Introduction to Bond Market

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1

Introduction to Bond Market

21st

& 24th

Dec 2007

Presented by

Capt (R) Georgy Gan



2

What is a Bond Market?

•

The bond market (also known as the debt, credit, or fixedincome 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 45trillion.

•

Malaysian bond market is an estimated RM 75.8 (USD22) billion.



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4

•

The bond market provide another avenue for

governments or corporations to raise capital.

• Essentially, bonds are debts or loans and when abond is issued,

•

it means the issuer (government or corporation) is

borrowing a specified amount of money from theinvestor for a specified period of time.



5

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 uponmaturity of the contract.



6

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 Governmentknown as Malaysian Government Securities (MGS).



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Bond Issuer

2.

Bonds issued by private entities or companies:

•

Purpose to help finance their ongoing businessactivities.

•

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 theamount of tax on the company profits)



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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 pledgeson specific assets.

•

it is however, secured by all properties not otherwise pledged.•

In the case of bankruptcy debenture holders are consideredgeneral creditors.

•

The advantage of debentures to the issuer is they leave specificassets burden free, and thereby leave them open for subsequentfinancing,•

an alternative instrument to issue of equity or preferenceshares.



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Bond Issuer

b.

Convertible Bond

– type of bond that can be converted into shares of stock

of the issuing company, usually at some pre-

announced ratio.

– the key benefit of raising money by selling convertiblebonds is a reduced cash interest

payment.

–

However, in exchange for the benefit of reduced

interest payments, the value of shareholder's equity isreduced due to the stock dilution

expected when

bondholders convert their bonds

into new shares

.



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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.



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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.

2.

Produce Capital Gains –

•

Sold prior its maturity at more than purchase price

•

Held to maturity



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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 onthe 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.



13

Why Invest in Bonds?

•

Most financial planners and fund managers view bonds as beingless 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 thebonds.

•

Bonds issued by stable governments of economically strongcountries are considered the least risky.

•

In general,

1.

it is in a nation’s 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.



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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 fromstrength 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.



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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 .



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How a Bond Traded?

1.

Primary Market:

•

When the issuer (government or corporations or institutions) first offers new issues, that first trading isdone 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 bondscome directly to the issuer.



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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 thathave acquired the bonds, which are now able to sell off the bonds before thematurity date, should they wish to do so.

•

The trading of bonds in the secondary market creates a market pricing of thebonds that depends on

•

the supply and demand of the bonds, and

•

prevailing interest rates, among other factors.



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•

The secondary market plays an important role because:

1. Investors purchasing bonds at the primary market knowthere is an avenue to sell-off their bonds.

2.

The secondary markets provide a gauge for issuers to

price their primary issues.



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THE DIFFERENCE BETWEEN INVESTING IN BONDS AND INVESTINGIN SHARES?

•

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

•

Advantages

•

Investor receives periodicfixed interest income,irrespective of whether the

company issuing the bondsis doing well or not.

•

Bondholders have a prior right over ordinaryshareholders on distributionof earnings and on claims inthe event of bankruptcy.

•

Disadvantages

•

As the income (coupons) derivedfrom bonds is fixed, the investor does not get paid more even if business is booming as in the caseof ordinary shareholders who maybe given higher dividends.

•

Bondholders have no voting rights

and are not owners of the companywhile shareholders have a right tovote at general meetings.



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Features of Bond



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Basic Types of Bonds

Irredeemable Redeemable

Zero Coupon Coupon Paying



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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 anissue of Innovative Perpetual Debt Instrument bond series IIwith a view to increasing Tier I capital. The issue will carry a

coupon of 10.45 per cent per annum with a step-up couponrate of 10.95 per cent for all the subsequent years if the calloption is not exercised at the end of 10th year from the deemeddate of allotment, said a press release from the bank.

•

Converted into another form of security



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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



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b.

Par Value

•

The amount that the borrower promises to pay before the end of the term tomaturity.

•

Known as principal, redemption value, face value & maturity value.

c.

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 beeven more exotic.

•

The name coupon originates from the fact that in the past, physicalbonds were issued which had coupons attached to them.

•

On coupon dates the bond holder would give the coupon to a bank inexchange for the interest payment.



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•

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 havecoupons 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.



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d.

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 couponevery six months.

