Bond market with an overview bond market of Bangladesh

Souman Guha
16241002
Sazzad Hossain
16241008
Partha Sharathi
16241012
Owamia Haque
16241014
Sheikh Rownak
116241016

Chapter Objective
Provide a
background on
bonds
Describe the
different types of
bonds and their
characteristics
Explain how bond
markets have
become globally
integrated
Describe other
types of long-
term debt
securities

Bonds
A bond is a debt
investment in which an
investor loans money to an
entity which borrows the
funds for a defined period
of time at a fixed interest
rate

Bond Markets
The bond market is where
debt securities are
issued and traded.

Institutional Participation In Bond
Markets
 Issuer
o Commercial banks
o Savings institutions
o Finance companies
 Investors
o Commercial banks
o Savings institutions
o Bond mutual funds
o Insurance companies
o Pension funds

How Bond Market Facilitates The Flow
Of Fund
Household
&
Institutional
Investors
U.S. Treasury
Corporations
Municipalities
Federal Agencies
$ to buy treasury bonds
$ to buy federal agency
bonds
$ to buy municipal bonds
$ to buy corporate bonds
Spending on govt.
programs
Purchases of
mortgages originated
by financial institutions
Spending on state
& local govt.
programs
Spending to
expand operations

Background on Bonds
 Long-term debt securities that are
issued by government agencies or
corporations
 Interest payments occur annually or
semiannually
 Par value is repaid at maturity
 Most bonds have maturity between 10
and 30 years

Bond Yields
A bond yield is
the amount of
return an
investor
realizes on a
bond.

Bond Yields
Yield From The Issuer’s Perspective:
 The issuer’s cost of financing with bonds is
commonly measured by the yield to maturity (YTM).
 It reflects the annualized yield that is paid by the
issuer over the life of the bond.
 It is based on the assumption that coupon payments
received can be reinvested at the same yield.
 Consists of two components: (1) a set of coupon
payments and (2) the difference between the par
value that the issuer must pay to investors at
maturity and the price it received when selling the
bonds.

YTM
 Consider an investor who can
purchase bonds with 10 years until
maturity, a par value of $1,000, and an
8 percent annualized coupon rate for
$936.
YTM =
C+(F-P)/n
(F+P)/2

Bond Yields
Yield From The Investor’s Perspective:
 An investor who invests in a bond when it is issued
and holds it until maturity will earn the yield to
maturity.
 If they hold the bond for a very short time period they
may estimate their holding period return as the sum
of the coupon payments plus the difference between
the selling price and the purchase price of the bond,
as a percentage of the purchase price.
 For relatively long holding periods, a better
approximation of the holding period yield is the
annualized discount rate that equates the payments
received to the initial investment.

“Yield” – Return On The Bonds
$100 bond,
8% interest
per year
Market Price Interest Current
Yield=(I/MP)
Price
$110
$90
$.08
$.08
(.08/110)
=7.27%
(.08/90)
=8.89%

Treasury
Bonds
The U.S. treasury
commonly issues
Treasury notes and
Treasury bonds to
finance federal
government expenditure

Treasury Bonds
 Many country govt. wants to use a fiscal
policy of spending more money than it
receives from taxes.
 Treasury bonds issued by country’s
treasury section.
 Reason behind the attractiveness of
Treasury bonds is free from credit risk.
 The amount of fund to be borrowed should
be limited.

 The treasury announces the plans for an
auction including the date, amount of fund
it needs, maturity of the bonds to be
issued.
 Competitive bidding is limited by 35 % of
offering amount and non competitive by
$5m.
Treasury Bond Auctions
Competitive
Non-
competitive

 Bond dealer serves as intermediaries
in the secondary market by matching
up buyers and sellers of treasury
bonds
 Set an ask price and wait for bidding
 Dealers gain profit from the spread of
bid and ask price
Trade Of Treasury Bonds

Stripped Treasury Bonds
 One security would represent the payment
of principal upon maturity and other
securities would represent the payment of
interest.
 It is commonly called STRIPS – Separate
Trading of Registered Interest and
Principal of Securities
 STRIPS are not issued by Treasury
instead they are created and sold by
Financial Institution.

Inflation Indexed Treasury Bonds
 Commonly referred as TIPS –
Treasury Inflation Protected
Securities.
 Inflation amount will be adjusted with
the principal amount.

Savings Bond
 Higher attractiveness for lower price.
 Savings bond have a 30 years of
maturity.
 Money can be redeemed any time after
12 months of issue and there is a
penalty.

Federal
Agency
Bonds These bonds are issued by
Federal agencies and use
proceed to purchase
mortgage in the secondary
market. Main objective of
issuing these bonds to
ensure sufficient finance
for owners who wish to
obtain mortgage.

