BONDS

What is bond? Concept of Value:

Book Value Liquidating Value Market Value Intrinsic Value

BONDS
Features
Coupon Face Value Coupon Rate Maturity Yield- To - Maturity

Basic Valuation Model

The value of any asset is the present value of all future cash flows it is expected to provide over the relevant time period. The value of any asset at time zero, V0, can be expressed as

where v0 CFT r n = = = = Value of the asset at time zero cash flow expected at the end of year t appropriate required return (discount rate) relevant time period
Slide 45
3

Intrinsic Value
10% coupon interest rate, 10-year bond with a $1,000 par value

Traditional Types of Bonds

Slide 38

SLIDE 39

Contemporary Types of Bonds

Slide 40

TYPES OF BONDS ISSUER IN MALAYSIA

Government Quasi-Government Corporate http://asianbondsonline.adb.org/malaysia/struc ture/instruments/bond_types.php

Government Bonds
Malaysian Government Securities (MGS) coupon-bearing, long-term bonds issued by the Government to raise funds from the domestic capital market. They are the most actively traded bonds. In addition, there are callable MGS which gives the government an option to redeem the bond ahead of its maturity date.
9

Government Bonds
Malaysian Treasury Bills (MTB) short-term securities issued by Bank Negara Malaysia (BNM) on behalf of the government. Treasury bills are used for working capital. Government Investment Issues (GII) noninterest-bearing government securities based on Islamic principles issued by the government and placed on a competitive tender with maturities of three to ten years. Funds are used for development expenditures.
10

Government Bonds
Bank Negara Monetary Notes (BNMN) discounted or coupon-bearing government securities with maturities of 91-, 182-, 364days and one to three years. BNMNs are issued by BNM to manage liquidity in both conventional and Islamic markets, and have replaced BNM Bills and BNM Negotiable Notes beginning December 2006. BNMNs are offered through competitive auction through principal dealers.
11

Government Bonds
Sukuk BNM Issues (SBNMI) zero coupon bonds with maturities of one-to-two years. SBNMI are based on al-Ijarah (sale and lease back concept). Merdeka savings bonds targeted at retirees by offering a slightly higher return than the market rate, and a tax exemption. A unique feature of Merdeka savings bonds is that they are all based on the Islamic banking concept of bai' alinah (sell-and-buy-back arrangement).
12

Others
Khazanah bonds issued by Khazanah National Berhad and guaranteed by the Government, these zero-coupon bonds are based on Islamic principles. The National Mortgage Corporation (Cagamas) is the major issuer of asset-backed securities in Malaysia. Securities issued by Cagamas are called Cagamas bonds in the domestic market.
13

How Bond is Traded

New Bond

Lead Arranger

FAST

BID FINANCIAL INSTITUTIONS DEVELOPMENT BANKS INSURANCE COMPANIES ETC

14

Asset Valuation and Risk

Laura wishes to estimate the value of an asset expected to provide cash inflows of $3000 per year at the end of years 1 through 4 and $15,000 at the end of year 5. Her research indicates that she must earn 10% on low-risk assets, 15% on average risk assets and 22% on high-risk assets.

15

a) Determine what is the most Laura should pay for the asset if it is classified as (1) low risk (2)average risk, and (3)high-risk. b) Suppose Laura is unable to assess the risk of the asset and wants to be certain she s making a good deal. On the basis of your findings in part a, what is the most she should pay? Why? c) All else are being the same, what effect does increasing risk have on the value of an asset? Explain in light of your findings in part (a).
16

Basic Bond Valuation

Complex Systems has an outstanding issue of $1,000-par-value bonds with a 12% coupon interest rate. The issue pays interest annually and has 16 years remaining to its maturity date. a) If bonds of similar risk are currently earning a 10% rate of return, how much should the Complex Systems bond shall sell today?

17

b) Describe the two possible reasons why the rate on similar-risk bonds is below the coupon interest rate on the Complex Systems bond. c) If the required return were at 12% instead of 10%, what would the current value of Complex Systems bond be? Contrast this finding with your findings in part (a) and discuss.

18