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Investment Opportunities in Kenya: A 6-Part Series Part 2A: Treasury Bonds

“Managing your wealth well is like tending a beautiful formal garden – you need to start with good soil and a good set of tools. Just as good soil has the proper fertility to nourish a plant, having the right foundation in financial literacy should empower you to potentially cultivate a successful investment portfolio. This 6-Part Series on Investment Opportunities in Kenya is part of our financial education series to help educate you on the fundamentals of investing as you prepare to tend your very own financial garden.”

~ Rachael Mboya (LL.M.) Uni. of Nairobi, Advocate of the High Court of Kenya

Do you often see advertisements inviting the general public to make investments into government bonds, usually done by the Central Bank of Kenya & other commercial banks, and wonder what these Bonds are really about? This article seeks to answer this question.

Government securities are considered risk-free investments. Government securities provide a return and/or a consistent source of income over a specified period of time. Investors who buy these securities are loaning money to the government, which promises to repay them after a specified period of time, called maturity. 

In Kenya, the National Treasury offers two types of government securities: Treasury bills and Treasury bonds.

Treasury Bills and Treasury bonds are securities through which the government borrows from the public. Treasury Bills are short term securities at issue and usually have tenors of 91, 182 or 364 days. Treasury bonds on the other hand are medium to long-term investment that typically offers you interest payments every six months throughout the bond’s maturity.

The main difference between Treasury Bills (T-Bills) and Bonds (T-Bonds) is the Tenor i.e. Bonds are issued for a longer-term (above 1 year) while Bills are short term (1 year and below). The minimum investment amount is Kshs. 100,000 while for the Treasury Bonds the minimum investment amount is Kshs. 50,000. The exception however, is in infrastructure bonds where the minimum investment amount is Kshs. 100,000.

These financial instruments are generally secure because, in essence, you are lending to the Government.

Bonds have been a go-to investment option for most passive and risk-averse investors due to their risk-free nature, fixed returns, and high liquidity. Did you know that bonds are the 2nd  most liquid asset class after cash? Liquidity basically means the ease with which an asset, or security, can be converted into ready cash without affecting its market price.

A.   What are Treasury Bonds?

If you are looking to build up a well-diversified portfolio, you will usually be advised to include both stocks and bonds among your investments. While stocks may offer you the potential for capital appreciation, bonds may provide a steady stream of investment income, and play an important role of potentially lowering your overall portfolio risks.

When you invest in a bond, you are essentially lending a sum of money to the bond issuer. In return, you are usually entitled to receive interest payments at scheduled intervals; and capital repayment of your initial principal amount at an agreed date in the future also known as the maturity date.

Treasury bonds are secure, medium to long-term investments that typically offer you interest payments every six months throughout the bond’s maturity. The Central Bank of Kenya auctions Treasury bonds on a monthly basis but offers a variety of bonds throughout the year. Their maturity periods can range from one year to 30 years. There are many different types of Treasury bonds, but their basic operations are similar.

B.   Who can invest in treasury Bonds?

Anyone can invest in a T-bill or T-bond as long as one has a Central Depository System (CDS) Account with Central Bank of Kenya, the minimum amount required to invest in each issue, and has satisfied all the requirements stated when applying to invest in a specific bond issue.

C.  Who are the typical Bond issuers?

Typical bond issuers include:

·        Governments/Government agencies (Treasury)

·        Banks

·        Non-bank financial institutions

·        Corporations

D.   What are the features of Treasury Bonds?

The following are the top features of a Treasury Bond in Kenya:

  • It offers secure investment as it is issued by the Government of Kenya
  • It offers liquidity. In the case you require part/whole of your capital investment, you can sell the bond to other investors.
  • Guaranteed earnings. The interest rates earned on an annual basis are market determined and paid out semi-annually making them a fixed source of income.

E.    How do Treasury Bonds work?

The borrowing organization i.e. the national government, issues a T-bond. The borrower promises to pay the bond back at an agreed-upon date. Until then, the borrower makes agreed-upon interest payments to the bondholder.

The borrower repays the principal amount invested, called the face value, when the bond matures. Most bondholders resell them before they mature at the end of the loan period. They can only do this because there is a secondary market for bonds. Bonds are either publicly traded on exchanges or sold privately between a broker and the creditor. Since they can be resold, the value of a bond rises and falls until it matures.

F.    Are Treasury bonds Tradable in the Secondary Market i.e. (the Nairobi Securities Exchange – NSE)?

YES. Treasury bonds are traded at the Nairobi Securities Exchange (NSE). In addition, investors may pledge them as collateral security against credit facilities (loans), and may also be transferred among holders of CDS accounts. CDS Statements are adjusted accordingly to reflect these transactions. Commercial banks also use them as collateral for liquidity management through Repurchase Agreements (Repos) and Intraday Liquidity Facility (ILF).

G.  What is the minimum amount you can invest in Treasury bonds in Kenya?

If you’d like to purchase a Treasury bond in Kenya, you must invest a minimum of Kshs. 50,000.

H.   How Do I Determine my Return on Investment a Treasury Bond?

For ease of calculating prices, the Central Bank includes a yield table in the prospectus for the T/bonds on offer. One can also use the Treasury bonds pricing calculator available on the CBK official website.

