ABMF 323 Money and Capital Market

Topic 3: Discuss in detail bonds as an investment instrument

Tutor: Mr. Lee Yan Chuan

Group 5

Group Members : Ong Kah Kian 14WBD00969

: Hon Zhong Yu 14WBD04028

: Sharran 14WBD04937

: Ng Wail Lim 14WBD00762

: Kaw Kean Yao 14WBD03086

: Chin Yin Hong 14WBD00866

: Teng Yee Ling 14WBD01416

 CONTENT PAGE
1.0 Introduction 1
2.0 Content
2.1 Definition 2
2.2 Types of bonds 3
2.3 Method of issuing bonds 4
2.4 Characteristic of bonds 4-5
2.5 Trading of bonds 6
2.6 Advantage&Disadvantage of Bonds 7-8
2.7 Bond rating 8
3.0 Recommendation&opinion
3.1Difference between bond 9
market&stock market
3.2 Difference between bond and 10
debenture
3.3 Opinion about 1MDB 11-13
4.0 Conclusion 13
5.0 Harvard references 14
1.0Introduction

The first thing that pops into most peoples mind when think of investing are stock
markets. After all, stocks are interesting. The swings in the market are examined thoroughly in
the newspapers and even covered by local evening newscasts. Issues of investors obtaining great
wealth in the stock market are common.

Bonds, on the other hand, dont have the same sex appeal. The lingo seems arcane and
confusing to the average person. Basically, bonds are liabilities which is traded where
bondholders are actually lending money to issuers. Example of bondholders are investors and
issuer are business firms also known as borrowers. Besides, bond are also recognized as fixed
income securities since payments are in fixed amounts. Thus, the borrower agrees to repay a
fixed amount of principal at a predetermined maturity date as well as a fixed amount of interest
for a specified period of time.

Furthermore, bonds are much more unattractive especially during raging bull markets,
when they seem to offer an insignificant return compared to stocks. However all it takes is a bear
market to remind investors of the virtues of a bonds safety and stability. In fact, it makes sense
for many investors to have at least a part of their portfolio invested in bonds.
2.0Content

2.1Definition

Bonds are long term debt.It is a sourse of financing that has maturity of more than 1 year.It is a
capital market. You loan your money to a company, a city, the government and they promise to
pay you back in full, with regular interest payments. A city may sell bonds to raise money to
build a bridge, while the federal government issues bonds to finance its spiraling debts.
Generally, a bond is a promise to repay the principal along with interest (coupons) on a specified
date (maturity). Some bonds do not pay interest, but all bonds require a repayment of principal.
When an investor buys a bond, he/she becomes a creditor of the issuer. However, the buyer does
not gain any kind of ownership rights to the issuer, unlike in the case of equities. On the hand,
a bond holder has a greater claim on an issuer's income than a shareholder in the case of financial
distress (this is true for all creditors).

Bonds are often divided into different categories based on tax status, credit quality, issuer type,
maturity and secured/unsecured (and there are several other ways to classifybonds as well).
Treasury bonds are generally considered the safest unsecured bonds, since the possibility of
the Treasury defaulting on payments is almost zero. The yield from a bond is made up of three
components: coupon interest, capital gains and interest on interest (if a bond pays no coupon
interest, the only yield will be capital gains). A bond might be sold at above or below
par (the amount paid out at maturity), but the market price will approach par value as the bond
approaches maturity. A riskier bond has to provide a higher payout to compensate for
that additional risk. Some bonds are tax-exempt, and these are typically issued by municipal(not
available in Malaysia), county or state governments, whose interest payments are not subject
to income tax, and sometimes also state or local income tax.
2.2Types of Bonds in The Market

Malaysia contains many types of bonds which is active for both Islamic and conventional
bonds. Future market can also be accepted for Malaysian government securities. Every bonds in
Malaysia always has risk but is whether high or low.

