A reset security is one that will have its coupon (interest rate it pays) reset at a margin over the prevailing interest rate on the reset date. In NZ we have annual, three and five year reset securities. This is in contrast to a fixed rate security that has the same coupon until it matures.

These can be a useful investment option but, if not monitored, they can turn into a not so good investment option depending on the timing and the state of the interest rate cycle.

For example take the Rabobank Capital preference securities (RBOHA), these reset in October every year. When these were issued at $1.00 interest rates were north of 7.00% and the coupon was set at 9.51%, the Official Cash Rate (OCR) is now 2.50% and the coupon is 3.70% and they are trading at about $0.80. This applies until October when the rate will be reset at 0.76% over whatever the 1 year swap rate is then.

Now, assuming the same credit risk, would you sooner invest in a fixed rate seven year bond at 6.25% or a Rabobank Capital preference security at 3.70%? Before you answer please consider the following.

These securities will reset again in October and if there is no movement in rates it looks like resetting around current levels, hence your yield on the Rabobank might be around 4.6% for the next year.

Now if interest rates start to rise and in two years time the Official Cash Rate is 5.50% and the RBOHA's reset at 6.26%, your yield is now 7.83%, because you only paid 80 cents for the them. So you can see there is potential for capital gain on the reset securities.

On the other hand current seven year bond issues are paying a coupon of 6.25%, but in a couple of years if interest rates rise, investors may be demanding a coupon of 7.50% for seven year issues. Therefore your seven year fixed rate bond may see a fall in its capital value - a problem if you wish to sell before maturity.

The above is a very simple example with many assumptions but it should give you an idea of how reset securities can work in your favour under the right conditions and fixed rate securities can work against you.

Likewise the five year resets like BISHA to reset on 28/03/2013, BNSPA to reset on 30/06/2014 and ANBHA to reset on 18/04/2013 to name but three, these may not be resetting near their current coupons, as all three have coupons over 9.00% at present, what will that do to the price?

Call an adviser at IRGBOP on 0800 867 323 to discuss this further and see the opportunities available in the reset securities.

Fisher & Paykel Finance Limited and its guaranteeing subsidiaries have a long and successful history in New Zealand.

A large part of their success can be attributed to staying focused on point of sale consumer finance business, which has been a predominant business activity of the Fisher & Paykel Finance group of companies since 1985.

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