What is a Bond Pricing Agency

Published on March 2017 | Categories: Documents | Downloads: 41 | Comments: 0 | Views: 340
of 61
Download PDF   Embed   Report

Comments

Content

Bond Pricing Agency
……In the overall scheme of things, now and across the horizon

RAM Economic Series June 2008
20 June 2008 Meor Amri bin Meor Ayob

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Fundamentals of the Market
The Full Circular Flow
Goods and services Buyer And Seller Money Medium Of Exchange

PRICE
Resources (Input)

Production and Distribution

People (Consumers)

Goods and Services (Output)

Money

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

AGENDA
The purpose of today’s presentation is to discuss on current bond pricing mechanisms and its application now and in the future.

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

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

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
96% y-o-y growth in Islamic PDS

Binariang GSM’s Senior Islamic bond issuance worth RM20 billion is the largest corporate bond issue in Malaysia yet

* Long term PDS are notes that are above 1 year in tenure and would naturally exclude commercial papers, BNM notes, repos and other related papers

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Bond Market Growth in Malaysia
Activity in the secondary market has been consistent
Despite the growth in bond issuances, liquidity and activity in the secondary market has not grown in tandem Liquidity has been observed to be active for better credit quality papers Key issue in the lack of liquidity is price and information transparency

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Pricing Process
Bond types identified and priced by BWM in the MYR market:
Discount Bonds Bullet Bonds Fixed Rate Bonds Amortizing Bonds Callable Bonds Convertible Bonds Exchange Bonds Bond with Warrants Fixed Rate ABS Callable ABS Fixed Rate MBS Callable MBS Stepping FRB Floating Rate Notes Floating Amortizing Notes Floating Rate ABS Floating Rate MBS Bond with Secondary Notes Amortizing Bonds with Secondary Notes Callable Amortizing Bonds Stepping Amortizing Bonds Callable Stepping Bonds Callable Stepping Amortizing Bonds Convertible Stepping Bonds Callable Bonds with Secondary Notes Convertible Bonds with Secondary Notes Callable Amortizing Bonds with Secondary Notes Stepping Amortizing Bonds with Secondary Notes Callable Discount Bond Callable Convertible Discount Bond Callable Stepping Bonds with Secondary Notes Exchangeable Stepping Bonds

As of June 2008
Total stocks in the market: Total stocks priced by BWM: 2717 1930

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Bond Market Growth in Malaysia
A number of Islamic concepts have been applied in the structuring of Islamic bonds
Islamic concepts applied in various bonds : Al Bai Bithaman Ajil Al Qardhul Hasan Bai' Bi Al-Taqsit Bai Dayn Bai Dayn & Murabahah Bai-Al-Einah Ijarah Istisna Mudharabah Murabahah Musyarakah Combinations include: Al Bai Bithaman Ajil & Bai Einah Mudharabah & Murabahah Murabahah & Bai Al Dayn Murabahah & Musyarakah Murabahah & Ijarah Istisna & Mudharabah

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

AGENDA
The purpose of today’s presentation is to discuss on current bond pricing mechanisms and its application now and in the future.

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

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

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 Problem Less than 1% are traded, where are the prices for the remaining 99%? 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 Increase Transparency BPA Managing & Monitoring Risk Compliance & Audit Increase Liquidity

The Need Daily valuation of bond portfolios for NAV calculation and portfolio valuation

Current method Quotes from brokers or banks, a few via internally generated models – bias?

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

What Is A Bond Pricing Agency
LAST TRADE MTM YIELD PRICE LAST TRADE YIELD

BOND NAME

VALUE DATE

MTM PRICE

LAST TRADE DATE

MGS 1/1987 7.600% 15.03.2008 MGS 2/1988 6.450% 01.07.2008 MGS 4/2003 3.917% 30.09.2008 MGS 3/1988 6.450% 30.11.2008 MGS 6/1998 7.005% 10Y 15.12.2008 KLIA 7.750% 17.01.2015 PN GII 1/2003 0.00000% 31.03.2008 GII 3/2004 0.00000% 29.10.2009 GII 2/2004 0.00000% 30.09.2011 SMC 7/2003 11.04.2008

