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Borrowing to buy Telstra

This article appeared in the September 2013 ASX Investor Update email newsletter. To subscribe to this newsletter please register with the MyASX section or visit the About MyASX page for past editions and more details.

Low interest rates and higher dividends strengthen the case for instalments - but know the risks involved with gearing.

Photo of Tania Smyth By Tania Smyth, CBA

For many years instalment warrants have been a popular way to borrow to invest in leading ASX-listed shares for individual investors and self-managed super funds (SMSFs). With interest rates at historical lows and attractive dividend yields, now may be a good time to learn about instalment warrants and consider whether they are suitable to help you meet your investment objectives.

(Editor's note: To learn more about the features, benefits and risks of instalments, take the free online ASX Warrants and instalments course. As with any geared investment, borrowing to buy shares can magnify gains and losses, and is a strategy that suits experienced investors). Investors interested in learning about warrants should also register for the ASX webinar, Enhancing Dividends Using Instalment Warrants, on September 19.

How they work

Instalment warrants are listed on ASX and can be bought and sold during normal market trading hours. They provide flexibility and transparency.

An instalment warrant exposes you to the price movements, dividends and franking credits associated with the underlying security. The first payment is typically 50-70 per cent of the underlying security's price, but some instalment warrants offer gearing levels up to 100 per cent, where the first instalment is interest only.

The second instalment, known as the completion payment, is a limited recourse loan made to you by the issuer of the instalment warrant. You can make the completion payment at any time up to the maturity date, to take legal ownership of the underlying securities.

The limited recourse nature of the loan means that unlike other forms of borrowing to invest, such as margin lending, there are no margin calls, no credit checks and the most an investor places at risk is their initial capital outlay - the amount paid to purchase the instalment warrant in the market plus any brokerage.

It is important to understand that instalment warrants have different features to suit a variety of investor needs. You should read the product disclosure statement (PDS) provided by the issuer to assess the warrant's features and whether it meets your trading and investment requirements. You will also need to sign a warrants agreement with your stockbroker or financial adviser to commence trading.

Case study: Increased exposure to Telstra over the medium term

On August 12, 2013, Telstra shares were trading at $5.08. Investors looking for an instalment warrant that gives medium-term geared exposure to Telstra could consider the TLSIYA instalment warrant issued by the Commonwealth Bank.

The IYA series of instalment warrants provides investors with gearing levels of around 50 per cent, based on the Telstra price in the example below. Any dividends are paid in cash and franking credits are passed through to investors. You also receive exposure to any capital movements in the selected underlying security. The maturity date of the IYA series is July 29, 2015.

The following table outlines details of the TLSIYA instalment warrant on August 12 (based on prices on that date) and considers the potential dividends that may be received over the investment period until the maturity date.

TLSIYA instalment warrant details and potential dividends

Instalment Warrant details Telstra price and dividend details
ASX Code First instalment price Completion payment (loan) Maturity date Current gearing level Telstra share price

Forecast dividends until maturity

Forecast franking credits Total forecast dividend
TLSIYA $2.87 $2.50 29/07/2015 49%  $5.08  $0.56 $0.24  $0.80

Source: CBA

The table is intended for illustration purposes only. The purchase price does not include brokerage that may be charged for purchasing instalments on ASX. Dividends and franking are not guaranteed. The cash dividend assumed until the maturity date is 56 cents and franked at 100 per cent. The analysis assumes franking credits and offsets are available to investors.

Based on the information above, the first instalment price to purchase TLSIYA is $2.87 and the completion payment (loan) is $2.50.

Income - Over the investment period and based on the forecast dividends above, you may receive 80 cents in total income per instalment warrant.

Interest - Like any borrowing, you need to consider the costs involved. When purchasing instalment warrants, an interest amount is paid as part of your first instalment price. The amount reflects that the loan is made to investors on a limited recourse basis. The first instalment price of $2.87 includes an interest amount of 29 cents for the $2.50 loan until the maturity date of July 29, 2015.

Based on the assumptions above, TLSIYA instalment warrants are positively geared (total income less the interest amount). It also means that the breakeven at maturity is $4.57 (first payment plus completion payment less total income).

Considerations for a successful strategy

  • You must have a positive view on the underlying shares when considering borrowing to invest.
  • Identify an instalment warrant that reflects your tolerance for risk. The higher the gearing level the higher the risk. Leverage can improve returns but it will also magnify losses. Any losses are limited to your first payment.
  • Consider the interest cost you are incurring over the investment period.
  • Talk with your financial adviser to determine whether this is an appropriate strategy for you.
  • Ensure you consider the relevant PDS for the instalment warrants that interest you.

Benefits of instalment warrants

  • Purchase ASX-listed securities in two payments.
  • The second instalment, known as the completion payment, is a limited recourse loan, repayment of which can be made at any time up to the maturity date. If not repaid then, any losses are limited to your first instalment.
  • Gain leveraged exposure to movements in the underlying securities price.
  • Exposure to improved dividend yield.
  • No margin calls or credit checks to complete.
  • Issued over a range of Australia's leading companies and exchange-traded funds (ETFs).

Risks to consider

  • The value of the underlying securities may fall, which would result in the value of the instalment warrants falling.
  • The leverage (gearing) incorporated in the instalments will magnify any losses that occur, and investors risk losing some or all of their initial capital outlay.
  • Impact of changes in volatility, interest rates and dividends, some of which may adversely affect the price of the instalment warrants.
  • Any changes in Australian tax law and legislation.

This is not an exhaustive list of the considerations, benefits and risks of instalment warrants. You should carefully consider the PDS and talk with your financial adviser.

About the author

Tania Smyth is senior business development manager, equity product sales, Commonwealth Bank.

From ASX

ASX Warrants explains how warrants work and has links to more detailed information.

The views, opinions or recommendations of the author in this article are solely those of the author and do not in any way reflect the views, opinions, recommendations, of ASX Limited ABN 98 008 624 691 and its related bodies corporate ("ASX"). ASX makes no representation or warranty with respect to the accuracy, completeness or currency of the content. The content is for educational purposes only and does not constitute financial advice. Independent advice should be obtained from an Australian financial services licensee before making investment decisions. To the extent permitted by law, ASX excludes all liability for any loss or damage arising in any way including by way of negligence.

© Copyright 2013 ASX Limited ABN 98 008 624 691. All rights reserved 2013.


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