FAQ
Which bonds (notes) are generally available?
The issue and transfer of bonds are covered by the Corporations Act 2001. Retail investors are able to buy and sell government and semi-government bonds as these issuers are exempt from the disclosure provisions of the Corporations Act 2001. To date, most non-government bonds issued by banks and corporations are issued to wholesale investors as defined in the Corporations Act 2001 and are not sold to retail investors although some bonds, such as the recent Tabcorp 2014 retail bond, are listed and traded on the ASX. Once a wholesale bond has been in circulation for 12 months from its issue date (a ‘seasoned bond’) any investor can purchase the bond in the secondary market.
Australian corporate bond issuers include companies such as Telstra and Woolworths. FIIG can provide a list of current bonds available in the secondary market on request. From time to time FIIG is also appointed as a broker for new issues of bonds by ADIs and companies.
What factors might influence an investor’s selection of a bond?
Prime factors include:
- the credit quality of the issuer and the risk appetite of the investor
- the term of the bond, or the period to the final maturity date (bearing in mind any first or subsequent call dates)
- the coupon rate and frequency (depending on the investor’s income or liability requirements)
- the yield
- relative value compared to others with similar risk characteristics
- the investor’s view on future interest rates
- the structure of the bond (including the obligations of the issuer, covenants, etc)
- convertability into equity
How do investors buy bonds?
Most bonds trade over the counter (OTC) which means that trades do not take place on an exchange but are negotiated directly between buyers and sellers or by using a fixed income broker. An investor will contact a fixed income broker (such as FIIG) who will provide yields and prices at which they will seek to buy and sell bonds. An investor can select a particular bond based on preference for issuer, coupon, maturity and yield and request an offer yield or offer price for that security, which is the yield at which the dealer will sell that bond to the investor. Some bonds are listed on the ASX.
What factors are reflected in the price of a bond?
The price of a bond is the net present value of the future coupon and principal payments discounted using current market yields. Current yields reflect market perceptions of a variety of factors, including perceptions about the direction of monetary policy. The capital price (or clean price) of a bond excludes any accrued but unpaid interest while the gross price (or dirty price) includes any accrued but unpaid interest.
How and when do investors pay for a bond purchase?
Unlike shares there is no exchange for most bond trades and brokers will find buyers and sellers who negotiate prices. Settlement for purchases and sales takes place three business days (T + 3) after the contract is issued (being the day upon which the transaction was made). Investors will be issued with instructions on where the funds should be sent to settle the transaction. New investors must comply with the identification requirements.
What initial paperwork does an investor receive after purchase of a bond?
Investors are issued with a contract note raised on the day the transaction was undertaken with full details of the transaction and instructions for settlement.
What broking fees, if any, does an investor pay when buying or selling bonds?
No broking fees are usually payable on OTC bond trades. Fixed income brokers such as FIIG receive a margin from trading as principal for the purchase and sale of bonds.
Do bond or note holders receive a certificate for their holding?
In most cases no. Bonds are held electronically through Exigo (previously Austraclear) at a registry or in the absence of an Exigo account in safe custody. If bonds are held in safe custody with a custodian, holding statements are available as well as statements recording sales and purchases of bonds held in the safe custody account. FIIG can arrange safe custody accounts for its customers.
How and when do investors receive their coupons?
Coupons (interest) are paid on specified dates by the issuer to the holders of the bonds recorded on the registry. The issuer determines the coupon frequency which can be monthly, quarterly, semi-annually or annually. Fixed rate bonds typically pay semi-annual coupons and floating rate notes (FRNs) and CPI bonds typically pay quarterly coupons. A term sheet or pricing supplement can be obtained from FIIG which outlines the coupon payment dates and other terms and conditions of specific bonds. The coupon is paid by the issuer to the registry who in turn distributes it to investors or custodians. Custodians will then transfer the coupons to investors. Payment can be electronic or in some cases by cheque. The process is the same for repayments for bonds that have been called or have reached final maturity date.
Does an investor have to hold a bond until maturity?
No. While many investors choose to hold bonds to maturity, bonds are transferable securities which can be sold prior to maturity. If investors sell a bond prior to maturity the return earned on the bond for the period held may be higher or lower than the coupon or yield, depending on movements in interest rates, liquidity and other factors.
How do investors sell bonds before maturity?
Bonds can be sold prior to maturity by approaching a fixed income broker and requesting a bid for the bonds. The bid yield or bid price will reflect prevailing interest rates, liquidity and other factors. If you sell a bond prior to maturity, the return earned on the bond for the period held may be higher or lower than the coupon or yield, depending on movements in interest rates. Some bonds can be traded on the ASX.
How are bonds taxed?
Generally, coupon income from bonds is subject to income tax. Capital gains may also be subject to tax. Investors should seek independent taxation advice specific to their circumstances.
Is stamp duty payable on buy and sell transactions?
In most cases stamp duty is not payable on bond transactions.
