This is a brief description of what a bond pricing agency is all about and it can do for the debt capital market
Welcome message from author
This document is posted to help you gain knowledge. Please leave a comment to let me know what you think about it! Share it to your friends and learn new things together.
Transcript
Bond Pricing Agency ……In the overall scheme of things,
�Bond Pricing, Current Practice and Pricing Issues
Bond Market Growth in Malaysia
The Malaysian bond market has seen tremendous growth over the past years
� Private Debt Securities (PDS) emerged as the largest source of private sector financing in the aftermath of the 1997 financial crisis
� It was reported that Malaysia’s Islamic bond market grew over 80% over the last 5 years, with a 96% y-o-y growth in long term PDS market for the year 2007
� Malaysia accounts for two thirds of global Islamic bonds outstanding in 2007
� Combinations include:�Al Bai BithamanAjil & Bai Einah�Mudharabah & Murabahah�Murabahah & Bai Al Dayn�Murabahah & Musyarakah�Murabahah & Ijarah�Istisna & Mudharabah
AGENDA
� Bond Market Growth in Malaysia
�What Is A Bond Pricing Agency
� Introducing Bondweb Malaysia Sdn Bhd
� Pricing Methodology
�Bond Pricing, Current Practice and Pricing Issues
The purpose of today’s presentation is to discuss on current bond pricing mechanisms and its application now and in the future.
�Bond Pricing, Current Practice and Pricing Issues
What Is A Bond Pricing Agency
A bond pricing agency (BPA) is a market neutral entity whose role is to provide fair valuations on bonds, complying with regulations issued by the Securities Commission
The Solution
�The BPA evaluates about 2,000+ bonds that are not traded on any given day, based on the market prices
�The BPA needs to employ reliable database and evaluation methodology. This methodology MUST be transparent and consistent
Problem
Less than 1% are traded, where are the prices for the remaining 99%?
The Need
Daily valuation of bond portfolios for NAV calculation and portfolio valuation
�Korea Bond Pricing�KIS Pricing, Inc�NICE Pricing Services, Inc
Malaysia
�Bondweb Malaysia Sdn BhdMexico
�Two price vendors under the purview of Banco De Mexico
MexicoMalaysia
Indonesia (in development)
Egypt (in development)
Thailand
�Thai Bond Market Association (SRO)
What Is A Bond Pricing Agency
BPAs are an important infrastructure to a country’s capital market in particular to emerging markets where there is uncertainty in fair valuations and illiquidity. Key benefits include:
Revitalizing the
Secondary
Market for Bonds
�BPA valuation approved by the SC may revitalize the bond market using mark-to-market prices as benchmark by publicly announcing them
�Marking-to-market system provide strategy alternatives to traditional hold-to-maturity strategies.
Revitalizing the
Primary Market
for Bonds
�From an origination and underwriting perspective, primary level pricing becomes challenging especially for lower credits
�Mark-to-market pricing on previously issued corporate bonds can promote new corporate bond issues by functioning as benchmarks for primary level pricing
�BPA’s transparency in the methodologies being used will spur the evolution of the bond market with further advance pricing methodologies
�When advance pricing methodologies are established, it will encourage more bond offerings and more active trading of these products in the secondary market.
Improving the
Soundness of
Financial
Institutions
�Providing price discovery may assist in financial institutions' compliance to international standards such as IAS 39 and Basel 2 requirements.
�Effectiveness of risk management will be further enhanced as the valuation process will be consistent and not arbitrary
AGENDA
� Bond Market Growth in Malaysia
�What Is A Bond Pricing Agency
� Introducing Bondweb Malaysia Sdn Bhd
� Pricing Methodology
�Bond Pricing, Current Practice and Pricing Issues
The purpose of today’s presentation is to discuss on current bond pricing mechanisms and its application now and in the future.
participants on market issues and newsparticipants on market issues and news
��To participate with the market in enhancing the To participate with the market in enhancing the
standards of pricing, trading and structuring fixed standards of pricing, trading and structuring fixed
income instrumentsincome instruments
Participating in the fostering of the bond market’s advancement
Introducing Bondweb Malaysia Sdn Bhd
BWM was established in 2004
�A market neutral joint venture providing bond pricing and information services between:� Rating Agency Malaysia Consultancy Sdn Bhd� Mainstream and Co., Ltd (Korea)� Lembaga Tabung Angkatan Tentera (LTAT) � UTIX Sdn Bhd (Usaha Tegas)� PacificMas Berhad� Malaysian Trustees Berhad
�With participation from:� MARC on data and technical support � SC and BNM in observer and advisory role� Market community (buy/sell side, brokers) via
Began groundwork in MalaysiaDiscussions with SC and BNMMarket study and research
2001
-
2004
Sept: Bondweb Malaysia Sdn Bhdestablished
2004
March: BWM website launchedJuly: Bondstream pilot launchSept: Full marked-to-market processOct: Commercial deployment of
� Market community (buy/sell side, brokers) via “Bottom Up” approach
�Adhered to strict SC requirements to qualify as BPA:� Audited methodology and process� Three months market acceptance test� RM10 million minimum paid up capital and professional indemnity insurance
� No controlling shareholdersStatus as at June2008:
Delivery Channels – custom designed software tool BondStream
�Bond Database� Stock Info� Facility Info� Rating Info� Bond Statistics � Statistics database� Corporate info database� Islamic bond data
�Trading data� Real-time Quotes� Daily trading activity� Historical trades back to 2000
�Analysis Tools� Bond Analysis Tools� Bond Calculator� W.I Simulator� Favourite bonds� Bond Advanced Search� Bond Trade search� Custom Report generator
�Market is not liquid, trade frequency is low. Still, trade prices (if properly monitored) can provide information for pricing.
