A bond is an instrument through which a government or corporate body can borrow money from the public with a promise to reimburse the investor. The money is borrowed for a fixed period of time and compensation made at a fixed interest rate.

How Do They Work?

An offer is first made by the government or a company to the public. In the case of Kenya, the government is the biggest issuer of bonds (commonly referred to as Treasury bonds) and the period from 1 – 30 years. Resident or non-resident individuals and/or corporate bodies who hold an account in local commercial bank can invest in them. Those without an account can open a CDS account directly at the Central Bank of Kenya. The investor (you) will need to have at minimum KES 50,000 to invest in the bond, except if it’s an infrastructure bond which needs a minimum of KES 100,000. Any amounts above those minimums are made in multiples of KES 50,000.

Once the offer is made, you make a bid for the bond. You do this by stating the amount you will use to buy and the interest you will charge. Bond holders are paid a fixed interest rate for the period of the bond. That said, making a bid of 10% for a 5-year bond worth KES 1 million means that you will be paid KES 100,000 every year until the period lapses. By the 5^th year, the total you will have made from the bond is KES 500,000. The principal amount is also given back to you making your total for the whole period KES 1.5 million. Quite the tidy sum.

Bonds are issued on a monthly basis and attract huge demand because of the guaranteed payment. The interest earned surpasses what banks offer on your savings. For this reason, the bidding is highly competitive. Investors want to earn high interest and the government is willing to pay. However, they usually pick the lowest bid. The lower the rate, the less they have to pay back. Inflation is therefore the government’s natural enemy when it comes to bonds. It often forces investors to bid at high interest rates and the government has no choice but to pick to least of the “evils”.

A quick look at the local newspapers will show you the different rates that were taken up during the inflation period. On 28 November 2011 (inflation peak), the government offered a 2-year bond that attracted an interest rate of approximately 22%. Data from Kenya National Bureau of Statistics shows that inflation decreased from the following month until last month. Looking back at the bonds offered in August 2012, a 2-year bond attracted an interest rate of approximately 11%. Just about half of the previous year’s investment.

If the economic trend of the last general elections is to go by, inflation is likely to accelerate between the months March and April. For some, it would provide an opportune moment to invest in bonds and earn an attractive annual interest. Save for the speculation, bonds are a good investment to have in your portfolio. The returns are sure and cannot be compared to any other investment. Don’t you think?