You are on page 1of 157

Introduction to Bond Market

21st & 24th Dec 2007

Presented by

Capt (R) Georgy Gan


1

What is a Bond Market?

The bond market (also known as the debt, credit, or fixed income market) is a financial market where participants buy and sell debt securities, usually in the form of bonds. As of 2006, the size of the: international bond market is an estimated USD 45 trillion. Malaysian bond market is an estimated RM 75.8 (USD 22) billion.

The bond market provide another avenue for governments or corporations to raise capital.
Essentially, bonds are debts or loans and when a bond is issued, it means the issuer (government or corporation) is borrowing a specified amount of money from the investor for a specified period of time.

What is Bond?

a bond is a debt security, in which the authorized issuer owes the holders a debt and is obliged to repay the principal and interest (the coupon) at a later date, termed maturity. financial contracts that pledge to repay a specified or fixed amount of money, with interest paid to the lenders upon maturity of the contract.

Bond Issuer

1.

Purpose to raise short and long term funding for their business and development activities. Government Bonds issued are basically risk free The risk of default is fully guaranteed by the Government known as Malaysian Government Securities (MGS).

Bond Issuer

2.

Bonds issued by private entities or companies: Purpose to help finance their ongoing business activities. an alternative instrument to issue of equity or preference shares. to increase of financial leverage (used borrowed funds to improve its return on investment) an incentive of tax deductible (helps to reduce the amount of tax on the company profits)
7

Bond Issuer

3.

Bonds issued by private entities or companies consist of debentures, secured (mortgaged) bond) and convertible bonds:a. Debenture. usually unsecured in the sense that there are no liens or pledges on specific assets. it is however, secured by all properties not otherwise pledged. In the case of bankruptcy debenture holders are considered general creditors. The advantage of debentures to the issuer is they leave specific assets burden free, and thereby leave them open for subsequent financing, an alternative instrument to issue of equity or preference shares.

Bond Issuer

b. Convertible Bond type of bond that can be converted into shares of stock of the issuing company, usually at some preannounced ratio. the key benefit of raising money by selling convertible bonds is a reduced cash interest payment. However, in exchange for the benefit of reduced interest payments, the value of shareholder's equity is reduced due to the stock dilution expected when bondholders convert their bonds into new shares .
9

Bond Issuer

c.

Secured Bond type of bond or note that is based on pools of assets, or collateralized by the cash flows from a specified pool of underlying assets. Assets are pooled to make otherwise minor and uneconomical investments worthwhile, while also reducing risk by diversifying the underlying assets. it can be used as credit enhancement by creating a security that has a higher rating than the issuing company which monetizes its assets. Allows it to pay a lower rate of interest than would be possible via a secured bank loan or debt issuance.

10

Investing in Bond

An attractive investments because: 1. Pay holders fixed interest income (coupon payment) Paid out on quarterly or half yearly Percentage of paid out is determined in advance. Paid out is base on a percentage of amount of bond. Produce Capital Gains Sold prior its maturity at more than purchase price Held to maturity

2.

11

Bond Investor Financial institutions, other private companies or managed funds (e.g. pension, insurance or unit trust funds). The individual investors do not normally participate in the bond market because they are normally sold over-the counter, in large amounts. An average investment being about RM5 million. There are corporate bonds (also called private debt securities) listed on the Bursa Malaysia that retail investors can buy. But in general, investors purchasing bonds are looking for investments that will give them a stable fixed income and which are less risky than the stock market.

12

Why Invest in Bonds? Most financial planners and fund managers view bonds as being less risky than shares but yielding more returns than fixed deposits. It is less risky than shares because it provides: 1. a fixed income from the coupons and 2. the return of the principal is as stable as the issuer of the bonds. Bonds issued by stable governments of economically strong countries are considered the least risky. In general, 1. it is in a nations interest that bonds issued by its government pay their coupons and pay the principal sum upon maturity, so that the credibility of the government remains strong and 2. it can continue to raise capital through the future issuance of bonds.
13

An alternative fund raising tool: When the stock market is bearish, Bonds provide an alternative avenue for corporations to raise capital. A mature bond market plays an important role in stabilising the overall financial system of a country. In many developed countries, the market capitalisation of the bond markets are larger than that of the stock markets. In Malaysia, the securities laws have been amended to facilitate the development of the bond market which has been growing from strength to strength. Over the past 10 years, the bond market has grown substantially both in terms of trading activities in the secondary market and in terms of market liquidity.

14

Bond Market Pricing Terminology

When the market price of the bond is less that its par value, the bond is considered as being sold at a discount. When the market price of the bond is more than its par value, then the bond is being sold at a premium.

15

How a Bond Traded?

1.

Primary Market: When the issuer (government or corporations or institutions) first offers new issues, that first trading is done at the primary market. this means is that the issuer is able to raise funds for its use and the money raised from the sale of the bonds come directly to the issuer.

16

2.

Secondary Market Subsequently, the bonds bought from the issuer can be bought and sold among other investors, and this is referred to as the secondary market. The secondary market provides liquidity to the individuals or institutions that have acquired the bonds, which are now able to sell off the bonds before the maturity date, should they wish to do so. The trading of bonds in the secondary market creates a market pricing of the bonds that depends on the supply and demand of the bonds, and prevailing interest rates, among other factors.

17

The secondary market plays an important role because: 1. Investors purchasing bonds at the primary market know there is an avenue to sell-off their bonds. 2. The secondary markets provide a gauge for issuers to price their primary issues.

18

THE DIFFERENCE BETWEEN INVESTING IN BONDS AND INVESTINGIN SHARES?

Bonds are medium to long-term debt instruments, which have the following advantages and disadvantages when compared to buying shares:

Advantages Investor receives periodic fixed interest income, irrespective of whether the company issuing the bonds is doing well or not. Bondholders have a prior right over ordinary shareholders on distribution of earnings and on claims in the event of bankruptcy.

Disadvantages As the income (coupons) derived from bonds is fixed, the investor does not get paid more even if business is booming as in the case of ordinary shareholders who may be given higher dividends. Bondholders have no voting rights and are not owners of the company while shareholders have a right to vote at general meetings.

19

Features of Bond

20

Basic Types of Bonds

Irredeemable

Redeemable

Zero Coupon

Coupon Paying

21

Irredeemable

Do not mature No maturity date Issuer is bound to make either Perpetuity payments, or e.g. War Bond or Perpetual Bond Perpetual Bond India Mumbai, Sept. 10, 2007. Bank of India has announced an issue of Innovative Perpetual Debt Instrument bond series II with a view to increasing Tier I capital. The issue will carry a coupon of 10.45 per cent per annum with a step-up coupon rate of 10.95 per cent for all the subsequent years if the call option is not exercised at the end of 10th year from the deemed date of allotment, said a press release from the bank. Converted into another form of security
22

Redeemable Bond a. Maturity Length of the time until loan contract or agreement expires Maturity date i. Date the debt will cease to exist ii. Issuer will redeem the bond iii. Issuer are committed to meet their obligations over this period Classification: i. Short Term 1 to 5 years ii. Intermediate term 5 to 12 years iii. Long Term > 12 years

23

b.

