A Guide to Issuing Bonds
1
Contents
Information Disclaimer
The contents of this booklet are believed to be accurate at
the date of issue. They are intended for general purposes only
and not considered as providing recommendations or advice.
The CMDA does not give warranty or accept any liability
(whether arising from negligence or otherwise) for any error
or omission or any loss arising from acting on the information
in this publication, except where under law, liability cannot be
excluded.
Introduction
1
What are Bonds?
1
Key Features of Bonds
1
Why Issue Bonds?
3
Risks and Challenges of Issuing Bonds
3
Understanding Bond Price
4
Structuring Bonds – Practical Issues
6
The Bond Issue Process
8
Listing and Trading Bonds on the SPSE
10
Appendix
11
A Guide to Issuing Bonds
Introduction
Raising capital is one of the most important challenges for any
business, be it a company, a statutory authority, town council,
Government or other institution. A business needs money
to expand or to pay for its day-to-day operations. It can get
money in various ways - by earning revenue from its goods and
services, by raising capital from shareholders or by borrowing.
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Bonds
Fiji,Bonds belong to a class of investments called fixed income
securities. Other examples are bills and notes.
Fixed income securities are like contracts where
the investor lends money to a business for an agreed
interest rate and period. Interest is usually paid in regular
installments.
bondholder, the bondholder gets a bond certificate from the
issuer. This certificate can be sold to another investor much
like shares.
In some ways, a bond is similar to a bank loan. The issuer
pays the bondholder an agreed interest rate. Usually interest
is paid in equal amounts (called coupons) throughout the life
of the bond. The bond is for an agreed term which is always
more than one year2. At the end of the term, the issuer pays
the amount borrowed back to the bondholder.
Key Features of Bonds
Let’s take a look at some of the key features of bonds. To help
you understand the basic terms, a diagram of a bond which
shows the different cash outflows and inflows for the issuer is
presented below.
Businesses have traditionally relied on capital from shareholders
and bank loans. This booklet introduces an alternative way
of raising capital – issuing bonds. We hope to answer the
following questions:
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What are bonds and how do they work?
Why might bonds be a good method of raising capital?
What are the risks of issuing bonds?
How do you go about issuing bonds?
2
Receive $100
(Price)
Today
Pay $6
Coupon
Year 1
Pay $6
Coupon
Pay $6
Coupon
Year 3
What are Bonds?
Pay $6
Coupon
Pay $100
(Face Value
Bondholder
Year 4
Year 5
Lend money
by buying
bonds
Pay regular coupons
Repay amount
borrowed at expiry
of bond
Issuer
E.g. company, institution, Government
A bond is a type of investment where the investor (the
bondholder) lends money to a company1 (the issuer) which
issues the bond. As proof that the issuer owes money to the
Bond Example
In this example, the price of the bond is $100. The bondholder
is lending $100 to the issuer.
The bond has a term of 5 years. This is the life of the bond.
The face value is $100. This is the amount the investor receives
at the end of 5 years.
The coupon rate is 6% paid each year. This is the interest rate.
The bondholder receives a $6 coupon at the end of each year.
For simplicity, we refer to “businesses” issuing bonds.
These businesses could be companies, institutions
(including statutory authorities and town councils) and
Government. Recent examples of issuers in Fiji are Fijian
Holdings Ltd, Fiji Pine Ltd, the Housing Authority and the
Fiji Development Bank.
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A bill is an example of a fixed income security with a term
of 1 year or less. Apart from the term, bonds and bills are
very similar.
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Why Does a Business Borrow?
Businesses need to raise money from time to time to
expand or to finance their day-to-day operations. Issuing
bonds is one way to do this. Other options include
borrowing from a bank or raising capital by issuing shares
to investors. The latter is called equity.
money from investors (bondholders). Recent issuers in Fiji
include Government and large institutions and companies such
as Fijian Holdings Ltd, Housing Authority, Fiji Electricity
Authority and Fiji Development Bank.
Bondholder - An investor in bonds. A bondholder may be an
individual person, a company or an institution. By investing in
bonds, the bondholder lends money to the issuer.
Term (also Maturity) – This is the life of a bond. At the end
of the term, the last coupon and the face value of the bond is
paid to the bondholder. The bond is said to have matured. The
term for bonds in Fiji generally ranges from one year to around
15 years.
Price - The amount a bondholder pays for a bond. In our
example, the price is $100.
Embedded Options - Some bonds give either the issuer and/
or the bondholder the option to take some action against the
other party under certain circumstances. The general term for
these is embedded options. Examples include call features and
conversion rights.
How are Bond Prices Quoted?
Examples of Embedded Options
By convention, price is stated as a percentage of the
bond’s face value. For example if a bond’s face value is
$100, a price of 100 means that the bond price is 100% of
the face value i.e. $100. A price of 98.5 is 1.5% lower than
the face value ($98.50) while a price of 102 is 2% higher
than the face value ($102).
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Face Value (also Par Value or Principal) - The amount the
issuer pays the bondholder at the end of the lending period.
Bonds can be issued at different face values. In our example the
face value is $100, which is the same as bonds recently issued
in Fiji.
Pay $6
Coupon
Year 2
Issuer - The business that issues a bond. The issuer borrows
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Note that the face value and price can be different. We will
discuss why this could be the case in Understanding Bond
Price.
Coupon and Coupon Rate - The coupon rate is the rate of
interest paid on a bond. Interest is usually paid in equal amounts
at regular intervals (e.g. every three, six or twelve months).
These are called coupons. In our example, the coupon rate is
6% payable annually. This means that each year the issuer pays
a $6 coupon (6% x $100 face value).
Coupon rates may be fixed or floating. Fixed rates do not
change during the life of the bond3. Floating rates allow periodic
adjustments to reflect prevailing market conditions.
In Fiji, fixed rate bonds generally have six-monthly coupon
payments while floating rate bonds often pay interest quarterly.
