BOND MARKET IN THE WORLD

ASSET CLASSES

EquitiesFixed

Income Securities

AlternativeAsset

Classes

FIXED INCOME SECURITIES

It is a financial obligation of an entity that promises to pay a specified sum of money at specified future dates.

Entity promising to make payment is called the issuer of the security.

Contd…FIXED INCOME

SECURITIES

Preferred Stock

Debt Obligations

BondsMortgag

eBackedSecuriti

es

BankLoans

Asset BackedSecuriti

es

BONDS Bonds are debt instruments in which one party lends money

to another party on predetermined terms.

Terms

Rate of interest to be paid

Periodicity of payments

Repayment of principal amount borrowed

FEATURES Indenture

A document where the promises of issuer and rights of bond holder are set forth in detail is called indenture

Covenants Affirmative covenants: Activities that borrower promises to do.

Negative covenants : Set forth the restrictions on borrowers

activities

Contd….

Principal

It is the amount borrowed and also known as Par Value or

Face Value of the bond

Bond traded below par value -trading at a discount

Bond traded above par value- trading at a premium

Coupon Rate

Interest rate that issuer agrees to pay

It is represented as percentage of par value

Coupon = Coupon Rate * Par value

Above par value

Below par value

Bond Bond

discount

Par value

premium

Maturity Short Term Bonds Intermediate Bonds Long term Bonds

Why Maturity is important?

Term to maturity indicates the time period over which

bond holder can expect to receive interest.

It indicates the no. of years before the principal will be paid in full

Yield on bonds depends on term to maturity

Contd….

TYPES OF BONDS Zero Coupon Bonds These bonds are not contracted to make periodic coupon

payments

These are sold at discount and interest is the difference

between the par value and price paid for the bond

Step-Up-Notes

They have the coupon rate that increases over time

Coupon Rate steps up and as such are called step up notes

When only one change- Single Step Up Note

When more than one change- Multiple Step Up Note

Contd….

Deferred Coupon Bonds

Interest payment is deferred for specified number of years.

Interest payments that are made after the deferred period

are higher than the interest payments that would have been

made had the issuer not deferred the interest payments.

Fixed Rate Securities

They provide fixed interest payment at each period for

certain number of years upto maturity.

Contd….

Floating Rate Securities/ Variable-Rate Securities

Coupon Rate= Reference Rate + Spread/Quoted Margin CAP and FlOOR Range Notes TIPS( Treasury Inflation Protection Securities)

U.S Dept of the Treasury in January 1997 began issuing inflation

adjusted securities known as TIPS. Reference rate is the rate of

inflation.

Contd….

Inverse Floaters

The issues whose coupon rate moves in opposite direction

from the change in reference rate.

It gives investor who believes that interest rates will

decline an opportunity to obtain a higher coupon rate.

Callable Bonds

Issuer of the bond can alter the tenor of bond by redeeming it

before maturity.

The call option provides the issuer the option to redeem a bond,

if interest rates decline, and re-issue the bonds at a lower rate.

It carries an added set of risk to the investor.

Contd….

Puttable Bonds Investor has the right to ask for redemption of bonds before

maturity.

It carries added risk to the issuer of the bond.

Convertible Bonds

A convertible bond provides the investor the option to convert the value of the outstanding bond into equity of the borrowing firm, on pre-specified terms.

Redemption of bond prior to maturity and replacement with

equity.

Conversion price and conversion ratio are specified in indenture.

YIELD

RETURN TO INVESTOR IN BOND =

Coupon, Return from reinvestment of coupons

and capital gain or loss from selling or

redeeming bonds.

Yield is calculated by comparing cash inflows with cash outflows of the investor.

VARIOUS INTERPREATATIONS

CURRENT YIELD

Current Yield = Annual Coupon Receipts/ Market Price of bond Does not consider time value of money and complete series of

expected future cash flows For example, if a 12.5% bond sells in the market for Rs. 104.50,

current yield will be computed as

Current Yield= (12.5/104. 5) * 100 = 11.96% Current Yield is no longer used as a standard yield measure,

because: • It fails to capture the future cash flows, re-investment income and

capital gains/losses on investment return. • It is considered a very simplistic and erroneous measure of yield.

Contd….

Yield To Maturity Given a pre-specified set of cash flows and a price, the YTM of a

bond is that rate which equates the discounted value of the future cash flows to the present price of the bond. It is the internal rate of return of the valuation equation.