In the case of Treasury Bonds, the interest is usually received periodically, usually semi-annually. The details of the payment dates are usually given in the prospectus for each bond sale, on the CBK website. Both the principal and interest amounts are sent directly to your bank account.

I.     How do you decide on how you want to invest in Treasury Bonds?

Treasury bonds are offered for a set number of years, ranging, from 1year to 30 years. When choosing a bond to invest in, you’ll need to consider what is available in the upcoming auction and how long of a commitment you want to make.

There are several types of bonds that are generally made available:

  1. Most bonds auctioned by the Central Bank are fixed coupon Treasury bonds, which means that the interest rate associated with the bond will not change over the bond’s life, so semi-annual interest payments from these bonds will stay the same.
  2. Infrastructure bonds are used by the government for specified infrastructure projects. These bonds typically see a lot of market interest because returns from them are tax-exempt.
  3. Zero coupon bonds are similar to Treasury bills, in that they are sold at a discount and do not have interest payments. They are also typically issued for a short period of time.

J.    How Do I know which Bonds are on Offer at any time?

Information about the Treasury bond(s) on offer every month is available in the Daily Nation Newspaper from the first or the second week of each month and also on the CBK official website.

K.   Do I pay withholding and/or income tax on Treasury bonds?

Yes. Withholding Tax of 15% on Treasury bonds with tenors up to 9 years and 10% for Treasury bonds of tenors of 10 years or more is charged on the discount as well as periodic interest payment, unless an investor is tax-exempt, in which case a tax exemption certificate must be provided or the investor has made arrangements to pay the tax directly to the Kenya Revenue Authority (KRA).

However, discount and interest earnings from infrastructure bonds as defined under Capital Markets Act and Income Tax Act do not attract any form of tax.

L.    What Happens When my Treasury Bond Matures?

The Central Bank remits electronically, the face value of the maturing bond directly to the investor’s commercial bank account on the due date. The investor’s CDS account is debited by the same value as the security, and statements are sent to the investor showing the new position.

Investors may however choose to roll over their security into a new forthcoming issue and in this case, they have to complete the application form giving rollover instructions, and submit it to Central Bank, before the closure of the period of sale for that bond, at 2.00 p.m.

M.  What makes Treasury Bonds an attractive investment for investors?

Below are some of the pros of investing in Treasury Bonds to build your investment portfolio:

  1. Security

Treasury bonds are units of government debt, meaning that you are investing in the Kenyan Government which promises security for your investment.

2. Higher returns than bank deposits

Treasury Bonds typically pay a higher yield (return) than bank deposits of a similar term.

3. Regular Returns

Most Treasury bonds carry semi-annual interest payments, allowing investors to receive returns every six months.

4. Flexibility

The Central Bank auctions several different types of Treasury bonds, enabling investors to find investments that fit their needs.

5. Auctioned Monthly & Weekly Respectively

Treasury bonds are auctioned every month, providing ample investment opportunities for diverse financial needs.

6. Hedge against inflation

With proper Treasury bond selection, you may potentially earn an investment return that keeps pace with or even exceed the inflation rate.

The price of the Bond can appreciate above the initial purchase price and allow investors to enjoy Capital gains.

7. Access to Loan Facilities

Investors can access a loan facility and use the Bond as collateral.

 

N.   What are the risks involved when investing in Treasury Bonds?

Treasury Bonds are considered safe investments however some of the risks involved include:

  1. Interest rate risk

Interest rates and bond prices are inversely related. Should interest rates rise, the price of your bond will tend to fall (and vice versa). The longer the time to maturity of a bond, the greater the interest rate risk.

2. Credit or Default risk

This is the risk that the bond issuer or borrower is unable to meet the coupon or principal payments on any outstanding bonds or debt (not just the bonds you may be holding) when they fall due (for example, due to bankruptcy or insolvency), and go into default.

3. Foreign Exchange risk

Some bonds are denominated (and the issuer’s payments made) in a foreign currency, which may fluctuate against your home currency. The impact of such foreign exchange movements may offset any interest or capital returns you may receive from the bond investment.

4. Liquidity risk

This is the risk of having to sell a bond at discounted prices due to the lack of a ready market or buyer. When a bond has a low credit rating (for example, due to the fact that it is part of a small issue or that the issuer’s financial situation is questionable), the liquidity risk will tend to be higher.

5. Event risk

Events such as leveraged buyouts, mergers, or regulatory changes may adversely affect both the bond issuer’s ability to make payments on the bond, and the price of the bond.

6. Sovereign risk

Payment of the bond may be affected by the political and economic events in the country of the issuer of the bond. For example, the issuer may be forced to make payments in the local currency of the issuer’s country instead of the original currency of the bond.

7. Inflation Risk

Treasuries offer no inflation protection hence inflation fluctuations may affect the return of investment on treasury bonds.

 

N/B: If you need more information and a step-by-step guideline on how to effectively invest in Treasury Bonds, do not hesitate to contact me on rmboyabusiness@gmail.com

“LinkedIn,” Linkedin.com, 2023, https://www.linkedin.com/pulse/investment-opportunities-kenya-6-part-series-part-2a-treasury-mboya/.

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