Every time you make an investment decision Money, one has to ask the question: what securities can bring the greatest income? To answer this question, it is worth understanding what profitability is and how to calculate it. Let's try to do it together.
The return on a security is the return an investor will receive. By general rule profitability shows efficiency financial investments. Return on securities and risk are interrelated concepts. Usually, the higher the risk (see), the greater the return financial instrument. Fixed income securities rarely make good returns.
Advice! Remember! Who does not risk .... he does not go to rest in the Seychelles.
Types of return on securities
The yield of securities is considered from different angles, broken down into shares (see) and bonds.
For stocks, the following types of returns are distinguished:
- current profitability;
- dividend yield;
- annual interest rate.
For bonds, the following types of yield can be considered:
- current profitability;
- yield to maturity;
- annual percentage yield;
- internal return (IRR (see)).
Advice! Remember that if the profit is received after three months, then when calculating the annual return, you need to multiply the percentage of profit by a factor of 4, since there are 12 months in a year. If the profit is received after 6 months. That annual profit obtained by multiplying it by a factor of 2.
There are several types of formula for calculating yield, the simplest formula for yield on securities is presented below:
Where:
- V e is the value of the financial asset at the end of the period;
- V b is the value of the financial asset at the beginning of the period
- r - profitability.
Advice! Don't be lazy to make necessary calculations, they take a little time, but allow you to correctly evaluate the investment.
Dependence of income and risk on the type of securities
Different types of securities have a different ratio of risk and return.
In general, the risk of investing in securities is classified as:
- short: government securities and bank certificates;
- average: mortgages, bonds;
- high: shares and derivative financial instruments.
Return on securities
The yield on government securities is usually not very high, but the risk of losing money in this case is minimal. The purchase of such securities is recommended for investors who prefer conservative strategies.
The probability of non-payment of income on such securities is low and is associated with very large problems in the economy that do not arise suddenly and even not very experienced investors can predict them. The main form of income on government securities is the receipt of coupon income, since governments mainly issue bonds.
Income from operations with securities are financial results.
Income, or financial result, can be:
- positive;
- negative.
When selling securities, the amount of income is determined:
- from transactions for the purchase and sale of securities (see);
- in the form of interest (coupon) on a security.
For calculus financial result The following documented expenses related to:
- purchase of securities;
- sale of securities;
- redemption of securities;
- storage of securities;
- the use of borrowed funds in transactions with securities;
- depository fee
- exchange fees, etc.
AT study guide"Corporate securities as a tool of investment attractiveness of companies" the following classification of forms of dividend payment is proposed. As can be seen from the diagram, the forms of payment of income on securities are diverse.
The most common dividend payout monetary form, but in some situations, other forms of income from securities are still used. The return on risk-free securities is not very high.
This yield can be obtained based on the use of the following financial instruments for comparison:
- bank deposits;
- government securities;
- foreign government securities;
- the key rate of the Central Bank of the Russian Federation;
- rates on interbank loans.
Let's consider all these options. by the most in a simple way definition of the risk-free rate is its comparison with bank deposit. For example, if most reliable banks have an interest rate of 9%, then this will be the risk-free rate.
The calculation of the rate on government securities, the key rate and the rate on interbank loans is similar. Information on Russian securities must be taken on the website of the Central Bank in the section "GKO-OFZ market rates". Information on foreign government securities can be found on the websites of international rating agencies. key rate and the rate on interbank loans is also published on the website of the Central Bank.
Advice! It is better to choose countries for assessing the rate on foreign government securities from the list of the most developed countries, such as the USA, Germany, Japan. It is these countries that are the foundation of the stability of the world economy.
The characteristic of income on securities shows which of the following ways it can be received:
- dividend;
- loan winnings;
- discount (discount) when buying a security;
- indexing face value valuable papers;
- fixed interest payment;
- floating interest rate;
- stepped interest rate.
Perpetual securities are most common on financial market. Perpetual securities are securities that can circulate on the market forever, until they are redeemed.
These include:
- bills (see);
- checks;
- deposit certificates;
- investment shares;
- securities, etc.
Bills and checks in Russia are not very popular.
Usually, a perpetual security yields permanent income from the interest rate. For example, there is a government bond with a face value of 2000 rubles and with annual interest the nominal rate is 8%. For the year, the investor's income will be 160 rubles. But if this bond can be bought on stock market for 500 rubles, then its yield will be 16%, and, accordingly, 320 rubles.
Advice! A perpetual security is such until the moment of its redemption, and the investor must follow the information on it. If a decision is made to repay it, it is necessary to perform all mandatory actions to present it for payment. The owner of the paper can set specific deadlines for its redemption.
What income do securities bring?
Different securities bring in money in different ways. Before investing, study what determines the income of a particular paper.
What is income. Types of income from securities
Revenue is the difference between revenue and costs. It can be of two types: current - for the period and final - for all time. Calculated in monetary units.
The following types of income from securities are known:
- dividends;
- change in market value;
- interest;
- discount;
- premium and margin.
They depend on the type of paper.
Share Income
A share is a security that allows you to receive a part of the company's profits, since its buyer automatically becomes a co-owner of the company.
There are two ways to make money on stocks: dividends and resale of securities at an increased market price.
Dividends
Dividends are part of the profit that the company pays to shareholders at the end of the reporting period.
According to the type of shares, dividends are:
- ordinary;
- privileged.
The amount of dividends is set by the board of directors at general meeting shareholders. Preferred dividends can be fixed and not depend on the company's profits. They are paid first.
According to the frequency of payments, dividends are divided into:
- annual;
- semi-annual;
- quarterly.
Most dividends are paid annually.
According to the method of payment, dividends are:
- cash - paid in cash;
- property - paid in shares, goods or property rights.
Dividends are divided into:
- full - paid in full;
- partial - paid in installments.
