1. Treasury Fund Management
Faisal Sarwar

2. BOND MARKET

3. What is a bond?
You've just loaned your friend (who has good credit standing) PKR 100,000 so that he can buy a car. He's promised to pay you 6% interest each year for the next 5 years, and then he’ll give you back your money.
A bond has a similar structure - only the friend is replaced with an issuing firm and the loan itself can be sold.

4. What is a bond? Bond is a borrowing arrangement
Bondholders are lenders – both institutional and individual investors
In most cases, the loan is for a fixed term, so that there is a specified repayment date.
Bond obligates the issuer to make specified payments to the bondholder on specified dates – very contractual
This is why bonds are called “fixed income”; the amount (almost always) and timing (almost always) is fixed
The intrinsic value of a bond, like stocks, is the present value of its future cash flows.
Bonds, have predictable cash flows and a finite life.

5. Bond Terminology
The Face Value – The nominal value of the bond to be paid back at maturity.
Term to Maturity – This is the remaining life of the bond, and is the difference between today’s date and the maturity date. Do not confuse this with the original maturity, which was the life of the bond at issuance.
The Coupon Rate – promised annual rate of interest, normally fixed at issuance for the life of the bond. Can be calculated by multiplying coupon rate with face value of the bond. Interest is normally paid semiannually, and the semiannual payment is one-half the annual total payment
Yield - The interest rate which can be earned on an investment, currently quoted by the market or implied by the current market price for the investment.
For a bond, it is the yield to maturity or the internal rate of return of a bond
It equals all the interest payments received (and assumes that we will reinvest the interest payment at the same rate as the current yield on the bond) plus any gain (if we purchased at a discount) or loss (if we purchased at a premium).

6. Valuation of Bonds
General Principle of Valuation: The price of any financial instrument is equal to the present value of expected future cash flows.
Estimate the expected future cash flows.
Determine the appropriate discount rate(s).
Calculate the present value of cash flows.
Steven V. Mann, PhD

7. Valuation of Bonds (cont.)
The value of bond is determined by four variables:
The Coupon Rate – promised annual rate of interest, normally fixed at issuance for the life of the bond. Can be calculated by multiplying coupon rate with face value of the bond. Interest is normally paid semiannually, and the semiannual payment is one-half the annual total payment.
The Face Value – The nominal value of the bond to be paid back at maturity.
Term to Maturity – This is the remaining life of the bond, and is the difference between today’s date and the maturity date. Do not confuse this with the original maturity, which was the life of the bond at issuance.
Yield to Maturity – This is the rate of return that will be earned on the bond if it is purchased at the current market price, held to maturity, and if all of the remaining coupons are reinvested at this same rate. This is the IRR of the bond.

8. Types of bond Government Bonds Corporate Bond (TFC)
Ijara sukuk (Islamic Bond)

9. Pakistan Investment Bonds
Launched in the year 2000 to replace FIBs as a long term investment.
Half yearly coupon bonds. 3, 5, 10 & 20 years maturity. Are sold to Primary Dealers through auction.
Auction of the bonds held on need basis
SBP announce the date , target amounts and coupon rates before every auction.
PDs allowed ‘short selling’ during ‘when issued period’ and can also accept ‘non-competitive bids’.
Active secondary market catering to banks and institutional investors etc.
Are SLR eligible securities up to 15% of DTL.

10. Screen Shots

11. Auction Detail PIB

12. TERM FINANCE CERTIFICATES (TFC)
Term Finance Certificates are redeemable capital instruments and may be issued by a company directly to the general public, which includes institutions.
Unlike straight bonds, they are redeemable capital and are of long tenors i.e. more than one year. They are quoted on a price basis rather than yield to maturity.
Earnings from TFCs are (Withholding tax as per the Income Tax Ordinance and zakat is
Some of the TFCs are listed on the stock exchange and are traded in the capital as well as in the money market.

