💼 Capital Market Overview

The capital market (also called the bond market) is where long-term debt instruments are traded. A bond, or fixed income security, offers investors a series of fixed interest payments during its life, along with a fixed repayment of principal at maturity.

• Bonds are issued by governments, public corporations, and companies.
• The money market deals with short-term debt (up to one year), while the capital market handles longer-term debt—up to 20 years or more.

🧾 Types of Bonds

• Coupon Bonds: Pay regular biannual interest and return the original capital at maturity.
• Zero-Coupon Bonds: Sold at a discount; no regular income, but pay full nominal value at maturity.
• Inflation-Linked Bonds: Adjust both interest payments and maturity value to keep pace with inflation. These offer protection against inflation but usually start with lower interest rates than coupon or zero-coupon bonds.

🔄 Examples of instruments traded here:

• RSA Retail Bonds
• Government Bonds
• Corporate Bonds
• Bond Unit Trusts
• Gilts

📚 Key Terminology

💡 Why Invest in the Capital Market?

• Offers guarantees and predictable income
• Can act as a hedge against inflation
• Suitable for long-term planning and portfolio diversification

⚠️ Risks to Keep in Mind

Risk Type	Description
Interest Rate Risk	Bond values fall when interest rates rise; measured by duration.
Yield Curve Risk	Uneven changes in yields across maturities affect bond values. (Changes in the shape of the yield curve mean that yields change by different amounts for bonds with different maturities)
Call Risk	Callable bonds may be redeemed early when rates fall, forcing reinvestment at lower rates
Reinvestment Risk	Future cash flows may earn lower returns if rates drop
Credit Risk	Issuer’s creditworthiness may deteriorate, lowering bond value
Liquidity Risk	Difficulty selling bonds at fair value due to low market demand
Inflation Risk	Rising prices reduce purchasing power of fixed interest payments
Volatility Risk	Bonds with embedded options are sensitive to interest rate volatility
Sovereign Risk	Government policies may affect debt repayment or foreign exchange flows

💡 Note: Bond interest is taxable, just like money market instruments. Standard interest exemptions apply.

Tax and volatility

• Bond interest is taxable, so investors must consider after-tax returns.
• Bonds are generally less volatile than stocks, but still require careful research.

📈 Primary vs. Secondary Market:
Bond Yields and Interest Rates

🏦 Primary Market (New Issues)

• In the primary market, yields move in the same direction as interest rates.
• When interest rates rise, newly issued bonds in the primary market offer higher coupon rates to stay competitive.
  Higher rates → higher coupon on new bonds.
• Buying directly from the issuer locks in the current rate. Yield to maturity (YTM) will be higher, if you buy the bond on the primary market at times when interest rates are high,

🔄 Secondary Market (Trading Existing Bonds)

• In the secondary market, bond prices fall when interest rates rise, and yields go up. In other words, in this market there is an inverse relationship between interest rates and bond prices. The reason for this is price adjustments.
• Existing bonds with lower coupon rates become less attractive when new bonds offer higher rates.
• To sell bonds in the secondary market, prices must drop—this raises the yield for the buyer (since they’re paying less for the same interest stream).
• Higher rates → lower bond prices → higher yield for buyers.

✅ “Bond yields move inversely to interest rates” applies only to the secondary market.

🧮 Quick Example for Students

You buy a bond with:

• 10% coupon
• Interest rates at 10%

A year later, interest rates rise to 12%. New bonds offer 12%, so your bond is less attractive.
Its price drops in the secondary market to match the new yield environment.

📊 Calculating Present Value of a Bond

Let's say you bought this bond.

Bond Details:

• Term to maturity: 5 years
• Coupon rate: 8.5% per annum (paid bi-annually in arrears)
• Principal: R1 000
• The current prevailing interest rate is 8%

Step-by-step:

• Coupon payment = R1 000 × 8.5% ÷ 2 = R42.50
• Payments occur 10 times (2 per year × 5 years)

Using a financial calculator:

• END mode
• 2 P/YR
• N = 10
• I/YR = 8
• PMT = 42.5
• FV = 1 000
• PV = R1 020.28

💡 If interest rates drop after issuance, the bond’s price (PV) in the secondary market will rise.

You can also use this Excel formula:

PV (Rate per period, Number of periods, Coupon payment per period, Principle, Begin/End Mode)
= PV(8%/2, 10, 42.5, 1 000, 0)

🌱 Final Thoughts

Bonds have a place in a well diversified investment portfolio.
Risk tend to be higher in the bond market than in the money market, but the returns also tend to be higher.

🧠Weekly Challenge

Visit the RSA Government Retail Savings Bonds website: 🔗 https://secure.rsaretailbonds.gov.za
Check out the Overview, Rates, Calculator, FAQ and Benefits pages.

✅ Check the current interest rates for RSA Retail Savings Bonds. How does it compare to the bank deposits that you looked at last week
💸 Note the minimum investment amounts for each bond product
🔄 Read about the restart option. What does it mean and when does it apply