Municipal
Bonds
A municipal bond is
a bond issued by the
Government or state or
local government.

Municipal Bonds
General Obligation Bonds Revenue Bonds
Payments on
general obligation
bonds are
Generated by
Municipals govt.
ability to tax.
Payments on
Revenue bonds
are generated by
revenues of
project.

Call
Provision
Most municipal bonds
contain a call provision
which allows the issuer to
repurchase the bonds at a
specified price before the
bonds mature.

Credit Risk Of Municipal Bonds
Both types of municipal bonds are subject
to some degree of credit risk.
Sometimes Government has to spend
more than the budget deficit .
But there is a risk that they might not be
able to pay the premium. In this case the
investors want an higher risk premium.
Again due to little disclosure of the
economy in state there lies a risk in
investing on municipal bonds.

Ratings of municipal bonds
Due to risk of default, investors
commonly monitor the ratings of the
municipal bonds.
The higher the rating the less the issuer
has to pay to risk premium.
This enables the issuer to issue the
municipal bonds at a higher price.

Insurance Against Credit Risk Of
Municipal Bonds
Some municipal bonds are insured
to protect against default.
The issuer pays for this protection
money to issue the bond at a higher
price.

Variable Rates Of Municipal Bonds
Variable rate municipal bonds have a
floating interest rate that is based on the
benchmark interest rate.
In this case the coupon payment adjusts
to the movement in the benchmark.
But under some certain conditions
variable rate can be converted to a fixed
rate.

Tax Advantages Of Municipal Bonds
The interest income is exempt from
federal taxes.
 The interest income earned on bonds
that are issued by a municipality within
a particular state is normally exempt
from the income taxes of that state.

Trading And Quotations Of
Municipal Bonds
There are hundreds of bond dealers that
can accommodate investors requests to
buy or sell municipal bonds in the
secondary market.
Investors who expect that they will not
hold a bond until maturity should only
consider bonds that feature active
secondary market trading.

Yield Offered On Municipal Bonds
The yield offered by a municipal bond differs
from the yield on a treasury bond with the
same maturity for three reasons.
The municipal bond must pay a risk premium
to compensate for the possibility of default
risk.
The municipal bond must pay a slight
premium to compensate for being less liquid
than treasury bonds with the same maturity.
The income earned from a municipal bond is
exempt from federal taxes.

Corporate
Bonds Long term debt securities
issued by corporation that
promises the investor coupon
payments on a semiannual
basis.
 Bonds maturity is typically
between 10 to 30 years but
corporation may issue bond
more than this period.
 Bonds have tax advantages
for issuer.

Corporate Bond Offerings
Public Offering: Whenever corporation plans
to issue bonds hires a security firm to
underwrite bonds. The bond underwriter assess
the circumstances and determine to set a price
for bond. Before placing in the market the
proposal have to register by Securities and
Exchange Commission (SEC). After approval
the underwriter will distribute the prospectus to
other security firms to help the bonds to place in
the market.

Corporate Bond Offerings
Private Placement: Small firms borrow
relatively small amount of funds by private
placement rather than Public offering. A private
placement does not have to be registered with
the Security and Exchange Commission (SEC)
but have to disclose all financial data to the
investors. Generally Institutional investors are
the main buyer of the private placement.

Credit Risk of Corporate Bond:
Corporate bonds are subject to the risk of default. So
there is risk premium in yield that paid by
corporation. Risk level depends on the Economic
situation.
Bond Ratings as a measure of Credit Risk: Rating
agencies rates the corporate bonds. Higher rated
bonds can be placed at higher prices because of the
lower credit risk.
oExample: Coca-Cola and IBM issued bonds in 2012
at a yield of less than 2%.
Junk Bond: Corporate bonds those have higher risk
is called Junk Bond. Junk bonds offer high yield that
contain a risk premium for high risk.

Secondary Market for Corporate Bonds
Dealer Role in Secondary Market: This market
served by dealers and they can play a broker role
by matching up Buyers and Sellers. They also
have inventory of bonds. Dealers commonly
handle large transaction.
Liquidity in Secondary Market: Bond issued by
large and well-known corporation in large volume
are highly liquid and small corporation in small
volume is less liquid. So small corporation may
have to accept a discounted price to attract
investors.

Electronic Bond Network
This is a platform for institutional investor who wish to
buy and sell bonds in the secondary market. Because of
this platform institutional investor can easily know the
ensuing bond to be sold/bought in the market.
Main reason to establish the platform is to reduce the
transaction cost.
Types of Order through Broker :
 Market order
 Limit Order
Trading Online: Popularity of trading in online is
increasing because of transparency. In this way investor
can know the spread of bid and ask. The online service
charge a standard fee for every trade.

