Federal Loan Bonds (OFZ) are one of the types of securities in Russia issued by the Ministry of Finance. Essentially, bonds have a standard format, with their distinguishing feature being that the reliability of these securities is guaranteed by the state itself.
By purchasing OFZ, you are essentially lending money to the government for a specific term. With OFZ, you will receive coupon income (usually every six months) throughout the bond’s term. Upon expiration, the initial face value of the bond is returned to you.
Types of OFZ
Federal Loan Bonds are divided into several types based on coupon payment type and face value.
By coupon payment type, government bonds are divided into:
- OFZ-PD — with fixed coupon income
The coupon amount for these securities remains constant throughout the bond’s circulation period. Coupon payment frequency is every six months.
- OFZ-FD — with fixed coupon
The coupon payment amount may change over time but is known in advance. For example, the coupon income might be set at 7% of the face value for the first few years, then 6% for the following years.
- OFZ-PK — with variable coupon income
Coupons for these bonds are tied to a floating interest rate, such as RUONIA (the rate for one-day interbank loans of the 28 largest banks) or official inflation. Coupon yield is calculated as the RUONIA rate plus a certain percentage, for example, 0.74%. Thus, only the current coupon is known, while each subsequent one is calculated based on the average RUONIA rate over the past six months. As a result, if money market rates rise, the coupon yield of OFZ-PK increases, and if rates fall, the yield decreases accordingly.
By face value, government bonds are divided into two types:
- OFZ-AD — with face value amortization
For these bonds, the face value is not redeemed all at once but gradually in parts. The amortization schedule is known in advance. The face value may be redeemed at equal intervals, with possible breaks. It can be redeemed in equal or unequal parts.
- OFZ-IN — with indexed face value
These are bonds with a face value indexed to consumer inflation. Face value indexing occurs daily. Data on the current and future face value is published on the Ministry of Finance website at least two business days before the start of the month, for at least one month ahead. The current coupon amount is also available there. Coupon income and income from indexing are not subject to taxation.
How is the OFZ rate calculated?
OFZ market rates can be fixed or variable. Fixed or constant rates are set for each coupon period of each individual issue. Variable rates are formed taking into account official data on inflation levels. The OFZ rate largely depends on the key rate of the Central Bank of Russia.
What is the yield of Federal Loan Bonds?
OFZ yield consists of two parts:
- Income that the OFZ holder receives from coupons;
- Profit from purchasing the bond below face value.
If a bond is bought above face value, excluding coupon income, it results in a loss since redemption occurs strictly at face value.
During circulation, OFZ accumulates coupon profit. As the coupon payment date approaches, the bond’s price increases. An investor reselling the bond before the coupon payment must account for accumulated payments on the security. The purchase price of bonds fluctuates around the face value. The exact price is determined by market conditions, which can be either above or below the bond’s face value.
When working with OFZ, consider the specifics of taxation for this type of income. Each type of OFZ income is subject to taxes. For example, income from the difference between purchase and sale of the bond is taxed at around 35%. Net coupon income is taxed at 15% of the amount received.
These factors are crucial to consider for profitable trading in the bond market. All activities in this segment are regulated by law.
What are the advantages of OFZ over other securities?
Investing in bonds is one of the most reliable investment methods. Compared to bank deposits, OFZ offer higher reliability. The reliability of bank deposits directly depends on the bank’s rating. There is a direct correlation: the higher the bank’s reliability, the safer the deposits. However, there is a significant drawback: higher reliability comes with lower interest rates. Analyzing offers from Russia’s largest banks (Sberbank, VTB, and others), their deposit rates are the lowest. The difference can be 50-80% compared to the sector average.
The state guarantees payments on OFZ. Accordingly, the reliability rating of government bonds equals the credit rating of the state itself. The state is responsible for its obligations to government debt holders. If the state fails to meet its obligations, a default occurs. However, the probability of default in a country is much lower than for any private company.
Only bonds from foreign issuers are more reliable, but they typically offer lower yields.
Where are OFZ traded and who can buy them?
OFZ are traded on the Moscow Exchange and can be purchased through any broker. Buyers and holders of OFZ can be Russian and foreign legal and individuals. The price of one bond is 1000 rubles, with yield in rubles.
The procedure for buying OFZ is no more complicated than opening a bank deposit. All you need is to choose a broker, sign a contract with them, and purchase OFZ. Many major banks also offer these services. They can provide consultations based on your goals regarding which bonds to buy at the moment.
