Chapter 11: Thebond marketthinus.weebly.com/uploads/3/0/6/3/30633117/lu_07.pdf · 2015-05-23 · As...

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Chapter 11:

The bond market

© VAN SCHAIK PUBLISHERS

Study outcomes


The objective of this chapter is to explain the market in which bonds are traded.

When you have studied this chapter you should be able to

• define the capital market

• define bonds and the bond market

• perform and explain basic calculations concerning the prices and yields on bonds

• discuss the trading of bonds in South Africa

• list and discuss different types of bond issued and traded in South Africa

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• describe the primary and secondary markets for bonds

• explain information on the bond market that appears in the media.

The capital market is the market in which long‐term financial instruments are sourced and traded. As explained in Chapter 10,

instruments with a maturity of longer than one year are regarded as capital market instruments, and those with a maturity of less than one year as money market instruments. The capital market consists of the bonds market and the share or equities market. Shares are perpetual instruments, meaning that they do not have an expiry date. Shares are discussed in Chapter 12. Bonds are capital market instruments with an expiry date, and are discussed in this chapter.


Study outcomes

Introduction

Figure 11.1 Bonds (Textbook page 314)


Issuer/borrower (deficitunit)

Bondholder/investor (surplus

unit)

Issue date

Flow of moneyBuying

priceDuring

lifespan Flow of

money Coupon

payments

Maturity

date Flow of

money

Principal

BOND

• Principal• Coupon rate• Maturity

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Overview


• Price and yields on bonds

• Factors that affect the interest rate on bonds

• Trading of bonds in South Africa

• Market for government bonds

• Market for municipal bonds

• Markets for parastatal and water authorities bonds

• Market for corporate bonds

• Reading the business news

Introduction

Prices and yields on bonds


The inverse relationship between bond prices andyieldsBox 11.1

F.11.1

F.11.2

Box 11.2

F.11.3

Table 11.1 Yield to maturity and corresponding prices fro R186 bond on 21 December 2014 (Textbook page 318)

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The clean price, accrued interestand all‐in price of a bondF.10.3

F.11.4

Box 11.3

Box 11.4


31 MarchLast coupon

payment

Registercloses10September

31Mar LCD

10July

cum-interestperiod

ex-interest or books closedperiod

9Sep LDR

10Sep BCD

15Sep BCD

30Sep NCD

30 SeptemberNext coupon

payment

Bond trades cum interest up to 9 September If bond is traded in cum-interest period, e.g. for settlement on 10 July, the next coupon goes to the newowner, but interest accrued between 31 March and 10 July belongs to the previous owner (seller). Buyer must therefore indirectly refund seller by paying a higher price on settlement date (t+3). All-in price = clean price + accrued interest.

Bond trades ex interest from 10 SeptemberIf bond is traded in ex-interest period, e.g. for settlement on 15 September, next coupon goes to the previous owner (seller), but interest accrued between 15 September and 30 September belongs to the new owner (buyer). Seller must therefore indirectly refund by receiving a lower price on settlement date (t+3). All-in price = clean price – accrued interest.

Assume two bond coupon payment dates on 31 March and 30 September. Thebond register closes 20 days before the interest date.

For the period from 31 March to 30 September:

• The register closes on 10 September, with the last date to register (LDR) on 9September.

• The last coupon payment date (LCD) is 31 March.• The next coupon payment date (NCD) is 30 September.• The last day to register (LDR) is 9 September.• The books close day (BCD) is 10 September – 20 days before 30 September.

Figure 11.2 How accrued interest affects the all‐in price of a bond (Textbook page 319)


Price volatility of bondsF.11.5

Box 11.5

Table 11.2 Price volatility of bonds with different maturities (Textbook page 324)



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Table 11.3 Price volatility of bonds with different coupon rates (Textbook page 324)



Price volatility of bonds

Duration


F.11.6

Box 11.6

• Why is duration so useful?

F.11.7


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Convexity

Figure 11.3 Convexity of bonds (Textbook page 326)

(a) (b)

Per

cent

age

chan

ge in

bon

d pr

ice

Per

cent

age

chan

ge in

bon

d pr

ice

60

50

40

30

20

10

0

–10

–20

–30

–4 –3 –2 –1

0 1 2 3 4

Change in yield to maturity

Change in yield to maturity

C

D

60

50

40

30

20

10

0

–10

–20

–30

–4 –3 –2 –1

0 1 2 3 4 CA

CB



Factors that affect the interest rate on bonds

Market interest rate levels

MaturityTable 1.4 Yield rates on government bonds on 5 February 2014

(Textbook page 327)


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Figure 11.4 Yield curve (Textbook page 328)

9.000

8.5008.0007.500

7.0006.5006.000 0.

02.0

4.0

6.0 8.0 10.0

Term to maturity (years)

Yie

ld

12.0

14.0

16.0

R201

R328C

R330C

R334C R332C

R338

C R336C R340C

R343CR344C

R346C

R348C R350C

R352CR342

C



Maturity

Expectations


Market forces

IssuerTable 11.5 Credit rating agency grades (Textbook page 330)

Table 11.6 Sovereign credit ratings for the period 1994 to 2014 (Textbook page 331)


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Trading of bonds in South Africa

Table 11.7 Turnover ratios in government bond markets (Textbook page 333)


Figure 11.5 Total nominal value of bonds in issue on the JSE Stock Exchange (Textbook page 334)

Commercial

Paper

Corporate bond

Parastatal & Municipalities

Government bonds

R

bil

lio

n

2007

2008

2009

2010

2011

2012

2013

800

600

400

200

1200

1600

2000

1800

1000

1400



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Table 11.8 Size of securities market at the end of 2013 (in billions of US dollars) (Textbook page 335)



Market for government bonds

Different types of bond issued by the South African government

Table 11.9 Examples of government bonds (Textbook page 336)


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• Fixed‐rate bonds


• Inflation‐linked bonds

• Zero‐coupon bonds

• Variable or floating‐rate bonds

• Retail savings bonds

• Foreign currency bonds

Table 11.10 Composition of foreign marketable debt of the South African National Government 2006‐2010

(Textbook page 340)

• Islamic bonds

• Stripping


Different types of bond issued by the South African government

Primary market and issuing procedures



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Secondary marketFigure 11.6 Turnover of liquid South African government bonds 2012/13

(Textbook page 344)





Secondary market

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Market for municipal bonds


Markets for parastatal and water authorities bonds

Table 11.11 Bonds of parastatals in South Africa (Textbook page 345)


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Market for corporate bonds

Table 11.12 Composition of listed securities by market value in 2013 (Textbook page 345)


Different types of corporate bond


• Yield

Figure 11.7 Cash flows on different types of bond (Textbook page 351)

• Security

• Terms

• Currency and country of issue

• Securitisation

• Medium‐term note programmes

• Catastrophe‐linked bonds

Figure 11.8 Catastrophe bond structure (Textbook page 356)


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Primary and secondary markets for corporatebonds



Reading the business news


Table 11.13 Information on individual bonds (Textbook page 358)

Figure 11.9 Total return indices and ALBI constituent bonds – 12 August 2014 (Textbook page 359)

Figure 11.10 Government bond yield rates on 12 August 2014 (Textbook page 360)

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