Fixed-income Securities Introduction

Ronald K. CHUNG, Ph.D. EQuity Consulting Co. Ltd. rkchung@consulteqcc.com ioriewong@consulteqcc.com

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General Course Info.

Lectures
Thurs, 15:30 18:30

Assessments
Class participation and discussion Exercise Mid-term test Final 10% 20% 30% 40%

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Resources
Textbook
Martellini, Lionel, P. Priaulet and S. Priaulet, Fixed-income
Securities, latest ed.

Reference
Fabozzi, Frank J., Bond Markets, Analysis and Strategies, latest ed.

Also
Tuckman, Bruce, Fixed Income Securities: Tools for Todays Markets, latest ed.
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Ch. 1 Bonds and Money-Market Instruments

Fixed-income markets

Bonds
MM

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Fixed Income Market

S/T (MM) v. L/T

Loans vs. Negotiable (Secondary markets for Bills,

Notes, Bonds) Issuers Fixed Income Derivatives (e.g., Collateralized ABS ) Domestic v. Global
Asia (Ex-JP): Financial center w/o F.I.?

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Domestic v. International
Euro bond

Bulldog bond
Dragon bond (USD in Asia) Kangaroo bond Maple bond Panda bond Samurai bond Dim Sum bond
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Dim Sum Anyone?

Oct 2010 bonds, denominated in CNY and issued in HK (thus the unofficial name), represent a tiny portion of China's total local-currency debt. The amount raised so far this year is a mere $1.46 billion, versus the $144.7 billion worth of yuan debt issued inside mainland China, according to Dealogic.

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Definition of a Bond
A financial claim by which the issuer (borrower) is

committed to paying back to the bond holder

(lender,) the amount borrowed (principal), plus periodic interests (coupon) during a given period of time (prior to maturity.)

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Definition
A standard bond is

a fixed-coupon bond without any embedded

option, delivering
its coupons (type fixed v. float, step up? Frequency) on periodic dates and principal on the maturity date.

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Key Terminologies Issuers

Name,
Type (p. 3 4)
(e.g., govt, munis, agencies, institutions, corp.)

Trading
Issued v. outstanding
Min amt / increment Par (v. redemption) Price: Issuance v. Quoted / Yield calc.

Domicile (v. currency) Guarantee Rating

Day count
accrual, settlement first coupon date
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Issuers
Government
Treasury (US, EU, UK, JP)
Agencies

Munis Corporates
Institutions

Firms

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Moodys Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 AAA AA+ AA AAA+ A ABBB+ BBB

S&P AAA AA+ AA AAA+ A A-

Fitch AAA AA+ AA AAA+ A A-

D&P

Brief Definition Gilt edge, prime, maximum safety Very high grade, high quality

Investment Grade: High Creditworthiness

Upper medium grade

BBB+ BBB

BBB+ BBB Lower medium grade

Baa3
Ba1 Ba2 Ba3 B1 B2

BBBBB+ BB BBB+ B

BBBBB+ BB BBB+ B

BBBBB+ BB BBB+ B Highly speculative Low grade, speculative

Distinctly Speculative: Low Creditworthiness

B3

BCCC+

B-

B-

Predominantly Speculative: Substantial Risk or in Default Caa Ca C CCC CCCCC C CI DDD DD D D DD CC C May be in default, extremely speculative Even more speculative than those above CI = Income bonds; no interest is being paid Default CCC CCC Substantial risk, in poor standing

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Sector Breakdown of US IG Index

Market Weight (%) Treasury Government sponsored Agency Supranational 36.96 36.13 0.83 25.16 AAA/AA A BBB 4.93 11.48 8.74
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25.81 12.06 11.06 1.00

Collateralized Credit Mortgage Asset-backed

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Non Standard Bonds

Strips
Separate Trading of Registered Interest and Principal
Coupon strips v. Principal strips

Floating Rates
FRN:
coupon rate indexed on S/T ref. rate (e.g., 3 mo LIBOR)

Variable- / Adjustable- rate bonds :

coupon rate indexed on L/T ref. rate (e.g., 10 y CMT)

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Example: Inflation-Indexed Bonds

Real coupon (RC), adjusted with
Inflation index = CPI(t+1) CPI(t)
Daily inflation reference, DRI
CPI(m-3) +

[(Actual AI days 1) / Total days in mo] * [CPI(m-2) CPI(m-1)]

Inflation adjusted Coupon

Par x RC x [DIR(t) / DIR(0)]

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HKs inflation linked I-Bond (2011)

A new investment tool is now available in Hong Kong: Hong Kong Government is going to issue its first retail government bond, an inflation-

linked iBond with life span of 3 years (Full name: HK$ Retail Bonds due 2014)
on July 28 and then list (Stock Code: 4208.hk) it on the Hong Kong Stock Exchange (HKEx stock code: 388.hk) the following day on July 29.

Interest payments of the iBond will be paid semiannually (January 28 and

July 28 each year), with the floating annual interest rate based on the local Composite Consumer Price Index (CCPI) Moving Average for the six most recent months, and a minimum guaranteed interest rate set at +1%

annually. No interest payment, however, can be further re-invested into

the iBond. The H.K. iBond is basically tax-free, and also exempt from stamp duty fee.

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Exercise
ID the key features on the bonds below

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Figure 1.3

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Case: Shimao (Mar. 1, 2011)

SINGAPOREShimao Property Holdings Ltd. reduced the size of an intended international dollar bond issue, amid a slew of recent issuance from China's real-estate sector. The property developer now is seeking to price a $350 million dollar bond to yield 10.875% to 11%, compared with initial

guidance of 11%. It had hoped to raise up to $500 million via the planned seven-year bond, which would be callable after
four years, the people said. The downsizing of the proposed deal and a rally in prices of Chinese property bonds helped orders increase to more than $575 million by late afternoon in Asia, one of the people said. It plans to use proceeds to finance the redemption of maturing floating-rate notes, repay other debts, fund development projects and for general corporate purposes. S&Ps Ratings Services assigned a speculative BB- rating to Shimao's proposed dollar bond, matching the rating on the developer's outstanding notes. Even so, it is a notch lower than Shimao's corporate credit rating on the view that offshore noteholders would be materially disadvantaged compared with onshore creditors if the company were to default. But S&P downgraded the outlook on the company's BB rating to negative on concerns that the China-based developer's credit ratios could deteriorate. "In our view, Shimao's key metrics and financial flexibility could weaken, given its aggressive debt issuance and expansion," said Frank Lu, an S&P credit analyst. The property firm's ratio of debt to earnings before interest, taxes, depreciation and amortization likely hovered around five at the end of 2010, S&P's trigger for a ratings cut, and probably will be even higher by the end of this year, he said. Moody's rates the proposed bond at B1, in line with the international dollar bonds the company sold in July, a term sheet for the planned deal showed. The agency rates the corporate at Ba3, the equivalent of a notch below S&P.

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