Par Value The amount that the borrower promises to pay before the end of the term to maturity. Known as principal, redemption value, face value & maturity value. Coupon the interest rate that the issuer pays to the bond holders. this rate is fixed throughout the life of the bond. It can also vary with a money market index, such as KLIBOR, or it can be even more exotic. The name coupon originates from the fact that in the past, physical bonds were issued which had coupons attached to them. On coupon dates the bond holder would give the coupon to a bank in exchange for the interest payment.

c.

24

Zero Coupon Bond A debt security that doesn't pay interest (a coupon) but is traded at a deep discount, rendering profit at maturity when the bond is redeemed for its full face value. Also known as an accrual bond. Coupon Bond For example, a $1,000 bond with a coupon of 7% will pay you $70 a year. The reason it's called a "coupon" is because some bonds literally have coupons attached to them. Holders receive interest by stripping off the coupons and redeeming them. This is less common today as more records are kept electronically.

25

d.

e.

Coupon dates dates on which the issuer pays the coupon to the bond holders. In Malaysia, most bonds are either semi-annual or annual. In the U.S., most bonds are semi-annual, which means that they pay a coupon every six months. In Europe, most bonds are annual and pay only one coupon a year. Indenture A contract between an issuer of bonds and the bondholder stating the time period before repayment, amount of interest paid, if the bond is convertible (and if so, at what price or what ratio), if the bond is callable and the amount of money that is to be repaid.

26

e.

Covenants a document specifying the rights of bond holders. A clause in a loan agreement written to protect the lender's claim by keeping the borrower's financial position approximately the same as it was at the time the loan agreement was made. Essentially, covenants spell out what the borrower may do and must do in order to satisfy the terms of the loan. E.g., the borrower may be prohibited from issuing more debt by using certain assets as collateral. Likewise, the borrower may be required to issue reports to bondholders on certain dates called protective covenant, restrictive covenant. In the U.S., federal and state securities and commercial laws apply to the enforcement of those documents, which are construed by courts as contracts. The terms may be changed only with great difficulty while the bonds are outstanding, with amendments to the governing document generally requiring approval by a majority (or super-majority) vote of the bond holders.

27

f.

Optionality: a bond may contain an embedded option; that is, it grants option like features to the buyer or issuer: 1. Callability Some bonds give the issuer the right to repay the bond before the maturity date on the call dates. These bonds are referred to as callable bonds. Most callable bonds allow the issuer to repay the bond at par. With some bonds, the issuer has to pay a premium, the so called call premium. This is mainly the case for high-yield bonds. These have very strict covenants, restricting the issuer in its operations. To be free from these covenants, the issuer can repay the bonds early, but only at a high cost.

28

2. Puttability Some bonds give the bond holder the right to force the issuer to repay the bond before the maturity date on the put dates. Call dates and Put dates the dates on which callable and puttable bonds can be redeemed early. There are four main categories. a. A Bermudan callable has several call dates, usually coinciding with coupon dates. b. A European callable has only one call date. This is a special case of a Bermudan callable. c. An American callable can be called at any time until the maturity date. d. A death put is an optional redemption feature on a debt instrument allowing the beneficiary of the estate of the deceased to put (sell) the bond (back to the issuer) in the event of the beneficiary's death or legal incapacitation. Also known as a "survivor's option".

29

g.

Sinking fund provision of the corporate bond indenture requires a certain portion of the issue to be retired periodically. The entire bond issue can be liquidated by the maturity date. If that is not the case, then the remainder is called balloon maturity. Issuers may either pay to trustees, which in turn call randomly selected bonds in the issue, or, alternatively, purchase bonds in open market, then return them to trustees.

30

h.

an exchangeable bond (or XB) is a straight bond with an imbedded option to exchange the bond for the stock of a company other than the issuer (usually a subsidiary or company in which the issuer owns a stake) at some future date and under prescribed conditions. An exchangeable bond is different from a convertible bond. A convertible bond gives the holder the option to convert bond into shares of the issuer.

31

Types of International Bond Market

32

1.

Fixed rate bond is a bond with a fixed coupon (interest) rate. A fixed rate bond is a long term debt paper that carries a predetermined interest rate. The interest rate is known as coupon rate and interest is payable at specified dates before bond maturity.

33

2.

Floating rate notes (FRNs) are bonds that have a variable coupon, equal to a money market reference rate, like LIBOR or federal funds rate, plus a spread. The spread is a rate that remains constant. Almost all FRNs have quarterly coupons, i.e. they pay out interest every three months, though counter examples do exist. At the beginning of each coupon period, the coupon is calculated by taking the fixing of the reference rate for that day and adding the spread. A typical coupon would look like 3 months USD LIBOR +0.20%.

34

3.

High yield bond (non-investment grade bond, speculative grade bond or junk bond) is a bond that is rated below investment grade at the time of purchase. These bonds have a higher risk of default or other adverse credit events, but typically pay higher yields than better quality bonds in order to make them attractive to investors.

35

4.

Inflation-indexed bonds (also known as linkers) are bonds where the principal is indexed to inflation, and thus purports to cut out the inflation risk. The first known inflation-indexed bond was issued by the Massachusetts Bay Company in 1780. The market has grown dramatically since the British government began issuing inflation-linked Gilts in 1981. Today, the asset class comprises over $500 Billion of the international debt market. The market primarily consists of sovereign debt, with privately issued inflation-linked bonds constituting a small portion of the market.

36

5.

Asset Backed Security is a bond or note that is based on pools of assets, or collateralized by the cash flows from a specified pool of underlying assets. Assets are pooled to make otherwise minor and uneconomical investments worthwhile, while also reducing risk by diversifying the underlying assets. Securitization makes these assets available for investment to a broader set of investors. These asset pools can be made of any type of receivable from the common, like credit card payments, auto loans, and mortgages, or esoteric cash flows such as aircraft leases, royalty payments and movie revenues. Typically, the securitized assets might be highly illiquid and private in nature.

37

6. Subordinated bond is a bond that has a lower priority than other bonds of the issuer in case of liquidation during bankruptcy. In case of liquidation, there is a hierarchy of creditors. First the liquidator is paid, then government taxes, and so on. The first bond holders in line to be paid are those holding what is called senior bonds. After they have been paid, the subordinated bond holders are paid. As a result, the risk is higher. Subordinated bonds usually have a lower credit rating than senior bonds. The main examples of subordinated bonds can be found in bonds issued by banks, and asset-backed securities..

38

7.

Bearer bond is an official certificate issued without a named holder. The person who has the paper certificate can claim the value of the bond. Often they are registered by a number to prevent counterfeiting, but may be traded like cash. Bearer bonds are very risky because they can be lost or stolen. Especially after federal income tax began in the United States, bearer bonds were seen as an opportunity to conceal income or assets.

39

8.

Bear bond is a bond issued in Russian roubles by a Russian entity in the Russian market. Lottery Bonds issued by France, Belgium and the other major nations of Europe. They are government bonds and only issued by a government. Outwardly, lottery bonds resemble ordinary fixed rate bonds, they have a fixed, though usually long, tenor and pay regular coupons. The serial number is the incentive for the purchaser to buy the bond. However there is a further complication; occasional bonds will receive a bonus. A small number of bonds are redeemed for an amount greater than their face value. Hence the holder of that particular bond will have won the lottery.