The conditions and procedure for payments are determined by the charter of the company or the meeting of shareholders. The dividend policy of each enterprise is individual.
If the organization has no profit for the last period, it can pay dividends from retained earnings previous years or from special funds. On the contrary, a company can save profits if it needs money for development.
You will receive dividends even if you own shares for only a few days. The main thing is to have time to get into the register of shareholders.
Change market price
If a company is not making a profit, it cannot pay dividends. Then the only way to make money on its shares is to resell them for more than the price at which they were bought.
The market price is formed as a result of trading and depends on supply and demand in the market. The better a company performs, the higher the demand for its shares and the more they will be worth. If the company's business went badly and the share price began to fall, it is better to sell them immediately. And if the price rises, buy again and resell at a higher price.
You can earn in both ways. Let's say you bought a stock for $1,000. A year later, you received 100 rubles of dividend and resold the share for 1200 rubles. In total, your income amounted to 300 rubles.
Bond income
Unlike a shareholder, a bondholder is not a co-owner of the company, but its creditor. There are two ways to earn income from bonds:
- a fixed percentage that the company undertakes to pay during the life of the bond;
- the difference between the market and nominal prices of a bond, or the purchase and sale prices.
Coupon payments
Stocks pay dividends, while bonds pay coupons. Only, unlike dividends, coupons are mandatory payments.
They are:
- fixed - the same amount is regularly paid, which is set in advance;
- variable - the amount of the payment can change.
Coupons, like dividends, are paid quarterly, semi-annually or yearly. Coupon income is accrued every day, but is paid on a specific date.
The amount of the coupon depends on the size of the company. How larger enterprise, the lower the coupon payments on its bonds.
Price difference
As with stocks, bonds make money by changing the price. On a specific date, the company buys back the bond from you at a set nominal price, or pays the amount in installments if the bond is amortizing. The main thing is to buy a bond at a price below par. Then the difference between the purchase price and the face value paid - the discount - will be your income.
If the bond is zero coupon, it usually sells for much less than face value. And the earnings on price changes are impressive. But most often such bonds are issued by companies close to bankruptcy.
It is not necessary to hold the bond until the end of the term, you can sell it at any time and earn on the difference between the purchase and sale prices. But if the bond is coupon, you will lose further interest payments and you will have to transfer to the new owner of the ACI - the accumulated coupon income.
Income from mutual funds
For mutual funds, income is obtained through the activities of management companies. They take into account all types of income from securities in order to get the highest profit for clients. Each management company its own methodology.
Shareholders earn on the growth in the value of the share. If the prices of securities in the assets of a mutual fund grow, the value of its shares increases. The investor's income is made up of the difference between the purchase price and the price at which he sells the increased share back to the management company. But the value of the share may fall, then the depositor will be at a loss.
Shareholders do not receive dividends or interest.
Income from other securities
Securities reflecting loan relationships
Interest and discount are the main types of income from securities that establish a loan relationship between the seller and the buyer. In addition to bonds, these include bills, deposit and savings certificates. Bills can be bought by anyone, savings certificates are purchased individuals, deposit - legal. Unlike a certificate, the holder of a bill of exchange cannot redeem it at any time without cost.
Interest rates on these securities are determined by the Central Bank. You can get income in the form of a discount if you buy securities at a price below par.
Securities giving the right to own
Proprietary securities include options, futures and warrants. The holders of these securities are either obliged, in the case of futures, or have the right, in the case of options and warrants, to purchase assets within a specified period of time at a specified price. Under warrants, securities are purchased, under options and futures - any assets.
As income, the seller receives a premium - a commission from the buyer, and the buyer earns on the difference in value: he sells the asset at a higher price if it has fallen, or buys at a lower price if it has risen. Option sellers or both parties to futures transactions can post margin, a guarantee that can be used to pay off a position if the other party defaults.
Where is the best place to invest
Securities are more profitable than bank deposits because the income from them is higher. But it depends on the risk. The riskier the paper, the more income it can bring.
Virtually no risk on government bills. The rest are low risk. government papers, to medium-risk — corporate bonds. They are suitable for lovers of conservative strategies.
The highest risk is for stocks, options and futures, but these papers bring the greatest income.
The Right service helps you choose stocks and bonds based on your desired risk/reward ratio. With the help of simple questions, he determines the strategy that suits you, builds a portfolio and manages it.
Classification of securities according to their investment opportunities
Essence and classification of securities
Investment activity using securities
Due to their specific features, securities make it possible to implement various investment strategies.
The main difference between securities and other objects of civil law transactions is that securities provide 2 types of rights.
First, there are real rights on the securities, first of all the right of ownership. This allows you to carry out any legal transactions with securities, including purchase and sale transactions. Real rights to a security provide such properties of securities as negotiability (the ability to be bought and sold on the market, as well as to act as an independent payment document), availability for civil circulation (securities may be subjects of any legitimate transactions- pledge, donation, inheritance, encumbrance with obligations, etc.).
Secondly, there are rights arising from possession of a security - the right to a part of the profit, to the unconditional return of a borrowed amount, to manage the issuing company, etc. It is this set of rights enshrined in a particular security that determines its value and market value. The reliable exercise of rights under a security is facilitated by its properties such as standardity (the law establishes standards for the issue and circulation of securities, rules for accounting and fulfillment of obligations, types, types and forms of securities, etc. series (issuing securities in series simplifies the procedure for confirming and exercising rights), regulation and state recognition (a security is only a financial document that is registered as a security in the manner prescribed by law and/or is recognized as such by law), mandatory performance(it is forbidden to refuse to fulfill obligations secured by a security, except for cases provided by law).
General classification of securities
Classification of securities can be carried out according to many criteria. First of all, securities must be divided into 2 type- issue and non-issue.
