Q: Hi. This rights issue was described in basic form, but there seems to be a much more complex/interesting issue. These debentures, if I exercise the rights, offer a tremendous hedge against inflation, as their yield is tied to the rate of change of inflation. What seems like the deal-breaker is the 33% premium I (would) have to pay to buy the Debentures.
It seems to me odd that I am asked to pay a 33% premium to earn less than 6.5% if inflation rates go down over time. This does not seem like a very tax-efficient strategy for taxable dividends. It just seems like a very unique product and pricing. Can you comment on those particular aspects please? I am interested in earning more income soon, and there is some appeal to this as a hedge against inflation, but the price of that insurance seems too high...?
It seems to me odd that I am asked to pay a 33% premium to earn less than 6.5% if inflation rates go down over time. This does not seem like a very tax-efficient strategy for taxable dividends. It just seems like a very unique product and pricing. Can you comment on those particular aspects please? I am interested in earning more income soon, and there is some appeal to this as a hedge against inflation, but the price of that insurance seems too high...?
5i Research Answer:
33% is a lot to pay for 6.5% debentures, but the rate currently is 13.3%, as inflation rose last year. What's more, the premium can be considered amortized over 17 years, to 2040 maturity, because of the warrants CSU has issued which allows debentures to be swapped for an identical series that has no redemption clause. Note the debentures income is taxed as interest, not dividends. There is some risk if inflation declines, but also of course a benefit if inflation rises. Considering the amortization of the loss over the timeframe noted, the yield to maturity of the debentures is still relatively attractive, especially when considering the built-in inflation protection.