presentation slides for the iffc conference in kuala lumpur - oct 2008
TRANSCRIPT
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Copyright BOND PRICING AGENCY MALAYSIA SDN.BHD. (FORMERLY BONDWEB MALAYSIA SDN BHD) - All r ightsreserved.
Malaysias First Bond Pricing Agency
Pricing Mechanism For Sukuk
And Bond Structures
Meor Amri Meor Ayob
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Copyright BOND PRICING AGENCY MALAYSIA SDN.BHD (FORMERLY BONDWEB MALAYSIA SDN BHD). - All rights
Bond Market Growth in MalaysiaThe Malaysian bond market has seen tremendous growth over the past years
* 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
96% y-o-ygrowthinIslamicPDS
Private Debt Securities (PDS)emerged
as the largest source of privatesector
financing in the aftermath of the1997
financial crisis
It was reported that MalaysiasIslamic bond market grew over 80%over the last 5 years, with a 96% y-o-
y growth in long term PDS market forthe year 2007
Malaysia accounts for two thirds ofglobal Islamic bonds outstanding in
2007
Binariang GSMs Senior Islamic bond
issuance worth RM20 billion is thelargest corporate bond issue in
Malaysiayet
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Bond Market Growth in MalaysiaActivity in the secondary market has been consistent
Despite the growth in bondissuances, liquidity and activity in
thesecondary market has not grown in
tandem
Liquidity has been observed to beactive
for better credit quality papers
Key issue in the lack of liquidity isprice and information transparency
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Bond Market Growth in MalaysiaA number of Islamic concepts have been applied in the structuring of Islamicbonds
Islamic concepts applied in variousbonds :
Al Bai Bithaman AjilAl Qardhul HasanBai' Bi Al-TaqsitBai DaynBai Dayn & MurabahahBai-Al-EinahIjarahIstisnaMudharabah
MurabahahMusyarakah
Combinations include:Al Bai Bithaman Ajil & BaiEinahMudharabah & MurabahahMurabahah & Bai Al DaynMurabahah & Musyarakah
Murabahah & IjarahIstisna & Mudharabah
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The Role of Bond Pricing
The Solution
The BPA evaluates about 2,000+ bonds thatare not traded on any given day, based on the
market prices
The BPA needs to employ reliable database
and evaluation methodology. This
methodology MUST be transparent and
consistent
ProblemLess than 1% are traded, where are the
prices for the remaining 99%?
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?
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Benefits of Bond Pricing for the Bond Market
Revitalizing the
Secondary
Market for Bonds
BPA valuation approved by the SC may revitalize the bond market using mark-to-market
prices as benchmark by publicly announcing themMarking-to-market system provide strategy alternatives to traditional hold-to-maturity
strategies.
Revitalizing the
Primary Market
for Bonds
From an origination and underwriting perspective, primary level pricing becomes
challenging especially for lower creditsMark-to-market pricing on previously issued corporate bonds can promote new corporate
bond issues by functioning as benchmarks for primary level pricing
Promoting New
Product
Development
BPAs transparency in the methodologies being used will spur the evolution of the bond
market with further advance pricing methodologiesWhen advance pricing methodologies are established, it will encourage more bond
offerings and more active trading of these products in the secondary market.