Issuable security characterized by the following features:
It establishes a set of property and non-property rights subject to certification, assignment and unconditional exercise in compliance with statutory form and order;
Placed by issues;
It has equal volume and terms of exercising rights within one issue, regardless of the time of purchase of the security.
Stocks and bonds are typical representatives of emissive securities.
Non-equity securities do not have a combination of these three characteristics. Non-issue securities include deposit and savings certificates, bills of exchange, checks.
AT legal aspect The most important is the fact that Federal Law No. 39-F3 of April 22, 1996 “On the Securities Market” regulates relations arising from the issue and circulation of only issue-grade securities, regardless of the type of issuer (the circulation of other securities is regulated by this Law only in cases provided for by federal law). This means that the norms specified in this Law (for example, on licensing activities professional participants securities market) are applicable primarily to transactions with bonds and shares.
Another classification method is the division of securities into classes depending on the subjects of rights certified by the security. On this basis, distinguish:
registered valuables paper- the rights certified by the security belong to the person named in the security. Information about the owners of registered securities should be available to the issuer in the form of a register of owners of securities, the transfer of rights to which and the exercise of the rights assigned to them require the mandatory identification of the owner. According to the Law, in Russia all shares of joint-stock companies must be registered;
securities for bearer- the rights belong to the bearer of the security; the transfer of rights to such securities and the exercise of the rights attached to them do not require identification of the owner. An example of such a paper in Russia was government savings loan bonds (OGSS);
order securities - the rights belong to the person named in the security, who can exercise these rights himself or appoint another authorized person by his order (order). A classic example of an order security is a promissory note.
Investment opportunities of a security is a complex characteristic that reflects a set of certain qualities of a security that makes it attractive to a particular investor. To the most essential qualities that determine investment attractiveness securities, include their profitability, liquidity, risk, method of providing income and the validity of the security.
The totality of these qualities of securities makes it possible to conditionally subdivide all securities into three type:
1. Fixed income securities.
3. Derivative securities.
Let us dwell separately on these types of securities and identify those investment qualities that distinguish them from each other.
These securities have in aggregate a number of specific properties:
1. As a rule, these are debt securities that secure the loan relationship between the borrower (the issuer of the security) and the lender (the investor, the owner of the security). Such securities include bonds, certificates, bills of exchange, checks, etc. According to the law, all payments on securities of this type are the obligations of the issuer and do not depend on its financial and economic condition. The issuer's evasion from making the declared payments on fixed income securities is sufficient reason for the holder of such a security to initiate a procedure for the enforcement of obligations.
2. For them, the issuer introduces a certain maturity date. This date is understood as the day when the borrower (issuer) must pay the investor, first, the borrowed amount, which is face value (face value) security, and, secondly, interest (if it is provided for by the terms of issue of the security).
3. They have a fixed or predetermined scheme for paying face value and interest (coupon) amounts. It is possible to specify different payment methods for fixed income securities, but three such schemes are most famous:
a) individual securities are placed by the issuer in the primary market at a price below par, the so-called discount price. Payments on such financial assets are made once on the redemption day, when the issuer pays the investor the face value of the security. Such securities are called discount, couponless. An example of a discount: domestic government short-term bonds (GKO) can serve as a security. These bonds are placed central bank RF during the auction at a discount price (say, 970 rubles), and after a specified period (3, 6 or 12 months), their repayment follows and the nominal value of 1000 rubles is paid.
One property of discount securities should be noted: until maturity, their market price is always below par (the reverse would imply the existence of negative par interest rates, which cannot be theoretically);
b) other fixed income securities can guarantee the receipt of fixed interest (coupon) amounts and face value at strictly defined intervals. Russian practice knows two schemes for paying fixed coupon amounts:
- constant coupon income - in this case, the amount of the interest payment is fixed once and does not change until maturity. For example, the issuer of the Alrosa 19 corporate bond guaranteed a constant coupon payment of 16% of the face value until maturity. A similar scheme is laid down in foreign currency bonds of the state internal foreign currency loan (OVVZ), for which coupon payments amount to a constant 3% of the face value;
- fixed coupon income- in these cases, the issuer fixes the amount of the coupon payment, which remains unchanged for several coupon periods. Then the coupon rate changes and is fixed again for several coupon periods, etc. For example, on March 20, 2002, the Ministry of Finance of the Russian Federation placed federal loan bonds with a fixed coupon income (OFZ - PK) with a maturity date of September 14, 2005. these bonds were subject to the following scheme of coupon payments: for the first and second coupons - in the amount of 15% per annum, for the third - sixth coupons - 14% per annum each, for the seventh - fourteenth coupons - 12% per annum each (for these bonds, coupon payments are provided for 4 times a year);
c) in last years in the world, securities are widely used, for which the interest (coupon) amounts paid are not fixed, but dependent, associated with other economic indicators- profitability of others financial resources, inflation rate, state stock market etc. An example is the government savings bonds issued in Russia. According to the Terms of the Issue of these bonds, the coupon yield on them is determined as the sum of two components: firstly, the product of the monthly consumer price indices (CPI) expressed in fractions of a unit for the 6 months preceding the month during which the coupon yield is declared, and, secondly, second, a fixed rate determined by the issuer in the issue decision (no more than 0.35% per coupon period).
4. As a rule, fixed income securities are quoted not in monetary units (as happens when shares are quoted), but as a percentage of the nominal value. For example, on February 22, 2005, at the close of trading on the MICEX for bonds of Alrosa 19, the bid price (bid) was 106.7% of the face value, and the offer price (asked) was 106.95% of the bond's face value.
Classification of fixed income securities. There are various ways to classify fixed income securities, but in the very general view they fall into three categories:
Perpetual (demand) deposits and term deposits;
Securities money market;
Bonds.