22-Feb-08 22-Feb-08 22-Feb-08 22-Feb-08 22-Feb-08 22-Feb-08 22-Feb-08 22-Feb-08 22-Feb-08 22-Feb-08

100.25 101.1 100.37 102.37 102.92 121.82 99.66 94.4 88.03 100

3.27 3.29 3.3 3.31 3.32 4.09 3.31 3.45 3.57 3.43

100.33 101.2 100.39 102.7 104.98 121.06 98.58 86.93 103.2 99.98

3.47 3.29 3.29 3.7 3.41 5.45 3.56 4.15 0 3.53

13-Feb-08 05-Feb-08 05-Feb-08 22-Nov-07 06-Jul-07 04-Mar-02 31-Oct-07 24-May-06 09-May-07 31-May-07

©CopyrightBONDWEB MALAYSIA SDN.BHD. - All rights reserved. ©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

What Is A Bond Pricing Agency
BPAs are new entities and currently only three countries use the BPA framework

Mexico

Egypt (in development)

Thailand Malaysia

Korea

Indonesia (in development)

Mexico Two price vendors under the purview of Banco De Mexico

Malaysia Bondweb Malaysia Sdn Bhd

Thailand Thai Bond Market Association (SRO)

Korea Korea Bond Pricing KIS Pricing, Inc NICE Pricing Services, Inc

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

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. 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

Revitalizing the Primary Market for Bonds

Promoting New Product Development

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

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

AGENDA
The purpose of today’s presentation is to discuss on current bond pricing mechanisms and its application now and in the future.

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

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Introducing Bondweb Malaysia Sdn Bhd
Bondweb Malaysia (BWM) was incorporated in 2004. We are the pioneering BPA for the Malaysian market.
Under the purview of the Securities Commission Appointed as a BPA by the Securities Commission on April 18, 2006 Met and exceeded the requirements as outlined in the Guidelines on the Registration of Bond Pricing Agencies Fair valuation for the Ringgit bond market Provides independent daily valuations for approximately 2000 MYR fixed income securities A one-stop comprehensive bond information service provider An emphasis on market relevant pricing Alliances with local business partners ensure speedier capturing of price discovery than any available source. Help facilitate finer price discovery hence spurring trading activity that enhances risk management and optimises capital allocation Bondweb user demographics includes Banks, Unit Trust and Asset Managers, Insurers, Government Agencies and Corporations

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Introducing Bondweb Malaysia Sdn Bhd
Vision and mission of Bondweb Malaysia Sdn Bhd

To create an open and low cost bond market information exchange platform accessible to all market players and optimised to local needs To provide a consistent and systematic bond fair valuation infrastructure currently lacking in the Malaysian fixed income market To provide a forum and platform for all market participants on market issues and news

To participate with the market in enhancing the standards of pricing, trading and structuring fixed income instruments

Participating in the fostering of the bond market’s advancement

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Introducing Bondweb Malaysia Sdn Bhd
BWM was established in 2004
2001 2004 Sept: Bondweb Malaysia Sdn Bhd established March: BWM website launched July: Bondstream pilot launch Sept: Full marked-to-market process Oct: Commercial deployment of Bondstream April 18: Appointed Malaysia’s first Bond Pricing Agency January 3 : Guidance Note 15 on Mandatory use of BPA prices by unit trust companies Began groundwork in Malaysia Discussions with SC and BNM Market study and research

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 “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 shareholders

2005

2006

2007

Status as at June2008: > 70 clients (banks, AMC, UTMC, insurance companies, corporate, quasi governments)

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Introducing Bondweb Malaysia Sdn Bhd

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Introducing Bondweb Malaysia Sdn Bhd
BWM’s Pricing Services
3 different delivery modes to suit clients’ requirements BWM provides valuations on a daily basis at INDIVIDUAL bond level A comprehensive data collection, validation, pricing and dissemination process is in place to ensure consistent and market neutral valuations The bond pricing process is transparent and uses global standard pricing models The models are customised to meet the unique needs of the Malaysian market BWM prices unlisted MYR bonds (Conventional and Islamic). For now we do not price short term papers, unrated bonds, loan stocks and listed bonds Web Download
CSV file download