Government Bond is a bond issued by a national government denominated in the countrys own
currency.Government bonds are usually referred to as risk free bonds with maturity exceeding
more than 3 years.For example,Malaysian Government Securities (MGS),Khazanah Bond and
Bon Simpanan Merdeka.

One of the type is the straight bonds which is also called government bonds or corporate bonds.
There are called "plain vanillas in certain debt markets, and these bonds dont have additional
features such as put or call options. They all contain high coupon rates. Normally the interest
payment are made either annually or semi-annually. The principle is paid to bond holder due to
the maturity.

The other type of bond is cagamas bonds which interest are bearing debt obligations backed by
housing loans. The Cagamas Berhad was established in 1986 to promote the broader spread of
house ownership and growth of the secondary mortgage market in Malaysia. It issues debt
securities to finance the purchase of housing loans from financial institutions and non- financial
institutions. The provision of liquidity to financial institutions at a reasonable cost to the primary
lenders of housing loans encourages further expansion of financing for houses at an affordable
cost.

Besides, Islamic bonds, also called Sukuk, are structured to comply with Shariah principles,
which prohibit the charging of interest. Malaysian authorities have taken the lead in developing
and innovating new Islamic securities structures and in pioneering the Islamic capital market.

Next, is the Zero Coupon Bond which income securities sold at discount are fixed. These bonds
have no interest payment. Funds will not block until the maturity, so investors are free to trade
the bonds. Secondary value of bonds are depends on the remaining term to maturity and current
interest rates.

The following type of bond is convertible bonds which are fixed-rate securities that grant the
bond holders the right to convert the bonds into specific number of the issuer's common shares at
a predetermined conversion rate. Once converted, the bonds cannot be converted back into PDS.

Furthermore,junk bonds has a bond rateBB or lowerbecause of its high default risk.

The last and following type of bond is the Khazanah Bonds which are issued by Khazanah
National, the investment holding arm of the Government of Malaysia. These unsecure zero-
coupon bonds are based on the Islamic principles of murabahah with maturities of 3, 5, 7 or
10years.
2.3Methods of Issuing Bonds

1.Auction Auction is undertaken by BNM for government bonds and Principal Dealers for BNM
notes. a. Auction by BNM BNM, via competitive auction, issues government bonds on behalf of
the government. Successful bidders are determined according to the lowest yields offered, and
the coupon rate is fixed at the weighted average yield of successful bids. b. Auction by Principal
Dealers Principal Dealers offer BNM notes through competitive auction.

2. Direct Placement or Tender Bonds issued by other statutory bodies and government-owned
corporations, as well as corporate bonds, are issued via direct placement or tender.

2.4Characteristics of Bonds

A Nominal Value(Par Value)

The nominal value is the par or face value.
Also known as the principal value which is the amount that the issuer agreed to
repay the bondholder at the maturity date.
B Coupon Rate
Is the nominal interest rate that determines the actual interest the bondholder
receives on owning the bond.
Payable annually, half yearly, or quarterly>however, half yearly is most popular
C Terms to maturity
Is the no. of years over which the issuer of the bond has promised to meet the
conditions and obligation of the bond issue.
During this time the bondholder is paid the promised coupon payment
It also indicates the remaining life of the bond
Maturity of the bond is the date the bond will cease to exist, at which time the
issuer will pay to the bondholder, the principal.
D Yield-to-maturity
Is the indicated (promised)compounded rate of return an investor will investor
will receive from a bond purchase at the current market price and held to maturity.
Is the effective interest rate earned on the bond investment.
Prices of bonds are quoted in relation to their yield.
E Call Provision
Entitles the issuer to random or call the bonds from their holders.
Investors will receive some compensation for the risk that the bond will be called
away.
The investor will then be subjected to re-investment risk.
 F Sinking Fund
Money put aside by the issuer periodically for the eventual repayment of the debt.
Ensures enough money to redeem the bond upon maturity.

