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Guide To Fixed Interest Securities

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You lend someone money, they pay you interest for the use of the
money and agree to pay your money back on a certain date. These are
also known as debt securities.

Bonds, bank accounts and term deposits, credit union and building society investments, and finance company debentures are all fixed interest securities.

Fixed securities generally pay you an agreed rate of interest at set
times. The interest can be paid in various ways. It may be:

  • paid to you at regular periods during the term of the investment; or
  • paid in a lump sum at the end of the investment; or
  • calculated
    at regular periods and added to the amount you have invested. This is
    called compound interest. Find out more about compound interest at www.sorted.org.nz

There are many different types of fixed interest securities.
Generally the higher the interest rate, the greater the risk. The
Government, banks, credit unions, building societies and finance
companies all offer fixed interest securities.

Government
The Government offers fixed interest investment in Kiwi Bonds through
the New Zealand Debt Management Office. Kiwi Bonds are very low risk
because the interest payments and the repayment of your money is
guaranteed by the Government. This is reflected in Kiwi Bond's credit rating of AAA, which is the highest possible.

You buy Kiwi Bonds for terms of six months, one year or two years.
You can't trade Kiwi Bonds, but you can transfer ownership to someone
else. Read more at http://www.nzdmo.govt.nz/kiwibonds/.

Registered banks
Banks offer a wide range of fixed interest products e.g. savings accounts and term deposits.

When you invest the bank uses your money to lend to someone else at a higher rate of interest than they are paying you.

A financial institution can call itself a bank only if it's registered with the Reserve Bank of New Zealand (RBNZ). Registered banks are supervised by the RBNZ and must comply with the conditions of their registration. Read more at www.rbnz.govt.nz

A bank must maintain a credit rating issued by one or more of three
credit rating agencies. It must have an investment statement which
explains the bank's fixed interest products and a general disclosure
statement which explains the bank's financial position. Banks also must
publish a key information summary of their financial performance and
risks every three months. If you ask for these documents they must give
them to you.

The RBNZ monitors how registered banks comply with their conditions
of registration, but neither it nor the Government guarantees that a
registered bank will not get into difficulty or fail.

Finance companies
Finance companies also offer fixed interest securities. They take in your money and lend it out for various ventures.

Finance companies come in various shapes and sizes, and the risk of
their investments varies as well. Sometimes people who borrow money
from finance companies do so because they cannot borrow money at
cheaper rates from a bank, because they don't meet the bank's lending
criteria. As with other investments, it is good to remember that higher
promised returns usually indicate higher risk.

An example:

An
investment of $5000 in a registered bank for a year is paying 6%
interest. At the same time an investment of $5000 in a finance company
for a year promises a return of 9%. That extra 3% return is a 50%
increase in interest and usually reflects a similar increase in risk.

Finance companies must have an investment statement and prospectus
which explain the investment. You should read the investment statement
and read, or at least ask about, the main points in the prospectus.
These should tell you about the people the finance company is lending
your money to. This will help you assess whether the interest offered
makes up for the risk of the investment.

The governance of a finance company is very important, as are the
skills and track records of its directors and managers. If you are
thinking of investing in a finance company ask what your investment adviser knows about the people running it.

The finance company must also have a trust deed
that sets out what the company can do with investors' money and a
trustee whose job is to look after investors' interests.
Most finance company investments are for a fixed term. Usually this
means you can't withdraw your money until the end of the term even if
the company's financial position deteriorates. If you can cash in the
investment early you will probably have to pay a fee.

Credit unions and building societies
Building societies and credit unions provide services and offer fixed interest securities, similar to a registered bank.

They must have prospectuses and investment statements that explain
the investments. They must give you these documents if you ask for
them.

They are not registered or supervised by the Reserve Bank of New
Zealand. However, they are supervised by trustees who are appointed to
look after the interests of investors.

A fee may be charged if you want to get your money back before the fixed term is up.

Can I get my money back?

Some fixed interest investments are "on call". This means you can get your money out at any time.

Other fixed interest investments are for a set term, such as a one year deposit. When you invest for a term the issuer
(i.e. the person or institution offering the investment) does not have
to repay you if you want your money back before the term is up.

If the issuer does allow you to take your money out early, there is likely to be a penalty and/or a fee.

This article was provided by the Securities Commission.

See also:

Guide to Managed Funds

Guide to Shares

 

 

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