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BISMILLAH ASSALAM-O-ALIKUM and a very warm welcome to all of you.

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Presentation on theme: "BISMILLAH ASSALAM-O-ALIKUM and a very warm welcome to all of you."— Presentation transcript:

1 BISMILLAH ASSALAM-O-ALIKUM and a very warm welcome to all of you

2 GROUP MEMBERS SARAH SHEIKH FAIZA FARHAT SHAMS-UN-NISA SAFIA NIAZ SAMRA KHALID AQSEEM ANJUM MBA 16

3 BOND VALUATION

4 FOCAL POINTS DEFINITION OF BOND CORE CONCEPTS TYPES FOREIGN CURRENCY BONDS

5 FOCAL POINTS BOND OPTIONS BOND & STOCK BONDS, BILLS & NOTES HOW BOND WORKS

6 FOCAL POINTS FACTORS AFFECTING PRICES BUYING BOND IN PAKISTAN DETERMINING BOND PRICES

7 FOCAL POINTS NUMERICAL RISK ASSOCIATED WITH BOND CURRENT MARKET SITUATION

8 BOND A promised stream of CFs. A bond is a formal contract to repay borrowed money with interest at fixed intervals.

9 BOND Bonds are debt instruments yielding a rate of return over a set period of time that can be traded in the market like any other security. (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 owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest (the coupon) and/or to repay the principal at a later date, 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.

22 TYPES By Issuer By Pay Off

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 ISSUER Agency Bond Agency 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 ISSUER Lottery Bond Lottery 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 OFF Fixed Rate Bond Fixed rate bonds have a coupon that remains constant throughout the life of the bond. Exchangeable Bond It 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 date example of zero coupon bonds is Series E savings bonds issued by the U.S government.

36 BY PAY OFF Asset-backed securities 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 Bonds These 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 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 non- Canadian entity in the Canadian market

38 BOND ISSUE IN FOREIGN CURRENCY Samurai bond A Japanese yen-denominated bond issued by a non- Japanese 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 non- Japanese institution or government

39 BOND ISSUE IN FOREIGN CURRENCY Bulldog bond A pound sterling-denominated bond issued in London by a foreign institution or government Arirang bond A Korean won-denominated bond issued by a non- Korean entity in the Korean market Kimchi bond A non-Korean won-denominated bond issued by a non- Korean entity in the Korean market

40 BOND ISSUE IN FOREIGN CURRENCY Formosa bond A non-New Taiwan Dollar-denominated bond issued by a non-Taiwan 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 State of Israel bond A bond denominated in multiple currencies issued by the State of Israel through the Development Corporation of Israel

41 BOND OPTIONS Callable 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 bond It lets a bondholder exchange a bond to a number of shares of the issuer's common stock.

42 BOND OPTIONS Embedded option 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 party Exchangeable bond It allows for exchange to shares of a corporation other than the issuer.

43 BOND OPTIONS Option-adjusted spread 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 OPTIONS Z-spread The 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 ownership Maturity

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 interest T-bills (Do Not Pay Interest Before Maturity) Notes (Till Maturity) Bonds (Till Maturity)

50 DIFFERENCE BETWEEN BONDS, BILLS AND NOTES Terms to maturity T-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 WORKS Very 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 WORKS For 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 following factors: The yield they pay The rate of interest investors can earn elsewhere

55 WHAT INFLUENCES BOND PRICES Strength of the Individual Company Future Demand Company’s Rating

56 WHAT INFLUENCES BOND PRICES PACRA STANDARD RATING LONG TERMSHORT TERM AAA, AA, AA1+, A1, A2, A3 BBB, BB, BB CCC, CC, CC D

57 WHAT INFLUENCES BOND PRICES Economic Conditions Economic instability Inflation Anticipating Interest High interest rates on savings accounts

58 RELATIONSHIP BETWEEN REQUIRED YIELD AND PRICE This is the basis for understanding, valuing and managing bonds. Inverse relationship The 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) PIB FIB T-BILLS

63 BUYING BONDS IN PAKISTAN CORPORATE BOND(Issued by stock broker) IJARAH TFC SKUCK DIMINISHING MUSHARIKA

64 DETERMINATION OF BOND PRICES A bond’s price equals the sum of the present values (PV) of all future cash flows Coupon Principal Discounted 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?

66 NUMERICAL Formula

67 NUMERICAL Formula Terms: INT=Dollar Of Interest Paid Each Year Coupon rate × Par value r d = Bond market rate of interest / Discount rate N = Number of year before the bond matures M = Par or maturity value of bond

68 NUMERICAL Q: 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 Formulae a: Yield to maturity: b: Bond current yield: c: Bond’s capital gain or loss yield: Total Yield- current yield

70 RISK ASSOCIATED WITH INVESTING IN BONDS Interest rate risk Duration Reinvestment rate risk Call risk Credit risk Unexpected inflation risk Liquidity risk

71 CURRENT MARKET SITUATION Currently in Pakistan two new funds are launched namely: NIT Government Bond Fund (NIT-GBF) NIT Income Fund (NIT-IF)

72 CURRENT MARKET SITUATION These two funds are launched by NIT and they are not bond funds rather they are income/money market funds. However money raised by these funds is being invested in the trading of the government bond.

73 THANK YOU TEACHER’S COMMENT


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