BondStream Pricing Terminal
Excel download

BWM Daily Valuations 6 pm KL Direct Data Feed
File to file transfer direct into client’s system

We incorporate a market feedback mechanism in the event where there are disputes or queries on the prices Intimate local knowledge of the instruments and market structure is vital to ensure credibility of the BPA

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Introducing Bondweb Malaysia Sdn Bhd
Product Lines
Optimised to the needs of market participants
1) Fair Valuation - Daily MTM prices/yields Bond Information - Primary Market Data - Secondary Market Data Reference Pricing Service Bond Index Basel II Support Pack RBC Support Pack Customized Data Delivery
Launched in 2008 Launched in 2005

2)

3) 4) 5) 6) 7)

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Introducing Bondweb Malaysia Sdn Bhd
Delivery Channels – bond information portal at www.bondweb.com.my
News and Research
Market News Market Research from local and international research houses

Secondary Market
Daily Trading Trade Statistics Trading Charts Historical Data

Community
Market Opinion Market Commentary

Yield Analysis
Yield Matrix Yield Curve

Primary Market
Facility Information Stock Information Issuer Financial Information Credit Rating Information Issue Statistics Tender Information

Other Market Information
Money Market Equity Market FX market

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Introducing Bondweb Malaysia Sdn Bhd
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

Analysis Tools
Bond Analysis Tools Bond Calculator W.I Simulator Favourite bonds Bond Advanced Search Bond Trade search Custom Report generator

Trading data
Real-time Quotes Daily trading activity Historical trades back to 2000 Trade map Market depth

Charting
Real-time quote charts Daily charts Yield curves Technical analysis tools

Fair Valuation
Daily MTM prices for MYR unlisted bonds YTM matrices on Conventional and Islamic bonds

Market Data
Indicative Money Market rates Research and commentaries Real time news

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

AGENDA
The purpose of today’s presentation is to discuss on current bond pricing mechanisms and its application now and in the future.

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

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Pricing Methodology
Bond Pricing Approach – Current Industry Practice and the Assumptions
Four common market practices are used in conducting bond pricing. BWM employs the hybrid approach Approach Type
YTM Matrix / Curve Pricing

YTM Matrix / Curve Pricing

Pricing Method
Quote Driven

Granularity
Curve Pricing

Individual Quotation Approach

Individual Quotation Approach Model Approach

Quote Driven

Individual Bond

Theoretical

Individual Bond

Model Approach (Mark To Model)

Hybrid Approach

Hybrid

Individual Bond

Hybrid Approach

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Pricing Methodology
Bond Pricing Approach – Current Industry Practice and the Assumptions

1y

2y 4 4.5 … …

3y 5 … … …

… … … … …

YTM Matrix / Curve Pricing

Quoted Bonds

AAA AA A BBB

3 3.5 … …

Marking to market

Individual Quotation Approach Assumptions: 1.Market Liquidity/Efficiency Contributed Quotations are assumed to be an unbiased market representation. Market is liquid without seasonal effects. 2.Homogeniety Bonds belonging to the same segment are assumed identical. Hybrid Approach

Model Approach (Mark To Model)

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Pricing Methodology
Bond Pricing Approach – Current Industry Practice and the Assumptions

YTM Matrix / Curve Pricing

Quoted Bonds

Traded Bonds

M a p

M a p

Marking to market

Individual Quotation Approach Assumptions: 1.Market Liquidity Efficiency Contributed Quotations are assumed to be an unbiased market representation. Selective Group of Contributors monitor individual bond value on an on-going basis. Individual bonds are assumed to be liquid, where the value of individual bonds are observable.

