TITLE PAGE:

MODELLING NIGERIAN’S FGN BOND YIELD CURVE

By

AKATUGBA, Mamuyovwi
Reg No.(1840804017)

BEING A DISSERTATION SUBMITTED TO THE POSTGRADUATE SCHOOL,

UNIVERSITY OF ABUJA IN PARTIAL FULFILMENT OF THE REQUIREMENTS
FOR THE AWARD OF MASTER OF SCIENCE (MSC) DEGREE IN FINANCIAL
MATHEMATICS

DEPARTMENT OF MATHEMATICS, FACULTY OF SCIENCE, UNIVERSITY OF

ABUJA, ABUJA, FEDERAL CAPITAL TERRITORY, NIGERIA

MARCH, 2023
 DECLARATION

I hereby declare that this dissertation was written by me and it is a record of my own research
work. It has not been presented before in any previous application for a higher degree.
References made to published literature have been duly acknowledged in accordance with the
conventional academic traditions.

Date:
Akatugba, Mamuyovwi

The above declaration is confirmed by:

Date:
Professor
(Chairman Supervisory Committee)
 CERTIFICATION

This is to certify that this dissertation titled, “Modelling Nigerian’s FGN Bond Yield Curves”
meets the regulations governing the award of the degree of Master of Science in Financial
Mathematics of the University of Abuja, Nigeria and it is hereby approved.

-------------------------------------------- Date ------------------------------------

Akatugba, Mamuyovwi (1840804017)
(Student Name & Registration No.)

__________________________ Date:
Professor Benjamin O. Oyelami
(Project Supervisor)

Date:
Prof.
(H.O.D Mathematics Uni Abuja)

Date:
Prof.
External Examiner

Date:
(Dean, Postgraduate School, Uni Abuja)
 DEDICATION

I dedicate this dissertation to God Almighty and to my parents, Chief & Mrs T. E. Akatugba.
 ACKNOWLEDGEMENTS

This dissertation would not have been possible without the support of many people. Many thanks
to my supervisor, Professor Benjamin O. Oyelami who showed me the right way to carry out the
work and opened my eyes to greater opportunities. Also, thanks to Dr. James Ajie, and my
lecturers for impacting such great knowledge in me. The non-academic staffs of the department
of mathematics UniAbuja my special thanks to you all also.
Finally, I wish to thank my lovely wife, Mrs. Uzoma Elizabeth Akatugba for her financial and
moral supports; my parents, Chief & Mrs T.E. Akatugha who have always believed in me; my
siblings, for their prayers, advice and financial supports and; all my friends, course mates, and
well-wishers for offering support and love. May God Almighty bless you all.

Akatugba, Mamuyovwi
March, 2023.
 TABLE OF CONTENTS

TITLE PAGE I

DECLARATION II

CERTIFICATION II

DEDICATION II

ACKNOWLEDGEMENTS II

TABLE OF CONTENTS II-VIII

ABSTRACT IX

CHAPTER ONE: INTRODUCTION 2

1.1. Aim and Objectives

1.2. Background to the Study 2

1.3. Definition of Terms 2

1.3.1. Bond 2

1.3.2. Coupon 2

1.3.3. Coupon Rate 2

1.3.4. Zero Coupon Bond 2

1.3.5. Par Value on a Stock 2

1.3.6. Forward Rate 2

1.3.7. Yield Curve 2

1.3.8. Yield to Maturity (YTM) 2

1.4. Modelling Nigeria’s Zero-Coupon, Forward and Par Yield Curve 5

1.5. Estimating & Fitting Zero-coupon, Forward and Par Yield Curve 6
CHAPTER TWO: LITERATURE REVIEW 7

2.1. Introduction 7

2.2. Brief History of Nigeria Bond Market 8

2.3. Theoretical Studies 9

2.4. Yield Curve Methods for Central Banking Purposes 12

2.5. The Yield Curve and Debt Financial Instrument 13

2.6. Summary of Some Theories Underlying the Term Structure of Interest Rates 15

CHAPTER THREE: METHODOLOGY 18

3.1. Introduction 18

3.2. Spline Based Method 18

3.3. Piecewise Polynomial Interpolation 2

3.3.1. Piecewise Linear Interpolation 2

3.4. Piecewise Cubic Hermite Interpolation (Hermite) 2

3.5. Piecewise Cubic Spline Interpolation (Cubic Splines) 2

3.6. Variable Roughness Penalty (VRP) 2

3.7. Parametric Approach 27

3.7.1. The Nelson and Siegel Method 27

3.7.2. Nelson-Siegel-Svensson(NSS) model 28

3.8. Filtration of Bond Data and Yield Extraction 30

3.9. Kalman Bond Filtration Theory 30

3.10. Yield Extraction 31

3.11. Zero-Coupon Bond (Discount Bonds) 32

3.12. Arbitrage-Free Pricing of Bonds 33

CHAPTER FOUR:DATA ANALYSIS AND RESULT 35

4.1. Data Description 35

4.2. Parameter Analysis: Nelson Siegel and Svensson Model 35

4.3. Results and Applications Error!

Bookmark not defined.

CHAPTER FIVE:CONCLUSION AND RECOMMENDATIONS 21

5.1. Conclusion 21

5.2. Contribution to Knowledge Error!

Bookmark not defined.2

REFERENCES 23

APPENDIX 27
 ABSTRACT

This dissertation is to investigate the behaviour of the Federal government bond in the
Nigerian bond market using bond yield curves. The yield curve represents a relationship
between the rate of return and the maturity of certain securities. Methods such as the
piecewise polynomial interpolation, piecewise cubic spline (with not-a-knot end condition),
and Nelson-Siegel-Svensson method were used in the study. The FGN bond historical Data
was analysed in two stages: Firstly, Nelson-Siegel and Nelson-Siegel-Svensson models were
compared for parametric models using FGN Bond data in years 2011 and 2012. After which,
the other models were compared with the Observed data in June 2020 to April 2023. The
results show that the Nelson-Siegel-Svensson method fits better to the data set and is
recommended for fitting the yield curve. Also the study shows that yield curves are a very
important economic indicator that is involve in the transmission of monetary policy to a broad
range of interest rates in the economy.
 CHAPTER ONE
1. INTRODUCTION
1.1. AIMS AND OBJECTIVES
a. AIM
The aim of this dissertation is to investigate the behaviour of the Federal government bond in the
Nigerian bond market using Bond yield curves.

b. OBJECTIVES
To:
(i) Obtain the best fit equations yield curve for the FGN bonds using Nelson-Siegel and Svensson
parametric models.
(ii) Produce yield curves from FGN bond historical data using polynomial interpolation and spline
methods.
(iii) Interpret yield curves obtained and effects on the Nigerian economy.

1.2. Background to the Study

The bond showcase of any nation does not as it were offer assistance the government to raise

reserves; it moreover contains a coordinate affect on the degree to which other viewpoints of the

whole monetary advertise can create (Lartey& Li, 2018). In the mean time, budgetary markets

are a key channel for the transmission of financial arrangement motivations to the genuine

economy and the changes in monetary markets can reflect agents’ desires almost future

macroeconomic advancements (Nymand-Andersen, 2018). Money related showcase markers can

be utilized to systematically analyse the budgetary relationship between financial arrangement

and the government budgetary markets’ structure and flow, and play a contributory part within

the Central Bank of Nigeria (CBN) money related arrangement decision-making prepare and

technique. Borio and Gambacorta (2017), contended that the quality of money related

arrangement decision-making is subordinate on, among other things, the availability and quality
of money related advertise pointers and their informative control. In this manner, a wide run of

Nigeria financial and money related advertise markers that are accessible can be examined.