2.5Trading of Bonds

The Malaysian bond market consists of listed and unlisted bonds. Unlisted bonds are largely
traded over the counter (OTC) while listed bonds are traded through Bursa Malaysia.

Over-the-Counter Market Trading

In Malaysias OTC market, the primary market segment is facilitated by Bank Negara Malaysia
(BNM) through the Fully Automated System for Issuing/Tendering (FAST). It provides
information on issue terms, real-time prices, completed trade details, and other relevant news
about debt securities. FAST was first launched by BNM in September 1996 to automate the
tendering procedure of government securities or Bank Negara Papers, which are issued through
the principal dealer (PD) network. In July 1997, FAST was further enhanced to include
commercial papers and mediumterm notes, which are issued via tender or private placement. In
addition, Bursa Malaysia operates the Electronic Trading Platform (ETP), which facilitates the
trading and reporting of secondary market activities. ETP acts as the centralized price and trade
repository, and interfaces with FAST and information vendors. More information can be obtained
through the Bursa Malaysia website.

Exchange trading

Bursa Malaysia is an exchange holding company approved under Sec. 15 of the Capital
Markets and Services Act 2007 (CMSA). It operates a fully-integrated exchange, offering a
complete range of exchange-related services including trading, clearing, settlement, and
depository services. The wholly-owned subsidiaries of Bursa Malaysia own and operate these
various businesses.

Examples of Steps of Trading Bonds

1. The seller and buyer trade over the counter by telephone (direct dealing or through money
broker). Ninety-five percent of bond trades are dealt in the OTC market. Commercial banks and
Islamic banks can trade the bonds.

2. All trades are recorded in the ETP.

3. The seller (or buyer) inputs trade data into Real-time Electronic Transfer of Funds and
Securities (RENTAS) to initiate unconfirmed settlement advice.

4. The buyer (or seller) confirms an unconfirmed settlement advice using by the Confirmation
menu of RENTAS.

5. The seller and buyer access the Report menu of RENTAS and confirm that confirmation of
local matching is performed.

6. 7. On settlement date, bond and cash are settled on DVP basis.

8. The seller and buyer access Report menu of RENTAS and confirm report of Bond settlement
and cash settlement.

2.6The advantages and disadvantages of Bonds

To Issuing Firm

Advantages

Tax deduction of interest payment

Coupon payments to bondholders are tax-deductible for the issuing firm

Increase in earnings per share

Since a bond is a fixed-income security, the surplus earnings available to shareholders after
deducting interest payment to bondholders during interest payment to bondholders during good
times would be higher.

Maintain control of the firm

Since bond holder are creditors of the firm, they do not have controlling rights over the
management of the firm as in the case of the firm as in the case of the shareholders. As such the
shareholder of the firm still maintain control of the firm.

Disadvantages

Debt must be paid

The fixed interest charge must be paid whether the firm is having a good or a bad year. Failure to
meet these payments may lead to bankruptcy suits by the bondholders.

Increased risk due to financial leverage

Bonds are categorized as long-term debts and the issuance of such security would increased the
financial leverage of the firm.

Restrictions on issuing firm

To protect themselves, bondholders may place certain restrictions or covenants on the issuing
firm to prevent it from defaulting on its obligations.

To investors

Advantages

Fixed returns

Bonds are fixed-income security and investors who purchase bonds can expect a stable return
since the interest payment Is fixed.
Lower risk

The bondholders would be able to have prior claims on the assets of the firm before the
shareholders in the assets of the firm before the shareholders in the event of liquidation of the
firm.

Disadvantages

Fixed interest payment

If the issuing firm has good earnings, bondholders do not get to enjoy the additional earnings.

Decline in real interest payment

Since bondholders get a fixed interest payment, they may lose out during times of high inflation.

Lower return

Because the risk is low, the returns are too

Reinvestment risk on callable bonds

Interest rate at which the money received are reinvested may not be as high as expected.

