Introduction:

In the financial market, the term "discounted basis" refers to a method of quoting prices for fixed-income securities, such as Treasury bills and commercial paper. It represents the difference between the face value of the security and its purchase price, expressed as a discount. The discounted basis is commonly used to determine the yield or return on short-term money market instruments. Understanding the concept of discounted basis is essential for investors, traders, and financial professionals involved in fixed-income securities.

In this article, we explore the concept of discounted basis, its calculation, and its significance in the financial market.

Understanding Discounted Basis:

The discounted basis is a way of expressing the price of a fixed-income security at a discount from its face value. This is commonly observed in short-term money market instruments, such as Treasury bills, which are typically issued at a discount and mature at their face value. The difference between the face value and the purchase price represents the discount.

Calculation of Discounted Basis:

To calculate the discounted basis, follow these steps:

1. Obtain Security Information: Identify the fixed-income security of interest and gather its face value (F) and purchase price (P).

2. Calculate the Discount: Subtract the purchase price (P) from the face value (F) to get the discount (D).

3. Calculate the Discounted Basis: Divide the discount (D) by the face value (F) and multiply by 100 to express it as a percentage.

Formula:

Discounted Basis = (Discount / Face Value) x 100

Significance in the Financial Market:

1. Yield Calculation: The discounted basis is used to calculate the yield or return on investment for money market instruments. Investors can determine the effective interest rate they earn on these short-term securities.

2. Risk Assessment: The discounted basis provides valuable information about the risk associated with money market instruments. Higher discounts may indicate higher perceived risks in the market.

3. Comparison of Securities: The discounted basis allows investors to compare the pricing of different fixed-income securities. It helps them assess the attractiveness of one security over another based on their discounted prices.

4. Treasury Auctions: In Treasury bill auctions, bids are submitted based on the discounted basis. The Treasury bills are then issued at the accepted discounted price.

Conclusion:

The discounted basis is a crucial concept in the financial market, particularly for short-term money market instruments. It provides a way to express the price of fixed-income securities as a discount from their face value, enabling investors to calculate yields and make informed investment decisions. Understanding the discounted basis is essential for participants in the fixed-income market, as it influences pricing, risk assessment, and yield calculations.

Whether in Treasury bill auctions or other money market transactions, the discounted basis plays a significant role in determining the attractiveness and value of short-term investments.