•

In Europe, most bonds are annual and pay only one coupon a year.

e.

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.



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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 loanagreement 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 certainassets as collateral.

•

Likewise, the borrower may be required to issue reports to bondholders oncertain 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 areoutstanding, with amendments to the governing document generally

requiring

approval by a majority (or super-majority) vote of the bond holders.



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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 thematurity 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 socalled call premium.

•

This is mainly the case for high-yield bonds.

•

These have very strict covenants, restricting the issuer in itsoperations.

•

To be free from these covenants, the issuer can repay thebonds early, but only at a high cost.



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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 coupondates.

b.

A European callable has only one call date. This is a special case of aBermudan 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 allowingthe beneficiary of the estate of the deceased to put (sell) the bond (back to theissuer) in the event of the beneficiary's death or legal incapacitation. Alsoknown as a "survivor's option".



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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 totrustees.



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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 andunder prescribed conditions.

•

An exchangeable bond is different from a convertible bond.

• A convertible bond gives the holder the option to convert bondinto shares of the issuer.



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Types of InternationalBond Market



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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 predeterminedinterest rate.

•

The interest rate is known as coupon rate

and interest is payable at

specified dates before bond maturity.



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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 examplesdo 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%.



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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 makethem attractive to investors.



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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 MassachusettsBay 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 internationaldebt market.

•

The market primarily consists of sovereign debt, with privately issuedinflation-linked bonds constituting a small portion of the market.



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5. Asset Backed Security is a bond

or note

•

that is based on pools of assets, or collateralized by the cash flowsfrom a specified pool of underlying assets.

•

Assets are pooled to make otherwise minor and uneconomicalinvestments 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 andmovie revenues.

•

Typically, the securitized assets might be highly illiquid and private innature.



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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 arepaid.

•

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 bondsissued by banks, and asset-backed securities..



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7. Bearer bond

•

is an official certificate issued without a named holder.

• The person who has the paper certificate can claim the value of thebond.

•

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.



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8. Bear bond•

is a bond issued in Russian roubles

by a Russian entity in the Russian

market.

9. 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 abonus.

•

A small number of bonds are redeemed for an amount greater than theirface value.

•

Hence the holder of that particular bond will have won the ‘lottery’.

Bonds Issued by Foreign Entities



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•

Issuing bonds denominated in foreign currencies also gives issuers the ability toaccess investment capital available in foreign markets.

• The proceeds from the issuance of these bonds can be used by companies1.

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.



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•

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 anon-Australian entity in the Australian market

• Maple bond, a Canadian Dollar-denominated bond issued by a non- Canadian entity in the Canadian market•

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-USentity in the US market

•

Shogun bond, a non-yen-denominated bond issued in Japan by a non-

Japanese institution or government



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•

Bulldog bond, a pound sterling-denominated bond issued in London by aforeign institution or government

• Matrioshka Bond, a Russian rouble-denominated bond issued in the RussianFederation 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 non-

Taiwan entity in the Taiwan market•

Panda bond, a Chinese renminbi-denominated bond issued by a non-Chinaentity in the People's Republic of China market.

Capital MarketMaster Plan Malaysia



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Master Plan - Malaysia

1. Begins in year 2001, 10 years plan strategicpositioning and future direction of Malaysian capital

2. As an integral part and indicator of nationdevelopment

3. Represent vital part of financial marketinfrastructure

4. The success of M’sian Capital Market contributesto the overall strength of the economy



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Objectives

Strategic Initiatives



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1. To be preferred Fund Raising Centre for Malaysian Companies

•

Enhance the efficiency of the fund raising process

• Implement a comprehensive programme to develop thecorporate 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 tradingof securities

2. To promote an effective investment management industry and a more conduciveenvironment



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environmentfor investors

•

Develop a strong framework for corporate governance and shareholder valuerecognition

•

Heighten efforts to establish a vibrant and competitive investment managementindustry

•

Enhance the role of institutional investors in the provision and

management of

funds•

Facilitate effective risk management by actively developing the derivativesmarket

•

Facilitate the introduction of a broad range of capital market products catering tovarious risk-return profiles

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



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•

Restructure M’sian

exchanges and clearing institutions to strengthen their

efficiency and competitiveness•

Ensure M’sian

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

4. To develop a strong and competitive environment for intermediation services



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•

Foster constructive competition through regulation of services, productsand fixed fee structure

