For most of your life, you will be earning and spending money. Rarely, though will your current income exactly balance with your consumption desires. Sometimes, you may have more money than you want to spend; at other times, you may want to purchase more than you benefit from your income (Reilly 2003).One would thus need to invest to meet some known or unforeseen circumstances in the future.
Treasury Bills have gained a high appeal among the Ghanaian population as securities with high returns and virtually no default risk (Aboagye, 2003). The establishment of the Ghana Stock Exchange (GSE) in 1990 represented a significant change in the securities markets in Ghana. There are currently 35 listed companies trading on the GSE. Shares on the GSE are traded regularly enabling listed equities to provide more liquidity than unlisted equities, since it is more difficult to dispose off unlisted shares than shares of listed companies. An asset is liquid if it can be quickly converted to cash at a price close to fair market value (Reilly2003) Treasury bills are highly liquid security.
According to finance theory “Those who bear systematic risk expect to be rewarded in the long run”. It is therefore logical that the expected returns on equity investment which is riskier should attract more returns than the return on treasury bills which has virtually no default risk unless the state is destroyed.
Investors are rewarded for bearing risks. In the stock market, investors are rewarded for bearing risk with a risk premium. This risk-return trade off is so fundamental in financial economics that it could well be described as the “first fundamental law of finance.” Ghysels(2004). Investors stand the chance to earn positive risk premiums. This induces them to make investments with potential gains to the whole economy. One issue that bothers investors is inflation.
In general, investors do not like rising prices because that introduces uncertainty into their lives and makes it difficult to plan for the future. Therefore, investors focus on the returns they will receive over and above the rate of inflation.
This is called the real return. The return that investors receive prior to considering the rate of inflation is called nominal returns. Economic theory holds that the real return is approximately given as the nominal return minus the rate of inflation.
Finance theory on the other hand, has it that the rate of return an investor earns is dependent on the level of risk involved in that investment. Risk refers to the chance that some unfavourable event will occur (Brigham 2001). Investment in stocks (shares) is taking high risk. This is because it is possible that the price of the stocks will drop to such an extent that you may lose all your monies invested. Again the return from stocks cannot be estimated precisely.
On the other hand, investment in treasury bills is risk free. The rate of return on treasury bills can be estimated quite precisely. That is, you are sure of exactly how much you will earn upon the maturity of the investment. Investments in stocks are relatively riskier because there is a significant danger of earning much less than the expected return. To illustrate the riskiness, suppose an investor buys GHS 10,000 of short term treasury bills with an expected return of 9%.In this case, the rate of return on the investment 9 percent, can be estimated quite precisely, and the investment is defined as being essentially risk free. However if the same amount has been invested in Stock of a company, then one could analyse and conclude that the rate of return is likely to be 20%, but the investor should recognise that the actual rate of return could range from +1000 percent to -100 percent. Because there is a significant danger of actually earning much less than the expected return, the stock would be relatively risky. Theory thus has it that no investment should be undertaken unless the expected return is high enough to compensate the investor for the perceived risk of investment. The high the probability of default, the riskier the investment; and the higher the risk, the higher the required rate of return.
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(The original author: Ernest Bruce-Twum