Model Approach (Mark To Model)

Hybrid Approach

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Pricing Methodology
Bond Pricing Approach – Current Industry Practice and the Assumptions
A n a l y t i c s A n a l y t i c s

YTM Matrix / Curve Pricing

Financial Data Interest Rate Data Asset Value Asset Volatility Recover Rate Risk Free Rate Curve Rate

Liquidity Model Credit Scoring Model Term Structure Model

Marking to market

Individual Quotation Approch

Model Approach (Mark To Model)

Assumptions: 1.Model Is Winner Mathematical model generates price Underlying information is accurate and timely

Hybrid Approach

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Pricing Methodology
Bond Pricing Approach – Current Industry Practice and the Assumptions

YTM Matrix / Curve Pricing

Individual Quotation Approch

Model Approach (Mark To Model)

Hybrid Approach (BWM’s Approach)

Back-test representation of market value by marking to model shows inaccuracies with actual market trades Market is winner not model

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Pricing Methodology
Bond Pricing Approach – Current Industry Practice and the Assumptions
Quoted Bonds

YTM Matrix / Curve Pricing

Traded Bonds

Individual Quotation Approch

Pre and Post Data Pool

Calibrating Implied Risk Premium From Market Data

Marking to market

Credit risk model

Model Approach (Mark To Model)

Liquidity risk model Term structure model

Assumptions: 1. Market Liquidity/Efficiency 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 ongoing basis.

Hybrid Approach

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Pricing Methodology
BWM’s Pricing Methodology – An Overview Bond Price = f ( Benchmark Rates + Credit Spread )

Y i e l d

Derivation of benchmark rate

Credit Risk
Term to Maturity

Liquidity Risk

Risk

Quotations

Segmentation Cube

Individual Bonds

Trades

Measuring the Market Price Of Risk

Individual Bond Valuation

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Pricing Methodology
A daily process is conducted to price all bonds
Background Study
Define Matrix Segment Classes Populate Info Into Segments Build Yield Curves

Daily Process
Assign Individual Spread

Price All Bonds

Segmentation Analysis

Apply filtering and watch list rules

Derivation of individual spread for PDS via:
Application of credit score Structure Industry Observation from past trades

Feedback and Verification with market

Any trading data Trade Data Aggregation

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.

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Pricing Methodology
Define Matrix Segment Classes
Data is segmented into classes and ranked according to its credit quality and liquidity performance
Macro Segmentation Micro Segmentation

Evaluating Risk at Individual Bond Level
Individual Bonds

Issuer Ranking Ranking bonds based on credit analysis and scoring Accounting-based Models (Altman’s type) Market-based Models (Structural model) Ranking bonds based on market liquidity Turnover Trade frequency

Credit Rating/Issuer Type Industry Product Structure Characteristic Liquidity

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Pricing Methodology
Populate Info Into Segments
Data is extracted and mapped to the proper segments
Official Sources
Term Sheet, FAST

BWM Internal Process
Term sheet Enhancement

Data Population
Macro Segment

ETP

Ratings Model Selection

Market Network
Term Sheet, Validation Broker Quotes Pricing Convention Swap Yields Trade Data Enhancement

Micro Segment

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Pricing Methodology
Populate Info Into Segments
Key challenge in data aggregation is
To collect accurate post and pre trading data. To enhance and update securities information on-going basis

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Pricing Methodology
Populate Info Into Segments
Data Filtering will identify trades and quotes that are not representative of current market levels Issues

Outliers from normal trade band

Y I E L D

Solution
Filtering Rule

Out of Credit Rule Liquidity Rule Assignment of Confidence Interval Relative Movement against General Market Direction
Term to Maturity

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Pricing Methodology
Build Yield Curves
Using the filtered data, calibrate risk free and credit curves for MGS and PDS

Calibrating Risk Free Curve from MGS

Bootstrap Calibration
MGS Data

Zero Coupon Yield

Maturity

Calibrating Credit Curve for PDS

PDS Data

Calibrating Risk Premium by each Segment

Credit Curves

Maturity

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Pricing Methodology
Government Bond Pricing
Generation of Spot Yield Curve

Gather Required Info

First Filtering

Validation of Result

Y i e l d

Market Info
Post-trade info from ETP Pre-trade info money brokers Pre-trade info bank contributions

