4 DEFINITION OF BOND CORE CONCEPTS TYPES FOREIGN CURRENCY BONDS FOCAL POINTSDEFINITION OF BONDCORE CONCEPTSTYPESFOREIGN CURRENCY BONDS
5 BOND OPTIONS BOND & STOCK BONDS, BILLS & NOTES HOW BOND WORKS FOCAL POINTSBOND OPTIONSBOND & STOCKBONDS, BILLS & NOTESHOW BOND WORKS
6 FOCAL POINTS FACTORS AFFECTING PRICES BUYING BOND IN PAKISTAN DETERMINING BOND PRICES
7 NUMERICAL RISK ASSOCIATED WITH BOND CURRENT MARKET SITUATION FOCAL POINTSNUMERICALRISK ASSOCIATED WITH BONDCURRENT MARKET SITUATION
8 BOND A promised stream of CFs. A bond is a formal contract to repay borrowed money with interestat fixed intervals.
9 BOND Bonds are debt instruments yielding a rate of return over a set period of time thatcan be traded in the market like any othersecurity. (As bond’s coupon varies depending on future events)
10 BOND Technically in finance, a bond is a debt security, in which the authorized issuer owesthe holders a debt and, depending on the termsof the bond, is obliged to pay interest (thecoupon) and/or to repay the principal at a laterdate, termed maturity.
11 CORE CONCEPTS Par/ Face Value The amount of money that is paid to the bondholders at maturity. For most bonds this amount is $1,000. It also generally represents the amount of money borrowed by the bond issuer.
12 CORE CONCEPTS Coupon Rate The coupon rate, which is generally fixed, determines the periodic coupon or interest payments. It is expressed as a percentage of the bond's face value. It also represents the interest cost of the bond to the issuer.
13 CORE CONCEPTS Coupon Payments The coupon payments represent the periodic interest payments from the bond issuer to the bondholder. The annual coupon payment is calculated by multiplying the coupon rate by the bond's face value. Since most bonds pay interest semiannually, generally one half of the annual coupon is paid to the bondholders every six months
14 CORE CONCEPTS Maturity Date The maturity date represents the date on which the bond matures, i.e., the date on which the face value is repaid. The last coupon payment is also paid on the maturity date.
15 CORE CONCEPTS Original Maturity The time from when the bond was issued until its maturity date.
16 CORE CONCEPTS Remaining Maturity The time currently remaining until the maturity date.
17 CORE CONCEPTS Call Date For bonds which are callable, i.e., bonds which can be redeemed by the issuer prior to maturity, the call date represents the earliest date at which the bond can be called.
18 CORE CONCEPTS Call Price The amount of money the issuer has to pay to call a callable bond (there is a premium for calling the bond early). When a bond first becomes callable, i.e., on the call date, the call price is often set to equal the face value plus one year's interest
19 CORE CONCEPTS Required Yield / Return The rate of return that investors currently require on a bond.
20 CORE CONCEPTS Yield to Maturity The rate of return that an investor would earn if he bought the bond at its current market price and held it until maturity. Alternatively, it represents the discount rate which equates the discounted value of a bond's future cash flows to its current market price.
21 CORE CONCEPTS Yield to Call The rate of return that an investor would earn if he bought a callable bond at its current market price and held it until the call date given that the bond was called on the call date.
23 BY ISSUER Registered Bond / Bearer Bond Registered bond is a bond whose ownership (and any subsequent purchaser) is recorded by the issuer, or by a transfer agent. It is the alternative to a Bearer bond. Interest payments, and the principal upon maturity, are sent to the registered owner.
24 BY ISSUER Corporate Bond A corporate bond is a bond issued by a corporation. It is a bond that a corporation issues to raise money in order to expand its business.]The term is usually applied to longer-term debt instruments
25 BY ISSUER Government Bond / Sovereign Bond A government bond is a bond issued by a national government. Bonds issued by national governments in the country's own currency are also referred to as soverign bonds.
26 BY ISSUER Municipal Bond Municipal bond is a bond issued by a state, U.S. Territory, city, local government, or their agencies. Interest income received by holders of municipal bonds is often exempt from the federal income tax and from the income tax of the state in which they are issued, although municipal bonds issued for certain purposes may not be tax exempt.
27 BY ISSUER Emerging Market Debt (EMD) is a term used to encompass bonds issued by less developed countries. It does not include borrowing from government, supranational organizations such as the IMF or private sources, though loans that are securitized and issued to the markets would be included
28 BY ISSUERAgency BondAgency debt is a security, usually a bond, issued by a U.S. government-sponsored agency. The offerings of these agencies are backed by the government, but not guaranteed by the government since the agencies are private entities.
29 BY ISSUERLottery BondLottery bond is a bond issued by a state, usually a European state. Interest is paid like a traditional fixed rate bond, but the issuer will redeem randomly selected individual bonds within the issue according to a schedule. Some of these redemptions will be for a higher value than the face value of the bond.
