BONDS: Understanding coupons and maturity dates

Bonds are debt instruments issued by governments, organizations or institutions to raise money through issuing debt instruments. Such funds are issued to source funds for targets developmental purposed.

Bond is times and a coupon or interest is usually paid either quarterly, biannually or annually to the investors.

However, investopedia defines bond thus: a bond is a debt investment in which an investor loans money to an entity, typically corporate or governmental, which borrows the funds for a defined period of time at a variable or fixed interest rate. … Owners of bonds are debt holders, or creditors, or the issuers.

Why it is called bond
Oxford living dictionary defined bond as a thing used to tie something or to fasten things together, an agreement with legal force.
The investment instrument bond, ties the lender and the borrower together as the dictionary explains.

Dave Kansas, in his book “The Complete Money and Investing Guidebook” pointed that bonds are a form of debt. Bonds are loans, or IOUs, but you serve as the bank.

You loan your money to a company, a city, the government, and they promise to pay you back in full, with regular interest payments. A city may sell bonds to raise money to build a bridge, while the federal government issues bonds to finance its spiraling debts.

How safe is bond?
Bonds guarantee fixed income and settlement at the time of maturity, and this serves as major form of attraction for investors who prefer assured earnings form their investments than unsure earnings from investing in shares.

Kansas in his book, said that, nervous investors often flock to the safety of bonds – and the steady stream of income they generate, especially, when the stock market becomes too volatile.

High risk or low risk?
Investment parlance requires that younger people should be more aggressive in their investing and take higher risks which is more rewarding, while much older people are usually advised to take less investment risks with assured but less returns.

However, the investment expert said that younger investors need to carve out a portion of retirement accounts for about 15 per cent or less, depending on one’s age, goals and risk tolerance for fixed income investment, in order to balance out riskier stock-based investments.

Are bonds risk free?
That bond guarantees steady income, doesn’t mean that all bonds are risk-free. Some bonds may be riskier. As with all investments, you’re paid more for buying a risky security. However, in the bond market, risk comes in a few different forms.

Troubled bonds are in some cases identified in municipal bonds, corporate bonds or states bonds, however not all in these categories are of higher risks, as they pay higher coupon than the federal government bond.

The first is the likelihood the bond issuer will make good on its payments. Less credit-worthy issuers will pay a higher yield, or interest rate. That’s why the riskiest issuers offer what’s called high-yield or “junk” bonds.

Those at the opposite end of the spectrum, or those with the best histories, are deemed investment-grade bonds.

Investing safe and earning low
The safest of the safe are issued by the Nigerian government, they’re backed by the “full faith and credit” of the government and are deemed virtually risk-free. As such, a Treasury bond will pay a lower yield then a bond issued by a company.

However, while federal government bonds pay less interest or coupon, corporate or municipal bond which is of higher risks pay higher coupon.

How long you hold the bond (or how long you lend your money to the bond issuer) also comes into play. Bonds with longer durations – say a 10-year bond versus a one-year bond – pay higher yields.

That’s because you’re being paid for keeping your money tied up for a longer period of time.

FGN Bond
FGN Bonds are debt securities (liabilities) of the Federal Government of Nigeria (FGN) issued by the Debt Management Office (DMO) for and on behalf of the Federal Government.

The FGN has an obligation to pay the bondholder the principal and agreed interest as and when due. When you buy FGN Bonds, you are lending to the FGN for a specified period of time.

The FGN Bonds are considered as the safest of all investments in domestic debt market because it is backed by the ‘full faith and credit’ of the Federal Government, and as such it is classified as a risk free debt instrument.

They have no default risk, meaning that it is absolutely certain your interest and principal will be paid as and when due. The interest income earned from the securities are tax.

Interest rates and bond prices
Interest rates have relationship with bond prices, interest rates however, probably have the single largest impact on bond prices. As interest rates rise, bond prices fall.

That’s because when rates climb, new bonds are issued at the higher rate, making existing bonds with lower rates less valuable.

Holding to maturity and selling in secondary market
The bond investor has the rights to either hold his investment till maturity or sell in the secondary market to recoup his money. Meanwhile, if you hold onto your bond until maturity, it doesn’t matter how much the price fluctuates.

Your interest rate was set when you bought it, and when the term is up, you’ll receive the face value (the money you initially invested) of the bond back — so long as the issuer doesn’t blow up.

However, if you need to sell your bond on the secondary market before it matures, you could get less than your original investment back.

Features of FGN Bonds
Denomination: minimum subscription of N10,000.00 + multiple of N1,000.00 thereafter.

Yield: – Interest payment
Fixed interest rates: Most FGN bonds have fixed interest rates which are paid semi-annually.

Floating interest rates: Some FGN bonds (e.g. 3rd & 4th tranches of the 1st FGN bonds) have floating rates of interest which fluctuates around a reference rate(NTB rates) on the basis of specified parameters.

There are also zero-coupon bonds (not yet in issue in Nigeria) whereby both interest and principal are repaid at the final maturity date of the bond.

Tenor: Minimum of two (2) years. There are bonds with maturities of 3. 5, 7 and 10 years, in issue and for the future we may have bonds with maturities of 15, 20,30 years or more.

Default Risk: FGN bonds as a sovereign debt are the safest investment instrument. Default risk is nil. The Government always pays what is due to subscribers on the agreed date.