Term to Maturity

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Pricing Methodology
Government Bond Pricing
Generation of Spot Yield Curve

Gather Required Info

First Filtering

Validation of Result

Y i e l d

Exclude Unusual Trades
Cross Trades Odd Lots Off Market Position Parking

Exclude Outliers
Compared to historical trades and quotes Compared to past evaluated yield

Term to Maturity

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Pricing Methodology
Government Bond Pricing
Generation of Spot Yield Curve

Gather Required Info

First Filtering

Validation of Result

Y i e l d

Generate YTM Curve
Zero curve is not directly observable from the market

Obtain Zero Rate From YTM Rate
Reflect the differences of practices in yield calculation (“practices” mean compounding period, day count basis, etc.) Standardise to semiannual basis ACT/ACT Bootstrap

Term to Maturity

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Pricing Methodology
Government Bond Pricing
Generation of Spot Yield Curve

Gather Required Info

First Filtering

Validation of Result

Y i e l d

Loop Back Test
Calibrate YTM / Zero curve to ensure MTM values are market relevant

Term to Maturity

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Pricing Methodology
PDS Credit Curve
Credit Spread Curve Generation

Data Population Into Segment

First Filtering

Validation

Y i e l d

Market Info
OTC trading Money brokers

Segmentation Cube

Term to Maturity

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Pricing Methodology
PDS Credit Curve
Generation of Spot Yield Curve

Data Population Into Segment

First Filtering

Validation of Result

Y i e l d

Exclude Unusual Trades
Cross Trades Odd Lots Off Market Position Parking

Exclude Outliers
Compared to historical trades and quotes Compared to past evaluated yield Out of credit rule

Term to Maturity

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Pricing Methodology
PDS Credit Curve
Credit Spread Curve Generation

Data Population Into Segment

First Filtering

Validation

Y i e l d

Credit Curve
Derive from trade prices in segment Risk free yield from MGS curve

Credit Spread Rule
Risk Free Yield Spread along the maturity Spread by size of risk

Term to Maturity

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Pricing Methodology
Assign Individual Spread
Now that the curves are ready, assign individual spread that reflects the bond’s appropriate risk according to the result from the ranking model

Y I E L D

2i from risk free

Credit risk spread

2 Credit class
curves

1 Risk free interest
rate curve

Y I E L D

Bond A Bond B Bond C Bond D Bond E

Tenor t Term to Maturity Term to Maturity
Curve YTM at Tenor t

Bond Price = f (Risk Free Interest Rate , Risk Spread) Risk Spread = f (Credit, Individual)
Negative Spread

Bond Bond Bond Bond Bond E D B C A

Positive Spread

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Pricing Methodology
Price All Bonds
Apply relevant bond type price formula
Eg1 : Fixed coupon bonds with regular period Notation f c F y AI D D2 n E/U Descriptions Coupon payment frequency in a year Coupon rate Face amount = Notional Yield * Accrued Interest No. of days in one regular coupon period No. of days between the value date and the next coupon Date Last coupon period No. of days between the pseudo issue / real last coupon date and the real first coupon / pseudo maturity date (short 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) 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)

c 1 ×F× F f 100 + − AI ∑ y 1 ( k −1+ D 2 D ) y 1 ( n−1+ D 2 D ) k =1 × ) (1 + × ) (1 + 100 f 100 f
n

Eg2 : Fixed coupon bonds with short first coupon

c c 1 FIF 1 ×F× × ×F× n F f E f 100 100 +∑ + − AI D2 D2 ) 1 1 ( k −1+ E 1 ( n −1+ D 2 E ) y y y E k =2 (1 + × ) (1 + × ) (1 + × ) 100 f 100 f 100 f
Eg3 : Fixed coupon bonds long first coupon

c c 1 LIF 1 ×F× ×F× × n−1 F f f U 100 100 ∑ y 1 (k−1+D2 D) + y 1 (n−1+ LIF +D2 ) + y 1 (n−1+ LIF+D2 ) − AI k =1 (1 + U U U U × ) × ) × ) (1+ (1 + 100 f 100 f 100 f
* Price computed using yield derived from the (credit spot rate at discount period t + individual spread)

