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Bonds are long-term loans

Issuers pay bond holders rate of interest (COUPON)
Interest payable either on a semi-annual or yearly basis until bond matures
Basic Types of

(No maturity date)

(With maturity

Zero Coupons
(Without interest)


Coupon Paying
(With interest)


Typically payable semi-annually, but some
are paid on a quarterly or monthly basis
Reset periodically to a specified prevailing

Zero coupon bond

market rate
Payable at maturity

Face value

Newly issued bond

When the price of the bond is above its


face value
When a bond price is below its face value


Yield is the return on investment


Short term

Less than 1 year

Long term

More than 1 year


Provisions that allow the issuer to repay the investor's

principal at a specified date before maturity


Provisions that allow the investor the option of

requiring the issuer to repurchase the bonds at
specified times prior to maturity



Bond investors apply principle of risk-return trade-off to value a particular bond
When a bond is exposed to high risk, investors will expect higher return
Issuers assess the risk involved in their investment to estimate the required return of bond
investors before they issue new bonds

Bond values are determined by either its promised yield (income from interest payment) or
its expected return (capital gain).
Investors required rate of return has three components: real rate of return, an expected
inflation premium and a risk premium
All bonds are valued according to the present value of their future cash flow streams .
A bonds yield is the investors required rate of return
Each investor expects to earn a different rate of return according to their risk preference
The required rate of return for an investor is the discount rate that equates the present
value of the future interest payments plus the value at maturity date with the current
market value of the bond
1. Current Yield
o The rate of return that bond holders receive as a reward for their initial
investment and for taking a certain amount of risk.
2. Yield to Maturity
o The discount rate that makes the present value of the bonds payment
(interest and capital gain) equal to its current price ( NPV = 0)
o Yield to maturity measures a bonds total return
o Yield takes into account the coupon payment (interest) as well as the
changes in a bonds market value over its life
o Yield to maturity assumes that bond holders reinvest the bonds periodic
coupon payments at the same rate over time
o Use trial and error method to estimate yield to maturity
Zero coupon bonds do not pay any interest
As time progresses, zero coupon bonds will increase in their value at a compound rate of
return up to maturity date
At maturity date, the bonds will be worth more than their initial investment.
When the required rate of return is equal to the coupon rate, a bond will sell at its par value.
When the required rate of return is more than the coupon rate, a bond will sell at a discount
When the required rate of return is less than the coupon rate, a bond will sell at a premium

Holders of convertible bonds can exchange their bonds for a specified number of shares
during a given period
Convertible bonds carry lower interest rates than non-convertible bonds due to the benefits
gained when common share prices go up
In times of rising share prices, the accrued value of convertible bonds will increase, enabling
the bond holders to exercise their options to convert the bonds into common shares and
subsequently sell them at a higher price in the capital market
Convertible bonds earn coupon interest even when shares sell at a lower price

Conversion ratio = Par value of bond
Conversion price
The number of shares that a bond holder will receive when he converts his bond into
common shares
Example: Zulhasan holds Abad Dinamiks convertible bond which has a face value of RM100
and a conversion price of RM20. What is the conversion ratio?
Conversion ratio = RM100/RM20 = 5 shares
Conversion price = Face value of a bond/Conversion ratio
Example:Arina Juaras convertible bond has a par value of RM100 with a conversion ratio of
25 shares. Calculate the conversion price.
Conversion price = RM100/25 shares = RM4 per share
A period of time during which bond holders are allowed to exercise their option to convert
their bonds into common shares
Conversion value = Current market price per share Conversion ratio
The market value of the underlying shares that bond holders receive when their bonds are
converted into common shares
Example: Laser Berhads convertible bond of RM100 carries a conversion ratio of 20 shares.
Determine its conversion value if the market price per share is RM5.50.
Conversion value = RM5.50 20 = RM110
The difference between market value of convertible bond and conversion value
Two approaches are used to calculate conversion premium:
1. Current market price base (price of a convertible bond less the conversion value)
Example: The current market price of Angkasas convertible bond is RM120. The
company has set the conversion ratio as 15 shares. Currently, Angkasas share is selling
at RM6. Calculate the conversion premium.
Conversion value = Conversion ratio Market price of share
= 15 RM6 = RM90
Conversion premium = 120 90 = RM30
2. Face value base
Example: SB Dynamic has issued a convertible bond with a face value of RM100. The
bonds conversion value is RM82. What is the conversion premium?
Conversion premium = RM100 RM82 = RM18


Investors convert bonds into share when market price of shares > conversion price
In times of rising prices, bondholders make capital gain when convert bonds into shares
subsequently selling them at higher price
Example: The board of directors of Telemax has issued 800,000 units of convertible bond.
The market price of the bond is RM105. The conversion ratio is 20 shares and the market
price of a share is RM5.
Conversion value = Conversion ratio Market price per share
= 25 shares RM5
= RM125
Conversion premium = RM125 RM105 = RM25 per share
Total premium = RM25 800,000 = RM20,000
The higher between the value of bonds as debt and the value of bonds as shares (Conversion
Provides the issuers the flexibility to retire a bond while giving bond holders the following
two options:
1. Convert the bond into common stocks
2. Redeem the convertible bond at a stipulated call price, which may contain a
small call premium
When share price > stipulated call price,
o Investors would exercise their option to convert the bonds into shares
o After conversion, shareholders may hold or sell at higher price
When share price < stipulated call price,
o Bondholders prefer to hold the bonds and continue earning their coupon payments
o The issuers prefer to exercise the forced conversion as it is beneficial in terms of
cheaper cost
Investors assess their bond investment strategies to maximize investment return
Some investors will buy bonds for interest income or hold them for capital gain
Type of strategies:
1. Diversification
o General rule: Do not put all your money in a single investment
o Diversify all type of risks within several bond investment
o To protect any unexpected losses
o Select bonds with different maturities to manage interest rate risk
2. Income Maximization
o Invest in corporate bonds with high coupon rate rather than treasury bond
o Corporate bonds have low credit ratings thus pay high interest rates
o Treasury bonds are risk free thus low yields

1. Interest Rate Risk
o A bonds yield rate depends on the market interest rate
2. Yield Curve Risk
o Arises when there is an adverse shift in market interest rate
3. Call Risk
o A callable bondholder will face in times of low market interest rates
o Beneficial to issuer as they can redeem old high coupon rate bonds and reissue at a
lower coupon rate
4. Credit Risk
o Arises when the issuing company defaults or fail to repay the principal and interest
in a timely manner
o Credit ratings indicate bond quality (low credit ratings indicate low quality)
o Low credit ratings carry high risk
5. Liquidity Risk
o Risk that bondholders need to bear when they are not able to sell their bonds
quickly at reasonable price due to a lack of marketability
o A financial risk due to uncertain liquidity
6. Price Volatility Risk
o Risk that the price of a bond will fluctuate rapidly within a short period of time