• Develop strong full-service brokers to provide a competitive market for integrated financial services

•

Ensure M’sian

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

5. To ensure stronger and more facilitative regulatory regime



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•

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

6. To establish Malaysia as an International Islamic Capital Market Centre



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•

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, taxand regulatory framework for the Islamic capital market

•

Enhance the value of recognition of the Malaysian Islamic capital marketinternationally

Implementation ofCapital Market Master Plan



52

Capital Market Master Plan

Phase 1 (2001–03) Phase 2 (2004–05) Phase 3 (2006–10)

Strengthen domesticcapacity, and developstrategic and nascent

sectors

Further strengthen keysectors and gradually

liberalise

market access

Further expansion and

strengthening of marketprocesses and infrastructure

towards becoming a fully

developed capital market, andenhancing internationalpositioning in areas of

comparative and competitive

advantage

Sources: The Securities Commission.



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Malaysia Bond Market



54

• The main function of Malaysia bond market is to bethe mediator between investors and depositors.

• In Malaysia, the Ringgit bond market includes Governmentsecurities and personal debt securities.•

Are geared towards developing the capital market tocomplement 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 aconcomitant broadening and deepening of the capital

market as an efficient and reliable source of funding for private sector activity.



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Strategic developmental initiativesfor the Malaysian bond market



56

for the Malaysian bond market

Strategy Initiatives

1.

Introducing an efficient andfacilitative issuance process

•

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

Strategic developmental initiatives



57

g p



2.

Establishing a reliable andefficient benchmark yield

•

Introduction of an auction calendar for Malaysian Government Securities(MGS) -2000

• Review of the principal dealers system




58

g p



3.

Widening the issuer and

investor base

•

Broadening of the investor base under the

Securities Commission Act for the OTC market•

Universal Brokers are allowed to trade in theOTC 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-neutralframework -

2003, 2005




59



3.

Widening the issuer and investor

base

•

Multilateral development banks, multilateral

financial institutions and multinationalcorporations are allowed to raise ringgit-

denominated bonds -

2004

•

Removal of withholding taxes on interest incomeearned on investments by nonresident

companies in ringgit-denominated Islamicsecurities and securities issued by theMalaysian Government -

2004

Strategic developmental initiativesfor the Malaysian bond market



60



4.

Improving liquidity Ain

the secondary

market•

Non-financial institutions are allowed to enter into repurchase transactions -

2000

•

The Securities Borrowing and LendingProgramme

is introduced via the RENTAS

system -

2001

•

Institutional Securities Custodian Programme

(ISCAP) is put in place to encourage institutionalinvestors to lend securities to BNM -

2004



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5.

Facilitating the introduction of riskmanagement instruments

•

Introduction of three-, five-

and 10-year MGS

futures -

2002, 2003

•

Introduction of Guidelines on Regulated Short-

selling of Securities -

2005

Sources: Bank Negara Malaysia; Securities Commission.



62



63



64

Regulatory Authorities



65

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 depositsexcept under and in accordance with a valid licence.

•

As the issuance of bonds is deemed to be "deposit taking", theapproval 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 liquidityand 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-termprojects, without causing an inflationary pressure in line with themacro economic objectives.

•

Effective 1 July 2000, the approving authority for private debtsecurities has been transferred from BNM to the SC.



66

2. Securities Commission (SC)

The SC was established on 1 March 1993pursuant to the Securities Commission Act1993 with the power to regulate the issue of and the dealings in securities, to encourage thedevelopment of the securities market and to

curb improper dealings.•

The SC also regulates all matters pertaining to unittrusts, and take-overs

and mergers.

•

Prior to the establishment of the SC, the power toregulate the issue of new securities was vested withthe Capital Issues Committee while all matterspertaining to take-overs

and mergers were vested

with the Panel on Take-overs

and Mergers.

• Both the CIC and the Panel were dissolved upon theestablishment of the SC.



67

3. Registrar of Companies (ROC)

The ROC under the Ministry of Domestic Tradeand Consumer Affairs, has extensive powersunder the Companies Act 1965 which lays down

the statutory requirements and policies ondisclosure of information.•

In general, an invitation to the public to depositmoney or lend money to a corporation must beaccompanied by a prospectus.

