Taka bonds and the trading market
Saturday, 4 August 2007
Shireen Scheik Mainuddin
WITH loan syndications and bond issuance both by the Treasury and the private sector, the long term financial market of Bangladesh has quietly emerged.
For persons new to the terminology, "long" includes both stocks about which a great deal is known, and bonds in various forms and of various tenors.
A bond is simply a loan, but in the form of a security. The issuer is equivalent to the borrower, the bond holder to the lender, and the coupon to the interest. Bonds enable the issuer to finance long-term investments with external funds.
Market participants normally use bonds for large issues offered to a wide public. The word 'note' is used for smaller issues originally sold to a limited number of investors but there are no clear demarcations. There are also "bills" which usually denote fixed income securities of three years or less from the issue date to maturity. Bonds have the highest risk, notes carry the second highest risk, and bills have the least risk. This is due to a statistical measure called duration, where lower durations have less risk, and are associated with shorter term obligations.
Bonds and stocks are both securities, but the difference is that stock holders own a part of the issuing company (have an equity stake), whereas bond holders are in essence lenders to the issuer. Also bonds usually have a defined term, or maturity, after which the bond is redeemed whereas stocks may be outstanding indefinitely.
The range of issuers of bonds is very large. Almost any organisation could issue bonds, but the underwriting and legal costs can be prohibitive and the regulations to issue bonds are normally very strict. Issuers are often classified as follows:
Supranational agencies, such as the European Investment Bank or the Asian Development Bank issue supranational bonds. National governments issue government bonds in their own currency and also issue sovereign bonds in foreign currencies. Sub-sovereign, provincial, state or local authorities (municipalities) may borrow for infrastructure projects throughs municipal bonds. Government-sponsored entities such as a state-owned airline or a power distribution company issue 'agency bonds" while companies (corporates) issue corporate bonds.
The interest rate that the issuer of a bond must pay is influenced by a variety of factors, such as current market interest rates, the length of the term and the credit worthiness of the issuer. These factors are likely to change over time, so the market value of a bond can vary after it is issued. Bond prices can become volatile if a rating agency upgrades or downgrades the credit rating of the issuer. A downgrade can cause the market price of the bond to fall. As with interest rate risk, this risk does not affect the bond's interest payments, but puts at risk the market price for holders of individual bonds who may have to sell them.
Bonds do suffer from less day-to-day volatility than stocks, and bonds' interest payments are higher than dividend payments that the same company would generally choose to pay to its stockholders. Bonds are liquid -- it is fairly easy to sell one's bond investments, though not nearly as easy as it is to sell stocks -- and the certainty of a fixed interest payment twice per year is attractive.
Bondholders also enjoy a measure of legal protection: under the law of most countries, if a company goes bankrupt, its bondholders will often receive some money back (the recovery amount), whereas the company's stock often ends up valueless. However, bonds can be risky. First the liquidator is paid, then government taxes, etc., and there is no guarantee of how much money will remain to repay bondholders. As an example, after an accounting scandal and a Chapter 11 bankruptcy at the giant telecommunications company Worldcom, in 2004, its bondholders ended up being paid 35.7 cents on the dollar. In a bankruptcy involving reorganisation or recapitalisation, as opposed to liquidation, bondholders may end up having the value of their bonds reduced.
A registered bond is a bond whose ownership (and any subsequent purchaser) is recorded by the issuer, or by a transfer agent and is the alternative to a Bearer bond. Interest payments, and the principal upon maturity, are sent to the registered owner.
As markets grow, corporates, banks, governments, and other sovereign entities issue bonds in foreign currencies which gives issuers the ability to access investment capital available in foreign markets and hedge foreign exchange rate risk. An important step in the international bond market's development is nicknames used by traders i.e the "Kangaroo " for an Australian dollar-denominated bond issued by a non-Australian entity in the Australian market , "Bulldog " for a sterling-denominated bond issued in London by a foreign institution or government and "Panda" for a Chinese renminbi-denominated bond issued by a non-China entity in the People's Republic of China market.
The authors views are that a range of issues need to be reviewed before Dhaka's long-term financial market moves into the active secondary stage which is so essential for liquidity purposes. The more thought given to the subject, the greater the chances that the market grows steadily and without debacle.
Briefly banks appeared to be moving very fast before fully utilising their position as effective intermediaries. An analysis of the annual reports of the private banks shows that in one private commercial bank (PCB), the percentage of portfolio concentrated on 251 large names is 100%. In another, it is 91% of the total to 59 borrowers. The SME sector which requires bank financing is therefore being largely neglected. Is it wise to permit large companies to free themselves from covenants with their banks and commitments to their shareholders at this stage? Should all bond issuers and long term borrowers be provided with implicit guidelines? Will this hamper or lead to healthier growth ?
Bonds markets, unlike stock or share markets, often do not have a centralised exchange or trading system. Rather, in most developed bond markets such as the U.S., Japan and western Europe, bonds trade in decentralised, dealer-based over-the-counter markets. In such a market, liquidity is provided by dealers and other market participants committing risk capital to trading activity. We have commenced Treasury Bond trading directly through the central clearing . While this has the positive effect of freely available instruments and information, it may fall short of the concept of the bond market acting as a hedge to changes in interest rates and stocks.
If a single most important factor is to be determined for an overall bond market indice, it is likely to be the country's sovereign rating. Therefore the bond market for Bangladesh will be directly impacted by an upgrade or reverse of the country's rating.
.........................................................
