Bond Type: Exchangeable Bonds

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This kind of bonds is a relatively new concept whereby issuers will exchange the bonds with shares from another company. An example is the Berjaya Holdings which issued exchangeable bonds to be exchanged for Berjaya Sports Toto shares.

The motivation behind issuing such a facility is to piggy-back on the share price performance of the other company. If planned correctly, issuer need not pay back the bonds as bond holders will see better value in exchanging it into shares than redeeming it at nominal or face value.

The risks to both issuers as well as the bond holders are as follows:

1.For the issuer, it must have the shares in the target company before issuing such a bond.

 

2.Issuer may dilute its holdings in the target company is bond holders exercise their rights to exchange. 

 

3.As the reference asset is not the issuer, the issuer may not have control over the whole life of the bonds.

 

4.Due to the convertibility factor, an overestimation of the company’s share price performance may caused the investors to overpay for the bonds.

 

5.The volatility of the equity markets can caused similar volatility in the shares of the bonds.

Bond Type: Convertible Bonds

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Issuers which listed shares can issue convertible bonds. The motivation behind issuing such a facility is to piggy-back on the share price performance of the issuer. If planned correctly, issuer need not pay back the bonds as bond holders will see better value in converting it into shares than redeeming it at nominal or face value.

The risks to both issuers as well as the bond holders are as follows:

1.For the issuer, there is a very strong possibility of share dilution. There is an opportunity for new shareholders to enter the company.

 

2.Due to the convertibility factor, an overestimation of the company’s share price performance may caused the investors to overpay for the bonds.

 

3.The volatility of the equity markets can caused similar volatility in the shares of the bonds. Generally, the volatility of bond market is less than the equity market (hence the lower returns).

Bond Type: Subordinated Bonds

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Issuers can issue bonds with varying degree of subordination. Unlike the junior/senior bond structure which is a split from a bond programme, subordinated bonds are stand-alone programme.

In the Malaysian context, banks are the most prolific issuers of subordinated bonds. This is because due to the Basel capital requirements for banks, subordinated bonds can be recognised as quasi-capital.

Because the subordination can be done at anytime, it is possible for issuers to have multiple bond issues with varying degrees of subordinations i.e. The most subordinated will take the first loss for the rest, the second most subordinated will take the next loss for next set of subordinated bond above it etc.   

In reality, investors are not keen to participant in bonds issued by such issuers as their priority may just change with a new issuance.

Bond Type: Commercial Paper versus Medium Term Notes

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Commercial Papers (CP) and Medium Term Notes (MTN) are bond that is different in terms of tenure. Generally, CPs are short-term bonds that have maturity of less than 1 year whereas MTNs are long-term bonds that have maturity of 1 year of more.

In terms of ratings, due to the peculiarity of the tenure classes, the way credit risk is assessed is different with different rating scales.  Generally, the purpose of the two types of structures are as follows:

1.CP: usually used for short-term cash flow management purposes.

2.MTN: usually used for mid- to long-term capital investments

Risks:

 

1.Issuers using CPs to finance mid- to long-term capital investments can face liquidity issues if no investors wants to rollover a CP programme upon maturity.

 

2.Moreover, the cost of a CP programme cannot be locked. Re-pricing will happen upon rollover.

Bond Type: Junior versus Senior Bonds

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•Purpose: to apportioned more credit risk to the junior piece

•Method: creating an internal credit enhancement

•Effect: reducing costs

By splitting a bond into two tranches, a junior bond with higher credit risk and a senior bonds with a lower credit risk, the issuer is able to offer the necessary risk reward payoffs to two sets of distinct investors. The first, which is risk adverse and the other who is risk preferring.  The design of such structuring is an internal credit enhancement and therefore offers the least costs to the issuer.

The risk reward payoff to the investors are as follows:

1.Junior bond holders usually get a higher coupon. However, in event of difficulties, they may not be paid even if the senior bond holders get paid i.e. they take first loss.

2.If the senior bond holders get paid but not the junior bond holders, generally it is do deemed as an event of default.