•

The Act also further requires that the prospectus beregistered with the ROC and contains an undertaking

that the corporation will, after the acceptance of anymoney or deposit or loan, issue to that person a



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•

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 theMinister 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 whosetotal 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 respectof all private debt securities other than securities issued by unlisted recreational clubs.The Registrar of Companies is responsible for the lodgement

of prospectuses.

MARKET PLAYERS



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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

Bond Risk



70

•

Inflation Risk

• Market Risk

•

Currency Risk

• Political risk

• Credit Risk

• Liquidity Risk

•

Maturity Risk

• Reinvestment Risk

•

Call Risk

• Price volatility

• Interest Rate Risk

HOW ARE BONDS RATED?



71

HOW ARE BONDS RATED?

• How do you know if an issuer is likely or not likely to default inpaying back your principal or in delivering on the agreedperiodic coupon payments?

Rating Agencies,



72

•

independent of corporations issuing bonds, that analyses and provides a ratingscale on bonds issued in the market.

•

Credit analysis for bonds

•

is focused almost exclusively on the chance that the bondholder will notreceive the scheduled interest payments or principal at maturity.

• This is known as the default risk.•

A borrower’s ability to repay or credit worthiness is an important criterion to thelender or bond purchaser.



73

•

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.

Rating Agencies in Malaysia



74

Rating Agencies in Malaysia

1.

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 ratingsprovided by such independent agencies in gauging the creditworthiness of bonds.

RAM Bond Rating



75

Long-Term RatingsRATING 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 andprincipal than debts in higher-rated categories.

•

BB

-

Inadequate safety for timely payment of interest and principal. Future cannot be considered as well-

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. Timelypayment 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 default,

whether or not formally declared.

Short-Term RatingsRATING 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 P2categories.

•

NP -

High investment risk, with doubtful capacity for timely payment of short-term obligations

MARC Bond Rating



76

RATING DEFINITION

Investment Grade•

AAA

-

indicates that the ability to repay principal and pay interest on timelybasis 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 thehighest 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 significantuncertainties that could affect ability to adequately service debt obligations

•

B

-

indicates higher degree of uncertainty, and therefore, greater likelihoodof 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

HOW DO I INVEST IN BONDS?



77

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 SecuritiesCommission are collective investment schemes that pool money frommany 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.



78

•

The general bond funds usually invest in the medium to long-term fixedincome instruments while money market funds and short-term bondfunds invest in short-term money market instruments.

•

Islamic bond funds would deal only with bonds issued by companiesapproved 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 fixedincome instruments are also traded on the money market), which acts

as an intermediary for individual institutions seeking short-term creditand those with surplus cash to lend.



79

• Banks and financial institutions issue moneymarket instruments such as Negotiable Instrument

of Deposit (NID) and Bankers Acceptance (BA),while the government issues money marketinstruments 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 Malaysianbond market continues to grow.

WHAT ARE THE DIFFERENT TYPES OF BONDS?



80

• Bonds are also classified according to the typeof 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 debtsecurities or Islamic bonds.



81

GOVERNMENT BONDS



82

•

Government bonds being traded are:

•

Government Investment Issues (GII)

•

Malaysian Government Securities (MGS).

• There are also short-term money market instrumentsissued by the government such as:

•

Bank Negara Malaysia Bills (BNB)

•

Malaysian Government Treasury Bills (MTB).



83

Conventional Instrument

Malaysian Government Securities(MGS)



84

•

MGS are gilt-edged securities because they are borrowings of thegovernment.

•

issued for the financing of long-term development projects by thegovernment.

•

issued by auction and by subscription but they can also be bought inthe secondary market or from Bank Negara Malaysia.

• The price of government bonds is influenced by Bank NegaraMalaysia’s 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 semi-

annually.



85

•

Beginning December 2006, BNM has also introduced Callable MGS whichprovides the Government of Malaysia with the option to redeem the issue atpar 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 BankNegara Malaysia on behalf of the Government.

•

The successful bidders are determined according to the lowest yields offeredand 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 dependingon Government financing requirement.



86

• The Government is committed to continuously issue 3-year, 5-year and10-year MGS as benchmark securities as part of its efforts to developthe 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 yieldcurve.

•

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 aprice basis to two decimal points.

