FEU-FERN COLLEGE

DEPARTMENT OF ACCOUNTS AND BUSINESS

QUEZON CITY

CAPITAL MARKETS

BOND MARKET

Submitted by: JOHN PAUL s. POLINAR

Submitted to: DR. EMILIA MANANGHAYA

Professor

Bond Market
The bond market (also known as the credit, or fixed income market) is a financial market where participants can issue new debt, known as the primary market, or buy and sell debt securities, known as the Secondary market, usually in the form of bonds. The primary goal of the bond market is to provide a mechanism for long term funding of public and private expenditures.

What is a BOND?
A bond is a debt security, in which the authorized issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay interest (the coupon) to use and/or to repay the principal at a later date, termed maturity. Thus a bond is like a loan: the holder of the bond is the lender (creditor), the issuer of the bond is the borrower (debtor), and the coupon is the interest. Bonds issued by corporations or the US government are usually taxable. Bonds issued by state governments or municipalities are usually exempt from tax.

Components
The issuer, one who issues the bond Principal amount Specified interest rate; paid to the issuer yearly (also known as the coupon) Date of maturity

Types of Bond Market

The Securities Industry and Financial Markets Association (SIFMA) classify the broader bond market into five specific bond markets. Government & Agency Corporate Municipal Mortgage backed, asset backed , and collateralized debt obligation Funding

Government & Agency Market

Securities issued by the government thru its Treasury department. Bureau of Treasury is the one managing this operation in the Philippines. The Treasury Department is the executive agency responsible for promoting economic prosperity and ensuring the financial security of the nation. The Department is responsible for a wide range of activities such as advising the President on economic and financial issues, encouraging sustainable economic growth, and fostering improved governance in financial institutions. The Department of the Treasury operates and maintains systems that are critical to the nation's financial infrastructure, such as the production of coin and currency, the disbursement of payments to the public, revenue collection, and the borrowing of funds necessary to run the federal government.

Types of Government Securities

Discount Securities pay only a contractually fixed amount at maturity, called maturity value or face value. Usually with maturities of 1 year or less Also called Treasury Bills

Coupon Securities pay interest every 6 months, plus principal at maturity. Also called Treasury Bonds

Automated Debt Auction Processing System (ADAPS)

Automated Debt Auction Processing System (ADAPS) is an electronic mode by which the National Government sells government securities to a network of GSEDs which are linked to the BTr through BIS every Monday for Treasury Bills and every second and fourth Tuesday for Treasury Bonds, whereby GSEDs tender their bids (both competitive and non-competitive) by keying-in the amount (minimum of P10.0 M) and yield of their choice (for a maximum of seven (7) competitive bids and one (1) non-competitive bid per tenor for any amount above P10.0 M) using a BIS terminal in the GSED office. Within seconds the bids are arrayed by the System in the terminals of the BTr. After the cut-off time of 1:00 P.M. the array is viewed by the Auction Committee which then decides on the award. The award is keyed-back to the respective terminal of GSEDs. Two days after the auction, the government securities are credited to the Securities Principal Account of the GSED in the Registry of Scripless Securities (RoSS) and the Demand Deposit Account of the GSED at Bangko Sentral ng Pilipinas is debited in favor of the Treasurer of the Philippines for the cost of the government securities awarded to the GSED concerned. This completes the trade in the primary market (from the issuer the National Government to the licensed dealers or GSEDs). This is also known as origination of GS.

Over-the-Counter (OTC)
Over-the-Counter (OTC) ) is another mode of originating GS for specific investors, namely, the Government Owned or Controlled Corporations (GOCC), the Local Government Units (LGU) and the Tax Exempt Institutions (TEI), e.g., pension funds, GSIS, SSS, etc.. It is non-competitive. The Over-the-Counter is open every day. The applicable yield rates for Treasury Bills issued to GOCCs/LGUs/TEIs shall be based on the rate of the immediately preceding Treasury Bill auction. For GOCCs, the rate shall be the lowest accepted yield rate, for LGUs, the weighted average yield rate and for TEIs, the yield shall be 90% of the weighted average yield rate. Treasury Bonds issued to GOCCs/LGUs/TEIs shall be priced based on the current market yield. The coupon rate for GOCCs and LGUs shall be based on the rate corresponding to the auctioned Treasury Bonds. The applicable coupon rate for TEIs shall be based on the 90% of the coupon rate.

Corporate Bond Market

A corporate bond is a bond issue by a corporation. It is a bond that a corporation issues to raise money in order to expand its business. The term is usually applied to longer-term debt instruments, generally with a maturity date falling at least a year after their issue date.

