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7.5.4 Mechanics Of Trade

Learn the comprehensive mechanics of non-electronic securities trade, including trade tickets, clearing and settlement, calculating accrued interest, and understanding bond indexes as described in the Canadian Securities Course.

Mechanics of the Trade

All non-electronic trades between the investment advisor and the trader are consummated over the phone, mandating full commercial agreement or commitment. These calls are recorded, with clear language and key terms used by all parties involved.

When trade commitments happen, one party agrees to deliver the full bond amount sold on the settlement date, either from the trading book or the client’s account. Conversely, the other party agrees to full payment on the settlement date from the trading book or the client’s account.

The Trade Ticket

The trade ticket is an essential electronic confirmation sent via secure, proprietary systems, and it includes the following:

  • Counterparties’ specific details, including the investment advisor’s employer and client info.
  • Full bond identification, including issuer name, maturity date, and coupon.
  • Committee on Uniform Security Identification Procedure (CUSIP) or other electronic IDs.
  • Nominal/par/face amount of the transaction.
  • Price and possibly yield.
  • Settlement date.
  • Custodian name for trade settlement.
  • Total settlement amount, including separately shown accrued interest.

Clearing and Settlement

Upon securities transaction confirmation, the change in legal ownership is immediate. However, payment and securities delivery happen at the end of the settlement period, differing based on security type:

  • T-bills: Settlement on the day of transaction.
  • Other securities (bonds, debentures, shares): Settlement on the second clearing day post-transaction.

Different Methods of Fixed-Income Securities Ownership

Ownership Characteristics History
Bearer bonds Physical certificate with detachable coupons for payments. Ownership via possession. Loss and theft risks led to reduction in use.
Registered bonds Holder name marked and sold only upon signing. Reduction in theft risk, better security.
Book-based bonds Electronic record keeping by depositories for ownership/settlement. CDS Clearing and Depository Services used in Canada.

Calculating Accrued Interest

Bonds typically pay interest semi-annually or at varying intervals. To ensure fairness between buyers and sellers when bonds are purchased mid-cycle, accrued interest needs to be calculated and paid to the seller:

$$ \text{Accrued Interest} = \frac{\text{Coupon Rate}}{100} \times \frac{\text{Time Period in Days}}{365} \times \text{Par Amount} $$

Example Calculation

You buy an 8% Government of Canada bond due March 15, 2025, with a $200,000 principal on May 7. With the last coupon paid March 15, the first day of accrued interest is March 16. With a settlement date of May 9, we determine days of accrued interest (from March 16 to May 9):

  • March 16-31: 16 days
  • April: 30 days
  • May 1-9: 9 days
  • Total: 55 days

Accrued interest: $2,410.96 ($200,000 x 8% x 55 / 365 / 100)

Bond Indexes

Definition and Usage

Bond indexes measure the relative performance and value of bonds over time and are used to:

  • Guide overall market or segment performance.
  • Assess bond portfolio managers’ performance.
  • Construct bond index funds.

Canadian Bond Market Indexes

FTSE Canada Universe Bond Index: Tracks Canadian bond market with government and corporate bonds. Weighted by market capitalization.

Global Bond Indexes

Global Bond Indexes: FTSE World Government Bond Index, Bloomberg Barclays U.S. Aggregate Bond Index, etc.

Key Terms & Definitions

Present Value

Present value (PV) is today’s value of a money amount to be received in the future, utilizing a discount rate.

Current Yield

Current Yield is the income yield of security relative to its current market price.

Other Important Terms

  • YTM (Yield to Maturity)
  • Real Rate of Return
  • Expectations Theory
  • Liquidity Preference Theory
  • Market Segmentation Theory

Summary and Key Takeaways

Summarizing the significant components of fixed-income securities:

  • Accrued interest ensures equitable transactions.
  • Understanding trade tickets and processing settlements are essential for trade compliance.
  • Various bond indexes provide valuable performance metrics and market outlook.

Review Questions

Answer the end-of-chapter questions to solidify your understanding.