Improving the
Soundness of
Financial
Institutions
Providing price discovery may assist in financial institutions' compliance to international
standards such as IAS 39 and Basel II requirements.Effectiveness of risk management will be further enhanced as the valuation process will
be consistent and not arbitrary
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7/29Copyright BOND PRICING AGENCY MALAYSIA SDN.BHD (FORMERLY BONDWEB MALAYSIA SDN BHD). - All rights
Delivery Channels
For 2000+ stocks delivered via a .csv (excel) file daily at 6.00 pm
BOND CODE ISIN CODE BOND NAME VALUE DATE MTM PRICE MTM YIELD LAST PRICE LAST YIELD LAST DATE DURATIONCONVEXITY
MO060001 MYBMO0600019 MGS 1/2006 4.262% 15.09.2016 17-Jan-07 103.89 3.78 103.85 3.78 16-Jan-07 7.79 72.77
MS03001S MYBMS03001S9 MGS 1/2003 4.41000% 29.01.2018 17-Jan-07 105.42 3.8 0 0 8.58 89.86
MS03002H MYBMS03002H0 MGS 2/2003 4.24000% 07.02.2018 17-Jan-07 103.9 3.8 0 0 8.66 91.06
MZ98005A MYBMZ98005A5 MGS 5/1998 8.000% 20Y 30102018 17-Jan-07 139.47 3.81 0 0 8.23 87.15
MS04003H MYBMS04003H7 MGS 3/2004 5.734% 30.07.2019 17-Jan-07 118.76 3.84 118 3.91 11-Dec-06 9.04 103.67
MY050003 MYBMY0500036 MGS 3/2005 4.837% 15.07.2025 17-Jan-07 110.58 4.02 110.59 4.02 10-Jan-07 12.43 199.78
MX060002 MYBMX0600028 MGS 2/2006 4.709% 15.09.2026 17-Jan-07 108.74 4.06 108.75 4.06 16-Jan-07 12.78 216.26
DE060266 MYBDE0602668 CAGN 1/2006 364D 25.05.2007 17-Jan-07 98.7 3.76 98.65 3.76 12-Jan-07 0.35 0.24
KV96101E MYBKV96101E2 KLIA 0.000% 30.01.2016 PN 17-Jan-07 128.29 3.99 128.27 3.99 15-Jan-07 6.65 56.4
PS93004H MYBPS93004H4 YTL POWER 10.000% 30.10.2008 PN 17-Jan-07 110.58 3.82 0 0 1.64 3.61
KV95001T MYBKV95001T3 KLIA 7.750% 17.01.2015 PN 17-Jan-07 126.63 3.85 121.06 5.45 04-Mar-02 6.21 47.52
GG04001F MYBGG04001F7 GII 1/2004 0.00000% 15.06.2007 17-Jan-07 98.62 3.43 98.42 3.7 08-Jan-07 0.4 0.32GI03001W MYBGI03001W1 GII 1/2003 0.00000% 31.03.2008 17-Jan-07 95.84 3.57 95.35 3.61 27-Nov-06 1.18 1.98
GI04003N MYBGI04003N5 GII 3/2004 0.00000% 29.10.2009 17-Jan-07 90.4 3.66 86.93 4.15 24-May-06 2.73 8.81
GK04002F MYBGK04002F9 GII 2/2004 0.00000% 30.09.2011 17-Jan-07 84.1 3.72 83.85 3.71 14-Dec-06 4.62 23.6
CI02014T MYBCI02014T5 SMC 14/2002 23.04.2007 17-Jan-07 100.13 3.62 99.25 4.82 28-Dec-05 0.26 0.14
CI02025A MYBCI02025A1 SMC 25/2002 22.08.2007 17-Jan-07 100.14 3.68 100.05 3.98 04-Oct-02 0.57 0.62
CI03007S MYBCI03007S0 SMC 7/2003 11.04.2008 17-Jan-07 99.67 3.78 99.7 3.73 01-Dec-06 1.18 2.01
CK02006N MYBCK02006N0 SMC 6/2002 26.02.2009 17-Jan-07 101.2 3.82 99.91 4.45 28-Dec-05 1.97 4.99
DN97062W MYBDN97062W6 PERWAJA 0.000% 31.07.2007 PN 17-Jan-07 102.5 3.52 107.47 3.59 29-Nov-05 0.51 0.52
DN97099H MYBDN97099H9 TENAGA 0.000% 01.10.2007 PN 17-Jan-07 102.86 3.81 103.73 3.81 30-Oct-06 0.67 0.79
DS97120S MYBDS97120S5 TENAGA 0.000% 01.10.2012 PN 17-Jan-07 119.85 4.33 119.63 4.74 04-Apr-06 4.57 25.99
QK00001W MYBQK00001W8 KHA1/00 1.02B 0-CP 7YR 20/3/2007 17-Jan-07 99.4 3.57 98.41 3.65 10-Oct-06 0.17 0.06
QI03001A MYBQI03001A5 KHA1/03 1B 0-CP 5Y 18/6/08 17-Jan-07 94.96 3.68 93.87 3.8 11-Oct-06 1.39 2.63
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What Is A Bond Pricing AgencyBPAs are new entities and currently only three countries use the BPA framework
KoreaKorea Bond PricingKIS Pricing, IncNICE Pricing Services, Inc
MalaysiaBondweb Malaysia Sdn Bhd
MexicoTwo price vendorsunder the purview ofBanco De Mexico
MexicoMalaysia
Indonesia (indevelopment)
KoreaEgypt (indevelopment)
Thailand
ThailandThai Bond Market Association(SRO)
