Debentures Overview and Types

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Questions and Answers

What is the main risk associated with debentures?

They may lose value if the issuing company goes bankrupt. (correct)

They guarantee capital growth.

They are always secured instruments.

They require no interest payments.

Debenture holders have a preferential claim to the company's assets in case of liquidation.

False

What type of debenture is repayable on a predetermined date?

Redeemable debenture

An __________ debenture lasts indefinitely and is never repaid by the company.

irredeemable Signup and view all the answers

If a company is perceived to be high risk, what must it offer to attract debenture buyers?

Higher interest rates Signup and view all the answers

Match the types of debentures with their features:

Redeemable debenture = Repayable on a predetermined date Irredeemable debenture = Never paid back but lasts indefinitely Convertible debenture = Can be converted into shares Fixed interest debenture = Sold at a fixed interest rate Signup and view all the answers

Debenture holders receive the same returns as shareholders.

False Signup and view all the answers

What is one key disadvantage of debenture investments regarding inflation?

The ROI on debentures seldom beats inflation. Signup and view all the answers

What is the primary purpose of a retirement annuity (RA)?

To provide an income to a person when they reach the age of 55. Signup and view all the answers

Pension funds allow employees to pool their contributions to achieve greater investment growth.

True Signup and view all the answers

What happens to contributions made to pension funds in terms of taxable income?

They are deducted from salaries before taxable income is calculated. Signup and view all the answers

A retirement annuity pays out in the form of a __________ and a monthly income.

lump sum Signup and view all the answers

What does the risk associated with a retirement annuity (RA) or pension fund depend on?

How and where the investments are made. Signup and view all the answers

Individuals should spend all the money accumulated in a previous pension fund instead of reinvesting it.

False Signup and view all the answers

Match the following terms with their descriptions:

Retirement Annuity (RA) = Provides an income at retirement age Pension Fund = Pools contributions from employees Tax relief = Encouragement to save for retirement ROI (Return on Investment) = Determined by investment decisions of the manager Signup and view all the answers

People often wait too long to make provisions for their __________.

retirement Signup and view all the answers

What type of fund invests all funds in shares?

Equity fund Signup and view all the answers

Investing in collectibles does not require a high level of knowledge and expertise.

False Signup and view all the answers

In how many years should a good Unit trust investment ideally outperform inflation?

3 to 5 years Signup and view all the answers

A portfolio in a foreign country may be established due to South Africa's exchange control mechanisms that limit the amount of money that may be taken out each year. This type of investment can be considered __________.

offshore investment Signup and view all the answers

Match the types of investment options with their characteristics:

Unit trusts = Managed by a fund manager Collectibles = Requires high level of expertise Stable fund = Diversifies investments to reduce risks Equity fund = Invests solely in shares Signup and view all the answers

Which of the following is NOT an example of collectibles?

Stocks Signup and view all the answers

The markets for true collectibles are very volatile.

False Signup and view all the answers

What is a common time frame for investing in Unit trusts?

medium to long-term Signup and view all the answers

What is a common factor that reduces the ROI of financial instruments like pension funds and retirement annuities (RAs)?

Administrative costs and management fees Signup and view all the answers

Endowments can only be funded through lump sum investments.

False Signup and view all the answers

What is the typical time frame for an endowment policy to mature?

5 to 10 years Signup and view all the answers

The investor can choose a risk profile for their investment, ranging from high risk in an equity fund to a _____ risk.

lower Signup and view all the answers

Match the following investment types with their characteristics:

Pension fund = Long-term retirement savings RA = Flexible retirement investment vehicle Endowment = Receives full amount after maturity or death Offshore investment = Diversifies risks across countries Signup and view all the answers

What happens if an endowment policyholder becomes disabled?

A Contribution Waiver can cover monthly contributions Signup and view all the answers

Offshore investments provide the opportunity to invest in assets that may not exist in South Africa.

True Signup and view all the answers

What is one potential benefit of investing offshore?

Access to more stable markets or investment opportunities not available in South Africa. Signup and view all the answers

What is a fixed deposit?

An investment made for a predetermined time at a fixed interest rate Signup and view all the answers

Investing in a fixed deposit carries a high risk of losing money.