9.

40

Bonds Issued by Foreign Entities

Issuing bonds denominated in foreign currencies also gives issuers the ability to access investment capital available in foreign markets. The proceeds from the issuance of these bonds can be used by companies 1. to break into foreign markets, or 2. can be converted into the issuing company's local currency to be used on existing operations. 3. Foreign issuer bonds can also be used to hedge foreign exchange rate risk.

41

Eurodollar bond, a U.S. dollar-denominated bond issued by a non-U.S. entity outside the U.S. Kangaroo bond, an Australian dollar-denominated bond issued by a non-Australian entity in the Australian market Maple bond, a Canadian Dollar-denominated bond issued by a nonCanadian entity in the Canadian market Samurai bond, a Japanese Yen-denominated bond issued by a nonJapanese entity in the Japanese market Yankee bond, a US Dollar-denominated bond issued by a non-US entity in the US market Shogun bond, a non-yen-denominated bond issued in Japan by a nonJapanese institution or government

42

Bulldog bond, a pound sterling-denominated bond issued in London by a foreign institution or government Matrioshka Bond, a Russian rouble-denominated bond issued in the Russian Federation by non-Russian entities. Arirang bond, a Korean won-denominated bond issued by a non-Korean entity in the Korean market Ninja loan, a Japanese yen syndicated loan by a foreign borrower Formosa bond, a non-New Taiwan Dollar-denominated bond issued by a nonTaiwan entity in the Taiwan market Panda bond, a Chinese renminbi-denominated bond issued by a non-China entity in the People's Republic of China market.

43

Capital Market Master Plan - Malaysia

1. Begins in year 2001, 10 years plan strategic positioning and future direction of Malaysian capital 2. As an integral part and indicator of nation development 3. Represent vital part of financial market infrastructure 4. The success of Msian Capital Market contributes to the overall strength of the economy

44

Objectives
Strategic Initiatives

45

1.

To be preferred Fund Raising Centre for Malaysian Companies

Enhance the efficiency of the fund raising process Implement a comprehensive programme to develop the corporate bond market as a competitive source of financing Facilitate the development of the venture capital industry to finance emerging high growth companies Foster a liquid and efficient market for the secondary trading of securities

46

2.

To promote an effective investment management industry and a more conducive environment for investors

Develop a strong framework for corporate governance and shareholder value recognition Heighten efforts to establish a vibrant and competitive investment management industry Enhance the role of institutional investors in the provision and management of funds Facilitate effective risk management by actively developing the derivatives market Facilitate the introduction of a broad range of capital market products catering to various risk-return profiles

47

3. To enhance the competitive position and efficiency of Market Institution

Restructure Msian exchanges and clearing institutions to strengthen their efficiency and competitiveness Ensure Msian exchanges are well positioned to respond to changing market dynamics through adoption of flexible business structures and commercially orientated strategies Enhance the efficiency of trading, clearing and settlement infrastructure

48

4.

To develop a strong and competitive environment for intermediation services

Foster constructive competition through regulation of services, products and fixed fee structure Develop strong full-service brokers to provide a competitive market for integrated financial services Ensure Msian intermediation services are anchored on appropriate prudent standards, with high levels of business conduct and professional skills Adopt a pragmatic programme for liberalization supported by appropriate safeguards

49

5.

To ensure stronger and more facilitative regulatory regime

Move towards a market based system of regulation for capital market activities Ensure regulatory parity and consistency between all institution and participants conducting similar capital market activities Ensure strong enforcement of the regulations governing the capital market Enhance capacity for maintaining systematic and stability

50

6.

To establish Malaysia as an International Islamic Capital Market Centre

Facilitate the development of a wide range products and services related to the Islamic capital market Create a viable market for the effective mobilization of Islamic Funds Ensure that there is an appropriate and comprehensive accounting, tax and regulatory framework for the Islamic capital market Enhance the value of recognition of the Malaysian Islamic capital market internationally

51

Implementation of Capital Market Master Plan

Phase 1 (200103)
Strengthen domestic capacity, and develop strategic and nascent sectors

Phase 2 (200405)
Further strengthen key sectors and gradually liberalise market access

Phase 3 (200610)
Further expansion and strengthening of market processes and infrastructure towards becoming a fully developed capital market, and enhancing international positioning in areas of comparative and competitive advantage

Sources: The Securities Commission.

52

Malaysia Bond Market

53

The main function of Malaysia bond market is to be the mediator between investors and depositors.
In Malaysia, the Ringgit bond market includes Government securities and personal debt securities. Are geared towards developing the capital market to complement the role of traditional lenders. As the nation's industrialisation drive gathers momentum, massive capital input will be required. The massive funding requirement will demand a concomitant broadening and deepening of the capital market as an efficient and reliable source of funding for private sector activity.

54

55

Strategic developmental initiatives for the Malaysian bond market

Strategy 1. Introducing an efficient and facilitative issuance process

Initiatives Release of Guidelines on the Offering of PDSs 2000 Introduction of a shelf-registration scheme 2000 Release of Guidelines on the Offering of Asset-backed Securities (ABSs) 2001 Release of Asset Securitisation Report 2002 Introduction of Guidelines on the Offering of Islamic Securities - 2004

56

Strategic developmental initiatives for the Malaysian bond market

Strategy
2. Establishing a reliable and efficient benchmark yield

Initiatives
Introduction of an auction calendar for Malaysian Government Securities (MGS) -2000 Review of the principal dealers system

57

Strategic developmental initiatives for the Malaysian bond market Strategy 3. Widening the issuer and investor base Initiatives Broadening of the investor base under the Securities Commission Act for the OTC market Universal Brokers are allowed to trade in the OTC market - 2002 ABSs are introduced together with tax-neutral framework and tax deductions onissuance expenses - 2003 Islamic PDSs are accorded various tax incentives (eg stamp duty waiver, tax deductions on issuance expenses) and a tax-neutral framework - 2003, 2005

58

Strategic developmental initiatives for the Malaysian bond market Strategy 3. Widening the issuer and investor base Initiatives Multilateral development banks, multilateral financial institutions and multinational corporations are allowed to raise ringgitdenominated bonds - 2004 Removal of withholding taxes on interest income earned on investments by nonresident companies in ringgit-denominated Islamic securities and securities issued by the Malaysian Government - 2004

59

Strategic developmental initiatives for the Malaysian bond market

Strategy 4. Improving liquidity Ain the secondary market

Initiatives Non-financial institutions are allowed to enter into repurchase transactions - 2000 The Securities Borrowing and Lending Programme is introduced via the RENTAS system - 2001 Institutional Securities Custodian Programme (ISCAP) is put in place to encourage institutional investors to lend securities to BNM - 2004

60

Strategic developmental initiatives for the Malaysian bond market

Strategy 5. Facilitating the introduction of risk management instruments

Initiatives Introduction of three-, five- and 10-year MGS futures - 2002, 2003 Introduction of Guidelines on Regulated Shortselling of Securities - 2005

Sources: Bank Negara Malaysia; Securities Commission.