FIF / LIF

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Pricing Methodology
Price All Bonds
Apply relevant bond type price formula
Eg4 : Stepping Bonds Notation f c F y AI D D2 n RPi Descriptions Coupon payment frequency in a year Coupon rate Face amount = Notional Yield * Accrued Interest No. of days in one regular coupon period No. of days between the value date and the next coupon Date Last coupon period Remaining principal at future time ti Current/forward coupon rate following convention

ck 1 ×F× F 100 f + − AI ∑ D2 ) y 1 ( k −1+ D y 1 ( n−1+ D 2 D ) k =1 (1 + × ) (1 + × ) 100 f 100 f
n

Eg5 : Amortizing Bonds

1 × RPk × n RPn 100 f + − AI ∑ D2 ) y y 1 ( k −1+ D 1 ( n −1+ D 2 D ) k =1 (1 + × ) (1 + × ) 100 f 100 f
Eg6 : FRN
_

c



Index t

I ndext c 1 1 ×F× ×F× n F f f 100 100 +∑ + − AI D2 ) D2 ) y 1 (k −1+ D y 1 (n−1+D2 D) y 1 ( D k =2 × ) × ) × ) (1 + (1+ (1+ 100 f 100 f 100 f
* Price computed using yield derived from the (credit spot rate at discount period t + individual spread)

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Pricing Methodology
Price All Bonds
Pricing for un-traded or rarely traded bonds
Obtain a base spread from the past real transaction data Track the change of spread over time Estimate the spread of the bond relative to changes in the yield curves and other peer group

Y i e l d
20bp

Yield curve(AA) Spread(AA)

Evaluation Yield
20bp 15bp

Real Transaction
Spread of specific bond Base yield curve (AAA)

15bp

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Pricing Methodology
In monitoring pricing performance, BWM provides feedback channels to encourage interaction with market participants. Key issues are announced to pricing customers and through website

Background Study
Define Matrix Segment Classes Populate Info Into Segments

Daily Process
Build Yield Curves Assign Individual Spread Price All Bonds

Feedback Process Internal Quality Control Officials verbal, web and written channels Market interaction

Public Announcement BWM shares the pricing process and models with clients, BWM publishes its findings and studies (available through Web) Outcome of pricing disagreement resolution is shared with all customers.

Market and Customer Feedback Customer can raise pricing queries at any time through any channel

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Pricing Methodology
As part of our quality control, BWM regularly monitors its pricing performance through utilising an internal monitoring system on a consistent basis
Initial Pricing Performance : Marking to Model phase, Apr 2005 to July 2005

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Pricing Methodology
As part of our quality control, BWM regularly monitors its pricing performance through utilising an internal monitoring system on a consistent basis
Interim Pricing Performance : Marking to Market phase, Jan 2008 to Mar 2008
Distribution MTM-Trade for Total Population 1-Jan-08 to 31-Mar-08
80% 70% 60% 50%

56.08%

Probability (%)

40% 30% 20% 10% 0% -10<=x<0 0<x<=10 20<x<=30 40<x<=50 60<x<=70 -90<=x<-80 -70<=x<-60 -50<=x<-40 -10% -20% -30<=x<-20 80<x<=90

Total Population (exclude outliers)

Spread Difference (bp)

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

AGENDA
The purpose of today’s presentation is to discuss on current bond pricing mechanisms and its application now and in the future.

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

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

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

I I I P
First Call Date

I I I P
Legal Maturity

I

Interest Payment Principle Payment

P

c 1 ×F× F 100 f P=∑ + − AI y 1 ( k −1+ D 2 D ) y 1 ( n '−1+ D 2 D ) k =1 × ) (1 + × ) (1 + 100 f 100 f
n'

where n' = first call date

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

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

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;up) At time T, the non-exercise price can be computed by: Pnon−exer (T ) = exp(−r × ∆t ) × [ P(T + 1; up) * prob(up)
+ P(T + 1; mid ) * prob(mid ) + P(T + 1; dw) * prob(dw)]