Most bonds have fixed interest rates. The alternatives are normally
called Floating Rate Notes (FRNs).
Floating Rate Example
A bond’s coupons are linked to the bank bill rate, the
interest rate paid by banks on bills of exchange. The
coupon rate is set at “3% + the bank bill rate”. If the bank
bill rate is 2%, the coupon rate will be adjusted to 5%.
Call feature – This allows the issuer to pay back (“call”)
the bond early. For example, a bond may mature on 31
December 2008 but allow the issuer to “call” the bond at
any time after 31 December 2006. Generally the issuer
must advise investors and gazette the call date three
months in advance. Call features are an advantage for
the issuer because when interest rates fall, the issuer can
call bonds and refinance by issuing new bonds at a lower
interest rate (i.e. coupon rate).
Conversion rights – This gives a bondholder the option of
converting his / her bondholding into shares of the issuer.
The time at which conversion can take place depends on
the terms of the particular bond. For example, say you
own $2,000 worth of bonds issued by Company X and
the terms of conversion say you can convert to ordinary
shares at $2 a share. You can either convert your $2,000
into 1,000 ordinary shares of Company X or withdraw
your $2,000 when the bond matures. Conversion rights
are an advantage to the bondholder. In our example, the
bondholder can choose to convert to ordinary shares at
$2 if he/she thinks the shares are really worth say $2.10.
Yield – This is a measure of the return that a bondholder makes
on a bond. The most common yield measures are “running
yield” which measures the return on a bond measure by the
relationship between the coupon and the current bond price,
and the yield to maturity4 which measures the rate of return on
a bond assuming it is held to maturity including the premium
or discount to the face value. The term yield in this booklet
refers to yield to maturity. The higher the yield, the higher the
It is more normal for bonds to carry fixed coupons (hence
the term “fixed income securities”). In this guide we
generally refer to bonds with fixed coupons.
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Yield to maturity is basically the interest rate that equates
the bond’s future cashflows to its price.
3
A Guide to Issuing Bonds
rate of return. We will discuss this further in Understanding
Bond Price.
Security – An issuer may “secure” the bond on some of its
assets, like property or shares that it owns. Thus if the issuer
defaults in paying bondholders, the bondholders will have the
rights to the proceeds from the sale of the assets. Security for a
bond reduces the risk to the bondholders and therefore makes
the bond more attractive to investors. Generally however bonds
rank behind loans from banks in priority for payment, but
ahead of ordinary trade creditors.
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of the bond with a big capital gain at maturity.
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Leverage Example
Crash Co needs $100,000 for a manufacturing operation
that will generate a 10% rate of return after a year (i.e.
$10,000).
If shareholders provide all the funds, they get a 10% rate of
return ($10,000). However if 50% of the funds is borrowed
at a 5% interest rate (i.e. interest = 5% x $50,000 = $2,500),
the shareholders get the remaining return of $7,500 on
their equity of $50,000. Their return in this case is 15%
($7,500/$50,000).
With leverage, the shareholders’ return is now higher
because the interest on debt is lower than the return on
the project.
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Flexibility – Bonds can be structured in many ways, to suit
Risks and Challenges of Issuing Bonds
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Financial risk – Because bonds are a debt, the issuer has
payment obligations that are enforceable under law. Even if
the issuer runs into financial difficulty, coupons and principal
payments must still be made. Compare this with ordinary
shares – a company can decide not to pay dividends in years
where it makes a loss.
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Refinancing risk – When bonds mature the issuer still
needs capital, it may have to refinance i.e. pay off the bonds
and find new capital to replace the funds paid out. However,
refinancing could be a problem if interest rates have been
rising – the issuer might end up refinancing at a higher
interest rate.
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Large bullet payment – The principal is paid when bonds
investors would be more work compared to say borrowing
from a bank. Imagine sending out coupon cheques and
Risks
Source of capital
Leverage
Delayed Interest
Delayed Principal
Fixed Interest Rate
Flexibility
Financial risk
Refinancing risk
Bullet payment
Admin cost
Disclosure
Tax
What drives the price of a bond? Understanding this will
help you structure a successful bond issue that meets investors’
expectations. As a first step, we look at the concept of “time
value of money”.
As mentioned earlier, a bond’s price can be higher or lower
than its par value. So after a bond is issued, how much will it
buy or sell for? Unfortunately, valuing a bond is not easy and
is beyond the scope of this introductory booklet. However,
this section tries to give you a basic understanding of what
determines the value of a bond. Further information can be
found in the appendix. Please consult your investment adviser
for specific advice.
Basic Concepts
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Administration cost – Administration of a large pool of
Benefits
Understanding Bond Price
mature. While delaying this payment may be convenient
initially, it means the issuer will have to make a large “bullet”
payment when the bonds mature. The issuer needs to plan
its cashflows carefully so it isn’t caught unprepared.
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Tax implications – Bond coupons are generally taxed
as income to the shareholder. In contrast, for example,
dividends on listed shares are tax-free. In this case, the
issuer may have to increase the yield on the bond to
compensate bondholders for tax and ensure its bonds
remain attractive.
Fixed interest rate – The interest rates can be fixed by
the needs of the issuer. For example, the issuer can choose
how often coupons are paid, the term, whether the coupon
rate is fixed or floating and the type of embedded options.
Less frequent payments – Coupons are typically paid
every three, six or twelve months, depending on the bond.
This may be more flexible and convenient for the issuer
compared to a bank loan which requires monthly interest
payments. A bullet bond goes even further by paying all
coupons and principal at maturity.
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Leverage vs Financial Risk
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Disclosure requirements – Where bonds are issued to
the public, detailed disclosure requirements are set by the
CMDA and other regulatory authorities. This compares
with a bank loan where details can be kept confidential.
