Securities Industry Development Centre
The Securities Industry Development Centre (SIDC),
the education and training arm of the Securities
Commission, plays a crucial role in raising the
standards of market participants through the
enhancement of skills and professionalism among the
various market groups. It fulfils its objectives by:
•
educating investors on investment risks and
rewards, financial planning and their rights and
responsibilities;
•
promoting a wider understanding of duties and
responsibilities of directors and shareholders of
public-listed companies;
•
promoting professionalism and expertise among
market intermediaries;
•
encouraging Bumiputera participation in the
capital market through education;
•
facilitating the development of educational
programmes for local university students and
academicians; and by
•
providing training assistance to regional
regulators.
Copyright
 Securities Commission, 2001
Copyright strictly reserved. No part of this booklet may
be reproduced or copied in any form or by any means
(e.g. graphic, electronic or mechanical, including
photocopying, recording, taping, or information
retrieval system) without the written permission of the
SIDC.
This booklet aims to provide an understanding of the
subject and is not an exhaustive write-up. It is not
intended to be a substitute for legal advice nor does it
diminish any duty (statutory or otherwise) that may be
applicable to any person under existing laws.
July 2001
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BOND BASICS
WHAT ARE BONDS?
Bonds are fixed income investments, so called
because the issuer of the bonds pays a regular
fixed interest or coupon to the investor who
buys the bonds until the bonds mature at a
specified date. Upon maturity, the issuer
returns the agreed principal sum of money to
the investor.
The basic characteristics of a bond are:
• A maturity date
• A fixed rate of interest payment or coupon
• A fixed face or par value (principal sum)
redeemable upon maturity
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WHO SELLS OR ISSUES BONDS?
The bond market provide another avenue for
governments or corporations to raise capital.
Essentially, bonds are debts or loans and when
a bond is issued, it means the issuer
(government or corporation) is borrowing a
specified amount of money from the investor
for a specified period of time.
WHO BUYS BONDS?
Financial institutions, other private companies
or managed funds (e.g. pension, insurance or
unit trust funds). The individual investors do
not normally participate in the bond market
because they are normally sold over-thecounter, in large amounts - an average
investment being about RM5 million.
There are corporate bonds (also called private
debt securities) listed on the Kuala Lumpur
Stock Exchange that retail investors can buy.
But in general, investors purchasing bonds are
looking for investments that will give them a
stable fixed income and which are less risky
than the stock market.
WHY INVEST IN BONDS?
Most financial planners and fund managers
view bonds as being less risky than shares but
yielding more returns than fixed deposits. It is
less risky than shares because it provides a
fixed income from the coupons and the return
of the principal is as stable as the issuer of the
bonds. Bonds issued by stable governments of
economically strong countries are considered
the least risky. In general, it is in a nation’s
interest that bonds issued by its government
pay their coupons and pay the principal sum
upon maturity, so that the credibility of the
government remains strong and it can
continue to raise capital through the future
issuance of bonds.
When the stock market is bearish, bonds
provide an alternative avenue for corporations
to raise capital. A mature bond market plays
an important role in stabilising the overall
financial system of a country. In many
developed countries, the market capitalisation
of the bond markets are larger than that of
the stock markets. In Malaysia, the securities
laws have been amended to facilitate the
development of the bond market which has
been growing from strength to strength. Over
the past 10 years, the bond market has grown
substantially both in terms of trading activities
in the secondary market and in terms of
market liquidity.
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HOW ARE BONDS TRADED?
When the issuer (government or corporations
or institutions) first offers new issues, that first
trading is done at the primary market. What
this means is that the issuer is able to raise
funds for its use and the money raised from
the sale of the bonds come directly to the
issuer.
Subsequently, the bonds bought from the
issuer can be bought and sold among other
investors, and this is referred to as the
secondary market. The secondary market
provides liquidity to the individuals or
institutions that have acquired the bonds,
which are now able to sell off the bonds
before the maturity date, should they wish to
do so. The trading of bonds in the secondary
market creates a market pricing of the bonds
that depends on the supply and demand of
the bonds, and prevailing interest rates,
among other factors.