This think about centers on one such monetary showcase marker, to be specific the calculation of

Nigeria government bond yield curves custom fitted to desires of Nigeria’s summit bank.

additionally, this consider contributes to the straightforwardness of the measurable fixings of

calculating and discharging day by day surrender bends, in this way, serves as a system to supply

day by day measurements to private and open budgetary specialists and the common open. After

all, the CBN would continuously require dependable representations of the term structure of

intrigued rates.

One of the most points of interest of a single agent bend for Nigerian government bonds is that

the basic disobedient may be considered to be nearly free of credit hazard. Subsequently, such a

bend gives a floor for the borrowing costs within the economy and gives a valuable benchmark

for surveying advertise intrigued rates. Other than, surrender bends can be utilized to gage

showcase desires concerning financial approach, financial movement and swelling over brief,

medium and long-term skylines. Surrender bends can moreover give profitable data for other

Central managing an account purposes, in specific, as input for financial stability, systemic risks,

financial integration and advertise operations investigation. In expansion, once a ostensible

surrender bend is computed, a term structure of genuine intrigued rates and break-even swelling

rates can be inferred and frequently discharged. It is hence critical to appraise a surrender bend

where changes basically reflect changes within the yields-to-maturity instead of in other qualities

of the basic obligation securities. Concurring to Lartey and Li (2018), there must be sufficient

perceptions accessible to appraise the bend with a sufficient degree of accuracy and it must not

be influenced by changes in seen credit chance.

Against this foundation, this consider presents the CBN discharged day by day abdicate bends

based on the taking after models viz. Piecewise Polynomial Introduction, Piecewise Cubic Spline

Addition, Nelson-Siegel-Svensson strategy (NSS).

1.3. Definition of Terms

1.3.1. Bond

A bond may be a settled salary instrument that speaks to a credit made by an speculator to a

borrower (regularly corporateor legislative). A bond might be thought of like an IOU between

the bank and borrower that incorporates the subtle elements of the loan and its installments.

Bonds are utilized by companies, districts, states, and majestic governments to back ventures and

operations. Proprietors of bonds are debtholders, or leasers, of the backer. Bond subtle elements

incorporate the conclusion date when the foremost of the credit is due to be paid to the bond

proprietor and ordinarily incorporate the terms for variable or settled intrigued installments made

by the borrower.

Comment 1.2.1.Bond costs are inversely relative to with intrigued rates: when rates go up, bond

costs drop and vice-versa. Bonds have development dates at which point the central sum must be

paid back in full or chance default.

1.3.2. Coupon

A coupon or coupon installment is the yearly intrigued rate paid on a bond, communicated as a

percentage of the confront esteem and paid from the issue date until development. Coupons are
more often than not alluded to in terms of the coupon rate (the sum of coupons paid in a year

partitioned by the confront esteem of the bond in address).

1.3.3. Coupon Rate

A coupon rate may be a ostensible abdicate paid by fixed-income security. It is the yearly

coupon installments paid by the backer relative to the bond's confront or standard esteem.

Comment 1.2.2.A bond’s coupon rate can be calculated by separating the whole of the security's

yearly coupon installments and dividing them by the bond’s standard esteem.

1.3.4. Zero-Coupon Bond

A zero-coupon bond may be a bond in which the confront esteem is reimbursed at the time of

development. It does not make occasional intrigued installments or has so-called coupons,

consequently the term zero-coupon bond. When the bond comes to development, its speculator

gets its standard esteem.

1.3.5. Par Esteem on a Stock

A standard esteem (moreover known as standard, ostensible esteem, or confront esteem) alludes

to the sum at which a security is issued or can be recovered. For case, a bond with a standard

esteem of $1,000 can be recovered at development for $1,000. Typically also imperative for

fixed-income securities such as bonds or favored offers since intrigued installments are based on

a rate of standard. So, an 8% bond with a standard esteem of $1,000 would pay $80 of intrigued

in a year. Common stock issued with standard esteem is redeemable to the company for that

amount—say $1.00 per share, for occurrence.

Comment 1.2.3.No-par esteem stock doesn't have a redeemable cost or maybe costs are decided

by the sum that speculators are willing to pay for the stocks on the open market. Most shares

issued nowadays are distinguished as being either no-par esteem or low-par esteem stock.

1.3.6. Forward Rate

A forward rate is an intrigued rate pertinent to a money related exchange that will take put within

the future. Forward rates are calculated from the spot rateand are balanced for the cost of

carrying to decide long haul intrigued rate that equates the add up to return of a longer-term

venture with a procedure of rolling over a shorter-term speculation. The term may too allude to

the rate settled for a future budgetary commitment, such as the intrigued rate on a loan

installment.

1.3.7. Yield Bend

In finance, the surrender bend could be a bend appearing a few yields to development or

intrigued rates over diverse contract lengths for a comparative obligation contract. The bend

appears the connection between the intrigued rate and the time to development, known as the

"term", of the debt for a given borrower in a given money.

1.3.8. Yield to Development (YTM)

Abdicate to development is the full return anticipated on a bond on the off chance that the bond

is held until it develops. Surrender to development is considered a long-term bond abdicate but is

communicated as an annual rate. In other words, it is the inside rate of return (IRR) of an

investment in a bond in case the speculator holds the bond until development, with all payments

made as planned and reinvested at the same rate. Abdicate to development is additionally alluded

to as “book yield” or “redemption yield.”

1.4. Modelling Nigeria’s Zero-Coupon, Forward and Standard Abdicate Bend

Yields on Nigeria’s obligation instruments avail investors the opportunity of finding out the

relative esteem of obligation speculation openings in Nigeria. Nigeria’s Zero-Coupon, forward

and standard yield curve speaks to an important indicator, as well as an important information

base, around the state of the country’s obligation advertise. It appears the market’s expected

returns on obligation disobedient for a assortment of development dates. Within the same way,

the abdicate bend summarizes the risk-free cost of credit or advances of different maturities

inside Nigeria. Successfully, it speaks to an marker through which the certainty of obligation

financial specialists in Nigeria, and, to a expansive degree, the accessibility of development

capital in Nigeria, can be measured. In this respect, the shape that the yield bend exhibits have

been known to have been utilized in foreseeing future designs of financial development or retreat

(Estrella, 2005; Papageorgiou & Skinner, 2002).

Nigeria’s Zero-Coupon surrender bend speaks to the yields on risk-free loaning, and it shapes the

premise for calibrating other yields. The shape of this default-free surrender bend is,

subsequently, of extraordinary intrigued to professionals in any budgetary advertise. Agreeing to

Wu (2003), Nigeria’s abdicate bend speaks to a preview of the current level of yields as seen by

her showcase. As such, Nigeria’s Zero-Coupon, Forward and Standard abdicate bend is forward-

looking—it does not capture the authentic design of such yields. For this reason, concurring to

Choudhry (2004), Nigeria’s abdicate bends must be arranged as as often as possible as

conceivable.

