Did you know that you can lend Money to your government? Well, you can use your savings to invest in government securities rather than letting it sit at the bank where by now we all know it is earning you very little interest.
What are government securities? Government securities refer to debt instruments that the government issues. This means that the government is borrowing from you or from the public so that they can utilize that money for their development agenda. Government securities are comprised of two major debt instruments. These are treasury bills and government bonds.
Treasury bills are short term debt instruments that last no more than 365 days or one year. Government bonds are debt instruments of a longer term period that normally lasts up to 15 years, if you are investing in Zambia.
Government securities are normally offered at face value. For Zambian securities, the face value is 100 kwacha. Treasury bills are bought at a price which is less than their face value. This is referred to as being bought at a discount. Government bonds can be bought at three prices. They can be bought at a discount like the Treasury bill, at face value or at a premium, which is an amount more than the face value.
How do you make money from government securities? Well, that is what we are all interested in isn’t it?
For the Treasury bills you make your money by earning an interest income. This is the difference between the face value, which is the amount that you expect to get at maturity of the Treasury bill less the cost value of the Treasury bill, which is normally at a discount. The difference between the face value and the cost value gives you the interest income that you are going to make on a Treasury bill.
When the Treasury bill matures, you will be paid both the face value amount as well as the interest income. The interest income is exposed to a 15% withholding tax deduction and a 1% handling fee. So you will be paid a net amount net of withholding tax and a handling fee. So you could say treasury bills give you one source of income, and that is the interest income you get from the discounted price.
Zambian bonds pay you 2 sources of income. The first, which is what excites many investors is the fixed interest rate referred to as a coupon rate. The coupon is computed on the face value amount of the bond and is paid every six months. So you make your money from government bonds by getting the coupon every six months for the duration of your bond. So if you bought a 2-year bond, you will receive the coupon amount 4 times up to the maturity date of the bond.
But that’s not all, you also get paid an interest income on your bond when it matures. And unlike the treasury bill interest income which is paid net of 15% withholding tax and 1% handling fee, the interest income on the bond will be paid without any charges.
Now, as with any investment, you need to consider the effect of inflation on the returns from your investment, because inflation can erode all the profit that you think you have made, at times, you may even be making negative returns when you take into account inflation. So we are going to take a look at the effect of inflation on the Treasury bills as well as the Government bonds. So don’t get too excited.
Before we do that, I want us to look at how you can go about investing in Zambian government securities, how you compute the income you expect to make on your investment and then we will take into account the effect of inflation on your returns. This should help us see if investing in Zambian Government Bonds makes finance sense.
Now, like in many countries across the globe, central banks are in charge of issuing government bonds on behalf of the government. In Zambia, the bank of Zambia, simply referred to as BOZ is in charge of issuing Zambian Government Securities. And since government securities can be traded on the secondary market, BOZ works closely with the Lusaka Stock exchange.
The first thing that you need to do in order for you to start investing in Zambian government securities is to open an account on the Central Securities Depository based at the bank of Zambia. To open this account, simply download the CSD application form, from boz.com, which is the Bank of Zambia website.
There are two forms that you can complete. You can complete the form as an individual or as a corporate. When you take a closer look at this application form, you will notice that you will need to have a local commercial bank account which should be denominated in Zambian kwacha. So in order for you to trade in Zambian government securities, you will need to open a local commercial bank account because the Bank of Zambia trades in government securities denominated in Zambian kwacha Only.
Once your account is opened, you are ready to start trading in government securities.
The Zambian government issues out adverts or prospectus on their website, or in newspapers. The advert, which is referred to as a tender shows clearly how much the government wants to borrow, the tenor, coupon rate if it’s a bond prospectus and the maturity dates. Treasury bills are advertised every 2 weeks, whereas bonds are advertised every month.
Let’s take a look at Government Bond Auction Number 01/2022/BA. BA, meaning bond auction, which was issued on 21st Jan 2022. So you can see the different tenors, I want us to focus on the 10yr bond. So the Zambian Government wants to buy 500 million 10yr bond, with a coupon rate of 13%. Notice that the 500 million is broken into 2 parts. You have a 360 million sitting under the competitive tender and the balance 40 million under non-competitive tender.
