Can I Buy Mexican Treasury Bills?

Can an individual invest in foreign bonds? How is that done? I'm interested in Mexican short-term bonds, as their interest rate is relatively high.

-- Phil Toole

Phil,

It would appear that individuals can do whatever they set their mind to, however ill-advised.

Which is not to denigrate your interest in Mexican Treasury bills, known by their acronym Cetes, which stands for Certificados de la Tesoreria de la Federacion. Their interest rates are indeed quite high compared with U.S. Treasury instruments of similar maturity. The yield as of Thursday on the 91-day Cetes was 21.10%, compared with 4.70% on the 91-day Treasury bill.

Like Treasury bills, Cetes are auctioned weekly, and you certainly can buy them, though probably not without a full-service broker. It will take two transactions: First you'll have to buy Mexican pesos, then the Cetes. Cetes are denominated in multiples of 100,000 pesos, equal to about $10,660 at the current exchange rate of 9.4 pesos to the dollar. (However, like Treasury bills, Cetes are discount instruments, so you pay less than face value and get face value when they mature.)

The most information I've been able to find on the Web in English is on the Chicago Mercantile Exchange Web site. The Merc lists futures and options on Cetes, which would be one possible alternative to buying the Cetes themselves, except that the instruments really haven't caught on. This is clear from Merc volume reports, also available on its site.

There are other possible alternatives though, and I think you'd be wise to consider them.

The first is simply buying peso futures, since it's essentially the same transaction and it will be easier to arrange.

You may be clear on why the two transactions are basically the same, but let me explain it for the benefit of everyone else.

By buying Cetes, you are trying to capture the difference in interest rates between Mexico and the U.S. The risk you are taking is currency risk, and the currency risk is precisely the reason why the Cetes pay more than Treasury bills in the first place.

Consider this scenario (all numbers rounded to make the math easier): The exchange rate is 9.5 pesos to the dollar, and the interest rate on 3-month Cetes is 20%, such that the price of a bill with a face value of 10 million pesos is 9.5 million pesos, which you buy for $1 million. The 5% difference between the face value and the price represents the interest you will earn over three months (one quarter of the 20% annualized rate). If the peso is still 9.5 to the dollar when the bill matures, you will indeed have earned interest at the rate of 20%. If the peso has improved against the dollar, you will do even better. But if it has lost value -- suppose a dollar costs 10 pesos when the bill matures (remember how quickly the peso lost half its value in late 1994, early 1995?) -- you are out of luck, big time. Because you'll have exactly the same amount of money you started with, $1 million.

You may be able to buy exposure to the peso more efficiently in the futures market. The relationship between a currency futures price and the current exchange rate is based on the very same spread you are hoping to capture by investing in Cetes rather than Treasury bills. Peso futures have a lower price than spot pesos because when you go long peso futures, the corresponding short starts earning Mexican interest rates on the pesos that will eventually be delivered to you. Meanwhile, you can invest your dollars in Treasury bills until you have to take delivery of your pesos. Without going into the actual math, the discounted price you pay for the futures reflects the difference between the Mexican and U.S. rates. You capture that difference with a long peso futures position as surely as you do when you buy Cetes instead of Treasury bills.

(Peso futures on the Merc, explained in greater detail on its Web site, represent 500,000 pesos per contract, and prices are quoted in dollars per peso. At yesterday's close, the price was 0.10225, or 10.225 cents. Each hundredth of a cent change in the value of the peso represents a $50,000 gain or loss to the futures investor.)

A second possible alternative is to avoid Mexico altogether. Not because the country isn't doing well, but, ironically, because it seems to be doing better all the time.

Remember, you're contemplating speculating on a currency. How's that currency been doing? It's still much weaker than before the devaluation of 1994, but it has improved a lot lately, as you can see from this chart.

The Mexican Peso Dance The number of Mexican pesos to the dollar.

Source: Reuters

The stronger currency reflects the country's improved finances, says Dan Peirce, head of emerging markets research at BancBoston Robertson Stephens. The question is whether continued improvement is likelier than deterioration, especially with a presidential election on the horizon in July 2000 that promises to be more pluralistic than any in recent history.

"It's hard to say what might come out of the political process, but they have a very strong finance ministry now, and who's to know how it might take shape?" Peirce says. He'd wait for an opportunity to buy Cetes when the currency is cheaper and the interest rate higher, possibly in response to some radical election rhetoric. The inherent strength of the economy should eventually rehabilitate the currency.

Alternatively, Pierce says, consider buying Letes instead of Cetes. Letes, or Letras del Tesoro, are Argentine Treasury bills, auctioned monthly. There's no currency risk involved; the Argentine peso is pegged to the dollar, and most Letes are dollar-denominated. But there's sovereign risk (the risk the country won't repay), so the yields are much higher than Treasury yields. At this month's auction earlier this week, the 91-day Letes were priced to yield 7.53%. The minimum bid size is $10,000 (for a noncompetitive bid; competitive bids, where you specify the minimum rate you will accept, require $100,000), and you'll need a full-service broker, probably one from a major firm.

Argentina is weaker than Mexico, and it too has an election coming up in October, but Peirce says Letes offer "only sovereign credit risk, and it's very short term."

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