Perpetual and term deposits. Currently, in Russia, securities of this category are mainly deposit and savings certificates. Deposit certificate and savings certificate - this is a written certificate of the credit institution - issuer on the deposit of funds, certifying the right of the depositor ("beneficiary") or his successor to receive upon expiration due date the amount of the deposit (deposit) and interest on it. Certificates of deposit can be issued by both banking and non-banking credit organizations and savings deposits - only banks. Deposits can be issued both in a single order and in series, they can be nominal or bearer. Both deposits are urgent. Settlements on deposit certificates are carried out only by bank transfer, on savings certificates cash settlements are possible.
An example of a demand deposit is checking accounts. In the West, they are offered to customers by many financial institutions - commercial banks, savings, loans and credit institutions. The owner of a checking account is paid an annual interest of 3 to 5% of the balance of the account; as a rule, the interest payment is made, its carrying amount has not fallen below in a year established level(usually in the range of 500-2500 dollars). Since the owner of a checking account is given the right to withdraw money at his request, checking accounts are called demand deposits.
Let us give examples of other securities of this type that are found on financial markets, for example, the United States. Money market investment deposits (MMI deposits) They are a type of certificate of deposit. Main distinguishing feature MMI deposits consists in the fact that the annual percentage amount paid on them is not strictly fixed, but is set at least 0.25% higher than the income of treasury bills ( treasure bills) with the same maturity. Minimum amount contribution to MMI the deposit is 10 thousand dollars, and the maturity is set above six months. So, an investor can buy MMI deposit for 10 thousand dollars with a maturity of 6 months. If treasury bills with a maturity of 6 months provided at that moment a yield of 4.2%, then MMI deposit interest will be at least 4.45%; in the event of an increase in the yield of treasury bills to 4.34%, the interest on MMI deposit increases to 4.59%.
Indexed CDs appeared in the USA in 1987. The main difference between these securities is that the interest paid on them is “tied” to the stock market indicators, i.e. is indexed. Usually, an investor, purchasing such a certificate, can choose a minimum interest rate, let's say 4.5%. If during the period of the deposit the stock market indicators went up, then the owner of the deposit will receive an increase in the paid percentage. Thus, these deposits guarantee their owner a certain minimum income and provide the possibility of additional benefits in the event of an increase in share prices on the stock market.
Eurodollar deposits are international time deposits. They are denominated in dollars and are issued by commercial banks located outside the United States. Eurodollar deposit accounts tend to carry higher interest rates than similar time deposits offered by American banks. This is explained more high level risk on eurodollar deposits due to other conditions of deposit insurance, floating exchange rates, political instability.
Deposits have an important positive quality - high reliability. This is explained by the fact that in many countries (at present, in Russia as well), deposits of individuals in banks on term and non-term deposits are provided with state insurance (in the USA, deposits up to 100 thousand dollars inclusive; in Russia, deposits up to 125 thousand rubles). In this regard, the risk associated with investing in deposits is low. However, deposits have a number of disadvantages: due to the low level of risk, the return on deposits is the lowest of all fixed income securities. In addition, deposits do not provide the proper degree of liquidity, since there is practically no secondary market for these securities. Therefore, many investors prefer to invest in money market securities.
Money market securities have distinctive features:
Usually their maturity does not exceed 12 months;
They have a fairly high liquidity, since they can be freely sold and bought by investors on secondary market valuable papers;
As a rule, they are placed by the issuer at a discount price. Money market securities allow borrowers (the state, but
West - and large corporations) receive borrowed funds from individual and institutional investors through the sale of short-term securities to the latter, which are, in fact, unsecured promissory notes. The most common type of money market security in Russia is government short-term bonds (GKOs).
Bonds are called fixed income securities that secure the right of its owner to receive a bond from the issuer within the period specified in it of its nominal value or other property equivalent. A bond may also provide for the right of its owner to receive a fixed percentage of the nominal value of the bond or other property rights. The yield on a bond is interest, or discount. There are 2 main differences between bonds and money market securities. First, a significant number of bonds are sold at par with subsequent interest payments. Secondly, the maturity of bonds exceeds a year and can last several decades. Bonds can be classified according to various criteria. In particular, the division of bonds depending on the type of their issuer matters. On this basis, bonds are divided into the following types:
State - the issuer is the state (in Russia - represented by the Ministry of Finance).
Bonds public institutions (represented by ministries and departments). As a rule, these institutions issue bonds and use the proceeds to lend to small businesses, the education system, housing construction, support farms. On the Russian market bonds of government institutions can serve as an example of bonds of the Bank of Russia.
Municipal - The issuer is regional and local authorities. Typically, investing in municipal bonds carries a higher risk than buying government bonds and securities of state institutions. This is due to a number of circumstances: firstly, practice shows that the issuer (local government) is sometimes unable to fulfill its bond promises, i.e. investing in local government bonds is associated with credit risk (risk of bankruptcy, default) ; secondly, despite the fact that many bonds are insured by private insurance companies, there were cases when the issuer (local government) went bankrupt and the insured was unable to cover its debts; thirdly, due to the fact that a significant number of bonds of this type are circulating on the financial market, the investor often has difficulty selling them, i.e. investing in municipal bonds is associated with the risk of illiquidity.
Corporate - Issuers are legal entities (often open joint-stock companies). The rules and features of the issue of bonds by joint-stock companies are given in federal law dated December 25, 1995 No. 208-FZ "On joint-stock companies". Corporate bonds are usually classified according to the degree of risk associated with their purchase. The most reliable are collateralized bonds. If the bonds are backed by the firm's real estate, then they are classified as mortgage bonds. Company funds can also be used as collateral.
Another category is unsecured bonds. In recent years, bonds of firms borrowing money for very risky projects have become widespread in the West - in case of success, they provide higher interest than on other bonds. Such bonds are "second-class, junk" (junk bonds).
