Interesting solid investments

Popular investment avenues

The article is intended for the general public who have no knowledge of the financial field. First, we will explain the theory and later we will see how it corresponds with reality. Finally, we will present our recommendation. We would be very happy to hear your response, questions, clarifications and any other comments you find appropriate, in the comments at the bottom of the page.

The general public tends to save their money mainly through 3 avenues.

• stock
• Debentures (bonds)
• Bank deposits

stock

Anyone who purchases a share of a company becomes a partner in that company. If you purchased shares of Elite Company, you are a partner in the company. Your share of ownership is the ratio of the number of shares you purchased to the total shares of the company. If the company distributes part of its profits to the shareholders, you will also benefit, according to your share in the company. The distribution of profits is called a dividend .

Debentures (bonds). [plural bonds]

When you buy a bond, you are lending money to the company whose bond you bought. We will focus on this channel later.

Bank deposits

A bank deposit is actually a loan you give to the bank.

Bonds

The bond constitutes a document of obligation of the entity that received the loan to repay it. The major consumers of loans through bonds are the State of Israel and the listed companies (known as: “conglomerates”). In the following, whenever we refer to a company, this will also include the Government of Israel, unless otherwise noted.

First-hand bond purchase

If a company needs a loan for some purpose, it can turn to a number of parties, such as: banks, credit companies, the company’s owners, or the general public through the Stock Exchange (SE) and ask them to lend to it. The state usually turns to the general public and in a few cases also to banks.

Public Address

When a company or state wants to receive a loan from the public, it must issue bonds (which are a commitment document) that detail all the terms of the loan. In practice, the public transfers the money to the company through some “stock exchange member” (who are the stock exchange members? See below) and in return receives a bond. In fact, the bond is a virtual document that is registered in the books of: 1) the companies that issue it 2) with the stock exchange members through whom the investor is conducted 3) the investor.

Within a few days of the bond transaction, they begin trading on the stock exchange.

The important terms detailed in the bond:

Loan repayment date

Repayment can be made in one payment in the future or in installments. For example, 10% or 20% every year.

Interest payment

What is the interest rate it will pay to lenders (bond buyers) and the payment dates. Typically, companies make payments every six months, on a fixed date, while the state makes payments once a year. (On a fixed date)

linkage

The loan and the interest can be linked to the price index, to the dollar (or another foreign currency), or even without linkage. Bonds without linkage are called: shekel bonds.

Buying bonds second hand

Investors who purchased bonds firsthand can sell the bonds on the stock exchange at any time. When someone purchases a bond on the stock exchange, they are actually taking the place of another lender (who sold the bond) and the company that issued the bond is obligated to them under all the terms of the bond. The purchase transaction is carried out on the stock exchange.

Company financial strength rating

Any company that issues bonds can contact one of the two companies that rate the repayment capacity of the loan (i.e., the bonds it issued). The contact is not mandatory, but most strong companies contact the bank to obtain a rating, since receiving a high rating has a positive effect on the public’s response to the loan on the one hand, and on the interest rate it will grant, on the other hand. The higher the rating (i.e., the more established the company), the lower the interest rate it will be able to offer.

There are 2 rating companies in Israel:

1. hierarchy
2. Ma’alot

The rating symbols for each are shown in Table 1.

The Maalot rating scale The rating consists of combinations of the Latin letters A, B, C. (In addition to the main grades, plus or minus signs can be added to the rating for refinement). AAA : The issuer has an excellent ability to repay its payments. AA : The issuer’s ability to repay payments is well above average. A : The issuer’s ability to repay the payments is above average. BBB : The issuer’s ability to repay its payments BB : The issuer’s ability to repay the payments on the bond is below average compared to other Israeli issuers. B : The issuer’s ability to repay payments is well below average. CCC : Certain chance of defaulting on payments. CC : Defaulting on payments seems highly likely. C : The issuer of this bond is about to cease or has ceased to pay interest and/or principal. D : The issuing company did not repay the payments on the bond (Default). Miderag’s rating scale For every rank in degrees, there is a corresponding rank in hierarchy. The rating consists of letters and numbers. The number 1 is the same as the + sign on the degree scale. The number 3 is the same as the – (minus) sign on the degree scale. The digit 2 is the same as the rating – without the additional +/-. Investment grade All bonds rated above BB+ and Ba1 are permitted for investment by provident funds and mutual funds. The risk of failure to pay interest and/or repay the principal is very low. They are investment grade machines . All ratings below are called speculative ratings .

Table 1

Explanation of Table 1

The table refers to unlinked corporate bonds (=shekels). The data in the explanation refers to the first row.

coupon

Any amount of money received as interest is called a coupon. The amount is derived from the amount of par value (par value) you own.

Let’s illustrate with an example. Moshe has 10,000 par value in Aloni Hetz 12 bonds.The company pays 2% interest every six months. On 3/31 and 9/31 of each year. Therefore, the coupon amount that Moses will receive every six months is 200 NIS (= 2% * 10,000 NIS) The price of the bond on the stock exchange has no effect on the coupon amount.

