How to choose between FGN bond, savings bond, others

Since the Federal Government of Nigeria began issuing the FGN Savings bond in 2017, the bonds have become a household name and investors often times look forward to the next issue. One known fact about the issues is that the Federal Government has been issuing the Savings bonds in pairs that differ by their coupon rate and maturity date.

Recently, the CBN reopened and reissued the 12.75% FGN APR 2023, 13.53% FGN MAR 2025 and 13.98% FGN FEB 2028 and it was reported that investors showed a stronger appetite for the 10-year bond, the 13.98% FGN FEB 2028 which was oversubscribed.

The question that we have been receiving from our readers is, when presented with two or multiple bonds, how does one choose which one to invest in, if one is not able to invest in all? It is that question that has given rise to this article

In bond investing, like in every type of investment, the right choice will always depend on the investor’s goals, investment time horizon, and risk appetite. I wish that those who have asked this question have the wherewithal to invest in multiple bonds because there is virtue in doing so.

Choosing and investing in bonds from different issuers helps the investor to manage credit risk by protecting such investor from the possibility that any one of the issuers will default in interest and principal payments.

Again, choosing and investing in different types of bonds like FGN bond (sovereign bond), Corporate, State Government bonds, and Savings bond helps protect the investor from possible losses from specific sectors of the economy. In the same way, choosing and investing in bonds of different maturities, popularly called laddering strategy, helps the investor to manage interest rate risks. That is the beauty of diversification within a bond portfolio.

However, whether you want to build a bond portfolio that will consist of bonds from different issuers, types and different maturities or you want to choose between two or more bonds, here are a few considerations to bear in mind.

In choosing between bonds, one should pay attention to the coupons being offered by the bonds. One would expect that, all other things being equal, if two or more bonds have the same maturity date, the bond with a higher coupon should be preferred. It follows therefore that a longer dated bond should offer a higher coupon than a short-dated bond.

The reason for this is that the additional years to maturity come with added risk which needs to be compensated for with a higher coupon. This is why the FGN Savings bonds’ whose maturity is longer by one year offers additional 1% coupon. Whether this additional 1% coupon is enough compensation for the added risk is one of the things to think of when choosing.

Unfortunately, this principle does not always work because there must be other reasons why two bonds with same maturity will offer different coupon payments. One of such reasons is the credit rating of the issuer. It is expected that if you have two issuers, one with a A+ credit rating and another with a B+ credit rating, then the issuer with the poorer credit rating will offer higher coupon as an enticement or compensation for the added risk of investing or lending to an issuer with less rating.

This decision variable arises if the choice is between bonds from different issuers, therefore, if you are choosing between bonds from different issuers, pay attention to the credit ratings and go for the one with better rating unless you have an appetite for greater risk.

As indicated already, the issue of credit rating does not apply with respect to the FGN Savings bonds or the reopened bonds since they are from the same issuer, the Federal Government of Nigeria. Does that mean then that the only decision variable that should be factored into the choice of FGN bonds, savings or otherwise, should be the coupon rate? Probably not

In comparing between fixed income securities with different coupons and maturities, investors have often used what has come to be known as yield to maturity or yield to call, for callable bonds) to put the bonds at a level playing field. This is of importance if the investor plans to hold the bond to maturity or until called.

Most Nigerian bond investors are hold to maturity investors, so in choosing between FGN bonds (Savings Bond or otherwise), you should pay attention to the yield to maturity of the bonds of interest. Yield to maturity is the return on investment that a bond holder gets if he or she holds the bond to maturity. It is different from the coupon rate, which is the interest one receives at each interest payment period.

It is important that you determine the yield to maturity so that you can compare alternative bonds or fixed income securities. The bond with a higher yield to maturity, YTM, should be preferred. Calculating the YTM could be a daunting process, especially if you do not have financial or scientific calculator. Even with those calculators, the fact that YTM calculation involves some iterations, makes it even more difficult. However, YTM can be easily calculated using Microsoft Excel.

All that you need is to know the settlement date of the bond, the coupon rate, interest payment frequency, the face value, the bond price (actual or indicative) and the maturity date. With that information and excel spreadsheet, you are ready to determine the YTM and decide on which bond to choose based on a comparison of their YTM.

To calculate a bond’s yield to maturity using Microsoft Excel, you need to have the correct data inputs entered into the rate function in a specific order. That order is given by the syntax: YIELD (settlement, maturity, rate, price, redemption, frequency, [basis]), Where:

Settlement is the bond’s settlement date which is the date after the issue date when the security is traded to the buyer.

Maturity: This is the bond’s maturity date.

Rate: This is the bond’s annual coupon rate.

Price:  This is bond’s price per N100 face value.

Redemption:  This is the bond’s redemption value per N100 face value, that is how much you will receive at maturity.

Frequency:  This is the number of coupon payments per year. For annual payments, frequency is 1; for semiannual, frequency is 2; for quarterly, frequency is 4.

Basis:  This is the type of day count basis to use. Nigeria uses the Actual/Actual day count, but some other countries or markets use day counts like 30/360, Actual/360, Actual/365. Below are the data input for different day counts in excel

We are going to illustrate YTM calculation with the recently announced 2-Year and 3-Year bond issue in August, however, as at issue date, the price of bonds may not be known but one can approximate by using the price of a currently trading bond whose characteristics, in terms of coupon, and maturity closely approximates the bond whose YTM is being calculated.

For example, the 2-Year FGN Savings Bond due July 11, 2020: 10.483% and 3-Year FGN Savings Bond due July 11, 2021: 11.483% prices as indicative of the August issue, one can calculate the YTM as follows

It can be seen from the above that excel makes the calculation easier and that the YTM for the 2-Year bond is 13.195% while it is 13.475% for the 3 Year bond. It means then that the 3 year bond yields additional 0.279% interest than the 2 Year bond but it does not look like that is enough compensation for holding the bond for an additional year, especially if you have an investment outlet that will yield more than that.

Now you know how to compare and choose between bonds, happy bond investing.