Now let’s just stop here a bit, what does this mean and why is it important?
To participate in a government security, you can participate as a competitive bidder or a non-competitive bidder.
Competitive bidding is similar to an auction. Bidders offer the government a desired interest rate that they would like to make on their investment and the face value amount of their offer. In an auction, you find that a bidder will offer a price for a certain item, maybe a painting. They would say I want to buy this painting for 100. Then there will be a counteroffer from another bidder, offering 120 and yet another person might offer 130, so the bidding process goes on until the highest price wins the bid.
This process is similar to what happens under the competitive bidding, so bidders will offer the Bank of Zambia different interest rates accompanied by the face value amounts and the Bank of Zambia will select the lowest interest rate. The lowest interest rate, normally offers the highest cost price. So bidders will bid different rates, resulting in different cost prices.
The Bank of Zambia then apportions the face value amount to the bidder with the lowest interest rate, followed by the next low rate and so on until the tender amount is fully apportioned. The bid price, or cut of price is the price for the last apportioned bidder, who normally has the lowest cost price. This is the Final Cut of Price and this is the price that all bidders are going to pay, regardless of how much they had quoted on their bid application. You may find that a bid application had a price higher than the cut off price or lower than the cut off price, but the final price that you are going to pay should your bid succeed is the cut off price that the Bank of Zambia selects. This is referred to as a single price auction method and is used to evaluate the cost value of your bid and the expected return.
When you invest as a non-competitive bidder, you don’t take part in the auction. You take the final cut of price that is selected from the competitive bidding process. The Bank of Zambia awards you a face value amount as a proportion of all the bidders that took part under the non-competitive bidding window.
In order for you to participate in the competitive bidding window, you will need to make investments above 500,000 kwacha. If your investment is between 1,000 kwacha and up to 499,000 kwacha, you will fall under the non-competitive window.
When you are done completing your bid application you are now ready to submit the bid and there are two ways you can submit your application.
You can submit the bid directly to the Bank of Zambia yourself. However, you will need a guarantee letter from a commercial bank in Zambia. The letter of guarantee assures the Bank of Zambia that the bank is going to settle the payment on your behalf when your bid is successful.
Your bank can also submit your bid on your behalf. Commercial banks normally charge for the letter of guarantee or for submitting the bid on your behalf, so you need to be aware of this cost. When I checked on one bank, I found that a letter of guarantee costs no less than 1,040 kwacha or they charge you a rate of 1% to 10% of the face value of your tender.
Once you submit your bid, you now become an investor in Zambian securities and you’re going to get an award notice showing you that your bid was successful.
Suppose you want to lend the government 100,000 for 10 years, what is the face value of this amount, or how much will the government pay on at maturity, and what will be your coupon income and your interest income? The results of the bid are published on the BOZ website. These show the cut off price that was selected from the auction. With this information you can estimate the cost value of your investment.
Let’s take a look at the results of the Government Bond Auction Number 01/2022/BA.
If you want to invest in a 10year bond and you’ve got 100,000 to invest you need to find the cut off price for the 10-year bond to know the face value of the 100,000. This is 56.4792. This is the price for 100 kwacha face value. So for every 100 kwacha that you invest in a 10 year bond you will pay a price of 56.4792. To get the face value of the 100,000-kwacha investment, you will need to multiply the 100,000 Kwacha by 100 and then divide by the cut off price of 56.4792. This will give you the face value of 177,056.33. Bonds are divided in multiples of 5,000. So you could be offered 175,000 face value. To compute the exact cost value of the 175,000 simply multiple 175,000 by the cut of price of 56.4792 and then divide by 100. This gives you a cost value of 98,838.6. This is the cost amount you will pay the government, in return, they will pay you back a face value of 175,000 at maturity date.
Now let’s look at the return on your investment? How much income will you make on this investment?