Markets for Corporate Debts

Commercial Paper market Bank loan market Equipment leasing market Bond market Medium-term note market Asset-backed securities market

Credit Ratings
A credit rating evaluates the credit worthiness of an issuer of specific types of debt, specifically, debt issued by a business enterprise such as a corporation or a government. It is an evaluation made by a credit rating agency of the debt issuers likelihood of default. Each of the agencies assigns its ratings based on an in-depth analysis of the issuer's financial condition and management, economic and debt characteristics, and the specific revenue sources securing the bond.
Moody's S&P Fitch

Long-term Short-term Long-term Short-term Long-term Short-term Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa3 Ba1 Ba2 Ba3 B1 B2 B3 Caa1 Caa2 Caa3 Ca C Not prime P-3 P-2 P-1 AAA AA+ AA AAA+ A ABBB+ BBB BBBBB+ BB BBB+ B BCCC+ CCC CCCCC C D / DDD / In default C CCC C In default with little prospect for recovery B A-3 A-1 A-2 A-1+ AAA AA+ AA AAA+ A ABBB+ BBB BBBBB+ BB BBB+ B BSubstantial risks Extremely speculative B Highly speculative Non-investment grade speculative F3 F1 F2 Lower medium grade Upper medium grade F1+ Prime High grade

Bank Loans
As an alternative to the issuance of securities, corporation can raise funds by borrowing from a bank. Or sourcing alternatives which are: Domestic bank; Subsidiary of a foreign bank established in the corporations home country; foreign bank domiciled in a country where the corporation does business; Subsidiary of a domestic bank established in a country where the corporation does business; Offshore or Eurobank.

Types of Corporate Bonds

Corporate debts fall into several broad categories: secured debt vs. unsecured debt senior debt vs. subordinated debt Generally, the higher one's position in the company's capital structure, the stronger one's claims to the company's assets in the event of a default.

Secured Loans
A secured loan is a loan in which the borrower pledges some asset (e.g. a car or property) as collateral for the loan, which then becomes a secured debt owed to the creditor who gives the loan. The debt is thus secured against the collateral in the event that the borrower defaults, the creditor takes possession of the asset used as collateral and may sell it to regain some or the entire amount originally lent to the borrower. Example: Mortgage Loan Nonrecourse Loan Foreclosure Loan Repossession Loan

Unsecured Debts
Unsecured debt refers to any type of debt or general obligation that is not collateralized by a lien on specific assets of the borrower in the case of a bankruptcy or liquidation or failure to meet the terms for repayment. In the event of the bankruptcy of the borrower, the unsecured creditors will have a general claim on the assets of the borrower after the specific pledged assets have been assigned to the secured creditors, although the unsecured creditors will usually realize a smaller proportion of their claims than the secured creditors. In some legal systems, unsecured creditors who are also indebted to the insolvent debtor are able (and in some jurisdictions, required) to set-off the debts, which actually puts the unsecured creditor with a matured liability to the debtor in a pre-preferential position.

Senior Debts
Senior debt, frequently issued in the form of senior notes or referred to as senior loans, is debt that takes priority over other unsecured or otherwise more "junior" debt owed by the issuer. Senior debt has greater seniority in the issuer's capital structure than subordinated debt. In the event the issuer goes bankrupt, senior debt theoretically must be repaid before other creditors receive any payment. Senior debt is often secured by collateral on which the lender has put in place a first lien. Usually this covers all the assets of a corporation and is often used for revolving credit lines. It is the debt that has priority for repayment in liquidation. It is a class of corporate debt that has priority with respect to interest and principal over other classes of debt and over all classes of equity by the same issuer.

Subordinated Debts
Subordinated debt (also known as subordinated loan, subordinated bond, subordinated debenture or junior debt) is debt which ranks after other debts should a company fall into liquidation or bankruptcy. Such debt is referred to as subordinate, because the debt providers (the lenders) have subordinate status in relationship to the normal debt. A typical example for this would be when a promoter of a company invests money in the form of debt, rather than in the form of stock. In the case of liquidation (e.g. the company winds up its affairs and dissolves) the promoter would be paid just before stockholdersassuming there are assets to distribute after all other liabilities and debts have been paid. Subordinated debt has a lower priority than other bonds of the issuer in case of liquidation during bankruptcy, below the liquidator, government tax authorities and senior debt holders in the hierarchy of creditors. Because subordinated debt is repayable after other debts have been paid, they are more risky for the lender of the money. It is unsecured and has lesser priority than that of an additional debt claim on the same asset.

