Chapter 2

Overview of bond sectors

and instruments
 Major learning outcomes:

– Understand the type of bonds issued by U.S. and other governments

– Identify how stripped Treasury bonds are created
– Describe mortgage-backed securities and collateralized mortgage
obligations
– Understand the bankruptcy process and bondholder rights
– Describe the different types of corporate debt
– Understand the types of asset-backed securities, including
collateralized debt obligations
– Describe the structure of the primary and secondary market for bonds
Sectors of the Bond Market
 Sectors of the Bond Market
• The bond market of a country consists of an internal bond
market (also called the national bond market) and an external
bond market (also called the international bond market, the
offshore bond market, or, more popularly, the Eurobond
market).
• There is no uniform system for classifying the sectors of the
international bond market
• From the perspective of an individual country, the bond
market is classified as either:
– Internal (domestic)
– External (foreign)
 Internal Bond Market
The national or domestic
market
– It is the country’s market
where the issuers are
domiciled
– The bonds are issued and
traded in the issuer’s domestic
market
The foreign bond market.
• It is a market in a different country
from where the issuer is domiciled
• Ex, In the U.S., the foreign bond
market is where bonds issued by non-
U.S. entities are issued and then
traded.
• Foreign bonds can be denominated in
any currency.
• Foreign bond issuers can be central
governments (and their agencies),
corporations, and supranationals (ex,
WB, ADB).
 External Bond Market
• The external bond market is called the international or
offshore bond market – it is also known as the Eurobond
market.

• These bonds are classified based on the currency in which the

issue is denominated.
– Eurobonds denominated in US dollars are called
Eurodollar bonds.
– Eurobonds denominated in Japanese yen are called
Euroyen bonds.

• A global bond is a debt obligation issued and traded in the

foreign bond market of one or more countries and the
Eurobond market.
 Eurobond Market
• Eurobonds are bonds which generally have the following
distinguishing features:
– (1) they are underwritten by an international syndicate,
– (2) at issuance they are offered simultaneously to investors
in a number of countries,
– (3) they are issued outside the jurisdiction of any single
country, and
– (4) they are in unregistered form.
 Instruments
(1) Gorvernment
• Bonds issued by a country’s central government
• Bonds can be issued in its national market or in the Eurobond
market (or the foreign sector of another country’s bond
market)
• Bonds can be issued in any denomination.
• bonds are rated by the various credit rating agencies.
– These are called sovereign debt ratings
– There are two types of sovereign debt ratings:
• Local currency
• Foreign currency
• Default risk is greater for foreign currency denominated debt.
U.S. Treasury Securities
 U.S. Treasury Securities
• fixed-principal securities
– Treasury bill - maturity of one year or less
– Treasury note - original maturity between two and 10
years
– Treasury bond - original maturity greater than 10 years
• inflation-indexed securities
– The Treasury issues inflation-protection securities (TIPS) -
principal and coupon payments are indexed to the
Consumer Price Index.
 Treasury Inflation-Adjusted
Securities (TIPS)
• Inflation-indexed Treasury securities (also known as TIPS)

– These are T-notes and bonds that provide inflation

protection.

– Issued first in 1997

– Initial maturities: 5, 10 and 30 years

– Adjusted for inflation every 6 months

 Treasury Inflation-Adjusted
Securities
• The coupon rate on a TIPS is set at a fixed rate determined by
an auction. The coupon is called the real rate, because it is the
rate the investor will ultimately earn above the inflation rate.
– The inflation index used is the CPI-U (all item, urban
consumer price index).
– The Treasury Department adjusts both the dollar amount
of the coupon payment and the maturity value on a semi-
annual basis.
– The principal is called the inflation-adjusted principal.
 Treasury Strips
• Treasury securities are often stripped of their coupons in the
private sector to create zero-coupon bonds, known as
Treasury Strips.
• The Treasury STRIPS program was introduced in January
1985. STRIPS is the acronym for Separate Trading of
Registered Interest and Principal of Securities.
– The STRIPS program lets investors hold and trade the
individual interest and principal components of eligible
Treasury notes and bonds as separate securities.
 Treasury Strips
• Strips created from the coupon payments are called coupon
strips; those created from the principal payment are called
principal strips.
• Zero-coupon Treasury instruments are created by dealers
stripping the coupon payments and principal payment of a
Treasury coupon security
• A disadvantage for a taxable entity investing in Treasury
strips is that accrued interest is taxed each year even though
interest is not received.
Treasury Strips
 Treasury Strips
• When a Treasury fixed-principal note or bond (or a TIPS) is
stripped, each interest payment and the principal payment
becomes a separate zero-coupon security.
– Each component has its own identifying number and can
be held or traded separately.
• STRIPS are also called zero-coupon securities because the
only time an investor receives a payment during the life of a
STRIP is when it matures.
 Treasury Strips
• Why do investors hold STRIPS?