1.5. Estimating & Fitting Zero-coupon, Forward and Standard Surrender Bend

i) Parametric Strategies
• The Nelson and Siegel strategy;

• The Svensson strategy (Extended Nelson and Siegel strategy).

ii) Spline-Based Methods

• Quadratic Splines;

• Cubic Splines;

• Smoothing Splines.

After assessing the surrender esteem of zero-coupon bonds, at that point the surrender bend itself

can be fitted utilizing any of the taking after strategies: Direct introduction, Logarithmic

addition, Polynomial models [Here the arrange of the polynomial decides the shape of the bend]

Cubic Splines Regression models.

Comment 1.4.1.This think about received both Parametric and Spline based approaches in

assessing the Zero-coupon, Forward and Standard abdicate bend of the Nigeria Bond Showcase.

These incorporate Piecewise Cubic Hermite Introduction (Hermite), Piecewise Cubic Spline

Addition (Cubic Spline), Nelson-Siegel-Svensson strategy (NSS), Penalized smoothing spline

(VRP).
 CHAPTER TWO

WRITING SURVEY

2.1 Presentation

The surrender bend has been broadly considered by specialists in both scholastic and

experimental domains. The bulk of the examinations centres basically on two strands—analysis

of the shape of the abdicate bend and the application of the surrender bend in money related

approach upgrade. Other bunches of analysts explore the convenience of the surrender bend in

foreseeing financial emergencies and the long-term prosperity of a nation’s financial system.

2.2 Brief History of Nigeria Bond Advertise

Nigerian bond market has been in presence since 1946, which was when the primary government

bond (the Advancement Stock) was issued (Soludo, 2005). Different money related changes

were attempted afterwards to create and extend the bond advertise. In 1958, financial reform was

presented and this come about within the creation of the Central Bank of Nigeria (CBN), as well

as the creation of attractive public debt securities. The CBN was ordered to be in charge of the

issue and administration of the government obligation securities. While the Advancement Stock

was issued to fund formative ventures and to supply an avenue for capital advertise speculation,

treasury bills were issued for open market operations and to supply an road for cash showcase

venture.

To empower exchanging at the auxiliary market level, the Nigerian Stock Trade (NSE) was

established in 1960 and was completely operational in 1961. The trade given a platform for
auxiliary advertise exchanging of the Advancement Stock. In 1968, Treasury Certificate was

presented to advance develop the money advertise of Nigeria. The Nigerian bond showcase

looked promising, at both essential and auxiliary advertise levels. Be that as it may, in 1986, a

auxiliary alteration program saw a decrease within the issue of the as it were capital showcase

obligation instrument, the Advancement Stock. The reason was to permit the monetary segment

to create a well-defined capital showcase that was not as it were based on open segment venture

alone but moreover private segment venture. More attention was then, in this manner, paid to the

advancement and enhancement of the value stock advertise (Akinsokeji, Adegboye & Edafe,

2016).

By 1988, the issuance of Improvement Stock had been totally suspended. In 1989, there was

anpresentation of another long-term bond—Treasury Bond which was nonmarketable. Around

58.6% of the treasury bills and 100% of treasury certificates were changed over into treasury

bonds. In other words, the treasury certificates were out from the advertise and as it were less

than half of the treasury bills were cleared out within the showcase. The nonmarketable treasury

bonds hence constituted a gigantic share (almost 69%) of the domestic bonds in Nigeria. The

remaining 31% of the government bonds were brief term in nature— treasury bills with

maturities of 91 days. As a result, the Nigerian bond showcase for all intents and purposes got to

be inert, as a colossal parcel of the bond showcase constituted nonmarketable treasury bonds.

The as it were government attractive securities were cash showcase obligation securities. The

Nigerian capital showcase therefore comprised value securities as it were.

In 2000, the Obligation Administration Office (DMO), a semiautonomous body, was built up to

issue and oversee the government government’s residential and remote obligation securities;

regulate the Nigerian bond showcase, and carry out fundamental changes to create the
government bond showcase more fluid and dynamic. The CBN was made to act as the issuing

house and enlistment center. In 2003, DMO issued its first Federal Government attractive long-

term bond—the Government Government of Nigeria (FGN) Bond. Since then, the DMO has

reliably been issuing long-term FGN bonds, whereas the CBN issues treasury bills. In 2006, the

Essential Dealers and Advertise Producers (PDMMs) played an dynamic part within the

issuance, deal, and showcasing of bonds. This come about in active auxiliary showcase

exchanging of bonds in Nigeria.

The Nigerian bond advertise is right now one of the most fluid in sub-Saharan Africa, likely fair

moment to the South African bond market (Ajayi, 2013). Numerous countries in Africa respect

the Nigerian bond advertise as a show from which to memorize, and based on which to create

their individual household bond markets. For occasion, in Admirable 2015, a assignment of

Kenyan monetary showcase authorities visited the FMDQ OTC to ponder the Nigerian OTC

advertise and the E-Bond Exchanging Framework. In early 2017, a designation from the

Ghanaian financial showcase too went on a ponder visit to ponder FMDQ OTC’s businesses and

operations, to overhaul their (Ghanaian) bond market operations (FMDQ OTC, 2017a).

The Nigerian bond market is now in a position that numerous African bond markets see up to.

Currently, the Nigerian government bonds have maturities extending from 3 months to 20 a long

time. The improvements accomplished within the Nigerian bond advertise are anticipated to

draw the consideration of speculators and settled salary analysts—both residential and universal.

2.3 Theoretical Considers

Agreeing to the Universal Organization of Securities Commissions (IOSCO), one critical

instrument required for investigation, estimating, and exchanging capacities within the bond
advertise is the benchmark surrender bend (IOSCO, 2011; Lartey & Li, 2018). The Nigerian

government as often as possible issues benchmark obligations to providea benchmark abdicate

bend. Agreeing to the African Budgetary Showcase Activity (AFMI), the Nigerian surrender

bend is built utilizing the FMDQ OTCstrategy (AFMI, 2016). In the interim, according to

FMDQ OTC (2017b), the Nigerian yield bend could be a graphical representation of the winning

mark-to-market yields of benchmark Treasury obligation rebellious, that is, the treasury bills and

FGN Bonds.

Oladunni (2015), states that the Nigerian surrender bend is developed by plotting the yields-to

development of bonds against their remaining terms-to-maturity. This means that even in spite of

the fact that the Nigerian bond advertise features a auxiliary showcase benchmark abdicate bend

(not at all like many other African bond markets), the surrender bend is used by the Nigerian

bond advertise may be a yield-to-maturity (YTM) bend and not a zero-coupon abdicate bend. In

the interim, even though the YTM bend is the foremost well known abdicate bend in numerous

bond markets and exchanging stages, it must be utilized with caution. There are a few challenges

inherent within the suspicions basic the concept of YTM. YTM accept steady installment of

coupons which are reinvested at consistent rates (coupon rate) amid the bond’s life. Be that as it

may, variances in advertise intrigued rates would not make this assumption realistic, resulting in

reinvestment hazard (Choudhry, 2008).

