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How to Trade Fixed Income Securities

The Securities Exchange of Thailand Act, B.E. 2535 has no definition of "Debt Securities" but has defined "Debentures, as follows:

"Debentures" are defined as debt securities no matter by what other names they are called. All units have equivalent value with returns specified equally in advance. An issuer issues debt securities to a borrower or purchaser that is a proof of guaranteed returns or other benefits, which excludes B/Es.

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Definition of bonds

  • Secured bond: A type of bond that is secured by the issuer's pledge of a specific asset, which is a form of loan collateral.
  • Unsecured bond: A bond that is not secured by an underlying asset or collateral. The bondholder is a creditor of the bond issuer.
  • Subordinated bond: A bond that ranks below other bonds with regard to claims on assets or earnings, but higher than preferred shareholders and common share holders.

How important is credit rating?

A credit rating is an assessment of the credit worthiness of the issuer of debt securities. It is based upon the history of borrowing and repayment as well as the availability of assets and the extent of liabilities.

Credit rating constitutes two areas : 1) company ratings and 2) issue ratings. Thus, debentures issued at different periods even if by the same company would have different ratings, such as secured and unsecured bonds or subordinated and unsubordinated bonds.

Major private independent rating agencies such as Moody's Investor Service (Mood's), Standard & Poor's Corp. (S&P), and Fitch, including Thailand's TRIS and Fitch (Thailand), use the same letter grades. A credit rating normally provides an evaluation of short-term and long-term bonds.

To illustrate bond ratings and definitions, we will use the format TRIS assigns to long-term debt issues: AAA and BBB high credit-quality investment grade; BB and D low credit-quality (speculative grade) or junk bond grade that have a high chance of principal and/or interest payment default, but conversely provide high returns.

Definitions of credit ratings

Investment grade

AAA Extremely strong capacity to meet financial commitments.
AA Very strong capacity to meet financial commitments. It differs from the highest-rated obligors only by a small degree.
A Strong capacity to meet its financial commitments but is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher-rated categories. However, the capacity to meet the financial commitment on the obligation is still strong.
BBB
Adequate capacity to meet its financial commitments. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to meet its financial commitments.

Speculative grade

BB Less vulnerable to non-payment than other speculative issues. However, it faces major ongoing uncertainties and exposure to adverse business, financial, or economic conditions that could lead to inadequate capacity to meet its financial commitments.
B More vulnerable than BB, but the obligor currently has the capacity to meet its financial commitments. Adverse business, financial, or economic conditions will likely impair the obligor's capacity or willingness to meet its financial commitment on the obligation.
C Currently vulnerable and is dependent upon favorable business, financial and economic conditions to meet its financial commitments.
D
In payment default.

Advantages of investments in fixed income products

  • High returns but low risk: Compared with savings account interest rates. For example, the interest rate on a savings account is less than 0.75%, while the government provides interest greater than 3%. If one can bear a little more risk, corporate debentures are a worthy option, the coupon rate of which is typically higher than that of Treasuries with a similar maturity.
  • A source of consistent income: Fixed income securities pay periodic interest and principal at maturity. Thus, this investment type is suitable for investors who like a consistent stream of return. It differs from investment in equity securities, as returns from these securities are more volatile.
  • Safe haven for your money: Investing in Treasuries keeps your money safe as there is no risk payment default, while investing in corporate bonds or other debt securities must take credit rating into consideration.
  • Risk diversification: Derivatives are a typical investment vehicle that provide an efficient method to manage and transfer risk.
  • Tradable: In a bond, it is very simple to sell one fixed-income holding for another in order to take advantage of the current market, and to better meet your current investment objectives or adjust to a change in your investment status. A wide variety of bonds are generally available to help you meet your specific portfolio goals, while bank savings do not facilitate such advantages.

Types of bonds

Over the Counter (OTC)

The Bond Market, aka over the counter, is completely different from the stock market. Trading transactions are conducted among investors without time and place specified.

The telephone is a major communication channel. Besides this, dealers can place bids and/or offer requests by pressing the broker box. Investors can contact a dealer to engage in transactions.

Apart from dealers, automatic order matching is available to accommodate retail investors, as well as FIRST, which is a negotiated trading platform for institutional investors. These systems, so far, have failed to meet investors requirements, as bond trading requires negotiations between two parties. Thus, about 90% of bond trading is OTC.

The Dealer as a key player, not a broker
Investors can contact an authorized dealer directly. Dealers of a securities company are able to conduct both debt and equity securities trading, but commercial banks and finance companies can perform only debt securities trading.

Income from spreads, not commissions
A spread, which is the difference between the purchasing price and selling price, is the only source of income for dealers in bond trading, as it is conducted between institutional investors and customers. On the other hand, equity trading is carried out by brokers who charge a commission for each transaction.

