When completing your application for a bond to the Bank of Zambia, did you ever get confused by the amount that you had indicated as the face value amount on the application form against the amount that the Bank of Zambia deducted from your bank account? Could it be a case where you indicated the face value amount of ZMW100,000 on your application for a 10-year bond, but only ZMW51,000 was deducted from your bank account? Why didn’t the Bank of Zambia deduct the entire ZMW100,000 that had been transferred to your bank account and which you had indicated as the face value amount on the application for a 10-year bond?
This is a real question that I got from a subscriber, and I thought I should write an article because maybe one or two of you faced a similar challenge. We could learn from each other.
So, here is the email the subscriber sent to me. He was writing to the Bank of Zambia, by the way, and he had copied me into this email. He writes: “I recently bid ZMW100,000 to purchase some 10-year bond. The bid was successful at an award price of ZMW51,786.1. In the award advice, you said ZMW51,786.1 will be deducted from my bank account. The remaining amount, which is ZMW48,213.90, will be left in my account as a discount. But since the minimum bid price is ZMW1000, why wasn’t the remaining amount used to purchase additional bonds?” He continues, “Does that mean that to invest the amount of ZMW100,000, I would have to make multiple bids?” That’s what he’s asking.
When this investor filled in his application form for a 10year bond, he indicated ZMW100,000 as face value on the form.
However, only ZMW51,786.1 was deducted from his bank account, as indicated through the award notice that was given or emailed. Now, why did the Bank of Zambia only deduct ZMW51,786.1, even though the bank balance was ZMW100,000, and he had clearly indicated on the bid application that it was a ZMW100,000 face value?
I can understand the confusion. Before I even go into looking at what the issue is here, I would encourage you to read the article I did on the basics of investing in Zambian government bonds. The article explains in depth and detail the entire process of investing in government bonds in Zambia.
This person is confused because, as a non-competitive bidder, they are not allowed to determine a cut-off price or a bid price. They take the bid price or cut-off price that they are offered by the Bank of Zambia. So, the final bid price that this investor was given on the 20th of January 2023 was ZMW51,786.1
When you look at face value, the face value is the amount which you expect to get back upon maturity of your bond. In this case, the investor is investing their money for 10 years and expects to get back ZMW100,000, in addition to coupon interest that they will receive every quarter, as well as an interest amount that they are referring to as a discount. I will explain the discount in a moment.
On the form, the investor indicates how much they want to get upon maturity of this bond. The Bank of Zambia has to recompute the cost value of this face value investment. The cost value is what you are buying, the ZMW100,000 bond investment for.
The Bank of Zambia works backward and recomputes your cost value. Using this formula: face value multiplied by cut-off price divided by the nominal value, the Bank of Zambia recomputed the cost value of this bond application. They got the cut-off price, which is ZMW51.7861, multiplied this by the face value, which is ZMW100,000, and divided this amount by the nominal value, which is ZMW100. This resulted in the ZMW51,786.1, which was deducted from this investor’s bank account. The balance of ZMW48,213.9 was left as a cash balance in the bank account.
One key thing to remember here is that when you indicate the face value on your application to the Bank of Zambia, the Bank of Zambia is going to recompute the cost value based on the cut-off bid price, which you are going to take as a non-competitive bidder. They are going to apply that cut-off price to your face value investment, and when they apply that, they are going to compute your cost value, which is the amount they will deduct from your bank account. Now, the balance that remains in your bank account is not technically the discount income. What remains in your bank account is just a bank balance. It’s just cash that has remained after the Bank of Zambia has deducted the cost value of your bond investment.
Your interest income, which you referred to as the discount, is what you will receive upon maturity of your 10-year bond. It is not currently sitting in your bank account, so please do not confuse it with your cash balance. Even though the computation shows the same amount of ZMW48,281, your interest income will only be received upon the maturity of the 10-year bond. The Bank of Zambia will send you the cash at that point, and not right now.
Suppose you wanted the entire ZMW100,000 to be deducted from your bank account. In that case, you need to understand that the cut-off price is not known until the results of the bond are out, and the Bank of Zambia has already apportioned all the bid applications. As a non-competitive leader, you take the bid price, and you are not aware of how much will be deducted from your bank account. However, you can estimate how much the Bank of Zambia will deduct by using the previous month’s cut-off price to determine the cost value of your face value investment in the Government Bond.
For instance, let’s consider last month’s bond results for a similar 10-year bond. What was the cutoff price? You will find that the cutoff price was ZMW51.110. Therefore, this investor should have recomputed the actual face value.
In other words, the ZMW100,000 is the cost value because the investor wants the entire amount to be deducted from the Bank of Zambia. The investor needs to do some calculations to arrive at the actual face value amount of their cost-value investment.
To get the actual face value amount of your cost value investment, you need to use the following formula: cost price multiplied by the nominal value divided by the cut-off price. I have explained how to arrive at these values in my previous articles on investing in government bonds.
In this example, the cost price is ZMW100,000 because the investor wants the entire amount to be deducted from their bank account. This means that the cost price is multiplied by the nominal value, which is always ZMW100, and then divided by the cut-off price. It’s important to note that the previous month’s cut-off price is used because the estimate is being made. We don’t know what the final cut-off price will be for January.
Using the previous month’s cut-off price of ZMW51.110, the adjusted face value amount is calculated to be ZMW195,656.43. To get the exact face value amount, the flow or ceiling formulas can be used to round up or down. It’s important not to exceed the desired investment amount, which in this case is ZMW100,000. The flow formula was used for this bid application, resulting in a face value amount of ZMW195,000.
It’s important to remember that the ZMW100,000 is the amount that the investor wants to be deducted from their bank account, and is therefore their cost value. The recomputed face value amount is ZMW195,000. To compute the actual cost value of this amount, the face value is multiplied by the cut-off price and then divided by the nominal value. This results in a cost value of ZMW99,664.5.
As you can see, the cost value is closer to the desired investment amount of ZMW100,000. It’s important to use the previous month’s results to estimate the cost value because we don’t know exactly how much the Bank of Zambia will deduct from the investor’s bank account. Using the previous month’s results gives a closer estimate of the amount that will be deducted.
In summary, when making an application to the Bank of Zambia, the application form indicates the face value amount that is being invested. This is the amount that the investor will receive upon maturity of the bond. Bank of Zambia will recompute the face value amount and deduct the cost value from the investor’s bank account. The cost value will be communicated to the investor through the award notice. If the entire face value amount is to be deducted from the bank account, it’s important to recompute the face value amount accordingly.
Please do not indicate ZMW100,000 if you do not want to invest that amount. If you want the full ZMW100,000 to be deducted, you must recalculate the new face value using the formulas I have outlined in this article. Once you have the new face value amount, you need to determine the actual cost value based on the previous month’s cut-off price from a similar tenure bond. This will provide a closer estimate of how much BOZ will deduct from your bank account. It is important to note that nobody knows exactly how much the Bank of Zambia will deduct from your bank account, as you are competing as a non-competitive bidder and therefore take the final cut-off price. However, using these estimates will give you a better idea of how much you want to invest in the government bond.
Now, addressing the issue of the discount mentioned in the question, it is not actually a discount, but rather a cash balance. This should not be confused with the interest income, which is mainly referred to as the discount you receive when your bond matures. When your bond matures, you will receive the full face value investment that you had indicated on your bond application, in addition to coupon interest incomes and the final interest income, which is the difference between the first value amount and the cost value that you invested. It is important to note that interest income is not taxed, but coupon income is subject to taxes.