Questions about investment markets (Part 2)

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Investments are never the same, and knowing about them, why one needs to invest, what to invest in, when to invest and how much to invest are questions that are frequently asked. We continue from last week where we endeavour to answer some of those questions that will fill the gaps on investing, so that you make informed decisions. We advise that you seek professional advice before investing.

What are Fixed Income Securities Investments?

The easiest way to think of fixed income/bonds/debenture is that it’s a loan. They are issued by companies and governments as a way of raising money. Bonds provide a regular stream of income (which is normally a fixed amount paid at regular intervals) over a specific period.

Attached to bonds is the promise to return the capital borrowed to investors at a set date in the future when the bond matures or becomes due. Bonds can offer stable returns and are perceived to be of lower risk than equities, although they typically deliver lower returns over the long term.

By investing in fixed interest securities issued by companies, other than those issued or guaranteed by certain governments, the investor is exposed to a greater risk of default in the repayment of the capital provided to the company or the interest payments due to the fund.

Bonds are generally long-term in nature, that is, longer than one year, as opposed to the money market which is less than one year.

What are the basic types of Bonds?

There are 3 common types of bonds namely:

  1. Government or Treasury Bonds These are Bonds issued by Government through the Reserve Bank of Zimbabwe or the central bank.
  2. Municipal or Quasi — Government Bonds These are Bonds issued by Municipalities or State enterprises.
  3. Corporate Bonds These are Bonds issued by private enterprises.

Who participates in the Bond market?

Government and Quasi — Government institutions;

Corporates,

Commercial banks;

Individuals;

Institutions such as Asset Management Companies;

Pension funds;

Why do Companies or the Government “float” Bonds in the market?

Government and companies use proceeds from the sale of Bonds for a wide variety of purposes such as:

Infrastructure and new equipment purchase;

Refinancing debt;

Financing mergers and acquisitions;

Financing any projects of a long-term nature.

The following are questions related to basic Bond terminology:

What is a Coupon?

This is periodic income received by the bondholder during the time between when the bond is issued and when it matures.

What is the Bond price?

It is the amount one pays to buy a bond. The price is normally calculated from the coupons of a bond and a discount rate (the yield rate). The actual mathematics of pricing a bond will be explained later.

What is a Bond yield?

The money that investors earn on a bond during the life of a bond from the date of purchase up to its maturity.

How does one earn a return from investing in Bonds?

An increase in Bond price, for instance, an investor can buy a bond at a price of $101 and sell it at $105 in the process earning a profit of $4;

Coupon payments: An investor only earns this coupon during the period in which they are holding the bond.

For further information on bond trading strategies, please refer to Securities Market Intermediaries such as Asset Managers or Brokers.

Why should I invest in bonds?

The main reason is that unlike equities, bonds provide a regular long-term income stream which can be comfortable for retirees or other investors who need a predictable source of income.

Other advantages include diversified investments which can reduce risk or improve a portfolio’s overall rate of return. With bonds as an anchor for a portfolio, an investor may feel more comfortable taking on greater risk with other investible assets in the hope of achieving greater returns.

What is the difference between Bonds and Shares?

When one invests in bonds, all the investor receives is interest and the principal amount on the bond no matter how profitable the company becomes. In the event of liquidation, bondholders are paid out first before shareholders.

What is a Bond Rating?

A bond rating is the grade given to the company that issues a bond on its ability to pay the bond principal and the interest. The bond rating is done by ratings agencies such as Standard & Poor’s, Fitch, Moody’s or Global Credit Rating Agency.

What are some of the risks of investing in Bonds?

Default Risk: The company may fail to make timely payments of interest or principal to the bondholder. Therefore, the ability of a company to pay its debt obligations on time should be of important concern to bondholders.

Interest Rate Risk: The price of a bond will fall if the market interest rate rises. If the price falls below what investors paid on purchasing the bond, investors can incur a loss.

