CHAPTER 3:

BOND MARKETS

FACULTY OF FINANCE
BANKING UNIVERSITY OF HCMC
 CONTENTS
2

I. Introduction
II. Types of Bond
III. Bond yields and Risk in Investing Bond
IV. Issuance in the Primary Market
V. Transactions in the Secondary Market
 I. INTRODUCTION
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— Bonds are securities that represent a debt owed by the issuer to

the investor. Bonds obligate the issuer to pay a specified amount
at a given date, generally with periodic interest payments.
— The par, face, or maturity value of the bond (they all mean the
same thing) is the amount that the issuer must pay at maturity.
— The coupon rate is the rate of interest that the issuer must pay,
and this periodic interest payment is often called the coupon
payment. This rate is usually fixed for the duration of the bond
and does not fluctuate with market interest rates.
— If the repayment terms of a bond are not met, the holder of a bond
has a claim on the assets of the issuer.
 II. TYPES OF BOND
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1. By issuers
2. By coupon structure
3. By embedded options
4. By bond rating
5. By location
 1. BY ISSUERS
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— Government bonds
— Municipal bonds
— Corporate bonds
 1. BY ISSUERS
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— Government bonds:
¡A government bond is a debt security issued by a
government to support government spending and
obligations.
¡ Government bonds issued by national governments
are often considered low-risk investments since the
issuing government backs them.
 1. BY ISSUERS
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— Municipal bonds
¡ Municipal bonds are securities issued by local, county, and
state governments.
¡ The proceeds from these bonds are used to finance public
interest projects, such as schools, utilities, and
transportation systems.
¡ Interest earned on municipal bonds that are issued to pay
for essential public projects are exempt from federal
taxation.
 1. BY ISSUERS
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— Corporate bonds
¡ Corporate bonds are bonds issued by corporations.
¡ The degree of risk varies widely among different bond
issues because the risk of default depends on the
company’s health, which can be affected by a number
of variables.
¡ The interest rate on corporate bonds varies with the
level of risk.
 2. BY COUPON STRUCTURE
9

— Coupon bonds
¡ A coupon bond includes attached coupons and pays periodic
(typically annual or semi-annual) interest payments during
its lifetime and its par value at maturity.
— Zero-coupon bonds
¡ A zero-coupon bond (also discount bond) does not make
periodic interest payments but instead trades at discounts.
When the bond reaches maturity, its investor receives its par
(or face) value
¡ The difference between the purchase price of a zero-coupon
bond and the par value indicates the investor's return.
 3. BY EMBEDDED OPTIONS
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— Callable bonds
— Putable bonds
— Convertible bonds
— Floating-rate bonds
— Conventional bonds
 3. BY EMBEDDED OPTIONS
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— Callable bonds
¡ A callable bond is a debt security that can be redeemed
early by the issuer before its maturity at the issuer's
discretion.
¡ A callable bond allows companies to pay off their debt
early and benefit from favourable interest rate drops.
¡ A callable bond benefits the issuer, and so investors of
these bonds are compensated with a more attractive
interest rate than on otherwise similar non-callable bonds.
 3. BY EMBEDDED OPTIONS
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— Putable bonds
¡ A putable bond is a debt instrument with an embedded
option that gives bondholders the right to demand early
repayment of the principal from the issuer.
¡ If interest rates rise after bond purchase, the future value
of coupon payments will become less valuable. Therefore,
investors sell bonds back to the issuer and may lend
proceeds elsewhere at a higher rate.
¡ Bondholders are ready to pay for such protection by
accepting a lower yield relative to that of a straight bond.
 3. BY EMBEDDED OPTIONS
13