• Neither stamp duty nor commissions are paid on the transfer of thesecurities.

•

For transactions via money brokers, brokerage fee is payable.

Bank Negara Monetary Notes (BNMN)



87

•

BNMN are securities issued by Bank Negara Malaysia replacing theexisting Bank Negara Bills (BNB):

•

purposes of managing liquidity in the conventional financial market.

•

The maturity of these issuances has been lengthened from one year tothree years.

•

New issuances of BNMN may be issued either on a discounted or acoupon-bearing basis depending on investors' demand.

•

Discount-based BNMN will be traded using the same marketconvention as the existing BNB and Malaysian Treasury Bills (MTB)while the coupon-based BNMN will adopt the market convention of Malaysian Government Securities (MGS).

Malaysian Treasury Bills (MTB)



88

•

MTB are short-term securities issued by the Government of Malaysia to raiseshort-term funds for Government's working capital.•

Bills are sold at discount through competitive auction, facilitated by BankNegara 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 competitiveyield offered.

•

Normal auction day is Thursday and the result of successful bidders will beannounced 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.

M di T N t (MTN )



89

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.

Kh h B d



90

Khazanah Bonds

• Issued by Khazanah National Berhad (an

investment holding arm of the Government of Malaysia) and guaranteed by the Government.



91

Islamic Instrument

Government Investment Issues (GII)



92

•

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 IslamMalaysia 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 asemi-annual basis.

•

GII is long-term non-interest-bearing Government securities based on Islamicprinciples issued by the Government of Malaysia for funding developmentalexpenditure.

•

Similar with MGS, GII is issued through competitive auction by Bank Negara

Malaysia on behalf of the Government.

Similar with MGS GII is issued through competitive auction by Bank



93

•

Similar with MGS, GII is issued through competitive auction by BankNegara 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 itsnominal value plus profit through a tender process.•

Profit rate is based on the weighted average yield of thesuccessful 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.



94

• The obligation of the Government to settle thepurchase 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 theGII holders.

•

GII is one of the financial instruments that are

actively traded in the Islamic Interbank MoneyMarket.

Bank Negara Monetary Notes–i(BNMN-i)

• BNMN-i are Islamic securities issued by Bank Negara Malaysia replacing



95

•

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 oneyear 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 marketconvention 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).

Malaysian Islamic Treasury Bills (MITB)



96

•

MITB are short-term securities issued by the Government of Malaysia based onIslamic 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 beannounced 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 buyback concept.•

Bank Negara Malaysia on behalf of the Government will sell the identifiedGovernment's assets on competitive tender basis, to form the underlyingtransaction of the deal.

• Allotment is based on highest price tendered (or lowest yield).



97

•

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 debtcreated.

•

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 tradedbased on Bai

ad-Dayn

(debt trading) principle in the secondary market.

Sukuk Bank Negara Malaysia Ijarah (SBNMI)



98

•

SBNMI is issued

• based on the Al-Ijarah or ‘sale and leaseback’ concept, a structure that is widely

used in the Middle East.• A special purpose vehicle (SPV) has been

established to issue the sukuk

Ijarah.

Merdeka Savings Bonds



99

• bond structure based on Shariah principleswith the purpose of providing assistance toretirees who depend primarily on interest

income from deposits placed with the bankinginstitutions.

Medium-Term Notes (MTNs)



100

• MTNs are instruments with tenor of • more than one year but up to 5 years, and may beissued based on conventional or Islamic principle.

• The mode of issue for MTNs can either be ondirect placement and/or by way of tender.

Comparison between Conventional and Islamic Government Securities



101

•

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 interms of their

•

effective cash flows, issuance structure, legal status in being a direct obligationof the Government, its holdings and nature of transaction as financial products.

Features MGS (Conventional) MTB (Conventional) GII (Islamic) MITB (Islamic)

Issuer Government of Malaysia Government of Malaysia Government of Malaysia Government of Malaysia



102

Tenor 3 to 20 years 91, 182 and 365 days 3 to 10 years 273 and 365 days

Issue size

(RM million)

500 to 3,500 80 to 110 1,000 to 3,500 100 to 200

Return payment (interest /profit)

Interest payment is semi-

annual. Coupon rate ismarket-determined base onthe weighted averagesuccessfull

yield of theissue. Day count basis is Actual / Actual.

