March.2.17‪Finance‬
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Whether you are just starting out in your career, saving for your children’s education, for a new home, or approaching retirement, investing in bonds can help you achieve your objectives.

“My name is Bond”

The Nigerian Bond Market

The Nigerian Stock Exchange (NSE) has announced the listing of $1 billion Federal Government (FGN) Eurobond on the floor of the Exchange. The 15-year domestic Sovereign Eurobond priced at #par and at a coupon of 7.875% per annum is the first FX denominated #security to be listed and traded in the Nigerian capital market.

The DG, Debt Management Office (DMO), Abraham Nwankwo said the listing of the Eurobond reinforces FGN’s commitment to deepen and grow the Nigerian #capitalmarket.

He noted that the Eurobond, which was #over-subscribed by 780 per cent, is part of FGN’s funding strategy for its 2016 capital expenditure and will be spent on key #infrastructure projects, in line with its economic plan.“ This huge over-subscription rate underscores a buoyant investors’ #appetite for building exposure to #Nigeria and demonstrates international #confidence in the economy’s #long–term prospects.”

This article provides an introduction to the basics of bond investing.

What is a Bond?

Would you rather “own” or “loan”? Buying stock represents ownership whilst bonds represent loans. Companies and Governments borrow money. A bond is a loan that an investor makes to a local, state or Federal Government, a company or other institution. When you buy a bond, the borrower, or issuer, promises to pay you interest in equal instalments, semi-annually, at the coupon rate. It also agrees to repay the borrowed amount, that is, the face value or principal, on a specified date, the maturity date.

For example, if you invest a face value of N1,000,000 in a five year bond paying a coupon rate of 10% per year, assuming you hold the bond to maturity, you will receive ten coupon payments of N50,000 each, a total of N500,000. At maturity, the issuer pays you back your N1,000,000 face value.

Bond tenures in established markets range from one day up to 40 years and occasionally beyond. Generally, a bond that matures in one to three years is referred to as a short-term bond. Medium or intermediate-term bonds mature in four to ten years, and long-term bonds in greater than ten years. Your choice will depend on your needs and on market conditions. Many investors “ladder” their bonds, buying several with staggered maturity dates timed for when they will need cash for say, children’s education or retirement.

Steady stable income

Because bonds typically offer safety and stability so are particularly useful for investors whose priority is for a predictable stream of interest income and the preservation of their principle. The return is usually better than cash investments but not as high as stock market investing which of course is more volatile.

Diversification

Bonds play an important role in a well-balanced portfolio and it makes sense to have at least part of a portfolio invested in bonds. Most financial advisors recommend that investors maintain a diversified investment portfolio consisting of bonds, stocks and cash, depending upon individual circumstances and objectives. Spreading your money across a good mix of assets helps to reduce risk.

Redeeming before maturity

Not all bonds will reach maturity, as most allow the bond issuer to redeem before the maturity date. Certain features are available on some bonds that can change their expected life span.

A bond issuer can “call” or retire the bond before maturity. Before you buy a bond, ask if there is a call provision as this may not always be obvious in the prospectus. On the other hand, an investor does not have to wait the full term of the bond to sell it. “Puts”, allow the investor the option of redeeming the bond before maturity. An investor may need cash for some purpose or interest rates may have risen since the bond was issued.

Individual Bonds versus Bond Mutual Funds

As an investor you can choose between investing directly in a bond or in a bond mutual fund. The main advantage of a bond mutual fund is its convenience. A professional fund manager backed by a strong research team can usually make better investment choices than the average individual investor. In addition, there is the ability to buy and sell units easily, and a diversification across a broad range of bonds. For smaller investors, a fund provides an opportunity to invest, as individual bonds are usually sold with minimum volumes.

Bonds and Risk

Even though they offer reliable fixed income, bonds are not risk free. When you invest in bonds, you face three risks, the risk of default, inflation, and of interest rate fluctuations.

Credit Quality

Default risk is the chance that the issuer, be it a government or a corporation, will be unable to repay your money. Bonds offer a wide range in choice from the very safe Federal Government Bonds, which are virtually free of default risk as they are backed by the full faith and credit of the Federal Government, to corporate bonds.

Rating agencies, assign ratings to bonds, which are based on in-depth analysis of the issuer’s financial condition and management, and other criteria. Ratings are periodically reviewed and as the condition of the issuer changes, the agency may adjust its’ rating accordingly. Ratings are made available to the public through their offices, published media reports, subscriptions and through the internet.

A triple A or AAA rating is the highest rating and Federal Government bonds would be assigned this rating as would some leading corporate bonds. Bonds rated in the BBB category or higher, are considered “investment grade”. High-yield bonds are riskier corporate bonds with low bond ratings, in the BB category and below. They are often called “junk bonds”. Because risk and reward go hand in hand, an investor that can tolerate higher risk, might select high yield bonds for the higher returns. A risk-averse investor may aim for high-quality bonds, such as Government bonds or corporate bonds issued by large successful companies.

Inflation

When you invest in bonds, inflation is a major risk as it erodes the purchasing power of future coupon payments. Rising inflation means rising interest rates that drive down bond prices. Longer maturity bonds are more sensitive to increases in inflation than shorter maturities. In the United States, Treasury Inflation-Protection Securities or TIPS have much appeal as they guarantee a return that is adjusted for inflation.

Interest rate fluctuation

The value of a bond fluctuates with changes in market interest rates. When interest rates fall, bond prices rise, and when interest rates go up, the prices of bonds go down. For example, if you are holding a bond issued at 10%, and interest rates on similar newly issued bonds are offering 12%, your bond will decrease in value as no one will want to buy your bond at a yield of 10% when they can get 12% elsewhere.

Are bonds for you?

Even though stocks usually provide a higher return, for those approaching retirement, fixed income is naturally an important aspect of their financial plan as this is required to pay for routine bills where there is no longer a regular salary coming in.

Bonds are also useful where you have a relatively short time frame within which to invest and cannot afford to ride any stock market volatility. Imagine a young executive plans to go back to school for an MBA in a year or two. Even though the stock market is likely to provide higher growth, she cannot afford to take a chance of losing part of the money being put aside specifically for her fees. A bond would be an ideal investment in both examples.

Understanding the relationship between bond prices and yields, the wide variety of bond types, tends to put more demands on the lay investors knowledge than other investment classes do, so if you decide to invest in bonds, please seek financial advice. A primary dealer, your broker or investment advisor can help you select a bond that best suits your needs.

There is no hard and fast rule about how much to invest and which bonds to invest in. Your needs and goals change over your life cycle reflecting your age, your investment objectives, your investment horizon and your risk tolerance level. Whether you are just starting out in your career, saving for your children’s education, for a new home, or approaching retirement, investing in bonds can help you achieve your objectives.

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2 Responses to ““My name is Bond””

  1. Olufunmilayoo says:

    The article is enlightening. Thank you ma for the education.

  2. Olufemi says:

    Many thanks for this expository piece.

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