Copyright © 2008 Pearson Education Canada 9-1 Chapter 9 Debt Securities

Copyright © 2008 Pearson Education Canada 9-2 Debt Securities Investor Is the lender Generally assumes less risk Less management attention required

Copyright © 2008 Pearson Education Canada 9-3 Five Groups of Debt Securities 1.Deposits 2.Money market securities 3.Mortgage-backed securities 4.Bonds and debentures 5.Canada savings bonds

Copyright © 2008 Pearson Education Canada Deposits Easy way to invest Examples Savings accounts Term deposits Guaranteed investment certificates Appropriate base for any investment portfolio

Copyright © 2008 Pearson Education Canada 9-5 Savings Accounts Availability Banks Trust companies Credit unions Caisses populaires

Copyright © 2008 Pearson Education Canada 9-6 Savings Account Features Vary by institution Some permit chequing Some require minimum balance Institutions compete on Interest rates offered Frequency of interest compounding More frequent compounding is better

Copyright © 2008 Pearson Education Canada 9-7 Term Deposits Availability Banks Trust companies Credit unions Caisses populaires

Copyright © 2008 Pearson Education Canada 9-8 Term Deposit Features Specified term usually less than a year Minimum investment usually Penalty for early withdrawal Guaranteed rate Usually higher than savings account Institutions compete on Interest rates offered Frequency of interest compounding

Copyright © 2008 Pearson Education Canada 9-9 Guaranteed Investment Certificates (GIC’s) Specified term of 1 to 5 years Minimum investment usually Some are redeemable Availability Banks Trust companies Credit unions Caisses populaires

Copyright © 2008 Pearson Education Canada 9-10 Deposit Insurance Canada Deposit Insurance Corporation CDIC Insures deposits in member institutions Maximum coverage $100,000 per account

Copyright © 2008 Pearson Education Canada Money Market Securities Large pool of short-term debt Maturities 30, 60, 90, 365 days Sold at a discount By governments By businesses

Copyright © 2008 Pearson Education Canada 9-12 Types of Marketable Securities Treasury bills Commercial paper Bankers’ acceptances Government of Canada money market strips

Copyright © 2008 Pearson Education Canada 9-13 Commercial Paper Large corporations borrow By selling commercial paper Price is discounted present value Minimum face value usually $100,000 Higher rate of return than T-bills

Copyright © 2008 Pearson Education Canada 9-14 Bankers’ Acceptances Short-term promissory notes Issued by a corporation Fully guaranteed by a bank

Copyright © 2008 Pearson Education Canada 9-15 Treasury Bills (T-bills) Short-term promissory notes Issued by federal government mainly Through Bank of CanadaBank of Canada Price is discounted present value Mature at par

Copyright © 2008 Pearson Education Canada 9-16 Secondary Market for T-bills Investment dealers Re-sell T-bills to small investors Investors must open an account With an investment dealer Usually minimum purchase of $1,000 Investor can re-sell at any time Not required to keep the T-bills to maturity

Copyright © 2008 Pearson Education Canada 9-17 Government of Canada Money Market Strips Interest coupons separated from bond Sold separately at a discount Similar to T-bills No limit on amount purchased

Copyright © 2008 Pearson Education Canada 9-18

Copyright © 2008 Pearson Education Canada Bonds and debentures Bonds Debt securities Issued By governments and corporations Interest paid periodically Matures at par value At some future date Up to 25 years

Copyright © 2008 Pearson Education Canada 9-20 Bonds Versus Debentures Term often used interchangeably Bonds Secured with property Debentures Unsecured Backed only by issuer’s reputation Most government bonds Actually debentures

Copyright © 2008 Pearson Education Canada 9-21 How Bonds Are Issued Issuer uses an investment dealer As underwriters Underwriter agrees To buy the entire bond issue At a specified price To re-sell at a slightly higher price

Copyright © 2008 Pearson Education Canada 9-22

Copyright © 2008 Pearson Education Canada 9-23 Interest Rate on New Bond Issues Affected by Interest rates in general Time to maturity Issuer's credit rating

Copyright © 2008 Pearson Education Canada 9-24 Interest Rate on Existing Bonds Affected by Different coupon rates Different degrees of risk Different maturity dates Other features Convertibility to common stock Callable Retractable

Copyright © 2008 Pearson Education Canada 9-25 Issuers of Bonds Federal government Provincial government Municipalities Corporations

Copyright © 2008 Pearson Education Canada 9-26 Bond Features Bonds may have a variety of features Callable Convertible Extendible Retractable Sinking fund Floating interest rate

Copyright © 2008 Pearson Education Canada 9-27 Callable Allows issuers To recall or buy outstanding bonds From current bondholders before the maturity date Money may come from Firm’s profits The sale of addition stock Or the sale of a new bond at a lower interest rate

Copyright © 2008 Pearson Education Canada 9-28 Convertible Permits bondholders To exchange bonds For a specified number of common shares Allows for the possibility of a capital gain

Copyright © 2008 Pearson Education Canada 9-29 Extendible Permits bondholder To extend the maturity date

Copyright © 2008 Pearson Education Canada 9-30 Retractable Permits bondholder To shorten the maturity date

Copyright © 2008 Pearson Education Canada 9-31 Floating Interest Rate Issued during a period Of rapidly changing interest rates Interest rates periodically adjusted In relation to the T-bill rate

Copyright © 2008 Pearson Education Canada 9-32 Sinking Fund Issuer sets aside money Into a fund For the redemption of the bond issue Funds held in trust By a trustee Usually a trust company

Copyright © 2008 Pearson Education Canada 9-33 Buying and Selling Bonds Bought and sold over the counter Dealers trade from their own inventory of bonds No commissions charged Dealers make money By adding a markup (spread) to their cost

Copyright © 2008 Pearson Education Canada 9-34 Yield to Maturity Interest rate that equates Current price of the bond with Present value of Interest payments And maturity value

Copyright © 2008 Pearson Education Canada 9-35 Accrued Interest Interest earned on the bond But not due And not paid to bond seller Buyer pays accrued interest Earned on the bond

Copyright © 2008 Pearson Education Canada 9-36 Bond Quotations Found in newspapers’ financial pages National Post Globe and Mail

Copyright © 2008 Pearson Education Canada 9-37

Copyright © 2008 Pearson Education Canada 9-38 Taxation of Bond Yields Depends upon whether it is Interest income 100% included in taxable income Capital gain 50% included in taxable income

Copyright © 2008 Pearson Education Canada Canada Savings Bonds Two Types of Canada Savings Bonds Regular interest bonds Interest paid annually Denominations $300 to $10,000 Compound interest bonds Interest paid at redemption or maturity Denominations $100 to $10,000

Copyright © 2008 Pearson Education Canada 9-40 Features of Canada Savings Bonds Not really bonds Issued by Bank of CanadaBank of Canada Sold by most financial institutions To Canadian residents only Guaranteed rate for one or more years

Copyright © 2008 Pearson Education Canada 9-41 Features of Canada Savings Bonds Not traded to another party Non-callable Redeemable at any time Interest is paid every November 1 No interest paid for partial months

Copyright © 2008 Pearson Education Canada 9-42