— Convertible bonds
¡ A convertible bond is a type of bond that provides a holder
with a right to convert the bond into a specified number of
common stock in the issuing firm.
¡ This right benefits bondholders, so the holders obtain a lower
yield relative to that of a straight bond.
¡ A convertible bond has two values:
÷ The value of straight bond: equals the market value of the bond
÷ The value of conversion: equals the market value of shares, which
can be converted from each bond
¡ The conversion ratio – also called the conversion premium—
determines how many shares can be converted from each bond.
 3. BY EMBEDDED OPTIONS
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— Floating-rate bonds
¡ A floating-rate bond is a bond whose interest rate is adjusted
periodically according to a predetermined formula;
¡ Its interest rate usually equal to a money market reference rate,
like LIBOR, plus a quoted. The spread is a rate that remains
constant.
¡ A typical coupon would look like 3 months USD LIBOR
+0.20%.
 3. BY EMBEDDED OPTIONS
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— Conventional bonds
¡ A conventional bond or a straight bond does not have any
embedded option.
¡ This bond has only a specified face value, interest payment
frequency, interest rate, and maturity date.
 4. BY BOND RATING
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— The bond credit rating represents the credit worthiness of

corporate or government bonds. The ratings are published
by credit rating agencies (such as Standard & Poor’s,
Moody’s and Fitch) and used by investment professionals to
assess the likelihood the debt will be repaid.
— Bonds with a rating of BBB- or Baa3 or a higher level are
called investment-grade bonds and bonds that have a
rating lower than BB or Ba are called junk bonds (also
called high-yield bonds) because they have an elevated risk
of default and hence higher yields.
 5. BY LOCATION
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— Domestic bonds
— Euro bonds
— Foreign bonds
 5. BY LOCATION
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— Domestic bonds
¡ A domestic bond is an obligation of a domestic issuer,
denominated in domestic currency, and sold and traded in
the domestic market.
¡ E.g., a British company issues debt in the United Kingdom
with the principal and interest payments based or
denominated in British pounds.
 5. BY LOCATION
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— Euro bonds
¡ An euro bond is a bond issued by a non-resident and denominated
in other than the currency of the country in which it is being
placed.
¡ An example is a British company issues debt in the United States
with the principal and interest payments denominated in pounds.
— Foreign bonds
¡ A foreign bond is an obligation of a foreign entity, denominated in
domestic currency, and sold and traded in the domestic market.
¡ E.g., a British company issues debt in the United States with the
principal and interest payments denominated in dollars.
 III. BOND YIELDS AND RISK IN INVESTING BOND
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1. Bond Yields
2. Main Risk in Investing Bond
3. Bond Valuation

TS. Nguyễn Duy Linh

 1. BOND YIELDS
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A. Nominal yield
B. Current yield
C. Promised yield to maturity (YTM)

— Nominal and current yields are mainly descriptive and

contribute little to investment decision making

TS. Nguyễn Duy Linh

 A. NOMINAL YIELD
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— Nominal yield is the coupon rate of a particular issue,

e.g. a bond with an 8 percent coupon rate has an 8
percent nominal yield.
— This provides a convenient way of describing the
coupon characteristics of an issue.

TS. Nguyễn Duy Linh

 B. CURRENT YIELD
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— This yield measures the current income from the bond as a

percentage of its price C
CY=
MP0
÷ C is the fixed annual coupon
÷ MP0 is the bond’s current market price

— It is important to income-oriented investors (e.g., retirees)

who want current cash flow from their investment
portfolios.
— Current yield has little use for investors who are interested
in total return because it excludes the important capital gain
or loss component.
TS. Nguyễn Duy Linh
 C. PROMISED YIELD TO MATURITY
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— The yield to maturity (YTM) is defined as the interest rate

that makes the present value of a bond’s payments equal to
its price.
— This interest rate is often interpreted as a measure of the
average rate of return that will be earned on a bond if:
¡ The investor holds the bond to maturity

¡ The investor reinvests all the interim cash flows at the

computed YTM rate

TS. Nguyễn Duy Linh

 C. PROMISED YIELD TO MATURITY
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— Computing the promised yield to maturity

