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Issue No.5

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In addition, bonds can be secured, unsecured or unsecured but bank guaranteed. They may also be convertible to shares or have detachable warrants. For the purpose of protecting investors, bonds have to be rated by the Rating Agency of Malaysia (RAM). The rating is made based on the issuer's activities, financial performance and the guaranteeing parties of the bond (if any). RAM's rating will indicate the quality of the bonds and safety of timely repayment of principal and interest.

Since its inception in 1990, RAM has rated 270 corporate bond issues with a total value of RM38 billion as at end of 1995. Remember the loan/debenture category you see on the KLSE stock market page of your newspaper are bonds. About 50 are listed on the KLSE.

Besides regular interest income, bonds investors enjoy capital gains due to the increase in the market value of the bond when interest rates fall. But if interest rates rise, bond prices will fall. Therefore, interest rate fluctuations are reflected in changes in the bonds' capital value. Anyone trading bonds is exposed to potential losses and gains in the face value of their investments (traders still earn interest through the coupon on a bond for the period they hold the security).

On the other hand, long-term holders of bonds are not exposed to fluctuations in income from their investments because their income stream is limited to earning interest through the coupon, which remains constant for the life of the bond (the fixed part of fixed income investments). For the holder-to-maturity, fluctuations in the capital value of the bond remain unrealized losses and gains and, at the maturity of the bond, the holder receives face value.

Example: In July 1996 an investor buys a parcel bonds with an 8.5% p.a. coupon and maturing in July 2000 at a yield of 9% p.a.. The purchase price is RM98.38 per RM100 face value. That is, the bonds have been purchased at a discount to the cash in value at maturity. This is because fixed income investors require a yield or return of 9% p.a. yet the coupon is only 8.5% p.a. Therefore the additional return required of 0.5% will be made up of capital growth.

If the general level of interest rates subsequently rises after 2 years (i.e. the returns fixed interest investors require increases), taking the bond yield to, say, 10%, the market price (or capital value) of the bond would fall to RM97.40 per RM100 face value.

An investor who bought a bond at a yield of 9% and sold it when the rate rose to 10% would thus have taken a loss. However, that loss would be to some extent offset by earnings through the coupon, with the extent of the offset reflecting the length of time the bonds were held and the size of the parcel.

On the other hand, should interest rates fall, the investor would have made a capital gain in addition to interest earned. The investor holding the same 8.5% coupon bonds bought at a yield of 9% for two years before deciding that interest rates were headed lower and it would be better to sell at a yield of 8%. The selling price would rise to RM100.89 per RM100 face value.

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