About Eskom Bonds

Eskom Bonds

Eskom bonds are fixed-interest securities, most of which have fixed interest payments biannually, fixed maturity dates and fixed maturity values. They are also known as gilts.

Eskom sells bonds to raise money for capital projects such as building power stations and transmission lines. Each new batch of Eskom bonds issued is given an issue number such as E168, which is a very well-known issue.

Each issue has a maturity date on which Eskom will redeem the bond. You can buy short-dated or long-dated bonds. Each batch pays interest - called the coupon - E168 has a coupon of 11%, but this is not what you earn on your investment.

Anyone can buy Eskom bonds. If you do, you become a registered bond holder. Eskom keeps a record of your name and address and sends you interest twice a year (E168 - June and December). You can sell your Eskom bonds at any time at current market rates. You can invest as much as you like in Eskom bonds, although investments of less than R500 000 nominal value are not allowed due to the costs involved in servicing the account in the light of the new FIC Act.

Who Buys Eskom Bonds?

There is no capital risk if you buy Eskom bonds and keep them to maturity date. They will be redeemed at their face value. But, if you decide to trade bonds on the market, the yield rate might move against you. Because Eskom bonds are negotiable instruments, they can be bought and sold freely. This means that they are subject to the economic laws of supply and demand. When demand is high (or supply is low) it costs more to buy, so your effective rate of return is lower. When demand is low (or supply is high) it costs less to buy, so your effective rate of return is higher.

Remember, the risk associated with Eskom bonds is always less than with (for example) shares, because even if you are trading in Eskom bonds and the market moves against you, you can always wait until the market moves in your favour or until the maturity date arrives.

If you need money urgently and do not want to sell, you can use the bonds as security for a bank loan.

How Does The Yield Rate Work?

Let us take a simple example, using round figures.

Say you are offered an Eskom bond certificate with a face value of R100 A coupon of 11%; A maturity date of 1 June 2008; And for settlement of the consideration on 1 June 1997. If the yield to maturity currently quoted on the market is 16%, you will have to pay the holder R75,00 for that certificate. Eskom will pay the registered holder of the certificate R11,00 a year interest - R100,00 face or nominal value times 11% - in two instalments of R5,50 each, on 1 June and 1 December. Interest earned of 16% on R75,00 paid for the certificate would amount to R12,00 per year and this amount less the R11,00 paid would be accumulated at 16% per year so that the value of the certificate will increase from R75,00 to equal R100,00 on 1 June 2008.

Now let us look at the opposite situation. If the yield rate currently quoted on the market is 8% you will have to pay about R122,00 for the certificate. Your annual interest of 11% is more than the interest earned (8% of R122,00 - ie R9,76) and the excess paid will reduce the value to R100,00 by June 2008.

How Do I Buy Eskom Bonds?

You have four basic choices:

1. If you already deal through a broker whom you know and trust, you could use this channel.

2. Perhaps your bank manager assists you with your financial matters. If so, that could also be an option.

3. If you prefer, contact Eskom direct by telephone, letter or fax, as follows for amounts bigger than R500 000 nv:

Telephone (011) 800-4050 or 800-3870 and ask for the Capital Market section of Treasury, or
Write to Eskom Treasury (Capital Market), P O Box 6841, Johannesburg 2000, South Africa, or
Telex/teletex 4-24481 Sa, or - Fax (011) 800-4499

4. You can E-mail helpdesk@treasury.eskom.co.za for assistance.

Settlement details will be arranged at the time of the transaction.

Technical Details

A fixed-interest security may be defined as a contract to pay interest at a prescribed rate on given dates and to repay the principal on a fixed date. Eskom conducts an active market in its bonds to ensure ready marketability.

Coupon and maturity dates vary widely with each issue and are determined by market conditions and the borrower's requirements at the time of issue. Interest is paid to the registered holder at the bank which the holder chooses. Within limits other suitable arrangements for payment can be made. Note that from time to time regulations are determined regarding the payment of interest or the maturity or sale value applying to holders not resident in South Africa.

When a bond is bought or sold it usually has a certain amount of interest accrued since the last interest payment. The accrued interest is included in the calculation of the amount to be paid.

Definition Of Terms

Coupon: The interest paid.

Yield to maturity: This is the market rate at which a bond is traded and represents the return on an investment in a security over the life of the bond if the interest accrued since the last interest payment and future interest payments, paid half-yearly, are taken into account. Price changes occur in steps of one-hundredth of a percentage point, referred to in the market as a basis point. Rate movements are recorded as the number of basis points up or down.

Nominal Value: The total number of units of R1,00 each bought or sold. This is also the value at maturity.

Clean Price: The price of the bond in monetary terms, excluding accrued interest.

Interest: Interest accrued from the last coupon payment until the settlement or interest payment date.

Total Price: The sum of the clean price and the accrued interest, representing the amount to be settled for each unit bond bought or sold on the settlement date. This amount times the nominal or maturity value would be the consideration - the amount to be paid or received.

Flat Yield: This is obtained by dividing the coupon by the clean price and expressing the result as a percentage.

Settlement Date: This is the actual day on which payment must be made for bonds purchased or monies received for bonds sold.

Non-Resident Holders Of Eskom Bonds

Many investors who are not resident in South Africa invest in Eskom bonds. Regulations and requirements pertaining to such transactions are determined by the South African authorities.

Eskom bonds are denominated in South African Rands, ie all interest and capital payments are in Rands and the regulations apply to the movement of funds and their conversion into other currencies. Subject to these regulations, interest and capital payments are made to the holders of the bonds at any bank of their choice, wherever that may be.

Currently, income from South African sources not exceeding R300 000,00 per year is not subject to South African tax. This allowance refers to all income from South African sources and not to the income from Eskom bonds only.

In order to control this aspect and movement of all funds for Exchange Control purposes, regulations stipulate that non-residents must nominate a South African bank authorised to do so to control the movement and taxation aspects for the South African authorities. The cost of such services is minimal and transfers of funds are expeditious as all banks have corresponding arrangements with banks all over the world.

Stockbrokers also have arrangements with banks and the transfer of funds on purchase or sale is handled at a very low cost.

GDRs (Global Depository Receipts) are also available to non-resident investors wishing to physically acquire scrip at the time of settlement by their South African agents. These GDR's are substitute certificates denoting that the owner owns the underlying securities and are used widely for settlement purposes in Europe and America.

The Relationship Between Bond And Yield Price

As yield to redemption rises, the clean and total prices fall.
The interest remains the same as the settlement date is unchanged.
The flat yield moves in line with the yield to maturity. The flat yield is below the yield to maturity as the clean price for the range of the interest accrued is below the par value of 100 cents. Thus the yield to maturity must be higher than the flat yield to take into account this capital gain.
As the yield to maturity falls, the clean price of the bond rises and the value of the investment increases. Conversely, if rates rise, prices fall and capital losses are made.

By carrying out similar exercises on various bonds, it can be shown that:

the longer the life of the bond, the greater the price movement (volatility) and hence capital gain or loss for the same change in market yield.
the higher the coupon rate, the lower the fluctuation in the clean price.

NOTE: When the yield to maturity is above the coupon rate, the clean price is below par and the bond is known as a discount bond. When yield to maturity is below the coupon rate, the clean price will be at a premium to par, therefore the bond is termed a premium bond.