– STRIPS are popular with investors who want to receive a known

payment at a specific future date.

– For example, some state lotteries invest the present value of large
lottery prizes in STRIPS to be sure that funds are available when needed to
meet annual payment obligations that result from the prizes.

– Pension funds invest in STRIPS to match the payment flows of their

assets with those of their liabilities to make benefit payments.

– STRIPS are also popular investments for individual retirement accounts,

401(k)-type savings plans, and other income tax-advantaged accounts that
permit earnings to accumulate without incurring immediate income tax
consequences.
 Instruments
(2) Semi-Government or Agency Bonds
• In the U.S. the federal agency securities are classified by the
types of issuers:
– Federally related institutions
– Government sponsored enterprises (GSEs)
• GSEs offer two types of debt:
– Debentures (either notes or bonds with maturities of 1 to 20
years)
– Discount notes (short-term obligations with maturities ranging
from overnight to 360 days)
• GSEs are frequent issuers of securities and have various well-
defined types of offerings including:
- Callable bonds and notes
– Notes and bonds that are eligible for stripping to create
zero-coupon GSE bonds
 Instruments
(2) Semi-Government or Agency Bonds
• Two of the GSEs charged with providing liquidity to the mortgage
market (Fannie Mae and Freddie Mac) issue securities backed by
the mortgage loans they purchase.
• In other words, they use the mortgage loans they underwrite or
purchase as collateral for the securities they issue.
– A significant part of their earnings is derived from the
difference between the yield on the mortgages they hold and
the cost of funds on their debt securities.
• These are called agency mortgage-backed securities and include:
– Mortgage pass-through securities
– Collateralized mortgage obligations (CMOs)
– Stripped mortgage-backed securities
 Mortgage Loans
• A mortgage loan is secured by some specific real estate property
(collateral) which obligates the borrower to make a
predetermined series of payments.
• Mortgage loan payments consist of interest, scheduled principal
payment, and prepayments.
– Prepayments are any payments in excess of the required
monthly mortgage payment.
– Prepayment risk is the uncertainty about the cash flows due
to prepayments.
• The mortgage gives the right to the lender to foreclose on the
loan and seize the property in the event the debt is not paid.
• The interest rate on the mortgage is called the mortgage or
contract rate.
 Mortgage Loans
• There are different types of mortgages including:
– Traditional fixed-rate fully amortizing
– Floating rate
– Interest-only (fixed or floating)
– Partial amortizing (fixed or floating)
• Investors/lenders do not always receive the amount in the
amortization schedule because:
– Uncertainty in the borrower’s payments
– Prepayments
– Servicing fees
• Servicing fees are collected by a bank or mortgage company and can
be as much as 50-75 basis points
• Prepayments by the borrower (especially when interest rates are
dropping) can result in prepayment or reinvestment risk for the
lender/investor.
Mortgage Pass-through Securities