• For example, if we find that an 11.99% 2009 bond is being issued at a price of Rs. 108 in 2000, we can state that,

108 = 5.995/(1+r) + 5.995/ (1+r)2 +……….105.995/(1+r)18

The value of r that solves the above equation can be found to be

5.29%,which is the semi-annual rate. The YTM of the bond is 10.58%.• Yield to maturity represents the yield on the bond, provided the

bond is held to maturity and the intermittent coupons are re-invested at the same YTM rate.

YIELD PRICE REALTIONSHIP

Value of bond

P =C1/ (1+r) + C2 / (1+r)2 +…….Cn/ (1+r )n

where P is the value of bond and C1, C2 ….Cn are cash flows expected from bond over n periods and r is the required rate of return for discounting cash flows.

Yield and price are inversely related Price of the bond changes in opposite direction from change in

the required yield.

PRINCIPLES Price-yield relationship between bonds is not a straight line, but is

convex. This means that price changes for yield changes are not

symmetrical, for increase and decrease in yield. The sensitivity of price to changes in yield in not uniform across

bonds. Therefore for a same change in yield, depending on the kind of bond one holds, the changes in price will be different.

Higher the term to maturity of the bond, greater the price sensitivity. Price sensitivities are higher for longer tenor bonds, while in the short-term bond, one can expect relative price stability for a wide range of changes in yield.

Lower the coupon, higher the price sensitivity. Other things remaining the same, bonds with higher coupon exhibit lower price sensitivity than bonds with lower coupons.

YIELD CURVE

Yield curve is drawn from the YTM of bonds.

When we obtain a plot of these relationships between YTMs and term of bonds, functional relationship between time and yield can be identified by fitting a curve through plotted points.

YIELD CURVE FROM A SAMPLE OF TRADED BONDS

Name Coupon (%)

MaturityDate

Term To Maturity

Price YTM (%)

CG2001 11.75 25-Aug-01 0.41 101 0.090924

CG2002 11.15 9-Jan-02 0.78 102.75 0.074125

CG2003 11.1 7-Apr-03 2.02 103.515 0.091537

CG2004 12.5 23-Mar-04 2.98 108.31 0.092473

CG2005 11.19 12-Aug-05 4.37 106.19 0.094220

CG2006 11.68 10-Apr-06 5.03 107.58 0.097364

CG2007 11.9 28-May-07 6.16 109.31 0.098426

CG2008 11.4 31-Aug-08 7.42 107.6 0.099240

CG2009 11.99 7-Apr-09 8.02 109.18 0.102808

CG2010 11.3 28-July-10 9.33 106.6 0.101823

CG2011 12.32 29-Jan-11 9.83 110.97 0.104987

CG2013 12.4 20-Aug-13 12.39 111.2 0.107401

RISKS ASSOCIATED WITH BONDS

Interest rate risk Coupon Rate= Yield required by market

Price =Par value Coupon Rate< Yield required by market

Price< Par value(discount) Coupon Rate> Yield required by market

Price> Par Value (premium)

Call and Repayment Risk The cash flow pattern of a callable bond is not known with

certainty because it is not known when the bond will be called. Investor is exposed to reinvestment risk.

Reinvestment Risk Suppose an investor purchases 20-year bond with a yield of

6%, to realize the yield of 6% every time a coupon interest payment is made, it is necessary to reinvest the payment at an interest rate of 6% until maturity.

The risk that coupon payments will be invested at less than 6% is reinvestment risk.

Default Risk

Risk that issuer will fail to satisfy the terms of the obligation with respect to the timely payment of interest and principal.

The percentage of a population of bonds that is expected to default is called default rate.

If an default occur, this does not mean that investor will lose entire amount invested. He can expect to recover a certain percentage of the investment called recovery rate.

GLOBAL BOND MARKETS

BOND MARKETSECTOR

INTERNAL BOND MARKET

EXTERNAL BONDMARKET

DOMESTICBOND

MARKET

FOREIGN BOND

MARKET

Contd….

INTERNAL BOND MARKET

It is also called as national bond market It includes domestic bond market and foreign bond market

DOMESTIC BOND MARKET

It is where the issuers domiciled in the country issue bonds and

where those bonds are subsequently traded.

FOREIGN BOND MARKET

It is where the issuers not domiciled in the country issue bonds

and where those bonds are subsequently traded.

Bonds traded in U.S Foreign Bond Market are termed as YANKEE

BONDS

Foreign Bonds in U.K are termed as BULLDOG BONDS

In Japan Yen denominated bonds are issued by British Corporation and subsequently traded in Japan’s bond market is a part of Japanese Foreign Bond Market and is nicknamed as SAMURAI BONDS

Bonds traded in Netherlands Foreign Bond Market are termed as REMBRANDT BONDS

Bonds traded in Spain Foreign Bond Market are termed as

MATADOR BONDS

Contd….

