Cash and fixed interest securities Flashcards
Cash characteristics
Security but no inflation protection Pays interest gross No investment risk No capital growth Liquid Higher rate for reduced access Remember rate calculation 1+r^n
Cash risk
Creditwortiness of Banks (can check ratings and look at tier one capital) FSCS scheme is £85,000 Inflation Interest rates change Exchange rate risk
Help to buy ISA
- £200 gets £50 bonus - maximum of £3000
- for homes to £450k in London and £250k elsewhere
- max initial is £1200 - max monthly is £200
- closes off at 30.11.2019
NS&I cash accounts
Tax Free = ISA and Premium Bonds
Growth= 1 or 3 year fixed term
Income=1 or 3 year fixed term
Savings accounts
Treasury bills
Issued by government to
finance daily cash flow
Routinely issued at weekly auctions
1, 3 & 6-month maturities (also 12 months but so far, no 12- month bill tenders have been held)
No interest paid - issued below par and repaid at par on maturity
Government backed and highly liquid
Certificates of Deposit
Receipts from banks for
deposits placed with them
Fixed rates of interest & fixed term (can trade prior to maturity)
Interest paid at maturity
Interest rate depends on market rates & bank’s credit rating
Commercial Bills
short-term negotiable debt instruments issued by companies Issued at discount to maturity value Typical maturities of between 30 and 90 days Unsecured Reduced liquidity
Fixed Interest Securities
- Issued by government, companies or other bodies to raise money for long-term borrowing
- Bond owner receives regular interest and repayment of capital at maturity
- Negotiable - can trade
- Fixed interest - borrower pays fixed rate for duration of loan
- Debt instrument
Characteristics of fixed interest securities (bonds)
• Fixed rate of interest • Fixed redemption value (par) • Fixed redemption date • Pricing - traded on par value, mid-market price quoted in FT (represents mid-point between buying & selling) • Clean price - ignores accrued interest
Accrued Interest
• Interest is paid twice yearly, but accrues daily
• Cum dividend - purchaser receives full 6 months’ interest (but pays accrued interest up to
settlement date to seller)
• Ex-dividend - where seller receives 6 months’ interest (but price adjusted to reflect this)
• Dirty price is the clean price +/- interest adjustment
Bond title
Name of issuer, coupon, maturity
Bond markets (primary, secondary, other currency market)
• Primary
o Government issue new gilts weekly
o Investors submit bids for price & quantity
o Other companies issue less frequently & use investment banks to manage
• Secondary
o Used for subsequent trading after issue
o Three sterling markets; Government sector, Corporate sector, Sterling loans to foreign
borrowers
• Other currency market
o Eurobond market (international bonds)
Types of risk (fixed interest)
Interest rate, liquidity, inflation, currency, default, market risk.
Three types of yield curve
Normal - Rising positve curve, higher yields for longer terms.
Flat curve - income similar for a long and short term, when economy is stable and no radical change expected.
Inverted curve - yields on longer term bonds are lower. Casued when investors expect short term rises to interest rates but lower long term rats.
DMO definitions
Short - less than 7
Medium - 7 to 15
Long 15 years plus
Index linked gilts
- Interest & capital repayment adjusted with inflation (using RPI)
- Lower yields than conventional stock
- Profits on disposal are CGT exempt but interest is taxable
Repo Market
• Sale & repurchase agreement
• One party agrees to sell gilts to another party
• With a formal agreement to repurchase equivalent securities at an agreed price on a specified
future date
• Transfer of assets - but operates as form of short-term lending
• Bank of England uses repo market to influence interest rates
Strips Market - Gilts
• Separating conventional gilts into interest (coupon) and redemption payments
• Which are then traded in their own right
• A 5-year gilt can be stripped to make 11 separate securities (5 x 2 coupon payments + 1
redemption payment = 11)
Corporate Bonds
• Allows companies to borrow money for long periods at fixed rate of interest o Greater risk than gilts so higher yields
o Prices typically more volatile
o Liquidity issues for lower quality bonds
o Wider spread on buying & selling prices o Credit ratings can change/affect prices
THINK RISKS
Debentures
- Written acknowledgment of debt
- Established by trust deed
- Fixed - charged over a specific asset
- Floating - general charge over company asset
Convertible Loan Stock
- Offers holders the option of converting to ordinary shares
- Conversion dates and rates are specified.
- In the event of conversion CGT is chargeable.