Federal Loan Bonds (OFZ)
Federal Loan Bonds (OFZ) - is one of the types of securities in Russia, which is issued by the Ministry of Finance. Essentially, bonds have a standard format, their peculiarity only in the fact that the reliability of securities is ensured by the state itself.
Essentially, when you buy a OFZ, you are lending money to the government for a certain period of time. You will receive coupon income (usually semiannually) for the entire term of the bond. At the end of the term, the original value of the bond itself is returned to you.
Types of OFZs
Federal Loan Bonds are divided into several types according to the type of coupon payment and face value.
According to the type of coupon payments government bonds are divided into:
- OFZ-PD - with a permanent coupon
The value of the coupon of these securities is constant over the entire circulation period of the bond. The frequency of coupon payment is once every six months.
- OFZ-FD - with a fixed coupon
The amount of coupon payments may change over time, but is known in advance. For example, the first few years the coupon yield may be set at 7% of face value, and the next few years at 6%.
- OFZ-PC - with a variable coupon yield
The coupons of such bonds are tied to some floating interest rate, such as RUONIA (the rate on overnight interbank loans of the 28 largest banks) or the official Inflation. The coupon yield is calculated as the RUONIA rate + some interest rate, for example 0.74%. Therefore, only the current coupon is known for such bonds, and each next one is calculated based on the average RUONIA value for the last 6 months. Thus, if the rates on the money market grow, the coupon yield of OFZ-PCs also grows, the rates fall - and the yield also falls.
Government bonds are divided into two types by denomination:
- OFZ-AD - with amortization of the nominal value
On this type of paper, the par value is not redeemed all at once, but gradually in installments. The amortization schedule is known in advance. The par value can be redeemed at equal intervals, but there may be breaks. The par value can be redeemed in equal installments or in unequal installments.
- OFZ-IN - with indexation of denomination
These are bonds with a face value indexed to consumer inflation. The par value is indexed daily. Data on the current and future par value is published on the website of the Ministry of Finance for the month ahead at least 2 working days before the beginning of the month. There you can also find the value of the current coupon. Coupon income and income from indexation are not taxed.
How is the OFZ rate calculated?
OFZ market rates are fixed and variable. Permanent or fixed rates are set for each coupon period of each individual issue. The variable rate is formed taking into account the official data characterizing the inflation rate. The OFZ rate largely depends on the key rate CENTRAL BANK OF RUSSIA.
What is the yield on federal loan bonds?
The yield on OFZs is formed of two parts:
- The income that the owner of a federal loan bond of the Russian Federation receives on the coupon;
- Profit from the purchase of the coupon at a cost below par.
If a bond is purchased at a price above par, without taking into account the coupon income, it leads to a loss, because its repayment is made strictly at par.
During the circulation of OFZs, coupon yields accumulate. As the next coupon payment is due, the value of the bond increases. An investor who resells a bond before the coupon payment is made is sure to take into account the payments accumulated on the paper. The purchase price of a bond is always in the nominal range. The exact price is determined by market conditions, which can be either higher or lower than the bond's value.
When working with OFZ, it is necessary to take into account the specifics of taxation of this type of income. Each of the types of income on OFZ is taxable. For example, for income earned on the difference between the purchase and sale of a bond, you would have to pay about 35%. Net coupon income is taxed at 15% of the amount received.
These points are extremely important to take into account for manipulations on the bond market to bring good profits. Any activity in this segment is regulated by law.
What is the advantage of OFZ over other securities?
Investing in bonds is one of the most reliable types of investment. If you compare it to bank deposits, the level of reliability of OFZs is higher. The reliability of bank deposits directly depends on the rating of the bank. There is a direct correlation: the higher the reliability of the bank, the higher the safety of deposits. But there is a significant disadvantage: a high reliability rating has to pay lower interest rates. If we analyze offers from the largest Russian banks (Sberbank, VTB and others), then we observe that their bank deposit rates are the lowest. The difference can be 50-80% than the average for this sector.
The guarantor of OFZ payments is the state. And accordingly, the reliability rating of government bonds is equal to the credit rating of the government itself. It is liable for its obligations to the holders of government debt. If the government ceases to be liable for its obligations, it is default. But the probability of a national default is much lower than that of any private company.
Only bonds of foreign issuers are higher in terms of reliability. But they tend to have lower yields.
Where are they traded and who can buy OFZ?
OFZs are traded on the Moscow Exchange and can be purchased through any broker. Both Russian and foreign legal entities and individuals can be buyers and holders of OFZs. The cost of one bond is 1,000 rubles, and the yield is ruble-denominated.
The procedure for buying OFZs is no more complicated than opening a bank deposit. All you need to do is to choose a broker, sign an agreement with him and make a purchase of OFZs. Also, many of the largest banks provide similar services. They will also be able to advise you, depending on your goals, on which bonds you can buy at the moment.