Making money with less risk: Consider Government of Jamaica bonds
published:
Sunday | August 10, 2008
Doyl Smith, Guest Writer
Bonds are a good option for investors looking for a long-term, low-risk investment. They can be issued by companies or governments.
The coupon or interest payment from Government of Jamaica (GOJ) instruments are as regular as clockwork and are typically higher than available in the standard fixed-rate 'repo' market.
If a bond is held to maturity, then the bond holder is guaranteed to get his/her principal back.
However, a bond does not have to be held to maturity and can be bought and sold as the price fluctuates on the open market.
A beautiful thing happens when an investor buys an undervalued bond, the price appreciates, and then sells the bond. The investor locks in a capital gain, in addition to receiving his/her coupon for the entire period until the sale.
The bond investor is also guaranteed repayment of the instrument's par value at maturity.
Buying a bond is equivalent to giving the issuer a loan for a specified period, during which the issuer pays returns to the investor at regular intervals.
The par value is the amount that the issuer has guaranteed to repay the bond holder when the loan matures. The par value of most GOJ bonds is $100.
DEFINING A BOND
If you have ever taken a loan for a car, a house, or for any other purpose, you have entered the debt market. Similar to how individuals take out a loan, so do governments.
Governments borrow for reasons ranging from building roads to establishing hospitals. Their challenge is that they need to borrow far more than the average bank can supply.
The solution is to raise money by issuing bonds (or other debt instruments) to a public market. This allows hundreds of investors the opportunity to individually lend a portion of the capital needed in return for a competitive interest rate.
In short, a government bond is a loan for which you are the lender and the government is the borrower.
YIELD TO MATURITY
One of the more complex bond terms is yield to maturity (YTM). It is a calculation done (provided by all bond brokers) that shows the total return a bond holder will receive, if the bond is held to maturity, based on the current price in the market.
Such calculations are done by bond brokers. The YTM calculation is an excellent way to compare several bonds with different coupon rates and maturities and determine which bond offers the best bang for your buck, or will give the best returns.
ACTIVE MARKET
There is a very active secondary market for bonds, similar to the stock market, where the price fluctuates depending on how the market values the bond and the level of supply.
The GOJ 2019 United States dollar (USD)-denominated bond issued in June, for example, is trading at an undervalued price (see graph). The relative value line - labeled 'R' on the graph - is where the curve should be. However, as at July 9, the price of the 2019 bond is skewing the yield curve, designated 'A' on the graph.
The GOJ 2019 is expected to be heavily in demand, pushing the price up in the process, and thereby lowering the yield until it is closer in line with the relative value line.
On Thursday, it was trading below par at a price of $97.75 with a YTM of 8.34 per cent. This is a rare opportunity for investors. The primary issue of foreign-currency denominated bonds, as per normal, is only open to overseas investors, but the 2019's current performance creates the opportunity for aggressive overseas bond traders to buy the bonds and 'flip' or sell them back to the local market for a fast profit.
With heavy layoffs on Wall Street - reports are that up to 20 per cent of employees with investment banks may get laid off - traders are very risk averse. Many of these 'bond flippers', not seeing expected demand, are now hurriedly trying to sell at a discount, that is, below par.
Jamaican investors on the other hand tend to be comfortable holding GOJ debt. The 2019 offers a good investment option for the cash that is now flowing in from the US$300 million-plus payout from the finalised Lascelles/CL Spirits deal.
Doyl Smith is a corporate relationship manager with the brokerage firm JMMB.
