Bond Concept II Ringgit Bond Market Knowledge: 1.

Over-The-Counter (OTC) market is a security traded through a dealer network as oppose to centralized exchange or Exchange House. In general, the reason for which a stock is traded over-the-counter is usually because the company is small, making it unable to meet exchange listing requirements. OTC market classified as secondary market while Exchange House classified as primary market. 2. ETP stands for Electronic Trading Platform which introduce by BNM in March 2008 for the

purpose of boost liquidity and transparency, as well as efficiency in bond trading market. Through infrastructure enhancement initiatives market accessibility and trading efficiency can be further improve as in line with the ongoing commitment. This platform allows dealers to match bids with offers, negotiate deals and access historical data through a common computerized network. ETP facilitates the trading and reporting of all secondary market activities. The functions of ETP are: central order book for matching, trade reporting and negotiation comprehensive dissemination system for price/yield and trade information dissemination data storage for market history data referential maintenance for exchange administrator real time market surveillance system Fully Automated System for Tendering (FAST) is the core ETP system which interfaces with other system and information vendors. 3. Brokers and dealers are terms associated with securities. The main difference between a broker and a dealer is in respect of their role in the market, as well as the capital required. A broker is a person who executes the trade on behalf of others, whereas a dealer is a person who trades business on their own behalf. A dealer is a person who will buy and sell securities on their account. While a broker is one who will buy and sell securities for their clients. Brokers do not have any assets, but only act as intermediary between sellers and buyers and regard to their service, a broker will be paid a commission of fees. Meanwhile, a dealer is a primary principal where they will have their own assets which they sell at a larger stage. Thus, they will not be paid a commission. When we speak about experience, dealers have a more experience compared to a broker. Main broker houses in the Ringgit Bond Market: i. ii. AFFIN BANK BERHAD AFFIN INVESTMENT BANK BERHAD

iii. iv. v. vi. vii. viii. ix. x. xi. xii.

AFFIN ISLAMIC BANK BERHAD AFFIN MONEYBROKERS SDN BHD ALLIANCE BANK MALAYSIA BERHAD ALLIANCE INVESTMENT BANK BERHAD ALLIANCE ISLAMIC BANK BERHAD AMANAH BUTLER MALAYSIA SDN BHD AMBANK (M) BERHAD AMINVESTMENT BANK BERHAD AMISLAMIC BANK BERHAD ASIAN FINANCE BANK BERHAD

4. Bonds are quoted in hundreds but in denomination of thousands. Bond quote of 87.5 is means the bond price is RM875.0 at bond market. A buyer would pay for a bond at the higher price is called as bid price. When someone sells a bond whose market price is 94, the highest point that a buyer would offer would be $945.00 per bond. The term "bid" comes from the fact that market makers are making a bid on the bond of the seller own. Basically, it's the price that seller willing to give for the bond. While the ask price is the lowest price offered for a bond by the seller. An investor that buys a bond with a bid of 94 and an ask price of $94 5/8 would pay for the bond at $946.25 (the lowest price that a seller of this bond will accept). Value date refers to the delivery date of funds traded. In the case of savings bonds, the interest is compounded semi-annually so the value date is every six months. This removes any uncertainty for investors because their calculations of interest payments will be the same as the governments. The date on which security transactions are settled is the settlement date. Settlement is generally three business days after the trade. The term refers to the date on which the actual transfer of cash and securities involved in a trade actually takes place. 5. Unit-trust is an SEC-registered investment company which purchases a fixed, unmanaged portfolio of income-producing securities and then sells shares in the trust to investors. Unittrusts typically incur lower annual operating expenses since they are not buying and selling shares. However, Unit-trusts often have sales charges and entrance/exit fees. The trust is one that invests only in tax-free securities, and then the income from the trust is also tax-free. A unit investment trust is generally considered a low-risk, low-return investment. Open-end fund is a type of mutual fund that does not have restrictions on the amount of shares the fund will issue. If demand is high enough, the fund will continue to issue shares no matter how many investors there are. Open-end funds also buy back shares when investors wish to sell.

