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Copyright © 2008 Pearson Education Canada9-1
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. Deposits2. Money market securities3. Mortgage-backed securities4. Bonds and debentures5. Canada savings bonds
Copyright © 2008 Pearson Education Canada 9-4
1. 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 9-11
2. 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 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 9-19
4. 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 9-39
5. 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 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