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BONDS

• What is bond?• Concept of Value:– Book Value– Liquidating Value– Market Value– Intrinsic Value

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BONDS

• Features– Coupon– Face Value– Coupon Rate– Maturity– Yield- To - Maturity

Basic Valuation Model

• The value of any asset is the present value of all future cash flows it is expected to provide over the relevant time period.

• The value of any asset at time zero, V0, can be expressed as

where

v0 = Value of the asset at time zeroCFT = cash flow expected at the end of year t

r = appropriate required return (discount rate)n = relevant time period

Slide 45 3

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Intrinsic Value 10% coupon interest rate, 10-year bond with a $1,000 par value

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Traditional Types of Bonds

Slide 38

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Contemporary Types of Bonds

Slide 40

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TYPES OF BONDS ISSUER IN MALAYSIA

• Government• Quasi-Government• Corporate

http://asianbondsonline.adb.org/malaysia/structure/instruments/bond_types.php

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Government Bonds

• Malaysian Government Securities (MGS)—coupon-bearing, long-term bonds issued by the Government to raise funds from the domestic capital market. They are the most actively traded bonds. In addition, there are callable MGS which gives the government an option to redeem the bond ahead of its maturity date.

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• Malaysian Treasury Bills (MTB)—short-term securities issued by Bank Negara Malaysia (BNM) on behalf of the government. Treasury bills are used for working capital.

• Government Investment Issues (GII)—non-interest-bearing government securities based on Islamic principles issued by the government and placed on a competitive tender with maturities of three to ten years. Funds are used for development expenditures.

Government Bonds

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• Bank Negara Monetary Notes (BNMN)—discounted or coupon-bearing government securities with maturities of 91-, 182-, 364-days and one to three years. BNMNs are issued by BNM to manage liquidity in both conventional and Islamic markets, and have replaced BNM Bills and BNM Negotiable Notes beginning December 2006. BNMNs are offered through competitive auction through principal dealers.

Government Bonds

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• Sukuk BNM Issues (SBNMI)—zero coupon bonds with maturities of one-to-two years. SBNMI are based on al-Ijarah (sale and lease back concept).

• Merdeka savings bonds—targeted at retirees by offering a slightly higher return than the market rate, and a tax exemption. A unique feature of Merdeka savings bonds is that they are all based on the Islamic banking concept of bai' al-inah (sell-and-buy-back arrangement).

Government Bonds

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Others

• Khazanah bonds—issued by Khazanah National Berhad and guaranteed by the Government, these zero-coupon bonds are based on Islamic principles.

• The National Mortgage Corporation (Cagamas) is the major issuer of asset-backed securities in Malaysia. Securities issued by Cagamas are called Cagamas bonds in the domestic market.

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How Bond is TradedNew Bond

Lead Arranger

FAST

FINANCIAL INSTITUTIONS

DEVELOPMENT BANKS

INSURANCE COMPANIES

ETC

BID

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Asset Valuation and Risk

Laura wishes to estimate the value of an asset expected to provide cash inflows of $3000 per year at the end of years 1 through 4 and $15,000 at the end of year 5. Her research indicates that she must earn 10% on low-risk assets, 15% on average risk assets and 22% on high-risk assets.

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a) Determine what is the most Laura should pay for the asset if it is classified as (1) low risk (2)average risk, and (3)high-risk.

b) Suppose Laura is unable to assess the risk of the asset and wants to be certain she’s making a good deal. On the basis of your findings in part a, what is the most she should pay? Why?

c) All else are being the same, what effect does increasing risk have on the value of an asset? Explain in light of your findings in part (a).

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Basic Bond Valuation

Complex Systems has an outstanding issue of $1,000-par-value bonds with a 12% coupon interest rate. The issue pays interest annually and has 16 years remaining to its maturity date.a) If bonds of similar risk are currently earning a

10% rate of return, how much should the Complex Systems bond shall sell today?

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b) Describe the two possible reasons why the rate on similar-risk bonds is below the coupon interest rate on the Complex Systems bond.

c) If the required return were at 12% instead of 10%, what would the current value of Complex Systems’ bond be? Contrast this finding with your findings in part (a) and discuss.