30 BY PAY OFF Callable Bond Some bonds give the issuer the right to repay the bond before the maturity date of the bond. 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, so called call premium.
31 BY PAY OFF Convertible Bond It lets a bondholder exchange a bond to a number of shares of the issuer's common stock.
32 BY PAY OFFFixed Rate Bond Fixed rate bonds have a coupon that remains constant throughout the life of the bond.Exchangeable BondIt allows for exchange to shares of a corporation other than the issuer
33 BY PAY OFF Inflation-Indexed Bond In this bond principal amount and the interest payments are indexed to inflation. The interest rate is normally lower than for fixed rate bonds with a comparable maturity. However, as the principal amount grows, the payments increase with inflation. Treasury Inflation-Protected Securities (TIPS) and I-bonds are examples of inflation linked bonds issued by the U.S. government
34 BY PAY OFF Perpetual Bond Perpetual bonds are also often called perpetuities. They have no maturity date. The most famous of these are the UK Consols, which are also known as Treasury Annuities or Undated Treasuries. Some of these were issued back in 1888 and still trade today, although the amounts are now insignificant.
35 BY PAY OFF Zero-Coupon Bond Zero-coupon bonds pay no regular interest. They are issued at a substantial discount to par value, so that the interest is effectively rolled up to maturity (and usually taxed as such). The bondholder receives the full principal amount on the redemption dateexample of zero coupon bonds is Series E savings bonds issued by the U.S government.
36 BY PAY OFF Asset-backed securities Junk Bonds Asset-backed securities are bonds whose interest and principal payments are backed by underlying cash flows from other assets. Examples of asset-backed securities are mortgage-backed securities (MBS's), collateralized mortgage obligations (CMOs) and collateralized debt obligations (CDOs).Junk BondsThese bonds have a higher risk of default , but typically pay higher yields than better quality bonds in order to make them attractive to investors.
37 BOND ISSUE IN FOREIGN CURRENCY Eurodollar bond (Pakistan also issued them)A U.S. dollar-denominated bond issued by a non-U.S. entity outside the U.S Kangaroo bondAn Australian dollar-denominated bond issued by a non-Australian entity in the Australian marketMaple bondA Canadian dollar-denominated bond issued by a non-Canadian entity in the Canadian market
38 BOND ISSUE IN FOREIGN CURRENCY Samurai bondA Japanese yen-denominated bond issued by a non-Japanese entity in the Japanese marketYankee bondA US dollar-denominated bond issued by a non-US entity in the US market Shogun bondA non-yen-denominated bond issued in Japan by a non-Japanese institution or government
39 BOND ISSUE IN FOREIGN CURRENCY Bulldog bondA pound sterling-denominated bond issued in London by a foreign institution or governmentArirang bondA Korean won-denominated bond issued by a non-Korean entity in the Korean marketKimchi bondA non-Korean won-denominated bond issued by a non-Korean entity in the Korean market
40 BOND ISSUE IN FOREIGN CURRENCY Formosa bondA non-New Taiwan Dollar-denominated bond issued by a non-Taiwan entity in the Taiwan marketPanda bondA Chinese renminbi-denominated bond issued by a non-China entity in the People's Republic of China marketState of Israel bondA bond denominated in multiple currencies issued by the State of Israel through the Development Corporation of Israel
41 BOND OPTIONS Callable bond Convertible bond A callable bond (also called redeemable bond) is a type of bond that allows the issuer of the bond to retain the privilege of redeeming the bond at some point before the bond reaches the date of maturity.Convertible bondIt lets a bondholder exchange a bond to a number of shares of the issuer's common stock.
42 BOND OPTIONS Embedded option Exchangeable bond Embedded options are a part of a financial bond and usually provide an option that is part of the structure in the bond that gives either the bondholder or the issuer the right to take some action against the other partyExchangeable bondIt allows for exchange to shares of a corporation other than the issuer.
43 BOND OPTIONS Option-adjusted spread Puttable bond Option adjusted spread (OAS) is the flat spread over the treasury yield curve required to discount a security payment to match its market price.Puttable bond Puttable bond is a combination of straight bond and embedded put option. The holder of the puttable bond has the right, but not the obligation, to demand early repayment of the principal. The put option is usually exercisable on specified dates.
44 BOND OPTIONSZ-spreadThe Z-spread (or ZSPRD) of a bond is the number of basis points one needs to apply to a series of zero rates such that the present value of the bond, accounting for accrued interest, equals the sum of all future cash flows discounted using the adjusted zero rate.
45 DIFFERENCE BETWEEN BONDS AND STOCKS Type of ownershipMaturity
46 DIFFERENCE BETWEEN BONDS AND STOCKS Bonds and stocks are both securities, but the major difference between the two is that stockholders have an equity stake in the company (i.e., they are owners), whereas bondholders have a creditor stake in the company (i.e., they are lenders).
