bonds 101

they say a promise is a debt. and if that promise is given by the government it is definitely going to be paid. its a good debt. this is based on the fact that governments being the supreme bodies in any land, never lie. bonds are one of the fixed income instruments often issued by governments through which they take loans from wananchi (and wenyenchi). How does a bond work? typically a bond is just a loan which is not on a reducing balance principle. you buy a bond from say govt or a company for an amount also called a par value or face value. normally the debt (bond) would be repaid to you on a specified date called the maturity date. before the par value is repaid , the issuer pays interest periodically to the holder of the bond. these interest payments are called coupons. most coupons are paid semi-annually but for your calculations you can enter them in your books as monthly or annual repayments.

lets take an example, if say you bought a bond worth 100,000 /= with a coupon of 5% on it. and say the maturity for that bond is 3 years. it means you expect to be paid 5000 Kshs every year (or 417 /= per month) for 3 years. on the last year, you will be paid 105,000. ie your coupon plus your initial amount.

you can see that the return doesn't look very good. but that is because bonds are considered risk free (no pain no gain is actually true) this is because governments cannot fail to repay their debts. normally the government just issues new bonds to repay old debts ( more like ponzi scheme? ) but don't forget that the government as opposed to ponzi gets income from taxes and fees as well.

corporates also issue bonds. and in the Kenya scenario we have seen, ARM, Safaricom KREP etc issuing bonds on the market. you can also call this borrowing through the market. for corporates, the rate of return on the bond depends on the risk it posses, the more risky the firm is, the higher the rate of return and vice versa. firms are normally rated for credit worthiness. but thats beyond the scope of this 101.

However, corporate bonds will always offer higher rate of return than government bonds since they are more risky

Odegle tip of the day bonds are also traded at the NSE and people buy and sell depending on whether they feel the bond is under priced or over priced. for more detailed reading, i recommend the book Investments by William Sharp available in most major bookshops in Nairobi