2.7Bond Ratings

Bond ratings are grades that are assigned to bond issues on the basis of
extensive,professionally.It is conducted financial analysis to designate investment quality.Ratings
basically point to the default risk of an issue.

Higher ratings mean that issues are investment grade.Besides,lower ratings mean that issues are
in the junk category and more speculative.The higher the rating,the lower the default risk and
hence,the lower the yield of an obligation.A lower rating means that the investor must assume
more of the default risk and has to be compensated with a higher yield.

3.0Recommendations

3.1Difference between the bond market and the stock market

The similarities of bond and stock are both are securities.

The bond market is where investors go to buy and sell debt securities, prominently bonds. The
stock market is a place where investors go to buy and sell equity securities like common stocks
and derivatives (options, futures etc.). Stocks are traded on stock exchanges. In Malaysia, the
market for stock exchange is Bursa Malaysia.Investors invest in stock are higher risk than invest
in bond market.

When we buy bonds, it means we are borrowing our money to the corporation. It is debt for the
company which sell bonds. While stocks are equity, when we buy stock. It means we are buying
part of the ownership of the company. In finance, a bond is a debt security, in which the
authorized issuer owes the holders a debt and is obliged to repay the principal and interest. In
financial markets, stock capital raised by a corporation or joint-stock company through the
issuance and distribution of shares.

In bonds market, they do not have centralized exchange or trading system. Stocks have
centralized exchange and trading system.So,this brings advantages to stock market.This is
because investor can trade the stock conviently.

Bonds are issued by public sector authorities, credit institutions, companies and supranational
institutions. Stock are issued by corporation or joint-stock companies.

Derivatives of bonds includes bond option, credit derivative, credit default swap, collateralized
debt obligation, collateralized mortgage .derivatives of stocks includes credit derivative, hybrid
security, options, futures, forwards, swaps. If there is any bankruptcy, bondholders are paid first
and the liability towards debenture holders is less.

As my recommendations,investors should invest in in bond market for those who are risk
averse.Low risk means investors will get low return.

3.2Difference between bonds and debentures

Both bonds and debentures are instruments available to a company to raise money from the
public. This is the similarity between the two, but on closer inspection, we find that there are
many glaring differences between the two.
 Bonds are more secure than debentures. As a debenture holder, you provide unsecured loan to
the company. It carries a higher rate of interest as the company does not give any collateral to
you for your money. For this reason bond holders receive a lower rate of interest but are more
secure.If there is any bankruptcy, bondholders are paid first and the liability towards debenture
holders is less. Debenture holders get periodical interest on their money and upon completion of
the term they get their principal amount back.

Bonds are the most frequently referenced type of debt instrument, serving as an IOU between
the issuer and the purchaser. An investor loans money to an institution, such as a government or
business; the bond acts as a written promise to repay the loan on a specific maturity date.
Normally, bonds also includeperiodic interest payments over the bond's duration, which means
that the repayment of principle and interest occur separately. Bond purchases are generally
considered safe, and highly rated corporate or government bonds come with little perceived
default risk.

Debentures have a more specific purpose than bonds. Both can be used to raise capital, but
debentures are typically issued to raise short-term capital for upcoming expenses or to pay for
expansions. Sometimes called revenue bonds because they may be expected to be paid for out of
the proceeds of a new business project, debentures are never asset-backed (they are not secured
by any collateral) and are only backed by the credit of the issuer.

These debt instruments provide companies and governments with a way to finance beyond their
normal cash flows. Some debentures and bonds areconvertible, which means that they can be
converted into company stock. In a sense, all debentures are bonds, but not all bonds are
debentures. Whenever a bond is unsecured, it can be referred to as a debenture.

