KAMPALA —In my Economics class in Senior 5, there was a mention of the words ‘Bills’ and ‘Bonds’. The teacher who only came in and dictated notes with little or no explanation did not take an initiative to break down these words for the students. Thus, this occasioned students to cram these terms and replicate them in the exact manner in which they were dictated during examinations without getting behind their actual meaning
The nature of the education system explains why even some scholars of finance or economics cannot properly explain what a bond/bill is and how to invest in such a security, what yields it generates and the terms of investment
For starters, treasury bills and treasury bonds are debt instruments. To make you understand this, I will compare them to shares which are equity instruments. Whenever you want to invest in a business, you predominantly have two sources of funding; equity (which is share capital subscribed by the owners of the business) and debt (which are loans borrowed to invest in the business)
Therefore, bonds and bills are in a layman’s language regarded as loan securities but in terms of an agreement. Whenever government wants to borrow money locally, it issues treasury bonds and bills to the public through Bank of Uganda. Much as bonds and bills are both debt instruments, they are different in the nature of their period of maturity. Treasury bills are short term debt instruments whereas Treasury bonds are long-term.
When you lend to government through a treasury bill, it will take less than a year for government to repay your interest and principal. Therefore, these are short term and a better hedge against systematic risk or economic downturn. There are 3 month treasury bills (91 days), 6 month treasury bills (182 days) and 12 month treasury bills (365 days). All these have a different rate of interest. The more the period held, the higher interest paid on top of the principal
Treasury bonds on the other hand have a longer maturity period. Their maturity period ranges from 2 years to 30 years. In some countries, there are bonds that go even up to 100 years. The commonest and usually purchased bonds in Uganda are 2 Year Treasury Bonds, 3 Year Treasury Bonds, 5 Year Treasury Bonds, 10 Year Treasury Bonds and 15 Year Treasury Bonds. Bonds can either be issued by the government (government bonds) or companies (corporate bonds) at premium (higher price) or discount (lower price).
When you purchase a bond from government, you are lending money to government (known as the issuer). In return, government promises to pay you a specified rate of interest during the life of the bond and to repay the face value of the bond (principal) at maturity. Key to note is that bonds are not only issued by government but also by companies when raising capital (corporate bonds)
There are a number of things to look at when investing in bonds; the price, maturity, interest rate, yield, credit quality, tax rate and redemption features.
Concerning the interest rate, bonds’ interest rates can either be fixed or floating (adjustable depending on prevailing market rates). However, most debt securities have adopted the former. This interest is compounded semi-annually or is entirely paid at maturity (what is referred to as Zero Coupon Bonds)
Maturity refers to the specific future date when the investor’s principal will be repaid. Maturity depends on the nature and type of bond. There are short term bonds (5 years or less), intermediate bonds (5-12 years) and long term bonds (more than 12 years).
Yield is the return you earn on the bond based on the price paid and interest received. For a bond, the two types of yield are current Yield (amount received annually from the bond) and Yield to Maturity/Yield to Call (amount received when the life of the bond expires or is called basing on the call and put redemption features)
Whenever you approach financial advisors and experts on investment guidance, they will usually tell you to diversify your portfolio. But what does this exactly mean? Look here;
Let’s say I’m investing UGX 10,000,000 in two securities, Shares and Bonds. It would be totally illogical for me to split this money into half and give each instrument a 50% investment while considering this the best alternative.
Shares are by nature risky investments because their performance relies on market activity and investor attitude towards a particular stock. Therefore, they need a lot of intrinsic modelling before a decision is made to invest. On the other hand, bonds are risk-free investments because whenever you purchase a government bond, you’re sure that at maturity, your principal and interest will definitely be paid
Therefore, depending on the risk tolerance levels of an investor, splitting your portfolio is determined by your aggressiveness in the market. Investors that are risk averse (fear to take risks) should be advised to invest over 70% in bonds and the remaining 30% in stocks. On the other hand, risk tolerant investors can be aggressive enough and invest about 60% in stocks and 40% in bonds. When you do this, you have built/split your portfolio
You may be wondering, how do I get started with investing in Treasury bills and bonds? Well, read carefully;
To invest, you need to open a Central Securities Depository Account (CSD) with Bank of Uganda through a Commercial Bank and then participate in the auction of these financial instruments. A CSD account is electronic and assists in the registration of investors and auctioning of securities.
Both residents and non residents above the age of 18 can purchase bills and bonds and unlike shares where very low amounts can be invested, the minimum amount for investment in treasury bills and bonds is UGX 100,000. There are competitive bids (in excess of UGX 200,000,000) and non-competitive bids (between UGX 100,000 UGX and 200,000,000)
Bank of Uganda has to first publicize details of an upcoming bond (including it’s yield) through the local newspaper and Bank of Uganda website and then invites bid offers. Bids should be submitted by 9:00 am on auction day
For details concerning CSD account opening, placing of bids, computation of bond/bill yields at maturity/call and any other details, reach me in my inbox.
This writer, Shadrack Kolya, is a financial analyst, writer and tech guru