In order to attract investors, companies are introducing additional benefits for bond buyers. For example, many Russian issuers corporate bonds in the release decision stipulate offer- the possibility of the bond owner to return the bond to the issuer within the established period at the redemption price (offer price). This can be beneficial for potential buyers of the bond in the event of an increase in interest rates and a decrease in the market price of bonds. The offer increases the liquidity of the bonds.
Russian legislation allows issuance by corporations convertible bonds, which can be converted either into shares or other bonds of the same company. The ability to convert a bond allows firms to introduce a clause in the terms of the issuance of early withdrawal of bonds, under which the firm has the right (but not the obligation) to call (repay) its bonds before the maturity date. This right allows issuing firms to respond more flexibly to fluctuations in the financial market in the event of a reduction in interest rates. Indeed, if the coupon payments on the Alrosa 19 bond are 16% per annum, then the owner of the bond receives 80 rubles in the form of interest payments. every six months (coupon payments on this bond are made 2 times a year). Let's imagine that the inflation rate decreases and the market interest rates fall to the level of 8% per annum. In this case, it is unprofitable for the issuing firm to pay an annual interest on the bond, which is 2 times higher than that established on the market. Therefore, it will redeem the bonds ahead of schedule and issue a new loan already at 8% per annum, thus saving millions of rubles. on interest payments.
Foreign - issuers are government agencies and corporations of other countries. These bonds are widely used in the West, because they allow you to get a higher return. Investing in bonds of other countries has another attractive feature - the change in their prices is not associated with fluctuations in the prices of domestic financial resources, which allows for greater diversification investment portfolio.
So, investment opportunities fixed income securities are determined by the combination of the following qualities:
a) they are debt securities and any payments on them represent liabilities of the issuer;
b) the owner of such securities knows in advance the dates and amounts of forthcoming coupon payments on them;
c) the securities are redeemed within the established period, when the issuer pays the owner of the security its face value;
d) after redemption and full settlements with their owners, fixed income securities cease to exist and cease to bring income to investors.
Fixed income securities are financial assets that have three properties:
- 1. Specific maturity date;
- 2. Presence of a fixed or predetermined scheme for the payment of nominal and interest;
- 3. And, as a rule, their price quote is indicated as a percentage of yield to maturity.
The maturity date means the day on which the borrower must repay to the investor, first, the borrowed amount, which is the face value of the security, and, secondly, interest (if any is provided for in the terms of the issue of the security).
Pre-agreed payment schemes for securities can take many forms. For example, individual securities are sold at a discount price, i.e. at a price below par. Payments on such funds are made once on the day of repayment. A good example of a security selling at a discount price is Government short-term bonds (GKOs) in Russia, Tgeasure bills (treasury bills) in the USA.
Other fixed income securities may guarantee the receipt of predetermined amounts or predetermined interest at certain intervals. For example, a government bond of an internal foreign currency loan of Russia with a face value of $10,000 and a maturity of 10 years is guaranteed to receive $300 (3% of the face value) in the form of coupon payments annually. Finally, in recent years, securities have become widespread in the world, for which the interest paid is not fixed, but dependent, related to the yield of other financial resources. An example of such funds are federal loan bonds with variable coupon(OFZ PK) and bonds of the state savings loan, the coupon rate on which is "tied" to the yield (return) of GKOs.
There are various ways to classify fixed income securities, however, they generally fall into three categories:
- 1) termless (demand) and term deposits;
- 2) money market securities;
- 3) bonds.
In countries with developed securities markets, the most common perpetual and term deposits are:
- a) checking accounts;
- b) savings accounts;
- c) certificates of deposit;
- d) money market certificate;
- e) indexed deposits;
- f) euro-dollar deposits.
Currently, in Russia, securities of this category are mainly deposit or savings certificates.
A deposit or savings certificate is a written certificate of the issuing bank on the deposit of funds, certifying the right of the depositor (beneficiary) or his successor to receive the amount of the deposit (deposit) and interest on it after the expiration of the established period.
Deposits can be issued both in a single order and in series, and can also be nominal or bearer. The maturity of certificates of deposit is limited to one year, and savings - three years. Certificates of deposit can only be issued to an organization that is a legal entity, and savings certificates - only to individuals.
Bank certificates cannot serve as either a settlement or means of payment for goods and services. Coupon interest is charged on certificates. Registered certificates are transferred to other persons with the help of a cession, bearer certificates - by simple delivery. To issue certificates, the bank must obtain permission from Central Bank Russia.
In many countries, investors' deposits in banks on term and non-term deposits are provided with state insurance (in the USA, deposits up to $100,000 inclusive are insured). In this regard, the risk associated with investing in deposits is low, as a result, the rate of return on deposits is the lowest of all fixed income securities. In addition, deposits do not provide the proper degree of liquidity. Therefore, many investors prefer to invest in money market securities.
Money market securities are a convenient tool for obtaining borrowed funds. Typically, these securities have a maturity of 1 to 12 months and have higher liquidity, as they can be freely sold and bought by investors in the secondary securities market. Money market securities allow borrowers, represented by the state, and in the West by large corporations, to receive borrowed funds from individual and institutional investors by selling short-term securities to the latter.
The most common type of money market security in Russia is government short-term bonds (GKOs), the equivalent of which in the United States are treasury bills (Tgeasure bills). In addition, in America, these securities include:
- - commercial papers (commercial paregs);
- - negotiable certificates of deposit of high denomination (large-denomination negotiable CDs);
- - euro-dollar certificates of deposit (Eurodollar Сds).
The most common type of fixed income securities are bonds.
A bond is an issuance security that secures the right of its holder to receive from the issuer of the bond, within the period stipulated by it, its nominal value and the percentage of this value fixed in it or other property equivalent.