Note that financial risk should be weighed against the benefits
of leverage. More debt increases the benefits of leverage
but also increases financial risk. Therefore businesses usually
look for a balance between the two i.e. take on some debt
but not too much!
An alternative source of capital – In Fiji, businesses have
traditionally relied on shareholders’ equity and bank loans
Alternative sources of funds like bonds mean that businesses
have a wider choice and more flexibility in funding.
Leverage – Borrowing can increase shareholder returns.
Let’s say you build a new factory and finance this through
a mix of borrowing and equity. If you can borrow at an
interest rate that is lower than the return from the factory,
the return to shareholders will increase. This is called
leverage. Bonds can be one method of leverage.
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issuing a fixed rate bond. In this way, if interest rates
increased, the issuer has locked in its interest rate.
Bonds offer a business a number of benefits. Some of them are
listed below:
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principal repayments to hundreds of bondholders as well
as maintaining all records.
the face and the issue price is the internal rate of return which
compensates investors for not getting coupons during the life
Why Issue Bonds?
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Delayed principal repayment – Compared to the typical
bank loan which requires that the principal is repaid in
installments, the bond principal is paid as a lump sum
on maturity. A zero coupon goes even further. This type
of bond is issued at a discount to its face value and pays
no coupons. The net present value of the difference between
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Why do you buy a car? For most people, it is because they
get the benefit of having their own means of transport.
Similarly, people invest in a bond because of what they will
get out of it, namely income and capital growth.
Are Bonds Suitable for your Organisation?
Bonds are just one of several funding options that you can
consider. But are they suitable for your business? Here are
some general characteristics of businesses that might be suited
to issuing bonds:
a Good credit quality – Poor credit quality means higher
returns are needed to compensate the investor for higher
risk and therefore issuing bonds will be more expensive.
In addition, because issuers with poor credit are likely to
be struggling with cashflows, debt may not be a good
idea because the issuer is legally required to make
regular payments regardless of how well or poorly it is
performing.
a Relatively large size – Investors are likely to be more
comfortable with large businesses that have extensive
resources.
a Good financial record – A profitable business is more
attractive for investors.
a Public profile – An established business with a good public
profile will probably find it easier to attract investors than
a new, less-known business.
a Relatively stable earnings – Bonds involve legallyenforceable payment obligations, regardless of whether
the issuer is profitable or not. Issuers with unstable
earnings risk defaulting on payments in bad earnings years
which could lead to legal proceedings against it by the
bondholders.
a Relatively low debt – Remember that debt increases
financial risk. As a general rule, a business should choose
a level of debt versus equity that (a) takes advantage of
leverage but (b) does not blow out its risk.
a Large borrowing requirement – The fixed cost of issuing
bonds (e.g. prospectus, trust deed, legal and accounting
advice, etc) is significant. Therefore small issues may not
be cost effective.
a Receptive to public scrutiny – Under the law, an issuer
making a public offer of bonds, shares or other securities
must regularly report material information to the public.
bondholder and the coupons and payment of face value
received by the bondholder.
Time Value of Money5
However, valuing a bond does not simply mean forecasting
and adding up all future income and capital growth because
It follows that the value of a bond should reflect the income
and growth it is expected to give the bondholder in future.
In other words, a bond can be viewed as simply a stream 5See the appendix for a more detailed discussion of time
of cashflows which includes the initial price paid by the value of money and bond values.
A Guide to Issuing Bonds
you need to take into account what is called the “time value” of
money.
Consider the following: Which would you rather have: $100
today or $100 in a year’s time? The logical choice is $100 today
because you can invest this to earn interest so that in a year’s
time, your initial investment will be worth more than $100.
For example, if you could invest to yield 10% for the year, a
$100 investment today would be worth $110 after one year.
Reversing this process, $110 in a year’s time would be worth
$100 today6. To use the technical jargon, at an interest rate or
yield of 10%, present value of $100 is equal to future value of
$110.
What happens if market interest rates increased to 8%? The
bond is still paying 6% so is now less attractive than other
investments paying 8%. Investors will want to pay less for this
bond. This is why a bond’s price can be lower than its face
value. This bond is said to be trading at a discount.
To summarise, a bond’s value (i.e. its price) and the interest
rates in the market are like a see-saw. As one goes up, the other
goes down. An increase in interest rate leads to a fall in bond
price and vice-versa.
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General
Interest
Rates
Because you can invest at some interest rate, $100 today
should be worth more than $100 in one year’s time (this
is true of any amount and interest rate for that matter).
Similarly, $100 in one year’s time should be worth less than
$100 today7.
How Interest Rates Affect a Bond’s Value?
As we have seen, interest rates affect a bond’s value. The bond
price may be higher or lower than its face value depending on
how its interest rate (the coupon rate) compares with interest
rates available on other investments.
Take a bond with a fixed coupon rate of 6%. The coupon rate
never changes even though interest rates may. Let’s say when
the bond is first issued, similar bonds and other investments
were also paying 6%. Therefore the bond’s coupon rate is in
line with the market and its price will be equal to its face value.
This bond is said to be trading at par.
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What happens if the market interest rate dropped to 4%?
Now the bond is still paying 6% so is more attractive than
other investments paying only 4%. Investors will be willing
to pay more for this bond. This is why a bond’s price can be
higher than its face value. This bond is said to be trading at a
premium.
Investors are prepared to
pay LESS for the same
bond
Bond
value
The higher the interest rate the greater the difference
between present value and future value. Say you invest for
a year at a 20% interest rate. A present value of $100 would
be equal to a future value of $120 and vice versa.
So what is the value of a bond? It is basically the present
value of the future cashflows (income and growth) that the
bondholder will receive.
How to Value a Bond?
Leverage
So what does all of this jargon mean? How do you actually go
about valuing a bond? Unfortunately, valuing a bond can be
quite complex and is beyond the scope of this booklet. However,
here are a few pointers:
Remember, debt can increase the return on equity through
leverage. However, with more debt, a business’s financial risk
increases because regardless of whether the business is making
profits or losses, it is locked into legally-enforceable payment
obligations. It is therefore important to strike a balance.
