G N KHALSA

GLOBAL CAPITAL MARKETS

BONDS
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 upon maturity of the contract

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 Government known as Malaysian Government Securities (MGS).

Bond Issuer
Bonds issued by private entities or companies: Purpose to help finance their ongoing business activities.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 the amount of tax on the company profits)

Bond Issuer
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 pledges on specific assets.
it is however, secured by all properties not otherwise pledged. In the case of bankruptcy debenture holders are considered general creditors. The advantage of debentures to the issuer is they leave specific assets burden free, and thereby leave them open for subsequent financing, an alternative instrument to issue of equity or preference shares.

Investing in Bond
An attractive investments because:
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.
Produce Capital Gains Sold prior its maturity at more than purchase price Held to maturity

Why Invest in Bonds?

Most financial planners and fund managers view bonds as being less risky than shares but yielding more returns than fixed deposits. It is less risky than shares because it provides:a fixed income from the coupons and the return of the principal is as stable as the issuer of the bonds. Bonds issued by stable governments of economically strong countries are considered the least risky. In general, it is in a nations 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 it can continue to raise capital through the future issuance of bonds.

 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 from strength 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

How a Bond is Traded ?

Primary Markets
Primary Market: When the issuer (government or corporations or institutions) first offers new issues, that first trading is done 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 bonds come directly to the issuer.

Secondary Market
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 that have acquired the bonds, which are now able to sell off the bonds before the maturity date, should they wish to do so.
The trading of bonds in the secondary market creates a market pricing of the bonds that depends on the supply and demand of the bonds, and prevailing interest rates, among other factors.

The secondary market plays an important role

Investors purchasing bonds at the primary market know there is an avenue to sell-off their bonds. The secondary markets provide a gauge for issuers to price their primary issues.

Bonds are medium to long-term debt instruments

Advantages
Investor receives periodic fixed interest income, irrespective of whether the company issuing the bonds is doing well or not. Bondholders have a prior right over ordinary shareholders on distribution of earnings and on claims in the event of bankruptcy.
Disadvantages As the income (coupons) derived from bonds is fixed, the investor does not get paid more even if business is booming as in the case of ordinary shareholders who may be given higher dividends. Bondholders have no voting rights and are not owners of the company while shareholders have a right to vote at general meetings.

Basic Types of Bonds

Irredeemable Perpetual Bond War Bond

Redeemable

Zero Coupon
Coupon Paying

Irredeemable
Do not mature No maturity date Issuer is bound to make eitherPerpetuity payments, ore.g. War Bond or Perpetual BondPerpetual Bond India

Converted into another form of security

Redeemable Bond
A. 1. Maturity Length of the time until loan contract or agreement expires 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
i. Short Term 1 to 5 years ii. Intermediate term 5 to 12 years iii. Long Term > 12 years

1) Par Value
1 The amount that the borrower promises to pay before the end of the term to maturity.
2 Known as principal, redemption value, face value & maturity value.

2)

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 be even more exotic.
The name coupon originates from the fact that in the past, physical bonds were issued which had coupons attached to them. On coupon dates the bond holder would give the coupon to a bank in exchange for the interest payment.

3) 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 coupon every six months. In Europe, most bonds are annual and pay only one coupon a year.

5)

Indenture

A contract between an issuer of bonds and the bondholder statingthe 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.

6) 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 loan agreement 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 certain assets as collateral. Likewise, the borrower may be required to issue reports to bondholders on certain dates called protective covenant, restrictive covenant.

7) Optionality
A bond may contain an embedded option; that is, it grants option like features to the buyer or issuer.

8) 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 to trustees

9) An Exchangeable Bond

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 and under prescribed conditions.
An exchangeable bond is different from a convertible bond. A convertible bond gives the holder the option to convert bond into shares of the issuer.

10)

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.

11)

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 have coupons 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.

Types of International Bond Market

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 predetermined interest rate. The interest rate is known as coupon rate and interest is payable at specified dates before bond maturity.

1.
2) Floating rate notes (FRNs)
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 examples do 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%.

3) High yield 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 make them attractive to investors.

4) Inflation-indexed bonds (also

known as linkers)
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 Massachusetts Bay 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 international debt market. The market primarily consists of sovereign debt, with privately issued inflation-linked bonds constituting a small portion of the market.

5)

Asset Backed Security

It is bond or a 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. 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 and movie revenues. Typically, the securitized assets might be highly illiquid and private in nature.

6)

Subordinated bond

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 are paid. 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 bonds issued by banks, and asset-backed securities.

7)

Bearer bond

It is an official certificate issued without a named holder. The person who has the paper certificate can claim the value of the bond. 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.

8)

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 a bonus. A small number of bonds are redeemed for an amount greater than their face value. Hence the holder of that particular bond will have won the lottery.

9)

Bear bond

It is a bond issued in Russian roubles by a Russian entity in the Russian market.

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