Sunday, June 09, 2019

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Interpreting Results of A Bond Issue By The Central Bank of Kenya

Sunday, June 09, 2019


I write a follow up article for interpreting the details of a bond issue. Central Bank of Kenya publishes the results usually a day after the bond auction. No long waits like other GoK services 😁. Investors look forward to first, whether CBK accepted their bid and second, what interest rate the bond will earn during its lifetime. Those two details are the essentials of a bond results.
Table A contains majority of the information. 

  • Due date it is the date when the bond or treasury bill(bonds and treasury are different but has same features of fixed investments) matures. Lets take the 364 days treasury bill, the auction was on 05/08/2018; one year later on 05/08/2019,  the investor shall receive back the full amount they put in the investment. The shortest maturity date is usually 91 days. 

  • Amounts offered- just as described here. it is the amount central banks aims to raise from investors

  • Bids received - total amount of money investors are selling to CBK

  • Performance rate




  • Bid-to-Cover ratio



When the ratio is more than 1, it imply  CBK received more bids than they need. So CBK had to turn down some bids because they already hit their target. 

When the ratio is equal to 1, it imply CBK received enough bids and accepted all and hit the target.

When the ration is less than 1, it imply they received less bids than they would have wanted. 
  • Interest Rate
          Two types of interest rates are released after the auction. The weighted average interest rate of accepted bids is calculated as follows:
     Example
      Lets say they were 2 bids, n=2
      Bid 1: 2,000,000 at 7.5%
      Bid 2: 4,000,000 at 8%
    Assume both bids were accepted
    What is the weighted average interest rate of accepted bids?
       2,000,000 * 7.5%    = 150,000
                                                  +
        4,000,000* 8%        = 320,000
 
                                         =470,000

                                         =470,000 divide (2,000,000+4,000,000)= 0.0783 . Approx. 7.83%


 The Market Weighted Average Interest Rate uses the same formula EXCEPT that the interest rates used prevailing rates for all the bonds issues in the market with their respective outstanding amounts.

Which interest rate is the bond investor going to earn? Neither of the two interest rates mentioned above. The bond investor will earn an interest rate determined by the Central Bank Auction Committee using the bids submitted.Usually, the lowest interest interest rate submitted among the bids received is the cut off for that auction. Just like any other market, the seller(in this case CBK), has an incentive to minimize costs(the interest it pays to investors); hence the decision to choose the lowest interest rate proposed.

So the competitive bids(submit bids in auction) are interest rate makers because they proposed rates are used to arrive at the final rate for that auction. While non competitive bids(they do not submit bids in the auction, but state the amount they want to buy at whatever interest rate that will be determined) are interest rate takers because they will get the interest rate decided by others.

  • Price
Source: Nairobi Stock Exchange Website
    
       - All government bonds and t-bills are quoted as shs. 100 as starting price. Although the quote price is 100, please note the minimum you can buy is  a bond worth shs. 50,000 except for M-AKIBA bonds.  The price vs Notional value of what you buy are two different figures.
      - The intuition or takeaway is that when the interest rate increase, the bond price reduce.  So for any bond price above 100, it means that current market rate are lower than the fixed rate that is attached to the bond you bought. The bond you own has more value because you are getting paid more than you would be getting at the current market rate. Bonds with a price below 100, means the current market rate is higher compared to what you are getting paid for the bond you own. So it has less value in the latter case.
    - clean and dirty price are found in the secondary market(Nairobi Stock Exchange) and not the primary market(Central Bank Kenya Auction Market) so I defer the explanation for another article. 

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