Characteristics of Corporate Bonds
 Sinking-Fund Provision: A requirement that the
firm retire a certain amount of the bond issue each
year. This provision is considered to be an
advantage to the remaining bondholders because
it reduces the payments necessary at maturity.
 Protective Covenants: Bond indentures normally
place restrictions on the issuing firm that are
designed to protect bondholders from being
exposed to increasing risk during the investment
period. It’s an agreement between the issuer & the
holder of a bond, requiring or forbidding certain
actions of the issuer.

 Call Provisions: A call provision is a provision on a
bond that allows the original issuer to repurchase
and retire the bonds.
 Bond Collateral: Bonds can be secured by collateral
and by the nature of that collateral. Usually, the
collateral is a mortgage on real property. A first
mortgage bond has first claim on the specified
assets. A chattel mortgage bond is secured by
personal property. Bonds unsecured by specific
property are called debentures. Subordinated
debentures have claims against the firm’s assets
that are junior to the claims of both mortgage bonds
and regular debentures.

 Low- and Zero-Coupon Bonds: Long-term debt
securities that are issued at a deep discount from
par value. To the issuing firm, these bonds have
the advantage of requiring low or no cash outflow
during their life.
 Variable-Rate Bonds: Long-term debt securities
with a coupon rate that is periodically adjusted.
Most of these bonds tie their coupon rate to the
London Interbank Offer Rate (LIBOR), the rate at
which banks lend funds to each other on an
international basis. The rate is typically adjusted
every three months.

 Convertibility: A convertible bond allows
investors to exchange the bond for a stated
number of shares of the firm’s common stock.
This conversion feature offers investors the
potential for high returns if the price of the firm’s
common stock rises. Investors are therefore
willing to accept a lower rate of interest on
these bonds, which allows the firm to obtain
financing at a lower cost.

How Corporate Bonds Finance
Restructuring
 Using Bonds To Finance a Leveraged Buy Out
 LBO involves the use of debt to purchase shares and take
company private.
 To cover large amount of debt payments, the owner
might sell off some assets of the firm for cash
 If improved operating performance, Firms engaged in
LBO will go Public.

How Corporate Bonds Finance
Restructuring
 Using Bonds To Revise Capital Structure
o Issuance of Bonds to Capital Restructure when they have
sufficient of Cash Flow
o Debt is Cheaper than equity
o Debt for Equity Swap ( issuing bonds to repurchase existing
stock)

Corporate Bond Market
of Bangladesh

Government debt securities such as treasury bills,
treasury bonds and National Savings Certificates (NSA)
dominate the market, among which NSA account for
roughly two-thirds.
The Milken Institute’s Capital Access index (CIA)
ranked Bangladesh 75th in bond market development
where India stood 35th place in the year 2008
Bangladesh’s bond market represents the smallest in
South Asia, accounting for only 12 percent of the
country’s gross domestic product (GDP) (World Bank
Report

Issuers
 ACI (Advanced Chemical Industries Limited)
 Islami Bank Bangladesh Limited
 Brac Bank
The trend line of ACI 20% convertible
zero coupon bond is fairly consistent and
upward sloping in comparison with to that
of IBBL perpetual mudaraba bond and
BRAC bank 25% subordinated
convertible bond.

Features Mudarabah Perpetual Bond
(MPB)
BRAC Bank 25% Subordinated
Convertible Bonds
ACI 20% Convertible Zero
Coupon Bonds
Maturity It is at perpetual nature & will not
be redeemed
84 months from the date of issue. 5 years with yearly redemption.
Rate of Profit or Interest Investor is getting profit by
deployment of Mudaraba Fund at
the weight 1.25 plus equivalent to
10% of declared dividend.
The interest Margin plus the
Reference Rate will be set at
12.50% (the Interest Floor) at all
times.
The discount rate is 10.50%
Conversion option No more conversion ratio The investor has the right to
convert 25% of the face value at
a pre-determined Conversion
Strike Price into the common
shares.
The investor has the option to
convert 20% of the bond at face
value in a predetermined
conversion strike price. The
investor will execute the
convertibility option assuming
that the market value of ACI
stock is higher than the
conversion strike price on the
conversion date.

