DAR ES SALAAM: LAST week, the Bank of Tanzania announced the reopening of Treasury bonds and bills for the fiscal year 2023/2024.
This decision involves reintroducing previous Treasury bonds with higher coupon rates.
Notably, two of the most sought-after maturities include the 20-year Treasury bond, which boasts an annual coupon rate of 15.49 per cent, and the 25-year Treasury bond, featuring an annual coupon rate of 15.95 per cent. Currently, the 20-year bond pays a coupon of 12.10 per cent, while the 25-year Treasury bond offers a coupon of 12.56 per cent.
The reintroduction of these previous bond offerings raises important questions for investors, especially regarding the implications for both existing and new bondholders.
Among the key considerations in fixed-income securities investment are duration and convexity, which play pivotal roles in determining how bond prices react to changes in interest rates. Duration measures the sensitivity of a bond’s price to changes in interest rates.
Bonds with longer durations are more susceptible to fluctuations in interest rates, while those with shorter durations are less affected. With the reintroduction of Treasury bonds with higher coupon rates, investors must assess the potential changes in duration and how it may affect their investment portfolios.
Convexity, on the other hand, complements duration by providing insight into a bond’s price sensitivity beyond what duration alone captures. Bonds with positive convexity exhibit a price-yield relationship that is curved upward, offering investors some protection against interest rate risk.
For existing bondholders (those holding bonds offering a coupon of 12.10 per cent and 12.56 per cent), the scenario presents potential negative impacts as the higher yields of the reopened bonds render their current holdings less appealing.
This shift could result in a decline in the prices of their bonds. Moreover, the higher duration of the older bonds, stemming from lower coupons, might further exacerbate this downward pressure on prices.
However, convexity could serve to mitigate this price decline. Depending on the specific convexity of the bonds, the actual decline in price might be somewhat less severe than initially predicted by duration alone.
Positive convexity would help cushion the price, while negative convexity could amplify the decline.
On the other hand, new bondholders who opt for the reopened bonds stand to benefit from the higher coupons, thereby receiving more income compared to the older bonds.
Nonetheless, they should exercise caution regarding the higher duration associated with these bonds. This means that their prices would be more sensitive to changes in interest rates, potentially leading to more significant fluctuations. Nevertheless, positive convexity could provide some protection against substantial price swings.
From a theoretical standpoint, assuming no other changes, certain expectations can be derived: Existing bond prices are anticipated to decrease due to competition from the higher-yielding reopened bonds.
Reopened bond prices are likely to exhibit greater volatility owing to their higher duration, albeit potentially cushioned by positive convexity.
Lastly, increased investor demand for the reopened bonds is expected due to their attractive coupons. It’s crucial to acknowledge the inherent complexity of the bond market, where various factors such as inflation expectations and overall economic sentiment wield significant influence over prices. In such a dynamic environment, maintaining a diversified portfolio and seeking professional advice are imperative for making wellinformed investment decisions.
Duration and convexity stand as essential tools for comprehending how bond prices respond to shifts in interest rates.
While the higher coupons offered by the reopened bonds present an enticing opportunity for new investors, they pose a challenge for existing bondholders, potentially leading to a negative impact on their holdings.
However, the role of convexity cannot be overlooked, as it has the potential to either mitigate or amplify these price swings based on its sign.
Therefore, it’s crucial to exercise due diligence and carefully assess the individual characteristics of each bond, alongside broader market dynamics, before making any investment decisions.
By doing so, investors can better navigate the complexities of the bond market and position themselves for long-term success.
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