61

62

63

64

Regulatory Authorities 1. Bank Negara Malaysia (BNM) BNM regulates the activities of financial institutions via the Banking And Financial Institutions Act 1989 (BAFIA). Under BAFIA, no person shall receive, take or accept deposits except under and in accordance with a valid licence. As the issuance of bonds is deemed to be "deposit taking", the approval of BNM is therefore required for any issuance of bonds. It is also part of BNM's overall strategy to monitor the extent of public and private debt as part of their policy measures to manage liquidity and to contain inflation. At the same time, BNM would ensure the availability of credit, in particular long-term credit at a reasonable cost to finance long-term projects, without causing an inflationary pressure in line with the macro economic objectives. Effective 1 July 2000, the approving authority for private debt securities has been transferred from BNM to the SC.
65

2. Securities Commission (SC) The SC was established on 1 March 1993 pursuant to the Securities Commission Act 1993 with the power to regulate the issue of and the dealings in securities, to encourage the development of the securities market and to curb improper dealings.
The SC also regulates all matters pertaining to unit trusts, and take-overs and mergers. Prior to the establishment of the SC, the power to regulate the issue of new securities was vested with the Capital Issues Committee while all matters pertaining to take-overs and mergers were vested with the Panel on Take-overs and Mergers. Both the CIC and the Panel were dissolved upon the 66 establishment of the SC.

3. Registrar of Companies (ROC) The ROC under the Ministry of Domestic Trade and Consumer Affairs, has extensive powers under the Companies Act 1965 which lays down the statutory requirements and policies on disclosure of information.
In general, an invitation to the public to deposit money or lend money to a corporation must be accompanied by a prospectus. The Act also further requires that the prospectus be registered with the ROC and contains an undertaking that the corporation will, after the acceptance of any 67 money or deposit or loan, issue to that person a

However, exemption from the prospectus requirement is provided under Section 47B of the Companies Act 1965 for PDS issued to prescribed corporation, insurance company, trustee corporation, statutory body, pension fund, unit trust scheme, licensed dealer or investment adviser, foreign incorporated companies, public company engaged primarily in the making of investments in marketable securities and such other persons as the Minister may declare to be exempt purchasers. The recently gazetted Companies (Exempt Purchasers) Order 1997 has declared the exempt purchasers to include licensed fund manager, a person who acquires shares or debentures as principal for a value of not less than RM250,000.00, individuals whose total net personal assets exceed RM3 million, corporations with the total net assets exceeding RM10 million, a licensed offshore bank and offshore insurer in Labuan. Effective from 1 July 2000, the SC is the registering authority for prospectuses in respect of all private debt securities other than securities issued by unlisted recreational clubs. The Registrar of Companies is responsible for the lodgement of prospectuses.

68

MARKET PLAYERS The players in the bond market are: Lead Arranger Co-Arranger Facility Agent Underwriter Guarantor Principal Dealers Tender Panel Member Market Maker Authorised Depository Institution Central Depository Trustee Registrar Paying Agent Money Brokers Rating Agencies

69

Bond Risk

Inflation Risk Market Risk Currency Risk Political risk Credit Risk Liquidity Risk

Maturity Risk Reinvestment Risk Call Risk Price volatility Interest Rate Risk

70

HOW ARE BONDS RATED?

How do you know if an issuer is likely or not likely to default in paying back your principal or in delivering on the agreed periodic coupon payments?

71

Rating Agencies,

independent of corporations issuing bonds, that analyses and provides a rating scale on bonds issued in the market. Credit analysis for bonds is focused almost exclusively on the chance that the bondholder will not receive the scheduled interest payments or principal at maturity. This is known as the default risk. A borrowers ability to repay or credit worthiness is an important criterion to the lender or bond purchaser.

72

Credit rating is an objective and impartial third-party opinion on the ability and willingness of an issuer of a bond to make full and timely payments of principal and interest over the life of the bond. A rating is designed to rank, within a consistent framework, the degree of future default risk of a particular bond relative to others in the market.

73

Rating Agencies in Malaysia Rating Agency Malaysia Bhd (RAM), which was established in 1990 and the 2. Malaysian Rating Corporation Bhd (MARC), established in 1996. Both are privately owned and independent organisations. Institutions and investment fund managers use credit ratings provided by such independent agencies in gauging the credit worthiness of bonds. 1.

74

RAM Bond Rating


Long-Term Ratings
RATING DEFINITION AAA Issues rated AAA are judged to be of the best quality and offer the highest safety for timely payment of interest and principal. AA High safety for timely payment of interest and principal. A Adequate safety for timely payment of interest and principal. More susceptible to changes in circumstances and economic conditions than debts in higher-rated categories. BBB Moderate safety for timely payment of interest and principal. Lacking in certain protective elements. Changes in circumstances are more likely to lead to weakened capacity to pay interest principal than debts in higher-rated categories. BB Inadequate safety for timely payment of interest and principal. Future cannot be considered as assured. B High risk associated with timely payment of interest and principal. Adverse business or economic conditions would lead to lack of ability on the part of the issuer to pay interest or principal. C Very high risk of default. Factors present make them vulnerable to default. Timely payment of interest and principal possible only if favourable circumstances continue D Payment of interest and/or repayment of principal are currently in default or face imminent whether or not formally declared. Short-Term Ratings RATING DEFINITION P1 Very strong safety with regard to timely payment on the instrument. P2 Strong ability with regard to timely payment of obligations. P3 Adequate safety with regard to timely payment of obligations. Instrument is more vulnerable to the effects of changing circumstances than those rated in the P1 and categories. NP High investment risk, with doubtful capacity for timely payment of short-term obligations

and well-

default,

P2

75

MARC Bond Rating


RATING DEFINITION

Investment Grade AAA indicates that the ability to repay principal and pay interest on timely basis is extremely high. AA indicates that the ability to repay principal and pay interest on timely basis with limited incremental risk compared to issues rated in the highest category. A indicates that the ability to repay principal and pay interest is strong these issues BBB the lowest investment grade category; indicates an adequate capacity to repay principal and pay interest. More vulnerable to adverse developments, both internal and external than obligations with higher rating. Non Investment Grade BB while not investment grade, this rating suggest that likelihood of default is considerably less than for lower-rated issues. However, there significant uncertainties that could affect ability to adequately service debt obligations B indicates higher degree of uncertainty, and therefore, greater likelihood of default. Adverse developments could negatively affect repayment of principal and payment of interest on timely basis. C High likelihood of default, with little capacity to address further `adverse changes in financial circumstances D Payment in default 76

HOW DO I INVEST IN BONDS?

The best way for Malaysians to invest in bonds is through bond funds or fixed income funds. Like other unit trust funds, bond funds approved by the Securities Commission are collective investment schemes that pool money from many investors for specific financial objectives (in the case of bond funds, to invest in bonds). The funds are managed by a group of professional managers and the income earned from the investments is then distributed in the form of dividends to unitholders in proportion to their ownership.

77

The general bond funds usually invest in the medium to long-term fixed income instruments while money market funds and short-term bond funds invest in short-term money market instruments. Islamic bond funds would deal only with bonds issued by companies approved under the Syariah Principles. The money market is a market for short-term fixed income instruments (usually with maturities less than a year, although some long-term fixed income instruments are also traded on the money market), which acts as an intermediary for individual institutions seeking short-term credit and those with surplus cash to lend.