• Loans included in an agency issued mortgage-backed

security are conforming loans—loans that meet the
underwriting standards established by the issuing entity.
• For a mortgage passthrough security the monthly payments
are passed through to the certificate holders on a pro rata
basis.
 Mortgage Pass-through Securities
• A mortgage pass-through security is created when one or more holder of
the mortgages form a portfolio or pool of mortgages and sells shares or
participation certificates in the pool to investors.
• When mortgages in the pool are collateralized, the mortgage pool is
considered to be securitized.
• The cash flow received by the investor depends on the cash flow of the
borrowers in the underlying pool of mortgages. (These cash flows are the
principal and interest payments less any servicing fees).
• Payments are made to security holders each month with the exact amount
uncertain.
• Ginnie Mae, Fannie Mae, and Freddie Mac mortgage loans must meet
underwriting standards (conforming loans). Mortgage-back securities not
issued by agencies are backed by pools of nonconforming loans.
 Mortgage Pass-through Securities
versus Non-Callable Coupon Bonds
• For a standard coupon bond, there are no principal payments
prior to maturity – unlike the monthly amortization payments
from a pass-through.

• Payments for a pass-through are monthly, whereas the standard

coupon bond pays interest semi-annually.

• Passthroughs have more payment uncertainty (because of

prepayments) than a standard non-callable bond.

• Principal risk exits for both types of securities, however, based

on the collateral and status of the conforming loans the risk
levels will vary.
Collateralized Mortgage Obligations

• In a collateralized mortgage obligation (CMO), there are

rules for the payment of interest and principal (scheduled
and prepaid) to the bond classes (tranches) in the CMO.

• The payment rules in a CMO structure allow for the

redistribution of prepayment risk to the tranches comprising
the CMO.
Collateralized Mortgage Obligations

• CMOs are a special type of agency mortgage securities.

• The motivation for CMOs is to distribute prepayment risk

among different classes of bonds.

• The collateral for a CMO issued by an agency is a pool of

pass-through securities which is placed in trust.

• The source of the CMO’s cash flow is the pool of mortgage

loans.
 Instruments
(3) municipal bonds

• Non-central government entities (states, counties, cities,

school districts, sanitation districts, etc.) are referred to as
municipal bonds.

• In the U.S. bond market, municipal securities are debt

obligations issued by state governments, local governments,
and entities created by state and local governments.
 Instruments
(3) municipal bonds
• In the U.S. there are both tax-exempt and taxable municipal
securities, where ‘‘tax-exempt’’ means that interest is exempt from
federal income taxation. The tax exemption applies to interest
income and not capital appreciation.
• Most municipal bonds are tax-exempt and trade in an over-the-
counter secondary market.
• Like other non-Treasury securities, municipal investors are exposed
to credit risk.
• There are two types of municipal securities:
– Tax-backed debt
– Revenue bonds
 Municipal Bonds
• Tax-backed debt
– are instruments secured by some form of tax revenue.
– includes general obligation debt (the broadest type of tax-
backed debt), appropriation-backed obligations, and debt
obligations supported by public credit enhancement programs.
• Revenue bonds are issued for enterprise financings that are
secured by the revenues generated by the completed projects
themselves, or for general public-purpose financings in which
the issuers pledge to the bondholders the tax and revenue
resources that were previously part of the general fund.
– Insured bonds, in addition to being secured by the issuer’s
revenue, are backed by insurance policies written by
commercial insurance companies.
 Instruments
(3) municipal bonds
 General Obligation Municipal Debt
• This is the broadest and most commonly issued type of tax-backed debt.
• Unlimited tax general obligation debt is secured by the issuer’s
(municipality’s) unlimited taxing power.
– The tax revenue source can include corporate and individual income
taxes, sales taxes, and property taxes.
– The debt is backed by the full faith and credit of the issuer.
• Limited tax general obligation debt is a limited tax pledge which might
involve a statutory limit on tax rate increases that the issuer may levy to
service the debt.
• “Double-barreled in security” bonds are a highly secure form of municipal
debt backed not only by the full faith and credit of the issuer, but also
might have provisions to be funded by certain fees, grants, and other
special charges from sources outside the municipality’s general fund.
 Appropriation-Backed
Obligation Municipal Debt
• Agencies or special authorities of some states have issued bonds
that are backed by the state’s ability to cover any shortfalls.

• The use of funds from the state’s general tax revenue must be
approved by the state legislature.

• Debt obligations backed by the state are not legally binding and
are called moral obligation bonds.

