Are Stock Markets Over-Valued?

Prices have gotten so high that “finding value in stock markets at present is like looking for the sixpence in a Christmas pudding,” wrote Duncan Lamont, head of research and analytics at Schroder Investment Management. Value is there, “but it’s hard work finding it. Others round the table are likely to end up disappointed.”

This is true globally, and according to Lamont, of five major equity regions, only one “could arguably make a case for being attractively valued,” as seen in the following chart. And this is based on data upto 2017, more current information many suggest it is worse now with indices moving further up.

Lamont’s analysis looks at five major regions — the U.S., the U.K., Europe (excluding the U.K.), Japan and emerging markets — and evaluates them based on five valuation measures: price-to-book, dividend yield, both forward and trailing price-to-earnings ratios, and CAPE, or the cyclically-adjusted price-to-earnings multiple.

Based on these measures, the U.S. stands out as the most expensive of the major market regions, with prices at least 10% above their 15-year average on four of the five valuation metrics. The forward P/E is 19, above the historical average of 15, while the trailing P/E of 24 tops the long-term average of 18. The average U.S. price-to-book ratio is 3.3, compared with the historical average of 2.8.

Perhaps the most ominous reading is the CAPE, which compares the S&P to its average, annual inflation-adjusted earnings over the previous 10 years. At 31, it is above the 15-year average of 25, and nearly twice a long-term average of 16.8 that goes back to 1881. The only other times it has topped 30 occurred in 1929, before the Great Depression, and between 1997 and 2002, during the dot-com bubble.

The fifth metric, dividend yields, shouldn’t offer much comfort to investors. The average comes in at 1.9%, which is essentially even with the long-term average of 2%. Other countries currently boast much higher yields. Australia, for example, has an average yield of 4.2%, according to Bespoke Investment Group.

While the other four regions Lamont studied look better than the U.S., they aren’t exactly exciting buys. Europe, excluding the U.K., is seen as overvalued on three of the five metrics, including all CAPE and both forward and trailing P/Es. On the other two categories, it is simply fairly valued. The U.K. by itself counts as overvalued on both trailing and forward P/E, but is seen as fairly valued otherwise.

Emerging markets are also seen as overvalued in three of the five valuation categories (both forward and trailing P/Es, and dividend yields). However, they are undervalued on the CAPE metric, which comes in at 15, below the long-term average of 16.

Japan is the only region not to be significantly overvalued on any of the five metrics. While it is slightly elevated on price-to-book and the CAPE ratio, it is modestly undervalued on forward P/E and dividend yields. The trailing P/E, at 16, is more than 10% below its 15-year average of 18.

Reference:

Ryan Vlastevica, This 1 chart shows the U.S. stock market is the most expensive in the world www.marketwatch.com  

China’s Rare-Earth Strategy

(Reuters) - Rare earth elements are used in a wide range of consumer products, from iPhones to electric car motors, as well as military jet engines, satellites and lasers.

FILE PHOTO: Samples of rare earth minerals from left: Cerium oxide, Bastnaesite, Neodymium oxide and Lanthanum carbonate at Molycorp's Mountain Pass Rare Earth facility in Mountain Pass, California June 29, 2015. REUTERS/David Becker/File Photo

Rising tensions between the United States and China have sparked concerns that Beijing could use its dominant position as a supplier of rare earths for leverage in the trade war between the two global economic powers. China supplied 80% of the rare earths imported by the United States from 2014 to 2017. China is home to at least 85% of the world’s capacity to process rare earth ores into material manufacturers can use, according to research firm Adamas Intelligence. It would take years to build enough processing plants to match China’s processing capacity of 220,000 tonnes - which is five times the combined capacity of the rest of the world. Alternative processing plants would struggle to compete with China’s low costs in the future, should trade tensions abate.

WHAT ARE RARE EARTHS USED IN?