Usually a business will have a target capital structure, e.g. “50%
equity/50% debt”. This will determine how much capital
should be raised through a bond issue.
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General interest rates increase but bond coupon rate stays
the same... the bond is now LESS attractive relative to
other investments
In our simple example below, we used a 10% interest rate. What
is the relevant interest rate for analysing a bond? Basically
this should be the interest rate available on other investments
that are similar to the bond (this is referred to as the market
yield). Why is this so? Because if an investor didn’t choose the
bond, he/she could get this yield (interest rate) from similar
investments anyway.
Therefore the market yield is like the benchmark to measure
a bond against. If the bond’s coupon rate isn’t as high as the
market yield, investors will pay less than the face value.
If the coupon rate is above the market yield, the bond is more
attractive and investors will be prepared to pay more than the
face value.
Future Value = $100 x 1.10 = $110 i.e. $100 today is
worth $110 in a year. Present value of $110 to be received
in a year = $110/1.10 = $100 i.e. $110 in a year is worth
$100 today. It follows that $100 to be received in a year is
worth less than $100 today!
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With a 10% interest rate, this is worth $100/1.1 =
$90.90.
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When the bond is first issued, the issuer tries to set a
coupon rate that is competitive with similar bonds. Too
high and the issuer ends up paying too much interest, too
low and investors might not be attracted.
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Government bonds - the Reserve Bank regularly publishes
information on yields and prices for different maturities and
coupon rates. This information reflects recent bond issues
and therefore provides an indication of the current value of
a Government bond.
Which Interest Rate?
This concept has some important implications for bond value:
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Non-Government bonds - Corporate and other nonGovernment bonds are generally riskier than Government
bonds so should really be giving you a higher yield than that
of a similar Government bond. The yield can be estimated
by adding a premium on the equivalent Government bond
yield to reflect the extra incremental risk. The resulting
yield can then be used to calculate the bond’s value i.e. the
present value of the bond’s future cashflows.
Estimating the amount of premium to add is not straightforward
and is best left to your investment adviser. This premium will
vary from issuer to issuer. The higher the overall risk of a
bond compared to a similar Government bond, the larger this
premium.
Structuring Bonds – Practical Issues
Structuring a bond issue normally requires specialist investment
advice and is outside the scope of this introductory booklet.
However, in this section we discuss some practical issues that
will help you when working with your investment adviser.
Determining an ideal capital structure depends on the individual
business, its industry and other factors, beyond the scope of this
booklet. As a rough guide, a business with stable earnings from
its operations will be better able to meet its debt obligations.
Term
The term of a bond depends on the reasons for raising capital and
the expected cashflows that will be available to meet payments.
For example, a large project might be funded with a ten-year
bond issue to allow enough cashflows to be generated to pay
off the bonds. Alternatively the issuer may choose to fund this
through a 5-year bond issue and refinance with a second 5-year
issue when the first lot of bonds mature. Various combinations
are possible. Please consult your investment adviser.
Credit Spread, Yield and the Coupon Rate
We have seen how government bonds are often regarded as
low risk or risk free, because government is seen as unlikely to
default on its payments.
Therefore, the yield on government bonds will normally be
the lowest in the market. Remember the lower/higher the
risk, the lower/higher the return (yield) has to be in order to
compensate investors.
Risk Premium and the Coupon Rate
In theory, as the required yield increases, the issuer will have
to increase the coupon rate or else the price investors are
willing to pay will fall. Issuers normally don’t want the latter
because this could mean that they raise less money than
planned i.e. investors are paying less for the same number
of bonds.
Therefore in practice, issuers will aim to keep the bond price
at the face value. They do this by setting the coupon rate at
the required yield. In MRC’s example, the coupon rate is 8%.
Determining the appropriate yield can be done through an
auction process.
Example
Max Risk Co (MRC) wants to issue a 10 year bond with a
$100 face value and a callable option. MRC is a mediumsized public company which has been profitable except for
the last 2 years when it made a small loss. It expects to
return to profitability this year.
MRC’s bonds are riskier than government bonds because
MRC has less resources, has earnings which have fluctuated
in recent years and has a callable option.
10-year government bonds have a yield of 6%. In this case,
MRC’s bonds might end up with an 8% yield.
A Guide to Issuing Bonds
The yield on non-government bond issues will depend on the
risk of those bonds compared to the equivalent government
bond. The difference between a bond’s yield and the yield on
a similar government bond is called the credit spread or risk
premium. Factors that determine the risk premium include:
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Management quality and performance record of the issuer;
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Financial, operating and competitive position of the issuer;
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Structure and ownership of the issuer;
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The value and quality of assets offered as security;
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Constraints imposed on the borrower (e.g. maximum debt
levels, which reduce risk for the bond-holder); and
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Ensures that the bond issue is seen as a success by the
markets;
The underwriter typically helps the issuer in pricing and
marketing the issue.
Bonds provide the issuer with considerable flexibility in
designing the features of the bond. We have discussed some
of the main options above. Here are just some of the other
features that could be considered:
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Security and Other Enhancements
Providing security reduces the risk for investors and the cost
to the issuer through a lower required yield. This is especially
important where the issuer might have a poor credit rating.
Examples of security include:
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Floating coupon rate – This allows the coupon rate to
increase or decrease depending on how interest rates
in the markets move. In this way, bondholders can be
protected against interest rate movements that could
devalue their bonds.
Bullet payment – Some bonds can be structured to
delay payment of interest until maturity.
Call provision – This allows the issuer to repay bonds
early if this is advantageous to the issuer. For example,
when interest rates are falling, the issuer could repay
bonds and refinance at a lower interest rate.