Thus, a bond is such a security for which the issuer ( entity that issued the bond into circulation) undertakes to pay to the investor (bond owner) according to a certain scheme periodically fixed amount interest and, in addition, on the maturity date, the issuer must also pay the investor the face value of the bond.
There are two main differences between bonds and money market securities. First, virtually all bonds are sold at par with interest paid, while money market securities are usually offered at a discount price. Secondly, the maturity of bonds exceeds a year and can last for several decades. Money market securities, on the other hand, are generally short-term financial instruments with maturities of up to one year.
The main issuers of bonds are:
- a) the state (in Russia it is the Ministry of Finance of the Russian Federation). It should be noted that in Russia the state is still the main issuer of bonds;
- b) a number of state institutions represented by ministries and departments. Typically, these institutions issue bonds and use the proceeds to lend to small businesses, the education system, and housing and farm support;
- c) local authorities (such bonds are usually called municipal). Dozens of issues of municipal bonds have been registered in Russia. Generally, investing in municipal bonds carries a higher risk than investing in government bonds and government securities. This is due to a number of circumstances:
Firstly, practice shows that the issuer (local authority) is sometimes unable to fulfill its bond promises, i.e. investing in local government bonds often involves credit risk (bankruptcy risk);
secondly, despite the fact that many bonds are insured by private insurance companies, there have been cases when the issuer (local government) went bankrupt, the insured was unable to cover his debts;
thirdly, due to the fact that a significant number of bonds of this type are circulating on the financial market, an investor often has difficulties with their sale, i.e. investment in municipal bonds is associated with the risk of illiquidity;
- d) corporations. For example, the business sector in developed countries market economy is the largest issuer of bonds after the state, and corporate bonds are extremely rare on the Russian securities market;
- e) foreign government agencies and corporations. The bonds of these institutions and corporations are widely used in the West, because they allow you to get the highest return. Investing in bonds of other countries has another attractive feature - price fluctuations in these countries are not associated with fluctuations in the prices of domestic financial resources, which makes it possible to achieve greater diversification of the investment portfolio. Bonds of other countries may have different kind, for example, be with a fixed or floating ("linked") coupon rate, be convertible, etc. The conditions for the acquisition of such securities are determined by law.
Source: Board of Governors of the Federal Reserve System. Division of Research and Statistics; and also Federal Reserve Bulletin, 1986, August, p.511-524. Chapter 24 Selecting Fixed Income Securities 281 The level of debt was $26.3 billion), while $77 billion of shares were retired. Reasons for the decline net worth corporations, only partly covered by the accumulation of retained earnings, there were takeovers of companies, buyout of companies on credit with transfer to private sector, restructuring and buying up own shares. Because of this, the amount of financial leverage (that is, the percentage of debt in the capital structure) quickly increased, and the market for low-quality subordinated debt instruments expanded accordingly. High-yield bond funds have become one of the most popular representatives of the mutual fund industry. In 1985, corporate bond funds, mostly high-yield ones, increased their net assets nearly $9.5 billion and amounted to 24 billion dollars. In 1986, their growth was equal to 17.5 billion dollars. Large buyers included financial institutions such as savings and loan associations and insurance companies. Interest coverage Interest payments In assessing creditworthiness, the traditional indicator of covering interest obligations with net income before interest and taxes remains the central indicator. But the criterion for the adequacy of coverage should be adjusted to take into account a significant change in the level of interest rates. Let's consider a simple example. In 1966 net profit industrial company XYZ before interest and taxes was $20 million, while the company had $100 million. debt at a rate of 4%. Interest coverage, that is, the ratio of interest to net income, is 5, which means that the bonds can be classified as investment grade. Two decades later, XYZ has grown and continues to thrive. Now its earnings before interest and taxes were $60 million, and its debt had only doubled to $200 million. But as a result of operations to refinance old bond issues and place new average rate rose to 10%. The interest coverage ratio has shrunk to 3 ($60 million in revenue divided by $20 million in interest bearing liabilities), and as a result the company has suffered a severe downgrade in its investment status. (Note, too, that the economic benefits generated by financial leverage have dwindled significantly.) The statistics on the value of the interest expense coverage ratio have lost almost all meaning. Moreover, this indicator has never been an adequate substitute for the actual indicator of debt service coverage, i.e. general expenses interest plus principal repayment costs (assuming debt serviceability is not determined by
* To calculate the pre-tax equivalent of debt repayment costs, use the coefficient: 100 / (100 - Tax rate), while it is assumed that in 1966 the tax was 52%, and in 1986 - 46%. liquidation value of assets, but the ability to make a profit). If the debt of LGK^ in 1966 and 1986 payable on a straight line over 10 years, debt service coverage could be calculated as in table 24.2. According to common sense Obviously, when a company grows by 200% and only half of that growth is financed by debt, its creditworthiness, as well as the investment quality of its bonds, increases as a result of the increase in reliability. If in 1966 the interest on the debt had been closer to the 1986 level, then naturally the comparison would have been in favor of 1986. Debt service to the percentage. In practice, the problem of full comparability between borrowers and the position of one borrower in different periods has no general solution. When analyzing fixed income securities, this problem has to be solved each time and to determine the "normal" debt service costs in order to minimize the instability of coverage ratios. The recalculation of reported interest payments on new Class A bond issues under the assumption of a 10-year moving average can be considered the normal rate of interest for these purposes, if left to Chapter 24. Fixed Income Securities Choice of Fixed Income Securities, the question of the effect on creditworthiness of losses or gains from non-recurring events or from timely short-term entries into the capital market. A relatively new problem is the large volume of variable rate bonds. The same problem often occurs with urgent bank loans. Since no one in the world can predict the rate of interest 10 or more years ahead, the analyst is left to accept some plausible hypothesis about this and proceed to quantitative tests. If bonds can only be categorized as investment grade at the lowest interest rates, they should be rejected. And such a decision is all the more reasonable, since the buyer of bonds is already taking the risk of a possible increase in the market interest in the future. To assess the dynamics of changes in the company's creditworthiness over a number of years, you can use a simple ratio - the ratio of the amount of debt to net after-tax profit, that is, an indicator of how many years the company needs to pay off debts. Because we are ignoring interest costs (although they are deducted from net income available for distribution to shareholders), changes in interest rates have little effect on this figure. General creditworthiness criterion A company obtains open access to the capital markets at reasonable rates of interest if it is able to meet all business obligations on time while maintaining a certain safety margin that guarantees solvency even in the event of adverse circumstances. It is up to the securities analyst to determine how adequate the safety margin is relative to the cash business risks. It is clear that in order to assess stability and profitability, the analyst must analyze the company in its entirety. Assets as a source of tender A company's ability to pay off debt by liquidating assets is a useful indicator, but only if the value of the assets is largely independent of the value of the business as a whole. From an addict financial company like General Motors Acceptance Corporation, they don't expect it to pay off its debts with profits. In good years, such as 1985, net income was only 1.4% of total debt. The margin of safety does not form the ability to make a profit, but the excess of the amount of collected receivables over the amount of debt. Below is the calculation of coverage ratios 282 Part Three. Analysis of debt bonds (in billions of dollars). Ignore all assets except accounts receivable. Accounts payable to the parent company is accounted for as part of secondary (subordinated) debt.