P(T)

P(T+1;mid)

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: P(T+1;dw) P(T) = min [ C, Pnon−exer (T ) ] So, the price of option embedded bond is P(0). 2) Hull and White suggested a two-stage method to generate the interest rate tree using the basic formula:
dr = [θ (t ) − ar ]dt + σdz

θ (t ) : the coefficient of long term mean a : mean speed σ : the volatility of short term interest rate

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

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 2) Hull and White suggested a two-stage method to generate the interest rate tree. a) The first stage in building a tree for this model is to build a tree for a variable r * that is initially zero following the process dr * = − ar * dt + σdz .
1 a 2 j 2 ∆t 2 − aj∆t + 6 2 2 A Pm = − a 2 j 2 ∆t 2 3 1 a 2 j 2 ∆t 2 + aj∆t Pd = + 6 2 Pu =
7 a 2 j 2 ∆t 2 − 3aj∆t + 6 2 1 2 2 Pm = − − a j ∆t 2 + 2aj∆t 3 1 a 2 j 2 ∆t 2 − aj∆t Pd = + 6 2 Pu =

E

Assumption: θ (t ) = 0, r (0) = 0
* * First Stage Model: dr = − ar dt + σdz

* 6 2 * Parameter Setting: ∆R = σ 3∆t , t = i∆t , R = j∆R 1 Pm = − − a 2 j 2 ∆t 2 − 2aj∆t 0.816 0.184 3 j min = − j max j max : Minimum integer between and a∆t , 7 a 2 j 2 ∆t 2 + 3aj∆t a∆t Pd = + 6 2 Tree expansion: If the short-term interest reaches the two boundaries j max or goes down j , then the probabilities to up, middle, down ( Pu , Pm , Pd ) will change. min

2 2 2 I P = 1 + a j ∆t + aj∆t u

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

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 2) Hull and White suggested a two-stage method to generate the interest rate tree.
* b) The second stage in the tree construction is to convert the tree r into a tree for r . This is accomplished by

displacing the nodes on the

* r-tree so that the initial term structure is exactly matched. The approach is to

set the interest rates on r-tree at time i∆t to be equal to the corresponding interest rates on r * -tree plus

α (i∆t ) while keeping the probabilities the same. The procedure is to calculate αs iteratively so that the initial
term structure is matched.
* Define α (t ) = r (t ) − r (t )

dα (t ) = [θ (t ) − aα (t )]dt

α can be calculated as follows:
Qi , j : Present value of security, which gives $1 at (i,j) node ( Q0, 0 = 1 ), α 0 = initial ∆t -period interest rate,

given by term structure) Qi +1, j = ∑ Qi , k p(k , j ) exp[−(α i + k∆R)∆t ]
k

where p ( k , j ) : transition probability from node (i,k) to node (i+1,j) ( Pu , Pm , Pd )
ln ∑ Qi , j e − j∆R∆t − ln Pi +1 ∆t where P is the price computed from the current term structure of interest rate
j

Pi +1 = ∑ Qi , j exp[−(α i + j∆R )∆t ]

αi =

j

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Bond Pricing, Current Practice and Pricing Issues - Islamic
Valuation method of Sukuks are indifferent to conventional bonds in market practice.
Syariah principles conformed via product structuring Fixed Payment Bond Conventional I I I P
I

Conventional valuation formula used Fixed Payment Bond Formula c 1 ×F× n F 100 f P=∑ + − Accrued Interest D2 ) y 1 ( k −1+ D y 1 ( n−1+ D 2 D ) k =1 (1 + × ) (1 + × ) 100 f 100 f
Notation f c F y D D2 n P Descriptions Payment frequency in a year Cash flow rate Face amount = Notional Yield No. of days in one regular coupon period No. of days between the value date and the next payment date Last payment period Clean Price

Interest Payment Principle Payment

P

Islamic SN SN SN
SN

Secondary Note in Islamic structure acts as the fixed profit payment as agreed in the contract.
Secondary Note Primary Note

PN

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

PN

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

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 payments Profit earned through financial consideration for the exchange by applying Syariah principles Additional risks that are uncommon in conventional bonds such as religious and regulatory risks Many more unaccounted Islamic features in current market valuation

Inclusion of asset volatility Term structure of asset Floating rate mechanism for the forward rate agreement in the unconditional and irrevocable purchase of asset at maturity Prepayment risk modeling Counterparty risk modeling

Rather than relying on the performance of the underlying assets, Islamic bonds are currently priced as per their conventional counterparts and almost arbitrarily.