False Signup and view all the answers

What happens if an investor withdraws funds from a fixed deposit before the maturity date?

A penalty will be charged. Signup and view all the answers

A money market account typically has a __________ time frame.

short-term Signup and view all the answers

Which statement is true about money market accounts?

They provide easy access to funds and usually outperform normal savings accounts. Signup and view all the answers

Match the following investment types with their characteristics:

Fixed Deposit = Long-term investment that incurs penalties for early withdrawal Money Market Account = Short-term investment with easy access to funds Cumulative Interest = Earned on the original deposit and reinvested interest Signup and view all the answers

The longer the investment time frame for fixed deposits, the lower the interest rate offered.

False Signup and view all the answers

What is a characteristic of a 32-day call account?

It has a notice period of 32 days for withdrawals. Signup and view all the answers

Study Notes

Debentures

Debentures are a type of debt security issued by companies to raise capital.
Debenture holders receive interest on their investment, which is paid by the company issuing the debenture.
The interest rate offered on debentures is determined by the company's creditworthiness and the perceived risk associated with the business.
Debenture holders can sell their debentures on the Johannesburg Stock Exchange (JSE) to other interested parties.

Types of Debentures

Redeemable Debentures: The company repays the principal amount of the debenture on a pre-determined date.
Irredeemable Debentures: The company never repays the principal amount. Debenture holders continue to receive interest indefinitely.
Convertible Debentures: These debentures can be converted into shares of the company at a pre-determined future date.

Debenture Risks

Debentures are unsecured financial instruments, meaning they do not have a claim on specific assets of the company.
If the company goes bankrupt, debenture holders have a lower priority than creditors in receiving their money.
The risk associated with debentures depends on the company's financial strength and the inherent risks of the business activities.
Debenture holders face a higher risk than investors in bank deposits but a lower risk than equity investors.

Debenture Return on Investment (ROI)

Companies are legally obligated to pay interest on debentures, which potentially offers a higher return than equity investments.
Debenture holders do not benefit from capital gains, only a steady stream of interest payments.
As debentures are unsecured, companies typically offer higher interest rates to compensate investors for the added risk.
Interest income on debentures is taxable, which can reduce the overall return on investment.

Debenture Time Frame

Debentures are typically issued as long-term financial instruments, providing interest income until redemption.

Retirement Annuities (RAs)

Retirement annuities (RAs) are insurance policies designed to provide income to individuals upon reaching the age of 55.
They involve monthly premium payments, with a lump sum payout at maturity along with a monthly income stream.
The payouts depend on the premium amount and the duration of the contribution period.
RA premium payments are tax-deductible, encouraging individuals to save for their retirement.

Pension Funds

Pension funds are established when employees contribute to a pooled fund, managed by a pension fund administrator.
The administrator invests the funds with the aim of generating returns that outpace inflation.
When employees retire, they receive a monthly pension from the fund.
Pension fund contributions are deducted from salaries before taxes are calculated, incentivizing individuals to save for retirement.

Risks Associated with RAs and Pension Funds

The risk associated with both RAs and pension funds depends on the investment strategy employed by the administrator.
Both instruments are valuable tools for securing retirement income.

Key Considerations for Retirement Planning

Individuals should start saving for retirement early in their careers.
Due to increased life expectancies, individuals need to plan for a longer retirement period and potential expenses.
It is essential to consider the loss of benefits during retirement.
When switching jobs, individuals should reinvest their pension fund payout into the new employer's pension fund to avoid losing accumulated benefits.

ROI for RAs and Pension Funds

The return on investment is determined by the skilled administration of the investment manager.
While some RAs and pension funds guarantee specific returns, these must be compared to the current inflation rate.
Administrative costs and management fees can impact the ultimate rate of return.

Time Frame for Retirement Planning

Saving for retirement should start early and continue throughout the employee's earning years. Individuals should aim for at least 40 to 45 years of consistent contributions.

Endowments

Endowments are long-term savings plans that can be funded with a lump sum or through monthly contributions.
Upon policy maturity (typically 5 to 10 years), the investor receives the full amount or, in case of death, the beneficiary receives the investment immediately.