• Because legislative approval is required, these are classified as

appropriation-backed obligations.
 Municipal Obligations Supported by
Public Credit Enhancement Programs
• Unlike the moral obligation debt obligations backed by the
state, which are not legally binding, these bonds carry some
form of public credit enhancement that is legally enforceable.

• These bonds are backed by a state or federal guarantee to use

funding to pay any defaulted debt service by the municipality.

• These are often used for debt obligations of a state’s school

systems.

• Some state and local governments have issued bonds where the
debt service is paid from dedicated revenue sources, such as
sales taxes or tobacco settlement fees.
 Revenue Municipal Bonds
• Revenue bonds are issued for organizations that are secured
by the revenues generated by the financed projects – or
specific revenue streams from the general fund are designed
to cover the debt obligations of the financed project.

• Revenue bonds typically involve the following type of

projects:
– Utility and transportation
– Housing and higher education
– Health care, sports, and convention centers
– Seaports and industrial parks
 Insured Municipal Bonds
• In addition to being secured by the issuer, these are also
backed by insurance policies written by commercial
insurance companies.

• This bond insurance requires the insurance company

(underwriter) to pay any debt obligations if the municipality
is unable.

• This insurance lasts for the life of the municipal bond.

 Prerefunded Municipal Bonds
• If interest rates have dropped and a municipality wants to
refinance, but the terms of the municipal bond do not allow
for immediate refunding, it is possible to do a “prerefunded”
or “advanced refunding” offering.

• Basically, a second financing is undertaken (at a lower cost)

and the proceeds are invested to be used at the time at which
the original (higher cost) financing can be called (refunded).
– Zero-coupons are often used to match coupon and
principal payments of the original bonds.

• Prerefunded bonds with structured maturity dates are known

as “escrowed-to-maturity” bonds. This is a form of structured
financing.
 Instruments
(4) Corporate Debt
• Corporations have two sources of debt financing: bank
borrowing and the issuance of debt securities.

• A company can issue debt by issuing securities in foreign

markets.

• The U.S. and U.K. corporate debt markets are the most
developed in the world.
Corporate Debt
 Secured, Unsecured, and Credit
Enhanced Corporate Bonds

• Secured debt has some form of collateral pledged to ensure

payment of the debt obligation.

• An obligation without any pledged collateral is unsecured debt.

• Some debt can be secured with a third-party guarantee, called

a credit enhancement.

– Note: secured and credit enhanced debt still does not

prevent bondholders in all cases from suffering financial
loss.
 Secured Corporate Bonds
• Secured debt has some form of real or personal property pledged as
collateral to ensure payment of the debt obligation.
– Mortgage debt grants the bondholders a lien against pledged assets.
(A lien is the legal right to sell mortgaged property to cover unpaid
debt obligations).
– Mortgage debt gives the bondholders a stronger position than other
creditors in the event of a reorganization.
• Companies with no real property to pledge can offer financial assets as
security – these are called collateral trust bonds.
• Mortgage bonds go by different names:
– First mortgage bonds
– First and general mortgage bonds
– First refunding mortgage bonds
– First mortgage and collateral trust bonds
• When firms cannot issue first mortgage bonds because of existing
covenants, they may issue secured bonds called secondary or general
and refunding mortgage bonds.
 Unsecured Corporate Bonds
• Debt with no security or pledges are referred to in the U.S. as
debenture bonds.

• Debenture bondholders have the claim of general creditors on all

assets of the issued not pledged to secured debts or loans.

• Subordinated debenture bonds are issues that rank below

secured and debenture bonds with regard to claims on assets in
bankruptcy or liquidation.

• The negative pledge clause provides protection for unsecured

bondholders by prohibiting the firm from creating new debt or
assuming any lien to secure a debt issue without equally
securing the unsecured issue.
Credit Enhanced Corporate Bonds

• This is a bond issue that has another company or third-party

securing or guaranteeing the debt.
– The use of credit guarantees by the parent company is used to
secure the debt of special projects or affiliates.
• A second credit enhancing feature is the letter of credit (LOC),
which is issued by a bank.
 Medium-Term Notes (MTN)
• A medium-term note is a debt instrument with the unique
characteristic that notes are offered continuously to investors
by an agent of the issuer.
– Maturities can vary from under 1 year to 30 years.
– The issue is registered with the Securities and Exchange
Commission under Rule 415 (shelf registration).
• This rule gives an issuer the maximum flexibility for issuing
securities on a continuous basis.
• MTNs can be flexible:
– They can be fixed or floating rate.
– Issued in U.S. or other currency.
– They can have the same features as other corporate bonds
(i.e. call provisions).
 Structured MTN
• The traditional MTN used to be a fixed-rate non-callable
coupon bond.

