A bond is an IOU. When you buy a bond, you are loaning money to a borrower (in finance terminology, the borrower is called an ‘issuer’) for a defined period of time.
At the end of the period, this loan is repaid.
In exchange for providing this loan, you receive a predetermined interest rate (the ‘coupon’) which is paid either quarterly, semi-annually, or annually.
Infrastructure Government Bond example:
In this example, the Government of Kenya is the “issuer” and you will be loaning it money for a period of 21 years.
What is interesting is that, in case you need your money back, you don’t have to wait for 21 years to be repaid. You can sell the bond through Ndovu.
The Government of Kenya is offering an interest rate of c.12.5%, which will be paid semi-annually, every year.
Here’s how it works:
You loan the Government of Kenya Ksh 100,000 today for a period of 5 years. This is what you earn every year until you decide to sell the bond:
| Loan Amount (Ksh) | 100,000 | ||||
| Annual Interest Rate | 12.50% | ||||
| Time | Year 1 | Year 2 | Year 3 | Year 4 | Year 5* |
| Total Earnings | 12,500 | 12,500 | 12,500 | 12,500 | 112,500 |
*We have assumed that market rates remain at 12.5% in year 5 for ease of calculation. Investors need to be aware that market interest rates are dynamic.
Now that you understand what a bond is, let’s get investing!