Rare earths are used in rechargeable batteries for electric and hybrid cars, advanced ceramics, computers, DVD players, wind turbines, catalysts in cars and oil refineries, monitors, televisions, lighting, lasers, fiber optics, superconductors and glass polishing.

Several rare earth elements, such as neodymium and dysprosium, are critical to the motors used in electric vehicles.

Some rare earth minerals are essential in military equipment such as jet engines, missile guidance systems, missile defense systems, satellites, as well as in lasers.

WHICH COMPANIES ARE MOST DEPENDENT ON CHINESE SUPPLIES?

Companies such as Raytheon Co (RTN.N), Lockheed Martin Corp (LMT.N) and BAE Systems Plc (BAES.L) all make sophisticated missiles that use rare earths metals in their guidance systems, and sensors. Apple Inc (AAPL.O) uses rare earth elements in speakers, cameras and to make phones vibrate.

The United States imported $160 million of rare earth compounds and metals in 2018, up nearly 17% from 2017. Around 60% of it was used in catalysts for oil refining and in vehicle engines.

WHAT ARE RARE EARTHS AND WHERE DO THEY OCCUR?

Rare earth metals are a group of 17 elements - lanthanum, cerium, praseodymium, neodymium, promethium, samarium, europium, gadolinium, terbium, dysprosium, holmium, erbium, thulium, ytterbium, lutetium, scandium, yttrium - that appear in low concentrations in the ground.

HOW ARE RARE EARTHS AFFECTED BY U.S. TARIFFS?

So far, the U.S. government has exempted rare earths from tariffs on Chinese goods.

HOW HAVE RARE EARTHS PRICES REACTED TO THE RISING TENSIONS?

The price of neodymium, mostly used in magnets, has surged 30% to $68.5 per kilogram since April, while dysprosium, also used in magnets, has risen 30% to $290 per kilogram in the same period.

Both materials are crucial. Neodymium enhances magnetic force but its performance declines under high temperature. Since motors can run very hot, dysprosium is added to help the neodymium resist heat. As more electric and hybrid vehicles hit the market, demand for the minerals is expected to soar.

WHAT ABOUT MALAYSIA AND LYNAS?

Dennis Ignatius, former Malaysian ambassador, is of the view Lynas is free to promote the company as a strategic alternative to China but the people of Malaysia shouldn’t be asked to pay the price for it in terms of health risks and environmental degradation. If Lynas is of such great strategic importance to the entire free world, perhaps countries like Japan, the US and Australia should share the burden by at least agreeing to store the toxic waste (now amounting to more than 450,000 tons) in their own countries instead of dumping it here.

In recent months, Malaysians have become increasingly aware of the dangers posed by toxic waste with schoolchildren the biggest victims. It is a harbinger of what is to come if the people themselves do not demand that the government they voted into office do far more to protect their environment. If the government fails to do its duty, the people must be ready to take to the streets once again to make their voices heard. Putrajaya must understand that the health, safety and well-being of Malaysians must take priority over geopolitics, foreign corporations or profits.

Reference:

U.S. dependence on China's rare earth: Trade war vulnerability www.reuters.com

Rurika Imahashi & Ck Tan, China's rare-earth strategy versus US risks backfiring www.asia.nikkei.com 

Dennis Ignatius, Lynas: Profits, politics & people www.freemalaysiatoday.com

Currency Wars in the Open?

Most wars use guns while trade wars are fought with tariffs. Currency wars are stealth battles. Normally, no country will admit to one. Why? Because no one wants a retaliation, especially if you are trying to export more by driving down exchange rates.

But the U.S. is different, President Trump brings out hostilities into the open by his misuse of Twitter. U.S. officials accuse China, Germany, Russia and Japan of gaining an advantage by keeping their currencies undervalued. Trump wants to move away from decades-long “strong dollar” policy. Weak dollar means “strong” America according to him (Trump). It may narrow trade deficit and improve earnings for U.S. companies in the short-term.