Bonds pay you 2 sources of income. The coupon income and the interest income. You compute the coupon income by multiplying the coupon rate by the face value amount. In this case you get 175,000 * 13% = 22,750. You need to deduct WHT of 15% and 1% handling fee. This gives you a net annual coupon income of 19,110. Coupons are paid every six months. Since your investment is for 10 years, you will get 20 coupon incomes of 9,555 every six months, until maturity when you get the interest income of 76,161.40. This is the difference between the cost value of your bond and the face value. The interest income is exempt from any charges (WHT and Handling fee) on the bond. The total coupon income for 10 years is 191,100. So your total income for the 10-year bond is 267,261.4.
Now you need to consider the effect of inflation on any investment that you are making, including government securities. It doesn’t matter what investment you’re making; you need to consider the effect of inflation on your investment. This is because the value of the money that you have today will not be equivalent to the value of the money that you need tomorrow because of the effect of inflation. So the kwachas that you have today will not buy the same amount of goods tomorrow because of the effect of inflation.
So you will need to take into account inflation when you are looking at investing. Inflation becomes extremely important especially when your investments are for longer terms, such as 5 years and above. The money you expect to make in 5 or 10 years, won’t be as valuable as it is today. So your return on investment at maturity of your bond or treasury bill must be way above the inflation rate. That’s how you know your investment made finance sense. Bonds are long term investments whose value is affected by future changes in inflation. And you don’t know what inflation will be 5 years from now. This is what makes investing in bonds risky and tricky.
Another risk you need to consider with bonds is the increase in the interest rates. This normally devalues your bond, because new bond issues have higher interest rates than yours, meaning if you had to liquidate your bond, you would most likely do so at a price below the face value. The opposite is also true. When interest rates are going down, your bond becomes valuable. Meaning, you can sell them at a premium on the secondary market. So be alert to these factors.
One way of managing inflation is investing in bonds of shorter maturity dates, say up to 5 years, when you check the results of this tender, you’ll see that majority bids are in the 5year maturity window and the lowest bid is on the 15year bond. Another way of managing inflation, is to read the economic environment and make predictions on how inflation will change over the years. If the economy is doing well, inflation should not change drastically. And you can use a range of rates to forecast the effect of inflation on your returns. Should the results give you a negative real return, then you should re-consider your investment.
Now let’s take a look at the effect of inflation on treasury bills and government bonds. To do this you need to look at the yield rate or yield to maturity. This is the rate of return you receive on a security that you buy and held to maturity. The highest yield rate on treasury bills currently is on a 364-day treasury bill of 15%. Inflation currently stands at about 15%. So your interest income on treasury bills is wiped out by inflation. Should inflation continuing coming down, and come to a single digit at the close of 2022 as projected in the budget 2022, then you will have positive returns.
The yield rate on the 10year bond example we’ve been looking at is 25%. You get this by using excel, simply type equals rate, bracket then type in these numbers here (10,22750,-98838.6,175000) and enter. Ten is the tenor, 22,750 is the annual coupon amount, -98,838.6 is the investment (present value), its negative because that’s what you are paying out. It’s a negative outflow and 175,000 is what you get back, it’s the future value. So you just use this rate formula in excel and that will tell you that the yield rate on this bond is 25%. You can also get this by looking at the results of the tender for this bid.
The 25% means that if you bought this bond for this price and then you held it to maturity, the entire 10 years, you would earn a rate of return on that investment of 25%. Simply stated, inflation should not exceed 25% in ten years. If you project that it will exceed 25%, then it will wipe out your investment.
So when it comes to investing in government securities take into account the effect of inflation on your investment. This is also why, you need to diversify your investment, so that your overall investment is balanced.
Other than the income that you make on your government securities. You can also use government securities as a liquid asset by trading in the secondary market. So assuming that you invested in a 10year bond, and you need money right now.
You can sell your bond in the secondary market, and depending on the prevailing interest rates, you can sell either at a discount, face value or at a premium. Another advantage with investing in government securities is that you can use the government securities as collateral to get financing from a financial institution. So it’s more like you have a property that you can use as collateral to get a loan. That’s great isn’t it?
Well, this is all I had to share in today’s video. I hope you picked out lots of insights that will get you started investing in government securities. If you’re already investing in government securities, we’d love to hear how this is going with you. Let us know by dropping a comment below.
