By Charles Ross, ContributorTHE buying and selling of bonds can be a very simple and straightforward process, but there are a few unusual features that must be understood:
THE BOOK ENTRY SYSTEM
First of all, unlike local registered stock (LRS), treasury bills or share certificates, no physical certificate is issued to denote ownership of global bonds. The bonds are traded by a book entry system whereby an account is opened at a participating broker and the client's bonds are deposited into this account. The book entry system is similar to the new securities depository that has been set up by the Jamaica Stock Exchange and is necessary to facilitate the electronic trading of the securities and the smooth and efficient clearance and settlement of trades in the bonds. Interest payments on the bonds are lodged to the clients' bond accounts, from where they are disbursed in keeping with their instructions.
PAYMENT FOR BOND FACE VALUE + INTEREST
Another interesting feature of the way in which bonds are traded is the requirement that the purchaser of a bond must pay the cost of the face value of the bond, plus the accrued interest on the bond at the time of settlement. When a bond is issued, the dates on which interest payments will be made are also fixed, with the most common interval for coupon payments being semi-annual or twice per year. Now, although the bonds can be bought and sold at any time, interest will only be paid on the fixed dates and the payment will be made to the individual who owns the bonds at that date. Therefore the only way that someone selling a bond in between the coupon dates can be assured of collecting his interest is for the person to whom he is selling his bonds to pay him for the interest that has accrued on his bonds between the last interest payment date and the date on which he sells his bonds. Since both the interest rate on the bonds and the dates on which interest is paid are fixed, this is a fairly easy computation to make.
A TYPICAL TRANSACTION
The structure of a typical transaction is best illustrated by a simple example. Keep in mind that most global bonds accrue interest based on a 360-day year, made up of twelve 30-day months. Now, suppose you wish to purchase US$100,000 Face Value of a bond that has a coupon of 10 per cent per annum paid semi-annually. The price of the bond is 110 and the settlement date is exactly 3 months since the last coupon payment date. The total transaction cost would be calculated as follows:
Cost of bonds
= Face Value x Price/100
= $100,000 x 1.10 = $110,000
Accrued interest
= Face Value x coupon x 90/360
= $100,000 x 10% x 0.25 = $2,500
Total transaction cost = $112,500
At the next coupon payment date, the purchaser of the bonds would receive US$5,000 as his interest payment, thus recovering the accrued interest that he paid out, plus the interest that he has earned since he purchased the bonds.
As with any trading activity that is conducted through brokers, there are commissions that are charged for the execution of the purchase and sale of global bonds. However, these are usually quite small (often fractions of 1 per cent) and are usually built into the price of the bond that is quoted by the broker. For example, in the illustration above, the broker handling the transaction would have his commission built into the price of 110, which the client would pay for the bonds. There would therefore be no additional charge for the broker's services.
BUYING GUIDE
Global bonds can be purchased in quite small denominations, with the exact minimum depending on the issuer and the terms of the specific bond that is being purchased. However, in practice, transactions that are smaller than about US$10,000, tend to be a bit more vulnerable to the vagaries of the market and may attract higher prices on the "buy" side of the transaction and lower prices on the "sell" side. It is also a bit more difficult to attract buyers for lots of bonds that are smaller than that amount.
INTERNATIONAL CLEARANCE PROCEDURE
In the age of globalisation, the international capital market is much more accessible than most of us would imagine. We can stay here in Jamaica and buy and sell global bonds issued by countries as far afield as Brazil, the Philippines, Kazakhstan or Qatar. This is possible because of developments such as the global securities clearance system called Euroclear. Listed as the world's largest settlement system for domestic and international securities transactions, Euroclear covers both bonds and equities and provides securities services to major financial institutions located in more than 80 countries worldwide. When clients place orders for bonds with their brokers, the Euroclear system is used to execute the transaction and facilitate the exchange of cash for securities. The system is very efficient and operates on a settlement cycle of T+3. In other words, within 3 days of an order being placed, payment must be made and the bonds delivered to the purchaser.
Charles Ross is Managing Director of Sterling Asset Management Ltd.