2. Credit Model
�Mathematical Model does not provide market price.�Mathematical Model provides the framework to derive the risk premium/spread in the market. Selective Group of Contributors monitor individual bond value on an on-going basis.
Model Approach
(Mark To Model)
Hybrid Approach
Liquidity risk model
Credit risk model
Term structure model
Pricing Methodology
BWM’s Pricing Methodology – An Overview
Bond Price = f ( Benchmark Rates + Credit Spread )
�BWM uses the prices of observed trades & quotations in the market to derive the prices of non-traded bonds, taking into account the differences between different issuers and structures.
�EVERY bond has its own individual spread relative to its risk status.
credit score�Structure�Industry�Observation from past
�trades
Any trading data
Trade DataAggregation
Pricing Methodology
Define Matrix Segment Classes
Data is segmented into classes and ranked according to its credit quality and liquidity performance
Notation Descriptionsf Coupon payment frequency in a yearc Coupon rateF Face amount = Notionaly Yield *AI Accrued InterestD No. of days in one regular coupon
periodD2 No. of days between the value date and
the next coupon Daten Last coupon periodE / U No. of days between the pseudo issue /
real last coupon date and the real first coupon / pseudo maturity date (short first / last coupon)
* Price computed using yield derived from the (credit spot rate at discount period t + individual spread)
first / last coupon)
No. of days between the pseudo issue / pseudo last coupon date and the pseudo first coupon / pseudo maturity date (long first coupon)
FIF / LIF No. of days between the real issue date / real last coupon and the real first coupon / real maturity date(Short First / Last Coupon Bond)
No. of days between the real issue / pseudo last coupon date and the pseudo first coupon / real maturity date (Long First / Last Coupon Bond)
AI
f
y
f
y
f
yE
Dnk E
DkE
D−
×+
+
×+
+
×++−
=+−
∑)21(
2)21(2
)1
1001()
1
1001()
1
1001(
AI
f
y
F
f
y
U
LIF
fF
c
f
y
fF
c
UD
U
LIFn
UD
U
LIFn
n
k DDk
−
×+
+
×+
×××
+
×+
××
++−++−
−
=+−
∑)21()21(
1
1)21(
)1
1001()
1
1001(
1
100
)1
1001(
1
100
Eg3 : Fixed coupon bonds long first coupon
Notation Descriptionsf Coupon payment frequency in a yearc Coupon rateF Face amount = Notionaly Yield *AI Accrued InterestD No. of days in one regular coupon
periodD2 No. of days between the value date and
the next coupon Daten Last coupon periodRPi Remaining principal at future time ti
In monitoring pricing performance, BWM provides feedback channels to encourage interaction with market participants. Key issues are announced to pricing customers and through website
Pricing Methodology
Daily ProcessBackground Study
Define Matrix
Segment Classes
Populate Info
Into Segments
Build Yield
Curves
Assign
Individual
Spread
Price All Bonds
Public AnnouncementPublic Announcement
�BWM shares the pricing process
Feedback ProcessFeedback Process
�� Officials verbal, web Officials verbal, web Internal Quality Internal Quality
�Bond Pricing, Current Practice and Pricing Issues
Bond Pricing, Current Practice and Pricing Issue
Sophisticated pricing methodologies are not used due to the lack of transparent data. Advanced pricing methodologies are still in primitive development.
Example: Pricing of option embedded bonds – current practice
� Current market practice is to price option embedded bonds to the first call� Cash flow after first call is discarded� Assumption is flawed� There are also no difference in pricing of American, European and Bermudan option
datecallfirstnwhere
AI
f
y
F
f
y
fP
DDnk D
Dk
=
−
×+
+
×+
=+−=
+−∑
'
)1
1001()
1
1001(
100
)21'(1)21(
Bond Pricing, Current Practice and Pricing Issue
Theoretical Method in Pricing of Bonds with Embedded Options
Example: Pricing of option embedded bonds – One Factor Hull & White Trinomial Tree
1) The price of option embedded bond can be computed by backwardation through an interest rate tree as follows:
P(T+1;mid)
P(T+1;dw)
P(T)
P(T+1;up)At time T, the non-exercise price can be computed by:
If the option is call and the exercise price at T is C, then the price of option bond at T can be determined as follows:
F Face amount = Notionaly YieldD No. of days in one regular coupon periodD2 No. of days between the value date and the next payment daten Last payment periodP Clean Price
SN
SN
SN
PN
SN Secondary
Note
PNPrimary
Note
� Secondary Note in Islamic structure acts as the fixed profit payment as agreed in the contract.
� Cash flow rate in Islamic structure derived as the ratio between the secondary note amount and the primary note amount
� Primary amount is the face amount
� Inclusion of asset volatility
� Term structure of asset
� Floating rate mechanism for the forward rate
Bond Pricing, Current Practice and Pricing Issues - Islamic
Islamic and conventional bonds are fundamentally different in both structure and thus valuation
Islamic Bond Differences from Conventional Bonds
� Not an exchange of paper or money but an exchange of Syariah approved assets
� In principle, Islamic bond structure is similar to asset securitisation
� Differing market perception resulting in differentiated trading behaviour – liquidity, risk premium, etc.
� No imposition of interest but uses secondary notes as profit
� Not necessarily. BWM’s prices are based on is own opinion. Each portfolio manager should assess BWM’s prices and use their own judgment in applying the prices.
5. Does BWM listen to pricing opinions from clients?� Yes. BWM is always eager to get customer’s feed-back and different pricing
opinions. If BWM decides to re-adjust its valuation after a feed-back, the result will be shared with all customers.