• Thursday, March 28, 2024
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5 subnational bonds offer risk premiums greater than 2.5 percent

5 subnational bonds offer risk premiums greater than 2.5 percent

Debt instruments are in a hierarchy of risk with the Federal government bond at the top of the ladder and sub-national bonds and corporate bonds following. As at Friday, 5 sub-national bond returned 2.5 percent in excess of the risk-free rate as a form of compensation for investors who tolerate the extra risk.

Investors are in the business of searching for investment vehicles that compensate for risk taking. More risk incurred should often promise more reward, else, there is no reasonable argument for an investor to allocate funds to that vehicle.

BusinessDay analysis of FMDQ daily quotation list at the end of trading on February 15, 2019 shows a total number of 5 sub-national bonds with risk premiums greater than 2.5 percent. Thus, at a higher risk of default, these bonds offer the highest return potential compared to instruments of the same maturity.

Bayelsa, Ekiti, Oyo, Plateau, Cross River state government bonds offer valuation yields above 2.5 percent of the corresponding FGN bond rate of the same maturity. The highest of which is the Oyo state 7-year bond which has a valuation yield of 19.91 percent and a risk premium of 4.01 percent.

Plateau and Cross River 7-year currently yields 18.87 and 18.67 percent respectively with risk premiums of 3.04 and 2.98 percent. Bayelsa 10-year and Ekiti 7-year complete the list with valuation yields of 15.72 percent add 19.00 percent with risk premiums of 2.75 and 2.53 percent.

The 5 state bonds have a total outstanding value of N39.49 billion and an average coupon rate of 16.4 percent.

The FGN Bonds are considered as the safest of all investments in domestic debt market because it is backed by the ‘full faith and credit’ of the Federal Government of Nigeria. Thus, a higher yield on bond instruments above the FGN bonds typically means higher risk of default on interest payment.

Nigeria is in an interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the same credit quality. An inverse yield curve predicts lower interest rates in the future as longer-term bonds are demanded, sending the yields down.

The risk-return spectrum is the relationship between the amount of return gained on an investment and the amount of risk undertaken in that investment. The more return sought, the more risk that must be undertaken. Investors will look to find vehicles that compensate the most for the risk taken.

 

Risk Premium

ISSUER ISSUE DATE Valuation Yield % Price
BAYELSA STATE GOVERNMENT 30-Jun-10 15.72 10
EKITI STATE GOVERNMENT 31-Dec-13 19 95.52
OYO STATE GOVERNMENT 17-Feb-15 19.94 95.55
PLATEAU STATE GOVERNMENT 30-Mar-15 18.78 98.14
CROSS RIVER STATE GOVERNMENT 27-May-15 18.67 97.39