78

Banks and financial institutions issue money market instruments such as Negotiable Instrument of Deposit (NID) and Bankers Acceptance (BA), while the government issues money market instruments such as Bank Negara Bills (BNB) and Malaysian Government Treasury Bills (MTB). It is expected that more bond funds will be introduced in the near future, as the Malaysian bond market continues to grow.
79

WHAT ARE THE DIFFERENT TYPES OF BONDS?

Bonds are also classified according to the type of issuer, for example those issued by
government are called government bonds, corporations as corporate bonds or often called private debt securities.

There are also quasi-government bonds, Cagamas bonds and Islamic private debt securities or Islamic bonds.
80

81

GOVERNMENT BONDS

Government bonds being traded are:


Government Investment Issues (GII) Malaysian Government Securities (MGS).

There are also short-term money market instruments issued by the government such as:
Bank Negara Malaysia Bills (BNB) Malaysian Government Treasury Bills (MTB).
82

Conventional Instrument

83

Malaysian Government Securities(MGS)

MGS are gilt-edged securities because they are borrowings of the government. issued for the financing of long-term development projects by the government. issued by auction and by subscription but they can also be bought in the secondary market or from Bank Negara Malaysia. The price of government bonds is influenced by Bank Negara Malaysias price list published monthly, as well as the prevailing supply and demand for the bond. MGS are fixed-rate coupon bearing bonds with bullet repayment of principal upon maturity while coupon payments are made semiannually.

84

Beginning December 2006, BNM has also introduced Callable MGS which provides the Government of Malaysia with the option to redeem the issue at par by giving an advance notice of five business days to the bond holders. Typically, the issue will be called in whole on specific coupon date(s), however these characteristics may vary in the future. Both MGS and MGS callable are issued via competitive auction by Bank Negara Malaysia on behalf of the Government. The successful bidders are determined according to the lowest yields offered and the coupon rate is fixed at the weighted average yield of successful bids. The actual issuance size is announced a week before the issuance date. The typical issuance size ranges from RM1 billion to RM3.5 billion depending on Government financing requirement.

85

The Government is committed to continuously issue 3-year, 5-year and 10-year MGS as benchmark securities as part of its efforts to develop the benchmark yield curve. The benchmark securities were often reopened to enlarge outstanding issue sizes in order to promote market liquidity. In addition, 15-year and 20-year MGS were also issued to lengthen the benchmark yield curve. Secondary market for benchmark securities is liquid with average daily transaction volume varying from RM100 million to RM500 million. Standard transaction is RM5 million per lot. Trades are settled in two business days (T+2) and are quoted on a price basis to two decimal points. Neither stamp duty nor commissions are paid on the transfer of the securities. For transactions via money brokers, brokerage fee is payable.

86

Bank Negara Monetary Notes (BNMN)

BNMN are securities issued by Bank Negara Malaysia replacing the existing Bank Negara Bills (BNB): purposes of managing liquidity in the conventional financial market. The maturity of these issuances has been lengthened from one year to three years. New issuances of BNMN may be issued either on a discounted or a coupon-bearing basis depending on investors' demand. Discount-based BNMN will be traded using the same market convention as the existing BNB and Malaysian Treasury Bills (MTB) while the coupon-based BNMN will adopt the market convention of Malaysian Government Securities (MGS).

87

Malaysian Treasury Bills (MTB) MTB are short-term securities issued by the Government of Malaysia to raise short-term funds for Government's working capital. Bills are sold at discount through competitive auction, facilitated by Bank Negara Malaysia, with original maturities of 3-month, 6-month, and 1-year. The redemption will be made at par. MTB are issued on weekly basis and the auction will be held one day before the issue date. The successful bidders will be determined according to the most competitive yield offered. Normal auction day is Thursday and the result of successful bidders will be announced one day after. MTB are tradable on yield basis (discounted rate) based on bands of remaining tenure (e.g., Band 4= 68 to 91 days to maturity). The standard trading amount is RM5 million, and it is actively traded in the secondary market.

88

Medium-Term Notes (MTNs)

MTNs are instruments with tenor of


more than one year but up to 5 years, and may be issued based on conventional or Islamic principle. The mode of issue for MTNs can either be on direct placement and/or by way of tender.

89

Khazanah Bonds

Issued by Khazanah National Berhad (an investment holding arm of the Government of Malaysia) and guaranteed by the Government.

90

Islamic Instrument

91

Government Investment Issues (GII)

Introduced in July 1983 (then known as Government Investment Certificates or GIC) issued in accordance with Islamic principles. GII are non-interest bearing government bonds issued to enable Bank Islam Malaysia and other institutions invest their liquid funds on an Islamic basis. The GII have maturities from one to five years, with coupon payments made on a semi-annual basis. GII is long-term non-interest-bearing Government securities based on Islamic principles issued by the Government of Malaysia for funding developmental expenditure. Similar with MGS, GII is issued through competitive auction by Bank Negara Malaysia on behalf of the Government.

92

Similar with MGS, GII is issued through competitive auction by Bank Negara Malaysia on behalf of the Government. The GII issuance programme is pre-announced in the auction calendar with issuance size ranging from RM1 billion to RM3.5 billion and original maturities of 3-year, 7- year, 5-year and 10-year. GII is based on Bai' Al-Inah principles, part of the sell and buy back concept in Islamic finance. Under this principle, the Government will sell specified nominal value of its assets and subsequently will buy back the assets at its nominal value plus profit through a tender process. Profit rate is based on the weighted average yield of the successful bids of the auction. The nominal value of buying back the assets will be settled at a specified future date or maturity, while the profit rate will be distributed half yearly.

93

The obligation of the Government to settle the purchase price is securitised in the form of GII and is issued to the investors. At maturity, the Government will redeem the GII and pay the nominal value of the securities to the GII holders. GII is one of the financial instruments that are actively traded in the Islamic Interbank Money Market.
94

Bank Negara Monetary Notesi (BNMN-i)

BNMN-i are Islamic securities issued by Bank Negara Malaysia replacing the existing Bank Negara Negotiable Notes (BNNN) for purposes of managing liquidity in the Islamic financial market. The instruments will be issued using Islamic principles which are deemed acceptable to Shariah requirement. The maturity of these issuances has also been lengthened from one year to three years. New issuances of BNMN-i may be issued either on a discounted or a coupon-bearing basis depending on investors' demand. Discount-based BNMN-i will be traded using the same market convention as the existing BNNN and Malaysian Islamic Treasury Bills (MITB) while the profit-based BNMN-i will adopt the market convention of Government Investment Issues (GII).

95

Malaysian Islamic Treasury Bills (MITB)

MITB are short-term securities issued by the Government of Malaysia based on Islamic principles. MITB are usually issued on a weekly basis with original maturities of 1-year. Normal auction day is Thursday and the results of successful bidders will be announced one day after, on Friday. Both conventional and Islamic institutions can buy and trade MITB. The MITB are structured based on Bai' Al-Inah principle, part of sell and buy back concept. Bank Negara Malaysia on behalf of the Government will sell the identified Government's assets on competitive tender basis, to form the underlying transaction of the deal. Allotment is based on highest price tendered (or lowest yield).

