Bond and
Bond Valuation
BOND
A bond is a debt investment in which an
investor loans money to an entity (typically
corporate or governmental) which borrows the
funds for a defined period of time at a variable
or fixed interest rate. Bonds are used by
companies, municipalities, states and sovereign
governments to raise money and finance a
variety of projects and activities. Owners of
bonds are debt holders, or creditors, of the
issuer.
Bond Market of Bangladesh
Bangladesh has seen significant economic growth over the years;
however, the bond market has yet to flourish in Bangladesh capital market, which has showed very little signs of growth. The lack of a flourishing bond market has deprived Bangladeshi investors and companies of various benefits that they could have reaped had their been a developed bond market. Bond markets serve as a source of long-term finance for companies with sound financial capabilities. Moreover, it also provides investors with a stable source of long-term income compared to the unstable and volatile returns of the stock market. Also considering the high volatility of the Dhaka Stock Exchange, a stable bond market would serve the necessities of a general investor very well. The bond market in Bangladesh is comprised mainly of Treasury bonds issued by the Government of Bangladesh with 221 T-bonds and only one corporate bond that has been currently floating in the market.
Bond market infrastructure in
Bangladesh
Categories of bond
• Corporate bonds are issued by companies. Another name is commercial paper.
• Municipal bonds are issued by states and municipalities. Municipal bonds can offer tax-free coupon income for residents of those municipalities.
• Treasury bonds (more than 10 years to maturity), notes (1-10 years maturity) and bills (less than one year to maturity) are collectively referred to as simply
"Treasuries."
Corporate bonds
Corporate bonds are long-term debt securities issued by corporations. They promise the owner coupon payments (interest) on a semiannual basis. The minimum denomination is
$1 000. Their Maturity is typically between 10 and 30 years.
Corporate Bond Offerings
Corporate bonds can be placed with investors through a public offering or a private placement.
Characteristics of Corporate Bonds
It is very comprehensive (normally several hundred pages) and is designed to address all matters related to the bond issue (collateral, payment dates, default provisions, call provisions, etc.
Bond Collateral
Debentures : Bonds unsecured by specific property are called debentures (backed only by the general credit of the issuing firm).
These bonds are normally issued by large) financially sound firms whose ability to service the debt is not in question.
Zero-Coupon Bonds: No coupon on bond. These zero-coupon bonds are therefore issued at a deep discount from par value. Zero-coupon corporate bonds are purchased mainly for tax-exempt investment accounts (such as pension funds and individual retirement accounts).
Corporate bonds of
Bangladesh
Amongst the three corporate bonds, IBBL's Mudaraba Perpetual Bond (MPB) is currently listed and traded in Bangladesh stock market as IBBLPBOND.
Treasury Bond
Long-term (maturity over 10 years) fixed interest rate debt security issued by a national (federal) government backed by its 'full faith and credit.' Next to treasury bills (maturity less than one year), and treasury notes (maturity one to ten years) T-bonds are the safest form of marketable investment. They have an active secondary market, and usually pay semi-annual interest.
Treasury Bond Auction
Details of coupon rates
offered on Treasury bonds in
the last three years
Municipal bonds
Municipal bonds are loans investors make to local governments. They are issued by cities, states, counties, or other local governments. For that reason, the interest they pay on the bonds is tax-free. In 2018, the municipal bond market was $3.8 trillion in USA market.
How to Buy Municipal Bonds
Most people buy municipal bonds through your financial advisor, bank, or even the municipality directly. Many people also benefit from municipal bonds through a bond fund.
Rates
Like any bond, municipal bond rates depend on three factors.
1. Most bond rates follow the equivalent Treasury bond yield.
2. It also depends on the municipality's credit rating.
3. The length of the bond will change the yield
Characteristics of Bonds
• Face value is the money amount the bond will be worth at its maturity, and is also the reference amount the bond issuer uses when calculating interest payments.
• Coupon rate is the rate of interest the bond issuer will pay on the face value of the bond, expressed as a percentage.
• Coupon dates are the dates on which the bond issuer will make interest payments. Typical intervals are annual or semi- annual coupon payments.
• Maturity date is the date on which the bond will mature and the bond issuer will pay the bond holder the face value of the bond.
• Issue price is the price at which the bond issuer originally sells the bonds.
What is a 'Coupon'
The annual interest rate paid on a bond, expressed as a percentage of the face value.
What is a 'Coupon rate‘
A bond's coupon rate can be calculated by dividing the sum of the security's annual coupon payments and dividing them by the bond's par value.