On the contrary, the zero-coupon surrender accept no coupon payment and thus expect no

reinvestment of coupons. This makes the zero-coupon surrender bend preferable to the YTM

bend. Bank for Worldwide Settlements (BIS) too prescribes that central banks yield gauges of

zero-coupon yields and the strategies of estimation to the BIS (BIS, 2005). To the best of our

information, the Nigerian auxiliary bond advertise, like numerous other African bond markets, is
however to have a zero-coupon surrender bend. The CBN is at the forefront of giving the

essential prerequisites to create the Nigerian bond market. One step taken by the central bank in

this respect has been an activity to commission a project to fit the Nigerian government zero-

coupon abdicate bend (Sholarin, 2014). Usually an sign that the Nigerian bond advertise really

requires a zero-coupon abdicate bend.

FMDQ OTC (2016), clarifies that when estimating closing costs (and yields) within the auxiliary

bond advertise, yields of non-trading imperial bonds are inferred (by the FMDQ OTC), by

utilizing simple interpolation and extrapolation, from the yields of exchanging majestic bonds.

This presupposes, to the leading of our information, that a straightforward (direct) strategy is

utilized to insert and extrapolate the yields. In any case, as direct insertion isn't differentiable, we

suggest not to utilize straight addition for the yield estimation and abdicate bend fitting (Lartey

& Li, 2018; Muthoni, Onyango & Ongati, 2015). Linear interpolation too tendsto create crimped

abdicate bends (Choudhry, 2004).

Sholarin (2014), used bootstrapping and piecewise cubic spline strategies to model the Nigerian

zero-coupon abdicate bend for the CBN. This was displayed in a Essential advertise sell off

yields. Lartey & Li (2018), propose that the essential showcase surrender bend includes a moo

recurrence (compared with the auxiliary advertise surrender bend), and the developments in the

essential showcase abdicate bend are frequently localized at the brief closes, whereas the long

closes might stay unaltered fora longer period (as long as unused long-term bonds are not

auctioned in the primary market). Moreover, the primary advertise yields are more regularly

impacted by the central bank’s direct involvement within the issuing and estimating prepare

(Mohanty, 2002). Moreover, the bend fitting method used by Sholarin (2014), is the piecewise

cubic spline strategy. Once more, indeed in spite of the fact that the piecewise cubic spline could
be a popular method for abdicate bend displaying, it might not be appropriate for all bond

markets, particularly the illiquid and immature ones (Lartey & Li, 2018). Because Sholarin

(2014), employments the piecewise Cubic Spline strategy on Nigerian primary showcase yields,

one cannot set up whether or not the strategy would too be appropriate for the Nigerian auxiliary

advertise yields. In this way, as to whether or not the piecewise cubic spline method is

reasonable for the Nigerian auxiliary showcase bond yields, that's a question that needs replying.

Besides the work by Sholarin (2014), to the best of our information, no other work has been done

to model or fit the zero-coupon abdicate bend for the Nigerian bond advertise. Anyanwu and

Oruh (2011), modelled the term structure of Nigerian Treasury Bills intrigued rate with the Cox,

Ingersoll and Ross (1985) demonstrate. Be that as it may, this form of displaying is dynamic

demonstrating of intrigued rates through time, but not static yield bend demonstrating (Bolder,

2015). The center of his work is on static kind of abdicate bend displaying. The other surrender

curve–related works that are done for the Nigerian bond market include Teriba (2006), who

examines the capacity of the abdicate bend and the abdicate spread to foresee development in

real outputs within the Nigerian economy.

Oyedele (2014), moreover does comparable work as Anyanwu and Oruh (2011), by considering

the relationship between the term structure of intrigued rates, on one side, and economic

activities and swelling rates, on the other side.Nkemka (2010), equally examined the use of term

structure of intrigued rates in esteeming bonds amid periods of financial mutilation. Too, Ojong,

Akpan and Nneji (2015), considered the applicability of the term structure of interest rate

speculations in Nigeria. Whereas, Isiaq and Bolaji (2016), examined the impacts of fiscal

arrangement on the term structure of interest rates in Nigeria.

However, none of the above-mentioned works models the Nigerian zero-coupon abdicate curve

for the secondary market. There is in this manner a crevice to be filled in writing as far as the

displaying of the zero-coupon surrender bend for the Nigerian auxiliary bond advertise is

concerned. Within the work by Lartey and Li (2019), it is suggested that even though the

Ghanaian auxiliary bond market is illiquid, immature and the yield quotation may well be

sporadic (AFMI, 2016), which there's not sufficient bond information within the Ghanaian

auxiliary bond advertise, a for all intents and purposes useable auxiliary advertise abdicate bend

might be displayed for the advertise. The work employments the piecewise cubic Hermite

strategy (Hermite strategy) to demonstrate the day by day recurrence auxiliary showcase zero-

coupon surrender bend for the government bonds exchanged on the e-bond trading stage of the

Ghana Fixed Income Showcase. The study states the reason for utilizing the Hermite strategy as

the truth that the strategy is continuously differentiable once and is shape-preserving and so is

appropriate for the Ghanaian bond advertise which is immature, illiquid, and has wide crevices in

between information points along the surrender spectrum. The study shows the every day

recurrence surrender bend which has many superiorities over the essential showcase surrender

bend.

Lartey and Li (2018), received the Hermite method which is compared with the piecewise cubic

spline strategy (with not-a-knot conclusion condition), the penalized smoothing method (variable

harshness punishment strategy or VRP strategy), and the Nelson-Siegel-Svensson (NSS)

strategy, in terms of both the zero-coupon and forward surrender bends. Within the case of the

zero-coupon (and standard) abdicate bends, the Hermite strategy demonstrates to deliver

exceptionally great bends which fit very well (way better than the other methods). Be that as it

may, this think about varies from Sholarin’s (2014) in numerous respects. The yields utilized for
Sholarin’s (2014)work are, for instance, the essential advertise sell off yields (Sholarin, 2014).

Indeed in spite of the fact that numerous bond markets utilize the primary market yields for

fitting their abdicate bends (e.g., the Ghanaian bond advertise), the focus of our think about is on

the secondary showcase surrender curve. Moreso, this ponder inspected the taking after:

i) Test the suitability of the Hermite strategy for creating zero-coupon, standard, and forward

surrender bends, relative to other strategies such as the piecewise cubic spline, NSS, and VRP

strategies.

ii) Compares the modelled yield curves with the by and by utilized YTM surrender curve in the

Nigerian auxiliary bond showcase.

iii) Study the common shape of the Nigerian zero-coupon yield curve from a hypothetical

perspective.

2.4 Yield Bend Strategies for Central Keeping money Purposes

Nigeria financial advertise pointers are important for financial policymakers. Developments in

costs and volumes of money related rebellious affect economic riches and financial estimation

and, through these channels, domestic investing decisions.Financial instrument cost

developments are moreover characteristic of changes in the desires of the private division

regarding economic prospects. More particularly, abdicate bends are estimated to supply a

realistic representation of the relationship between the returns and the terms-to-maturity of debt

securities at any given time (Anyanwu & Oruh, 2011). The data content of a abdicate bend

reflects the resource estimating prepare in monetary markets. When buying and selling bonds,

speculators incorporate their desires of future expansion and genuine interest rates and an
evaluation of dangers. An financial specialist calculates the cost of a bond by marking down the

anticipated future cash streams.

