CHAPTER 5:

BOND MARKET
(CONTINUATION)
Table of Contents

Security to bonds Issuance

Risk of Investing in Bonds
Philippine Dealing and Exchange (PDEx)
How to Invest in Bonds
Valuation of Bonds
Bond at a Discount
Security to Bond Issuance

Unsecured debentures - bonds have no specific security attached to

them.
Secured debenture - has some particular asset attached to it like a
factory or building.

Mortgage bonds
involves real estate collateral.
Legal document registered against a particular real estate asset.
a bond with a trust indenture that "secures" its collateral by way
of a mortgage.
"First mortgage bond" has the first mortgage and senior claim on
an asset or group of assets.
Types of Bonds
1. Term Bonds - bonds that mature on a single date. A term bond is the same as a straight bond.

2. Serial Bonds - bonds wherein the principal amount matures in series rather than a single
payment.
This type of bond gives a favorable remark from investors in the sense that they can pick
maturities that will satisfy their requirements.
Examples of serial bonds are equipment trust certificates and municipal bonds.

3. Secured Bonds - bonds issued with fixed assets pledged as collateral.

Example: Mortgage bonds.
First mortgage - mortgage for the first time and also known as closed-end mortgage
bonds
Second mortgage - one with less favored or mortgage for the second time.
At times of default, the bondholders of the first mortgage bonds have a priority over the
property pledged over the bondholders of the second mortgage.
4. Open-end Mortgage Bond - bond that is not commonly acceptable by
bondholders due to the equal claims of the second mortgage to the
first mortgage.

5. Property Mortgaged - contains the full description so that in case of

default, the mortgagee could easily locate which assets they can
satisfy their claim.

6. Collateral Trust Bond - many firms, as part of their investment, own

stocks and bonds of other corporations.
7. Equipment obligation Bonds - equipment is used as collateral.

8. Unsecured Bonds - are bonds issued with no collateral.

Example: Debenture bond.

9. Debentures
may include a negative pledge clause or an equal and ratable
security clause.
Negative pledge clause - the issuer is restricted from pledging
assets to secure another debt unless allowed by the debenture
bondholders. In this case, the bond contract has to be amended.
Equal and ratable security - bondholders will allow the issuer to
attach fixed assets as a pledge to secure another debt.
10. Subordinate Bond - another example of a debenture bond.
The claims under this type of bond are inferior to the claims of the other creditors
named in the bond indenture.
Borrowing cost of subordinated bonds is higher than those of other debts because of
the higher risk the investor is willing to take.

11. Income Bond - is also an unsecured bond. The bondholder of this kind receives interest
only when the firm has sufficient income.
Interest payment can be skipped under the income bonds whenever the firm is
incurring losses.

12. Registered Bond - requires that the name of the bondholders be registered in the
books of the corporation.
The corporation or the trustee keeps the record of the owners of the registered
bonds and is constantly changing whenever a sale or transfer takes place.
A common advantage of a registered bond is security from losing or stealing the bond
certificate, or it is being destroyed by a fortuitous event.
13. Bearer Bonds - coupons or bearer bonds are bonds where a sheet of
coupons is attached to the bond certificate. - Unlike in registered bonds,
the issuing company does not know who the bondholders are when the
bonds are sold or transferred. Thus, interest on coupon bonds is paid to the
bearer.

14. Convertible Bonds - the holders of the convertible bonds can exchange
the bond for a predetermined number of shares of the corporate stock.

15. Callable Bonds - bonds that may be called in for redemption before the
maturity date.
16. Guaranteed Bonds - a bond is a guaranteed bond when another
company or an individual, other than the issuing company, accepts a
common obligation to pay the interest and principal in case of default.
Guarantor - the one who accepts the guarantee of payment is.

17. Junk Bonds - characterized by high-risk, high-yield bonds issued by

companies that are heavily in debt or have an otherwise weak financial
condition.

18. Floating Rate Bond - a type of bond where the interest payment
fluctuates due to the interest rate.
Bond Ratings
The bond rating companies normally set the bond ratings on the
following:

1. Profitability of operations,
2. Competitive position in the industry,
3. Overall financial strength,
4. Ability to pay interest and principal in full and on time.
5. Issues liquidity and additional debt capacity.
6. Specific collateral and other bond provisions such as protection
provided to bondholders in the event of bankruptcy, takeover, and so
forth.
Risks of Investing in Bonds

Government bonds are bonds issued by the government, these are safer
than those offered by private corporations. Corporate bonds are riskier,
it guarantees the bondholders higher interest rates.