When the market price of the bond is less that
its par value, the bond is considered as being
sold at a discount. When the market price of
the bond is more than its par value, then the
bond is being sold at a premium.
The secondary market plays an important role
because:
• Investors purchasing bonds at the primary
market know there is an avenue to sell-off
their bonds.
• The secondary markets provide a gauge for
issuers to price their primary issues.
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WHAT’S THE DIFFERENCE BETWEEN
INVESTING IN BONDS AND INVESTING
IN SHARES?
Bonds are medium to long-term debt
instruments, which have the following
advantages and disadvantages when
compared to buying shares:
Advantages
• Investor receives
periodic fixed
interest income,
irrespective of
whether the
company issuing the
bonds is doing well
or not.
• Bondholders have a
prior right over
ordinary
shareholders on
distribution of
earnings and on
claims in the event
of bankruptcy.
Disadvantages
• As the income
(coupons) derived
from bonds is fixed,
the investor does not
get paid more even if
business is booming
as in the case of
ordinary shareholders
who may be given
higher dividends.
• Bondholders have no
voting rights and are
not owners of the
company while
shareholders have a
right to vote at
general meetings.
HOW DO I INVEST IN BONDS?
The best way for Malaysians to invest in bonds
is through bond funds or fixed income funds.
Like other unit trust funds, bond funds
approved by the Securities Commission are
collective investment schemes that pool
money from many investors for specific
financial objectives (in the case of bond funds,
to invest in bonds). The funds are managed by
a group of professional managers and the
income earned from the investments is then
distributed in the form of dividends to
unitholders in proportion to their ownership.
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The general bond funds usually invest in the
medium to long-term fixed income
instruments while money market funds and
short-term bond funds invest in short-term
money market instruments. Islamic bond
funds would deal only with bonds issued by
companies approved under the Syariah
Principles.
The money market is a market for short-term
fixed income instruments (usually with
maturities less than a year, although some
long-term fixed income instruments are also
traded on the money market), which acts as
an intermediary for individual institutions
seeking short-term credit and those with
surplus cash to lend. Banks and financial
institutions issue money market instruments
such as Negotiable Instrument of Deposit
(NID) and Bankers Acceptance (BA), while the
government issues money market instruments
such as Bank Negara Bills (BNB) and Malaysian
Government Treasury Bills (MTB).
It is expected that more bond funds will be
introduced in the near future, as the
Malaysian bond market continues to grow.
WHAT ARE THE DIFFERENT TYPES OF
BONDS?
Bonds are classified according to their
maturity terms as short-term, medium-term or
long-term. What constitutes short-term,
medium-term or long-term debt securities
vary from one rating agency to another, and
from one textbook to another. Some describe
short-term debt securities as those having
maturities of one, three, or six months, usually
less than a year. Medium-term bonds as
having maturities of between one to seven
years, while long-term bonds, usually
government bonds as having maturities up to
30 years. There are other rating agencies that
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classify short-term bonds as those with
maturity of one to five years, medium-term
bonds as between five to twelve, and longterm bonds as those above twelve years.
Bonds are also classified according to the type
of issuer, for example those issued by
government are called government bonds,
those by the corporations as corporate bonds
or often called private debt securities. There
are also quasi-government bonds, Cagamas
bonds and Islamic private debt securities or
Islamic bonds.
GOVERNMENT BONDS
Examples of government bonds being traded
are Government Investment Issues (GII) and
Malaysian Government Securities (MGS).
There are also short-term money market
instruments issued by the government such as
the Bank Negara Malaysia Bills (BNB) and
Malaysian Government Treasury Bills (MTB).
Government Investment Issues (GII)
The GII was introduced in July 1983 (then
known as Government Investment Certificates
or GIC) and they are government bonds
issued in accordance with Islamic principles.
GII are non-interest bearing government
bonds issued to enable Bank Islam Malaysia
and other institutions invest their liquid funds
on an Islamic basis. The GII have maturities
from one to five years, with interest payments
made on a semi-annual basis.
Malaysian Government Securities
(MGS)
MGS are gilt-edged securities because they
are borrowings of the government. They are
issued for the financing of long-term
development projects by the government.
