IFT Notes for Level I CFA® Program
LM01 Fixed-Income Securities: Defining Elements
3. Legal, Regulatory, and Tax Considerations
Fixed-income securities are subject to different legal and regulatory requirements depending on where they are issued and traded. National bond market is the bond market in a particular country.
- Domestic bonds: These are bonds that are issued and traded in a country, and denominated in the currency of that country. Bonds in domestic currency issued by a company incorporated in that country are called domestic bonds. For example, bonds denominated in Yen, issued by Toyota to be traded in Japan.
- Foreign bonds: These are bonds issued by a foreign company but traded in the domestic market. For example, bonds denominated in U.S. dollars issued by the Australian Rio Tinto Group.
Eurobonds are issued internationally, outside the jurisdiction of any single country and are denoted in currency other than that of the countries in which they trade. They are subject to less regulation than domestic bonds.
Bearer Bonds versus Registered Bonds
In the case of bearer bonds, the trustee does not maintain a record of who owns the bonds. That information is recorded in the clearing system. In the case of registered bonds, records of who owns the bond are maintained using a name or serial number. In the past, Eurobonds were typically bearer bonds. However, nowadays, Eurobonds as well as domestic and foreign bonds are registered bonds.
Bonds that are issued simultaneously in multiple markets, such as the Eurobond market and in at least one domestic bond market. This ensures sufficient demand for the issue irrespective of the investors’ location.
3.1 Tax Considerations
There are two sources of return from a bond: income from coupon payments and capital gain. The way these two components are treated for tax purposes is different.
- The income portion of a bond investment is generally taxed at the ordinary income tax rate. For example, if you fall under the 30% income tax category, then the coupon income will be taxed at this rate.
- Assume you buy a bond for $900 and later sell it for $1,000. This $100 is considered capital gain. Tax on capital gain may be different for long-term and short-term investments. Short-term is usually less than one year while more than one year is considered long-term. Often, the tax rate for long-term capital gains is lower than that for short-term capital gains.
- In some countries, a pro-rated portion of discount may be included in interest income. For example, assume you buy a 3-year zero-coupon bond, with a par value of $1,000, at $900. The gain of $100 is over three years. Now, the taxing authority in some countries such as the U.S. may decide to tax this $100 gain on a pro-rata basis over three years instead of taxing it all at once at the end of three years.
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