96

Price is determined after profit element is imputed (discounting factor). The successful bidders will then pay cash to the Government. The bidders will subsequently sell back the assets to the Government at par based on credit term. The Government will issue MITB to bidders to represent the debt created. MITB are tradable on yield basis (discounted rate) based on bands of remaining tenure (e.g., Band 4= 68 to 91 days to maturity). The standard trading amount is RM5 million, and it is actively traded based on Bai ad-Dayn (debt trading) principle in the secondary market.

97

Sukuk Bank Negara Malaysia Ijarah (SBNMI)

SBNMI is issued
based on the Al-Ijarah or sale and lease back concept, a structure that is widely used in the Middle East. A special purpose vehicle (SPV) has been established to issue the sukuk Ijarah.

98

Merdeka Savings Bonds

bond structure based on Shariah principles with the purpose of providing assistance to retirees who depend primarily on interest income from deposits placed with the banking institutions.

99

Medium-Term Notes (MTNs)

MTNs are instruments with tenor of


more than one year but up to 5 years, and may be issued based on conventional or Islamic principle. The mode of issue for MTNs can either be on direct placement and/or by way of tender.

100

Comparison between Conventional and Islamic Government Securities

The conventional securities and the Islamic securities differ only in its structure in terms of complying with Islamic principles in its issuance. Islamic Government securities are similar to conventional Government securities in terms of their effective cash flows, issuance structure, legal status in being a direct obligation of the Government, its holdings and nature of transaction as financial products.

101

Features Issuer Tenor Issue size (RM million) Return payment (interest / profit)

MGS (Conventional) Government of Malaysia 3 to 20 years 500 to 3,500 Interest payment is semiannual. Coupon rate is market-determined base on the weighted average successfull yield of the issue. Day count basis is Actual / Actual.

MTB (Conventional) Government of Malaysia 91, 182 and 365 days 80 to 110 Bills are issued on discount basis

GII (Islamic) Government of Malaysia 3 to 10 years 1,000 to 3,500 Zero coupon GII) Bonds are issued on discount basis (Profit based GII) Profit payment is semi-annual. Profit rate is market determined based on the weighted average successful yield of the issue. Day count basis is Actual / Actual.

MITB (Islamic) Government of Malaysia 273 and 365 days 100 to 200 Bills are issued on discount basis

Method of sale in primary market

Offered periodically via competitive multiple-price auction to Principal Dealers on a yield basis for new issues and price basis on reopened basis, or issued through private placement to selected institutions

By competitive multipleprice auction on a yield basis

Competitive multiple-price tenders are submited by Islamic bank or Principal Dealers with Islamic finance operations and are on a yield basis

By competitive multipleprice auction on a yield basis

102

Features Issuer Tenor Issue size (RM million) Redemption

MGS (Conventional) Government of Malaysia 3 to 20 years 500 to 3,500 Offered periodically via competitive multipleprice auction to Principal Dealers on a yield basis for new issues and price basis on reopened basis, or issued through private placement to selected institutions Bonds are exempted from withholding tax. No capital gain tax. Over-the-counter

MTB (Conventional) Government of Malaysia 91, 182 and 365 days 80 to 110 By competitive multiple-price auction on a yield basis

GII (Islamic) Government of Malaysia 3 to 10 years 1,000 to 3,500 Competitive multipleprice tenders are submited by Islamic bank or Principal Dealers with Islamic finance operations and are on a yield basis

MITB (Islamic) Government of Malaysia 273 and 365 days 100 to 200 By competitive multiple-price auction on a yield basis

Taxation

Bonds are exempted from withholding tax. No capital gain tax. Over-the-counter

Bonds are exempted from withholding tax. No capital gain tax. Over-the-counter

Bonds are exempted from withholding tax. No capital gain tax. Over-the-counter

Secondary Market trading

103

Cagamas Instruments
Floating Rate Bonds Securities or bonds issued by the Government of Malaysia. Fixed Rate Bonds These bonds are fixed coupon medium/long-term bonds where the interest is payable semi annually. Cagamas Notes These notes are short-term securities with the tenor of 12 months or less. The notes are similar to MTB and normally issued at a discount. Islamic Notes Al Mudharabah These debt securities are of medium-term tenor issued under the Islamic principle of Al Mudharabah with a pre-determined profit sharing ratio.

104

CORPORATE BONDS

Here are examples of the types of corporate bonds issued in the Malaysian capital market: Straight bonds Convertible bonds Bonds with warrants Floating rate bonds Zero coupon bonds

Mortgage bonds Islamic bonds Secured and unsecured bonds Guaranteed bonds
105

106

Straight bonds Straight bonds are, as the name suggests, bonds as simple as they can be, with a fixed coupon rate, and maturity on a date fixed at the time of issue. are often called plain vanillas as these bonds do not carry any other enhancement features but tend to carry high interest rates. The coupon is made either semi-annually or annually and the principal sum is paid at maturity to the bondholder.

107

Convertible bonds give the holders a right to convert the bonds to a number of the issuers stock or shares during a period, and at a price agreed at the time of issuing the convertible bonds. The coupon rate for such convertible bonds are typically lower compared to a straight bond because the holder is given the right of conversion. The issuer benefits from paying lower coupons, as well as maximising the proceeds received upon conversion by setting a higher conversion price to its existing share price.

108

The investor also benefits because if the company performs well, its shares can be bought (through conversion) at what may prove to be a favourable price (if the conversion price is more favourable than the market price by the time of conversion). When the bond is converted to shares, it loses its principal sum invested and the income from the coupons, but the investor who is now a shareholder will benefit from payments of dividends and any future increase in the share prices.

109

Bonds with warrants Bonds issued with detachable warrants are common in Malaysia. The issuer offers the entire issue of bonds with warrants at face value to a primary subscriber. The primary subscriber subsequently detaches the warrants and sells them to shareholders of the issuer in the secondary market. The bonds are themselves distributed to institutional investors. Bonds with warrants have low coupon rates and are sold at a discount to yield the rate of return required by investors in the secondary market.

110

A warrant gives the holder the option to purchase a specified number of shares at a preset exercise price and within a certain time period (exercise period). The exercise price is the amount the warrant holder has to pay in order to convert the warrant into an ordinary share. For investors, it is attractive to have the option to buy shares at preset prices. For the issuer, bonds with warrants allow the issuer to first raise money through the sale of the bonds and later, when the warrants are exercised, money is again raised in purchasing the shares at the preset price.

111

Floating-rate bonds

The coupon rate of a floating-rate bond is instead pegged to an agreed benchmark, such as
the KLIBOR (Kuala Lumpur Interbank Offered Rate) and as this reference rises and falls, the floating rate also moves accordingly.

112

Mortgage bonds

Mortgage bonds require the issuer to pledge certain real assets as security for the bond.
In the event of a default, the bondholders can foreclose on the pledged assets to satisfy their claims, although in practice such foreclosures are unusual.

113

Islamic bonds

Islamic bonds are structured according to the Islamic principle of deferred payment sale, and require the endorsement of the
Syariah Advisory Council of the Securities Commission.

114

Secured and unsecured bonds

The debt payments of secured bonds are secured by a pledge of the issuers assets, typically shares, a building or land. In the event of a default, the investors would have a claim on the pledged assets. Conversely, unsecured loans are bonds not backed by any collateral. In the event of a default, the bondholders would have a general claim on the issuing company. Due to its higher risk factor, unsecured loans offer higher interest rates than secured bonds.

