The bond lifecycle: All bonds have a have a defined lifecycle. Although elements of that lifecycle might vary – it might be a five or 10-year bond, pay a three percent or five percent coupon – the stages of the lifecycle are the same, from issue through to maturity. Because Exchange Traded Bond units (XTBs) are issued over corporate bonds, they too have a defined lifecycle.
In examining the lifecycle of XTBs, we’ll follow the life and times of YTMQF3, an XTB over a corporate bond issued by Qantas Airways Limited.
The bond is issued
Bonds can be issued by governments, statutory bodies and corporates. Australian companies can raise money via equity (issuing shares) or debt. The latter can take two forms – borrowing from a bank or other financial institution, or issuing bonds.
Bonds are originated in the primary market, from where they are bought by investors. The minimum parcel size, which is often substantial, means that most bond issues are bought by wholesale investors such as fund managers, brokers or superannuation funds.
Although Qantas is a listed company, it also uses the bond market to raise capital. On 19 May 2014, it launched a corporate bond to raise $300 million. The bond pays a fixed rate of 7.75% per annum. Coupons are payable semi-annually (in two coupons of 3.87%), in arrears on 19 May and 19 November up to and including the Maturity Date.
The Maturity Date of this bond is 19 May 2022 – in other words, it’s a bond with an eight year lifecycle.
The lifecycle commences
A bond is basically an IOU, with the returns to investors determined by two factors as illustrated in figure one:
- The principal, or the price paid for the bond on issue – this is repaid at the end of the bond’s lifecycle, when the bond matures.
- Investors receive regular and predefined interest or coupon payments.
Bonds may pay coupons monthly, quarterly, semi-annually or occasionally, on an annual basis. Quarterly and semi-annually are the most common.
Figure one: Example of a bond’s cash flow
Source: Australian Corporate Bond Company
Once bonds are issued and in circulation, they are traded in the secondary market; a range of factors can affect the bond’s price and yield once trading in the secondary market commences. Read more about the relationship between bond prices and yield here (link to price/yield article)
The Qantas bond we are following was launched with a face value of $10,000 and a semi-annual fixed coupon of 7.75%.
XTB YTMQF3 is launched
It is a current regulatory requirement that a corporate bond must have been in circulation for 12 months before an XTB can be launched over it. The underling corporate bond continues to make its semi-annual coupon payments and trade in the secondary market.
XTBs provide investors with access to the returns of individual corporate bonds. They are securities traded on ASX that bring together the predictable income from corporate bonds, with the transparency and liquidity of the ASX market.
Once the Qantas bond had been in circulation for over 12-months, Australian Corporate Bond Company (ACBC) issued a Product Disclosure Statement (PDS) dated 1 October 2015 setting out essential information about the investment. This includes details about:
- Key features, benefits and risks of the offer
- How to make applications and withdrawals
- Information about the underlying bond
- Fees and costs associated with the XTB
Once the PDS was issued, trading in YTMQF3 commenced, Market Makers create and redeem XTB units as required.
Key features of YTMQF3 are:
- As with all XTBs, the face value of XTB units is $100
- Interest (coupons) is paid semi-annually in arrears
- It is paid as 100% cash, into the nominated bank accounts of XTB holders
- Interest is not deferrable nor are interest payments discretionary
- The Australian Corporate Bond Trust, on behalf of investors, ranks equally with all other senior and unsecured creditors of the Issuer.
The lifecycle continues
Once an XTB has been launched, it moves in synch with its underlying corporate bond. If the price of the underlying bond rises, so too does the price of the XTB. The yield and price of each XTB reflects the yield and price of the underlying bond, after fees and expenses.
Bonds may trade at a premium or a discount to their face value. This is reflected in the price of the relevant XTB.
At 30 August 2017, YTMQF3 is trading at a premium to its face value. An investor purchasing units today will pay $122.13 per unit, with a Yield to Maturity of 3.17% (as at 30 August).
The bond matures
When a bond reaches its maturity date, investor receive a final coupon payment and are repaid the principal amount.
Figure two: maturity of a $10,000 bond
|Purchase price||Principal repaid at maturity|
Upon maturity, investors in XTBs receive repayment of principal at $100 per unit.
When YTMQF3 matures on 22 May 2022, investors will receive the final coupon payment of 3.875% and the return of principal, at $100 per unit.
Once matured, the principal can easily be rolled into another XTB; this way, you ensure the ongoing receipt of regular coupon payments, with the knowledge that the principal will be repaid when that next XTB matures, subject to there being no default by the underlying bond issuer.
XTBs over corporate bonds are a capital stable and predictable income generating security. They can deliver superior returns to those offered by term deposits, without the price volatility associated with shares and hybrids.