Definitions
The following provides an explanation of stages (A) through (J) on the previous page
| A. Security: |
This is straightforward. This is
the security you have purchased. It could be Fletcher Capital
Notes or Government Stock. |
| B. Maturity: |
This is the date at which the principal
(face value) is repaid to you, along with the final interest
payment. Sometimes called the election date with Capital Notes. |
| C.
Coupon (6%): |
This is the fixed rate of interest
the issuer will pay on the face value of the bond/Capital note.
Typically there are two payments made each year. This is 6%
of $100,000. This equals $6,000 gross per annum. Therefore you
will receive $3,000 gross at each payment date. Tax will be
deducted at each payment. |
| D. Face Value: |
This represents the nominal value
of the security you wish to purchase: i.e. $100,000. |
| E.
Yield (5.7%): |
"Yield to maturity" is the return
you will receive, relative to the amount you have invested until
the bond matures. This is different to debentures that pay a
fixed rate of interest or bank related fixed term investments.
As bonds and capital notes are priced directly by market forces,
their yield changes on an almost constant basis, like shares.
If interest rates increase above the coupon amount, then for
the bond to equal market return, the capital value of the bond
will decrease. The opposite is also true, if interest rates
decrease below the coupon amount, the principal amount of the
bond will increase. At all times, remember that yield is the
effective rate of return per annum on the paid value of the
bond until maturity. |
| F. Capital Value: |
This reflects the actual market value
for the $100,00 face value of the security. How much you pay
for the face value of the bond is dependent on the yield at
the time of purchase. If the yield is greater than the coupon
amount, the bond will be discounted (less than) face value.
If the yield is less than the coupon amount, the bond will be
at a premium to face value. This is the current situation in
the interest rate environment in New Zealand. Remember that
current interest rates determine the value of the bond. If the
yield is less than the coupon amount of the bond the value of
the bond increases to bring the effective return back to market
yield. This is easily understood by the following example:
When a bond is first issued, the buyer of the bond will receive
a fixed amount per annum. This is the coupon. In our example
this is 6%, or $6,000 per annum. If the interest rates change,
say to 5.7%, then the value of the bond will increase. Initially
we have an 6% return, calculated by:
| Coupon Payment |
X |
6,000 |
= |
6% |
|
|
| Value of Bond |
100,000 |
To find the value of the bond with a yield of 5.7%, we have
to find out the following:
| 6,000 |
|
= |
|
5.7% Where X is the new value of the Bond |
|
| X |
To Solve this equation, simply re-arrange the formula to:
Thus the answer is $105,263.15
These are the basics of Bond Valuation.
|
| G. Accrued Interest: |
Interest on Government Stock and
most capital notes/bonds are paid twice yearly. When the bond
has been purchased between two interest dates, interest accrues
to the holder. This is calculated by the following:
| 6,000 |
= |
(1 - D) |
. AI |
|
|
| 2 |
182 |
Where D is the days until the next interest payment date, 182
equals the number of days in the period between payment dates,
and $6,000 divided by 2 is the half year coupon.
AI means Accured Interest. |
| H. Total: |
This is simply the accrued interest
plus the capital value. This is the amount you must pay when
you purchase the security. |
| I. Valuation
Date: |
This is the date at which the bond
is calculated. |
| J. Settlement
Date: |
This is the date at which we must
receive funds so we can then forward payment to the vendor.
If you are selling then the settlement date is one day after
the valuation date. |
Capital gains made on bonds and/or capital notes are subject to taxation. This is because these gains are counted as interest income. If you were to realise a capital gain caused by a fall in interest rates and sold your bond, this would be taxable. Conversely if you made a loss on selling then this can be claimed for tax purposes.
If you wish to invest on behalf of a Deceased Estate, Trust or Minor (e.g. grandchild), investments must be made in the names of the Trustees who must all sign the application form. The name of the Estate, Trust or Minor can be identified either on the application form when space is provided, or in the first line of the address.
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