Debt Instruments
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Increase income yield and diversify your portfolio.
Investments in Government or company borrowings carrying a fixed interest rate.
Debt instruments are a collective group of investment products which enable an issuer to raise money through a contract typically laying out the fixed interest rate for the period of the loan, or the calculation of the interest payable if linked to another variable. An example of the former may be a UK Government stock or a Corporate bond, an example of the latter could be an index-linked UK Government stock, an index-linked corporate stock or a Floating Rate Note (FRN) linked to the Libor rate.
The bonds can then be traded on the open market and investment returns may be calculated if held to maturity. In holding to maturity the investor is taking a view on the likely economic background for the maturity period of the instrument or may be happy to accept the return being offered for the period in question. More likely is that the investor will take a view for a shorter time frame in which a capital appreciation can be made, such as a short to medium term bet on the movement in interest rates.
In terms of risk we view Government or Supranational debt as less risky than Corporate debt with corresponding levels of potential gain or loss to be considered. The degree of certainty of payment of the interest on the due dates is what sets the potential risk to the investor. The assessment of this risk is governed by Ratings Agencies around the world from AAA, Government or companies of high quality, down to Junk bond status which may be applied to very weak companies. This rating can change over time leading to an added level of uncertainty to returns from the debt instruments.
A diversified portfolio will normally contain some debt exposure, usually via the better quality assets in order to diversify the returns from a portfolio and because the risks are generally lower than for equity holdings, both in the UK and Overseas.
Risks
- The value of your investments and any income from them may go down and you may get back less than you originally invested.
- If you are unsure about the suitability of this service please contact us for advice.
Case Study on Debt Instruments
The recent credit crunch has its origins in the fact that the ratings of debt can change. In the debt market the packaging of debt such that one instrument can contain a range of underlying assets with varying risks has destabilised the market. As stated risks can change, a mortgagee may go from AAA to a lower rating if for any reason they are unable to make the loan repayments and once in breach of their obligation, the debt is very much reduced in value.
The fault for the sharpness of the fall in the value of these securities has been ten years in the making. The markets, in order to achieve higher returns, had bought up these instruments to such an extent that the pricing of poor quality debt was priced very close to the very best debt issued by Governments. In riding the rollercoaster on the way up the appropriate level of risk was forgotten and all it was going to take was a trigger to undermine this pricing.
This came in the form of the increase in mortgage defaults of loans that were extended to those who could quite clearly not make repayments for longer than the short term investment they were lent for. As house prices fell these repayments became unsustainable and house prices fell as excess stock had to be cleared. Much property had been built for these speculators, compounding the problem.
The subsequent story has been well covered and we have seen the central banks inject capital to stablilise the financial system and mortgage banks reinvent sensible lending criteria. The basis for a recovery is in place but the time taken for investors to regain confidence in the debt market is debatable.
Debt Instruments
Increase the income yield and diversify your portfolio.
Disclaimer: You should be aware that the price and value of any investments and the income, if any, from them can fluctuate and may fall against your interests. You may get back less than the amount originally invested.
Information on past performance, where given, is not necessarily a guide to future performance. Exchange rate fluctuations may have an adverse effect on the value of financial instruments quoted in a currency other than your agreed settlement currency. The investment and services offered may not be suitable for all investors. Investors with any doubts as to the merits of an investment should seek advice from a suitably qualified professional advisor. You should also be satisfied that the product is suitable for you in the light of your circumstances and financial position.If you are unsure about the suitability of an investment please contact us for advice.
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