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Bond Pricing Regulations
As per SC Guidelines on the Registration of Bond Pricing Agencies dated 25 January 2006 -
strict requirements to qualify covering:
Methodology and Process : Audited
Pricing performance : 3 month market acceptance test
Expertise : Fit and proper persons
System: Adequate security and backup
Shareholders : No controlling party
Minimum paid up capital : RM 10 million
Professional indemnity insurance : RM 10 million
Bond Pricing Agency Malaysia has met and exceeded these requirements, and was appointedas the first registered Bond Pricing Agency on 18th April 2006
BPA Registration Requirements
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The Nature of Bond Pricing Business
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Introducing Bond Pricing Agency Malaysia Sdn Bhd
Bond Pricing Agency Malaysia Sdn Bhd (BPAM) was established in 2004
With participation from:MARC and RAM on data and technical
supportSC and BNM in observer and advisory roleMarket community (buy/sell side, brokers)
via
Bottom Up approach
Adhered to strict SC requirements to qualify as
BPA:Audited methodology and processThree months market acceptance testRM10 million minimum paid up capital and
professional indemnity insuranceNo controlling shareholders
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Compliance and Quality Assurance
Bond Pricing Agency Malaysia (BPAM) is currently the only registered Bond Pricing
Agency (BPA) with the Securities Commission
BPAM meets and exceeds the requirements set out in the Guidelines on the
Registration of Bond Pricing Agencies dated 25 January 2006
BPAM is already supporting the implementation of the Basel II, IAS 39 and Risk Based
Capital requirement for banks and insurance companies
Therefore, BPAM is fully compliant to meet the needs of Unit Trust Management
Companies, Asset Managers and Financial Institutions with regard to the provision of
Fair Value Bond Prices
The Securities Commission issued Guidance Note 15 dated 15 December 2006 pursuant to the
Guidelines on Unit Trusts Funds, which outlined the policy for Unit Trusts on use of BPA prices:
Funds investing in Ringgit-denominated bonds shall value bond portfolios on daily basis using
fair value prices quoted by a Bond Pricing Agency (BPA) registered with the SC.
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BPAM Clients
http://www.bankislam.com.my/default.aspxhttp://www.kfh.com.my/http://202.144.198.79/osk/default.asp -
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BPAM Clients
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Pricing Process
BPAMs Bond Pricing Services
BPAM provides valuations on a daily basis at INDIVIDUAL bond level
A comprehensive data collection, validation, pricing and dissemination process is in place to
ensure consistent and market neutral valuations
The bond pricing process is transparent and uses global standard pricing models
The models are customized to meet the unique needs of the Malaysian market
BPAM prices unlisted MYR bonds (Conventional and Islamic). For now we do not price short
term papers, unrated bonds, loan stocks and listed bonds
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
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Pricing Methodology
Bond Pricing Approach Current Industry Practice and the Assumptions
YTM Matrix /Curve Pricing
Individual
Quotation
Approach
Model
Approach
(Mark To
Model)
Hybrid
Approach
Four common market practices are used in conducting bond pricing.
