possible to that of the T-bill (i.e. adequately compensating for inflation), but must not necessarily have the rigid fixed maturity of the standard T-bill (i.e. instant access with no penalty). One instrument that combines these desirable qualities is the Repurchase Agreement or “Repo” for short.

Repurchase Agreement (“Repo”): The Repo is a two-step agreement under which one party sells an instrument to a counter party with the commitment to buy back that same instrument at predetermined price at a later date.

This definition can be clarified with a simple example. An investor seeking “near T-Bill rates” for his ¢1mm savings will approach a Treasury Bill Primary Dealing institution to execute a Repo agreement. The “Repo” agreement shall require the institution to sell the investor ¢1mm equivalent of T-bills with the commitment to buy it back whenever the investor wishes to exit the transaction.

Some 18 days, say, after entering into the agreement, the investor may decide to terminate the Repo. He will make this intention known to the institution which shall be obliged to buy back the T bills from him, at a price equivalent to ¢1mm plus an interest. It should hopefully not surprise the reader that the interest rate earned, shall be as close to, or, possibly higher than inflation since it is linked to the underlying T-Bill rate.

To complete our simple example, let's set out the cash flows:

Day 1: Investor places ¢1mm in a Repo account at a Primary Dealer and receives an equivalent portfolio of T-Bills (held by the Dealer)

Day 18: Investor sells T-Bills portfolio back to SDC and receives ¢1,006,904.11 for that period, implying 14%* rate interest * The Repo rate SDC would typically offer for a transaction of this size (larger amounts obviously attract higher interest)

Firstly, the reader will notice that the 18 days maturity falls outside the 91, 182 days required by the typical T-Bill. The investor could just as well have terminated the Repo transaction after 5, 12, 21, or 37 days without a rediscount penalty. This is the kind flexibility any savvy investor should always be on the look out for. In general, operating cash, surplus funds, and targeted-purpose money being held in transit are ideal categories of funds to be used for Repo transactions.

Secondly, because this is a T-Bill linked transaction, the interest rate earned by the investor on the Repo is very close to the underlying T-Bill rate. Technically, the Repo rate could aptly be described as a derivative of the T-Bill rate.

The basic laws of finance demand that Repo rates should be slightly lower than the T-Bill rates. This is to be expected since that the longer an investor commits to save, the higher the rates they should enjoy. Since the Repo can be cancelled at any time, and this usually happens before the 91 T-Bill maturity, it is only fair that it offers a rate lower than that of a full term T-Bill. In our example, the Repo option clearly offers the investor a much better deal than what he would have received if he had redeemed a 91day T-Bill, 18 days into its life.

The above discussion has been simplified in order to highlight the key differences between various the savings vehicles available to the investor. It should be obvious that the choice of 18 days is simply random. A similar argument could be constructed for a range of time intervals up to 91 days and the conclusion would be the same.

Again, using ¢1mm as an example may not sufficiently convince some readers of the difference between the various instruments. After all why go through the trouble of switching accounts just to save a few cedis. However, on a slightly larger bank balance the enhanced yield offered by the Repo becomes more obvious.

Product Interest rate (%) Rediscount Rate / Penalty Interest earned (¢) * Current Account 1% - 493.15 Savings Account 8% - 3,945.21 Treasury Bill 17.27% 240%-24.5% (50,067.10) Repo Account 14% - 6,904.11

* Based on average interest and rediscount rates and assumes ¢1mm is deposited for a period of 18days. T Bill redeemed at 18 days would attract a significant penalty in the form of a rediscount rate.

Even though the SDC Group is an active participant in the Repo market, the authors of this article would not wish to claim credit for 'creating' the Repo. The product is certainly not new, but rather one that has been around for a considerable period of time and extensively engaged to introduce efficiency into financial sectors all over the world.

In conclusion, savers and investors alike are encouraged to constantly keep an eye on how much interest their money is earning and seek competent advice on how to enhance this return. Even though at present inflation in Ghana has been significantly brought under control, it still in the double digits and should remain a factor in considering which investment or savings vehicle to hold your funds in. The inflation rate should represent the lowest rate of return a saver should willingly accept for their funds. By the SDC Group research team – Contacts: Steve Lartey - General Manager, (Business Development) & Kojo Addo-Kufuor - General Manager, SDC Brokerage Services. SDC Group offer a range of financial products, investment and advisory services - including Treasury Bill-linked investment, including Repos and Reverse Repos, stock brokerage services, and related forms of financing. Views expressed by the author(s) do not necessarily reflect those of GhanaHomePage.

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