presentation slides for the iffc conference in kuala lumpur - oct 2008

8/14/2019 Presentation slides for the IFFC Conference in Kuala Lumpur - Oct 2008

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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


2/29

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


3/29


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


4/29


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


5/29


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?


6/29


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


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



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)



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



The Nature of Bond Pricing Business



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



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.



BPAM Clients
http://www.bankislam.com.my/default.aspxhttp://www.kfh.com.my/http://202.144.198.79/osk/default.asp



BPAM Clients



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



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



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



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



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



* 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



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(




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





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

++=

=

++=



24/29




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


Bond Pricing Current Practice and Pricing


25/29


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


26/29


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.


27/29



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


28/29



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


Discount

Negotiated Mark up

Advance


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


29/29

THANK YOU

No. 17-8 & 19-8 , The Boulevard, Mid Valley City, Lingkaran Syed Putra, 59200 Kuala Lumpur, MalaysiaTel: +603 2772 0888 Fax: +603 2772 0808 Email : [email protected]

presentation slides for the iffc conference in kuala lumpur - oct 2008

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