• Today, the MTNs are more complex with many creative

features (i.e. options, caps, floating rates, floors, etc).

• MTNs created when the issuer simultaneously transacts in

the derivative markets is called a structured note.
– The most common derivative instrument used to create
a structured note is a swap.
 Structured MTN

• A swap is an exchange of streams of payments over time

according to specified terms. The most common type is an
interest rate swap, in which one party agrees to pay a fixed
interest rate in return for receiving a adjustable rate from
another party.
– Structured offering (which involve the use of derivative
instruments) allow issuers to create investment vehicles that
are customized to the needs of institutional investors to
satisfy their investment objectives.
 Structured MTN
• Some structured notes can be highly innovative, including
coupon rates that adjust to changes in foreign exchange rates,
stock market levels, and commodity prices.

• “Rule busters” MTNs allow investors to participate indirectly

in asset classes forbidden by their investment policy

• More common structured MTNs include:

– Step-up notes
– Inverse floaters
– Deleveraged floaters
– Dual-indexed floaters
– Range notes
– Index amortizing notes
 Structured MTN
• Deleveraged Floaters
– This is a floater that has a coupon formula where the
coupon rate is computed as a fraction of the reference
rate plus a quoted margin

• Coupon rate = b x (reference rate) + quoted

margin,
•
• where b is a value between 0 and 1.
 Structured MTN
• Dual-Indexed Floaters
– The coupon rate is typically a fixed percentage plus the
difference between two reference rates. Note: a reset
period (i.e. quarterly) needs to be established.

– Coupon rate = (reference rate1 – reference rate2) +

quoted margin
 Structured MTN
• Range Note Floater
– A type of floater whose coupon rate is equal to the
reference rate (as long as the reference rate is within a
certain rate at the reset date).
– If the reference rate falls outside the range, the coupon
rate is zero for the period.
• Index Amortizing Notes
– A structured note with a fixed coupon whose principal
payments change according to changes in an underlying
interest rate.
 Commercial Paper
• Commercial paper is a short-term unsecured promissory
note issued in the open market by a corporation in need of
short-term funding.
– Most commercial paper has a maturity of 50 days, but it
can be as much as 270 days.
– Commercial paper is commonly ‘rolled over,’ meaning
that retiring paper is funded with the issuance of new
commercial paper.
– There is little secondary market trading.
 Commercial Paper
• Commercial paper is usually issued by financial companies:
– Captive finance companies (which are usually
subsidiaries of manufacturing companies (GMAC,
GECC)) issue commercial paper to secure financing for
customers of the parent company.
– These are the largest players in the market.
• Commercial paper is classified as:
– Directly placed – sold by the issuing firm without an
agent or intermediary. Most financial company
commercial paper is placed in this manner.
– Dealer-placed – requires the services of an agent to sell
an issuer’s commercial paper.
 Bank Obligations

• Commercial banks issue two types of debt obligations:

– Negotiable CDs (certificates of deposit)
– Bankers acceptances (instruments to help facilitate
commercial trade transactions)

• These are used by banks to raise short-term funds.

