Peet Serfontein & Chantal Marx
At its core, a bond is a loan agreement. When you purchase a bond, you are lending money to the issuer - this could be the South African government, a state-owned enterprise or a private company. In return, the issuer agrees to pay periodic interest (called the coupon) and to repay the principal (face value) on a specified maturity date.
There are two broadline type of bonds:
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Government bonds: In South Africa, government bonds are issued by the National Treasury to fund state expenditure. Government bonds are generally regarded as low risk, as they are backed by the state's ability to tax and print currency.
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Corporate bonds: Issued by companies, these typically carry higher risk than government bonds, since repayment depends on the company's financial health. They usually offer higher coupons to compensate investors for the additional risk.
Yield
The "yield" of a bond is the expected yearly coupon payments expressed as a function of the price. It is usually the benchmark for the "value" attached to the bond.
For example, a government bond that is issued for R100 that pays semi annual coupons of R5 will carry a yield of (R5 +R5)/100 = 10%. If the yield rises it means the price has fallen in the secondary market and vice versa.
Maturity
The maturity of a bond - the date on which the principal is repaid - is an important factor when the price of the bond is determined. Bonds can be short-term (less than two years), medium -term (two-to-ten-10 years) or long -term (1ten-or-more years).
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Short-term bonds are less sensitive to interest rate changes but offer lower yields.
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Long-term bonds provide higher yields but are more volatile, as their prices react strongly to shifts in interest rates and inflation expectations.
The yield on the ten-year bond is often referred to as the benchmark yield as it is widely used in the pricing of other securities such as equities and property stocks.
Clean versus all-in price
Unlike equities, bonds are quoted in two different price forms:
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Clean price: This reflects the bond's market value excluding any accrued interest.
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All-in (dirty) price: This includes the clean price plus accrued interest since the last coupon payment.
For example, if a South African government bond trades at a clean price of R102 and has R1.50 in accrued interest, the all-in price an investor pays would be R103.50.
Other factors influencing bond prices
There are several other dynamics that influence the price of a bond in South Africa:
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Interest rates: The most significant driver. Bond prices move inversely to interest rates. If the South African Reserve Bank (SARB) raises the repo rate, new bonds will offer higher initial yields, making older, lower-yielding bonds less attractive. Their price falls as a result.
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Credit risk: For corporate bonds in particular, the risk of default matters. A company with weak financials will need to pay higher yields to attract investors, lowering the price of its bonds.
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Inflation: High inflation erodes the purchasing power of coupon payments. If inflation expectations rise in South Africa, bond yields tend to increase, pushing prices lower.
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Liquidity and market demand: Highly traded government bonds usually command more stable pricing than thinly traded corporate bonds.
The inverse relationship of bonds, equities and interest rates
Bonds often behave in the opposite way to equities, creating a natural hedge in diversified portfolios:
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Equities: Represent ownership in a business. They typically perform well during periods of growth, when corporate profits rise, but may struggle during recessions.
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Bonds: Provide steady income and tend to hold value during downturns, as investors seek safety.
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Inflation: High inflation erodes the purchasing power of coupon payments. If inflation expectations rise in South Africa, bond yields tend to increase, pushing prices lower.
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Interest rates: The crucial link. Rising interest rates usually hurt both bonds (lower prices) and equities (higher cost of borrowing and lower valuations). However, when rates are cut, bonds rally as yields fall, while equities may also benefit from cheaper capital and increased spending
In South Africa, this interplay is clear when the SARB adjusts monetary policy in response to inflation or growth - bond yields react almost immediately, while equity markets reflect the broader economic impact over time.
Why bonds matter for South African investors
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Income generation: Coupons provide predictable cash flows, useful for retirees or income-focused investors.
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Diversification: Bonds act as a counterbalance to volatile equity markets.
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Economic barometer: Government bond yields often reflect investor sentiment about South Africa's fiscal health, inflation outlook and policy credibility.
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Access to global markets: Through rand-denominated Eurobonds or dollar-denominated South African corporate bonds, investors can diversify currency exposure.
