Download Introduction to Investments

Introduction to Investments
MTH6100 Actuarial Mathematics
Fixed Interest Securities
• Issued by Governments & companies when they wish to borrow
money (usually long term money).
• Usually listed & tradeable
• Priced per nominal amount of bond (eg per £100 nominal)
• Regular interest payments (“coupons”) of known amount paid until
date of maturity (“redemption date”)
• “Par” means the nominal amount
• Bond prices and redemption amounts are defined in relation to par “at par” “above par” and “below par”
Fixed Interest Securities - Example
Vodaphone 5.625% 4 Dec 2025
• Annual coupon of £5.625 per £100 nominal.
• Repayable at par in December 2025.
• Current price is above par at £122.281 per £100
nominal.
• Pre-tax IRR to an investor at current price is 2.75% pa.
This is known as the “gross redemption yield”.
• The running yield is the term for the immediate cash
return to an investor before allowing for tax and any
capital gains or losses on the bond.
• Running Yield = 𝐶𝑜𝑢𝑝𝑜𝑛 𝑝𝑒𝑟 £100 𝑛𝑜𝑚𝑖𝑛𝑎𝑙
=
5.625% 𝑥 100
122.281
= 4.6%
𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 £100 𝑛𝑜𝑚𝑖𝑛𝑎𝑙
Government Bonds v Corporate Bonds
Government Bonds
Corporate Bonds
• UK gilts, US treasuries, JGB, German
bund
• Known by name of issuer
• Often considered very low risk (but…)
• Risk depends on quality of issuer
• Markets usually large and liquid
• Markets largely illiquid except for
largest issues
• Usually easy to buy/sell with low
trading costs
• Higher trading costs
• Insurer/pension fund demand for long • Many insurers and pension schemes
term and index linked bonds reducing
would follow a “buy and hold”
liquidity for some issues
strategy
“57 Varieties” of Corporate Bond
Debentures
Bonds that provide some sort of security to investors.
Example: A mortgage debenture
Unsecured
Bonds with no special security for investors. Investors rank
alongside other creditors in the event of bankruptcy.
Eurobonds
A particular form of bond which is traded internationally and
which is often issued in $ or Euro. Typically for larger more
liquid issues.
Convertibles
Convertible into shares of the company in some conditions.
Two broad scenarios:
i) Issued by bank/insurance company as part of their
regulatory capital; or
ii) “conversion option” added to make bond more attractive
to investors.
Asset Backed Securities
Fixed interest securities backed by income producing assets.
Example: utility cashflows, “Bowie bond”
Certificates of Deposit
Short term borrowings (up to 6 months by banks and building
societies).
Typical Problems
• Explain the key characteristics of a {government security}
• Determine the price…
• Determine the gross or net redemption yield…
• Analyse impact of bond restructuring
• Complexities:
• Tax
• Optional redemption dates
• Index Linked Securities