Inflation Risk: Inflation is the general rise in the prices of goods and services causing a decline in purchasing power. Inflation often causes the government to increase interest rates to the control demand for credit (which fuels inflation). An Interest rate hike causes bond prices to fall.

Liquidity Risk: This is the risk that sees investors seeking to sell their bonds not receiving a price that reflects the true value of the bonds (based on the bond’s interest rate and creditworthiness of the company).

Call risk: The terms of some bonds give the company the right to buy back the bond before maturity date.

What are Money Market or Cash Investments?

The Money Market is one where short-term securities of tenure of less than one year are traded.  In these investment forms, both individual and institutional investors deposit their funds in anticipation of interest returns whilst being able to withdraw their funds in the short term.  Money market investments can be as short as overnight placements or for placement periods for as long as 7 days; 14 days; 30 days; 60 days or 90 days.

What are examples of Money Market Instruments?

Who participates in Money Markets?

Banks;

Insurance Companies;

Building Societies;

Asset Management Companies;

Government;

Corporate entities;

Individuals

Why should one invest in Money Markets?

Money Markets have a regular interest income. There are no transaction fees for entry and exit and there are also tax advantages if the instrument is tax free. Money Markets protect against portfolio volatility and are highly liquid.

What are the Disadvantages of Money Market Investments?

They have low returns and a slow capital appreciation.

How do you earn a return when investing in the Money Market?

The key source of return in a money market instrument is accrued interest, which is either earned on maturity of the instrument or when the instrument is disposed before it matures. For further information on money trading strategies, you are advised to consult Securities Market Intermediaries such as Asset Managers.

What are Unit Trust Investments and Portfolio Investments?

Investing directly into different assets can become costly and difficult to manage particularly for small investors. Unit Trusts or Collective Investment Schemes allow investors to pool contributions together, and to share the costs and benefits of investing.

Each individual investor then has an indirect or direct claim on the assets purchased, subject to fees levied by the intermediary. Investment usually involves diversification of assets to avoid unnecessary and unproductive risk.

Unit trusts are established when a registered Fund Manager accepts or pools money from small investors and invests it in shares, bonds, the money market or other securities under a trust deed.

A Trust is created by a legal document called “Trust Deed” prepared by a legal representative who outlines the purpose of the trust, the rights and obligations of the trustees and unit holders, powers of the trustee, and identifies various parties such as initial unit holders and Trustee(s).

What are the types of Unit Trust Funds?

These include the Money Market (funds invested in money market), Bond Fund (funds invested in bonds), Equities Fund (funds invested in shares), and Hybrid Fund (funds invested in both money market, bonds and shares.) In Zimbabwe Unit Trusts are regulated through the Collective Investment Schemes Act.

What are the sources of information for Investments?

The following are possible sources of information that will assist you when making investment decisions:

Company Annual reports;

Company Results Briefings and Presentations;

Company Websites and Social Media Pages;

Industry Reports;

Regulatory bodies, for example, Potraz, RBZ to get information on competitive analyses;

Regulatory filings, such as, Tax returns and filings to the Securities and Exchange Commission of Zimbabwe (SECZ);

Stock exchanges and data vendors to get past stock prices and other important metrics;

Publicly available information like qualitative information on leadership quality and company corporate governance.

What is the Risk Return Matrix?

The risk matrix is based on the long run relationships of risk and return. Investment is putting money into something with the expectation of gain, usually over a longer term.

Investment has a connotation of a long-term holding period, in contrast to speculation or gambling, which is the purchase of assets seeking profit from short-term price movements.

Join us as we continue our journey to financial inclusion as we talk about how the markets work in Zimbabwe. If you have any queries, comments or want to tell us about your hustle, visit www.myzimhustle.co.zw , go to the MyZimHustle facebook page, visit @MyZimHustle on Twitter or whatsapp 0775 574 587 (whatsapp only)

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