Instalments

You can use instalments to gain leveraged exposure to shares, baskets of shares, or listed managed investments such as exchange traded funds (ETFs). Reasons to invest include leverage, diversification, generating dividend income and extracting cash. They are also one of the few leveraged investments for Self Managed Super Funds (SMSF).

Instalments allow you to gain exposure to shares (and other securities) by making a part payment upfront and delaying an optional final payment until a later date. This allows you to buy shares for a fraction of the current share price while receiving the benefits of capital growth, dividends and franking credits.

There are different types of instalments; general characteristics include:

  • When issued, the instalment price reflects a percentage of the market value of the underlying securities. This percentage depends on the gearing ratio of the instalment.
  • The gearing ratio is defined as the loan amount relative to the current share price, and varies with fluctuations in the share price. On issue, it can range from 40% to 110%. The higher the loan amount, the more highly geared the instalment.
  • The amount of the final instalment (loan amount) is generally fixed and represents a loan by the issuer. The payment of the final instalment is optional.
  • A funding cost component is usually included in the instalment payments. This represents prepaid interest (generally up to 12 months) and a borrowing fee. Some components may be tax deductible under certain circumstances. 
  • You are entitled to the benefits of dividends or distributions (including franking credits) paid on the underlying assets. (In some cases 'special dividends' may be used to reduce the loan amount instead of being paid directly to you). Instalments may also pass on the voting entitlements of the underlying asset.

The fourth letter of ASX warrant code is 'I' or 'J' (or 'S' for self funding instalments).

Benefits of instalments

  • Leverage
    Gain a leveraged exposure to the movement of the underlying asset which may enhance your capital returns. Also, by paying a fraction of the underlying asset upfront you are able to increase your exposure for the same capital outlay.
  • Diversification
    Build a broader asset base by diversifying through instalments, giving you an equivalent exposure to an underlying asset on a per share basis while having remaining funds available to invest into other assets.
  • Generating income 
    Derive a regular income stream through the entitlement to dividends and franking credits. Writing call options over instalments can be another source of income to your portfolio.
  • Unlock wealth from existing share holdings
    As an alternative to selling shares to extract cash, you can convert your share into instalments without triggering a Capital Gains Tax (CGT) event.  This strategy is known as cash extraction, and can be an ideal way to spread risk and build a wider asset base, while maintaining exposure to your existing shares.

Risks of instalments

  • The underlying asset fails to perform as you expected.
  • When investing in instalments, the maximum amount at risk is your initial investment (plus transaction costs).  You are not obligated to repay the loan unlike other forms of borrowing, such as margin lending. 
  • Instalments offer a leveraged exposure to sharemarket, therefore percentage profits and losses are magnified.

Example of an ordinary (or vanilla) instalment

Warrant code NABISL
Underlying instrument Ordinary shares of National Australia Bank Ltd
Warrant type Instalment
Expiry date 21 December 2006
Exercise price $13.50
Exercise style American
Conversion ratio 1

If you bought NABISL instalments you would have the right to buy one ordinary share in NAB for $13.50 on or before 21 December 2006. You will receive the full dividends and franking credits that are paid on NAB Ltd ordinary shares during the life of the instalment.

The disclosure document outlines the terms and conditions for each instalment series. You should be familiar with those prior to trading. You can access information on how to find a disclosure document on the ASX website. Alternatively, you may contact your adviser or the warrant issuer.

To learn more about instalments, visit our online warrants class or view alternative educational offerings.