Purpose to raise fund to meet the capital adequacy
ratio of the Bank. Since the raising of Tier-1
Capital has impact on share value dilution
and dividend paying capacity of the bank,
the IBBL has been looking for alternate
sources of Tier-2 Capital as a subordinated
investment instrument and identified the
issuance of Mudaraba Perpetual Bond to
resolve the issue of capital adequacy.
The main purpose of the
bond is to raise Tier 2 capital
(subject to regulatory
approval) and undertake
normal commercial activities
with the proceeds as
permitted by the Bangladesh
Bank.
As a part of ACI’s vision to look for
alternative funding arrangement
and be pioneer in undertaking new
product in the capital market, ACI
Management envisage that raising
of money through Zero Coupon
Bonds would be an alternative
option for the company
investors 100% issue is offered to public through IPO 90% of the total issue size is
offered to institutional
investors including onshore
and offshore investors and
the remaining 10% is offered
53.85% of the total issue size is
offered to institutional investors
and the remaining 46.15% is offered
to public through IPO
Conversion
date
Not applicable The conversion date is the
same date will be 5th, 6th &
7th anniversary of bond
issuance date
Conversion date will be same as the
Principal Payment Date at the end
of each maturity.

Globalization Of Bond Markets
• Bond markets have become increasingly
integrated as a result of frequent cross-
border investments in bonds
• Low-quality bonds issued globally by
governments and large corporations are
global junk bonds.
• The global development of the bond
market is primarily attributed to bond
offerings by country governments.

Global Government Debt Market
Sovereign Bonds are attractive to
investors because of Governments Ability
to meet debt obligation
Countries that defaulted are Argentina
(1982,1989,1990,2001)
Brazil (1986,1989,1991) Costarica
(1989) Russia (1993,1998)
Yugoslavia (1992)

Greek Debt Crisis
In 2010, Greek Experienced Credit crisis
bought by weak economy and large
government budget deficit.
In 2009, the risk premium offered by
Greece was similar to offered by other
countries in 2010, it reached 7% points
while risk premiums for other countries
ranged between only 1 to 3 %.

Eurobond Market
 Bonds denominated in various currencies are
placed in the Eurobond market
 Dollar-denominated bearer bonds are available in
the Eurobond market
 Underwriting syndicates help place Eurobond
issues
 Government do not involve in regulation
 Favorable Tax status
 Denominated in their preferred currency

An Australian Company issued bonds denominated in
US dollar in Japan
•The coupon rate on a Eurobond denominated in Swiss francs is 5 percentage
points lower than the rate on a dollar-denominated bond
•A U.S. Firm may consider issuing Swiss franc–denominated bonds and converting
the francs to dollars for use in the united states. Then it could instruct a subsidiary
in Switzerland to cover the periodic coupon payments with earnings that the
subsidiary generates. In this way, a lower financing rate would be achieved without
exposure to exchange rate risk.
Example

• A structured note is a debt obligation that also
contains an embedded derivative component that
adjust the security's risk/return profile.
• The return performance of a structured note will
track both that of the underlying debt obligation and
the derivative embedded within it.
Structured Notes

Structured Notes
 The amount of interest and principal to be paid
is based on specific market conditions.
 Repayment may be tied to a Treasury bond price index
or even to a stock index or a particular currency.
 Sometimes issuers use structured notes to reduce their risk.
 Structured notes become popular in 1990s.
 Long term debt instruments that allow investors to bet
indirectly on or against a specific market that they cannot bet
on directly because of restrictions.

Risk of Structured Notes
Misinterpretation of interest rates will results in loss.
Portfolio manager responsible for managing more than $7
billion on behalf of orange county, California, invested in
structured notes that would earn high returns if interest rates
declined.
In 1994, orange county filed for bankruptcy as he predicted
wrong.

Exchange-traded notes (ETNs) are a type
of unsecured, unsubordinated debt security first issued by
Barclays Bank PLC based on the performance of a market
index minus applicable fees, with no period coupon payments
distributed and no principal protections. Similar to exchange-
traded funds (ETFs), ETNs are traded on a major exchange,
such as the New York Stock Exchange .
Exchange-traded notes (ETNs)

Exchange Traded Notes
 Debt instrument in which issuer promises to
pay a return based on the performance of
specific debt index after deducing specified
fees.
 Maturity of 10 to 30 years
 Not backed up by assets exposes to default
risk
 Common issuers are Goldman Sachs &
Morgan Stanley

Auction Rated Securities
• A debt instrument (corporate or municipal bonds) with a long-
term nominal maturity for which the interest rate is regularly
(periodically 7 to 35 days) reset through a Dutch auction.
• a way for specific borrowers (e.g., municipalities and student
loan organizations) to borrow for long-term periods while
relying on a series of short-term investments by investors.
• Since February 2008, most such auctions have failed, and the
auction market has been largely frozen. In late 2008, investment
banks that had marketed and distributed auction rate securities
agreed to repurchase most of them at par.

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