Treasury bonds are not risk free

Often investors rush for government securities especially Treasury bonds, referring to them as the safest investment vehicles. And they are generally deemed to be risk free because they are backed by the full faith and credit of the government. These securities also offer higher returns than those on bank deposits, and on top of that, the liquidity they offer is attractive since it provides an exit window. This means that inventors can sale them anytime at market prices on the secondary market. They can also be deposited with the custodian on a securities deposit account, where they are safeguarded at a low cost and can act as collateral if the bond market is developed. However, the guarantee for returns due to less price fluctuations usually results into fewer returns when compared to other investments like shares. This means that there is an opportunity cost attached to these investments, which leads to low interest rates. Risk-averse investors therefore, tend to shy away from venturing into high-risk stocks or investments to their portfolio but in turn they forego higher rates of return. Investors looking for “safer” investments will generally invest government bonds, which generally have lower returns. Yet, investors feel confident that government will not default on its obligations to bond holders, the biggest risk faced in buying government bonds is inflation risk. As inflation goes up, the spending power of your money goes down. With government securities, there is always the risk that inflation will outpace your rate of return (profit), effectively diminishing the spending power of your savings. If we put things into perspective, government of Rwanda issued a three year bond in January at a coupon rate of eight percent annually when inflation was at around 14 percent. Since then, Rwanda’s inflation has soared to 21.9 percent. Since the coupon rate or interest rate on this bond is not adjusted for inflation, as inflation goes up, the bond’s value falls. For an investor who would want to resale this bond, perhaps due to speculation that inflation will continue to rise in future, he/she would sale it at a lesser price than its cost. And even if you hold onto your bond and don’t sale, targeting to get interest from government, the money you receive in interest will have diminished in value. The general interest rate risk in the economy is also a big factor to ponder about when making choice to invest in bonds. If interest rates rise your returns will be affected negatively. Contact: gahamanyi1@gmail.com