Note: As at the time of writing this post, rates are generally low. Yield on 10 Year FGN Bonds is 4.6% and the coupon on FGN Savings Bond is 2.5% p.a. In an environment where inflation is at 13.22% (10/20), these may not encourage capital flows to this asset class. Except of course, safety of investment has primacy over returns.
FGN Bonds are very popular and form large portion of the portfolio of most institutional investors. The reason is not far fetched.
FGN bonds are safe investment because they are backed by the full faith of the government. And until recently, coupons on FGN Bonds are attractive and above inflation rate. So it makes sense for these big time investors to allocate more funds to government bonds: they enjoy the safety it provides as well as maximize return on investment.
But it is not only institutional investors that can invest in FGN Bonds. Retail investors also can. In this post, you will learn how you can invest in FGN Bonds as a retail investor.
What’s FGN Bonds
These are long term debt instruments that the government use to borrow money from the investing public for the development of public infrastructure. Thus, when you invest in bonds issued by the Government you are actually lending money to them. And government is under the obligation to pay you agreed interest.
FGN Bonds are usually long term in nature. It ranges from 2 years to 20 years and attract fixed interest payment which is usually payable half-yearly over the life of the bonds. At maturity, the Federal Government redeems the bonds, just the way a borrower returns borrowed money to the creditor.
Interest may also be variable or floating. For example, the third and fourth tranche of the 1st FGN Bonds float around the the Treasury Bills rates within some set parameters.
The Debt Management Office is the institution that manages federal government debt. As a result they have the responsibility of issuing bonds on behalf of the FGN
FGN Bonds are risk free. In other words, investors are sure that they will get their money back. There is no default risk in FGN Bonds as long as the country remains in existence.
Why Government Issues Bonds
Government issues bonds basically to raise money to finance capital projects: roads, dams, ports, railways and other public infrastructure. Government issues different types of bonds. Some are types to specific projects, or targeted at certain segment of the market. For example, the Diaspora Bond that targets at Nigerians living abroad. Or they may target foreign portfolio investors and in foreign currency like Eurobonds.
Federal Government may also issue bonds to finance budget deficit or to pay debts to owe to local contractors or to refinance foreign debts.
Benefits of Investing in Bonds
Investing in Federal Government Bonds offer a lot of benefits to the investor. The most important is that the investment is risk free as stated earlier. You are certain of the safety of your capital. But another important benefit you get from investing in sovereign bonds is the tax free income. This means that the interest you earn on your investment is not subject to any form of tax. This is unlike dividend and rental income which are subject to with-holding tax.
Investment in bonds also offers stable returns. You earn fixed amount of return every six months for the entire maturity period of the bond. What more, you can use your certificate of investment as collateral to borrow money from the bank. Interestingly, in addition to all these benefits, you are free to trade your bond certificate before maturity. This is possible because there is a secondary market for bonds which is the Nigeria Stock Exchange. If you do not wish to hold your investment till maturity, simply instruct your broker to sell at the debt segment of the stock exchange.
The minimum subscription for FGN Bonds in the primary auction is NGN50 million. It is lower in the secondary market. Some dealers accept N10 million. Isn’t NGN50 million too much for retail investors?
And that’s why the government introduced the FGN Savings Bond in March, 2017. The FGN Savings Bond is a retail bond targeted at retail investors. It also has shorter maturity of between 2 to 3 years. Minimum investment in these bonds is NGN5,000.
The government may also issue bonds with very low minimum subscription to widen participation. An example is the 5 – 30 year Re-opening bond issued in April 2020 by the CBN on behalf the Federal Government. Minimum investment for this bond was set at NGN10,000.
How to Invest In FGN Bonds
Government bonds can be purchased either through primary auction or from the secondary market. The primary auction is for new issues. The secondary market is where the bond holders can go and sell liquify their investment if they do not want to hold till maturity.
The Nigeria Stock Exchange is the secondary market for bonds in Nigeria.
To invest in bonds is simple. You will have to open a cscs account first through an a registered stock broker. Then go to a Primary Dealer Market Maker of your choice. They will give you the relevant form which you will fill stating your personal details, bank account, cscs number, bid amount and volume required. The PDMM executes your order and your cscs account is credited with your investment after two days.
Meanwhile, Primary Dealer Market Makers (PDMM) are financial institutions that are appointed by the DMO to deal and make markets for the Bonds market in Nigeria. They comprise of banks and investment firms.
A Word About Yield
A bond yield is the amount of return an investor gets for investing in the bond. Ordinarily this should simply equal the coupon rate. However, it gets complex particularly if the holder wishes to sell before maturity.
Bond yields are calculated as the annual coupon divided by the bond price.
Thus, if you hold NGN1,000,000 worth of 10 year 12% FGN Bond and wishes to sell after three years at which time buyers are willing to pay NGN800,000; the yield shall be: 120,000/800,000 = 15%.
Bonds prices and yield move in opposite direction. That is, the higher the price of bonds the lower the yield and the lower the price, the higher the yield. Prices of bonds are affected by a number of factors such as interest and inflation rate, forces of demand and supply amongst other factors.