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Bond Pricing, Current Practice and Pricing Issues - Islamic
Example – KL Sentral Sdn Bhd (KLSSB) Musyarakah Venture with Kuwait Finance House (KFH) as option writer
Investors
Market prices KLSSB as a fixed payment bond to legal maturity disregarding asset issues.

KLSSB issues Sukuk and receives proceeds in return

1

5

Proceeds from PU for Sukuk redemption and profit payments

Trustee

Trustee overseeing the Musyarakah

Bond has pricing issue on asset pricing
Cashflow payments in arrears via aggregated project revenue Unconditional and irrevocable purchase of assets

Musyarakah partners appoint KLSSB as the Project Agent

KLSSB
(as Wakeel to Investors) 4

KLSSB

Put Option

KFH
Put Option terms and conditions

Forward pricing of assets require a forward rate benchmark of asset class Consideration must be taken for counterparty risk at the end of the contract Bond has pricing issue on asset’s embedded option
IHH IH IHL I0 IL ILL ILH

Purchase Undertaking (PU)

Distributable profit to be shared semi-annually based on an agreed profit sharing ration of 99%:1% to KLSSB and Sukukholders

3

2

Stake of Musyarakah partners based on their capital contribution of 74:26 from KLSSB (in kind) and Sukukholders (cash)

….

Musyarakah Venture to sell Project Lands

Asset volatility and term structure of asset class. Eg equity industry index volatility Asset data greatly needed Optionality of the put/call feature

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Bond Pricing, Current Practice and Pricing Issues - Islamic
In asset pricing, many considerations must be taken in the cash flow structure and risk exposure
Cash Flow
Sale
Price
Discount Negotiated Mark up

Lease
Payment
Advance Staggered End of Period

Equity
Payment
Advance Staggered End of Period

Delivery
Immediate Deferred End of Period

Price
Discount Negotiated Mark up

Delivery
Immediate Deferred End of Period

Price
Discount Negotiated Mark up

Payment
Advance Staggered End of Period

Risk Exposure to Asset
Asset
Property
Fixed Floating

Breakdown necessary to avoid mismatch in the Islamic bond’s risk consideration Sukuk contract is the cosmetic of the asset

Entity
Usufruct
Fixed Floating On Issuer On the Business

Key challenge is on data aggregation on specific asset classes and using these information in pricing models

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Pricing Methodology

FAQ

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

FAQ

1.

Why is BWM’s price is different from next day’s actual traded price? BWM publishes end of day price, not next day’s price forecast.

2. Does BWM publish Credit Opinions? No. BWM is not a Credit Rating Agency. 3. Does BWM announce future price opinions? No, BWM is market neutral. BWM does not provide its opinion on future price direction. 4. Should pricing in NAV accounting be the same with BWM’s prices? 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.

©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

THANK YOU
Meor Amri bin Meor Ayob
[email protected]

Pricing Specialists Simon Ng Tan Keang Chuan Paige Tan Nuraizah Harun Noor Bazlina Sharifmuddin Wong Yin Yee

Email Address [email protected] General Line +603 2711 5125

Financial Engineer Ken Poh Darryl Foo 19-5 , The Boulevard, Mid Valley City, Lingkaran Syed Putra, 59200 Kuala Lumpur, Malaysia Tel: +603 2711 5122 Fax: +603 2284 1807 Email : [email protected]
©Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.

Sponsor Documents

Or use your account on DocShare.tips

Hide

Forgot your password?

Or register your new account on DocShare.tips

Hide

Lost your password? Please enter your email address. You will receive a link to create a new password.

Back to log-in

Close