Types of Interest Rate Securities
There is a range of terminologies used to describe the types of Interest Rate Securities, which may refer to a key feature of a particular type of ASX IRS. The list below provides an overview of the distinguishing characteristics of the three broad categories (government bonds, corporate bonds and hybrid securities) and identifies a number of sub-types within each category.
Government Bonds are debt securities issued by a government.
Exchange-traded Australian Government Bonds ("AGBs") are a convenient and readily accessible way for investors to invest in bonds issued by the Australian Government. An Exchange-traded AGB holder has beneficial ownership of an Australian Government Bond in the form of a CHESS Depositary Interest (CDI). This means obtaining all of the economic benefits (including coupon and principal payments) attached to legal ownership of the Bonds over which the CDIs have been issued. Legal ownership of the Bonds is held in trust for the holder by an entity appointed by the Australian Government. AGBs are considered to have the lowest possible credit risk and therefore may be suitable for investors seeking stable and highly secure cashflows.
There are two different types of Exchange-traded AGBs:
- Exchange-traded Treasury Bonds (TBs) are medium to long-term debt securities that carry an annual rate of interest fixed over the life of the security, payable six monthly.
- Exchange-traded Treasury Indexed Bonds (TIBs) are medium to long-term debt securities for which the capital value of the security is adjusted for movements in the Consumer Price Index (CPI). Interest is paid quarterly, at a fixed rate, on the adjusted capital value. At maturity, investors receive the adjusted capital value of the security – the value adjusted for movement in the CPI over the life of the bond.
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Corporate Bonds are like a loan whereby an amount is lent, interest as a percentage is paid at regular intervals and the amount borrowed is repaid in cash at a specified future date. A notable exception is perpetual securities (see below).
- Vanilla style: Bonds issued by companies that can be either secured or unsecured. They have a fixed maturity and coupon rate meaning that cash flows are known throughout the life of the bond and the face value is repaid at a fixed date in the future.
- Floating Rate Notes (FRNs): Bonds that can be either secured or unsecured. FRNs pay a variable coupon amount, generally quarterly or semi-annually, which is referenced to a short-term benchmark rate such as the 90-day bank bill swap rate.
- Perpetuals: Some FRNs are perpetual and have no specified maturity date. Without a fixed redemption date an investor may have to sell on-market (at a premium or discount to face value) to realise their investment. The issuer may have the right (but not an obligation) to redeem a perpetual; however, there can be no guarantee of this occurring.
Hybrid securities are an investment, interest may be paid at regular intervals as either a percentage amount or which may be fully franked with the repayment of the loan amount being either repaid in cash or converting to equity (ordinary shares in the issuer). The manner in which the conversion to equity is calculated can vary. For example, some hybrids convert on a one for one basis – one hybrid for one ordinary share, while others convert on a dollar value – current or discounted share price divided into hybrid face value or a set dollar amount.
- Convertible Notes: Pay a fixed coupon rate and can be converted into ordinary shares at a particular date or period of time in the future.
- Convertible: Securities that have both debt and equity characteristics that convert into a dollar amount of the ordinary shares of a company at a future date at a set dollar amount or at a discount to the ordinary share price at that time.
- Reset Preference Shares: Typically pay a fixed rate where the coupon is set for a defined term. At the end of the defined term, the securities are remarketed where they are either redeemed or a new fixed coupon rate is set. They are typically perpetual in nature.
- Step up Preference Shares: Securities that have both debt and equity characteristics. These securities normally pay a floating rate coupon and have a call date after a set period. If these securities are not called at the first call date then the coupon ‘steps-up’; to a higher rate to compensate investors for non-redemption. They are typically perpetual in nature.
- Stepped up Preference Shares: Securities that have both debt and equity characteristics that have already passed the call/step-up date and pay an additional amount over and above the original coupon. They are typically perpetual in nature although the issuer has the option to redeem the securities on any future coupon payment date.