3.3Opinion

Our group members would like to discuss the latest news about 1Malaysia Development Bhd.s
bonds .
 Firstly, 1Malaysia Development Bhd.s bonds are trading like junk as investors seek greater
clarity over the state investment funds plans to wind down and sell off assets .The problens
faced by 1 Malaysia Development Bhd is they have a lot of assets that arent generating enough
cash flow to service their debt . 1MDBs next two dollar bond coupons are due on March 9 and
May 11, according to data compiled by Bloomberg. The company struggled to meet its loan
repayment despite redeeming a US$2.32 billion Cayman Islands investment.

According to the report, 1MDB is hoping to ease its crippling debt burden by listing its power-
generation assets through an initial public offering (IPO) scheduled for November
2014.Cornerstone investors will include state-owned entities from Abu Dhabi (20%) and Qatar-
based investor groups (5%).1MDB has regularly made the headlines for all the wrong reasons
ever since it was set up by Prime Minister Datuk Seri Najib Razak in 2009.All the bad news
caused the company has bad reputation.

Recently,the board of director have held meetings with members of the media where I listened
to and responded to their concerns in order to increase their transparency.However, According to
1MDBs latest annual audited accounts, the company has total borrowings of nearly RM42
billion. For this, 1MDB stated it has RM51.4 billion in total assets.Yet year after year 1MDB
continually relied on property revaluation gains essentially paper profits that does not translate
into money in the bank ,to post profits with the exception of the 2014 financial year
(FY14),during which even property revaluation gains were insufficient to push numbers into the
black.What this means is that since its incorporation, 1MDB has continuously been in red. What
has 1MDB been doing with its borrowings then?.

Furthermore, One of the strangest things about 1MDB, despite boasting professional
management, is the mismatch between its investments and financing costs.According to 1MDBs
latest annual audited accounts, 1MDB is paying interest ranging from 5% to 18% annually for its
borrowings. Now contrast this with the investment returns 1MDB reported in the same accounts:
just 3.26% for its RM13.4 billion in various places overseas.Not to mention the heart-wrenching
0.68% interest rate 1MDB made in FY14 for its big pile of cash amounting to RM4 billion,
stated by 1MDB in the same accounts.Spectacular returns may be more difficult these days but
surely 1MDBs professionals can find prudent investments for reasonable returns to cover its
financing costs at the very least. Why invest in something that gives you less return that it costs
you to invest in the first place?

Nevertheless, Really? It is established that 1MDB is facing difficulty paying some of its short-
term loans. Bernama previously reported chairman Lodin Wok Kamaruddin as saying that the
company is looking to restructure some of its short-term loans to match its longer-term
investments.Remember that 1MDB had been on a borrowing spree with a mysterious urgency to
raise funds over the years. Yet if it is making long-term investments, why the urgency in the first
place?

In fact 1MDB had been sitting on huge cash piles even as it borrowed more and more. In 2013,
for example, it had cash and near-cash items amounting to RM23 billion yet it went on to borrow
billions more.This adds to the mystery of the short-term loans, which typically come with higher
interest rates. Why willingly pay higher interest rates for cash in a hurry if youre not in a hurry
to use the cash anyway?

According to 1MDBs latest annual audited accounts, the company has RM3.84 billion in cash
and bank balances with another RM12.88 billion in available-for-sale investments.But one week
ago Reuters reported that businessman Ananda Krishnan is lending 1MDB RM2 billion to repay
its loan commitments with local banks. Neither the government nor 1MDB had explicitly denied
this.

Why does 1MDB need to borrow money from a private businessman to repay its loans if it had
so much cash on hand? Of RM3.84 billion, some RM2.37 billion are unrestricted deposits and
placements with licensed banks, according to 1MDBs accounts.

In mid-January this year, 1MDB stated that its investment of US$2.32 billion in a Cayman
Islands-registered fund had been fully redeemed.