Other Bonds with special features

Convertible and Exchangeable bonds
The conversion provision in a corporate bond issue grants the bondholder the right to convert the bond to a predetermined number of shares of common stock of the issuer. Convertible bond a corporate bond with a call option to buy the common of the issuer. Exchangeable bond grants the bondholder the right to exchange the bond for the common stock of a firm other than issuer of the bond.

Debts with warrants

Warrant grants the holder the right to purchase a designated security at specified price from the issuer of the bond. A warrant is simply a call option.

Putable Bonds
Bond that grants the holder the right to sell the issue back to the issuer at par value at designated dates.

Zero-Coupon Bonds
Zero-Coupon Bonds are issued at a discount to their face value and at the time of maturity, the principal/face value is repaid to the holders. No interest (coupon) is paid to the holders and hence, there are no cash inflows in zero coupon bonds.

Floating-Rate Securities
These are securities that offer interest payments which reset periodically, with rates tied to a representative interest rate index.

High Yield Debt

is a bond that is rated below investment grade. These bonds have a higher risk of default or other adverse credit events, but typically pay higher yields than better quality bonds in order to make them attractive to investors.
A high-yield bond (non-investment-grade bond, speculative-grade bond, or junk bond)

Municipal Bonds Market

Municipal Bond is a bond issued by any local government, or their agencies. Potential issuers of municipal bonds includes cities, counties, redevelopment agencies, special-purpose districts, school districts, public utility districts, publicly owned airports and seaports, and any other governmental entity (or group of governments) below the state level. Municipal bonds may be general obligations of the issuer or secured by specified revenues.

Types of Municipal Securities

Tax-Backed Debt are debt instruments which is secured by some form of tax revenues Revenue Bond bonds intended for either projects or enterprise financings. The bond issuer pledges to the bondholders the revenues generated by the operating projects financed.

Residential Mortgage Market

Is a collection of markets, which a primary market and secondary where mortgages are traded. A mortgage is a pledge of property to secure payment of a debt. Typically, property refers to real estates. If the property owner (the mortgagor) fails to pay the lender (mortgagee), the lender has the right to foreclose the loan and seize the property in order to insure that it is repaid.

Types of Residential Mortgage Loan

Lien Status - Indicates the loans seniority in the event of the forced liquidation of the property due to default by the obligor. o First Lien the lender would have first call on the proceeds of the liquidation of the property if it were to be repossessed. o Second Lien (Junior Lien) the claims of the lender on the proceeds in the case of liquidation comes after the holders of the first lien are paid in full. Interest rate type - Loan that carries interest rate. Two types of note rate on a mortgage loan are: o Fixed-rate mortgage (FRM) the interest rate of this loan is set at the closing of the loan and remains unchanged over the life of the loan. o Adjustable-rate mortgage (ARM) the rate changes over the life of the loan based on the both movement of index or reference rate, and spread over the margin index

Amortization type - Is the amount of the monthly payment that represents the
repayment of the principal borrowed.

Credit Guarantee - A credit guarantee is a form of insurance that helps to protect the interests of a seller from the chance of non-payment by a buyer. This type of coverage is often utilized when goods are imported, affording the exporter a degree of protection that would be difficult to achieve otherwise. Loan Balance - Is the maximum amount intended by the bank for the creditor to be his
loan. He could use this amount from time to time.

Prepayments and prepayment penalties - The amount of the payment made in

excess of the monthly mortgage payment.

Risk Associated with Investing in Bonds

Interest Rate Risk The price of the bond will change in the opposite direction from the change in interest rate. As interest rate rises the bond price decreases and vice versa. If an investor has to sell a bond prior to the maturity date, it means the realisation of capital loss. Reinvestment Income or Reinvestment Risk The additional income from such reinvestment called interest depends on the prevailing interest rate levels at the time of reinvestment. Call Risk The issuer usually retains this right in order to have flexibility to refinance the bond in the future is market interest rate drops below the coupon rate Disadvantage for investors for callable bond: cash flow pattern not known with certainty, interest rate drop, and capital appreciation will reduce. Credit Risk If the issuer of a bond will fail to satisfy the terms of the obligation with respect to the timely payment of interest and repayment of the amount borrowed. Yield = market yield + risk associated with credit risk Inflation Risk Purchasing power risk arises because of the variation in the value of cash flow from the security due to inflation. Exchange Rate Risk Risk associated with the currency value for non-local denominated bonds. Liquidity Risk It depends on the size of the spread between bid and ask price quoted. Wider the spread is risky. For investors keeping till maturity, this is unimportant. Market to market should be calculated portfolio value. Volatility Risk Value of bond will increase when expected interest rate volatility increases.