A close-end fund is mean a fund with limited number of units in issue and has limited offered period. A closed-end fund also differs from a mutual fund in that it may issue senior securities such as preferred stocks or bonds. The price of a share in a closed-end fund is determined entirely by the market and is not directly related to the NAV per share. Shares of a closed-end fund may sell at a discount or premium to the NAV. The process of buying or selling shares of a closed-end fund is identical to the purchase or sale of any other listed stock. Closed-end mutual funds are actively managed. Unit trust funds in Malaysia: i. ii. iii. iv. v. AFFIN FUND MANAGEMENT BERHAD ALLIANCE INVESTMENT MANAGEMENT BERHAD AMANAH MUTUAL BERHAD AMANAH SAHAM KEDAH BERHAD AMANAH SAHAM NASIONAL BERHAD

6. Mark-to-market is a term refers to current market value instead of its acquisition price or book value used in a process of daily revaluation of a securities market. Management controls should provide for independent market risk management which is mark-to-market mechanisms at the firm to develop and monitor the application of risk limit policies, to review and approve pricing models and valuation systems for use by front and back office staff, to re-assess such systems from time to time as appropriate, to monitor for significant variances in the volatilities, and to carry out stress simulations. Firms on both an entity and a group basis should have the capability to make accurate risk valuations daily, using an acceptable pricing methodology to mark-to-market and to identify concentrations. Potential exposures to credit and market risk should also be calculated using appropriate methodologies. Exposures may be aggregated provided netting arrangements are acceptable and enforceable. Arrangements should be made to value dynamic portfolios sufficiently frequently to address exposures taking into account legal netting arrangements. Outputs of simulations should be tested against actual results and adjusted accordingly. 7. When quoting the price or yield of a Treasury, all market commentary refers to the on-the-run issue. The on-the-run bond or note is the most frequently traded Treasury security of its maturity. Because on-the-run issues are the most liquid, they typically are a little bit more expensive and, therefore, yield less than their off-the-run counterparts. All bonds and notes issued before the most recently issued bond or note of a particular maturity. Off-the-run securities are less frequently traded; they typically are less expensive and carry a slightly greater yield.

Basic Interest Rate Concept and Understanding: 1. OPR is stand for Overnight Policy Rate. OPR is used as indicator of the monetary policy stance. According to BNM, the OPR will have a dual role as a signaling device to indicate the monetary policy stance and as a target rate for the day-to-day liquidity operations of the Central Bank. Any change in the monetary policy stance would be signaled by a change in the OPR. It will serve as the primary reference rate in determining other market rates in Malaysian Financial Market. As to reflect the unchanged stance of monetary policy, the OPR will be set at the current interbank overnight rate of 2.70%. 2. The Kuala Lumpur Interbank Offered Rate, or KLIBOR, is the average interest rate at which term deposits are offered between prime banks in the Malaysian wholesale money market or interbank market. 3. Interest Rate Swap (IRS) is an agreement between two parties (known as counterparties) where one stream of future interest payments is exchanged for another based on a specified principal amount. Interest rate swaps usually exchange a fixed payment for a floating payment that is linked to an interest rate (most often the KLIBOR). A company will use interest rate swaps to limit or manage exposure to the fluctuations in interest rates, or to obtain a marginally lower interest rate than it would have been able to get without the swap. 4. Ask price is the lowest price offered by the dealer. It's basically the amount that the market makers are "asking" the buyer to give for the stock. So the buyer would have to buy the security at ask price which is 5% of the principal price with the dealer. The bid is the price that the seller can sell the stock for. The term bid comes from the fact that dealers are making a bid on the stock of the seller. According to the question, the seller has to sell the stock at the 4.95% which is the lowest price set by the dealer. 5. As we refer to the question, I own RM 1 Million worth of bonds that give me a fixed rate coupon payment for 3 years. These bonds will be less valuable if the interest rate is predicted to increase within 3 years period. By swapping this fixed rate coupon payment, an exchange for a floating rate if interest with the fixed rate coupon that I have now would be profitable. Thus, I could receive a higher yield if the buyer agrees to pay the floating interest rate of KLIBOR and I will pay to the buyer the fixed rate of coupon. Engaging in swap can help resolve the involvement of interest rate risk.

