Whilst browsing through financial headlines, the word “Bonds” has most likely popped up a lot of times and typically a lot of people have no clue as to what it means or how to leverage on opportunities it offers. Trading in bonds remains the safest and most predictable investment vehicle all over the world and Nigeria is not an exception.
Our discourse this week focuses on the meaning and types of bonds as well as the advantages and process of trading bonds.
MEANING
You can think of bonds as a loan. A company or government issues bonds to fund business growth or meet immediate spending needs and in return, the investor receives interest. Instead of borrowing money from a bank, a company or government can sell bonds to a large group of investors to raise the funds it needs to operate or grow. Issuing a bond is usually less expensive than a bank loan and tends to offer more flexibility.
The borrower promises to make periodic interest payments (called coupons) on the bond, as well as to repay the original loan (the principal) to the bond holder on a stipulated date (the maturity date).
TYPES
The common types of bonds available in Nigeria include:
Federal Government Bonds – They are issued by the Federal Government of Nigeria through the Debt Management Office. The income earned on FGN bonds is tax free. The FGN bond is considered as the safest of all investments in the securities market because it is guaranteed by the government. FGN bonds have no default risk, meaning that it is virtually certain your interest and principal will be paid as and when due.
State/Local Government Bonds – These are issued by a state or local government and interests are usually higher than FGN bonds. Interest earned on this bond also attracts no Value Added Tax.
Corporate Bonds – They are issued by private or public companies and normally have higher interest rates than government bonds because of the additional risk they carry.
PROCESS
Bonds can be purchased either through the primary or secondary market. The primary market is when you buy directly from the issuer i.e. when the Federal Government sells bonds whilst the secondary market is where bonds are bought from the bonds market e.g. on the floor of the Nigerian Stock Exchange or through Primary Dealer Market Makers (PDMM) who are operators licensed to buy and sell bonds in Nigeria.
The process of buying bonds involves obtaining and filling the necessary application forms from the Issuer and submitting same with evidence of payment of the amount you wish to invest. The bonds purchased are confirmed through issuance of certificates.
THE RISK OF INVESTING IN BONDS.
Bonds are generally considered less risky than shares because their prices tend to be less volatile and are guaranteed by the issuers. The major risk with bonds is usually inflation on account of the interests earned being quite low.
ADVANTAGES OF INVESTING IN BONDS
- Guaranteed Repayment of Principal and Interest
- Bonds pay interest regularly, so they can help generate a steady, predictable stream of income from your savings.
- Interest earned on Government issued bonds are tax free
CONCLUSION
Bonds are a safe and conservative investment. They provide a predictable stream of income and are a great savings vehicle for when you don’t want to put your money at risk. It is however important to consult your financial advisors before investing in this security market.
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