CSI Global Education Inc.
Investment Products
CHAPTER 6: Fixed-Income Securities: Features and Types
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Chapter Highlights
• Corporations and governments borrow for a variety of reasons:
– finance future growth
– finance current operations
• Significant evolution in the market for debt and fixed-income securities: many types and features to choose from
• Common characteristic with most fixed-income securities: payment of a regular income stream
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Debt or Fixed-Income Securities
• A type of security that promises to pay the lender rent (“interest”) and returns the principal (“par”) at a specified date.
• The security may or may not be secured by a specific pledge.
• The debt is typically outstanding for more than one year.
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Rationale Behind Issuance of Debt
• Matching term of assets with term of liabilities
• Use of financial leverage
• Financing deficits
• Financing growth opportunities
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Bond Features
Coupon Rate
• the expressed rate of interest income paid by the issuer
• typically fixed for the term of the security
• some bonds do pay a variable coupon rate
Par Value
• the nominal or face value of the bond
• the amount the issue pays at maturity of the security
• quoted using a base value of 100
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Bond Features
Term to Maturity
• the remaining life of a bond
• the date on which the bond matures and the principal is returned to the holder
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Categorizing Bonds by Term to Maturity
Money Market
• Up to one year term
Short-Term Bonds
• Up to five years remaining to maturity
Medium-Term Bonds
• From five to ten years remaining to maturity
Long-Term Bonds
• Greater than ten years remaining to maturity
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Callable Bonds
Callable (Redeemable)
• issuer may pay bond off (i.e. call it in) before maturity
• depends on behaviour of market interest rates
• call price typically set above the par value of the bond
• premium seen as a compensation for being called before maturity
Question:
When would the issuer find it advantageous to call a bond?
What if the bond was ‘non-callable’ or ‘non-redeemable’?
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Convertibles
• a ‘two-way’ security
• combines the advantages of a bond with the option of exchanging the bond for common shares
• with the conversion privilege the holder has an opportunity to participate in the capital appreciation of the underlying shares
• the feature makes the issue more attractive or saleable
• bondholders must be aware of forced conversion clauses
When to convert to the common shares?
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Sinking Fund and Purchase Fund Debt
Sinking Funds
• Sums of money which are set aside out of earnings each year to provide for the repayment of all or part of a debt issue by maturity
Purchase Fund
• A fund set up to retire through purchases in the market a specified amount of the outstanding bonds or debentures if purchases can be made at or below a stipulated price
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Extendible and Retractable Bonds
Extendible debt
• Bonds that are issued with a short maturity term but with the “option” for the holder (or issuer) to exchange the debt for an identical amount of longer-term debt
Retractable Bonds
• Bonds are issued with a long maturity term but with the option for the holder (or issuer) to turn in the bond for redemption at par several years sooner
When would the issuer elect to exercise either option?
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Types of Bonds – Government
Marketable Canada and Provincial Bonds
• marketable & transferable
Canada Savings Bonds
Provincial Savings Bonds
• purchased only by provincial residents
• purchased only at a specified time of the year
Instalment Debentures (Serial Bonds) – municipal
• part of the bond matures each year during the term
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Treasury Bills
Features:
• Offered in $1,000 increments
• Original terms of 3-month, 6-month and 1-year maturities
• Do not pay interest
– sold at a discount and mature at 100 (par)
– difference between purchase price and par is the returnon the investment
– this return is taxable as income and not as a capital gain
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CSBs: Basic Characteristics
• Issued by the Federal Government and must be sold back to the government – i.e. no secondary market trading
• Redeemable at par at any time
• Non-assignable, must be registered in the name of an individual
• Can be purchased in denominations as low as $100
• Limits placed on the total amount any one person can purchase
• Market values are not affected by changes in the interest rates
• Available only to Canadian residents
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Types of Corporate BondsMortgage Bonds
• secured by pledge of land, buildings or equipment
Collateral Trust Bonds
• secured by pledge of securities
Equipment Trust Certificates
• secured by equipment – for example, railway cars
Debentures
• unsecured – general credit of issuer
Subordinated Debentures
• junior to other securities or debt
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Types of Corporate Bonds
Corporate Notes
• rank behind all other fixed-interest securities of the issuer
Foreign Bonds and Eurobonds
• issued in currency and country other than issuer
Units
• package of two or more corporate securities
Strip Bonds (Zero Coupon)
• principal repayment part of high-quality bond
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Foreign Bonds and Eurobonds
Domestic Bonds:
Bonds denominated in the currency and the country of the issuer.
Foreign Bonds:
Bonds issued in a currency and country other than the issuer.
Eurobonds:
Bonds denominated in a currency that is different from the country of issue. The issuing country and the country that the bond is issued in are also different.
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Foreign Bonds and Eurobonds
Example: A Canadian company issued bonds denominated in Japanese Yen in the Japanese market, these would be foreign bonds.
Example: Bonds issued by a Canadian company or government in Japan, denominated in U.S. dollars would be Eurobonds.
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Summary
Issuer: Issued in: Currency: Called:
Can. Canada Cdn$ ___________
Can. Germany Euros ___________
US France Sterling ___________
Can. Italy Cdn$ ___________
UK US US$ ___________
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Summary
Issuer: Issued in: Currency: Called:
Canada Canada Cdn$ Domestic
Canada Germany Euros Foreign
US France Sterling Eurobond
Canada Italy Cdn$ Eurobond
UK US US$ Foreign
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Explain the Following Bond Quote
XYZ Co 11½ 1 June /14 99.25 99.75 11.75
• XYZ is the company
• 11½ is the coupon
• 1 June /14 is the maturity date
• the bond matures on June 1, 2014
• 99.25 represents the percentage of par (the bid price)
• 99.75 represents the ask price
• 11.75 is the bond’s yield to maturity