Frequently Asked Questions (FAQs)

For lingering questions, check the online Chapter 7 FAQs for more information.

📚✨ Quiz Time! ✨📚

🧐 Assess and Solidify Your Understanding

Welcome to the Knowledge Checkpoint! You’ll find 10 carefully curated quizzes designed to reinforce the key concepts covered. These questions will help you gauge your grasp of the material, identify areas that need further review, and ensure you’re on the right track towards mastering the content for the Canadian Securities certification exams. Take your time, think critically, and use these quizzes as a tool to enhance your learning journey. 📘✨

Good luck! 🍀💪

## What legal significance do non-electronic trades between the investment advisor and the trader carry? - [ ] They are considered informal agreements. - [ ] They do not carry any legal responsibility. - [x] They carry the legal responsibility of a full commercial agreement or commitment. - [ ] They are regulated by a third-party institution. > **Explanation:** All non-electronic trades carried out between the investment advisor and the trader over the phone are legally binding and carry the responsibility of a full commercial agreement or commitment. ## In a trade ticket, which detail is not typically included? - [ ] The nominal, par, or face amount of the transaction. - [ ] The settlement date. - [x] The buyer's tax identification number. - [ ] The name of the custodian where the trade will settle. > **Explanation:** A trade ticket includes details such as the nominal, par, or face amount, settlement date, and name of the custodian, but it does not include the buyer's tax identification number. ## When do T-bills settle? - [x] On the day of the transaction. - [ ] Two days after the transaction. - [ ] One week after the transaction. - [ ] Immediately. > **Explanation:** T-bills settle on the day of the transaction, unlike other securities like bonds and debentures which settle two days after the transaction. ## What information does a bond's CUSIP number provide? - [ ] Interest payment dates - [ ] Bondholder's personal information - [x] Unique identification of the bond - [ ] Settlement period details > **Explanation:** The CUSIP number is an alphanumeric code used to uniquely identify securities in North America. ## How is accrued interest calculated? - [x] Using the formula: Accrued Interest = Par Amount × (Coupon Rate/100) × (Time Period/365) - [ ] By dividing the bond's face value by the interest rate. - [ ] Using the formula: Accrued Interest = Yield × Settlement Date - [ ] By adding coupon payments to the bond price. > **Explanation:** The accrued interest is calculated using the formula: Accrued Interest = Par Amount × (Coupon Rate/100) × (Time Period/365). ## Why do registered bonds include the name of the owner? - [ ] To prevent taxation errors - [ ] To increase liquidity - [x] To reduce the risk of theft and loss - [ ] To monitor market activity > **Explanation:** Registered bonds bear the name of the rightful owner to prevent theft and loss, as they can only be sold or transferred when the owner signs the certificate. ## What is a bond index used for? - [ ] Setting regulatory policies - [ ] Pricing new bond issues - [ ] Informing tax advice - [x] Measuring the performance of a group of securities > **Explanation:** A bond index measures the relative value and performance of a group of securities over time. ## What purpose do the coupon payments on bearer bonds serve? - [ ] Enhancing liquidity - [ ] Reducing transaction costs - [x] Allowing the holder to receive payments - [ ] Adjusting interest rates > **Explanation:** Coupon payments attached to bearer bonds allow the investor to receive payment from the issuer on each coupon payment date. ## Why do bondholders receive accrued interest payments when selling a bond? - [ ] To compensate the buyer - [x] To ensure equitable transactions between the buyer and seller - [ ] To manage taxes - [ ] To improve bond pricing > **Explanation:** Sellers receive accrued interest payments to ensure that the transaction between buyer and seller is equitable, compensating for the interest accumulated during the previous holding period. ## What does FTSE Canada Universe Bond Index track? - [ ] Only Canadian government bonds - [ ] Only high-yield corporate bonds - [ ] U.S. municipal bonds - [x] A broad cross-section of Canadian government and corporate bonds > **Explanation:** The FTSE Canada Universe Bond Index tracks a broad cross-section of Canadian government and corporate bonds.

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Saturday, July 13, 2024