Issuers of Foreign Bonds

Central Governments and their subsidiaries

Corporations

Supranationals: An entity formed by two or more Central

Governments through international treaties.

International Bank For Reconstruction And Development

Inter-American Development Bank

Contd….

EXTERNAL BOND MARKET It is also called as International Bond Market, The Offshore Bond

Market, or, The Euro Bond Market These bonds are underwritten by an international syndicate. At issuance, they are offered simultaneously to investors in number

of countries. They are issued outside the jurisdiction of any single country. They are in unregistered form. They are classified based on the currency in which they are

denominated. Euro Bonds denominated in U.S dollars- Eurodollar bonds Euro Bonds denominated in Japanese Yen- Euroyen bonds. A Global Bond is one that is issued in several bond markets

throughout the world.

Contd….

CLASSIFICATION IN TERMS OF TRADING

BLOCS DOLLAR BLOC

It includes United States, New Zealand, Canada and Australia.

EURO BLOC

It includes Euro Zone Market Bloc and Non- Euro Zone Market Bloc.

Euro Zone Market Bloc: Which has the common currency, Euro.

Germany, France, Holland, Belgium, Austria, Italy, Spain

Finland, Portugal, Greece.

Non- Euro Zone Market Bloc: Norway , Denmark and Sweden Japan Emerging Markets

NON-U.S SOVEREIGN BOND ISSUERS

GERMAN GOVERNMENT

BUNDS: Maturities of 8-30 years

BUNDESOBLIGATIONEN, BOBLS: Notes with maturity of 5

years

These have fixed-rate coupons and are bullet structures

Ten year Bunds are the largest sector of German

government securities

UNITED KINGDOM

GILT – EDGED STOCKS or GILTS:

Largest sector of the gilt market is straight fixed rate coupon

bonds.

Second major sector is index-linked issues-LINKERS.

Issues of outstanding gilts called IRREDEMABLES.

Issues with no maturity date called UNDATED GILTS.

Contd….

FRENCH TREASURY

OBLIGATION ASSIMILABLE DU TRESOR(OATS)

Long dated bonds with maturities upto 30 years

They are not callable

Mostly have fixed-rate coupon

BONS DU TRESOR A TAUX FIXE A INTERET

ANNUEL (BTANs)

Notes with maturities between 2 and 5 years

Contd….

ITALIAN GOVERNMENT

BUONI DEL TRESORO POLIENNALI(BTPs)

Bonds with fixed rate coupon that are issued with maturities of

5,10 and 30 years.

CERTIFICATI DI CREDITO DEL TRESORO(CCTs)

Floating rate notes with 7 year maturity

CERTIFICATI DI TRESORO A ZERO COUPON( CTZs)

2 year Zero coupon notes

CERTIFICATI DEL TRESORO COB OPZIONE(CTOs)

Bonds with put option

Contd….

CANADIAN GOVERNEMNT

Bonds have fixed coupon rate except for the inflation protection bonds(Real return bonds)

AUSTRALIAN GOVERNMENT

About three-quarters consists of fixed rate bonds and inflation protection bonds called “Treasury indexed bonds”

The balance of the market consists of floating rate issues called as “Treasury adjustable bonds” that have a maturity between 3to 5 years and the reference rate is the Australian Bank Bill Index.

Contd….

JAPANESE GOVERNMENT SECURITIES(JCBs)

Two types: Medium term bonds

Bonds with coupons ( maturities of 2,3 and 4 years)

Zero coupon bonds

5 year zero coupon bond Long dated bonds are interest bearing

Contd….

EMERGING MARKETS

Financial markets of Latin America, Asia(except Japan) and

Eastern Europe are viewed as emerging markets.

Investing in government bonds of emerging market countries are more risky than that of industrialized countries.

Contd….

HOW TO READ A BOND TABLE

Column 1: Issuer - This is the company, state (or province) or country that is issuing the bond. Column 2: Coupon - The coupon refers to the fixed interest rate that the issuer pays to the lender. Column 3: Maturity Date - This is the date on which the borrower will repay the investors their principal. Column 4: Bid Price - This is the price someone is willing to pay for the bond. It is quoted in relation to 100, no matter what the par value is. Column 5: Yield - The yield indicates annual return until the bond matures. Usually, this is the yield to maturity, not current yield. If the bond is callable it will have a "c--" where the "--" is the year the bond can be called. For example, c10 means the bond can be called as early as 2010