Bonds - SEB

Bonds

General information

By buying a bond, the investor grants to the bond's issuer a loan with floating or fixed interest rate for a specified period. Bonds are used by companies, municipalities, states and sovereign governments to raise money and finance a variety of projects and activities.

Fixed interest rate bonds

? The amount repaid is larger than the principal

? Coupon is fixed and interest is paid regularly

? If an investor holds a bond until the maturity date, its return is known

Floating interest rate bonds

? The amount repaid is larger than the principal

? Coupon is floating and interest is paid regularly

? The coupon is based on an index or other rate for each relevant period

Discounted bonds

? The amount repaid is equal to the principal

? No coupon payments are made

? Are sold at the price lower than the principal

Classification

Very low risk level ? investment grade bonds1 quoted in main currencies2, issued by a state (including short-term government bonds, i.e. T-bills) or by a 100% state-owned company or a with 100% guarantee of the state and with maturity less than 3 years (1096 days).

Low risk level ? investment grade bonds quoted in main currency, ? issued by a state or a 100% state-owned company or a with 100% guarantee of the state and with maturity more than 3 years; ? issued by a company with any maturity.

Medium risk level ? ? non-investment grade bonds3, quoted in main currency; ? investment grade bonds, not quoted in main currency.

High risk level are non-investment grade bonds, not quoted in main currencies.

Complexity: all bonds are treated as complex instruments.

Value

The value of bond depends on:

Current interest rates. The price of bond and return always move in opposite directions. One should not confuse the bond's coupon interest with its return. Coupon is interest, which the issuer promises to pay until the maturity of the bond. Return of bond is the actual interest that the investor earns when buying a bond from the secondary market. Return will be formed pursuant to the bond's market price. The market price of a bond depends on market interest rates.

If the buyer of the bond keeps the bond until maturity, they will get (coupon) interest payments determined by the issuer and upon maturity, the issuer will refund the nominal value of bond. If the market rates do not change during this period, the coupon and the rate of return of the bond shall be equal. The bond holder may realise the bond at any time whereas not bearing any capital loss or earning any profit.

1 EUR, USD, GBP, CHF, CAD, AUD, JPY, SEK, DKK, NOK are defined as main currencies.

2 Investment grade bonds are bonds rated as investment grade by Standard & Poor's (rated BBB- or higher), Moody's (rated Baa3 or higher) and Fitch (rated BBB or higher).

3 N on-investment grade bonds are bonds rated as non-investment grade by Standard & Poor's (rated BB+ or lower), Moody's (rated Ba1 or lower) and

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Fitch (rated BB+ or lower).

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The situation changes when market rates change. If interest rates at the market rise, the market participants will expect increased return on bonds traded on secondary market. The market rate of a bond decreases to the extent that when buying the bond from secondary market, the return earned on it is in conformity with the market interest rate. Accordingly, if the investor wants to sell the previously bought bond at the market, they will bear the risk of capital loss, since the price of the bond has dropped. If the buyer of the bond keeps the bond until maturity, they will still get (coupon) interest payments determined by the issuer and upon maturity, the issuer pay the principal of bond. Since the profitability of investments is calculated based on market price, the investor has suffered a calculated loss even if they do not realise the bond. Such estimated loss is reflected in different overviews and reports of investments, presented to the investor (for example in Internet Bank).

If interest rates at the market drop, the exact opposite happens to that what was just described. The market rate of a bond increases to the extent that when buying the bond from secondary market, the return earned is in conformity with the market interest rate. Accordingly, if the investor wants to sell the previously bought bond at the market, they will earn capital gain, since the price of the bond has increased. If the buyer of the bond keeps the bond until maturity, they will still get (coupon) interest payments determined by the issuer and upon maturity, the issuer will refund the principal of bond.

Interest rate

Bond price

The issuer's credit rating and its ability to redeem the bond. The highest credit rating is AAA and the lowest D (default). Non-investment grade bonds (also called junk bonds) are with credit ratings BB+ to D. The three major rating agencies in the world use slightly different credit rating formats (e.g. the highest rating of Moody's is Aaa, that of Standard & Poor's and Fitch, however, AAA).

The relationship between interest rate and term to maturity of assets is known as interest rate term structure. A bond with a longer maturity usually will pay a higher interest rate than a shorter-term bond. The longer the maturity of your bond, the greater the price volatility.

Peculiarities of bonds

Investment grade bonds have smaller probability of default compared to high yield bonds

Liquid bonds can normally be sold before maturitydate, however, the price depends on the market conditions

Sale of the bond on secondary market may be riskier compared to holding it until maturity date

Market value during the investment period can be higher or lower compared to the initial investment

Potentially lower return Governments Investment grade Short maturity

Potentially higher return Companies

Non-investment grade Long maturity

Very low risk

Low risk

Medium risk

High risk

Very high risk

Fees: ? bond trading fee ? safekeeping fee

More detailed information about the fees is provided in SEB's price list, on the Investor Protection website or in documents concerning the specific security.

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Bonds

Risks

Liquidity risk is associated with the market risk and lies primarily in the fact that the client may suffer losses due to absence of liquidity in the respective regulated market, which impedes the sale of securities at the time desired by the client or the securities cannot be sold at a price close to the market price or at a price desired by the client.

Currency risk may emerge when investor invests in a bond denominated in other than investor's main currency.

For investors it is less risky to invest in their main currency, unless they have sufficient knowledge of currency risks.

Default risk occurs when the issuer will not be able to make the required interest payments or redeem the principal at the redemption date. In case of a default of an issuer, investor can lose everything he had invested.

For government bonds, the issuer is less likely to become insolvent than for corporate bonds.

For investment grade bonds, the issuer is less likely to become insolvent than for high yield bonds.

Market risk is a risk that the client suffers losses due to overall adverse price movements in the securities market or in a certain area thereof. Adverse price movements may be caused, for instance, by poor economic indicators of the relevant state or branch of the economy, unstable economic environment, unstable securities market, etc.

Interest rate risk ? Interest rate may change the price of a bond. The interest risk is related to the market risk and lies in the fact that the client may suffer losses from adverse developments on the market, which may be manifested in changes in interest rates, interest rate volatility, interest rate gap between investment objects of different risk levels, early repayment of debts, etc.

Reinvestment risk appears for a callable bond, since the issuer may call back the bond before maturity date and the investor may be forced to reinvest the received funds in securities with a lower yield.

Credit risk ? the client may suffer losses due to the fact that the value of financial instruments acquired by it falls, since the issuer of the securities may exhibit poor financial performance, economic difficulties or other similar indicators. The issuer's poor economic performance may cause, among other things, the inability of the relevant issuer to perform obligations arising from the securities before the investors.

Taxation

Income from investments is taxed. An investment account allows Estonian tax residents to postpone the taxation of return on investments. The taxation depends on the investor's tax residency and legal form, but also the income type and several other circumstances. For more specific instructions, consult the tax office or contact a tax advisor.

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