More often than not, the term “yield curve” alludes to the term structure of interest rates of zero-

coupon bonds without default risk.The surrender bend offers a useful set of data for financial

policy purposes and gages data approximately the expected path of future short-term rates and

the outlook for financial action and expansion (Ojonget al, 2015). The relative level of brief- and

long-term intrigued rates at a certain datedepends on advertise participants’ expectations of

future short-term intrigued rates. Therefore, the slant of the yield bend has often showed up to be

a valuable marker for anticipating future financial activity. A steepening of the bend regularly

anticipated acceleration of financial movement whereas a straightening, and in specific, an

inversion, of the bend frequently shown an inescapable lull (Nymand-Andersen, 2018). The

clarification is that a expansive positive spread between long- and short-term intrigued rates may

show that the showcase expects an increment in short-term intrigued rates since of a more

positive viewpoint for economic growth. In expansion to development desires, the longer end of

the abdicate bend may too reflect advertise participants’ views approximately drift advancements

in expansion.

2.5 The Abdicate Bend and Obligation Budgetary Instrument

When it comes to choosing fixed-income financial resources for venture purposes, it is the yield

of such disobedient, certainly not its cost that things. This can be since, as part of the fixed-

income items bunch, obligation rebellious show on a very basic level distinctive characteristics

and highlights to their value partners.

A unmistakable include of settled wage budgetary disobedient is that the greatness of their

coupon payment is pre-determined, ab-initio, and will stay settled all through the maturity period

of the obligation disobedient (within the case of plain vanilla or difficult bullet bonds). This

clarifies why the price of such instruments must vacillate in an inverse heading to intrigued rates

movements to preserve a consistent yield or return to speculators (Papageorgiou, 2002).

From an investor’s perspective, the surrender of a fixed-income money related item speaks to a

return on such an instrument that perfectly matches or breaks even with the cost of such

obligation. Approached from another measurement, the surrender speaks to the Inner Rate of

Return, otherwise known as the Abdicate to Development or Net Recovery Surrender on the

given obligation instrument. It is achieved at that point where the net display value of the given

investment breaks even with zero. At such a point, it is additionally known that the showcase

esteem of such resource is exactly break even with to its Standard value (Martellini et al, 2003;

Fabozzi, 2006).

The surrender of a obligation financial instrument too serves as a measuring stick through which

alternative debt instruments of similar features and characteristics can be compared and their

productivity discovered. The yield of a debt instrument moreover shapes the premise for

estimating such an instrument.

For these reasons, a customary stream of data almost yields is profoundly alluring to fixed-

income speculators and investigators. To the extent that the chance profile of two debt rebellious

is identical and exhibit similar characteristics, an financial specialist would select a debt

instrument that offers a higher return (Chen, 2021). This attestation applies primarily to hard

bullet or plain vanilla bonds; it certainly does not apply to option-embedded obligation

rebellious, such as callable bonds, puttable bonds, warrants and convertibles, or any other
outlandish obligation disobedient. Financial specialists show different thought processes for

locking in their speculationsfor different development lengths. It is, subsequently, considered

exceptionally supportive to offer a set of yields that corresponds to different lengths of venture

lengths to help in ascertaining the commensurate market-expected return and compare the same

against elective obligation rebellious of comparable hazard profiles and characteristics.

Genuinely, the abdicate of a budgetary obligation instrument reflects the annualized percentage

increment in the value of the venture and, as such, its curve represents a graphical appearance of

the relationship between the yields on as of now tradable obligation disobedient of the same

credit quality, against their term to maturity. The common desire of monetary showcase

members approximately the state of intrigued rate level shows itself within the level, incline and

curvature of the yield bend (Nymand-Andersen, 2018).The yield curve viably serves as an vital

marker and a solid source of data concerning the state of a debt capital market. As such, much of

the analysis and estimating activity that takes put within the obligation markets rotates around

the abdicate bend fitting for such debt disobedient.

The abdicate curve offers a set of interesting qualities, which makes it one of the foremost

powerful tools of budgetary and macroeconomic examination. Its bend gives a quick, simple and

reliable forecasting tool without the rigors of progressed specialized capabilities (Estrella &

Mishkin, 1996). It may be used to authenticate or inquiry elective conclusions gotten from

alternative economic markers. Where a critical inconsistency exists between the translation of

the surrender bend and such alternative macroeconomic pointers, it would be passable to address

the conclusions from such elective pointers and uphold the veracity of the yield bend concurring

to Choudhry (2004). The surrender bend, therefore, qualifies as a great and exceptionally solid

pointer of market sentiment, and its shape offers a huge sum of high-quality data almost the
prompt and prospects of a nation’s economy. Its slope may be a solid prologue to an economic

boom or subsidence, agreeing to (Estrella, 2006).

2.6 An Overview of Theoretical Frameworks Supporting the Understanding of the Term

Structure of Interest Rates.

The Liquidity Preference Theory posits that investors are inherently averse to risk and, therefore,

require a premium in compensation for holding securities with longer maturities. The

aforementioned pertains to the fundamental tenet that investors prioritize the acquisition of

immediate cash over the commitment of resources to a future obligation. This inclination

necessitates a risk premium as a means of compensation. Assuming all other factors are held

constant, it is reasonable to anticipate an upward trajectory of the yield curve.

The pure expectations hypothesis postulates that the yield curve is determined by the forward

rates, which are fundamentally predicated on anticipated future spot rates. In this framework,

there is no consideration of risk premia. Rather than opting for the acquisition of a long-term

bond, a prudent investor may contemplate the viability of reinvesting in short-term bonds

equivalent to the remaining lifespan of the aforementioned long-term bond. Abstracting from

risk assessments, the aggregate yield on a long-term bond investment ought to correspond to the

anticipated accumulated return on a revolving short-term bond investment. Furthermore, it can

be deduced that the mean anticipated short-term interest rate within the investment time frame

ought to be equivalent to the extended-term interest rate. An instance thereof, a yield curve

exhibiting an upward inclination, which manifests elevated long-term interest rates vis-à-vis
short-term interest rates, would indicate a presumptive escalation in short-term rates. Based on

empirical data, it has been observed that the aforementioned hypothesis tends to frequently

exaggerate projected short-term interest rates. This overestimation can potentially be attributed to

the presence of residual risk premiums. Therefore, in order to attain market anticipations

pertaining to forthcoming short-term interest rates from the yield curve, it is imperative to derive

estimations of such risk premia. The present endeavor presents a complex task, accentuated by

the observation that risk premia appear to exhibit temporal volatility. Despite possible

limitations, the expectations hypothesis remains a viable initial approach for assessing interest

rate expectations derived from the yield curve. It is noteworthy that risk premia exhibit a

tendency to remain relatively low and stable during regular market conditions, particularly for

shorter periods.

The hypothesis of segmented markets postulates that the yield curve is influenced by the

interplay of supply and demand across various sectors, with each sector exhibiting a degree of

detachment from the remaining portions of the curve. This hypothesis posits that individual bond

market segments are predominantly comprised of investors who exhibit a distinct inclination

towards investing in securities belonging to a specific maturity time frame, namely short-term,

intermediate-term, or long-term. Consequently, the configuration of the yield curve is determined

by the interplay of supply and demand dynamics across the various maturity lengths.