%
𝐶 𝐹
𝑃! = # "
+ %
1 + 𝑌𝑇𝑀 1 + 𝑌𝑇𝑀
"#$

— YTM for a zero-coupon bond

𝐹
𝑃! = "
1 + 𝑌𝑇𝑀

TS. Nguyễn Duy Linh

 C. PROMISED YIELD TO MATURITY
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— Premium Bonds:
Coupon rate > Current yield > YTM

— Discount Bonds:
Coupon rate < Current yield < YTM

— Far value = Market price

Coupon rate = Current yield = YTM

TS. Nguyễn Duy Linh

 2. MAIN RISKS IN INVESTING BOND
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A. Interest Rate Risk

B. Reinvestment Risk
C. Credit (Default) Risk
D. Inflation Risk
E. Liquidity Risk
F. Exchange rate risk

TS. Nguyễn Duy Linh

 A. INTEREST RATE RISK
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— Interest rate risk is the riskiness of an asset’s return that

results from interest-rate changes. In particular, bond prices
and yields are inversely related.
— As interest rates rise and fall, bondholders experience capital
losses and gains. These gains or losses make fixed-income
investments risky, even if the coupon and principal
payments are guaranteed.
— Interest rate risk increases for bonds with longer maturities
and lower coupon payments, and decreases for bonds with
shorter maturities and higher coupon payments.

TS. Nguyễn Duy Linh

 B. REINVESTMENT RISK
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— Reinvestment risk is the component of interest rate risk due

to the uncertainty of the rate at which coupon payments/the
proceeds from the short-term bond will be reinvested.
— Reinvestment risk is related to interest rate risk but has the
opposite effect on a bond's performance.
— Reinvestment risk increases for bonds with longer maturities
and higher coupon payments, and decreases for bonds with
shorter maturities and lower coupon rates.

TS. Nguyễn Duy Linh

 C. CREDIT RISK
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— Credit (default) risk occurs when the issuer of the bond is

unable or unwilling to make interest payments when
promised or to pay off the face value when the bond
matures.
— Bond default risk is measured by Moody’s Investor
Services, Standard & Poor’s Corporation, and Fitch
Investors Service.

TS. Nguyễn Duy Linh

 D. INFLATION RISK
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— Inflation risk occurs when the increase in inflation reduces

the purchasing power of a bond’s future coupons and
principal.
— Inflation may lead to higher interest rates which is negative
for bond prices.
— Inflation Linked Bonds are structured to protect investors
from the risk of inflation. The coupon stream and the
principal (or nominal) increase in line with the rate of
inflation and therefore, investors are protected from the
threat of inflation.

TS. Nguyễn Duy Linh

 E. LIQUIDITY RISK
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— This is the risk that investors may have difficulty finding a

buyer when they want to sell and may be forced to sell at a
significant discount to market value.
— The more liquid an asset is, the more desirable it is (higher
demand), holding everything else constant.
— Bonds that trade frequently and in large amounts, such as
Treasury securities, usually have less liquidity risk than
bonds which trade less frequently.
— Liquidity risk becomes a smaller factor in overall return as
an investors holding period lengthens

TS. Nguyễn Duy Linh

 F. EXCHANGE RATE RISK/CURRENCY RISK
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— An investor is exposed to currency risk if a bond is

denominated in a currency other than his home currency.
Exchange rate risk arises from uncertainty in exchange rate
fluctuations.
— We can assess the magnitude of exchange rate risk by
examining historical rates of change in various exchange
rates and their correlations.

TS. Nguyễn Duy Linh

 3. BOND VALUATION
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A. Valuing a coupon bond

B. Valuing a zero-coupon bond (discount bond)
C. Valuing a perpetual bond

TS. Nguyễn Duy Linh

 A. VALUING A COUPON BOND
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— The value of a coupon bond is the present value of the interest

payments plus the present value of the principal payment:
¡ The interest payments are paid annually
"
𝐶 𝐹 𝐶 1 𝐹
𝑃! = . + 𝑃! = 1 − +
(1 + 𝑖)# (1 + 𝑖)" 𝑖 (1 + 𝑖)" (1 + 𝑖)"
#$%

