I am sure you would have come across the word bonds quite a number of times. I am even sure you must have seen one of those copious headlines of government issuing several billions of naira in bonds. If you are a financial analyst, an economist, or some kind of expert, you wouldn’t have any qualms understanding the import of those transactions but if you’re otherwise my guess is that you’re also searching for a limpid understanding of what bonds are and how they work. Shortly, I will be giving you just that. Note that, we are talking about bonds here as debt instruments only.
So just what are bonds? What are the types and characteristics of bonds? What are the legalities involved in creating bonds?
What are Bonds?
A bond is a debt instrument issued by an authority or body to a holder (person) at a fixed rate over a particular period. Black’s Law Dictionary puts it this way “it is an obligation to pay a fixed sum of money, at a definite time, with a stated interest…”The online resource site Wikipedia defined it as an instrument of indebtedness of the bond issuer to the holders. It is a debt security under which the issuer owes the holders a debt and depending on the terms of the bond, it is obliged to pay them interest and to repay the principal at a later date. In his address to Nigerians in diaspora on Federal Government Bonds, the Director-General of the Debt Management Office defined bonds as financial instruments used by government and corporations to borrow. They are usually used to finance medium to long terms projects which most times require massive capital outlay.
In simple terms a bond is instrument saying you lent me some money, I will pay you over a period of time at the rate. Certain key terms must be noted as well. They include the bond issuer, the bondholders, interest (coupon), and maturity period. The bond issuer (or sometimes called the obligor) is the authority that issues the bonds. This could either be the government or a corporate entity-the borrower. The bond holder is the investor that buys the bond-the lender. The interest, otherwise known as the coupon, is what is charged in addition to the principal. The maturity period (sometimes tenor) is the time within which to repay the bond. Bonds in Nigeria usually have a maturity period of between 3 to 25 years.
How are bonds different from shares? Shares give a right of equity stake (participation) while bonds do not. Rather they are loans. Bonds usually have a definite term or maturity period after which the bond is redeemed whereas shares may be outstanding indefinitely except of course redeemable shares.
Types of Bonds
Generally bonds could either be government bonds or corporate bonds. Government bonds can be issued by the Federal, state or local governments or their ministries, departments and agencies. Where the Federal Government issue bonds, they are known as sovereign bonds. While state and local governments and their parastatals issue what is called revenue bonds. Corporate bonds are those issued by public companies. They are sometimes referred to as revenue bonds as well.
Bonds are usually issued in the primary market through monthly auctionscarried out by the issuers or in the secondary market through what is called the Primary Dealer Market Maker (“PDMM”) systemor on the floor of the Nigeria Stock Market. The PDMM is mostly used where the bonds are federal government’s. Corporate bonds are many times issued by underwriting. Underwriting is a situation where one or more securities firms or banks buy the entire issues of bonds from the issuer and resell.
To issue a bond, the issuing authority must apply to the Security and Exchange Commission (SEC) for authorisation. This application is not in a letter but in a form (usually called SEC Form 6). To accompany the application is a legal instrument authorizing the issuance of the bond by the issuer. Such legal instrument will depend on the nature of the issuer. If it’s the federal government issuing, for example, the legal instrument will have to be an appropriation act, a supplementary appropriation act, or a resolution of the National Assembly authorising the bond and guarantee by the Minister of Finance (in line with the Debt Management Office Act). If it’s a company, then it will be a resolution of the company at a duly convened meeting authorising the bond. And so on, as the case may be.
Added to the legal instruments are two other vital documents, to wit, a report from a recognised rating agency and an irrevocable letter of authority (also called Irrevocable Standing Payment Order (“ISPO”)). The letter of authority or ISPO is a letter to the Accountant-General of the federation or of a state, to deduct at source from the issuer’s allocation accruing to the issuer. All governments and government MDAs are required to produce the ISPO before registration of their bonds. Except they are granted an exemption after fulfilling some requirements. This is not required of companies.
Indeed bonds are very interesting investment avenues especially government bonds which are quite secure, with certain maturity dates and a secure guarantee of payment unlike other forms of securities. Although their often long tenors, of sometimes up to twenty-five years, may dissuade potentials investors and the like.
See you next week!
Yibs David Amakiri
 Citing S. E. Quindry Bonds, Bondholders Rights and Remedies, pg. 3-4.
 Based on competitive or multiple price auctions.
 This is a system whereby some institutions are given exclusive right to purchase and underwrite all government securities issued for their own holding and/or resale.