Investments Topic 3 - Fixed-Rate Securities

Question 1

Main examples of fixed-interest securities

Answer 1

• Gilts
• Bonds
• Permanent interest-bearing shares (PIBS)
• Eurobonds

Question 2

Gilts issued by the DMO, can be issued for (length of gilts)

Answer 2

5, 10, 30, 50 and 55 years. 50- and 55-year terms are newly introduced and come under ultra-long gilts.

Question 3

Gilts can be fixed-interest or

Answer 3

index-linked

Question 4

Gilt categories

Answer 4

• Short dated (or shorts) – gilts with less than 7 years to run until redemption
• Medium-dated (or mediums) – gilts with between 7 and 15 years to run
• Long-dated (or longs) – those with more than 15 to run

Question 5

How to calculate running yield

Answer 5

Question 6

How to calculate redemption yield

Answer 6

• Establish running (initial) yield
• Establish capital gain/loss from selling the security
• Divide gain/loss by number of years remaining on the gilt
• Calculate gain or loss as a percentage of the current marekt price
• Add/subtract the gained/lost yield from the inital yield

Question 7

Gilts can be bought and sold through

Answer 7

banks, stockbrokers and other financial institutions

Question 8

How often if gilft interest calculated

Answer 8

every day

Question 9

What does ex-dividend mean

Answer 9

Seller rather than the buyer is entitled to the next dividend/interest payment

Question 10

If a dividend is sold ex-dividend, what must the seller do to the price

Answer 10

Reduce it by the amount of interest they are being paid

Question 11

Characteristsic of a Normal curve

Answer 11

• On longer-term bonds there should be a higher yield as economies and investment returns are uncertain
• Normal yield curve shows yield increasing over time
• The more uncertainty over inflation and interest rates the steeper the curve as people will chase long-term security

Question 12

Characteristics of a flat curve

Answer 12

• Not as common, when rates and inflation do not really move
• Bonds bought and sold at more or less the same price

Question 13

Characteristics of a reverse (inverted) curve

Answer 13

• If interest rates are predicted to fall in the future, investors tend to move from longer to shorter-term bonds
• This is because if the rates fall, the price of bonds increases thus reducing yield
• This curve can also be caused by low supply and high demand for longer-term bonds

Question 14

Taxation of gilts/bonds

Answer 14

• Capital gains from gilts are exempt from CGT
• Interest is paid gross and is taxable as savings, giving use of the allowances

Question 15

Volatility and risk of bonds

Answer 15

• Generally less risky than shares, but can be risky if it is a low coupon for a long time
• Might lose on gilts if values are vulnerable to inflation, rises in stock market occur and shares are desirable and if increased gov. borrowing occurs and ‘floods the market’ hurting gilt prices

Question 16

Main credit rating company for corporate bonds

Answer 16

Standard and Poor’s (S&P).

Question 17

Types of corporate bonds

Answer 17

• Debentures – loan secured on company assets, on specific assets (fixed charge) or on assets in general (floating charge). Debenture holder has priority of repayment if the company folds
• Loan stock
• Convertible loan stock – refers to debenture/loans stock that contains the option to convert to the company’s shares at a set time and price
• Deep-discount bonds – pays a very low coupon on the bond, and they can be bought back
• Zero-coupon bonds – no interest paid but a deep-discount is applied so you can make a capital gain
• Junk bonds – offer a higher yield and coupon due to the financial status of the issuer
• Convertible bonds – bonds can be converted into a predefined number of shares at the bondholders request at certain times in the bond’s life. Lower coupon rate
• Contingent convertible bonds (known as CoCos) – bond is convertible into shares contingent on an event happening. Trigger events will lead to conversion and the point where the CoCos will absorb losses

Question 18

What makes a Qualifying corporate bond:

Answer 18

• In sterling and no right to redeem in other currency
• Does not have right to convert into shares
• Holder cannot subscribe for additional shares or securities
• Interest rate does not exceed commercial average
• Can be redeemable at par or on terms that are compatible with other listed securities

Question 19

Income tax on corporate bonds

Answer 19

• Interest is paid gross and interest treated as savings
• Taxation of deep-discounted securities is more complicated
• HMRC define deep-discounted securities as a security that is redeemed at more than 15% of issue price OR if the discount is less than 15%, then the discount is more than 0.5% for each year of the bond’s term
• Any gain or sale made is subject to income tax

Question 20

Eurobonds are essentially

Answer 20

long-term bonds that are sold outside of the issuing country

Question 21

There is no real definition of Eurobonds, but there are some common characteristics:

Answer 21

• Similar to corp. bonds as they have par value and redemption date, but interest can be fixed or floating
• Interest payable semi-annually or annually
• Term between 5-30 years
• There is no register of bondholders, and the interest is paid straight to the person who physically holds the bond – done online now
• Eurobonds can be traded at any time
• Issuer can choose currency appropriate for its needs
• Eurobonds are paid without deduction of tax although interest may be taxable in hands of recipient
• Higher minimum dealing amounts mean that the bonds are normally beyond the means of the individual investor
• Eurobonds listed on exchange market, most active on London and Luxembourg

Question 22

Permanent interest-bearing shares (PIBS)

Answer 22

Issued by building societies to raise capital and are broadly similar to corp. bonds – minimum dealing of £10,000 usually.

• Fixed rate on a half-yearly basis, interest paid gross and is taxable as savings
• No redemption date, and does not have to be paid back
• Ranked below all other building society creditors, not covered by FSCS

Question 23

If a building society ever converts to a bank, a PIBS turns into a

Answer 23

perpetual subordinate bond