Philippine Rating Agency - agency that rates the bonds according to

their riskiness.
a non-profit agency that ensures to prevent conflict of interest
between interested parties.
Risks of Investing in Bonds

1. Interest rate risk - When interest rates rise, bond prices fall. When
interest rates fall, bond prices rise.
2. Inflation risk - This is the risk that the return you earn on your
investment does not keep pace with inflation.
3. Market risk - This is the risk once the entire bond market declines.
4. Credit risk - If you buy bonds from a company or government that is
not financially stable, there is more of a risk you will lose money.
Philippine Dealing and Exchange (PDEX) - is a
dealing exchange for major banks here in the
Philippines.
incorporated to provide trading infrastructure for fixed-
income securities like bonds.
responsible for PDEx for calculating the Philippine Dealing
System Treasury Reference Rates (PDST Rates).
PDEx is one of the two major stock exchanges in the country.
How to Invest in Bonds

Qualification for eligible person to invest in bond:

1. One Primary Identification Card and one Secondary

Identification Card,
2. The investor should be at least 18 years old,
3. Should secure a Tax Identification Number (TIN), and
4. The required minimum amount of the bond normally
ranges from P10,000 to P100,000 pesos.
Anti-Money Laundering Act (AMLA)

this helps the financial institutions to know

more about their client in terms of their
residence, their source of income, and other
important information about the client.
A bank’s usual procedure to obtain a bond is through:

Contacting and asking its Sales Channels- Wealth Management or Retail Bank.
Banks may offer a bond to their clients
Once there is a referral to the bank's Trust Business Development team, the
business development officer will contact the client.
The business development officer will ask the client about their investment
objectives, time horizon, funds for investment, and the like to determine the
type of product that would be best to recommend to the client.
The officer will have bond options for the client after evaluating if a fixed
income is appropriate for the client.
An investment proposal is prepared for the client and important information
about the security such as the issuer, coupon rate, yield to maturity, cash flow
schedule, and the like is presented as well.
If the client approves of the investment, the client will open an account with the
Trust and Asset Management Department by accomplishing the following forms:

1. Account Opening Form - Individual Document. Know your client (KYC) documents Banks
undergo Know Your Customer (KYC) procedures to establish customer identity, know
their financial activities, and assess the risk posed.
2. Client Suitability Assessment Form - used by banks to gauge the client's risk appetite
and financial objectives and to determine the type of bond that suits them best.
3. Investment Management Agreement - This document states the relationship
between the client and EW Trust and Asset Management Group.
4. Letter of Instruction - This letter states the instruction to purchase the security on
the client's behalf.
5. Risk Disclosure Statement - This form tells the different risks the client is exposed
to (l.e. interest rate risk, credit risk, etc.)
Sale of Bonds

Bonds are sold in equal denominations for simplicity.

Each of the bonds issued is evidenced by a certificate
called a bond certificate.
Bonds issued may either be interest-bearing bonds
or non-interest-bearing bonds.
Interest-bearing bond is a bond that earns interest
on specific periodic intervals, normally six months.
Bond issuance is not free from any costs.
Example:

A company issues a P100,000, 10%, 10-year bond. The semiannual interest

payment is made every January 1 and July 1 of the year. How much is the
interest expense on July 1?

P100,000 x 10% x 6/12 = P5,000

Assuming a tax rate of 40%, the after-tax semiannual interest is:

P 5000(1 - 0.4) = P3,000
Valuation of Bonds
To value a bond, individuals or firms must know the following:

1. Par value - initial value of the bond.

sometimes referred to as the principal or face value of the bond
2. Coupon rate - interest rate stated in the bond certificate. It is the basis for
which the interest is paid until it matures.
3. Required rate of return - actual rate received by the bondholder.
sometimes called the discount rate, effective rate, or market rate of return.
4. Maturity date - final date on which repayment of the bond principal is due.
It is the process of determining the amount of security by the time it is issued.
The value of the bond is obtained by getting the sum of all the present value of
all interest payments plus the present value of the principal using the
investor's required rate of return.
TO COMPUTE THE VALUE OF THE BOND:
Example:
On March 1, 2022, Rottie, Inc. sold P500,000.00 face value bonds with a required rate
of return of 12.0%. The bonds will mature in ten years with 12% interest payable
annually every January 1. What is the value of the bond?
Required rate of return is > the coupon rate,
the bond is said to be issued at a discount.

Required return is < the coupon rate, the bond

is said to be issued at a premium.
Bond at a Discount
Bond discount in effect is a loss to the issuing
company and an income to the bondholder.

Selling price of the bond is < the face value of the

bond, the bond is said to be issued at a discount.
In a bond discount, the buyer's required rate of
return is greater than the nominal rate.
Example:
On March 1, 2022, Rottie, Inc. sold P500,000.00 face value bonds with a
required rate of return of 12.0%. The bonds will mature in ten years with
10% interest payable annually every January 1. What is the value of the
bond?
THANK YOU