MGS are issued by auction and by
subscription but they can also be bought in
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the secondary market or from Bank Negara
Malaysia. The price of government bonds is
influenced by Bank Negara Malaysia’s price list
published monthly, as well as the prevailing
supply and demand for the bond.
CORPORATE BONDS
Here are examples of the types of corporate
bonds issued in the Malaysian capital market:
• Straight bonds
• Convertible bonds
• Bonds with warrants
• Floating rate bonds
• Zero coupon bonds
• Mortgage bonds
• Islamic bonds
• Secured and unsecured bonds
• Guaranteed bonds
Straight bonds
Straight bonds are, as the name suggests,
bonds as simple as they can be, with a fixed
coupon rate, and maturity on a date fixed at
the time of issue. They are often called “plain
vanillas” as these bonds do not carry any
other enhancement features but tend to carry
high interest rates. The coupon is made either
semi-annually or annually and the principal
sum is paid at maturity to the bondholder.
Convertible bonds
Convertible bonds give the holders a right to
convert the bonds to a number of the issuer’s
stock or shares during a period, and at a price
agreed at the time of issuing the convertible
bonds.
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The coupon rate for such convertible bonds
are typically lower compared to a straight
bond because the holder is given the right of
conversion. The issuer benefits from paying
lower coupons, as well as maximising the
proceeds received upon conversion by setting
a higher conversion price to its existing share
price. The investor also benefits because if the
company performs well, its shares can be
bought (through conversion) at what may
prove to be a favourable price (if the
conversion price is more favourable than the
market price by the time of conversion).
When the bond is converted to shares, it loses
its principal sum invested and the income
from the coupons, but the investor who is
now a shareholder will benefit from payments
of dividends and any future increase in the
share prices.
Bonds with warrants
Bonds issued with detachable warrants are
common in Malaysia. The issuer offers the
entire issue of bonds with warrants at face
value to a primary subscriber. The primary
subscriber subsequently detaches the warrants
and sells them to shareholders of the issuer in
the secondary market. The bonds are
themselves distributed to institutional
investors. Bonds with warrants have low
coupon rates and are sold at a discount to
yield the rate of return required by investors in
the secondary market.
A warrant gives the holder the option to
purchase a specified number of shares at a
preset exercise price and within a certain time
period (exercise period).The exercise price is
the amount the warrant holder has to pay in
order to convert the warrant into an ordinary
share.
For investors, it is attractive to have the option
to buy shares at preset prices. For the issuer,
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bonds with warrants allow the issuer to first
raise money through the sale of the bonds
and later, when the warrants are exercised,
money is again raised in purchasing the shares
at the preset price.
Floating-rate bonds
In a straight bond, the coupon rate is fixed for
the entire life of the bond. The coupon rate of
a floating-rate bond is instead pegged to an
agreed benchmark, such as the KLIBOR (Kuala
Lumpur Interbank Offered Rate) and as this
reference rises and falls, the floating rate also
moves accordingly.
Zero-coupon bonds
Zero-coupon bonds are so called because no
periodic coupons are paid during the life of
the bond. Zero-coupon bonds are normally
sold at a discount, meaning at a price lower
than its face or par value so that the investor
earns from the difference between the
discount price and the face value when the
bond matures. Zero-coupon bonds can also
be issued at face value with an agreed
accrued interest to be paid upon maturity.
Mortgage bonds
Mortgage bonds require the issuer to pledge
certain real assets as security for the bond. In
the event of a default, the bondholders can
foreclose on the pledged assets to satisfy their
claims, although in practice such foreclosures
are unusual.
Islamic bonds
Islamic bonds are structured according to the
Islamic principle of deferred payment sale, and
require the endorsement of the Syariah
Advisory Council of the Securities
Commission.
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Secured and unsecured bonds
The debt payments of secured bonds are
secured by a pledge of the issuer’s assets,
typically shares, a building or land. In the
event of a default, the investors would have a
claim on the pledged assets.
Conversely, unsecured loans are bonds not
backed by any collateral. In the event of a
default, the bondholders would have a
general claim on the issuing company. Due to
its higher risk factor, unsecured loans offer
higher interest rates than secured bonds.
