UNIVERSITY OF ECONOMICS & LAW SCHOOL OF FINANCE & BANKING Bond Security Analysis Main Content Focused points in this session 1 The definition & characteristics of bond 4 Ranking & Analyzing bond 2 Interest & Maturity of bond 5 Bond yield 3 Information & Registration of bond 6 Convertible bond Security Analysis 2 What is bond? Definitions & characteristics of bond • A bond is a type of security that defines the obligation of the issuer (the borrower) to pay the securities holder (the lender) a specified amount of money • Usually over specified periods of time • And the principal (the original loan) must be repaid at the maturity date Security Analysis 3 What is bond? Definitions & characteristics of bond • Debt security • No ownership of the company, no right to vote, no share of the company's profits • Receive fixed payments: interest (coupon) and principal • Receive interest payments & principal payment (when the company goes bankrupt) before to shareholders Security Analysis 4 Components of bond? Par value & Nominal interest rate • Par value: is the amount the issuer reimburses to investors on the maturity date (principal). • Nominal interest rate (interest payment / coupon) • Bonds pay interest periodically: every 6 months, once a year • Interest payment / coupon = Nominal interest (Coupon rate) x Par value (face value) • The interest rate of a bond depends on: • Supply - demand for capital in the market • Maturity period of bonds: short, medium, long term • The bond's risk of bankruptcy is usually assessed by rating bonds Security Analysis 5 Components of bond? Term of maturity & Price • • Term of maturity • Maturity date is the date that the issuer returns the principal to the bond holder • Principal is usually repayable once at the maturity date. • Principal capital can be paid in installments up to the maturity date (serial maturities). Bond price • Before and after a bond is traded on the secondary market, it can be traded at a price lower, equal or higher than its par value. • A bond's price compared to its par value depends on the relationship of the market interest rate and the bond's nominal interest rate Security Analysis 6 Bond issuer Who can issue bonds? • Company: issued to meet investment or working capital needs • Local government: fundraising for public projects • Government: to raise capital for government fund Security Analysis 7 Bond rating Base to rank bonds • Famous rating agencies: S&P, Moody, Fitch • The basis of rating: the ability to repay interest and debt of the bond issuer • It is usually assessed through the following specific criteria: • Outstanding debt and current debt structure • The firm's cash flow stability • Ability to meet the obligations to repay principal and interest on schedule • The safety of collateral • The capacity of the Board of Directors Security Analysis 8 Components of bond? Par value & Nominal interest rate • Bond certificates usually include the following information: • Name of issuing company (organization) • Bond type • Denominations • Release date • Date due • Retrieval properties (if any) - call features • Nominal interest rate and payment date • Payment place • Trust indentures Security Analysis 9 Corporate bond Picture of bond Security Analysis 10 Local government bond Picture of bond Security Analysis 11 Government bond Picture of bond Security Analysis 12 Bond yield Different methods to define the bond yield • Bond yield is affected by interest rate, term of maturity, bought and sold bond prices, and other characteristics of bond • Nominal yield is a fixed percentage on par value, printed on the bond certificate. • Current yield = coupon / current bond price • Yield to maturity (YTM) • Yield to call (YTC) indicates the yield that a bond holder would receive if he held the bond up to the date the bond was recovered Security Analysis 13 Calculate Yield To Maturity YTM Yield to maturity (YTM) is the average break-even rate of a bond if the bond is bought at a time and holds the bond until the maturity date 𝐶 𝐶 𝑃= + 1 + 𝑌𝑇𝑀 1 + 𝑌𝑇𝑀 𝐶 + 2 1 + 𝑌𝑇𝑀 𝑀 + ...+ 3 1 + 𝑌𝑇𝑀 Security Analysis 𝑇 14 Calculate Yield To Call YTC • Yield to call (YTC) indicates the yield that a bond holder would receive if he held the bond up to the date the bond was called (before maturity) • Annual income = Coupon + [(call price – bought price)/years to call] • Average price = (call price + bought price)/2 • Yield to call = annual income / average price • Applied on bonds with recovery terms Security Analysis 15 Calculate Yield To Call YTC Bond bought at price Relationship Lower than Par value Nominal yield < Yield to Maturity < Yield to Call Equal to Par value Nominal yield = Yield to Maturity = Yield to Call Higher than Par value Nominal yield > Yield to Maturity > Yield to Call Security Analysis 16 Convertible bonds Definitions & Characteristics • A bond has the option to convert to a number of common shares at a certain price at a predetermined time • Conversion ratio: The number of shares that a bond can be converted to • For example: The conversion rate 45: 1 means that 1 bond will exchange 45 shares • LSS offered to sell 1.5 million convertible bonds, i = 12%, par value 100K / bond, term of 2 years. Issue date: October 10, 2018 and all bonds are required to be converted to shares on October 10, 2020 with a conversion rate of 10: 1 (1 bond will convert to 10 shares) • Conversion price: is the price that the bond holder can convert to common stocks • Security Analysis Conversion conditions may change over time 17 Factors that affect conversion terms How to define the value of stocks • Stock price when convertible bonds are issued • The company's production situation in the future • Conversion time: the longer the time, the conversation right has more value • Conversion rate (the higher the interest rate, the higher the conversion price) • The conversion price is usually set higher than the market price of the stock, the lower the spread, the more a conversion will be encouraged Security Analysis 18 Protection terms Terms regarding to convertible bonds • Priority right to buy convertible bonds for shareholders: • Avoid dilution of ownership when converting • Shareholders have the right to buy convertible bonds at preferential prices (like preemptive right with stocks), can sell this right • Adjust the ratio when splitting shares or paying dividends by shares • Regulate the maximum number of additional shares that the company can issue while convertible bonds are still in transaction and the minimum price that the company can issue shares Security Analysis 19 Conversion parity Parity in prices of convertible bonds & stocks • Parity price of common stock = Convertible price / Conversion rate • Parity price of convertible bonds = Market share price x Conversion rate • When the stock market price increases, the price of a convertible bond will increase and equal to the parity price of the convertible bond • When the market goes down, the convertible bond price falls to the price of the bond with the same nature but is not convertible Security Analysis 20 Value of convertible bonds How convertible bond value? • Convertible bonds has the right to convert to stocks in the future => Convertible bonds are usually more valuable than ordinary bonds. • • Value of convertible bonds = Value of bonds + Value of convertible right The minimum value of convertible bonds includes: • The value of an ordinary bond (bond without a conversion characteristic) • The value of the stock that the bond can be converted to • For example: convertible bonds at par value of $ 1000, nominal rate 5%, conversion rate 50:1, market price of common share is $ 30, YTM 8% • Convertible at $ 1000, nominal rate 5%, conversion rate 50:1, call price at $ 1050, market price of common share at $ 30 Security Analysis 21