¡ The interest payments are paid semi-annually

2n
C 2 F 𝐶/2 1 𝐹
P0 = å + 𝑃! = 1− +
t =1 (1 + i 2)t (1 + i 2) 2n 𝑖/2 (1 + 𝑖/2)&% (1 + 𝑖/2)&%

• C: the annual coupon payment • i: the prevailing yield to maturity

• n: the number of years to maturity for this bond issue
• F: the par (face) value of the bond
TS. Nguyễn Duy Linh
 VALUING A COUPON BOND
THE PRICE-YIELD CURVE
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The Price-Yield Curve for a 20-Year, 8% Coupon Bond

Price
2.500

1.985
2.000

1.547
1.500
1.231

1.000
1.000 828
699
600
523
500

- YTM
0% 2% 4% 6% 8% 10% 12% 14% 16% 18%

Coupon r

TS. Nguyễn Duy Linh

 B. VALUING A ZERO-COUPON BOND
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— The value of a zero-coupon bond is present value of the

principal payment:
¡ The interest payments are paid annually 𝐹
𝑃! =
(1 + 𝑖)"

¡ The interest payments are paid semi-annually 𝐹

𝑃! =
(1 + 𝑖/2)#"

• n: the number of years to maturity • i: the prevailing yield to maturity

• F: the par (face) value of the bond for this bond issue

TS. Nguyễn Duy Linh

 C. VALUING A PERPETUAL BOND
40

— Perpetual bonds are fixed income securities which are not

redeemable, i.e., they do not have a maturity date.

— The value of a perpetual bond is the coupon amount

which divided by the discount rate.
𝐶𝐹
𝑃1 =
𝑖

TS. Nguyễn Duy Linh

 IV. ISSUANCE IN THE PRIMARY MARKET
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— Bidding procedures for government bonds

A. Method
B. Determination of purchasing price
 A. METHOD
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— The competitive bid

¡ Fixed-rate tender
¡ Variable-rate tender

— Combination of competitive bid and non-competitive

bid
¡ Fixed-rate tender

¡ Variable-rate tender
 B. DETERMINATION OF PURCHASING PRICE
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— For a discount bond

¡ Purchasing price: 𝑀𝐺
𝐺= /
1 + 𝐿𝑠
G : The price of a T-bill
MG : The par value of a bond
Ls : Bid-winning interest rate (%/year)
n : Term to mautiry (year)

¡ At maturity: T = par value

 B. DETERMINATION OF PURCHASING PRICE
44

— For a coupond bond whose coupon rate has not been specified
¡ Purchasing price: G = Par value

¡ Periodic interest payment: L = MG × Ls / k

L : Interest payment
k : Number of interest payments per year

¡ At maturity: T = Par value + L

 B. DETERMINATION OF PURCHASING PRICE
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— For a coupond bond whose coupon rate has ALREADY

been specified
¡ Purchasing price:
𝑀𝐺×𝐿𝑡 1 MG
𝐺= 1 − "
+ "
Ls 1 + 𝐿𝑠 1 + 𝐿𝑠

÷ Lt: the nominal rate (coupon rate)

÷ Ls: Bid-winning interest rate

¡ Periodic interest payment: L = MG × Lt

¡ At maturity: T = Par value + L
 V. TRANSACTIONS IN THE SECONDARY MARKET
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— The Viet Nam bond market consists of two market

segments:
¡ the OTC market and
¡ the exchange market

— Traditionally, most bonds were traded in the OTC market

bilaterally by phone or some other measure.
— More than 90% of all bonds issued in Viet Nam are
government-sector bonds.
 V. TRANSACTIONS IN THE SECONDARY MARKET
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— Corporate bonds listed on HNX and HOSE are traded on

these two exchanges, although trading volumes and values
are still very small compared with those of unlisted bonds.
Unlisted corporate bonds are traded in the OTC market.
— Government bonds—comprising central government
bonds, government-guaranteed bonds, and municipal
bonds—and foreign-currency-denominated bonds are
listed and traded in the specialized government bond
market, which is operated by HNX.