Real property - fixed assets, land; and
This list is not exhaustive. Talk to your investment adviser
about other bond features that might be suitable for your
business.
Collateral – shares, and bonds owned by the issuer.
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A guarantee provided by a third party; and
A bank letter of credit.
Underwriting
A bond issuer may consider having the issue underwritten.
In an underwriting, the underwriter, usually a company,
institution or wealthy individual, promises to take part or all
of the shortfall bonds that are not demanded by investors. The
issue may also be sub-underwritten by other parties. This helps
spread underwriting risk and is especially important when an
issue is too large for the underwriters.
The advantages of underwriting include the following:
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Reduces risk for the issuer by ensuring that a minimum
amount of capital will be raised;
Managing coupon and face value payments, including
mailing out cheques or depositing payments into
bondholder accounts.
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Keeping track of sales of bonds in the secondary market.
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Ensuring all records are up to date.
Tax Implications
The taxation of bonds differs from shares because bonds are
generally treated as debt.
The following diagram summarises the general tax treatment
of bonds compared with shares.
Just like shares issued to the public, a bond issue requires
careful administration to ensure that the issuer meets all its
payment and other obligations on time.
Some of the common administrative tasks include:
Administration is sometimes referred to as the registry
function and the party carrying out this function is called the
registrar.
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Receipt of applications and payment when bonds are
issued.
Running the auction process to determine the appropriate
yields and allotting bonds to successful applicants.
The Bond Issue Process
This section deals mainly with issues of bonds to the public, as
opposed to private placements. In general, private placements
to selected institutions and other investors (without a general
offer to the public) are treated as a private transaction, subject
to what is agreed between the parties. In contrast, issues to the
public must meet strict requirements set by the CMDA.
Public issues must be approved beforehand by the CMDA.
This requires that a proposal be made to the CMDA. Once
the proposal is approved, key steps in the bond issue are:
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Preparation of a prospectus, which provides detailed
information for the benefit of investors.
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Appointment of a trustee to represent the interests of the
bondholders. The relationship between the trustee and
issuer is governed by a document called the trust deed.
A trustee is required by law and is usually a company
specialising in providing trustee services.
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Appointment of a registrar to handle the administration of
the bond issue. The registry function may be carried out by
the issuer or outsourced to a third party.
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Conversion to a non-private company where applicable
– By definition in the Companies Act, a private company
cannot offer shares or bonds to the public. Therefore to
carry out a public offer, a private company must convert to a
non-private (“public”) company.
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Application for stock exchange quotation – If it is decided
to quote the bonds on the stock exchange, application needs
to be made to the stock exchange.
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Appointment of underwriters and sub-underwriters.
n
Roadshow to key institutions and other investors to build
demand for bonds.
n
Running of the offer period.
n
Auction process and allotment of bonds (see below).
A key implication is that bondholders pay tax on coupons
while shareholders can be tax-exempt. The issuer may have to
increase the yield on the bond to compensate bondholders for
tax and ensure bonds remain attractive.
Bonds
n
n
n
Registration
yield demanded by bondholders. However, a sinking fund ties
up cashflow over the bond’s term.
Basic Requirements
The Reserve Bank of Fiji currently carries out administration
of Government bond issues. For other bond issues, the issuer
may prefer to do this in-house or enter into an agreement for
a third party, such as the RBF, to carry out these tasks on the
issuer’s behalf.
n
Bonds can be made less risky in other ways, for example:
n
n
Helps to stimulate demand in the secondary market; and
Other Special Features
Embedded options. Note that some embedded options
(e.g. a convertible option) are valuable to a bondholder while
others (e.g. a callable option) increases a bondholder’s risk.
This callable option may also be seen by the bondholders as
a sign of confidence in the issuer’s operations.
8
Coupons are paid out of
income
Coupons are tax-deductible
Coupons = interest income
to bondholder
Bondholder is taxed
regardless of whether tax is
paid at company level
Shares
n
n
n
n
Dividends are paid out of
profits
Listed company dividends are
tax free
Inter-company dividends are
tax free
Shareholder is not taxed to
the extent that tax is paid at
company level
Sinking Fund
One of the risks of bonds is that the issuer will have to make a
large payment of face value when the bond matures. Planning
for this is important to avoid a cash crisis. Companies with
strong cashflows and large cash reserves may not have to
worry. For others, a sinking fund, where money is set aside
in installments to meet principal repayments, may be a wise
move.
A sinking fund is basically like amortising a bank loan over
time. This reduces credit risk and therefore, may reduce the
As a very basic guide, a typical bond issue could take around 12
weeks to complete. A conceptual timeline for a public issue of
bonds is presented. In practice this will depend on the particular
issue.
A Guide to Issuing Bonds
Your investment adviser will be able to help you plan and
implement a bond issue in a timely and cost effective manner.
Offshore investors have to obtain approval from the Fiji
Islands Trade and Investment Bureau (“FTIB”) to invest
in Fiji. Bond issuers have to bear in mind the Foreign
Investment Regulations 2005 that states the minimum
percentage ownership that needs to be retained for certain
industries by local residents. The remaining percentage
could then be offered to offshore investors buying bonds
which have provisions of conversion to equity or other
embedded options that could deem the instruments as
equity or quasi-equity.
1. Companies Act
7. Reserve Bank of Fiji Act
Reserve Bank of Fiji exchange control approval has to be
obtained for any offshore investors interested in investing
in bonds issued in Fiji.
2. Income Tax Act
Specific binding tax rulings may need to be obtained by
issuers for their specific circumstances. Specifically, treatment
of income from interest payments to bondholders, whether
it is taxable in their hands or the interest withholding tax
needs to be deducted at source as a statutory obligation from
the interest paid to the non-resident bondholders (if any)
needs to be clearly documented. If an organisation intends
to raise capital outside of Fiji, risks such as foreign exchange
risk needs to be addressed together with any impacts on the
resultant tax situation arising from any realised or unrealised
gains/losses.