The most famous frenzy of competitive devaluations came during the Great Depression. Many abandoned the gold standard. Until 1971, the Bretton Woods system prevented the beggar-thy-neighbour strategies by linking value of currencies to the U.S. dollar. More currently, large countries allow market forces to determine exchange rates. So deliberate devaluation is rare.

So is Trump up the wrong tree? Yes, in the long-run, it is, productivity, innovation, inflation, growth rates, interest rates and a host of other variables (including speculation) that determine currency changes. In the short-term, however, Trump may win a battle or two but he will lose the war and hopefully his Presidency!

Reference:

1. How Currency Wars are Like Real Wars – for Wealth, Lucy Meakin  www.bloomberg.com

2. Albert Edwards: The US Is About To Take Global Currency War To A Whole New Level, Tyler Durder, ZeroHedge, 11 July 2019

CFA Institute Investment Foundations Program: Chapter 9 – Debt Securities (Part II)

In a previous article, we introduced the CFA Institute Investment Foundation Program (Read more here).  It is a free program designed for anyone who wants to enter or advance within the investment management industry, including IT, operations, accounting, administration, and marketing.  Candidates who successfully pass the online exam earn the CFA Institute Investment Foundations Certificate.

There are total of 20 Chapters in 7 modules, covering all the essential topics in finance, economics, ethics and regulations.  This series of articles will highlight the core knowledge of each chapter.

Chapter 9 provides an overview of quantitative concepts. The learning outcome of chapter 9 is as follows:

·        Identify issuers of debt securities;

·        Describe features of debt securities;

·        Describe seniority ranking of debt securities when default occurs;

·        Describe types of bonds;

·        Describe bonds with embedded provisions;

·        Describe securitisation and asset-backed securities;

·        Define current yield;

·        Describe the discounted cash flow approach to valuing debt securities;

·        Describe a bond’s yield to maturity;

·        Explain the relationship between a bond’s price and its yield to maturity;

·        Define yield curve;

·        Explain risks of investing in debt securities;

·        Define a credit spread.

Valuing debt securities is relatively straightforward compared with, say, valuing equity securities (see the Equity Securities chapter) because bonds typically have a finite life and predictable cash flows. The value of a debt security is usually estimated by using a discounted cash flow (DCF) approach. The DCF valuation approach is a valuation approach that takes into account the time value of money. Recall from the discussion of the time value of money in the Quantitative Concepts chapter that the timing of a cash flow affects the cash flow’s value. The DCF valuation approach estimates the value of a security as the present value of all future cash flows that the investor expects to receive from the security.

The cash flows for a debt security are typically the future coupon payments and the final principal payment. The value of a bond is the present value of the future coupon payments and the final principal payment expected from the bond. This valuation approach relies on an analysis of the investment fundamentals and characteristics of the issuer. The analysis includes an estimate of the probability of receiving the promised cash flows and an establishment of the appropriate discount rate. Once an estimate of the value of a bond is calculated, it can be compared with the current price of the bond to determine whether the bond is overvalued, undervalued, or fairly valued.

A bond’s current yield is calculated as the annual coupon payment divided by the current market price. This measure is simple to calculate and is often quoted. A bond’s current yield provides bondholders with an estimate of the annualised return from coupon income only, without concern for the effect of any capital gain or loss resulting from changes in the bond’s value over time. The current yield should not be confused with the discount rate used to calculate the value of the bond.

For fixed-rate bonds and zero-coupon bonds, the timing and promised amount of the interest payments and final principal payment are known. Thus, the value of a fixed-rate bond or zero-coupon bond can be expressed as

where V0 is the current value of the bond, CFt is the bond’s cash flow (coupon payments and/or par value) at time t, r is the discount rate, and n is the number of periods until the maturity date. The bond’s cash flows and the timing of the cash flows are defined in the bond contract, but the discount rate reflects market conditions as well as the riskiness of the borrower.