Endowment Risks

Investors can choose a risk profile for their endowment ranging from high-risk (equity-based) to lower-risk (balanced investments).
Some insurers offer Contribution Waiver options to cover monthly payments in the event of serious illness or disability.

ROI for Endowments

The return on investment depends on the chosen risk profile.
Management and administrative fees reduce the overall ROI.

Endowment Time Frame

Endowments are intended for long-term savings, typically spanning 5 to 10 years.

Offshore Investments

Offshore investments offer opportunities for diversification across various countries.

Risks of Offshore Investments

Risks are spread across different countries, with developed economies often regarded as more stable than emerging markets.

ROI for Offshore Investments

Fluctuations in exchange rates can impact the attractiveness of investing in another currency.
Offshore markets may provide investment opportunities not available in South Africa.
Individuals planning on emigrating may consider establishing an investment portfolio in their destination country.
South Africa's exchange control limits the amount of money that can be taken abroad annually.

Time Frame for Offshore Investments

The only time constraint is the yearly limit set by South Africa's exchange control regulations.
Offshore investments can be used for both short-term and long-term strategies

Unit Trusts

Unit trusts are essentially baskets of shares traded on the stock exchange.
Investors can choose a risk profile that aligns with their tolerance level.
Each unit trust is managed by a fund manager who oversees investments.
Unit trusts can be diversified across industries and companies on the JSE or within specific sectors.
Investors decide how to allocate their funds - lump sum, monthly contributions or a combination of both.

Risks of Unit Trusts

Risk profiles vary greatly depending on the chosen fund. Options range from high-risk equity funds to more stable, diversified funds with allocations to equities, international markets, and money market instruments.

ROI for Unit Trusts

Over the medium term (3 to 5 years), unit trusts aim to outperform inflation.

Time Frame for Unit Trusts

Unit trusts are generally considered medium to long-term investments.

Collectibles

Collectibles include antiques, coins, artwork, stamps, jewelry, and Kruger Rands.

Risks of Collectibles

The South African collectables market is relatively small compared to international markets, but technology is bridging this gap.
Trading collectibles requires a high level of knowledge and expertise.

ROI for Collectibles

The value of genuine collectibles tends to increase over time, assuming they are properly maintained.

Time Frame for Collectibles

Collectibles markets are not highly volatile, showing gradual growth over a long period.

Notice Deposits (Fixed Deposits)

Fixed deposits involve investing a fixed amount of money for a specific period at a fixed or variable interest rate.
Funds can only be withdrawn upon maturity or the investor's death. Early withdrawal incurs penalties.

Risks of Fixed Deposits

Bank deposits generally carry a low risk of loss.
The main risk lies in the possibility of the bank being liquidated. This event is rare, but the African Bank Curatorship in 2014 demonstrates that even bank deposits are not entirely risk-free.

ROI for Fixed Deposits

The interest rate for fixed deposits varies across banks and depends on the investment amount.
Longer timeframes and larger investment amounts typically correspond with higher interest rates.
Capital growth can be achieved by reinvesting interest payments, resulting in cumulative interest on both the principal and accrued interest.

Time Frame for Fixed Deposits

Fixed deposit terms range from one to 10 years, or even longer.
Longer investment durations generally yield higher interest rates.

Money Market Accounts

Money market accounts are short-term investments, often popular due to their liquidity.
They facilitate easy access to funds, with options like call accounts offering indefinite investment periods.
The investor only needs to provide notice before withdrawing funds—for example, a 32-day call account requires 32 days' notice.

Risks of Money Market Accounts

Money market accounts are low-risk investments, but they offer lower interest rates than long-term options.

ROI for Money Market Accounts

Interest rates on money market accounts typically surpass those of traditional savings accounts. This makes them attractive for short-term investments.

Time Frame for Money Market Accounts

Money market accounts are short-term investments, ranging from a month to a year in duration.

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Description

Learn about debentures, a crucial financial instrument used by companies to raise capital. This quiz covers types of debentures, risks involved, and the benefits for debenture holders. Test your knowledge on redeemable, irredeemable, and convertible debentures.