3. South Pacific Stock Exchange Listing Rules
If the issuer intends to quote the bonds on the South Pacific
Stock Exchange (“SPSE”) for day-to-day trading then
the SPSE Listing Rules (“LR”) has to be complied with
including the payment of SPSE fees and charges. The LR
impose strict obligations on companies and non-compliance
could result in being disqualified from the official list and
loss of official quotations for their bonds.
Please note that the above key legislation are in no way an
exhaustive list. Professional advice needs to be considered on
a case by case basis.
Primary and Secondary Markets
When bonds are first issued, this is done in the primary
market.
Bonds can be issued just to a selected group of investors,
usually large institutions and companies (this is called a
private placement). Where bonds are offered to the public
(a public offer), various laws apply, including the Capital
Markets Development Authority Act and associated rules and
regulations.
Conceptual Timeline
5. Company’s Articles of Association
The Articles of Association has to be checked to ascertain
whether the directors of the company are empowered to
issue bonds and raise money from the public. If this is
not possible, amendments may be required to the Articles
of Association to allow for the capital raising through the
bond instrument.
Prospectus and
other regulatory
requirements
Plan, budget,
structure
4. Trustee Act
Similar to unit trusts, a trustee has to be appointed to
represent the interests of the bondholders. There must be
a trust deed which sets out the relationship between the
issuer and the trustee holding the principles outlined in the
Trustee Act 1966.
Having an auction process provides a number of advantages.
6. Foreign Investment Act
Other legislation and regulations that need to be considered
Certain sections of the Companies Act 1985 need to be
complied with prior to issuing bonds to the public. These
sections outline basic requirements for prospectuses,
allotment and special provisions, etc. The key sections to
keep in mind fall under Part III of the Companies Act i.e.,
Share Capital and Debentures.
10
Phase 1
1
2
3
Registration, book
building, auction and
allotment
Phase 2
4
5
6 7
Week
Phase 3
8
9
10
Primary Market vs Secondary Market
The bond market can be viewed as two markets:
Primary Market - Created when a company first offers
bonds to the public. A company seeking to raise funds by
issuing bonds must publish a prospectus offering investors
the opportunity to buy. Investors would first evaluate the
prospectus before subscribing for bonds.
For example, the bond issue more accurately reflects market
demand and is more transparent. Competition can also result
in more competitive terms for the issuer.
Once tenders are received, successful bidders are chosen
according to set criteria, typically based on yield. Common
approaches include the following:
n
are ranked from the lowest to the highest yield (note that
higher yield means lower price). Starting with the lowest
yield and working up, the yield at which the quantity
offered for sale equals the quantity demanded is identified.
This yield is called the “stop yield”). All competitive and
noncompetitive bids are filled at the price implied by
the stop yield. Sometimes there may be more quantity
demanded than is available. In this case, bonds may have to
be pro-rated.
Secondary Market – Where existing bonds are traded.
Bonds in Fiji may be traded in the secondary market directly
between bondholders or through an intermediary, called a
broker. Brokers must be licensed by the CMDA.
The prospectuses must be approved by the CMDA and
registered with the Companies Office.The purpose of the
prospectus is to help investors make informed investment
decisions before they decide to invest.The prospectus will have
attached the application form and instructions for completing
an application.
Tender and Allocation Process
Bonds are generally issued through an auction process. In
such a process, investors submit tenders for the bonds and
this allows the issuer to determine what the appropriate yield
and coupon rate should be. Some of the common methods of
issuing bonds are shown in the diagram below.
Non-Competitive Auction
Under this method, investors apply
for quantity or dollar amount of
the bonds they want to purchase.
The price is assigned based on the
outcome of the competitive bids.
Single Price (“Dutch auction”) – Here, competitive bids
n
Multiple Price – Here, quantity is allocated at the yield
demanded, starting from lowest to highest until the
supply of bonds is fully allocated. In other words, each
group of bidders is paid a different price. Where both
non-competitive bids are accepted, they typically receive a
weighted average of the competitive yields accepted.
Successful tenderers are then issued with a bond certificate(s)
as proof of ownership.
Listing and Trading Bonds on the SPSE
Bonds can be bought and sold in the secondary market either
directly between buyer and seller or using a broker as a “gobetween”.
One of the options for trading bonds is the stock exchange,
where bonds can be traded just like shares. To trade bonds
on the stock exchange, the issuer must quote its bonds on the
11 12
One of the most important requirements is that the issuer must
prepare and make available to investors a document called a
prospectus. The prospectus sets out detailed information on
the issuer, including its history, operations, resources, financial
performance, how the funds being raised will be used, how to
apply for bonds and whether there is any minimum amount
that must be applied for.
Competitive Auction
Under
this
method,
investors specify both
the quantity of the bonds
demanded and the price
they are willing to pay.
Dual Auction
Here both competitive
(price and quantity) and
non-competitive (quantity
only) bids are allowed.
The South Pacific Stock Exchange
The SPSE is currently the only stock exchange in Fiji.
Trading sessions are held on weekdays at 10:30am
where matching buy and sell orders are transacted.
Trades are settled within T + 3 working days. At this
time, the buyer receives the bond certificate(s) and the
seller receives payment.
A Guide to Issuing Bonds
Exchange. This requires an application for quotation to be
made by the issuer and may be subject to quotation fees.
Listing bonds on the stock exchange offers several benefits
including:
n
Liquidity and marketability of bonds
n
A mechanism for shareholders to sell their shares
n
Enhanced prestige and corporate profile
Under the Capital Markets Development Authority Act,
investors must use a broker licensed by the CMDA when
buying or selling bonds on a stock exchange. The broker
follows the client’s instructions in taking the order to the stock
exchange, including the quantity to be traded, price, or range of
prices, to trade at, and the length of time for which the order
is valid. In return for its services, the broker may charge a
small fee which includes the broker’s commission and SPSE
and CMDA levies.