The discount rate that equates the present value of a bond’s promised cash flows to its market price is the bond’s yield to maturity, or yield. An investor can compare this yield to maturity with the required rate of return on the bond given its riskiness to decide whether to purchase it.

A bond’s yield to maturity can be expressed as

where P0 represents the current market price of the bond, and r_ytm represents the bond’s yield to maturity.

When investors try to determine the appropriate discount rate (yield to maturity or required rate of return) for a particular bond, they often begin by looking at the yields to maturity offered by government bonds. The term structure of interest rates, often referred to simply as the term structure, shows how interest rates on government bonds vary with maturity. The term structure is often presented in graphical form, referred to as the yield curve. The yield curve graphs the yield to maturity of government bonds (y-axis) against the maturity of these bonds (x-axis). It is important when developing a yield curve to ensure that bonds have identical features other than their maturity, such as identical coupon rates. In other words, the bonds considered should only differ in maturity.

Investing in debt securities is generally considered less risky than investing in equity securities, but bondholders still face a number of risks. These risks include credit risk, interest rate risk, inflation risk, liquidity risk, reinvestment risk, and call risk.

Credit risk, sometimes referred to as default risk, is the risk of loss if the borrower, or bond issuer, fails to make full and timely payments of interest and/or principal.  Investors may be able to assess the credit risk of a bond by reviewing its credit rating. Independent credit rating agencies assess the credit quality of particular bonds and assign them ratings based on the creditworthiness of the issuer. Exhibit 3 presents the credit ratings systems of Standard & Poor’s, Moody’s Investors Service, and Fitch Ratings.

Interest rate risk is the risk that interest rates will change. Interest rate risk usually refers to the risk associated with decreases in bond prices resulting from increases in interest rates.

Nearly all debt securities expose investors to inflation risk because the promised interest payments and final principal payment from most debt securities are nominal amounts—that is, the amounts do not change with inflation.

Liquidity risk refers to the risk of being unable to sell a bond prior to the maturity date without having to accept a significant discount to market value. Bonds that do not trade very frequently exhibit high liquidity risk.

Reinvestment risk refers to the fact that in a period of falling interest rates, the coupon payments received during the life of a bond and/or the principal payment received from a bond that is called early must be reinvested at a lower interest rate than the bond’s original coupon rate.

Call risk, sometimes referred to as prepayment risk, refers to the risk that the issuer will buy back (redeem or call) the bond issue prior to maturity through the exercise of a call provision.

  

Source: https://www.cfainstitute.org/en/programs/investment-foundations

The term structure of interest rates on government bonds presented in graphical form is referred to as the:

A yield curve.

B current yield.

C credit spread.

 

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Eight Ways to Make Your First Million Dollars/Ringgit!

Dharmesh Shah (of HubSpot) lists eight ways to becoming a millionaire:

(i) stop the obsession on money

- shift your perspective, see money as not the primary goal but a byproduct of doing the right things!

(ii) start tracking how many people you can help

- work hard to make others successful – employees, customers, vendors, suppliers, and if they can do that then success will follow.

(iii) start serving a million people

- find a way to serve lots of people and benefits will follow. And serve them incredibly well and the money will follow.

(iv) see making money as making more things

- there are two types of people:

(a) those who want to make the money and it doesn’t matter what they do; and

(b) those who want to make more things, improve product/service, and extend their excellence.

“We don’t make movies to make money, we make money to make more movies” – Walt Disney.

(v) do one thing better

- pick one service/product you are better than most people. Just one thing! Work, train, learn, practice, evaluate, refine and sell.

(vi) get a list of world’s best 10 people doing the one thing right

- use their criteria for your own progress to being the best

- the new nomenclature suggests, “benchmarking”

(vii) track progress

- measure, measure, measure

(viii) build routines for progress

- try to take small steps daily to the final goal. And stick to the routine – whether it is marketing, selling, developing or processing. Refine, revise and adapt.