Bills are issued on discountbasis

Zero coupon GII) Bonds areissued on discount basis

(Profit based GII) Profitpayment is semi-annual.Profit rate is marketdetermined based on theweighted average

successful yield of theissue. Day count basis is Actual / Actual.

Bills are issued on discountbasis

Method of sale in primarymarket

Offered periodically viacompetitive multiple-priceauction to Principal Dealers

on a yield basis for newissues and price basis onreopened basis, or issuedthrough private placement toselected institutions

By competitive multiple-

price auction on a yieldbasis

Competitive multiple-pricetenders are submited

byIslamic bank or Principal

Dealers with Islamic finance operations and are on ayield basis

By competitive multiple-

price auction on a yieldbasis

Features MGS (Conventional) MTB (Conventional) GII (Islamic) MITB (Islamic)Issuer Government of Government of Government of Government of



103

Issuer Government of Malaysia

Government of Malaysia



Tenor 3 to 20 years 91, 182 and 365 days 3 to 10 years 273 and 365 days

Issue size(RM million)

500 to 3,500 80 to 110 1,000 to 3,500 100 to 200

Redemption Offered periodically viacompetitive multiple-

price auction toPrincipal Dealers on a

yield basis for newissues and price basison reopened basis, or issued through privateplacement to selectedinstitutions

By competitivemultiple-price auctionon a yield basis

Competitive multiple-

price tenders aresubmited

by Islamic

bank or Principal

Dealers with Islamic finance operations andare on a yield basis

By competitivemultiple-price auctionon a yield basis

Taxation Bonds are exemptedfrom withholding tax.No capital gain tax.

Bonds are exemptedfrom withholding tax.No capital gain tax.



Secondary Markettrading

Over-the-counter Over-the-counter Over-the-counter Over-the-counter

Cagamas

Instruments

• Floating Rate Bonds



104

•

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 interestis 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.

CORPORATE BONDS

H l f th t f t b d



105

•

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



106

Straight bonds

• Straight bonds are as the name suggests bonds as simple as they can



107

Straight bonds are, as the name suggests, bonds as simple as they canbe,

•

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.

Convertible bonds

• give the holders a right to convert the bonds to a number of the issuer’s



108

•

give the holders a right to convert the bonds to a number of the

issuer s

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 conversionprice to its existing share price.

• The investor also benefits because if the company performs well its



109

The investor also benefits because if the company performs well,

its

shares can be bought (through conversion) at what may prove to be afavourable

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 nowa shareholder will benefit from payments of dividends and any future

increase in the share prices.

Bonds with warrants

• Bonds issued with detachable warrants are common in Malaysia.



110

y

•

The issuer offers the entire issue of bonds with warrants at face value to aprimary subscriber.

• The primary subscriber subsequently detaches the warrants and sells them toshareholders 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 yieldthe rate of return required by investors in the secondary market.

• A warrant gives the holder the option to purchase a specified number



111

g p p p

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 areexercised, money is again raised in purchasing the shares at the

preset price.

Floating-rate bonds



112

• The coupon rate of a floating-rate bond isinstead pegged to an agreed benchmark, suchas

• the KLIBOR (Kuala Lumpur Interbank OfferedRate) and as this reference rises and falls, thefloating rate also moves accordingly.

Mortgage bonds



113

• Mortgage bonds require the issuer to pledgecertain 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 areunusual.

Islamic bonds



114

• Islamic bonds are structured according to theIslamic principle of deferred payment sale,and require the endorsement of the

• Syariah• Advisory Council of the Securities Commission.

Secured and unsecured bonds



115

•

The debt payments of secured bonds are secured by a pledge of theissuer’s assets, typically shares, a building or land.

• In the event of a default, the investors would have a claim on thepledged assets.

•

Conversely, unsecured loans are bonds not backed by any collateral.

• In the event of a default, the bondholders would have a general claimon the issuing company.•

Due to its higher risk factor, unsecured loans offer higher interest ratesthan secured bonds.

Guaranteed bonds



116

• Guaranteed bonds are guaranteed for full debtrepayment by a guarantor, which could be theparent 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.



117

WHAT ARE THE COMMON TERMS USED IN ASSOCIATION WITH BONDS?