The difference between interest (annual) and yield (annual)

Interest. (Refer to the example above)

The amount of interest that Moses receives in any given year is derived from the interest percentage stated on the bond, which is 2% every six months, i.e.: 400 NIS.

yield

The yield is calculated using 2 components:

1. The interest received
2. The difference between the bond price at the time of purchase and the amount received at maturity, which is always 1 NIS per par. If Moshe paid 0.9 NIS (90 ag) for every 1 par, then 10 ag is added to him at the time of maturity for each par, which is additional profit on the interest.

In this scenario, the yield is greater than the interest. On the other hand, if Moshe purchased every 1 par value of a bond for 1.05 NIS, then he would incur a loss of 5 NIS at maturity (the difference between the purchase price and 1 NIS). In this scenario, the yield is less than the interest .

The difference between the redemption price and the purchase price is known as: capital gain , or capital loss.

The effect of interest rate changes on the bond price

Let’s consider the following scenario: On 12/31/22, the interest rate in the economy is 3%, the price of an Elite bond is 1.0 NIS, and the annual interest rate is -3%. (This is also the annual yield). Moshe holds 10,000 par value of Elite bonds. On 3/1/23, the interest rate in the economy is raised to 10% (exaggerated for the sake of explanation) and the banks are also willing to pay 10% on deposits with them. In this scenario, Moshe will rush to sell the bonds he owns (which yield 3% per year) and deposit the money in the bank for 10% per year, and this is what all holders of the aforementioned bonds will likely do.

The question is who will buy a bond yielding 3% for 1 NIS when at the bank he can get 10%. Of course, the answer is: no one. In order to succeed in selling, the bond price needs to fall so that the yield on the bond equals 10% (as you get at the bank) but since the interest on the bond is fixed at 3%, then the capital gain needs to jump upwards. The jump occurs when the gap between the bond price and 1 NIS increases. In other words, the bond price needs to fall. And in general, an increase in interest rates in the economy causes a decrease in the bond price. On the other hand, if the interest rate in the economy drops to 1% and the bank also pays 1% on deposits. Then no one will sell a bond yielding 3% in favor of a deposit yielding 1%. In this scenario, the bond price needs to rise so that the yield it yields drops to 1%. The decrease to 1% will be caused by an increase in the bond price, which will result in a reduction in capital gains, and in cases of a significant interest rate decrease, we will also receive a capital loss, meaning the bond price on the stock exchange will be higher than 1 NIS.

Insights from the relationship between interest and yield

When the bond price is less than 1 NIS – the interest is less than the yield, since a capital gain is added to the interest amount. When the bond price is greater than 1 NIS – the interest is greater than the yield. A capital loss is subtracted from the interest amount. When the bond price is 1 NIS – the interest is equal to the yield.

The impact of the CMA on bond prices, following changes in interest rates

Let’s use an example:

Date A

Moshe holds 10,000 par value Elite bonds, priced at 1 NIS per par value. The interest per year is 4% The yield per year is 4% (since the price is 1 NIS and there are no capital gains or losses) The interest on a bank deposit is 4%

Date 2

The interest rate in the economy rises to 6%, and so does the interest rate on a bank deposit. Of course, no investor would be willing to buy a high-yield bond at a price of 1 shekel and receive a return of 4% (= 4 ag) when he could receive 6% (6 ag) from the bank for every 1 shekel. Moshe, who holds the bond, will receive 2 ag less than Avraham, who deposits his money in the bank. If the MTR of the bond is 10 years, then Moshe will lose 20 ag over the period (= 10 years * 2 ag). In light of this, the price of the bond needs to fall by 20 ag (20%) for an investor to be indifferent between buying the bond and depositing it in the bank. If the MTR is for 30 years, the price will need to fall by 60 ag (60%), i.e. to 40 ag.

Date B – Option II – Interest rates in the economy fall from 4% to 1%

When the interest rate drops from 4% to 1%, Moses will have priority over Abraham. Moses will receive 4 ag per year (4%) while Abraham will receive 1 ag (1%) in a bank deposit. A difference of 3 ag per year. At a 10-year maturity, the cumulative difference in Moses’ favor will amount to 30 ag. Therefore, the price of the bond on the stock exchange, at a maturity of 10, must be increased by 30 ag (to NIS 1.30) so that it is worthwhile for Moses to sell the bond in favor of a bank deposit. Whoever buys the bond at NIS 1.30 will receive cumulatively:

Just as he would have received if he had deposited his money in the bank. The above calculations are theoretical. In reality, the trend exists, but the price on the stock exchange is different in most cases from the theoretical price. See Table 1, column 10 (adjusted price, which is the theoretical price) versus column 3 (the price on the stock exchange).

Acceptable rules of thumb

1. For every 1% increase in interest rates, the bond price will decrease by 1% * the MRR.
   At a discount of 10 – the price decreased by 10%
   At a discount of 30 – at a price reduced by 30%
   If the interest rate falls by 2%, the bond price will fall by 2% * MCA
   At a discount of 10, the price dropped by 20%.
2. For every 1% decrease in interest rates, the bond price will increase by 1% * the MCA.
   There is symmetry, with an opposite sign, between a 1% increase in interest rates and a 1% decrease in interest rates.