One day you will be world class because you focused, re-invented, kept the faith! Then without really noticing you are a millionaire.

Reference:

Jeff Haden, 8 Surprising Ways to Make Your First Million Dollars www.inc.com

China: Facing Economic Slowdown?

China’s economy grew by 6.2 per cent in the second quarter of 2019. This is the lowest growth since March 1992. Nevertheless, it falls within official GDP target for 2019 of between 6-6.5 per cent. It also reflects the continuing trade war with the U.S.

China’s marginalized private sector provided the main driver of industrial growth in June, expanding by 8.3 per cent. Fixed asset investment grew by 5.8 per cent while investment in mining surged by 22.3 per cent in the first half of 2019. Retail sales grew by 9.8 per cent while imports declined by 7.3 per cent in June and exports fell by 1.3 per cent on a year on year basis.

“Uncertainty caused by U.S.-China trade war was an important factor and we think this will persist” says Tom Rafferty, The Economist Intelligence Unit.

Apple’s sales in China have tumbled. Its revenue dropped 21.5 per cent in second quarter of 2019 compared to a year ago. Revenue from China of USD 10.2 billion is 18 per cent of Apple’s total revenue.

Americans are buying more from suppliers in Vietnam, Taiwan, Bangladesh and South Korea, as they try to avoid U.S. tariffs on Chinese consumer goods.

The expectation is China will unveil more stimulus measures to stabilize growth. Lowering interest rates is another possibility. At USD 26 trillion, China will rise above America in nominal GDP terms by 2030. That’s according to HSBC. And India will be the third largest economy by then.

Implications for Malaysia?

In the immediate, Malaysia will benefit from relocation of some electronics firms from China to Malaysia because of U.S. tariffs. That is perhaps outweighed by a general decline in exports to China. We need new measures to overcome a general slowdown in 2020!

Reference:

China's economic growth slumps to lowest in 27 years as the trade war hits, CNN, 15 July 2019

China economy reports lowest GDP growth on record for second quarter as US trade war bites, SCMP, 15 July 2019

Will China Overtake the U.S.?

There is no guarantee that China’s economy will surpass the U.S. according to Cary Huang of SCMP (21 April 2019). The perception that China is the No.2 global power and is on the road to being No.1 is based on two questionable assumptions – China’s growth rates will continue and the size of its economy equates to national power.

China’s official GDP (in 2018) was USD 13 trillion, which is about two-thirds of U.S.’s USD 20.9 trillion economy. So based on growth rates over past decade, some economists forecast China’s GDP will overtake the U.S. by 2030 or sooner. The grand assumption is growth rates will continue in the present fashion. But China’s growth momentum has been slowing down since 2007 when it peaked at 14.23 per cent. There is a downward spiral as its base is now much bigger. With China switching to a consumption mode, its economy is anticipated to slow down substantially.

Next, is the question of size of the economy and national power. Even if China’s economy surpasses the U.S., it does not follow China will be economically powerful or wealthy as Americans. In China’s case, it has overcapacity and bad debts, producing what is termed “bad” GDP. A more meaningful measure is perhaps GDP per capita, and China’s GDP per capita was USD 9,400 in 2018. This pales compared to U.S. GDP per capita of USD 53,712. China’s GDP per capita is also below the world average of USD 11,570 in 2018. So it is still seen as a middle-low income country.

  

A nation’s power is not limited to its economic size but about productivity, innovation, technology and management skills. It’s about military, diplomatic, scientific, educational, cultural and the arts. So it cannot dictate the world’s rules since its primary stage of socialism has not evolved into greater human rights and respect of the individual. Alas, Trump (and his cronies) have regressed into a less liberal mode on U.S. traditional celebration of diversity. This now endangers U.S.’s lead on innovation and technology in the near term.

So will China overtake the U.S.? Yes, in nominal GDP terms or on purchasing power parity basis but not in terms of per capita basis for a long while yet.