118

•

The following characteristics and terms are always associated with bondsand 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

Nominal value

• The nominal value of a bond is the par or face



119

The nominal value of a bond is the par or facevalue 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.

Coupon rate

• The coupon rate is the amount of interest the



120

•

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.

Term-to-maturity



121

•

This is the number of years over which the issuer of the bond haspromised to meet the conditions and obligations of the bond issue.

•

During this time, the bondholder is paid the promised couponpayments and it also indicates the time period remaining before thebondholder is paid back the principal.

•

The term-to-maturity also affects the bond yield and the bond price.

Trust deed



122

•

A trust deed is the legal agreement detailingthe issuer’s obligations related to the bondissue.

• It contains the terms of the bond issue and anyrestrictive provisions placed on the company, suchas 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.

Trustee

• The trustee is the third party with whom the trust deed isd



123

made.

• The job of the trustee is to see that the terms andconditions 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 theinterests of the bondholders in the event of a default.

Types of issuer



124

• 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.

Yield



125

•

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, theyield is the discount rate or interest rate that an investor wants from investingin 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.

Call provision



126

•

A call provision entitles the issuer to

repurchase or “call” the bond form their holders at a stated price within a

predetermined period.

Sinking fund



127

• 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 bondtrust deed to protect investors.

How RM Bonds are



128

How RM Bonds are

Traded?

• When the issuer first offers new issues, that first trading is done in the primary market,



129

, g p y ,

•

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 amongother investors.

•

The secondary market provides to the bond holders should they wish to sell thebonds before the maturity date.

•

The trading of bonds in the secondary market creates a market pricing of thebonds that depends on the supply and demand of the bonds, and the prevailinginterest rates, among other factors.

•

When the market price of the bond is less than its par value, the bond is beingsold at a discount.

•

When the market price of the bond is more than its par value, the bond is sold at a

premium.

Primary Bond Market

• BNM issues Malaysian Government Securities (MGS) via auction processthrough Principal Dealers (PDs).



130

•

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 REUTERSand Bloomberg.

•

PDs

submit bids via Fully Automated System for Issuing/Tendering

(FAST) by 11.30am 1 day before issue date. BNM processes and confirmstender 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.



131

• Method Of Issuance



132

• The two methods of issuance adopted in

the primary market of Government

securities in Malaysia are1.

market auction and

2. private placement.

Primary Investor

• Securities auctions are open to all investors, but all bidders are to submit bidsthrough PDs.



133

•

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.

Secondary Bond Market

•

Deal reporting and dissemination of information is captured in BondInformation Dissemination System (BIDS).



134

•

Seller initiates trade reporting in Bond Information and Dissemination

System (BIDS) and buyer confirms trades. Once confirmed, thetransaction becomes latest deal done in Bond Information andDissemination 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 TimeElectronic Transfer of Funds and Securities (RENTAS) via DvP

process.

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



135

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 themost 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 providecontinuous 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-wayprices in the Bond Information and Dissemination System (BIDS) system.

•

All trading done via the OTC market must be captured on Bond Information andDissemination System (BIDS) system where the sellers of securities will key in thedeal and buyers will confirm within a stipulated 10 minutes cut-off time from tradeexecution.

• Normal business hours for a regular government securities trade is for standardsettlement or value spot i.e. 2 business days (T+2) settlement, from 9.00 a.m. to4.30 p.m. from Monday to Friday excluding holidays.

• Government securities can also be traded on value today, value tomorrow or value



136

y,

forward.

• All Government securities trades are settled based on a delivery versuspayment (DvP) basis although free-of-payment settlement (FoP) is availablewhere 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 inthe Real Time Electronic Transfer of Funds and Securities (RENTAS) system.

•

Non-RENTAS members such as institutional investors and other financialinstitutions can transact scripless

securities via their ADI.

•

Cash payments of coupons and redemption proceeds will be passed to theinvestors via their respective ADIs.

Market Infrastructure



137

The Fully Automated System for Tendering (FAST)

• is an automated tendering system whereby invitations to tender, bids submission andprocessing of tender for SSTS instuments and short term private debt securities are doneelectronically



138

electronically.Objective

To improve the overall efficiency of the tendering procedures, to reduce errors and delaysarising from manual handling of tenders as well as to eliminate potential disputes that mayarise 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 inthe system for dissemination to all FAST members before the tender closing date.