BPAM employs the hybrid approach
Approach Type Pricing Method Granularity
YTM Matrix / Curve
Pricing
Quote Driven Curve Pricing
Individual Quotation
Approach
Quote Driven Individual Bond
Model Approach Theoretical Individual Bond
Hybrid Approach Hybrid Individual Bond
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Pricing Methodology
BPAMs Pricing Methodology An Overview
Bond Price = f ( Benchmark Rates + Credit Spread )
Credit RiskLiquidity
Risk
Risk
Measuring the
Market Price
Of Risk
Segmentation Cube
Individual Bond
Valuation
Trades
Quotations
Individual Bonds
i
l
Term to Maturity
Derivation of benchmark rate
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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
TermtoMaturity
Real Transaction
Base yield curve
(AAA)
Yield curve(AA)
Spread(AA)20bp
Spread of specific bond20bp
Evaluation Yield
15bp
15bp
Evalu
ation
Date
Pricing Process
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Callable Amortizing Bonds with Secondary NotesDiscount Bonds
Bullet BondsFixed Rate BondsAmortizing BondsCallable BondsConvertible BondsExchange BondsBond with WarrantsFixed Rate ABS
Callable ABSFixed Rate MBSCallable MBSStepping FRBFloating Rate NotesFloating Amortizing NotesFloating Rate ABS
Floating Rate MBSBond with Secondary NotesAmortizing Bonds with Secondary NotesCallable Amortizing BondsStepping Amortizing Bonds
Bond types identified and priced by BPAM in the MYR market:
As of April 2008:
Total stocks in the market: 2693
Priced by BPAM: 1908
Pricing Methodology
Callable Stepping BondsCallable Stepping Amortizing Bonds
Convertible Stepping BondsCallable Bonds with Secondary NotesConvertible Bonds with Secondary Notes
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* Price computed using yield derived from the(credit spot rate at discount period t + individual spread)
Notation Descriptionsf Coupon payment frequency in a
yearc Coupon rateF Face amount = Notionaly Yield *AI Accrued InterestD No. of days in one regular coupon
periodD2 No. of days between the value
date and the next coupon Daten Last coupon period
E / U No. of days between the pseudoissue / real last coupon date andthe real first coupon / pseudomaturity date (short first / lastcoupon)No. of days between the pseudoissue / pseudo last coupon dateand the pseudo first coupon /pseudo maturity date (long firstcoupon)
FIF / LIF No. of days between the real issuedate / real last coupon and the realfirst coupon / real maturity date
(Short First / Last Coupon Bond)
No. of days between the real issue/ pseudo last coupon date and thepseudo first coupon / real maturitydate (Long First / Last CouponBond)
Pricing Methodology
Price All Bonds
AI
f
y
F
f
y
fF
c
DDn
n
k DDk
+
+
+
+=+
)21(1
)21(
)1
1001()
1
1001(
1
100
Eg1 : Fixed coupon bonds with regular period
Eg2 : Fixed coupon bonds with short first coupon
AI
f
y
F
f
y
fF
c
f
y
E
FIF
fF
c
EDn
n
k EDk
ED
+
+
+
+
+
+=
+
)21(2
)21(2
)1
1001()
1
1001(
1
100
)1
1001(
1
100
AI
fy
F
fy
U
LIF
fF
c
fy
fF
c
U
D
U
LIFn
U
D
U
LIFn
n
k D
Dk
+
+
+
+
+
++++
=+
)21()21(
1
1)21(
)1100
1()1100
1(
1
100
)1100
1(
1
100
Eg3 : Fixed coupon bonds long first coupon
Apply relevant bond type price formula
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Bond Pricing, Current Practice and Pricing Issue
Sophisticated pricing methodologies are not used due to the lack of transparentdata. Advanced pricing methodologies are still in primitive development.
