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27 June 2023

Treasury Bonds: What you need to Know

What are Treasury Bonds?

Treasury Bonds are debt securities issued by the government to raise funds for various public spending initiatives.

A brief background into Treasury Bonds

T-bonds are considered among the safest investments available, backed by the creditworthiness and taxing authority of the government. In the case of Treasury Bonds in Nigeria, they are issued by The Debt Management Office (DMO).

As debt instruments, Treasury Bonds represent loans made by investors to the government. In return for their investment, bondholders receive regular interest payments, known as coupon payments, typically paid semi-annually.

The bond’s principal amount, or face value, is repaid upon maturity, which can range from a few months to as long as 30 years. This makes Treasury Bonds appealing to investors with varying investment horizons and risk appetites.

Treasury Bills (T-bills) vs Treasury Notes (T-notes) vs Treasury Bonds (T-bonds)

Treasury Bills (T-bills)

Treasury Bills are short-term debt instruments with maturities of one year or less. They are issued at a discount to their face value, meaning investors purchase them for less than their eventual repayment amount. The difference between the purchase price and the face value represents the investor’s return. T-bills do not pay periodic interest like other bonds.

Treasury Notes (T-notes)

Treasury Notes are intermediate-term debt securities with maturities ranging from 2 to 10 years. Unlike T-bills, T-notes pay periodic interest to investors, usually semi-annually. These interest payments are fixed, with the investor receiving a predetermined percentage of the bond’s face value.

Treasury Bonds (T-bonds)

Treasury Bonds, often referred to as long-term bonds, have maturities ranging from 10 to 30 years. Like T-notes, T-bonds pay periodic interest to bondholders. The interest payments are fixed providing investors with a predictable income stream.

Features of Treasury Bonds

  1. Face Value: Treasury Bonds have a predetermined face value, which represents the principal amount that will be repaid to the bondholder at maturity.
  2. Coupon Rate: T-Bonds pay periodic interest, known as coupon payments. The coupon rate is the fixed percentage of the bond’s face value that determines the amount of interest paid. For example, a bond with a face value of N1,000,000 and a coupon rate of 3% would provide an annual interest payment of N30,000 (N1,000,000 x 3%).
  3. Maturity: This is the length of time until the bondholder receives the face value repayment.
  4. Yield: The yield of a Treasury Bond represents the effective return an investor can expect to receive from holding the bond until maturity. Yield is influenced by factors such as coupon rate, purchase price, and time to maturity.
  5. Price and Yields Relationship: There is an inverse relationship between the price of a Treasury Bond and its yield. When interest rates rise, newly issued bonds typically offer higher yields, which can lead to a decline in the market value of existing bonds. Conversely, when interest rates fall, existing bonds with relatively higher coupon rates become more attractive, potentially increasing their market value.
  6. Marketability and Liquidity: T-Bonds are highly marketable and traded actively in the secondary market. This means that investors can buy or sell them before their maturity date.
  7. Credit Risk: Treasury Bonds are considered to have minimal credit risk due to the full faith and credit of the Nigerian government backing them.
  8. Tax Considerations: Treasury Bonds are no longer tax-exempt in Nigeria.

Benefits of Treasury Bonds

Here are some key benefits of investing in Treasury Bonds:

  1. Safety and Security: Treasury Bonds are considered one of the safest investments available. They are backed by the full faith and credit of the Nigerian government, meaning that the likelihood of default is extremely low.
  2. Low Risk: T-Bonds are renowned for their low-risk profile compared to other investments, such as stocks or corporate bonds.
  3. Stable Income Stream: T-Bonds provide investors with a predictable and stable income stream in the form of periodic coupon payments.
  4. Diversification: Their low correlation with stocks can help reduce overall portfolio volatility and provide a cushion during periods of market turbulence.
  5. Liquidity: Treasury Bonds are highly liquid instruments. Investors can buy or sell them before their maturity dates.
  6. Capital Preservation: Due to their low risk and government backing, Treasury Bonds are generally considered a safe-haven investment. Hence, investors may seek them for the relative stability and preservation of capital they offer.
  7. Benchmark for Interest Rates: The yields on Treasury Bonds are closely watched and used as reference rates for pricing other debt securities.
  8. Inflation Hedge: Treasury Bonds, especially those with longer maturities, can serve as a potential hedge against inflation.

Risks and Considerations of Treasury Bonds

While Treasury Bonds are generally considered low-risk investments, it is important for investors to be aware of the potential risks and considerations associated with these securities.

  1. Interest Rate Risk: Changes in prevailing interest rates can affect the value of existing bonds in the market. When interest rates rise, newly issued bonds typically offer higher yields, making existing bonds with lower coupon rates less attractive.
  2. Inflation Risk: Inflation erodes the purchasing power of fixed-income investments over time. If the inflation rate exceeds the fixed interest rate offered by Treasury Bonds, the real (inflation-adjusted) return on investment may decrease.
  3. Reinvestment Risk: There is a risk associated with reinvesting the periodic interest payments. If interest rates decline, the investor may need to reinvest the coupon payments at lower rates, potentially resulting in lower overall returns.
  4. Market Volatility The prices of Treasury Bonds can fluctuate in response to changes in market conditions, investor sentiment, and economic factors. Investors should be prepared for short-term price movements. However, T-Bonds tend to be less volatile than riskier investments like stocks.
  5. Opportunity Cost: There is the opportunity cost of potentially higher returns that could be achieved by investing in riskier assets, such as stocks or corporate bonds. Assessing your risk tolerance and investment objectives is crucial when choosing how to allocate your resources.
  6. Callable Bonds: Some Treasury Bonds may have a callable feature, which means the issuer has the option to redeem the bonds before their maturity dates. Callable bonds introduce uncertainty regarding the duration of the investment to investors.
  7. Duration Risk: Duration is a measure of a bond’s sensitivity to changes in interest rates. Longer-term bonds may experience greater price volatility in response to changes in interest rates.

Role of Treasury Bonds in the Economy

Treasury Bonds play a significant role in the economy by serving as a fundamental instrument for government borrowing and financing.

They enable the government to raise capital to fund various public expenditures, such as infrastructure projects, social programs, and debt refinancing. The issuance of Treasury Bonds allows the government to access funds from a broad base of domestic and international investors.

Moreover, Treasury Bonds play a crucial role in shaping interest rates and influencing financial markets. The yields on Treasury Bonds serve as a benchmark for pricing various other debt instruments, such as mortgages, corporate bonds, and consumer loans.

Additionally, Treasury Bonds contribute to the overall stability of the financial system. As low-risk investments, they provide a safe haven for investors during times of economic uncertainty or market volatility. The demand for Treasury Bonds helps foster liquidity and stability in the bond market, which is vital for efficient capital allocation and risk management.

In summary, Treasury Bonds have a multifaceted role in the economy. They support government financing needs, influence interest rates, and stabilize financial markets.

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