Investing in the Treasury Bond Secondary Market: A Guide For Beginners

Treasury Bonds (T-Bonds) are debt securities issued by the national government and bought by individual or corporate investors. The first issuance of bonds by the national government is the Treasury Bond primary market.

The secondary market for T-Bonds is the bond market, where investors may buy an existing Bond previously issued but purchased through brokers or other third parties. In such a case, the broker or third party acts as an intermediary between the buying and selling bond parties.

The secondary market bond brokers usually buy the T-Bonds floated by the government and re-sell them to investors who might have missed the opportunity in the primary market.

Example of a Taxed Treasury Bond: Fixed Coupon Bonds Issuances (FXDs)

Most T-Bonds have fixed coupon or interest rates. This means that the rate of return will be constant throughout the Bond’s life, and the investor can tell how much they will receive in total by the time the Bond matures.

If you decide to invest in a T-Bond whose duration is ten years with a face value of Kshs 200,000 and a coupon rate of 10%, you will earn Kshs 10,000 every six months. The interest or coupon received by the investor will be charged a 15% Withholding tax.

This means you will receive Kshs 8,500 every six months throughout the Bond’s life to maturity. And upon maturity, you will receive the principal amount invested of Kshs 200,000.

In other words, the Bond’s life will have two semi-annual coupon payments of Kshs 8,500 each. So, the total 10-year coupons will be 2 * 8,500 * 10= Kshs 170,000.00

Total return on the Investment will therefore be Kshs 170,000 + Kshs 200,000 = Kshs 370,000.00

Suppose a T-Bond broker floats or sells a T-Bond in the secondary market with Bond details as below:

Bond Issue: FXD1/2012/20
Maturity Date: 1st November 2032
Coupon Rate: 12%,
Ask Price: 107.123
Yield to Maturity: 11.76%.

This means that the T-Bond is the first issue of its kind, and it has a fixed coupon rate (FXD1), was issued in 2012, and has a 20-year bond life or duration.

Furthermore, the T-Bond will mature on 1st November 2032, with a coupon rate of 12% per year, paid every six months to the investor.

The ask price, in this case, is the unit price per Bond share that the broker is willing to sell to any potential buyer. The investor will then purchase the Bond based on the available investment amount and compute with the ask price to get the total payable amount.

The yield to maturity percentage is the annualized percentage return the investor will receive if they bought the Bond at the Ask price and held it until maturity.

Note that the yield to maturity is an optional part for the investor. Suppose the investor is paid the semi-annual coupons and decides to re-invest each coupon paid back into the Bond. In that case, the investor will receive the principal amount plus total accrued coupons re-invested to maturity and returns quantified on the Yield to Maturity rate upon maturity.

If the investor opts not to re-invest, the yields to maturity do not apply. Each time an investor re-invests the coupon received, the following principal amount becomes the principal amount plus the re-invested coupon, repeated throughout the Bond until maturity.

Example of a Tax-Exempt Treasury Bond: Infrastructure Bonds Issuances (IFBs)

The national government issues Infrastructure Bonds for purposes of funding infrastructure projects. In Kenya, they attract a lot of interest in both the primary and secondary market from investors because they are not taxed.

If you decide to invest in an Infrastructure Bond whose duration is ten years with a face value of Kshs 200,000 and a coupon rate of 10%, you will earn Kshs 10,000 every six months. Upon maturity, you will receive the principal amount invested of Kshs 200,000.

In other words, the Bond life will have two semi-annual coupon payments of Kshs 10,000 each. So, the total 10-year coupons will be 2 * 10,000 * 10= Kshs 200,000.00
Total return on the Investment will therefore be Kshs 200,000 + Kshs 200,000 = Kshs 400,000.00

If a broker floats or sells a T-Bond in the secondary market with Bond details as below:

Bond Issue: IFB1/2015/09
Maturity Date: 2nd December 2024
Coupon Rate: 11%,
Ask Price: 110.914,
Yield to Maturity: 7.60%

This means that the T-Bond is an infrastructure T-Bond, the first of its kind, and it has a fixed coupon rate (IFB1), was issued in 2015, and has a 9-year bond life or duration. The T-Bond will mature on 2nd December 2024, at a coupon rate of 11% per year.

The concepts of Yield to Maturity and Ask price apply here as they did to the FXDs explained in the first part. The underlying difference is that, unlike the FXDs T-Bonds, the IFBs T-Bond’s principal amount reduces each time a coupon is paid to the investor. This means the principal amount upon which the second and subsequent coupons are paid will be less than the initial invested amount.

Upon maturity, the principal amount is not reimbursed to the investor, unlike the FXDs, which pay the investor back the principal amount invested upon maturity. On many occasions, the IFBs offer higher coupon and yield rates and are always tax-exempt.

Takeaways from the Treasury Bond Secondary Market

The individual or corporate investor may buy Bonds directly, aiming to hold them until they mature to profit from the coupons they earn.

However, they may also decide to buy into a Bond exchange-traded fund (ETF) or a Bond mutual fund through brokers, as earlier stated.

Professional Bond brokers and traders dominate the T-Bonds secondary market, where existing issuances are bought and sold to investors at a discount to their face value. The discount amount depends partly on how many payments are still active or due before the T-Bond reaches maturity.

But the Bond price also is dependent on the direction of interest rates. Suppose an investor thinks interest rates on new bond issues will be lower. In that case, the existing bonds may be worth a little more since it’s not affected by intermediary interest or market risk such as inflation.

It is important to note that the secondary market carries similar risks just like the primary market for T-Bonds. This is because they are both issued by the national government. For this reason, a T-Bond is prone to lose significant value if the government goes bankrupt or defaults. This means it can no longer repay in full the initial investment nor the interest owed during the bond duration or upon its maturity.