12
Appendix
NPV Example
Bond Valuation Mathematics
Consider the following cashflows from an investment:
Future Value (FV) – this is the value which an amount today
Year 0 = -$100 (i.e. invest $100);
Year 1 = $10;
Year 2 = $10;
Year 3 = $110
will grow to if it earns interest.
= Present Value x (1+r)n, where n = number of periods in
which interest is earned.
What is the Net Present Value if the market interest rate
is 5%?
NPV
n
Enhanced value
Future Value Example
Calculate FV of $300 invested for 10 years if it earns 8% a
year.
FV = 300 X (1+ 0.08)10 = $647.68
Present Value (PV) – this is the value today of a future
amount assuming an interest rate. PV is the reverse of FV.
= Future Value ÷ (1+r)n where n = number of periods in
which interest is earned.
Present Value Example
Calculate PV of $1000 to be received in 5 years assuming
a discount rate (interest rate) of 9%.
PV = 1000/ (1+ 0.09)5 = $649.93
Net Present Value (NPV) - NPV is the value today of all
current and future cashflows. It reflects time value of money
using the basic PV formula above. Obviously, a dollar today
has a present value of $1. However, future cashflows are
discounted by a market interest rate (or what is often called
a discount factor) to take into account the fact that future
amounts are worth less today. The formula for calculating a
stream of cashflows is:
NPV
=
-C0 + C1 + C2 +... + Cn
(1+r)1 (1+r)2
(1+r)n
Where:
-C0 = cashflow in year 0 (now)
C1 = cashflow in year 1
C2 = cashflow in year 2
Cn = cashflow in year n
r = market interest rate
n = last year of cashflow stream
=
-100 +
10
(1+0.05)1
=
-100 +
10
1.05
=
-100 +
=
$13.62
+ 10
(1+0.05)2
+
110
(1+0.05)3
+
+
110
1.157625
9.5238 +
10
1.1025
9.0703 +
95.0221
Valuing a Bond
Conceptually, the value of a bond is the net present value of its
cashflows:
Price
=
C1
+C2
+...
(1+r)1 (1+r)2
+
P + Cn
(1+r)n
Where:
C1 = Annual coupon in year 1
C2 = Annual coupon in year 2
Cn = Annual coupon in year n
P = Principal repaid in year n
r = market interest rate for bond with term of n years
In reality valuing a bond is a little more complicated because of
several special factors. For example, accrued dividends mean
that the basic bond price will fluctuate over time. The pricing
formula used by the Reserve Bank of Fiji for valuing bonds is
as follows:
P = C/2 x A + FV - (n + k)
Where:
P =
price per $100 face value
C = coupon (assumes coupons are paid semi-annually)
A = 1 - (1 + i/2) - (n + k)
i/2
F =
face value
V =
(1 + i/2)
n =
number of whole half years to maturity
k =
f/d where: f = actual number of days from
settlement date to next coupon date
d = actual number of days in that half
year coupon period
i =
current yield to maturity or rate of return.
A Guide to Issuing Bonds
A Bond Valuation Example
A bondholder wishes to sell the following bond in the
secondary market:
Coupon
Face Value
Maturity date
Settlement date
Last coupon date
Next coupon date
i
n
f
d
Price
= 9% = $9 (paid in semi-annual
amounts of $4.50)
= $100.00
= 14 February 2006
= 30 September 2003
= 14 August 2003
= 14 February 2004
= 6.75%
=4
= 30/09/03 to 14/02/04 = 137 days
= 14/08/03 to 14/02/04 = 184 days
= 9/2 x 1 - (1+0.0675/2)- (4+0.74457)
0.0675/2
+ 100 x (1 + 0.0675/2) - (4+0.74457)
= 4.5 x 0.14571/0.033750 +100(0.85429)
= 4.5 x 4.31737 + 85.42900
= $104.86
* Please consult your investment adviser or broker for
specific advice on valuing a bond.
Clean vs Dirty Price
The RBF formula given above does not take into account the
interest accrued on the bond since the last coupon payment
date. For example, say you have a semi-annual coupon bond
and the last coupon payment was three months ago. If you
sold the bond today you should be entitled to half of the next
coupon (3 months out of the 6 months). Where the price
includes this accrued interest, it is called the dirty price.
Normally bonds are quoted without accrued interest. This is
called the clean price. To calculate the dirty price, the accrued
interest is added to the clean price. The formula for accrued
interest (A1) is:
A1 = number of days from last coupon payment date to settlement date
number of days in coupon period
Dirty Price
Continuing with our bond example, the calculation of the
clean price is as follows:
A1 period
= 47 days/184 days = 0.25543
A1
= 0.25543 x $4.50 = $1.15
Dirty price
= Clean price + A1
= $104.86 + $1.15
= $106.01
How Interest Rates Affect Bond Prices – Examples
14
Glossary
Accrued Interest
an amount of interest accumulated, but not yet paid, between semi-annual payment dates
Auction
usual method of issuing bonds where investors submit bids
Bondholder
an investor in bonds
Call option
type of embedded option which allows the issuer to pay back the bond early
Call provision
some bonds notably perpetual securities have a call provision attached. This gives the issuer
the right, but not the obligation, to buy back the bonds from investors at a particular point in
time at a certain price
Scenario 1 - Interest rates rise
Clean price
Price that does not include the interest accrued since the last coupon payment
Interest rates have risen and investors are now looking for a
12% coupon rate on similar bonds.
This means the market value of your bonds must be at a level
where a buyer earns at least 12%. The bond will continue to
pay $100 annual coupons. But since the buyer requires a return
of 12%, he will pay you less than the par value of $1,000.