Can bonds provide protection for investors from rising inflation or rising interest rates?
Not all bonds are equally affected by rising interest rates or inflation. Examples of bonds that offer protection from inflation and rising interest rates include:
- short-dated money market securities
- floating rate notes
- inflation linked bonds for longer term protection against inflation
What factors might influence an investor to sell a bond?
Some of the factors are as follows:
- a change in the investor’s view on interest rates or credit quality of the issuer
- the opportunity to realise a capital gain on sale of the bond
- a decision by the issuer not to call on a call date (or perhaps concern over a rumour)
- a change in the issuer’s circumstances, perhaps causing a rating downgrade
- better relative value from alternative bonds
What is the difference between a wholesale and a retail bond?
A wholesale bond refers to a debt security which, at the time of issue, could be sold only to wholesale clients or investors as defined in the Corporations Act 2001 on the basis that any disclosure (e.g. information memorandum) was not made in accordance with the retail disclosure requirements of the Corporations Act 2001. Wholesale bonds trade in the OTC market rather than on an exchange. In certain circumstances, a wholesale bond can be sold to retail investors in the secondary market after a period of 12 months from the date of issue. The number and volume of wholesale bonds outstanding significantly exceeds that of the retail bond market.
A retail bond refers to a debt security which, at the time of issue, can be sold to retail clients and investors as well as wholesale clients and investors as defined in the Corporations Act 2001 on the basis that an appropriate disclosure document (e.g. a prospectus) has been prepared and lodged with ASIC and provided to retail investors in accordance with the Corporations Act 2001. Retail bonds may be listed and traded on the ASX.
Retail investors generally need a minimum of $1,000 to $5,000 to invest, whereas wholesale investors typically need $500,000.
How do bond holders find out the current value of their bonds?
FIIG or fixed income brokers can provide investors with bond valuations. Some bond pricing information may be available from the ASX.
Market timing versus buy or hold strategies
Long term holders seeking a regular coupon may buy fixed income securities on issue and hold to maturity. Others may seek a higher yield by buying at a time when a discount to face value is available (i.e. market timing) and then hold to maturity.
As with most asset classes, the benefits of good market timing and a hold to maturity strategy can be the delivery of a long term higher yield than would normally be available.
How and when do investors receive funds on maturity?
Typically the face value of the bond plus the final coupon is paid to the investor’s account on the agreed maturity date (being either a call date or final maturity date) either via Exigo or the custodian.
What are some of the benefits of investing directly in bonds over investing in a managed bond fund?
- investors have total control over the selection of assets and the timing of purchases and sales of these assets
- investors in direct debt securities are not affected by the decisions of other investors, for example, the impact of a large number of withdrawal requests leading to a freeze in redemptions
- the investor has the ability to better match asset cash flows with ongoing and future liabilities
- investors in direct debt securities can time transactions to best suit their tax planning objectives
- the absence of fees normally levied by the managers of managed funds
- the lack of transparency of what bonds are held by the managed fund - for example, some enhanced cash funds hold shares (equities)
- the lack of certainty of return as managed funds operate on a pooled return after the fund managers fees
- less uncertainty with regard to asset cash flows as distributions from managed funds may be frozen for reasons including the non-payment of coupons by the issuers of the underlying assets
What does the term ‘investment grade’ mean in credit rating terms?
All bond or FRN issues with a minimum S&P rating of BBB (or equivalent) are regarded as being investment grade. Investment grade credit is usually more liquid than noninvestment grade credit.
When dealing with FIIG’s term deposit service are investment funds sent to FIIG?
No. The investor remits the funds directly to the ADI with whom they have chosen to invest.
When dealing with FIIG’s term deposit service are investment funds pooled with other investors?
No, the investor holds an account in their name with the ADI with whom they have chosen to invest.
How is term deposit interest calculated?
Interest is calculated using the simple interest formula: principal × (rate / 100) × (days / 365)
So $100,000 invested for 90 days @ a rate of 6.50% would earn: $100,000 × (6.50 / 100) × (90 / 365) = $1,602.74
Can I get my money back before the maturity of a term deposit?
In most cases funds can be returned to investors prior to the maturity date of the term deposit, however there may be some exit fees payable and/or penalties may apply if market interest rates have changed. ADIs will have their own requirements in relation to early repayment and these will be disclosed in their disclosure documents.
Why do I need to complete the Identification Forms?
Completion of identification forms is a legal requirement for any investment. If an investor is not properly identified an investment cannot be accepted.
Is my term deposit transferable?
Term deposits are not transferable. Investors who need access to funds should consider shorter-dated term deposits, a 24-hour call facility or short term transferable securities issued by the same institution.
How often do interest rates change?
The official cash rate is reviewed and set by the Reserve Bank Board (RBA) at its monthly meeting. Term deposit rates offered by ADIs are reviewed and often changed on a daily basis depending on the ADI’s need for funding.
Longer term rates move in anticipation of future changes to rates and monetary policy as administered by the RBA.