 Negotiable CDs
• A certificates of deposit is a financial asset issued by a bank
that indicates a specific amount of money has been deposited.
The CD has:
– A set maturity date
– A specific interest rate
– No set denomination
• CDs in the U.S. are insured by Federal Deposit Insurance
Corporation (FDIC) up to $100,000 per customer per bank.
• Non-negotiable CDs have penalties for early withdrawal.
Negotiable CDs allows the initial depositor to sell the CD in
the open market prior to maturity.
• Negotiable CDs are usually issued in denominations of $1
million or greater.
 Negotiable CDs
• The Eurodollar CD is dollar denominated and issued primarily in
London by U.S., European, Canadian, and Japanese banks.
• The interest paid on Eurodollar CDs is viewed as the global cost
of bank borrowing and is watched closely in the world financial
markets.
– This is due to the fact that these interest rates represent the
rates at which major banks offer to pay each other to borrow
money. The interest rate paid is called the London interbank
offered rate (LIBOR).
• Eurodollar CDs rank in maturities from overnight to 5 years.
Reference to the 1-month LIBOR indicates the interest rates that
major international banks are offering to pay to other banks over a
1 month period.
• LIBOR is the reference rate used for most loans and floating-rate
securities.
 Bankers Acceptances

• A bankers acceptance is a money market instrument - a short-

term discount instrument that usually arises in the course of
international trade.

• Bankers acceptances are typically used to finance

international transactions in goods and services, and currently
represent an estimated of over $5 billion market.
 Bankers Acceptances

• A bankers acceptance starts as an order to a bank by a bank's

customer to pay a sum of money at a future date, typically
within six months.
– At this stage, it is like a postdated check. When the bank
endorses the order for payment as "accepted", it assumes
responsibility for ultimate payment to the holder of the
acceptance.
– At this point, the acceptance may be traded in secondary
markets much like any other claim on the bank.
 Bankers Acceptances

• Bankers acceptances are considered very safe assets, as they

allow traders to substitute the bank's credit standing for their
own.
– They are used widely in foreign trade where the
creditworthiness of one trader is unknown to the trading
partner.
– Banker acceptances sell at a discount from face value of the
payment order, just as T-bills sell at a discount from par
value.
 Asset-Backed Securities
• Asset-backed securities are obligations backed by a pool of
loans or receivables.

• Residential mortgages are the largest segment of the asset-

backed market, the other major type of assets that are
securitized include:
– Auto loans and leases
– Consumer loans
– Commercial assets (aircraft, CNC machines, trade
receivables)
– Credit cards
– Home equity loans
– Manufactured housing loans
 Asset-Backed Securities
• Corporations that have a significant amount of receivables or loans on their
balance sheet, and who need to raise funds, can issue asset-backed obligations
at favorable rates.
– The firm must create a separate entity that holds the receivables/ loans.
Special purpose corporations.
– The separate entity can issue an asset-backed debt obligation with the
receivables/loans pledged as collateral.
– The credit risk of the standalone entity with only the receivables/loans on
its balance sheet may have a stronger credit rating that the other firm (not
a parent company).
– To obtain even a higher credit rating (and lower cost of money), the firm
can credit enhance the asset-backed obligations.
• These third-party guarantees can be in the form of a guarantee by the firm, a
letter of credit, or bond insurance.
Collateralized Debt Obligations
• Another segment of the asset-backed securities market is
the collateralized debt obligation (CDO), which has grown
significantly the past few years.

• The CDO is structured in a similar manner as the

collateralized mortgage obligation (CMO), except that
rather than mortgages the assets pledged as collateral are:
– Domestic and foreign bonds
– Bank loans
– Distressed debt
– Foreign bank loans
– Asset-backed securities
– Commercial and residential mortgage-backed securities
 Collateralized Debt Obligations

• Like CMOs, CDOs can be packaged to provide unique income

streams and risk levels (tranches)

• Investment companies and hedge funds (and other sponsors of

CDOs) seek arbitrage returns by bundling together a pool of
similar debt obligations and selling them to institutional
investors and accredited investors who have unique investment
objectives.
– The investment company or hedge fund earns a fixed return
or spread on the cost of the obligations versus the
repackaging into a CDO.
 Primary Market for Bonds
• The traditional process for issuing new bonds involves
investment bankers performing one or more of the following:
– Advising the issuer on the terms and timing of the
offering;
– Buying the securities from the issuer; and
– Distributing the issue to the public.