In executing a buy transaction with a customer of fixed income instruments, the dealer will buy the securities into its own port for sale to a buyer later, and vice versa in case of a sale. This type of business usually benefits large financial institutions with substantial capital to support such transactions, for example, commercial banks.

Secondary market
After the initial transaction in the primary market is completed, subsequent trading is carried out in the secondary market. Most transactions are conducted Over the Counter (OTC) where investors can place bids or offers towards authorized financial institutions / securities companies

Types of Investment

Primary market
The first market activity that an investor buys issued directly from the issuer. Issuing firms usually appoint underwriters or selling agents to take care of issue transactions. The price is at par value and the coupon rate at a specified level, and a minimum purchasing amount is basically fixed.

Treasury bills are generally sold to institutional investors such as financial institutions, insurance companies and mutual funds.

Treasury bonds are an option for small investors.

Secondary market

After an initial transaction in the primary market is completed, trading can subsequently be carried out in the secondary market. Most transactions are conducted over the counter where investors can place bids or offers with authorized financial institutions/securities companies.

Risks

  1. Credit Risk
    (aka Default Risk) is the risk that the issuer of a bond may default. It is the top priority to consider, since bond investments mean that investors lend money to bond issuers contingent upon the issuers giving interest and principal back at specific period of time. Treasuries are default-free as they are guaranteed by the government. But for corporate bonds, credit rating is a guidance showing the financial status of the issuer. The SEC regulates all bonds issued by private firms and need to be rated.
  2. Interest Rate Risk, Market Risk or Price Risk:
    Typically, bond prices move in an opposite direction as market interest rates. This means that bond prices will increase when interest rates decline, and vice versa. Bonds with a long-term maturity will face high volatility from interest rate and price risks.

    Investors should be aware of the maturity of any bond if planning to liquidate a bond prior to its maturity. If an investor holds a bond to its maturity, there is no interest rate concern as the investor will receive principal and interest at the specified amount.

Taxation on Investment

  1. Individual Taxation (provided as of 1 February 2006)
    • Domestic
    Interest Income Capital Gain Discount
    15 % withholding with option for year- end income calculation 15% withholding with option for year-end income calculation except zero-coupon which is taxed at first hand) 15% withholding (only first hand) with option for year-end income calculation
    • Foreign
    Interest Income Capital Gain Discount
    15% withholding with option for year- end income calculation
    except

    interest from bond issued by government, state agencies, or financial institution under specific law for the agricultural, commerce and industrial lending

    15% withholding with option for year- end income calculation
    except

    1. Capital gains from zero-coupon which is taxed at first hand

    2. Capital gains from bond issued by government, state agencies, or financial institution under specific law for the agricultural, commerce and industrial lending

    15% withholding only from first hand with option for year- end income calculation
    except

    discount from bond issued by government, state agencies, or financial institution under specific law for the agricultural, commerce and industrial lending

  2. Corporate Taxation
    • Domestic
    Interest Income Capital Gain Discount
    - 1% withholding and realize as the income to be taxable at the end of the year

    - 10% withholding in case the bondholder is a foundation or association, except a foundation or association which prescribed by the minister, and the issuer is

    1) the registered partnership which does business in Thailand or

    2) the commercial bank, the company registered under the law of finance business, securities business and credit foncier business,

    - not withholding incase the bondholder and the issuer are the commercial bank, the company registered under the law of finance business, securities business and credit foncier business,

    - financial institution subject to 3.3% specific business tax on the interest earned

    No withholding but the capital gain is realized as other income. - 1% withholding and realize as the income to be taxable at the end of the year

    - 10% withholding in case the bondholder is a foundation or association, except a foundation or association which prescribed by the minister, and the issuer is

    1) the registered partnership which does business in Thailand or

    2) the commercial bank, the company registered under the law of finance business, securities business and credit foncier business,

    - not withholding incase the bondholder and the issuer are the commercial bank, the company registered under the law of finance business, securities business and credit foncier business,

    - financial institution subject to 3.3% specific business tax on the discount earned

    • Foreign*
    Interest Income Capital Gain Discount
    15% withholding
    except

    Interest from bond issued by government, state agencies, or financial institution under specific law for the agricultural, commerce and industrial lending

    15% withholding
    except

    Capital gains from bond issued by government, state agencies, or financial institution under specific law for the agricultural, commerce and industrial lending

    15% withholding only from first hand
    except

    Discount from bond issued by government, state agencies, or financial institution under specific law for the agricultural, commerce and industrial lending

Note* Please review the international tax treaty provisions, which may subsequently differ from the above mentioned tax rates.


For More Information, Contact Fixed Income Sales & Trading Department

Ms. Sarintorn Kongsomboon
Tel: 02-695-5405
Fax: 02-624-6279
Email: sarintornk@ktzmico.com


KT ZMICO Securities Co., Ltd.

Floors 17, Liberty Square
287 Silom Road, Bangrak
Bangkok 10500 Thailand
Tel: (66-2) 695-5000

Fax: (66-2) 631-1709

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