The writer was formerly a banker and is presently a consultant
WITH loan syndications and bond issuance both by the Treasury and the private sector, the long term financial market of Bangladesh has quietly emerged.
For persons new to the terminology, "long" includes both stocks about which a great deal is known, and bonds in various forms and of various tenors.
A bond is simply a loan, but in the form of a security. The issuer is equivalent to the borrower, the bond holder to the lender, and the coupon to the interest. Bonds enable the issuer to finance long-term investments with external funds.
Market participants normally use bonds for large issues offered to a wide public. The word 'note' is used for smaller issues originally sold to a limited number of investors but there are no clear demarcations. There are also "bills" which usually denote fixed income securities of three years or less from the issue date to maturity. Bonds have the highest risk, notes carry the second highest risk, and bills have the least risk. This is due to a statistical measure called duration, where lower durations have less risk, and are associated with shorter term obligations.
Bonds and stocks are both securities, but the difference is that stock holders own a part of the issuing company (have an equity stake), whereas bond holders are in essence lenders to the issuer. Also bonds usually have a defined term, or maturity, after which the bond is redeemed whereas stocks may be outstanding indefinitely.
The range of issuers of bonds is very large. Almost any organisation could issue bonds, but the underwriting and legal costs can be prohibitive and the regulations to issue bonds are normally very strict. Issuers are often classified as follows:
Supranational agencies, such as the European Investment Bank or the Asian Development Bank issue supranational bonds. National governments issue government bonds in their own currency and also issue sovereign bonds in foreign currencies. Sub-sovereign, provincial, state or local authorities (municipalities) may borrow for infrastructure projects throughs municipal bonds. Government-sponsored entities such as a state-owned airline or a power distribution company issue 'agency bonds" while companies (corporates) issue corporate bonds.
The interest rate that the issuer of a bond must pay is influenced by a variety of factors, such as current market interest rates, the length of the term and the credit worthiness of the issuer. These factors are likely to change over time, so the market value of a bond can vary after it is issued. Bond prices can become volatile if a rating agency upgrades or downgrades the credit rating of the issuer. A downgrade can cause the market price of the bond to fall. As with interest rate risk, this risk does not affect the bond's interest payments, but puts at risk the market price for holders of individual bonds who may have to sell them.
Bonds do suffer from less day-to-day volatility than stocks, and bonds' interest payments are higher than dividend payments that the same company would generally choose to pay to its stockholders. Bonds are liquid -- it is fairly easy to sell one's bond investments, though not nearly as easy as it is to sell stocks -- and the certainty of a fixed interest payment twice per year is attractive.
Bondholders also enjoy a measure of legal protection: under the law of most countries, if a company goes bankrupt, its bondholders will often receive some money back (the recovery amount), whereas the company's stock often ends up valueless. However, bonds can be risky. First the liquidator is paid, then government taxes, etc., and there is no guarantee of how much money will remain to repay bondholders. As an example, after an accounting scandal and a Chapter 11 bankruptcy at the giant telecommunications company Worldcom, in 2004, its bondholders ended up being paid 35.7 cents on the dollar. In a bankruptcy involving reorganisation or recapitalisation, as opposed to liquidation, bondholders may end up having the value of their bonds reduced.
A registered bond is a bond whose ownership (and any subsequent purchaser) is recorded by the issuer, or by a transfer agent and is the alternative to a Bearer bond. Interest payments, and the principal upon maturity, are sent to the registered owner.
As markets grow, corporates, banks, governments, and other sovereign entities issue bonds in foreign currencies which gives issuers the ability to access investment capital available in foreign markets and hedge foreign exchange rate risk. An important step in the international bond market's development is nicknames used by traders i.e the "Kangaroo " for an Australian dollar-denominated bond issued by a non-Australian entity in the Australian market , "Bulldog " for a sterling-denominated bond issued in London by a foreign institution or government and "Panda" for a Chinese renminbi-denominated bond issued by a non-China entity in the People's Republic of China market.
The authors views are that a range of issues need to be reviewed before Dhaka's long-term financial market moves into the active secondary stage which is so essential for liquidity purposes. The more thought given to the subject, the greater the chances that the market grows steadily and without debacle.
Briefly banks appeared to be moving very fast before fully utilising their position as effective intermediaries. An analysis of the annual reports of the private banks shows that in one private commercial bank (PCB), the percentage of portfolio concentrated on 251 large names is 100%. In another, it is 91% of the total to 59 borrowers. The SME sector which requires bank financing is therefore being largely neglected. Is it wise to permit large companies to free themselves from covenants with their banks and commitments to their shareholders at this stage? Should all bond issuers and long term borrowers be provided with implicit guidelines? Will this hamper or lead to healthier growth ?
Bonds markets, unlike stock or share markets, often do not have a centralised exchange or trading system. Rather, in most developed bond markets such as the U.S., Japan and western Europe, bonds trade in decentralised, dealer-based over-the-counter markets. In such a market, liquidity is provided by dealers and other market participants committing risk capital to trading activity. We have commenced Treasury Bond trading directly through the central clearing . While this has the positive effect of freely available instruments and information, it may fall short of the concept of the bond market acting as a hedge to changes in interest rates and stocks.
If a single most important factor is to be determined for an overall bond market indice, it is likely to be the country's sovereign rating. Therefore the bond market for Bangladesh will be directly impacted by an upgrade or reverse of the country's rating.
.........................................................
The writer was formerly a banker and is presently a consultant