On Tuesday, May 24 2023, the Governor of Lagos State, Governor Babajide Sanwo-Olu signed N135 billion bonds which he said would deliver key infrastructure projects in Lagos. Governor Sanwo-Olu announced that the fund would be used to develop 33 schools and other capital projects in the state and noted that “The state issued a 10-year tenure bond value at N115 billion at 15.25 per cent in its fourth issuance under the Debt and Hybrid Issuance Programme duly approved by the State House of Assembly.”
Ever since, there has been several discussions around the initiative largely from a position of ignorance about the investment vehicle. In this article, we are going to look at what you need to know about bonds.
What Is a Bond?
A bond is a fixed-income instrument that represents a loan made by an investor to a borrower (typically corporate or governmental). Simply put, Bonds are issued by governments and corporations when they want to raise money for projects just like the Lagos State Government did. As an individual, when you buy a bond, you’re giving the issuer a loan, and they agree to pay you back the face value of the loan on a specific date, and to pay you periodic interest payments along the way, usually twice a year.
Bonds provide a solution by allowing many individual investors to assume the role of the lender. Indeed, public debt markets let thousands of investors each lend a portion of the capital needed. Moreover, markets allow lenders to sell their bonds to other investors or to buy bonds from other individuals—long after the original issuing organization raised capital.
Bond details include the end date when the principal of the loan is due to be paid to the bond owner and usually include the terms for variable or fixed interest payments made by the borrower.
Why invest in Bonds?
Unlike stocks, bonds issued by companies give you no ownership rights. So, you don’t necessarily benefit from the company’s growth, but you won’t see as much impact when the company isn’t doing as well, either—as long as it still has the resources to stay current on its loans. Bonds, then, give you 2 potential benefits when you hold them as part of your portfolio: They give you a stream of income, and they offset some of the volatility you might see from owning stocks.
Holding bonds vs. trading bonds
If you buy a bond, you can simply collect the interest payments while waiting for the bond to reach maturity—the date the issuer has agreed to pay back the bond’s face value. However, you can also buy and sell bonds on the secondary market. After bonds are initially issued, their worth will fluctuate like a stocks would. If you’re holding the bond to maturity, the fluctuations won’t matter—your interest payments and face value won’t change.
But if you buy and sell bonds, you’ll need to keep in mind that the price you’ll pay or receive is no longer the face value of the bond. The bond’s susceptibility to changes in value is an important consideration when choosing your bonds.
Bond terms to know
The language of bonds can be a little confusing, and the terms that are important to know will depend on whether you’re buying bonds when they’re issued and holding them to maturity, or buying and selling them on the secondary market.
Coupon: This is the interest rate paid by the bond. In most cases, it won’t change after the bond is issued.
Yield: This is a measure of interest that takes into account the bond’s fluctuating changes in value. There are different ways to measure yield, but the simplest is the coupon of the bond divided by the current price.
Face value: This is the amount the bond is worth when it’s issued, also known as “par” value. Most bonds have a face value of $1,000.
Price: This is the amount the bond would currently cost on the secondary market. Several factors play into a bond’s current price, but one of the biggest is how favorable its coupon is compared with other similar bonds.
Tips to determine buying decision
Several factors may play into your bond-buying decisions. When you want to buy funds, consider the following:
Maturity & duration: A bond’s maturity refers to the length of time until you’ll get the bond’s face value back.As with any other kind of loan—like a mortgage—changes in overall interest rates will have more of an effect on bonds with longer maturities.
For example, if current interest rates are 2% lower than your rate on a mortgage on which you have 3 years left to pay, it’s going to matter much less than it would for someone who has 25 years of mortgage payments left.
Because bonds with longer maturities have a greater level of risk due to changes in interest rates, they generally offer higher yields so they’re more attractive to potential buyers. The relationship between maturity and yields is called the yield curve.
Bond duration, like maturity, is measured in years. It’s the outcome of a complex calculation that includes the bond’s present value, yield, coupon, and other features. It’s the best way to assess a bond’s sensitivity to interest rate changes—bonds with longer durations are more sensitive.
Quality: Unlike with stocks, there are organizations that rate the quality of each bond by assigning a credit rating, so you know how likely it is that you’ll get your expected payments.Just as with a car loan or a mortgage, the better the borrower’s credit rating, the lower the yield.
If the rating is low—”below investment grade”—the bond may have a high yield but it will also have a risk level more like a stock. On the other hand, if the bond’s rating is very high, you can be relatively certain you’ll receive the promised payments.
Types of bonds
- U.S. Treasuries: These are considered the safest possible bond investments.In the US,you’ll have to pay federal income tax on interest from these bonds, but the interest is generally exempt from state tax. Because they’re so safe, yields are generally the lowest available, and payments may not keep pace with inflation. Treasuries are extremely liquid.
Certain types of Treasuries have specific characteristics:
Treasury bills have maturities of 1 year or less. Unlike most other bonds, these securities don’t pay interest. Instead, they’re issued at a “discount”—you pay less than face value when you buy it but get the full face value back when the bond reaches its maturity date.
Treasury notes have maturities between 2 years and 10 years.
Treasury bonds have maturities of more than 10 years—most commonly, 30 years.
Treasury Inflation-Protected Securities (TIPS) have a return that fluctuates with inflation.
- Government agency bonds : Some agencies of the government can issue bonds as well—including housing-related agencies. Most agency bonds are taxable at the federal and state level.These bonds are typically high-quality and very liquid, although yields may not keep pace with inflation. Some agency bonds are fully backed by the government, making them almost as safe as Treasuries.
Because mortgages can be refinanced, bonds that are backed by agencies are especially susceptible to changes in interest rates. The families holding these mortgages may refinance (and pay off the original loans) either faster or slower than average depending on which is more advantageous.
If interest rates rise, fewer people will refinance and you (or the fund you’re investing in) will have less money coming in that can be reinvested at the higher rate. If interest rates fall, refinancing will accelerate and you’ll be forced to reinvest the money at a lower rate
- Municipal bonds
These bonds (also called “munis” or “muni bonds”) are issued by states and other municipalities. They’re generally safe because the issuer has the ability to raise money through taxes.
- Corporate bonds
These bonds are issued by companies, and their credit risk ranges over the whole spectrum. Interest from these bonds is taxable at both the federal and state levels. Because these bonds aren’t quite as safe as government bonds, their yields are generally higher.
- High-yield bonds (“junk bonds”) are a type of corporate bond with low credit ratings.
To choose your preferred find, it is advised that you make some research and if possible, seek expert advice. For expert advice on bonds and other investment guides, please reach us and let’s take it from there.