In addition, assets are a source of debt repayment in the following cases: natural resources; accounts receivable when selling manufactured products in installments; transport equipment - rolling stock on railways, aircraft and oil tankers; oil pipelines operating under a “take or pay” contract, that is, providing for a penalty for refusing to purchase; rental of equipment - communication and production, computer technology; real estate mortgages. For the analyst, the quality of the collateral and the creditworthiness of the user are significant factors. An analyst's judgment of a bond issuer's creditworthiness is based on the terms of the debt repayment agreement. When crediting aircraft purchases by an airline, for example, there is no need to secure the repayment of the loan through lease agreements, conditional sales or pledge agreements movable property unless, of course, the loan agreement deprives the borrower of the right to mortgage the aircraft. Modern equipment, if in good condition, is quite liquid and is a good collateral for loans to airlines, which are characterized by weak credit positions. Chapter 24 Selecting Fixed Income Securities 283 When there is an overcapacity of oil tankers, the collateral value of a tanker can fall extremely low, but if it is chartered without a team by a major international oil company, the tanker will be a first-class loan collateral. This is a typical example of how creditworthiness depends on the ability of the user of an asset to service debt. Industrial bonds backed by income have become an important tool in the capital market today. The reputation of an obscure municipality or county is something intangible. The attention of an analyst is required only by the one who lends it, as a rule, it is a large company. Securing a loan with property that is owned and used in the borrower's business does little to add value to most debt instruments. Used specialized property is valuable only for its contribution to profit. The real source of creditworthiness is profitable activity. The right to pledged assets has also lost value as a result of the change in the bankruptcy procedure: today the desire to reorganize in order to save the business, instead of liquidating the bankrupt and paying debts in accordance with the seniority of the claims, prevails. Under bankruptcy law, the transfer of mortgaged property to creditors can be delayed for quite long terms, and this reduces the potential value of the collateral. Therefore, an investor buying bonds should primarily be concerned about not getting into a bad situation, and not about finding protection in case such a situation occurs. So if the company's junior bonds are not reliable enough, it is hardly worth investing in senior bonds. It can be put differently: if the company is creditworthy, you should buy more profitable bonds, and these are, most often, just junior or secondary obligations. Restricting investment to only prime bonds is like declaring a lack of credibility in credit ratings. A caveat must be made to minor bonds: if the principal bonds are to be paid for only by giving up a small additional profitability may be worth paying for modest protection from the unexpected. If an investor is concerned about the liquidity of bonds, then again, senior bonds should be preferred in the expectation that their prices are less volatile. Profitability as a source of payment For most corporate bonds, the source of payment is the company's earnings. A power plant serving an expanding territory can redeem a bond issue ahead of schedule by issuing another issue, but refinancing is possible for it 284 Part Three. Analyze a bond only by virtue of the fact that the market is aware of its ability to make a profit. Capital-intensive industrial companies are expected to repay bonds, although the amount of debt they place on the market may increase as the enterprise grows. Consider the statistics of non-fulfillment of obligations under bonded loans (see Table 24.3). It is easy to see that debt defaults become more frequent during periods of recession or depression. It would probably be better to take a bond default rate for low-quality issues, but this happens with investment-grade issues as well (see Table 24.4). The distribution of bond defaults by industry (see Table 24.5) shows that the dynamism and profitability of an industry do not guarantee success. It can be assumed that investors may be affected by the prestige of the industry, depriving them of the usual security. Failure to fulfill obligations to redeem corporate bonds
Source: Altman E.I. and Nammacher S.A. Investing in Junk Bonds. New York: John Wiley & Sons, 1987, p. 107. Table 24.4. Rating of outstanding bond issues (in %)
Source: Altman E.I. and Nammacher S.A. Investing in Junk Bonds. New York: John Wiley & Sons, 1987, p. 131. Chapter 24. Selection of fixed income securities 284 Table 24.5. Non-redemption of corporate bonds by industry, 1970-1985
Source: Altman E.I. and Nammacher S.A. Investing in Junk Bonds. New York: John Wiley & Sons, 1987, p.133. arrogance and provoking the adoption of specific risks that they would otherwise consider unacceptable. An example is the story of Viatron Computer Systems. The company offered but failed to deliver a cheap and efficient system like the one that turned out to be very effective. Viatron, however, was in bankruptcy the year it offered its unsecured convertible bonds to the market. A long time ago, three criteria for creditworthiness were defined: the presence of collateral (assets as a source of debt repayment), profitability and character. The third criterion is too often considered data and assessed inadequately. There is no need to look up the Ivar Kreuger and International Match Corporation scandals to find examples of dishonesty in business. Equity Funding, Flight Transportation, Itel, Saxon, U.S. Financial, Westgate accounted for 6% of bondholder losses (see Table 24.5), and investor losses were even greater. The level of profitability that justifies investing in bonds depends on both business positions (position in the industry, customer relations, creating new products quality of marketing and management, etc.) and financial positions (liquidity, capital adequacy, pricing, cost control, profit planning, etc.). It is also important to consider the state of the industry. Even this short- 285 Part Three. An analysis of bonds cue list shows that a lot depends on the company itself. However, the question remains: is it even possible to measure the reliability of a company's ability to