13. GoP Ijara Sukuk
Auction of GOP Ijara Sukuk has been started by SBP & the first auction held on
Maturity of the Sukuk is three years
Islamic banks & banks having branches of Islamic Banking can participate in the auction
Profit rate on Sukuk linked with six months MTBs.
The cut off rate will be applied to all successful bidders
Investor Portfolio Securities (IPS) Account: necessary for investing in GoP Ijara Sukuk
Profit Payment: basis of rental rate announced
Redemption: only at maturity

14. Primary Dealers for Ijara Sukuk

15. Auction Summary

16. Ijara sukuk auction detail

17. How Govt Securities Auction Conduct

18. Auction of Govt.Securities
SBP conducts auctions to raise debt for govt.
Only primary dealers can participate in auctions.
SBP announces pre auction target .
Auction target decided by the Government.
Bids are invited on Wednesday of the auction week.
Settlement of the auction take place on the following Thursday.

19. Auction of Govt.Securities
Treasury Bills auction held fortnightly.
Maturities of treasury bills are 3,6 and 12 months.
PIBs auction held on need basis.
The bonds maturities range from three to thirty years.(3,5,10, and 20 years).
Auction program/result being announced through Reuter, Bloomburg, SBP web/ e.board and newspapers.
SBP follows practice of American auction

20. Yield to Maturity
The yield to maturity gives the exact return that you will actually earn under the following conditions:
You purchase the bond at today’s price
You hold the bond to maturity
You reinvest all interest payments at the same YTM
The last condition is the most difficult to achieve with interest rates changing all the time. So, YTM is just an estimate of your actual return.
However, the YTM does take into account the increase or decrease in the price of the bond (capital gain or loss) over the life of the bond.

21. YTM calculation

22. YTM vs Coupon Rate
If a bond's coupon rate is less than its YTM, then the bond is selling at a discount.
If a bond's coupon rate is more than its YTM, then the bond is selling at a premium.
If a bond's coupon rate is equal to its YTM, then the bond is selling at par.

23. Years remaining to Maturity
Bond Value
1,372
kd = 7%.
1,211
kd = 10%. M
1,000
837
kd = 13%.
775
Years remaining to Maturity

24. At maturity, the value of any bond must equal its par value.
The value of a premium bond would decrease to $1,000.
The value of a discount bond would increase to $1,000.
A par bond stays at $1,000 if kd remains constant.

25. Relationship between Price and YTM
Required Yield
Price

26. Bond Calculation
Here is the bond valuation equation, slightly restated to make the point:
Note that the bond’s intrinsic value (VB) has been replaced with its price (PB), and the required return (kd) with its yield (YTM).
Our problem now is to solve for that YTM given the price.

27. Example 1 – Bond Valuation
Suppose that you are interested in purchasing a 3-year bond with a 10% semiannual coupon rate and a face value of $1,000. If your required return is 7%, what is the intrinsic value of this bond?
Here is a timeline showing the cash flows: 1 2 3 4 5 6 50
1000

28. Example 1 (cont.) Note that the cash flows of the bond consist of:
An annuity, the interest payments, paid every six months. This is calculated as:
A lump sum which is the return of the face value of the bond at the end of its life. This payment is made at the same time as the last interest payment.

29. Example 1 (cont.)
We can find the intrinsic value (aka fair value) of these cash flows by finding the present value of the interest payments and then adding the present value of the face value:
Note - The first term is the present value of an annuity and the second is the present value of a lump sum. Do the math, and you’ll find that the bond is worth $1, Note that this value must decline until it reaches $1,000 at maturity.

30. Prices Clean/Quoted Price Dirty Price/ Total Amount Accrued Interest
The Price at which trades buy & Sell bonds.
It exclude accrued interest
Dirty Price/ Total Amount
The total amount you pay when you purchase a bond.
Clean price + accrued interest
Accrued Interest
It is the amount of interest that it has accumulated since last coupon.

31. Example
HBL want to buy Rs50 Mio PIB 10 years Bond one month forward date, Askari Bank quotes them 10.50%/10.25% rate, other information given below Issue Date 19-July-2012
Maturity Date 19-July-2022
Trade Date 17-Aug-2015
Coupon Rate 12.00% semi annually Calculate
Buy Rate, Price of Bond, Clean Price, Accrued Days & Interest and Dirty Price