Corporate Bonds in Bangladesh
Bangladesh corporate debt market is very small in size. The outstanding amount is only 0.15% of GDP. Thus corporate bond market in Bangladesh is at a budding stage. During 1988-2013, only 3 corporate bonds were issued by public offerings. Out of these 3, 2 of these bonds are partially convertible to common stocks. The biggest issue of corporate bond was made first in 2007. It was a perpetual bond named ‘IBBL Mudaraba Perpetual Bond’ with a size of Taka 3,000 million (approximately US$ 40 million).
It is an Islamic bond on profit sharing basis since interest is prohibited by Sariah Principles. After two other corporate bonds have been issued ACI Zero Coupon Bond and subordinated Brac bonds.
The factors which determine the yields of this 3 bonds are :
Corporate bonds compete in the market for investor dollars. If prevailing interest rates should rise, the yields bonds provide at a given price become less attractive. Demand for the bonds falls, creating downward pressure on prices. Bond prices tend to decline with the effective interest rate climbing until it is competitive with new interest rate levels. Of course, if prevailing rates go down, the opposite effect is likely; increased investor demand for the now superior yields of corporate bonds drives bond prices up until the resulting yields fall to the new interest rate levels.
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* One of the most important factors that affects the interest rates of corporate bonds hence the yield is the credit risk. Corporate bonds are assessed based on the probability a company will be able to redeem (pay off) the bonds at maturity. Most investors rely on bond rating services to provide credit risk ratings. The bonds of companies with the best credit ratings pay lower interest rates as a rule because investors will accept lower yields in return for reduced risk. If the credit rating is bad, then the company needs to pay higher yield to compensate for the higher risk. For Bangladesh all the 3 corporate bonds have got the highest credit rating A+ from credit rating information and services limited (CRISL).
This shows that the risk is lower hence investors are still happy with the lower yields.
Credit risk is the potential for loss resulting from an actual or perceived deterioration in the financial health of the issuing company. Two subcategories of credit risk are default risk and downgrade risk.
* Default Risk Defaults occur when a company fails to pay an interest or principal payment to a debt holder as scheduled and as specified in the legal agreements, i.e. the indenture. The risk of default on principal or interest, or both, is greater for high-yield bonds than for investment-grade bonds. Factors such as business cycle volatility, excessive leverage or threats from competitors may lead to default. In a corporate bankruptcy or dissolution, although secured bondholders and holders of senior debt issues may receive some distribution of corporate assets, it is rarely enough to “make whole” their total investment. Bonds of companies in default may trade at very low prices, if they trade at all, and “liquidity” may disappear.
* Downgrade risk Downgrades result when rating agencies lower their rating on a bond—for example, a change by Standard & Poor’s from a B to a CCC rating. Downgrades are usually accompanied by bond price declines. In some cases, the market anticipates downgrades by bidding down prices prior to the actual rating agency announcement. Before bonds are downgraded, agencies often place them on a “creditwatch” status, which also tends to cause price declines.
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It goes without saying, that interest rates influence our decisions, and affect many activities in our lives. Interest rates can be expressed as a percentage of the amount borrowed or saved. People always try to be well-informed about changes in economy and finance. They say that it helps them to make better decisions about their personal finance. It is evident that interest rates affected the ...
* Convertibility option: A convertible bond possesses qualities of both stocks and bonds since it is a bond that can be converted to stock. Since the convertible bond provides an option to the bondholder to convert to common stock (and thereby benefit from any stock price increases), it pays a lower interest rate than other types of debt of the same risk. Hence bonds with convertible option offer lower yields in Bangladesh 2 corporate bonds provide this advantage hence they usully offer lower yields. The price of a convertible bond begins to increase as the stock price approaches the conversion price. In general, the more the stock price increases and/or becomes volatile, the higher the price of the convertible bond.
* Seniority of bond : Subordinated bonds are ranked lower than other normal bonds because in the case of default, subordinate bond holders wouldn’t get paid out until the senior debt/bond holders are paid in full. Therefore, subordinated bond is more risky than unsubordinated bond. In order to compensate this high risk high yield are usually offered. Out of this 3 bonds Brac Bank are subordinated bonds so they should offer high yields compare to other two bonds.
* Interest Rate Risk: A fundamental principle of bond investing is that market interest rates and bond prices generally move in opposite directions. When market interest rates rise, prices of fixed-rate bonds fall this phenomenon is known as interest rate risk. When investor plans to hold a bond till maturity none of the factors will affect him but if he is planning to sell a bond then the bond price will fall if interest rate rises as the coupon (interest) of a bond is set at the time of issuance so if interest rate rises no investor will be willing to buy your bond as it is offering lower yield than market new rates. Thus it can be risky to buy long-term bonds at the time of low interest rates because there is a chance that interest rate might rise in future.
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* Type of Bond : Zero and Perpetual
A bond with no maturity date. Perpetual bonds are not redeemable but pay a steady stream of interest forever.
A variety of risks are associated with perpetual bonds. Perhaps the most notable is that a perpetual period is a long time to carry on credit risk. As time passes, bond issuers, including both governments and corporations, can get into financial trouble and even fail. Another significant risk associated with time is that general interest rates may rise as the years pass. If rates rise significantly, the interest rate paid by a perpetual bond may be much lower than the prevailing interest rate, meaning investors could earn more money by holding a different bond. Because of these risks perpetual bond needs to offer higher yield than regular bond. In Bangladesh IBBL Mudaraba perpetual bank offer this higher yield.
* Zero Coupon Bond vs Regular Coupon Bond
On the other hand Zero-coupon bonds are often the most volatile fixed-income investments because they have no periodic interest payments to mitigate the risk of holding them; as a result, investors demand a slightly higher yield to hold them. So ACI Bonds need to give higher yield.