To be precise, the fund redeemed the remaining US$1.1 billion after having redeemed US$1.22
billion previously of the original US$2.32 billion invested. But this money was subsequently
invested in a fund under the regulatory supervision of the Cayman Monetary Authority, said
Arul in the statement.Now as noted above 1MDB is facing loan repayment issues and the
company would know its cash requirements in meeting the obligations. Why re-invest the money
redeemed when you need cash at home urgently?These issues are just the tip of the iceberg that
is 1MDBs issues.

We think that we should be aware of this bonds.This is due to the reason that the stuffs about
1MDB are many of uncertainty.Recent loan servicing difficulties have created stress on
Malaysian financial assets and further such news could have the same result.
4.0Conclusion

Throughout all the researches and survey that we found, it was very interesting that bonds is that
huge knowledge to us. We are pleased that this assignment has been issue to us and we having a
wonderful time spending together doing this assignment.

In sum, trading of bonds occur in bond market. Bond market is where trading of debt securities
occurs. The bond market basically includes government-issued securities and corporate debt
securities that facilitate the transfer of capital from saver to the issuers or organization that
require capital for government projects, business expansions and ongoing operations. There are
variety of bonds that represents different kinds of investment such as straight bond, convertible
bonds, zero coupon, cagamas bonds and others which some are not in Malaysia. Plus, most
trading in the bond market done it in the way of over-the-counter (OTC), and is composed of the
primary market and the secondary market.

Bonds are attractive in the way that bonds provide interest income which many investors
perceive greater safety in bond investment than in stock investment and also the opportunity for
capital gains but compared to stocks, bonds offer lower returns. Bonds also give a lower risk and
stability to portfolio compared to stock that gives a higher risk with a higher return. Of course,
there are risks too in bonds like higher of interest risk for longer the bond held, default risk,
purchasing power (inflation), liquidity risk, call risk and also the famous re-investment risk.

In comparison, bonds market have a lower risk and more stable than the stock market.
Unfortunate, stock market come with a greater return with a greater risk than bonds market and
that what make most of the investors would like to invest in stock market rather than in bonds
market. Despite that, stock market are easier to sell or buy than in the bonds market as bonds
market didnt list for public and it always go over-the-counter which means that the investment is
done through broker and not directly to public.

In the nutshell, whether you like to invest in bonds, stocks, money markets, real estate or others,
the most important part is that the investment can get you a return that you would like to have.
To my suggestion, try to invest when one is young as the sooner you get into the investment
world, the greater knowledge and experiences you would have compared to the other people.
And all but not least, I would like to thank to Mr Lee as our tutor who guide us to make this
project happen.

5.0References

Securities Commission Malaysia.Available from:[Online] (http://www.sc.com.my/) [Accessed:

8 May 2015].
 MALAYSIAN DEBT SECURITIES AND SUKUK MARKET 2009 A Guide for Issuers and
Investors A Joint Publication by Bank Negara Malaysia and Securities Commission Malaysia
.Available from:[Online]
(http://www.sc.com.my/eng/html/bondmkt/MalaysianDebtSecuritiesSukuk_2009.pdf)[Accessed:
8 May 2015].

Bond Info Hub (Bank Negara Malaysia) .Available from:[Online]

(http://bondinfo.bnm.gov.my/portal/server.pt?open=514&objID=27275&parent
name=MyPage&parentid=0&mode=2 ). [Accessed: 8 May 2015]

BIS Papers No 26. The corporate bond market in Malaysia. Muhammad bin Ibrahim and
Adrian Wong, Bank Negara Malaysia.Available from:[Online]
(http://www.bis.org/publ/bppdf/bispap26p.pdf). [Accessed: 8 May 2015].

AsianBondsOnline website. Available from:[Online] (www.asianbondsonline.adb.org).

[Accessed: 8 May 2015].

Criteria Maximum Marks Remarks

Marks Allocated
1. Introduction 15
2. Body - facts 50
3. Recommendations/opinion if 10
any
4. Conclusion 10

5 Presentation 15

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