The Preferred Habitat Theory posits that investors possess a penchant for specific maturities

and consequently, may move to alternative maturities in the event that the gain in yield is

deemed adequate to offset the said transfer. This theory is inherently linked to the Segmented

Markets Hypothesis. The phenomenon of yield curve adjustments and alterations in

configuration is a direct outcome of market fluctuations or shocks, which, in turn, exhibit level,
slope, and curvature implications on the curve. The phenomenon of the level effect can be

observed when the interest rate varies uniformly across all maturity levels. Conversely, slope

changes are characterized by a disproportionate variation between short-term and long-term

interest rates. The dominant impact of curvature is observed in the medium-term interest rates,

whereby the yield curve takes on a more pronounced hump-shaped form than it does under

ordinary conditions. Typically, yield curves exhibit an upward sloping trend, indicative of the

fact that securities with longer maturation periods offer greater return yields compared to those

with shorter maturities. The cause underlying this pattern is the greater risk premium expected

when lenders face lengthier repayment periods.

 CHAPTER THREE

METHODOLOGY

3.1 Introduction

Various estimation techniques are available for deriving Zero-Coupon, forward rates and par

curves from observed bond prices. These methods vary in complexity and may range from

relatively simple to highly intricate. There exist two key methodologies to model yield curves:

spline-based and parametric model-based.

3.2 Spline-Based Method

The spline-based methodology is a mathematical approach utilized to interpolate or approximate

a curve function by means of a piecewise-defined polynomial that possesses a larger degree of

smoothness when compared to piecewise-defined polynomial functions of lower degree.

The spline-based methodology employs piecewise polynomials to achieve a flexible and accurate

curve fitting to the data. The implementation of splines provides a mechanism for ensuring that

the fractions that compose the piecewise function possess a smooth curvature throughout the

span of their support. In order to apply the aforementioned approach, it is imperative to designate

both the quantity and placement of knot points. Piecewise polynomials can be fitted to the

forward rate function as well as the discount function or the logarithm of the discount function.

The methodology employed by the spline base method diverges in its approach to the

determination of coefficients for each contiguous polynomial subset. The dependency of the

roughness penalty functions on maturity and their temporal variation remain unclear and warrant

further investigation within an academic context.

3.3 Piecewise Polynomial Interpolation

For certain values, we are given the function values . In some cases,

below we will also assume that we are additionally given some derivatives . We

want to find an interpolating function that satisfies all the given data and is hopefully close

to the function .We could use a single interpolating polynomial . But this is usually a
bad idea: for a large value of n, we will obtain large oscillations. We should only use an
interpolating polynomial if we know that this will not be a problem and several of the
following conditions hold

 the derivatives do not grow very fast (e.g., );

 the points are close together, and we evaluate at a point inside of the

interval ;

 the points are close together, and we evaluate at a point inside of the

interval ;

 if we want to evaluate over a whole interval [a,b]we should choose as

Chebyshev nodes for this interval.

In all other cases, it is much better to use a piecewise polynomial: We break the interval [a,b]
into smaller subintervals and use polynomial interpolation with low degree polynomials on each
subinterval. Typically, we choose a polynomial degree of about 3. This is a good compromise
between small errors and control of oscillations.

3.3.1 Piecewise Linear Interpolation

We are given x-values and y-values for . With we get

We then define as the piecewise linear function with

We then have from the error formula for polynomial interpolation with 2 points that

since the function has its maximum in the midpoint of the interval

. We see that the interpolation error satisfies where

.If we choose equidistantpoints , we have

, i.e., doubling the number of points reduces the errorbound by a

factor of 4.

However, if the function has different behaviour on different parts of the interval we can

get better results by choosing the points accordingly: If is small in a certain

region we can use a wider spacing hi; if is large in another reason we should place the
nodes more closely, so that hi is small there. In this way, we can achieve a small overall error

with a small number of nodes. We say the choice of the nodes is adapted to the
behaviour of the function f .One advantage of piecewise linear interpolation is that the behaviour
of p resembles the behaviour of f.
 wherever the function f is increasing/decreasing, we have that the function p is
increasing/decreasing. However, we have drawbacks:
 the function is not smooth: it has kinks (jumps of ) at the nodes in
general.

 the error for only decreases fairly slowly with decreasing

spacing .We would rather have a higher power like

3.4 Piecewise (Cubic Hermite) Interpolation

Piecewise cubic splines are broadly utilized to fit a smooth persistent work through discrete
information. Inserting cubic splines are well known for fitting information since they utilize low-
order polynomials and have persistently; a property that imperative (Wolberg & Alfy,
1991).However, the smoothness steady regularly damages another alluring property—
monotonicity. On the opposite, the cubic Hermite strategy guarantees monotonicity; whereas the
cubic Hermite strategy has one persistent subsidiary, the cubic spline has two ceaseless
subsidiaries. Another recognizing figure is that for cubic Hermite, the subordinate ought to be
indicated though, for the cubic splines, the subordinates are not indicated but upheld.

 .

 where .

 where .

In this case, one can construct on each interval a Cubic Hermite polynomial with

For example, on the first interval we obtain the following divided difference table:

Let
yielding the following for the interpolating polynomial on the interval :

(3.1)

(3.2)

(3.3)

(We will need the second derivative later). In the same way, we define on the interval

: The piecewise cubic Hermite polynomial is then given by

(3.4)

Then we obtain from the error formula for polynomial interpolation with 4 points
that

(3.5)

since the function has its maximum in the midpoint of the interval

.We see that the interpolation error satisfies where

. If we choose equidistant points with we have

, i.e., doubling the number of points reduces the error

bound by a factor of 16.However, if the function has different behaviour on different parts

of the interval we can get better results by choosing the points accordingly: If

is small in a certain region we can use a wider spacing ; if is large in another reason
we should place the nodes more closely, so that hi is small there. In this way, we can achieve a
small overall error

with a small number of nodes.

Again, a major advantage of using piecewise polynomials is that we can pick a non- uniform
spacing of the nodes adapted to the behaviour of the function f.
The cubic Hermite Spline has the following drawbacks:

 We need the derivatives at all nodes x . In many cases, these values are
not available.

 We have that is continuous but has jumps at the points in general.

We would like to have a smoother function .

Assuming we have data points i =0,1,...,m. Such that, equal the

term to maturity: represents the corresponding yield data point, and represents

the first derivative at .

We determine a function , such that on each sub interval , is a cubic polynomial

(3.6)

the given function is interpolated by , subject to the following conditions:

(3.7)

(3.8)
where N equals the number of interpolating polynomials and each requires data points. We

need to satisfy the total of constants, where is the order of derivative. In this
study, we use first-order derivative (i.e. ).

For each , let while satisfying the above constants, we solve for then-
unknown coefficients of each piecewise polynomial.