• Underwriting (risk assumption or firm commitment) and

‘best efforts’ offerings
Bought Deal and Auction Process
• Bought deals work as follows:
– The underwriters offer a potential issuer of debt
securities a firm bid to purchase a specified amount of
securities with a certain coupon rate and maturity.
– The issuer is given up to a day to accept or reject the bid.
• If accepted, the underwriters have ‘bought the deal’ and
can sell the securities to other investment firms and
institutional investors that it has pre-sold the deal (reducing
the risk to the underwriter). Hedging strategies can also be
employed to reduce the risk.
 Bought Deal and Auction Process

• The ‘auction process’ involves the issuer announcing the

terms and soliciting interested underwriters to submit a bid –
this is also known as a competitive bidding underwriting.

– The investment banking syndicate that bids the lowest

yield wins the entire offering.
 Methods of Distributing New
Government Securities
• 1. Regular auction cycle/multiple-price method
– a regular auction cycle and winning bidders are allocated
at the yield they bid. In other words, stop out rate will be
registered rate of awarded bidders (multiple rate)

• 2. Regular auction cycle/single-price method

– a regular auction cycle and all winning bidders are
awarded at the highest yield accepted by the government.
In other words, stop out rate will be applied to awarded
bidders (single rate)
 AUCTION

• Auction is the choice of organizations and individuals

involved in the bid which meet requirements of the issuer.
• Principle of bond auction
• Keeping confidential information of organizations and
individuals to participate in auction.
• Ensuring equality among organizations and individuals to
participate in auction.
• Competing interest rate among organizations and individuals
to participate in.
66
 AUCTION
• Competitive interest rate auction: means bidders offer bid
rate in order to issuer or authorized organization select a stop
out rate.

• Noncompetitive interest rate auction: means bidders don’t

offer bid rate, they register to buy bonds with stop out rate is
determined as a result of competitive interest rate auction

67
• After accepting all noncompetitive bids, Treasury accepts
competitive bids beginning at the lowest competitive rates or
yields bid. Treasury then accepts bids at each successively
higher rate or yield, stopping at the rate or yield at which the
offering amount is reached. All competitive bidders bidding at
or below this rate or yield, the "stop-out" rate or yield, as well
as all noncompetitive bidders, will pay the same price for their
securities – the price that corresponds to the "stop-out" rate or
yield. Bids right at the stop-out rate or yield are prorated,
which means that Treasury accepts only the proportion of each
bid needed to reach the offering amount. The technique of
awarding all successful bidders the same rate or yield is called
a "single-price“ or "uniform-price" auction technique, which
Treasury has used for all marketable securities auctions
68
Competitive interest rate auction
• Example: there are 8 bidders take place in the tender of
government bond to mobilize VND300 bio (par value
VND1mio) as follow:

Bidder Interest rate(%) Amount (bio VND)

1 9 80
2 9 70
3 8.5 90
4 8 100
5 7 50
6 6 50
7 5.5 60
8 5 69
40
 Regular auction cycle method
Dear Bid Bid Total
• Regular Auction Cycle/Single-price Price Amount

method: 1 98.5 200m 200m

2 98.45 100m 300m

• Total T-bond to be auctioned: $1b
3 98.32 150m 450m

• Successful bids: those with a bid price 4 98.10 50m 500m

5 98.09 250m 750m

• higher than 97.87
…..

• Price to pay by those successful bids: 20 97.87 100m 1,000m

97.87 21 97.85 90m 1,090m

22 97.84 120m 1,210m

23 97.79 200m 1,410m

….. ….
 International bond issuance

• To compliance with International practices

• Rating credit
• To require transparency and publicity in the mobilization
and use of capital

71
Process of international bond
issuance

Agreement Authorization
Issuing stage
stage stage

72
 The Primary Market for MTNs

• Unlike traditional corporate bonds that are underwritten and

distributed by an investment banker, MTNs are often sold on a
“best efforts” basis.

– Either broker/dealers or investment banks will be paid a fee

by the issuer to help sell the MTNs.
 The secondary market
• The secondary market for Treasuries is an over-the-counter
market with a group of dealers offering virtually around-the-
clock trading of these securities.
• On-the-run issues (or current coupon issue ): the most
recently auctioned Treasury issue for a maturity;
• Off-the-run issues are issues auctioned prior to the current
coupon issue.