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Bond Pricing Agency: in The Overall Scheme of Things, Now and Across The Horizon
Bond Pricing Agency: in The Overall Scheme of Things, Now and Across The Horizon
PRICE
Resources (Input)
People (Consumers)
Money
AGENDA
The purpose of todays 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
Binariang GSMs 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
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
AGENDA
The purpose of todays 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
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?
BOND NAME
VALUE DATE
MTM PRICE
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
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.
Mexico
Thailand Malaysia
Korea
Korea Korea Bond Pricing KIS Pricing, Inc NICE Pricing Services, Inc
BPAs 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.
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
AGENDA
The purpose of todays 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
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
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)
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
2)
3) 4) 5) 6) 7)
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
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
AGENDA
The purpose of todays 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
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
Pricing Method
Quote Driven
Granularity
Curve Pricing
Quote Driven
Individual Bond
Theoretical
Individual Bond
Hybrid Approach
Hybrid
Individual Bond
Hybrid Approach
Pricing Methodology
Bond Pricing Approach Current Industry Practice and the Assumptions
1y
2y 4 4.5
3y 5
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
Pricing Methodology
Bond Pricing Approach Current Industry Practice and the Assumptions
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.
Hybrid Approach
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
Financial Data Interest Rate Data Asset Value Asset Volatility Recover Rate Risk Free Rate Curve Rate
Marking to market
Assumptions: 1.Model Is Winner Mathematical model generates price Underlying information is accurate and timely
Hybrid Approach
Pricing Methodology
Bond Pricing Approach Current Industry Practice and the Assumptions
Back-test representation of market value by marking to model shows inaccuracies with actual market trades Market is winner not model
Pricing Methodology
Bond Pricing Approach Current Industry Practice and the Assumptions
Quoted Bonds
Traded Bonds
Marking to market
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
Pricing Methodology
BWMs Pricing Methodology An Overview Bond Price = f ( Benchmark Rates + Credit Spread )
Y i e l d
Credit Risk
Term to Maturity
Liquidity Risk
Risk
Quotations
Segmentation Cube
Individual Bonds
Trades
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
Segmentation Analysis
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.
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
Issuer Ranking Ranking bonds based on credit analysis and scoring Accounting-based Models (Altmans type) Market-based Models (Structural model) Ranking bonds based on market liquidity Turnover Trade frequency
Pricing Methodology
Populate Info Into Segments
Data is extracted and mapped to the proper segments
Official Sources
Term Sheet, FAST
Data Population
Macro Segment
ETP
Market Network
Term Sheet, Validation Broker Quotes Pricing Convention Swap Yields Trade Data Enhancement
Micro Segment
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
Pricing Methodology
Populate Info Into Segments
Data Filtering will identify trades and quotes that are not representative of current market levels Issues
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
Pricing Methodology
Build Yield Curves
Using the filtered data, calibrate risk free and credit curves for MGS and PDS
Bootstrap Calibration
MGS Data
Maturity
PDS Data
Credit Curves
Maturity
Pricing Methodology
Government Bond Pricing
Generation of Spot Yield Curve
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
Pricing Methodology
Government Bond Pricing
Generation of Spot Yield Curve
First Filtering
Validation of Result
Y i e l d
Exclude Outliers
Compared to historical trades and quotes Compared to past evaluated yield
Term to Maturity
Pricing Methodology
Government Bond Pricing
Generation of Spot Yield Curve
First Filtering
Validation of Result
Y i e l d
Term to Maturity
Pricing Methodology
Government Bond Pricing
Generation of Spot Yield Curve
First Filtering
Validation of Result
Y i e l d
Term to Maturity
Pricing Methodology
PDS Credit Curve
Credit Spread Curve Generation
First Filtering
Validation
Y i e l d
Market Info
OTC trading Money brokers
Segmentation Cube
Term to Maturity
Pricing Methodology
PDS Credit Curve
Generation of Spot Yield Curve
First Filtering
Validation of Result
Y i e l d
Exclude Outliers
Compared to historical trades and quotes Compared to past evaluated yield Out of credit rule
Term to Maturity
Pricing Methodology
PDS Credit Curve
Credit Spread Curve Generation
First Filtering
Validation
Y i e l d
Credit Curve
Derive from trade prices in segment Risk free yield from MGS curve
Term to Maturity
Pricing Methodology
Assign Individual Spread
Now that the curves are ready, assign individual spread that reflects the bonds appropriate risk according to the result from the ranking model
Y I E L D
2 Credit class
curves
Y I E L D
Bond Price = f (Risk Free Interest Rate , Risk Spread) Risk Spread = f (Credit, Individual)
Negative Spread
Positive Spread
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 c 1 LIF 1 F F n1 F f f U 100 100 y 1 (k1+D2 D) + y 1 (n1+ LIF +D2 ) + y 1 (n1+ 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
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
Index t
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
Evaluation Yield
20bp 15bp
Real Transaction
Spread of specific bond Base yield curve (AAA)
15bp
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
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
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
AGENDA
The purpose of todays 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
I I I P
First Call Date
I I I P
Legal Maturity
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
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, Pnonexer (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 = [ (t ) ar ]dt + dz
(t ) : the coefficient of long term mean a : mean speed : the volatility of short term interest rate
Assumption: (t ) = 0, r (0) = 0
* * First Stage Model: dr = ar dt + dz
* 6 2 * Parameter Setting: R = 3t , t = it , R = jR 1 Pm = a 2 j 2 t 2 2ajt 0.816 0.184 3 j min = j max j max : Minimum integer between and at , 7 a 2 j 2 t 2 + 3ajt at 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 + ajt u
* r-tree so that the initial term structure is exactly matched. The approach is to
set the interest rates on r-tree at time it to be equal to the corresponding interest rates on r * -tree plus
(it ) while keeping the probabilities the same. The procedure is to calculate s iteratively so that the initial
term structure is matched.
* Define (t ) = r (t ) r (t )
d (t ) = [ (t ) a (t )]dt
Pi +1 = Qi , j exp[( i + jR )t ]
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 ( n1+ 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
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
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.
Trustee
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 assets embedded option
IHH IH IHL I0 IL ILL ILH
Distributable profit to be shared semi-annually based on an agreed profit sharing ration of 99%:1% to KLSSB and Sukukholders
Stake of Musyarakah partners based on their capital contribution of 74:26 from KLSSB (in kind) and Sukukholders (cash)
Asset volatility and term structure of asset class. Eg equity industry index volatility Asset data greatly needed Optionality of the put/call feature
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
Breakdown necessary to avoid mismatch in the Islamic bonds 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
Pricing Methodology
FAQ
FAQ
1.
Why is BWMs price is different from next days actual traded price? BWM publishes end of day price, not next days 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 BWMs prices? Not necessarily. BWMs prices are based on is own opinion. Each portfolio manager should assess BWMs 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 customers 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.
THANK YOU
Meor Amri bin Meor Ayob
meor@bondweb.com.my
Pricing Specialists Simon Ng Tan Keang Chuan Paige Tan Nuraizah Harun Noor Bazlina Sharifmuddin Wong Yin Yee
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 : enquiries@bondweb.com.my
Copyright BONDWEB MALAYSIA SDN.BHD. - All rights reserved.