115

Guaranteed bonds

Guaranteed bonds are guaranteed for full debt repayment by a guarantor, which could be the parent company or one or more financial institutions.
The safety of the bond therefore depends on the financial capability of the issuer and the guarantor to satisfy the terms of the guarantee.

116

117

WHAT ARE THE COMMON TERMS USED IN ASSOCIATION WITH BONDS?

The following characteristics and terms are always associated with bonds and we need to understand what they mean in order to understand bonds. Nominal value Coupon rate Term-to-maturity Trust deed Trustee Type of issuer Yield Call provision Sinking fund

118

Nominal value

The nominal value of a bond is the par or face value and sometimes, also referred to as the principal value of the bond.
This is the amount the issuer of the bond has agreed to pay the bondholder at the maturity date. In view of this, the principal is also called the redemption or maturity value.

119

Coupon rate
The coupon rate is the amount of interest the bondholder will receive periodically. E.g. if the nominal value of the bond is RM100,000 and the coupon rate is 7%, then the bondholder will receive an annual interest of RM7,000. If the agreed periodic payment is every six months, then the bondholder will receive RM3,500 every six months.

120

Term-to-maturity

This is the number of years over which the issuer of the bond has promised to meet the conditions and obligations of the bond issue. During this time, the bondholder is paid the promised coupon payments and it also indicates the time period remaining before the bondholder is paid back the principal. The term-to-maturity also affects the bond yield and the bond price.

121

Trust deed

A trust deed is the legal agreement detailing the issuers obligations related to the bond issue.
It contains the terms of the bond issue and any restrictive provisions placed on the company, such as a requirement for the company to set up a sinking fund, or the inclusion of a call provision. An independent trustee administers the trust deed.
122

Trustee

The trustee is the third party with whom the trust deed is made. The job of the trustee is to see that the terms and conditions of the trust deed are carried out. As the trust deed also contains provisions in the event of default, the trustee would undertake action to protect the interests of the bondholders in the event of a default.

123

Types of issuer

A key feature of a bond is the nature of the issuer.


In Malaysia, the issuers of bonds can be
the government, banks, financial institutions companies.
124

Yield

There is often confusion between the yield and the coupon rate of a bond. While the coupon rate is fixed at issue, and does not change till maturity, the yield is the discount rate or interest rate that an investor wants from investing in a bond. Price bonds are quoted in relation to their yields. As the required yield increases, the price of the bond decreases. The reverse is also true.

125

Call provision

A call provision entitles the issuer to repurchase or call the bond form their holders at a stated price within a predetermined period.
126

Sinking fund

In a sinking fund bond, the issuer periodically puts aside money for the eventual repayment of the debt.
This provision may be included in the bond trust deed to protect investors.

127

How RM Bonds are Traded?

128

When the issuer first offers new issues, that first trading is done in the primary market, where the money raised from the sale of the bonds goes directly to the issuer for its use. Subsequently, in the secondary market, the bonds can be bought and sold among other investors. The secondary market provides to the bond holders should they wish to sell the bonds before the maturity date. The trading of bonds in the secondary market creates a market pricing of the bonds that depends on the supply and demand of the bonds, and the prevailing interest rates, among other factors. When the market price of the bond is less than its par value, the bond is being sold at a discount. When the market price of the bond is more than its par value, the bond is sold at a premium.

129

Primary Bond Market BNM issues Malaysian Government Securities (MGS) via auction process through Principal Dealers (PDs). BNM invites for tender via Fully Automated System for Issuing/Tendering (FAST) 7 days before issuance date. Tender details are announced in Bond Information Dissemination System (BIDS) and feed into REUTERS and Bloomberg. PDs submit bids via Fully Automated System for Issuing/Tendering (FAST) by 11.30am 1 day before issue date. BNM processes and confirms tender results by 12pm. Securities allotment via Delivery-versus-Payment (DvP) is processed through Real Time Electronic Transfer of Funds and Securities (RENTAS) on issue date.

130

131

Method Of Issuance
The two methods of issuance adopted in the primary market of Government securities in Malaysia are
1. market auction and 2. private placement.

132

Primary Investor
Securities auctions are open to all investors, but all bidders are to submit bids through PDs. Among the primary investors of Government securities are the 1. Employees Provident Fund (EPF), 2. Petroliam Nasional Berhad (Petronas - largest petroleum company in Malaysia), 3. financial institutions (including PDs), 4. insurance companies including Takaful operators (Islamic insurers), 5. asset management companies and 6. corporates.

133

Secondary Bond Market Deal reporting and dissemination of information is captured in Bond Information Dissemination System (BIDS). Seller initiates trade reporting in Bond Information and Dissemination System (BIDS) and buyer confirms trades. Once confirmed, the transaction becomes latest deal done in Bond Information and Dissemination System (BIDS). Bond Information and Dissemination System (BIDS) provide last deal done information (price/yield, volume) and daily turnover volume. Concluded deals entered into Financial Institution (FI) treasury system. Trades settlement take place on value date through Real Time Electronic Transfer of Funds and Securities (RENTAS) via DvP process.
134

Secondary Market Trading


Government securities and other scripless debt instruments are traded in the secondary or "over-the-counter" (OTC) market either via a money broker, direct dealing on telephones or via the Electronic Broking System (EBS). In the secondary market, MGS benchmarks, the 3-year, 5-year and 10-year are the most actively traded and commonly referred to as "on-the-run" issues. While non MGS benchmarks are referred to as "off-the-run" issues. Principal Dealers (PDs) appointed by Bank Negara Malaysia are committed to provide continuous two-way prices in MGS, as they are obliged to make market. Every morning PDs will submit and advertise their indicative bids and offers on all benchmark securities in the Bond Information and Dissemination System (BIDS) system. Non-PD financial institutions may also choose to make market by quoting two-way prices in the Bond Information and Dissemination System (BIDS) system. All trading done via the OTC market must be captured on Bond Information and Dissemination System (BIDS) system where the sellers of securities will key in the deal and buyers will confirm within a stipulated 10 minutes cut-off time from trade execution.

135

Normal business hours for a regular government securities trade is for standard settlement or value spot i.e. 2 business days (T+2) settlement, from 9.00 a.m. to 4.30 p.m. from Monday to Friday excluding holidays. Government securities can also be traded on value today, value tomorrow or value forward. All Government securities trades are settled based on a delivery versus payment (DvP) basis although free-of-payment settlement (FoP) is available where necessary. Reopened MGS shares the same stock identifiers with the existing stocks, therefore are indistinguishable and fungible. As Government securities are scripless securities, ownership and transfer of Government securities are reflected as book entries in the Authorised Depository Institutions (ADIs) custody accounts with Bank Negara Malaysia in the Real Time Electronic Transfer of Funds and Securities (RENTAS) system. Non-RENTAS members such as institutional investors and other financial institutions can transact scripless securities via their ADI. Cash payments of coupons and redemption proceeds will be passed to the investors via their respective ADIs.