Guaranteed bonds
Guaranteed bonds are guaranteed for full
debt repayment by a guarantor, which could
be the parent company or one or more
financial institutions. The safety of the bond
therefore depends on the financial capability
of the issuer and the guarantor to satisfy the
terms of the guarantee.
WHAT ARE THE COMMON TERMS
USED IN ASSOCIATION WITH BONDS?
The following characteristics and terms are
always associated with bonds and we need to
understand what they mean in order to
understand bonds.
• Nominal value
• Coupon rate
• Term-to-maturity
• Trust deed
• Trustee
• Type of issuer
• Yield
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• Call provision
• Sinking fund
Nominal value
The nominal value of a bond is the par or face
value and sometimes, also referred to as the
principal value of the bond. This is the amount
the issuer of the bond has agreed to pay the
bondholder at the maturity date. In view of
this, the principal is also called the redemption
or maturity value.
Coupon rate
The coupon rate is the amount of interest the
bondholder will receive periodically. For
example if the nominal value of the bond is
RM100,000 and the coupon rate is 7%, then
the bondholder will receive an annual interest
of RM7,000. If the agreed periodic payment is
every six months, then the bondholder will
receive RM3,500 every six months.
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Term-to-maturity
This is the number of years over which the
issuer of the bond has promised to meet the
conditions and obligations of the bond issue.
During this time, the bondholder is paid the
promised coupon payments and it also
indicates the time period remaining before the
bondholder is paid back the principal. The
term-to-maturity also affects the bond yield
and the bond price.
Trust deed
A trust deed is the legal agreement detailing
the issuer’s obligations related to the bond
issue. It contains the terms of the bond issue
and any restrictive provisions placed on the
company, such as a requirement for the
company to set up a sinking fund, or the
inclusion of a call provision. An independent
trustee administers the trust deed.
Trustee
The trustee is the third party with whom the
trust deed is made. The job of the trustee is to
see that the terms and conditions of the trust
deed are carried out. As the trust deed also
contains provisions in the event of default, the
trustee would undertake action to protect the
interests of the bondholders in the event of a
default.
Types of issuer
A key feature of a bond is the nature of the
issuer. In Malaysia, the issuers of bonds can be
the government, banks, financial institutions
and companies.
Yield
There is often confusion between the yield
and the coupon rate of a bond. While the
coupon rate is fixed at issue, and does not
change till maturity, the yield is the discount
rate or interest rate that an investor wants
from investing in a bond. Price bonds are
quoted in relation to their yields. As the
required yield increases, the price of the bond
decreases. The reverse is also true.
Call provision
A call provision entitles the issuer to
repurchase or “call” the bond form their
holders at a stated price within a
predetermined period.
Sinking fund
In a sinking fund bond, the issuer periodically
puts aside money for the eventual repayment
of the debt. This provision may be included in
the bond trust deed to protect investors.
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HOW ARE BONDS RATED?
How do you know if an issuer is likely or not
likely to default in paying back your principal
or in delivering on the agreed periodic coupon
payments? There are rating agencies,
independent of corporations issuing bonds,
that analyses and provides a rating scale on
bonds issued in the market.
Credit analysis for bonds is focused almost
exclusively on the chance that the bondholder
will not receive the scheduled interest
payments or principal at maturity. This is
known as the default risk. A borrower’s ability
to repay or credit worthiness is an important
criterion to the lender or bond purchaser.
Credit rating is an objective and impartial
third-party opinion on the ability and
willingness of an issuer of a bond to make full
and timely payments of principal and interest
over the life of the bond.
A rating is designed to rank, within a
consistent framework, the degree of future
default risk of a particular bond relative to
others in the market.
There are two rating agencies in Malaysia,
namely Rating Agency Malaysia Bhd (RAM),
which was established in 1990 and the
Malaysian Rating Corporation Bhd (MARC),
established in 1996. Both are privately owned
and independent organisations. Institutions
and investment fund managers use credit
ratings provided by such independent
agencies in gauging the credit worthiness of
bonds.
For RAM’s rating, investors have come to
regard securities rated at AAA to BBB to be
investment grade, and those rated BBB and
below to be speculative grade. Bonds rate C
carry very high risk of default while those
rated D are already in default.
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