Issue Date
The issue date is simply the date on which a bond is issued and begins to accrue interest.
Maturity date
The issue date is simply the date on which a bond is issued and begins to accrue interest.
Settlement Date
The date on which ownership of a security actually changes hands. Typically, this is several days after the trade date.
Dirty Price
The "dirty price" is the total price of the bond, including accrued interest. This is the amount that you would actually pay (or receive) if you purchase (or sell) the bond.
Coupon Payment Date
The specified dates (typically two per year) on which interest payments are made
Current Yield
A measure of the income provided by the bond. The current yield is simply the annual interest payment divided by the current market price of the bond.
Yield to Maturity
The yield to maturity (YTM) of a bond is the compound average annual expected rate of return if the bond is purchased at its current market price and held to maturity. The YTM is the internal rate of return (IRR) of the bond.
Yield Vs Coupon Rate
Current yield compares the coupon rate to the current market price of the bond. Therefore, if a $1,000 bond with a 6% coupon rate sells for $1,000, then the current yield is also 6%. However, because the market price of bonds can fluctuate, it may be possible to purchase this bond for a price that is above or below
$1,000. If this same bond is purchased for $800, then the current yield becomes 7.5% because the $60 annual coupon payments represent a larger share of the purchase price.
Yield Vs Bond Value
The fact that bond prices and yields move in opposite directions is often confusing to new investors. Bond prices and yields are like a seesaw: when bond yields go up, prices go down, and when bond yields go down, prices go up.
Bond Vs Bills
Bonds:
Bonds are considered to be debt security usually issued to raise capital or money by banks, financial institutions, government, Companies etc.
Bonds includes debentures, fixed income securities...
Bonds could be issued either for a long period or for a short period as required by the institution.
Bonds are also issued during the time of inflation in the country. But, the interest on these bonds are not subject to tax.
Bill:
In general bill is a written or printed paper issued by a seller for the goods bought buy a person.
Bills are of different types based on the requirements like,
Treasury bills: which are issued by the RBI(Reserve Bank of India), these are issued to meet the shirt term financial deficiencies faced by the government. These are issued for a period of 14 days or 182 days or 91 days or 364 days.
Public bills: which deals with questions of national interest.
Private bills: these bills grants special rights, powers, exemptions to person including corporations.
BOND VALUATION PROCESS
• Bonds are debt obligations with long-term maturities that are commonly issued by governments or corporations to obtain long-term funds. They are also purchased by financial
institutions that wish to invest funds for long-term periods.
• Bond valuation is conceptually similar to the valuation of
capital budgeting projects, businesses, or even real estate. The appropriate price reflects the present value of the cash flows to be generated by the bond in the form of periodic interest (or coupon) payments and the principal payment to be
provided at maturity.
Impact of the Discount Rate on
Bond Valuation
EXPLAINING BOND PRICE MOVEMENTS
• Risk-free rate (Rf)
• Credit risk premium (RP)
Factors That Affect the Risk- Free Rate
The long-term risk-free rate is driven by
• Inflationary expectations (INF),
• Economic growth (ECON)
• The money supply (MS), and
• The budget deficit (DEF):
Summary of Factors Affecting Bond Prices
• Risk-free rate (Rf)
• Credit risk premium (RP)
• Inflationary expectations (INF),
• Economic growth (ECON)
• The money supply (MS), and
• The budget deficit (DEF):
SENSITIVITY OF BOND PRICES TO INTEREST RATE MOVEMENTS
• Bond Price Elasticity: The sensitivity of bond prices (Pb) to changes in the required rate of return (k) is commonly measured by the bond price elasticity (Peb), which is estimated as
• Duration: An alternative measure of bond price sensitivity is the bond’s duration, which is a measurement of the life of the bond on a present value basis. The longer a bond’s duration, the greater its sensitivity to interest rate changes. A commonly used measure of a bond’s duration (DUR) is
BOND INVESTMENT STRATEGIES
• Matching Strategy : The matching strategy involves estimating future cash outflows and then developing a bond portfolio that can generate sufficient coupon or principal payments to cover those outflows.
• Laddered Strategy: With a laddered strategy, funds are evenly allocated to bonds in each of several different maturity classes.
• Barbell Strategy: The bonds with the short term to maturity provide liquidity if the investor needs to sell bonds in order to obtain cash.
• Interest Rate Strategy: With the interest rate strategy, funds are allocated in a manner that capitalizes on interest rate forecasts.