Example: Pricing of option embedded bonds current practice
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
I
II
I InterestPayment
P
PrinciplePayment
P
I
II
LegalMaturity
First CallDate
datecallfirstnwhere
AI
f
y
F
f
y
fFc
PD
Dn
n
k DDk
=
+
+
+
=+=
+
'
)1
1001()
1
1001(
1100
)21'(
'
1)21(
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Bond Pricing, Current Practice and Pricing Issue
Theoretical Method in Pricing of Bonds with Embedded Options
Example: Pricing of option embedded bonds One Factor Hull & White Trinomial Tree
1) The price of option embedded bond can be computed by backwardation through an interest ratetree as follows:
P(T+1;mid)
P(T+1;dw)
P(T)
P(T+1;up)At time T, the non-exercise price can be computed by:
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) = min [ C, ]
So, the price of option embedded bond is P(0).
)](*);1(
)(*);1(
)(*);1([)exp()(
dwprobdwTP
midprobmidTP
upprobupTPtrTP exernon
++
++
+=
)(TP exernon
1) Hull and White suggested a two-stage method to generate the interest rate tree using the basicformula:
: the coefficient of long term mean: mean speed: the volatility of short term interest rate
dzdtartdr += ])([
)(t
a
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Bond Pricing, Current Practice and Pricing Issue
Theoretical Method in Pricing of Bonds with Embedded Options
1) Hull and White suggested a two-stage method to generate the interest rate tree.
a) The first stage in building a tree for this model is to build a tree for a
variable that is initially zero following
the process .
*r
dzdtardr +=**
Assumption: ,
First Stage Model:
Parameter Setting: , ,
: Minimum integer between and ,
Tree expansion: If the short-term interest reaches the two boundaries
or goes down , then the probabilities to up, middle, down ( ) will change.
0)( =t 0)0( =r
dzdtardr += **
tR = 3
* tit = RjR =
*
maxjta
184.0
ta
816.0maxmin jj =
maxj minj dmu PPP ,,
26
1
32
26
1
222
222
222
tajtjaP
tjaP
tajtjaP
d
m
u
++=
=
+=
26
1
23
1
2
3
6
7
222
222
222
tajtjaP
tajtjaP
tajtjaP
d
m
u
+=
+=
+=
2
3
6
7
23
1
26
1
222
222
222
tajtjaP
tajtjaP
tajtjaP
d
m
u
++=
=
++=
Example: Pricing of option embedded bonds One Factor Hull & White Trinomial Tree
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Bond Pricing, Current Practice and Pricing Issue
Theoretical Method in Pricing of Bonds with Embedded Options
1) Hull and White suggested a two-stage method to generate the interest rate tree.
b)The second stage in the tree construction is to convert the tree into a tree for r . This is
accomplished by displacing the nodes on the -tree so that the initial term structure is exactly
matched. The approach is to set the interest rates on r-tree at time to be equal to the
corresponding interest rates on -tree plus
while keeping the probabilities the same. The procedure is to calculate s iteratively so
that the initial term structure is matched.
*r
*r
ti *r
)( ti
Define
can be calculated as follows:
: Present value of security, which gives $1 at (i,j) node ( ), = initial -period
interest rate,
given by term structure)
where : transition probability from node (i,k) to node (i+1,j) ( )
where P is the price computed from the current term structure of interest rate
)()()( * trtrt = dttattd )]()([)( =
jiQ , 10,0 =Q 0 t
+=+k
ikiji tRkjkpQQ ])(exp[),(,,1
),( jkpdmu PPP ,,
+=+j
ijii tRjQP ])(exp[,1 t
PeQj
i
tRj
ji
i
=
+
1,lnln
Example: Pricing of option embedded bonds One Factor Hull & White Trinomial Tree
Bond Pricing Current Practice and Pricing
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Bond Pricing, Current Practice and PricingIssues - Islamic
Valuation method of Sukuks are indifferent to conventional bonds in marketpractice.
Fixed Payment Bond
Conventional
P
I
II
I InterestPayment
P
PrinciplePayment
Islamic
InterestAccrued
f
y
F
f
y
fF
c
PD
Dn
n
k DDk
+
+
+
=+
=+
)21(
1)21(
)1
1001()
1
1001(
1
100
Notation
Descriptionsf Payment frequency in a year
c Cash flow rateF Face amount = Notionaly YieldD No. of days in one regular coupon periodD2 No. of days between the value date and the next
payment daten Last payment periodP Clean Price
SN
SN
SN
PN
SN SecondaryNote
PN
PrimaryNote
Secondary Note in Islamic structure acts as the fixed profitpayment as agreed in the contract.
