Earning money from government bonds
RACHEAL NABISUBI
The word ‘market’ is most often used as a catchy term to mean different things but applies to both primary and secondary markets.
There are two types of markets used when investing in securities which involve knowing how stocks, bonds and other securities are traded.
Whereas the primary market refers to a market where securities are created, the secondary market is where they are traded among investors.
Mr Robert Nyehangane, head of treasury, Housing Finance bank, says the secondary market is as a result of primary market.
Primary market
A Primary market is where we get instruments sold by the government through the Bank of Uganda (BoU).
“In a primary market, investors buy debt instruments which are bonds from the issuer of that instrument which is the government bond. The secondary market is a market where you buy security from a third party,” Mr Nyehangane says.
For instance, a third party being that investor or bank that bought security from the issuer in the primary market.
He adds that in this case, Housing Finance is a third party that will have bought government security from BoU in the market. It is also a primary dealer that will be able to sell to the public and to the rest of the investors as a third party.
“Any individual one can buy security from any bank which is a bond bought from BoU ranging from individuals who have saved their money, investment clubs, small and medium enterprises (SMEs), large corporates and Non-Government Organisations (NGOs),” he adds.
He says that for as long as you have saved that money and want to invest in security that yields you high value, you are eligible for as long as you have a minimum of Shs100,000.
Ms Robinah Mukasa, Absa manager communications, says that for starters government bonds and perhaps bills - which are collectively referred to as Government securities, are instruments that are used by the government to borrow money from the public.
“The government borrows money through issuing bills and bonds in the primary market,” Ms Mukasa says.
The primary market is one in which the government borrows from the public; for instance, markets of first issue/auction of securities.
Ms Mukasa notes that this market is largely open to Primary Dealing banks. A Primary Dealing Bank is a financial institution that has been mandated by the Central Bank to participate in primary market buying of Securities such as Absa Bank.
Ms Mukasa explains that any exchanges of the already issued securities made outside the Primary market between customers are then considered to be in the secondary market.
The secondary market is thus a market where bonds/bills are exchanged between customers. Customers here include banks, individuals and other corporates.
Secondary markets are meant to provide liquidity (ability to buy and sell).
“Taking part in the secondary market requires a few things, starting with a bank account as well as a CSD (Central Securities Depository) account. The CSD account is your account with Bank of Uganda, but opened up through a mandated bank, like Absa, and it is on this account that your securities are kept,” she said.
It is followed by an expression of a client’s requirement in terms of what they want to buy/sell (amount, period, yield among others) and when in agreement with a Primary Dealing (PD) bank, a customer will fill a purchase (or sell) form that the PD will use an instruction to debit the customer account (or CSD account in case customer is selling) and credit their CSD (or bank account in case the customer is buying).
Earning from gov’t bonds
Dr Adam Mugume, the executive director of Research & Policy, Bank of Uganda (BoU), says people can make money from government bonds using two approaches.
“First, a person interested in investing in Government securities requests his/her bank to submit a bid indicating amount and tenure as per securities auction calendar,” Dr Mugume says.
He adds that the second approach is to buy the securities on what is referred to as the secondary market.
“This is where already issued securities are traded. This is a daily market. Your bankers will give you the alternatives and advise you on a fee they charge for these kinds of transactions,” Dr Mugume says.
He adds that people should invest in government bonds or secondary markets because if one buys a five-year bond, the yield is about 15.6 per cent per annum.
“Few investments in Uganda can give that return. Second, if one wants cash, the bond is sold in a secondary market or discounted at Bank of Uganda,” he explains.
Ms Mukasa says the bond earns interest that is paid semi-annually. This cash flow is called a coupon and is constant for the life of the bond.
In addition, a person can also earn Capital gains where their bonds can increase in value due to market movements.
Advantages
Ms Mukasa cites some of the advantages of taking part in government bonds. For instance, investment amounts can be as low as Shs100,000, bonds are passive income generating assets that also offer principle protection (capital is more or less guaranteed).
Bonds are risk free investments but there is possibility of losing money due to default.
She says coupons (semi-annual) cash flows are guaranteed to be paid at particular dates hence providing predictable cash flows.
In addition, bonds can be used as collateral to access loans. Of course, returns on government bonds are relatively higher than many other assets
Ms Mukasa says bond valuation requires qualified people to handle such as within the bank, attract Withholding Tax (10 per cent for 10 to 15 years and 20 per cent for those below) and the ease of accessing the cash can be a challenge for light hearted investors.
