Understanding Benchmark Bonds

Benchmark Bonds Programme – A Bonds’ Market Development Initiative Commentary by Cappitus Chironga of Monetary Operations and Debt Management In September 2007, the Central Bank of Kenya embarked on an initiative to issue benchmark bonds to address the fragmentation problem. The Bank in consultation with Treasury and Market Leaders Forum adopted 2, 5, 10, 15 and 20-year bonds to form benchmark issues. To implement this programme, a number of strategies such as reopening, switching, bond conversion as well as reissuing some maturities were identified. Benchmark bonds are large-sized, frequently traded papers at stable prices with their yields being used to derive benchmark yield curve which is used as reference points for pricing other instruments or facilities. Bond reopening is a standard practice in many developed and emerging markets that is used to address the bond market fragmentation problem. Bond fragmentation refers to the existence of too many small outstanding bonds scattered everywhere in the secondary market. This scenario leads to illiquid and sometimes volatile bond market, more often resulting into a distorted yield curve. This is because the liquidity around such instruments is held by a few investors who may be speculators or are pursuing buy-and-hold strategies, the latter case applying to pension funds. In addition, fragmentation makes it difficult for both the issuer and investors to plan their portfolios in terms of ...