Understanding Bonds: A Practical Guide to Investors, Businesses, & Governments

Uses of Bonds

Basically, bonds can be used for different purposes, including:

• Funding Capital Expenditure
• Capital Preservation
• Hedging Against Risk Exposure
• Earning Fixed Income
• Funding Business Operations
• Raising Capital for Investment Opportunities.

The owner of the bond is called bondholder, creditor, or investor, while the issuer of the bond is called borrower. The bond price is highly sensitive to changes in interest rates. For instance, when the market interest rate increases, the bond price falls, and vice versa.

How Bonds Are Used in Practice

Let’s explore the practical ways in which bonds are used in real life by an individual, corporate, and government:

How Individual Can Use Bonds

Example: Retirement Planning

Mr. Calafiori is a professional accountant retiring in 5 years’ time. He has decided to invest ₦5,000,000 in FGN savings bonds for the next 5 years at 14% interest per annum.

From The Scenario Above:

• Calafiori will earn annual interest of ₦700,000 (i.e. 14% x ₦5,000,000) for the next 5 years
• Over the 5 years period, would have earned a total profit of ₦3.5 million
• He has secure steady income while preserving his capital
• This helps him to cover some of his living expenses as he transitions into retirement
• At maturity, his initial investment of ₦5,000,000 will be repaid.

How Companies Use Bonds

Example: Project Expansion

Eskoba Plc is a telecom company based in Ado-Ekiti, Ekiti State. The company’s board of directors agreed in the last meeting to expand their broadband infrastructure nationwide to enhance connectivity. The company does not want to issue additional shares to finance the investment due to dilution of ownership. Instead, it issues 9% ₦10,000,000,000 corporate bond. The bond will be redeemable at par in 5 years’ time.

What Next:

• Investors lend the company the finance required by purchasing the bond
• Eskoba Plc will pay annual interest of ₦900 million (i.e. 9% x ₦10 billion) to the investors
• At maturity i.e. after 5 years, the company will repay the principal amount

From This Scenario:

• The company get the required funding without losing control of the business
• Investors earn predictable stream of income over the period of the investment.

How Governments Use Bonds

Example: Infrastructure Development

The Federal Government of Nigeria (FGN) has concluded plans to build new roads and upgrade existing transportation infrastructure across the six geopolitical zones. The finance required of ₦550 billion to execute the project is not readily available. To raise the funds, FGN has decided to issue a 10-year sovereign bond at interest rate of 15%.

What Next:

• High-net-worth-individuals, retail, and Institutional investors subscribe to the bond.
• FGN pays interest of ₦82.5 billion (i.e. ₦550 billion x 15%) every year to the investors (i.e. the bondholders) for the next 10 years.
• FGN will repay the bondholders (investors) the principal of ₦550 billion after 10 years.

From The Scenario Above:

• The FGN is able to fund the intended project without having to raise taxes
• Investors earn returns on their investment with relatively low risk.