Competitive auction
Auction method where investors apply for both the yield and the quantity they wish to purchase
Competitive bid
a bid for bonds submitted under auction specifying both yield and quantity
Conversion rights
type of embedded option, which gives a bondholder the option of converting his/her bondholding
into shares of the issuer
Coupon
regular interest payments made to the bondholder
Coupon rate
percentage of interest paid on a bond
Credit risk
risk that the issuer may be unable to pay bondholders
Dirty price
price that includes interest accrued since the last coupon payment
Distribution return
The return an investor gets from the dividends or realized capital gains from his investment
Diversification
spreading your money over different investments to reduce overall risk
Dual auction
combination of competitive and non-competitive auction methods
Embedded option
option given to the issuer and/or the bondholder to take some action against the other party
under certain circumstances
Face value
amount paid to the bondholder at the end of the lending period
Fixed coupon rate
coupon rate, which does not change over the life of the bond
Say you buy a $1,000 bond when it is issued in the primary
market. The bond has a coupon rate of 10% and a maturity of
10 years. Therefore, each year for the next ten years, you will
receive an annual coupon of $100 (i.e. 10% x $1,000). At the
end of 10 years, the $1,000 you lent is repaid to you.
To see how interest rates affect the price of bonds, say you decide
to sell the bonds after 4 years. Let’s look at two scenarios: (1)
interest rates have risen and (2) interest rates have fallen.
Using the bond price formula, the price of the bond is $917.
The buyer will receive $100 coupons each year plus a principal
repayment of $1,000 in the sixth year when the bond matures.
The $100 per year plus the gain of $83 (1,000 face value – 917)
equals a 12% per annum yield on the initial $917 invested by
the new investor.
As the original bondholder, you will incur a capital loss on your
investment.
Scenario 2 - Interest rates fall
Now assume that interest rates have fallen and investors are
now seeking a coupon rate of 8% on similar bonds.
You would require the buyer to pay a price that yields a return
equal to the current market rate of 8%. Because the bond pays
an annual coupon of 10% (higher than the current market rate
of 8%), the bond price should be higher than the original price
you paid.
Using the bond formula, the buyer will have to pay you $1,092
for the bond, which would yield him a return of 8%. This is
equivalent to the current market rate. You therefore make a
capital gain of $92.
The examples illustrate that during the life of a bond, its capital
value can change at any time in line with changes in the overall
level of market interest rates. This is the risk that investors
trading in the secondary market face. In contrast, investors
who hold the bonds to maturity are guaranteed that they will
be repaid the par value of the bonds when the bond matures.
Fixed income securities class of investments which includes bonds issued by the government, statutory authorities
and companies. A typical feature is these securities make regular interest payments and repay the
principal on maturity
Floating coupon
coupon rate that may be periodically adjusted to take into account prevailing market conditions
Future value
value which an amount today will grow to in future if it earns interest
Growth return
the return an investor gets from selling his investment at a
profit i.e. for a higher price that he bought them
Income return
a bondholder’s return from receiving regular coupons
Inflation
when the cost of a product or service rises and quality Remains the same; also when spending
increases relative to supply – think of it as too much chasing too few goods
A Guide to Issuing Bonds
Interest rate risk
risk that rising interest rates cause bond prices to fall
Issuer
company or institution that issues a bond. The issuer borrows money from bondholders
Liquidity risk
risk that a bond cannot be easily sold at or close to its market value
Maturity
see “Term”
Multiple price
method of allocating bonds where successful competitive bids receive the tendered yield
Allocation while non-competitive bids receive a weighted average of competitive yields accepted
Net present value
value today of all current and future cash flows
Non-competitive
auction method where the yield of bonds is fixed and investors only apply for the number
of bonds they want to purchase
Non-competitive bid
a bid submitted under auction specifying only the quantity
Par value
the face value of an investment set at the time of issue
Political risk
risk that unexpected events adversely affect the value of a bond
Present value
value today of a future amount assuming a specific rate of return
Price
amount an investor pays for an investment
Primary market
where an issuer first offers bonds to the public
Principal
amount paid to the bondholder at the end of the lending period
Prospectus
a formal offer document required by law which sets out detailed information on
the company that will help potential investors to analyze the investment
Re-investment risk
risk that if interest rates fall, coupons would have to be re-invested at a lower interest rate
Secondary market
trading in bonds or shares that have already been issued
Security
assets of the issuer that may be sold to reimburse bondholders if the
issuer fails to meet its obligations
Single price
(“dutch auction”)
method of allocating bonds where all bonds are issued at the highest
accepted yield allocation tendered by investors
Term
the life of a bond
Yield
the return on investment usually expressed as a percentage of the initial investment
Yield to maturity
type of “yield” which measures the rate of return on a bond assuming it is held to maturity
CMDA Educational Booklets
n
n
n
n
n
n
n
n
n
n
n
n
n
Investing in Shares
Investing in Unit Trusts
Investing in Bonds
Rewarding Employees
Using Employee Share Schemes - FAQ
Why You Should Invest - FAQ
Investing in Shares - FAQ
Choosing the Right Shares - FAQ
How to Use a Broker or Investment
Adviser - FAQ
Investing Wisely - FAQ
How to List Your Company on the
Local Stock Exchange
Vakatubu I Lavo e na Voli Sea
Vakatabu I Lavo ena “Unit Trusts”
If you wish to receive these free educational
booklets, please contact us:
Level 5, FNPF Place,
343-359 Victoria Parade,
Suva,
P.O. Box 2441,
Government Buildings,
Suva
Tel: (679) 3304 944
Fax: (679) 3312 021
Email: cmda@connect.com.fj
Website: www.cmda.com.fj
CapitalMarketsDevelopmentAuthority
P.O.Box2441,GovernmentBuildings,Level5,FNPFPlace,
343-359VictoriaParade,Suva,FijiIslands.Tel:(679)3304944Fax:(679)3312021
Email:cmda@connect.com.fjWebsite:www.cmda.com.fj