FGN Bond Auctions I Scheduled 15 Oct, 2014 Summary of Bond Auction

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1 FGN Bond Auctions I Scheduled 15 Oct, 2014 Summary of Bond Auction 13.05% FGN AUG 2016 Auction Date 15/10/14 Settlement Date 17/10/14 Advised Yield % Maturity Date 16/08/16 Coupon 13.05% Next Coupon Date 16/02/15 Clean Price NGN % FGN MAR 2024 Auction Date 15/10/14 Settlement Date 17/10/14 Advised Yield % Maturity Date 14/03/24 Coupon 14.20% Next Coupon Date 13/03/15 Clean Price NGN % FGN JULY 2034 Auction Date 15/10/14 Settlement Date 17/10/14 Advised Yield % Maturity Date 18/07/34 Coupon 12.15% Next Coupon Date 18/01/15 Clean Price NGN P a g e Issue on Offer/Summary The Federal Government of Nigeria (FGN) through the Debt Management Office (DMO) will be conducting a bond auction on Wednesday 15 th October, 2014 at the primary bond market. Three major instruments (FGN 3-year, 10-year and 20-year bonds) are to be auctioned as scheduled for a total amount of NGN73.612bn and are all re-openings % FGN AUG 2016 (3-Yr Re-opening) NGN18, 612,000, % FGN MAR 2024 (10-Yr Re-opening) NGN30, 000,000, % FGN JULY 2034 (20-Yr Re-opening) NGN25, 000,000,000 Given our analysis of the current yield environment vis-à-vis our bond valuation models, we present below our advised bid rates: Instrument Advised Yield 13.05% FGN AUG % % 14.20%FGN MAR % % 12.15% FGN JULY % % Current Yield Analysis Much in line with our expectations for the end of the year, rates have advanced by an average of 0.64% across tenors in the period since the last auction, held on the 17 th of September, The yields on all the three instruments for re-opening have increased in the period since the last auction, with increases of 0.97%, 0.36%, 0.04% recorded on the 3YR, 10YR and 20YR instruments respectively. The expectations that risk premiums might widen towards year-end due to consternation regarding the upcoming election is apparently coming to pass, we extol the benefits of holding these high yielding instruments in portfolios, especially since there will be no new bond auction in this year that will provide higher yielding instruments. We believe the Nigerian sovereign yield curve (which shows the current yield for fixed income instruments of different maturities) reflects an appropriate measure for pricing the different bonds. Our methodology adopts the iteration process in determining the suitable discounting factor for the different streams of cash flows for the instruments considered. This forms the basis for our valuation of the 3-year, 10-year and 20-year instruments discounting the stream of coupons (cash inflows) by the iterated yields and summing the present value of the future cash flows to arrive at our intrinsic price.

2 Chart 1: Historical Yield on Current 3-Year and 10-Year FGN Instrument % % % Aug 20-Aug 27-Aug 3-Sep 10-Sep 17-Sep 24-Sep 1-Oct 8-Oct Source: FMDQOTC, Meristem Research Bond Absolute and Relative Valuation We valued the three bonds (13.05% FGN AUG 2016, 14.20% FGN MAR 2024 and 12.15% FGN JUL 2034) to be auctioned using the current yield curve as the basis for discounting. We arrived at a fair value of NGN103.45, NGN and NGN98.95 implying yields of 11.98%, 12.26% and 12.29% respectively. Instrument Fair Value Implied Yield IRR 13.05% FGN AUG % 5.85% 14.20% FGN MAR % 6.19% 12.15% FGN JUL % 6.16% However, given the current yield environment, market liquidity as well as a review of the recent past auctions, we introduced market sentiment factor into our valuation on which we advise bid yield ranges for both issues on offer. On the basis of relative valuation of the bonds, we believe that the 10-year instrument has the highest return on investment from the perspective of the Internal Rate of Return 2 P a g e

3 (IRR). While the 3-year and 20-year instruments have IRR of 5.85% and 6.16% respectively, the 10-year instrument has an IRR of 6.19%. We however, advise that investors place the highest weight on the 10-year instrument if the three instruments are being considered in same basket due to our valuation of the fair yield, and the spread with current market rates. About Bonds A bond is a fixed income debt instrument issued by the government (federal or state government) or corporate institutions with a definite date of maturity and a fixed interest payment (known as coupon) payable either semi-annually or annually. Unlike equities, bonds are issued with a guarantee of the initial investment and can have tenors as long as 20 years. A treasury note refers to a government bond instrument with a term to maturity of 1 to 10 years while a treasury bond has a maturity of 10 years and above. Bonds issued by state governments of a country are referred to as municipal bonds while those issued by organizations are corporate bonds. The government usually issue bonds at the primary market to raise domestic funds to meet its fiscal responsibilities. This can be done from time to time as the need arises. Nigerian FGN bond instruments are named by their maturity, coupon, tenor etc such as 13.05% FGN AUG 2016 instrument. How is Return Determined? Bonds are mostly issued with a coupon otherwise known as, the periodic interest payable. Bond instruments are usually issued at par; that is, N100 or N1000 as is the case with Nigerian bonds. A 2-year bond issued at 12% annual coupon with a par value of N1000 implies that the issuer will make 3 semi-annual payments of N60, and a final N1060 on the maturity date. Bonds can be purchased at both the primary and secondary markets, they are either quoted in price or yields. There is an inverse relationship between the price of a bond and its yield to maturity (YTM). At issuance, the yield on a bond instrument is most likely the coupon on that instrument. At the secondary market therefore, an investor can trade bonds by quoting a yield that reflects the variance between the par value and the current price based on the current market dynamics. 3 P a g e

4 How does the Auction Process work? Bond instruments are issued through a competitive bidding process at auctions as conducted by the Debt Management Office which serves as the representative of the government. An existing government instrument can be re-issued also at the primary market in which case the DMO re-issues based on the current market yield to maturity. Bonds are auctioned at established rates which determine the return to investors. Purchasing these instruments in the primary market and holding it till maturity would mean that the investor gets a fixed interest payment, however, there is a secondary market in which investors can trade these bonds to meet their immediate liquidity needs. 4 P a g e

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