Cash flow rate in Islamic structure derived as the ratio betweenthe secondary note amount and the primary note amount
Primary amount is the face amount
Syariah principles conformed via product
structuring
Conventional valuation formula used
Fixed Payment Bond Formula
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Inclusion of asset volatility
Term structure of asset
Floating rate mechanism for the forwardrate agreement in the unconditional andirrevocable purchase of asset atmaturity
Prepayment risk modeling
Counterparty risk modeling
Bond Pricing, Current Practice and Pricing Issues - Islamic
Islamic and conventional bonds are fundamentally different in both structure andthus valuation
Islamic Bond Differences from Conventional Bonds
Not an exchange of paper or money but anexchange of Syariah approved assets
In principle, Islamic bond structure is similar to assetsecuritisation
Differing market perception resulting indifferentiated trading behaviour liquidity, riskpremium, etc.
No imposition of interest but uses secondary notesas profit payments
Profit earned through financial consideration for theexchange by applying Syariah principles
Additional risks that are uncommon in conventional
bonds such as religious and regulatory risks
Many moreunaccounted Islamicfeatures in currentmarket valuation
Rather than relying on the performance of the underlying assets, Islamic bondsare currently priced as per their conventional counterparts and almost
arbitrarily.
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Bond Pricing, Current Practice and Pricing Issues - Islamic
Example KL Sentral Sdn Bhd (KLSSB) Musyarakah Venture with Kuwait FinanceHouse (KFH) as option writer
Investors
Trustee
KLSSBKLSSB(as Wakeel to
Investors)
Purchase Undertaking(PU)
Trusteeoverseeing theMusyarakah
KFH
PutOptiontermsandconditions
PutOption
1
Proceedsfrom PU forSukukredemptionand profitpayments
Musyarakah Venture to sellProject Lands
Stake of Musyarakahpartners based on their
capital contribution of74:26 from KLSSB (inkind) and Sukukholders(cash)
MusyarakahpartnersappointKLSSB asthe ProjectAgent
Distributable profit to beshared semi-annually
based on an agreedprofit sharing ration of99%:1% to KLSSB and
Sukukholders
KLSSBissues
Sukuk andreceives
proceeds inreturn
Cashflow payments inarrears via aggregatedproject revenueUnconditional and irrevocablepurchase of assets
Market prices KLSSB as afixed payment bond to legal
maturity disregarding assetissues.
IH
IL
IHH
IHL
ILH
ILL
I0
Bond has pricing issue on assets embeddedoption
Bond has pricing issue on asset pricing
Forward pricing of assets require a forward ratebenchmark of asset class
Consideration must be taken for counterpartyriskat the end of the contract
.
Asset volatilityandterm structure of assetclass.Eg equity industry index volatility
Asset datagreatly needed Optionality of the put/call feature
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Bond Pricing, Current Practice and Pricing Issues - Islamic
In asset pricing, many considerations must be taken in the cash flow structure andrisk exposure
Cash Flow
Sale
DeliveryPrice Payment
Lease
DeliveryPrice Payment
Equity
PaymentPrice
Discount
Negotiated Mark up
Immediate
DeferredEnd ofPeriod
Advance
StaggeredEnd ofPeriod
Discount
Negotiated Mark up
Immediate
DeferredEnd ofPeriod
Advance
StaggeredEnd ofPeriod
Discount
Negotiated Mark up
Advance
StaggeredEnd ofPeriod
Risk Exposure to Asset
Asset
UsufructProperty
Fixed
Floating
Fixed
Floating
Entity
On Issuer
On theBusiness
Breakdown necessary to avoid mismatch in theIslamic bonds risk consideration
Sukuk contract is the cosmetic of the asset
Key challenge is on dataaggregation on specific assetclasses and using theseinformation in pricing models
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