Commodity-Linked Securities

Investment instruments or securities that are linked to one or more commodity prices are known as commodity-linked securities. These commodity-linked securities provide income to the owner, generally in the form of pay-outs. Like, stocks and bonds, commodities are a class of assets but they are physical products that have uniform quality and are produced in large quantities, for example, cotton, gold, oil, gas, etc.

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Types of Commodity Linked Securities:

Commodity Linked Securities can be of 2 types:

 

Commodity Linked Bonds:

Commodity-linked bonds or commodity-backed bonds are debt securities where the coupon payments and the principal of the bonds depend upon the price of the underlying commodity. The securities that are offered by the government & whose yield depends on the global inflation index and price of a specific commodity are commodity-linked bonds.

Features of commodity-linked bonds:

• Either the bond’s face value or its coupon rate is dependent on the price of the underlying commodity. Hence, the bond’s price will fluctuate according to the rise and fall of the commodities price.
• Commodity-linked bonds provide bondholders with a steady source of income and also can be used as a speculative vehicle for investors who think the commodities price will increase.
• They are also used as a hedging tool against inflation.
• Commodity-backed securities generally have longer maturities (greater than 5 years) and are classified as long-term liabilities.
• They have a lower coupon rate than regular bonds. This is because the investor can earn more when the commodities price increases.

Commodity Linked Equities:

Another type of commodity-linked securities is commodity-linked equities. Commodity Linked Equities are those equities issued by companies whose value depends on the price of one or more commodities. For example, the stock price of Shell and Bharat petroleum. The value of the equity depends on the commodity it is linked with.

Examples:

1. Commodity-linked bonds are issued by companies that produce the associate commodity. The popular examples of CLB are bonds linked to gold, oil, and coal.
2. The popular examples of commodity-linked equities are stock prices of energy companies such as Shell and BP. Oil and Gas companies are directly affected due to changes in oil prices.

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Bottom Line:

• CLS provides the investor with a steady source of income.
• It is the most profitable vehicle for investors who speculate that the commodity of the price will rise. This is because the investor has the potential to earn more if the commodity gains value.
• Commodity Linked Securities are securities that depend on the price of the underlying security. Commodities like gold, silver, corn, oil, etc can be used as the underlying securities.
• The payoff of the commodity-linked bonds increases with a rise in the value of the commodity or decreases with the fall in the value of the commodity.
• They are beneficial as they provide a steady source of income to the investors and are also used as a hedging tool.

 

Authors: Urvi Surti and Abha Shetty

About the Author:

Urvi is a commerce graduate and has a keen interest in Finance. She has completed her Chartered Wealth Management (CWM) from the American Academy of Financial Management and is currently pursuing a career in Financial Risk Management (FRM).

Abha is a second-year BMS student and FRM level 1 candidate. She is very intrigued by the world of financial markets and hopes to master the art of investing and trading.

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