(3.9)

(3.10)

(3.11)

(3.12)

Substituting through into , the value of each interpolating

cubic polynomial S is determined. Each cubic polynomial produces a curve and these curves join
smoothly to form the entire yield curve. The interpolating function S can also be solved by
expressing it in terms of the basic functions and the derivatives of the original functions:

(3.13)

while satisfying the constants

(3.14)

(3.15)

one requires the following conditions

(3.16)

(3.17)
To satisfy

(3.18)

one requires the following conditions

(3.19)

(3.20)
To determine the first-order derivatives of the functions, Catymull-Rom(1974) method is used

for the estimation of

(3.21)

At the endpoints

(3.22)

(3.23)

Remark 3.4.1.Catmull-Rom method specifically models the subclass of splines that is local and
interpolating.

3.5 Piecewise( Cubic Spline ) Interpolation

Piecewise cubic splines are widely used to fit a smooth continuous function through discrete
data. Interpolating cubic splines are popular for fitting data because they use low-order

polynomials and have continually; a property that constraint (Wolberg & Alfy,
1991).However, the smoothness constant often violates another desirable property—
monotonicity. On the contrary, the cubic Hermite method ensures monotonicity; while the cubic

Hermite method has one continuous derivative , the cubic spline has two continuous

derivatives . Another distinguishing factor is that for cubic Hermite, the derivative needs to
be specified whereas, for the cubic splines, the derivatives are not specified but enforced.

Assuming we have yield data points i= . Such that

equal the terms to maturity and represents the corresponding yield data point. We need to

find a function , such that on each subinterval , is a cubic polynomial i=

(3.24)

The parameters are solved subject to the following constraints

(3.25)

(3.26)

(3.27)

(3.28)

(3.29)

The last constraint is added to impose a not-a-knot condition at both ends of the
cubic spline curve. Similar to the Hermite curve, each cubic polynomial produces a curve and
these curves join smoothly to form the entire yield curve.

Remark 3.5.1. The cubic spline, interpolated values are determined by the global behaviour of
the curve whereas, with the cubic Hermite, interpolated values are determined by local
behaviour.

3.6Variable Roughness Penalty (VRP)

Using the penalized smoothing spline (model), the forward curve can be specified as

(3.30)

The first term is the difference between the observed price and the predicted price
(weighted by the bonds duration D) summed over all bonds in the data set.

The second term is the penalty term: is a penalty function and is the spline estimation
function, based upon the criteria of smoothness, flexibility and stability. An important innovation
of this technique is that the degree of smoothing is a function of maturity and in particular that
the curve is more flexible at the short end (where the curve is likely to exhibit the greatest
curvature) than at the long end (where expectations are likely to be more smooth).

Remark 3.6.1.To control the trade-off between the smoothness of the curve and the goodness of
fit, a roughness penalty is included to penalise the excessive curvature of the forward curve. The

size of this roughness penalty is determined by a time-variant function that varies with the
horizon .

Formally, the VRP method minimizes the objective function in the

(3.31)

Where

is the observed price of the bond, is its modified duration, is the fitted price or

predicted price, is maturity, is the maturity of the longest bond and is the vector of
spline parameters.
From the above objective function (3.32), it can be seen that the VRP technique minimizes the

sum of the squared bond price residuals subject to a penalty for curvature. In addition, the
bond prices are weighted according to the inverse modified duration.

Remark 3.6.2.The optimization procedure for the VRP technique has two steps. First, the

parameters of the smoothing function , are optimized and then holding these parameters
constant, we estimate the spline parameters on a decay basis.

3.7 Parametric Approach

The foremost commonly utilized parametric models for the surrender bend are the Nelson-Siegel
and Svensson(NSS), Soderlind and Svesson models. One of the engaging highlights of these
models is that one can recoup the inferred momentary forward rate from the surrender bend and
bad habit versa.

The fundamental rule of parametric models too alluded to as function-based models is the detail
of a single-piece work that's characterized over the complete development space. While the
different approaches in this course of models advocate diverse choices of this work, they all
share the common approach that the demonstrate parameter is decided through the minimization
of the squared inductions of hypothetical costs from watched costs.

3.7.1 The Nelson and Siegel Method

Nelson-Siegel model was first proposed by Charles Nelson and Andrew Siegel in 1987. This is a
parametric function with four parameters for estimating the forward rate.

(3.32)
Integrating the forward rates function in across a continuum of maturities up to a
tenor point, yields the spot rate function as

(3.33)

Where are the parameters to be estimated in terms of

 r = zero rate;
 m = maturity.

Where,

This is the long term zero Rate of a return on a zero-coupon. It must be positive.

This parameter along with determines the term Zero Rate (the vertical intercept).

This parameter determines the magnitude and direction of the hump occurring at

This parameter positions the first hump and must be positive.

These parameters are related to the long term and short term interest rates, slope of the yield
curve and the extent of the hump in the curve.

Remark 3.7.1.Limitation of the Nelson and Siegel Model:The description of the zero rates for
different tenor points gets distorted somewhat with the Nelson-Siegel model. Hence we consider
the feasibility of generating a yield curve using Nelson-Siegel-Svensson (NSS) model.

3.7.2 Nelson-Siegel-Svensson(NSS) model

Lars Svensson in his research paper for the National Bureau of Economic Research (NBER),
Cambridge (1994), extended the Nelson Siegel functional form to enable it to take one more
hump along the tenors. He added slope change and a hump (or U shape).

Remark 3.7.2.NSS method is a parametric function with six parameters for estimating the

forward rate. .
The instantaneous forward yield curve is specified at the time as

(3.34)

Integrating (the forward yield formula), we obtain the zero-coupon yield curve
specified as

(3.35)

Where and are the additional parameters to interpolate an additional slope change and a
hump (U-shape).

Where

This parameter positions the second hump on the curve and must be positive.

This parameter, which is analogous to , determines the magnitude and direction of the
second hump.

Remark 3.7.3.Convergence

if

if

When and
One would note that

Hence,

The basic process of determining the optimal parameter for the zero rate function that best fits in
the Nigeria Bond market is as follows:

i) A vector of starting parameters is selected

ii) The zero and forward rates are determined using these starting parameters.
iii) The present value of the various bond cash flows and a vector of theoretical bond prices is
determined.
iv) Price errors are calculated by taking the difference between the theoretical and traded
prices.

Remark 3.7.4. Steps 1 & 4 are repeated until the sum of the squares of the price errors weighted
by the inverse of the respective bond's duration (the objective function) is minimized.

3.8 Filtration of Bond Data and Yield Extraction

We extracted the YTM, zero-coupon, par and forward yields from the bond data. Kalman
filtration model is adopted in this study for the filtration of the Bond data.

3.9 Kalman Bond Filtration Theory

As in the continuous-time case, the solution to the continuous discrete linear Gaussian is solvable
in closed form. A linear Gaussian continuous discrete state model has the general form.

Where and is a Brownian motion with diffusion matrix .

Assuming that the filtering solution is given by the following
,
Kalman filtration algorithm.

ALGORITHM

The Kalman filter recursion is started from the prior mean and covariance . For

, we then perform the following steps. Prediction step:

Update steps:

the Kalman gives the following distributions

Remark 3.9.1.If we wish to predict the state , the forward yield from time to some time

, then we just need to form the discretization matrices for the time step and
perform the previous prediction step.

3.10Yield Extraction
Although the FMDQ OTC provides YTM alongside the bond prices, we compute our YTM from
the bond prices and bill discount rates, using the procedure in the work by Lartey and Li (2018).
We then apply to compute the YTM, following the guidelines provided by the Securities
and Exchange Commission (SEC) and the CBN on securities settlement in Nigeria which states
that the settlement period in the secondary bond market is (SEC & CBN, 2016).

