You probably have heard a lot about the Singapore Savings Bonds (SSB) and have formulated your investment strategy for it. Even my colleague who did not study finance can tell me that she will churn her SSB for newer ones if interest rate rises. Having studied finance and traded Singapore Government Securities (SGS) before, I should do one better than hers.
Before going into my investment strategy for SSB and SGS, let us understand what are the characteristics of SSB and SGS. SGS is the traditional government bond which is backed by the government. Like any other bonds, its price will rise if interest rate falls and fall if interest rate rises. SSB, on the other hand, is capital-guaranteed by the government. Regardless of the direction of interest rate, its price will never rise or fall. In fact, you cannot trade SSB in a secondary market. You can only sell it back to the government at the original price.
Thus, when interest rate rises, churning your current, lower-coupon (i.e. interest) SSB for newer ones with higher coupons to keep up with the higher inflation rate can be a good investment strategy. SGS, on the other hand, would be a poor investment as its price will fall in such an environment. However, when interest rate falls, instead of keeping your SSB until maturity, it is a good strategy to switch out of SSB into SGS to take advantage of the capital appreciation potential of SGS. When interest rate has fallen low enough, you can then switch back from SGS to SSB for the capital-guarantee feature of SSB.
To understand what kind of figures are we talking about, let us consider a 10-year SGS whose coupon rate is 3% and an equivalent SSB. The coupons from SSB will step-up in such a way that if you hold it for 10 years until maturity, the effective annual coupon rate is equivalent to 3%. On the other hand, SGS will pay a coupon of 3% from the first year onwards for the next 10 years.
Ignoring the effects of decreasing maturity of the SSB/ SGS with the pasage of time, if interest rate (known as Yield-to-Maturity) for a 10-year SGS were to rise to 4%, the price of the SSB would still be $100 (bond prices are quoted in face value of $100, so I will use the same convention here), whereas the SGS would fall to $91.82, a fall of 8%. Conversely, if interest rate were to fall to 2%, the price of the SSB would still be $100, while the SGS would rise to $109.02, a rise of 9%. Thus, if interest rate were to swing between 2% and 4%, the price of SGS would swing by $17.20. If this sounds interesting to you, you may wish to know that you are not limited to a 10-year tenure for SGS. The longest-maturity SGS is 30 years. The corresponding price range for a 30-year SGS for interest rate between 2% to 4% is $82.62 to $122.48, or a swing of $39.86. Not only that, the SGS will pay the full 3% coupon every year, whereas you will get the full 3% coupon from SSB only if you hold it for 10 years.
Generally, how I view a SGS with a 3% coupon trading at an interest rate of 2% is, you will only get an effective 2% coupon from this point in time onwards (because the price will fall from $109.02 to $100 as it approaches maturity). The remaining 1% (i.e. 3% coupon minus 2% interest rate) is "paid upfront" in the form of capital appreciation. Selling the SGS at $109.02 effectively locks in the 1% coupon for the remaining maturity of the SGS.
How do you know if interest rates are going up or down? I do not know. But every month, I will keep track of where interest rates are relative to historical values. You can find it at my statistics blog, which is reproduced below for July's statistics.
|Cumulative Interest Rate Distribution (Jul 15)|
The figure above shows that the interest rate for the 10-year SGS (brown line) is finely poised around the 50th percentile mark, which means that historical interest rate for that SGS has been above the current interest rate 50% of the time and below it 50% of the time. Do take note that the 20-year and 30-year SGS were introduced in Feb 2007 and Mar 2012 respectively. Hence, the historical interest rate range that they can trade in might not be representative.
To conclude, SSB or SGS alone might not be a good investment asset for all interest rate environments, but together, they can make a very interesting investment asset!
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Hi, may i know which formulas you used to calculate these:ReplyDelete
" if interest rate (known as Yield-to-Maturity) for a 10-year SGS were to rise to 4%, the price of the SSB would still be $100 (bond prices are quoted in face value of $100, so I will use the same convention here), whereas the SGS would fall to $91.82, a fall of 8%."
Hi, you can use the bond calculator available at the SGS website to calculate SGS prices. SSBs can only be redeemed at face value + accrued interest.Delete
Hi, Bonds will be fixed for all the or it's vary according time and bank policy?ReplyDelete
Hi, SGS interest rate is fixed all the way until the bond matures. SSB interest rates vary each year but are known upfront. You can check them at the SSB website.Delete