Investing in bonds and T-bills can be a great way to earn a steady stream of income while protecting your assets from market volatility. But before you get started, it’s important to understand the basics of these investments so you can make an informed decision about whether they are right for you. In this blog post, we’ll discuss the important terminologies you will come across and need to be familiar with before investing in T-bills and bonds.
What are T-Bills and Bonds?
T-bills (Treasury bills) and bonds are both debt securities issued by the government or corporations. They are essentially loans that investors make to the issuer, who promises to pay back the principal plus interest.
T-Bills
T-bills, or Treasury bills, are issued by the government to fund its operations. They are considered to be the safest investments available because they are backed by the full faith and credit of the government.
T-bills are sold at a discount to their face value and mature at face value. For example, a KES 1,000 T-bill might be sold for KES 990 and mature at KES 1,000, giving the investor a KES 10 profit.
T-bills are also very liquid investments, which means they can be easily bought and sold on the secondary market. They are often used as a short-term cash management tool by investors, corporations, and governments.
Bonds
Bonds are also debt securities, but they have longer maturities than T-bills. They are issued by governments or corporations and are used to fund a variety of projects or operations. Bonds can be fixed-rate or floating-rate, meaning the interest rate can change over time based on a specified benchmark, such as the prime rate.
Like T-bills, bonds are sold at a discount or premium to their face value and pay interest to investors. The interest rate, or coupon rate, is fixed at the time of issuance and remains the same throughout the life of the bond. When the bond matures, the issuer repays the face value to the investor.
Bonds can be less liquid than T-bills, meaning they are not as easily bought and sold on the secondary market. However, they are still considered relatively safe investments, especially those issued by governments.
The difference between T-bills and bonds is the length of time until maturity. T-bills are short-term investments with maturities of one year or less, while bonds have longer maturities ranging from two years to 30 years or more.
However, while T-bills and bonds are safe investments, they tend to offer lower returns than other investments. Usually, the higher the risk, the more significant the potential rewards. Therefore, the risk-reward ratio of these securities is generally lower.
What are the Key Terms You Need to Know?
Now that you have a background on what T-Bills and Bonds are, let’s dive in to terminologies commonly used in the industry you need to be familiar with. Below are some of the key terms:
- Coupon
A coupon payment is the amount of annual interest that will be paid to the bondholder on an annual basis. The coupon payment per bond unit is:
Coupon Payment = Face Value of Bond X Coupon Rate of the Bond in %
This amount will be paid as per a pre-defined schedule – monthly, quarterly, bi-annually, or annually until the date of maturity. Kenyan bonds issue the coupons bi-annually that is after every 6 months. For example, if the coupon rate of a bond is 12% p. a, a bondholder receives 6% every 6 months.
On issue of the bond, the coupon may be pre-determined as the bond is going for bidding or market-determined meaning the coupon rate is also put on bid and it adopts the average yield once the bidding process closes.
- Par value
Par value is also known as the face value of the bond and is the amount the issuer promises to repay the holder upon maturity. The majority of bonds are issued with a par value of KES 100.
- Bond Price
Price refers to how much is actually paid for the bond at purchase.
The bond price can either be discounted or at a premium.
When the bond is at a discount, it means it has been issued with a value less than the par value that is less than KES 100 at purchase. This might be to entice investors to purchase. Most zero coupon fixed income instruments are offered at a discount like T-bills but mature at par.
If the bond is priced at a premium, it means that the bond value is more than the par value of KES 100. For example, a bond can be issued at purchase for KES 105 but will mature at KES 100. This is mostly with bonds with high coupon rates like Infrastructure Bonds.
The price of the bond is affected by the forces of demand and supply.
- Maturity
This is a pre-defined date when the issuer of the bond agrees to pay back the face value of the bond to the bondholder. It is called the bond maturity date. Once the principal amount is returned, the bondholder stops receiving the interest payments as well.
- Yield to Maturity (YTM)
Yield to maturity is the effective returns that an investor gets by investing in a bond and then holding it till maturity. Simply put, it is the total rate of return that will have been earned by a bond when it makes all interest payments and repays the original principal. YTM is essentially a bond’s internal rate of return (IRR) if held to maturity. This is a combination of the interest paid by the bond, the price you paid for it, and the discount or premium you paid to the par value that you’ll get back upon maturity.
- Issuer
A bond’s issuer is the entity that is using the bond to borrow money, and that is responsible for paying the agreed-upon interest, and eventually repaying the principal. Bond issuers can include, but are not necessarily limited to, the Government, County Governments and corporations.
- Tap sale/issue
A tap sale is a procedure that allows the borrower (National Treasury) to sell bonds or other short-term debt instruments from past issues. The bonds are issued at their original face value and maturity, but are sold at the current market price.
- Primary market
Where the issuer of the bond offers it to the public for the first time. Investors are able to purchase securities directly from the issuer.
- Secondary Market
In the secondary market, securities are traded after the primary offering has been closed. Anyone can purchase the bonds on the secondary market as long as they are willing to pay the asking price per share. The prices on the secondary market fluctuate with demand.
- Floating Rate Bond
The coupon/interest rate fluctuates according to the market interest rate with a benchmark rate most of the time.
- Fixed-rate Bond
A bond that pays the same level of interest over its entire term. An investor who wants to earn a guaranteed interest rate for a specified term could purchase a fixed-rate bond.
In conclusion, investing in T-bills and bonds can be a great way to earn a steady income and diversify your portfolio. These securities offer low-risk and modest returns, making them highly suitable for short-term investment goals. However, as with any investment, it’s important to understand the underlying principles and terminologies to make informed decisions. Use the information in this blog to start investing in T-bills and bonds with confidence.
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