Morning guys,

i was reading the other day about the above topic and couldn't help ponder if infact the effective duration (sensitivity of a bonds price to changes in yeild)convexity and the term structure of interest rates are actually considered when pricing/valuing bonds in kenya? if so, do the annualized yields correlate to the one in europe considering the theories of the term structure?

so ur askin if kes govt bond yields correlate to those of european bond yields? correlation implies a departure of 2 or more variables from independence...so are u askin whether the kes yield curve and the european bond yield curve are correlated ama? if thats ur question u wud have to do a correlation analysis..lucky for u i have a tool which i use for this..

@Scooby indeed true bearing in mind the term structure theories of liquidity,preference,expectations and market segmentation, but the gist of my question is that we know that factors such as the type of issuer,taxability of interest,inclusion of options financability of the issue etc etc, all affect the term structure.... is it in order to say that lower duration means higher yield and vice versa and if so higher volatility implies lower yield to maturity?

@kizee ebu send me that link. i am asking if the annualized yields factoring in all elements that affect convexity (callability,yield curve etc affects or accounts for the inaccuracies of the linear duration line?

Hi Emyln,

A lower duration means that an investor has lesser concerns about interest rate risk (or in your words, lower interest rate volatility) and would therefore not mind getting a lower interest rate for their investment. The opposite is true for long duration.

The issue of yields is not influenced by the government or CBK. Thats a function of the secondary market. The high demand this year for treasury bonds has resulted in the market prices of bonds hitting the roof - thereby resulting in the significantly lower current yields (for you its yield to maturity).

As I mentioned, the government is taking advantage of that to price the current infrastructure bond at 6%. And in order to ensure that its fully taken up, they offered such incentives as tax free interest (as opposed to taxable interest).

As for type of issuer, government bonds are deemed to be risk free hence can offer a lower interest rate. If Housing Finance had also decided to issue a similar infrastructure bond, it would have been forced to charge a higher interest rate as they are deemed to be more risky that the government.

The market in Kenya is yet to fully adopt the impact of optionalities when pricing the bonds. The KenGen and ARM bonds should have charged a higher interest rate than what they were offered at. The use of options does affect the duration of a bond/portfolio.

Ya'll need to keep this post going.

@scooby. What’s your take on the rise of some of the yield curves? 91D, 182D and 15 yr yld have risen marginally. Given the liquidity there's no profit incentive in lowering the 91D to interbank right?

scooby, the difference is

1. Zero-Coupon Bond(kengen bond) – Duration is equal to its time to maturity.

2.Vanilla Bond(cfc stanbic bank) - Duration will always be less than its time to maturity

so duration need not be the time in years for a bond to mature, it refers to the changes in bond price to changes in yield.

in breif:
Factors 1 and 2: Coupon rate and Term to Maturity
If term to maturity and a bond's initial price remain constant, the higher the coupon, the lower the volatility, and the lower the coupon, the higher the volatility. If the coupon rate and the bond's initial price are constant, the bond with a longer term to maturity will display higher price volatility and a bond with a shorter term to maturity will display lower price volatility.

Therefore, if you would like to invest in a bond with minimal interest rate risk, a bond with high coupon payments and a short term to maturity would be the best. An investor who predicts that interest rates will decline would best potentially take advantage of a bond with low coupon payments and a long term to maturity, since these factors would magnify a bond's price increase,

Factor 3: Yield to Maturity (YTM)
The sensitivity of a bond's price to changes in interest rates also depends on its yield to maturity. A bond with a high yield to maturity will display lower price volatility than a bond with a lower yield to maturity, but a similar coupon rate and term to maturity. Yield to maturity is affected by the bond's credit rating this ofcourse applies in the european and western economies. Therefore, bonds with poor credit ratings typically display lower price volatility than bonds with excellent credit ratings.

@emlyn. Is KenGen a zero coupon?

the cfc senior and subordinated bond implies that the bond interest payments are arranged into tranches or classes-the senior tranch implies that investors are willing to receive interest stable interest with relatively low risk. the subordinated tancch means that investors are willing to invest bearing the high risk levels of the issue.

note that it can be interest only or principle only

@emlyn. I find this statement interesting. Using the logical above, how would the yield curve look if a bond with a higher coupon rate (high yield) has a lower duration? I'm also doing some research on this, do you have an online source you could share with me that could explain the above statement? Thanks.

@scooby. The profile of most bond portfolios for banks haven't changed expect perhaps for CFC, NIC and DTBK who have more bonds under held-for-sale & available-for-sale. In the cfc annual report a bulk of the government securities were tradable and it reflects in the non interest income.

@emlyn. Great stuff man. Although I'll admit I haven't a clue what have of that article said. But now that you have done the research, can you make a play on this market? Say I gave you a bond fund to run, what would you suggest? government or corporate bond? etc.