An introduction to fixed interest securities

Fixed interest securities, often known as bonds, are a form of lending that governments and entities may use as an alternative way to raise funds. When you buy a share in a company you own a small part of that company, when you buy fixed interest securities, you become a lender to that issuer.

In return for a principal amount, the issuer intends to pay interest to the investor for a specified time. The interest rate is often fixed, but can also be floating. The principal amount invested is planned to be repaid to the investor on maturity.

There are a range of fixed interest securities available that you can invest in and trade via ASB Securities including:

New Zealand Government bonds

The New Zealand Government issues bonds to support government spending. Government bonds are typically regarded as being low risk investments. Although they’re not guaranteed, the New Zealand Government has never defaulted on its debt obligations. Government bonds generally offer lower returns than corporate bonds.

Corporate bonds

Corporate bonds are issued by a company to raise funds for a variety of reasons. They generally offer higher returns than government bonds because they are considered to be higher risk. A feature of corporate bonds is their ‘seniority’ to other types of corporate debt. This means that in the event of a company falling into financial difficulty, holders of corporate bonds would generally receive their money back before other debt or share holders.

You can find more information on the New Zealand debt market including listed corporate bonds on the Financial Markets Authority and NZX websites.

In addition to corporate bonds, there are number of other financial instruments available to corporations to use to raise money.

Capital bonds or capital notes

Companies may issue capital notes to raise funds. It’ll generally have a fixed interest rate (coupon) and a specific ‘election date’. What happens on election date can vary between different types of capital note, and is specified in the offer documentation.

Step-up securities

A step-up security generally pays a fixed interest rate or margin up until a specified date (the step-up date). Beyond the specified date - if the security has not been redeemed by the issuer by the specified date - the distribution payment may step-up to a higher rate. The step-up rate is fixed prior to the issue of the security. A single security can have more than one step-up date during its lifetime.

Reset securities

These are typically issued with a fixed interest rate, which is payable up until a specified date (the reset date). What happens on reset date can vary between different types of securities, and is specified in the offer documentation.

Other corporate debt instruments

ASB Securities can also provide you access to other corporate-issued fixed income securities including:

• Redeemable Preference Shares - these are a hybrid of a share and a fixed interest security. These shares have a fixed maturity date and are usually redeemable by the issuer for cash or ordinary shares at maturity.
• Perpetual Preference Shares - this is also a hybrid of a share and a fixed interest security. There is no specified maturity date, however the issuer has the right to repay on specified dates and in specified circumstances.

Term deposits

If an income stream is important to you but the fixed interest securities described above do not meet your needs or you wish to diversify further, you may wish to consider a term deposit.

A term deposit is a low maintenance investment option that earns a fixed return over a set time period. If you are an ASB Securities client, we can assist with opening term deposits for you.

Like any investment, bonds and other fixed interest securities come with their own risks. Before you invest, you need to understand the risks, which may include:

Credit risk

The risk that the issuer fails to pay you interest or pay back the money they owe you when the bond matures.

S&P Global Ratings and Moody’s are two internationally recognised ratings agencies that assess the creditworthiness of debt securities and their issuers. The ratings agencies don’t assess all debt securities, but checking whether they’ve rated the bond you’re interested in is a good place to start when you’re looking at fixed interest securities. The Financial Markets Authority website also has some information on credit ratings.

Liquidity risk

If you can’t easily sell your security for cash before its maturity date, this is known as liquidity risk. This could occur if there is a lack of buyers.

Interest rate risk

Broadly speaking, fixed interest security prices and interest rates move in opposite directions. Therefore, fixed interest investors need to understand the risk that if interest rates rise, the value of bonds will typically fall. So if you have to sell your bonds before they mature and interest rates are high, you may make a loss on your investment or vice versa.