3.11 Zero-Coupon Bond(Discount Bonds)

The Zero-Coupon Bonds makes a single payment at the maturity date , we define the following

which is necessarily less than a unit price if there is a positive interest rate. On the other hand, we

expect a positive return when we invest at and receive a unit price back at , which
implies a return rate

or

One immediate use of the Zero-coupon bond prices is to price a stream of cash flows promised

by a coupon bond. Suppose a bond provides amounts at , and we use vector

notation with , then the total time present value of the

stream of cash flows is
We can use the current Coupon-bond price to recover zero-coupon bond prices, a procedure

called bootstrapping. Suppose we have denotes the present value of an entity that pays at

, then we have

3.12 Arbitrage-Free Pricing of Bonds

We consider only short models, where the driving force is always and we can view as
the market response to the short rate change for various maturities. One basic instrument that
is affected by most transparently is the money market account, and we introduce the money

market price with

And the solution is

Remark 3.12.1 as a function of describes the change of the money market account and it
is always growing as long as .

Now we can look at the opposite of , the discount factor

Which describes the discounting from to . One special case with the discount factor is when
and we introduce

s
Theorem 3.12.1. (Arbitrage Free Condition): The market is arbitrage-free if there exists a

probability measure such that the discounted zero-coupon bond price is

a martingale for each , that is

Once we have this probability measure, we can express

If we have a derivative that has a payoff at value of the derivative at should be

 CHAPTER FOUR

INFORMATION EXAMINATION AND RESULT

4.1. Information Depiction

The information utilized in this experimental ponder comprise of day by day coupon of

Government Government of Nigeria (FGN) bond from 7th October 2011 to 27th April 2023. The

information sets have a board information structure with a time measurement and a cross-

sessional (development) measurement. We have utilized a few sources, firstly, the Obligation

Administration Office Site, To begin with Bank of Nigeria Site and the Central Bank of Nigeria

Site, these has given a riches of data with respect to diverse bond issues, circular offers, bond sell

off, their exchanging costs, characteristics, bond upgrades and outline.

4.2. Parameter Examination: Nelson Siegel and Svensson Demonstrate

Surrender bends are calculated week by week from 7th October 2011 to 24th Admirable 2012

utilizing both Nelson-Siegel and Svensson models. The Parameters , and are evaluated for

Nelson-Siegel show, and , , and and for Svensson show, after which, Piecewise Polynomial

Additions were done utilizing Maple Program for the period of perception. The Nelson-Siegel

demonstrate, which has as it were four parameters, empowers us to gauge the surrender bend,

without being over-parameterized, when the number of watched bond costs is constrained

(Kladivko, 2010).

A critical shortcoming of the Nelson-Siegel show, coming about from its moo versatility, is the

goodness of fit that's lower than within the case of polynomial models.
When the bend is fitted to an sporadic set of information focuses this could result in moderately

huge deviations of show values from really watched rates (Marciniak, 2006).

Table 4.1: Nelson Siegel Svensson Model Parameters on Nigeria financial market
Table 4.2: t-statistics for the difference between NS & NSS Model

Remark4.2.1. gives information about the goodness of fit of these models and provide an
answer to which model fits better to the data, i.e. which model approximates better to the real
data points. It indicates the percentage of the total variation in interest rate which can be
explained by the model.

4.2: Results and Applications

Figures 4.1 Shows yield curves calculated and drawn, using polynomial interpolation on weekly
basis from 7th October 2011 to 24th August 2012 with associated interest rates and continuous
monthly compounding time to maturity, based on parameters estimated and presented in Table
4.1.
Figure 4.2 & 4.3: Depicts the FGN Bond yield curve over the period of observation. (November
20, 2019 to April 27, 2023)
The curve indicates that the market environment is sending mixed signals to investors who are
interpreting interest rate movement in various ways. It occurs when the market is a transition that
emits different but simultaneous indications of what interest rate will do. In other words, there
may be some signal that short-term interest rates will rise and other signals that interest rates will
fall

Figure 4.4, displays the Nelson-Siegel Zero Rate curve on Nigeria financial market on 7th
October 2011 to 24th August 2012 (the parameters for the model and determination coefficient
are presented in Table 4.1).
>
>

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 CHAPTER FIVE
CONCLUSION AND COMMITMENT TO INFORMATION

5.1. CONCLUSION

The reason of this consider was to explore the behavior of the Government government bond,

within the Nigerian bond advertise utilizing bond abdicate bends and to compare the abdicate

bends. Firstly, Nelson Siegel and Nelson Siegel Svensson Models were compared, and the

parameters were assessed. The comes about moreover appeared that the NSS show fits superior

to the information ( gives data approximately the goodness of fit of these models and give an

reply to which demonstrate fits superior to the information, i.e. which demonstrate approximates

way better to the genuine information focuses) as appeared in table 4.1 and table 4.2, which

shows the rate of the overall variety in intrigued rate which can be clarified by the models. The

surrender bends delivered for the 2011 and 2012 FGN bonds is an sign that the longer the bonds

length, the higher the yields (Figure 4.1).

Besides, the surrender bends create utilizing polynomial insertion and the spline strategies as

appeared in (Figure 4.2 and Figure 4.3): is an sign that the advertise environment is sending

blended flag to financial specialists who are translating intrigued rates development in different

ways. Regularly, intrigued rates or “yields” rise with longer-term bonds, Long-term bonds are

more hazardous than short-term bonds since there's more time for swelling to rise and eat absent

at your rule. Be that as it may, once in a whereas the yields begins to see exceptionally

comparable; now and then, long-term intrigued rates might even fall underneath short-term rates

(the abdicate bend is altered).

It happens when there's a move that emanates diverse but concurrent signs of what intrigued rate

will do. In other words, there may be a few signals that short-term rates will rise or fall.
You'll be pondering why investors would select to buy long-term settled salary venture when

there's an modified surrender bend, which demonstrate that financial specialists anticipate to get

less stipend for taking on more hazard. A few speculators in any case, decipher an modified

surrender bend as an sign that the economy will before long involvement a moderate down or

retreat which causes future intrigued rates to provide indeed lower yields. Some time recently a

lull, it is better to bolt cash into long-term speculation at winning yields because future yields

will be indeed lower.

This demonstrates that, the YTM curve may be utilized within the showcase as an critical

financial marker, is included within the transmission of monetary policy to a wide extend of

intrigued rates within the economy.

YTM may moreover be utilized within the advertise to play the part of the standard surrender

bend (since standard abdicate is essentially YTM that's break even with to coupon rate or YTM

of on-the-run bonds), but cannot be utilized to play the part of the zero-coupon surrender bend.

Hence, other than the YTM (whether for on-the-run or off-the-run bonds), the advertise too

needs a zero-coupon abdicate bend.

5.2. CONTRIBUTION TO INFORMATION

This think about contributes to the straightforwardness of the measurable fixings of calculating

and discharging day by day abdicate bends and in this way gives a source of day by day

measurements to private and public financial specialists and the common open that will offer

assistance them make taught speculation choices.

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 APPENDIX
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