Reference:

If China thinks it’s overtaking the US any time soon, here’s a wake-up call, SCMP, 21 April 2019

Silicon Valley Can Still Beat China, Bloomberg, 14 July 2019

China will overtake the U.S. as world’s top economy in 2020, says Standard Chartered Bank, Big Think, 14 January 2019

Was 1BestariNet Ham-stringed?

 Any good platform could be ham-stringed by poor promotion and usage.  That’s the story by the Auditor-General (“A-G”) on 1BestariNet.

The audit report states that YTL Communications was not responsible for promoting the usage and adoption of the Frog VLE under the 1BestariNet project. The latest audit scrutinised the performance and management of Phase 2 of the 1BestariNet project.  The contract to provide the platform was awarded to YTL Communications for a period of three years –July 2016 to June 2019.

Unicliq Sdn Bhd (“Unicliq”) a third-party contractor was awarded the role called “change management”. Unicliq had 16 months to perform (Sept 17 to Dec 2018). Briefings, incentive scheme were ideas to encourage adoption of the Frog VLE among pupils. The 30% activation target was not achieved. On 19 April 2019, the MOE acknowledged that Unicliq failed to achieve the target. The audit noted that contents of the change management were insignificant for optimal use of the Frog VLE.

What are some possible lessons?

·     MOE made an investment of RM633 million (over 3 years for Phase 1) and paid Unicliq another RM8.2 million for making use of a platform that was not mandatory for teachers and pupils alike;

·       MOE needs to set clear policies for use of platforms in schools as mentioned by the A-G;

·       MOE complains of low usage when promotion and adoption were given to a third-party with perhaps little or no skills in meeting a set target. In a BCG report in 2010, it was pointed out that it typically takes 10-15 years for a school system to get a good level of usage. And the project was thus scoped for 15 years;

·       “Basikal or Shinkazen” depends on what you set-out in your terms of reference. You cannot set-out to buy a bicycle and expect delivery of a high-speed train;

·      “contracts are contracts” – it is pointless to negotiate and sign a contract and then scream that it was not fair – that goes for either party;

·       Recovery and resuscitating an existing platform is better than starting from scratch – unless there was no delivery in the first place (which was not true for 1BestariNet!);

·       Utilisation (or promotion) of the platform should be with the provider (of the platform) who has the skill sets and knowledge to do so; and

·       MOE could have had forums, annual feedback sessions and designated “champions” to get activation up, and that may not need a third-party!

Where do we go from here?

As usual in Malaysia, no heads will roll for RM633 million (Phase 1) spent and project abandoned. We are compassionate people.

Unless we promote a culture of merit and accountability, no amount of money or platforms will solve the education malaise. My humble suggestion is to get Rafidah Aziz to head MOE and we will have a future!

References:
1. Low adoption of Frog Virtual Learning due to lack of promotion, The Star, 18 July 2019

2. MoE should have promoted 1BestariNet better, TheEdge Markets, 17 July 2019

CFA Institute Investment Foundations Program: Chapter 9 – Debt Securities (Part I)

In a previous article, we introduced the CFA Institute Investment Foundation Program (Read more here).  It is a free program designed for anyone who wants to enter or advance within the investment management industry, including IT, operations, accounting, administration, and marketing.  Candidates who successfully pass the online exam earn the CFA Institute Investment Foundations Certificate.

There are total of 20 Chapters in 7 modules, covering all the essential topics in finance, economics, ethics and regulations.  This series of articles will highlight the core knowledge of each chapter.

Chapter 9 provides an overview of quantitative concepts. The learning outcome of chapter 9 is as follows:

·        Identify issuers of debt securities;

·        Describe features of debt securities;

·        Describe seniority ranking of debt securities when default occurs;

·        Describe types of bonds;

·        Describe bonds with embedded provisions;

·        Describe securitisation and asset-backed securities;

·        Define current yield;

·        Describe the discounted cash flow approach to valuing debt securities;

·        Describe a bond’s yield to maturity;

·        Explain the relationship between a bond’s price and its yield to maturity;

·        Define yield curve;

·        Explain risks of investing in debt securities;

·        Define a credit spread.