47 DIFFERENCE BETWEEN BONDS AND STOCKS Bonds usually have a defined term, or maturity, after which the bond is redeemed, whereas stocks may be outstanding indefinitely. An exception is a consol bond, which is a perpetuity (i.e., bond with no maturity)
48 DIFFERENCE BETWEEN BONDS, BILLS AND NOTES All of these are marketable securities that are sold in order to pay off maturing debt , but we can differentiate on the basis of following:
49 DIFFERENCE BETWEEN BONDS, BILLS AND NOTES Payment of interestT-bills (Do Not Pay Interest Before Maturity)Notes (Till Maturity)Bonds (Till Maturity)
50 DIFFERENCE BETWEEN BONDS, BILLS AND NOTES Terms to maturityT-bills (less than one year)Notes (2,3,5 or 10-year terms)Bonds are long-term investments with terms of more than 10 years.
51 HOW BOND WORKSVery few investors hold bonds until maturity and instead trade them like shares. So, although they have a fixed price when they are issued, demand from investors can push the price above and below this level. This effectively increases or decreases the income you earn.
52 HOW BOND WORKSFor example, a company agrees to pay bondholders a set amount of Rs.100 on a Rs1000 bond, the yield on that bond is 10%. If the bond is then traded in the open market and is sold for Rs.1100, the income is still Rs.100 but the yield has dropped to 9%. If, however, demand for the bond is low and the price falls to Rs.900, the yield rises to 11%
53 PROCESS OF ISSUING BONDS The most common process of issuing bonds is through underwriting. In underwriting, one or more securities firms or banks, forming a syndicate, buy an entire issue of bonds from an issuer and re-sell them to investors. The security firm takes the risk of being unable to sell on the issue to end investors. However government bonds are instead typically auctioned.
54 WHAT INFLUENCES BOND PRICES Bond prices are influenced by the followingfactors:The yield they payThe rate of interest investors can earn elsewhere
55 WHAT INFLUENCES BOND PRICES Strength of the Individual CompanyFuture DemandCompany’s Rating
56 WHAT INFLUENCES BOND PRICES PACRA STANDARD RATING LONG TERM SHORT TERM AAA, AA, A A1+, A1, A2, A3 BBB, BB, B B CCC, CC, C C D
57 WHAT INFLUENCES BOND PRICES Economic ConditionsEconomic instabilityInflationAnticipating InterestHigh interest rates on savings accounts
58 RELATIONSHIP BETWEEN REQUIRED YIELD AND PRICE This is the basis for understanding, valuing andmanaging bonds.Inverse relationshipThe price and yield of bond are inversely related
59 RELATIONSHIP BETWEEN REQUIRED YIELD AND PRICE Inverse price/yield relationship
60 RELATIONSHIP BETWEEN REQUIRED YIELD AND PRICE When the coupon rate = the required yield price = par value.When the coupon rate < the required yield price < par value.
61 RELATIONSHIP BETWEEN REQUIRED YIELD AND PRICE When the coupon rate > the required yield price > par value.At maturity price = par value.
62 BUYING BONDS IN PAKISTAN GOVERNMENT BONDS (Issued by SBP)PIBFIBT-BILLS
63 BUYING BONDS IN PAKISTAN CORPORATE BOND(Issued by stock broker)IJARAHTFCSKUCKDIMINISHING MUSHARIKA
64 DETERMINATION OF BOND PRICES A bond’s price equals the sum of the presentvalues (PV) of all future cash flowsCouponPrincipalDiscounted at the required yield
65 NUMERICAL BOND VALUATION: Q :Callaghan motors bond have 10 years remaining to maturity .Interest is paid annually, bond have a $1000 par value and the coupon interest rate is 8%. Bond have a yield to maturity of 9%.What is current market price of these bonds?
67 NUMERICAL Formula Terms: INT=Dollar Of Interest Paid Each Year Coupon rate × Par valuerd = Bond market rate of interest / Discount rateN = Number of year before the bond maturesM = Par or maturity value of bond
68 NUMERICALQ: A 10 year,12% semiannual coupon bond, with par value of $ 1000 may be called in 4 years at call price of $1060.The bonds sell for $1100. a: What is bond yield to maturity? b: What is bond current yield? c: What is bond’s capital gain or loss yield? d: What is bond’s yield to call?
69 NUMERICAL b: Bond current yield: Formulae a: Yield to maturity: c: Bond’s capital gain or loss yield:Total Yield- current yield
70 RISK ASSOCIATED WITH INVESTING IN BONDS Interest rate riskDurationReinvestment rate riskCall riskCredit riskUnexpected inflation riskLiquidity risk
71 CURRENT MARKET SITUATION Currently in Pakistan two new funds arelaunched namely:NIT Government Bond Fund (NIT-GBF)NIT Income Fund (NIT-IF)
72 CURRENT MARKET SITUATION These two funds are launched by NIT and theyare not bond funds rather they areincome/money market funds. However moneyraised by these funds is being invested in thetrading of the government bond.