Basic Bond Pricing Mathematics: 1. a) A callable bond of municipal, corporate, federal agency or government security gives the issuer of the bond the right to redeem it at predetermined prices at specified times prior to maturity. Meanwhile the period before the bonds can be called is a non-callable period which called as lockout period. The bonds then are a callable bond after the lockout period.

b) Bondholder has an option to redeem the bond where the issuer have to repurchase the security at a specific date before the maturity date at a predetermine price. Somehow, the price that bondholder redeemed usually at par value due to opportunity cost of the yield for the puttable bonds. c) The convertible bonds have the value like all bonds where it depends on the level of prevailing interest rates and the credit quality of the issuer. The exchange feature of a convertible bond gives the right for the investor to convert the par amount of the bond for common shares a specified price or "conversion ratio". Conversion ratio gives the right to the investor to convert RM100 par amount of the convertible bonds into its conversion ration of RM25 per share. This conversion ratio would be said to be 4:1" or "four to one". d) Amortizing bond is a financial certificate that has been reduced in value for records on accounting statements. An amortized bond is one that is treated as an asset, with the discount amount being amortized to interest expense over the life of the bond. If a bond is issued at a discount that is offered for sale below its par, the discount must be treated either as an expense or it can be amortized as an asset. e) An inflation-linked bond is a bond that provides protection against inflation. In most countries, the Consumer Price Index (CPI) or its equivalent is used as an inflation proxy. As the principal amount rises with inflation, the rate of interest is applied to this increased amount. So, this causes the interest payment to increase over time. At maturity, the principal is repaid at the inflated amount. In this fashion, an investor has complete inflation protection, as long as the investor's inflation rate equals the CPI. f) Asset-Backed Securities (ABS) is securities which are based on pools of underlying assets. These assets are usually illiquid and private in nature. The "pooling" of assets occurs to make the securitization large enough to be economical and to diversify the qualities of the underlying assets. A securitization occurs to make these assets available for investment to a much broader range of investors. ABS is essentially the same thing as mortgage backed security except that the securities backing it are assets such as loans, leases, credit card debt, a company's receivables, royalties and so on, and not mortgage-based securities. g) A perpetual bond has no maturity date as long as the issuer holds the principal amount of the bonds. The issuer does not repay the principal but a perpetual bond pays the bondholder a fixed coupon. When interest rates rise, perpetual bonds fall and vice versa because prices for perpetual bonds vary widely according to long-term interest rates.

2.

Yield to maturity (YTM) is defined as the interest rate that makes the present value of a bonds payments equal to its price. According to the formula above, the compounding feature of the YTM is the nominal interest rate for every year until the maturity date. This is because, in bonds the coupon payment is reinvested thereby increasing your bond amount by the coupon each time it is paid. In this case, the bondholder will be earning interest on interest in bond investment. 3. The accrued interest on a bond is the amount of interest that has been deemed to have cumulated on the bond, but which has not been paid yet. Clean price = Dirty price Accrued interest B =

AI

As referred to the formula above, clean price is the actual price that will be paid that is dirty price less the accrued interest. The reason markets use clean prices is that the dirty prices fluctuate with interest payments. This means that clean prices show the underlying trend in prices more clearly. 4. Let B P C t n i = bond price = principal amount = coupon rate = time = maturity date = market interest rate

So,

B=

If the coupon paid semi-annually, thus the formula as below;

B=

5. Yield = 6.228% Coupon = RM 6 Years to Maturity = 10 yr Face Value = RM 100 Coupon Pmt = Semi-annual

B=

Year 0 1 2 3 4 5 6 7 8 9 10

PVIFA 0.000 1.910 3.707 5.397 6.986 8.481 9.887 11.209 12.452 13.622 14.722

Bond CF 0 3 3 3 3 3 3 3 3 3 3

PVIF 1 0.941 0.885 0.832 0.782 0.736 0.692 0.651 0.612 0.576 0.542

PV 100 99.782 99.577 99.385 99.204 99.033 98.873 98.722 98.580 98.447 98.322

So, price of the bond is 98.322. 6. Zero coupon bonds Yield = 3.5% Face Value = RM 100 Years to Maturity = 10 yr Coupon Payment per year = Semi-annual Bond Price =

= 54.15

7. The yield to call is the rate of return that an investor would earn if he bought a callable bond at its current market price and held it until the call date given that the bond was called on the call date. It represents the discount rate which equates the discounted value of a bond's future cash flows to its current market price given that the bond is called on the call date.