When a large company or government borrows money, it usually does so through financial markets. The company or government issues securities that are generically called debt securities, or bonds. Debt securities represent a contractual obligation of the issuer to the holder of the debt security. Companies and governments may have more than one issue of debt securities (bonds). Each of these bond issues has different features attached to it, which affect the bond’s expected return, risk, and value.

A typical bond includes the following three features: par value (also called principal value or face value), coupon rate, and maturity date. These features define the promised cash flows of the bond and the timing of these flows.

Par value. The par (principal) value is the amount that will be paid by the issuer to the bondholders at maturity to retire the bonds.

Coupon rate. The coupon rate is the promised interest rate on the bond.

Maturity date. Debt securities are issued over a wide range of maturities, from as short as one day to as long as 100 years or more. In fact, some bonds are perpetual, with no pre-specified maturity date at all. But it is rare for new bond issues to have a maturity of longer than 30 years. The life of the bond ends on its maturity date, assuming that all promised payments have been made.

The bond contract gives bondholders the right to take legal action if the issuer fails to make the promised payments or fails to satisfy other terms specified in the contract. If the bond issuer fails to make the promised payments, which is referred to as default, the debtholders typically have legal recourse to recover the promised payments. In the event that the company is liquidated, assets are distributed following a priority of claims, or seniority ranking. This priority of claims can affect the amount that an investor receives upon liquidation.

Bonds, in general, can be classified by issuer type, by type of market they trade in, and by type of coupon rate.  Although the term “bond” may be used to describe any debt security, irrespective of its maturity, debt securities can also be referred to by different names based on time to maturity at issuance. Debt securities with maturities of one year or less may be referred to as bills. Debt securities with maturities from 1 to 10 years may be referred to as notes. Debt securities with maturities longer than 10 years are referred to as bonds.

Issuer. Bonds issued by companies are referred to as corporate bonds and bonds issued by central governments are sovereign or government bonds. Local and regional government bodies may also issue bonds.

Market. At issuance, investors buy bonds directly from an issuer in the primary market. The primary market is the market in which new securities are issued and sold to investors. The bondholders may later sell their bonds to other investors in the secondary market. In the secondary market, investors trade with other investors. When investors buy bonds in the secondary market, they are entitled to receive the bonds’ remaining promised payments, including coupon payments until maturity and principal at maturity.

Coupon rates. Bonds are often categorised by their coupon rates: fixed-rate bonds, floating-rate bonds, and zero-coupon bonds. These categories of bonds are described further in the following sections.

Bonds may pay fixed-rate, floating-rate, or zero-coupon payments.  Fixed-rate bonds are the most common bonds. They offer fixed coupon payments based on an interest (or coupon) rate that does not change over time. These coupon payments are typically paid semi-annually.

Floating-rate bonds typically offer coupon payments based on a reference rate that changes over time plus a fixed spread; the reference interest rate is reset on each coupon payment date to reflect current market rates.

The only cash flow offered by a zero-coupon bond is a single payment equal to the bond’s par value to be paid on the bond’s maturity date.

Many bonds come with embedded provisions that provide the issuer or the bondholder with particular rights, such as to call, put, or convert the bond.

Securitisation is a process that creates new debt securities backed by a pool of other debt securities. These new debt securities are called asset-backed securities. Most asset-backed securities generate monthly payments that include both interest and principal components.

Source: https://www.cfainstitute.org/en/programs/investment-foundations

Sample Question:

Which debt security promises its investors only one payment over the life of the bond?

A Fixed-rate bond

B Zero-coupon bond

C Floating-rate bond

 

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