(ii) Tender Information

The invitation by the facility agents would be the source of the tender information. All



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y y g

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 relevantterms 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 tothe 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 theamount of the issue is fully allotted. The system also allows for intervention by thefacility agents.

(v) Tender Results

Once the results are verified and finalised, they will bet itt d th h th t t th bidd All bidd



140

transmitted through the system to the bidders. All bidders are

able to retrieve their own results. However, the other FASTmembers can only view the general results. The generalbidding results are also announced through the informationproviders such as Reuters and Telerate.

(vi) Data Analysis

FAST members can download bidding information at their

workstations for data analysis and end-user reporting.

•

(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



141

securities and cash transfer.

• For PDS tendered through FAST, the settlement is done manuallyeither 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, discounthouses and Islamic banks), development banks, insurance

companies, statutory bodies, other financial bodies and other market participants, as approved by Bank Negara Malaysia.

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 andrelevant news on the various debt securities issued by both the Government and



142

ythe private sector. The transparency of information provided by BIDS is expected

to facilitate both the primary and secondary market activities in the domestic bondmarket.

Objective

To provide transparency with regards to information on bonds issued, therebyfacilitating efficient trading in the secondary over-the-counter market andenhancing liquidity in the debt securities market.

•

Process Flow

(i) Maintenance of Static Database

The lead arrangers and rating agencies will input information into BIDS throughtheir workstations located at their premises. These information will bedisseminated real-time.

•

(ii) Advertisement of Indicative Prices

The licensed financial institutions can input indicative bids and offers into BIDS. This willprovide users with information on the demand and supply situation in the market.

• (iii) Capturing of Trades Done



143

( ) p g

Trades done are reported in BIDS and the system will disseminate

the last done price andvolume real-time.

(iv) Individual Corporate Homepage/Members News

Information relevant to the debt securities market can be input into corporate homepagesand 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 marketparticipants, as approved by Bank Negara Malaysia.

RENTAS

• The RENTAS System is a real time gross settlement system (RTGS) for the transfer and settlement of high value ringgit denominated interbank



144

g gg

funds and scripless

securities transactions.

•

RENTAS System will enable payment instructions between theparticipants of the System to be processed and settled individually andcontinuously 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 withoutbeing exposed to the risk of the funds not being settled.

•

The RENTAS System will also contribute to the reductionof settlement risk in scripless securities transactions by

idi h i f d li t (DVP)



145

providing a mechanism for delivery-versus payment (DVP).

•

This mechanism would enable transfer instructions for bothscripless

securities and funds to be effected on a trade-by-

trade basis, with final (unconditional) transfer of the

securities from the seller to the buyer (delivery) occurringat the same time as the final transfer of the funds from thebuyer to the seller (payment).



146

Bond Calculation

Bond Valuation

• Bond valuation is the process of determining



147

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 streamof 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 tothe present using the appropriate discount rate.

The present value relationship

• The fair price of a straight bond is determined by discounting the expectedh fl



148

cash flows:

•

Cash flows:

•

the periodic coupon payments C, each of which is made onceevery 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 valueplus 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

Bond Price



149

Bond Price,

∑Po =C F

+

( 1 + r n ) ( 1 + r N )n N

n = 1

N

• Because the price is the present value of thecash flows, there is an inverse relationship



150

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 .

Coupon yield

• The coupon yield is simply the coupon



151

• The coupon yield is simply the couponpayment (C) as a percentage of the facevalue (F).

Æ Coupon yield = C / F

•

Coupon yield is also called nominal yield.

Current yield



152

• The current yield is simply the couponpayment (C) as a percentage of the bond

price (P).Æ Current yield = C / P o.

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



153

•

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 requiredreturn on the bond.

•

Solve for YTM where

YTM = (Par Value – Current Price) / n

(Current Price + Par Value ) / 2

• Market Price =



154

Market Price

∑MPo =

C F+

(1 + YTMn

) ( 1 + YTMN

)n

N

n = 1

N

•

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



155

•

The concept of current yield is closely related to other bond concepts,including yield to maturity, and coupon yield. The relationship betweenyield 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.

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 yieldat the same rate as invested.



156

• 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 sellingat par.

Introduction to Bond Market



157

THE ENDTHE END

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Documents

Introduction to Bond Market