make a profit? It is worth referring to the works devoted to the prediction of bankruptcies, since in these works attempts are made to find those financial indicators, which may warn of the possibility of the collapse of the corporation. In the central work of Beaver and Altman1 there is a lot of evidence that this or that combination financial ratios can identify probable bankrupts in advance. The Altman Z-Score has been developed in the ZETA model, which is traded by Robert Haldeman under the name "ZETA Credit Risk Score"2. To obtain the final assessment, 7 financial ratios are used: 1) cumulative profitability - the ratio of the amount of retained earnings to total assets; 2) profit stability - an indicator of the standard deviation of profit before interest and income for 10 years from the trend line, referred to total assets; 3) capitalization - the average annual value for a five-year period market value ordinary shares, calculated as the ratio of the total capitalization of senior liabilities carried at par or at salvage value, and ordinary shares at market price; 4) size - the amount of tangible assets; 5) liquidity - the ratio of current assets to current liabilities; 6) debt service - interest coverage ratio; 7) total profitability - the ratio of profit before interest and taxes to total assets. In February 1987, ZETA averages in the following way correlated with the credit rating of companies:
1 Beaver W. Financial Ratios as Predictors of Failures//Journal of Accounting Research, 1967. January; Altman E.I. Financial Ratios, Discriminant Analysis and the Prediction of Corporate Bankruptcy//Journal of Finance, 1968, September. For a detailed review of the issue, see: Altman E.I. Corporate Financial Distress. New York: Wiley, 1983. 2 Zeta Services, Inc. 5. Marineview Plaza, Hoboken, New Jersey. ZETA estimates are regularly calculated for over 4,800 companies. Chapter 24. Selecting Fixed Income Securities 286 The result of this analysis and the identification of possible candidates for bankruptcy are indicators that help the analyst identify companies that investors believe are candidates for growth or decline. credit rating. If the value of the ZETA score falls below 2.9, then the company's rating is doomed to fall below BBB, that is, it falls out of the group of investment grade securities3. The role of reporting indicators Judging the security and reliability of loans can only be based on data on the company's performance. To determine debt coverage, the analyst seeks to measure quality metrics that have already proven to be reliable and thus provide hope for the future. Exploring the possibilities for a favorable change in the future is an activity for buyers of junk bonds and questionable stocks. AT individual cases, when we are talking about solid and reliable borrowers, it is enough for an analyst to study the reported data on profitability and liquidity in order to establish the security of loans in an unfavorable development of the economic situation. But in the usual case, the only reliable sources of analysis are adjusted income statements and balance sheets. We have already discussed the necessary adjustments in Part 2 of this book. Reporting, especially stripped of embellishment, is also the best source for understanding development prospects. For prospects, it is best to take the latest data on sensitivity to macroeconomic and industry factors. An analyst can learn a lot from closely observing how a company reacts to the vicissitudes of commodity markets. Debt Coverage: Stability and Volatility A buyer of bonds usually accepts the inevitability of interest rate risk, especially in the case of long-term bonds, but does not intend to take credit risk, and even without adequate compensation. It is preferable to have a small but stable debt coverage rate than an average higher but very volatile one. The criteria for assessing a company's ability to repay a debt should primarily take into account industry characteristics(and in the second - characteristics of the company). If, by the very nature of the business, the company receives a steady cash flow, very little debt coverage is acceptable. It is precisely because of income stability that power generators show many examples of high quality. Rating Industrial Bonds. Morristown, New Jersey: Financial Executives Research Foundation, 1983. 286 Part Three. Analysis of bonds of honest bond issues. However, even in this area, the development of nuclear power plants has greatly changed the established indicators of growth and stability. Life constantly reminds us not to rely too much on traditional rules and ratios. Changes When a company drastically changes the structure of its business or funding, the analyst must rethink and revise the most important statistics. If at the same time it is possible to single out some industry sector, part of the data for past periods can be used without radical processing. In other cases, when designing future financial statements, the analyst has to rely on his imagination and common sense. If the restructuring affects mainly the financing of the company, the task of the analyst is relatively simple. In the case of a buyout of companies on credit, for example, management does not have the ability to borrow funds, and the direction of the business is to a certain extent predetermined. Inevitably, capital investment will be limited, and it will take some time to repay the loan taken to buy back the shares. When there is relatively little debt crowding out in the capital structure own funds, such consequences usually do not occur. Defining creditworthiness It is useful for corporate finance officers, lenders and investors to use a broad definition of creditworthiness. When it comes not to short-term speculation, but to investments in stocks and bonds, the investor must evaluate the following three factors: 1) the ability of the company, in an unfavorable situation in the industry or in the economy as a whole, to continue operations without allowing large losses or reduction in production; 2) the ability of the company for a sufficiently long time to respond to current liabilities and serve debentures even in the event of an unfavorable situation; 3) the company's ability to access new sources of funding to upgrade or expand its critical business lines even in the face of an unfavorable situation. Since a reliable assessment of such factors is impossible in principle, when predicting the magnitude and stability of future income, it is important to assess the degree of credit security.