136

Market Infrastructure

137

The Fully Automated System for Tendering (FAST)

is an automated tendering system whereby invitations to tender, bids submission and processing of tender for SSTS instuments and short term private debt securities are done electronically. Objective To improve the overall efficiency of the tendering procedures, to reduce errors and delays arising from manual handling of tenders as well as to eliminate potential disputes that may arise from the bidding process.

Process Flow The FAST system can be summarised in 7 business processes as follows: (i) Invitation to Tender The facility agents invite for tenders by entering information on the forthcoming tender at least 3 business days before the tender date. Any changes in the information is updated in the system for dissemination to all FAST members before the tender closing date.

138

(ii) Tender Information The invitation by the facility agents would be the source of the tender information. All members of FAST can assess to the information on the forthcoming tenders, which includes the type of security, tender date, issue date, maturity date, issue amount and other details relating to the issue. The Information Memorandum will state the relevant terms and conditions pertaining to a particular issuer for tender. (iii) Submission of Tender All bids by members must be submitted before the stipulated cut-off time. Access to the system after the cut-off time is denied. (iv) Tender Processing After the cut-off time, the system automatically sorts and ranks the bids (yield/price) in ascending/descending order and award the stocks to the successful bidders until the amount of the issue is fully allotted. The system also allows for intervention by the facility agents.

139

(v) Tender Results Once the results are verified and finalised, they will be transmitted through the system to the bidders. All bidders are able to retrieve their own results. However, the other FAST members can only view the general results. The general bidding results are also announced through the information providers such as Reuters and Telerate. (vi) Data Analysis FAST members can download bidding information at their workstations for data analysis and end-user reporting.

140

(vii) Settlement For fund settlement purposes, the results of the tender for SSTS instruments will be linked to RENTAS for allotment of securities and cash transfer.
For PDS tendered through FAST, the settlement is done manually either through Interbank Funds Transfer System (IFTS) or cheque clearing.

FAST Membership Membership in FAST is currently opened to licensed inancial institutions (commercial banks, merchant banks, discount houses and Islamic banks), development banks, insurance companies, statutory bodies, other financial bodies and other market participants, as approved by Bank Negara Malaysia.
141

Bond Information and Dissemination System, BIDS

is a computerised centralised database on Malaysian debt securities, providing information on the terms of issue, real-time prices, details of trades done and relevant news on the various debt securities issued by both the Government and the private sector. The transparency of information provided by BIDS is expected to facilitate both the primary and secondary market activities in the domestic bond market. Objective To provide transparency with regards to information on bonds issued, thereby facilitating efficient trading in the secondary over-the-counter market and enhancing liquidity in the debt securities market.

Process Flow (i) Maintenance of Static Database The lead arrangers and rating agencies will input information into BIDS through their workstations located at their premises. These information will be disseminated real-time.
142

(ii) Advertisement of Indicative Prices The licensed financial institutions can input indicative bids and offers into BIDS. This will provide users with information on the demand and supply situation in the market.

(iii) Capturing of Trades Done Trades done are reported in BIDS and the system will disseminate the last done price and volume real-time. (iv) Individual Corporate Homepage/Members News Information relevant to the debt securities market can be input into corporate homepages and members' news pages.

BIDS Membership Membership in BIDS is currently opened to licensed financial institutions (commercial banks, merchant banks, Tier-1 finance companies, discount houses and Islamic banks), Cagamas Berhad, the rating agencies, money brokers, insurance companies and other market participants, as approved by Bank Negara Malaysia.

143

RENTAS

The RENTAS System is a real time gross settlement system (RTGS) for the transfer and settlement of high value ringgit denominated interbank funds and scripless securities transactions. RENTAS System will enable payment instructions between the participants of the System to be processed and settled individually and continuously throughout the working day. All settled transactions will be considered as final and irrevocable. Thus, the receiver will be able to use the funds immediately without being exposed to the risk of the funds not being settled.

144

The RENTAS System will also contribute to the reduction of settlement risk in scripless securities transactions by providing a mechanism for delivery-versus payment (DVP). This mechanism would enable transfer instructions for both scripless securities and funds to be effected on a trade-bytrade basis, with final (unconditional) transfer of the securities from the seller to the buyer (delivery) occurring at the same time as the final transfer of the funds from the buyer to the seller (payment).

145

Bond Calculation

146

Bond Valuation

Bond valuation is the process of determining the fair price of a bond.


As with any security or capital investment, the fair value of a bond is the present value of the stream of cash flows it is expected to generate. Hence, the price or value of a bond is determined by discounting the bond's expected cash flows to the present using the appropriate discount rate.
147

The present value relationship The fair price of a straight bond is determined by discounting the expected cash flows: Cash flows: the periodic coupon payments C, each of which is made once every period; the par or face value F, which is payable at maturity of the bond after T periods.(NB final year payment will include the par value plus the coupon payment for the year) Discount rate: the required (annually compounded) yield or rate of return r. r is the market interest rate for new bond issues with similar risk ratings

148

Bond Price,
Po =
N

n=1

( 1 + rn )

( 1 + rN )

149

Because the price is the present value of the cash flows, there is an inverse relationship between price and discount rate: the higher the discount rate the lower the value of the bond (and vice versa).
A bond trading below its face value is trading at a discount, A bond trading above its face value is at a premium.
150

Coupon yield

The coupon yield is simply the coupon payment (C) as a percentage of the face value (F).
Coupon yield = C / F

Coupon yield is also called nominal yield.

151

Current yield

The current yield is simply the coupon payment (C) as a percentage of the bond price (P).
Current yield = C / Po.

152

Yield to Maturity

The yield to maturity (YTM) is the discount rate which returns the market price of the bond. It is thus the internal rate of return of an investment in the bond made at the observed price. What an investor will earn on the bond if it is held to maturity. YTM can also be used to price a bond, where it is used as the required return on the bond. Solve for YTM where YTM = (Par Value Current Price) / n (Current Price + Par Value ) / 2

153

Market Price =
N

C
n

MPo = (1 + YTMn)
n=1

( 1 + YTMN )

154

To achieve a return equal to YTM, the bond owner must: reinvest each coupon received at this rate, hold the bond until maturity, and redeem the bond at par. The concept of current yield is closely related to other bond concepts, including yield to maturity, and coupon yield. The relationship between yield to maturity and coupon rate is as follows: When a bond sells at a discount, YTM > current yield > coupon yield. When a bond sells at a premium, coupon yield > current yield > YTM. When a bond sells at par, YTM = current yield = coupon yield. The YTM is of limited use in valuing bonds with uncertain cash flows, such as mortgage-backed securities or asset-backed securities. In these instances, other measures such as option adjusted spread should be used instead when comparing yields across different types of bonds.
155

Yield to maturity (YTM) is the yield promised by the bondholder on the assumption that the bond will be held to maturity, that all coupon and principal payments will be made and coupon payments are reinvested at the bond's promised yield at the same rate as invested. It is a measurement of the return of the bond. This technique in theory allows investors to calculate the fair value of different financial instruments. The YTM is almost always given in terms of annual effective rate. The calculation of YTM is identical to the calculation of internal rate of return. If a bond's current yield is less than its YTM, then the bond is selling at a discount. If a bond's current yield is more than its YTM, then the bond is selling at a premium. If a bond's current yield is equal to its YTM, then the bond is selling at par.
156

Introduction to Bond Market

THE END THANK YOU

157