Chapter 5

Bond Markets in the MENA Region

1
Most of the debt for
USA, Japan, China,
France, Italy , Germany
among other OECD
countries is internally
held and in the
county’s respective
currency.
Lebanon has the third
highest debt to GDP
ratio in the world

2
 Global Debt Hit a Record High in 2021

The stock of global debt has gone from $83 trillion in 2000 to $210 in 2013 and to
around $285 trillion in 2021—a rate of increase nearly double the pace of world GDP
growth. Debt rose from 230% of GDP in 2000 to 320% on the eve of the pandemic,
before covid-19 propelled it to the even greater height of 355% in 2021.

3
Bond Markets Are Less Susceptible to Swings in Sentiment and Price
Compared to Stock Markets.
While the value of a stock stems from a stream of potential earnings extending far into the
future, the value of a bond depends on 1) the issuer’s ability to pay interest until the bond
matures, and 2) to find the cash to repay the principal (probably by issuing another bond).
That makes Bond markets less susceptible to swings in sentiment and price. In other
words, the financial crisis of 2007 was the exception, not the rule.
Part of the reason for the explosion in bond issuance has been the steady decline in
borrowing costs over the past two decades. In early 2000 a ten-year Treasury offered a
yield of 6.5%. Today it pays 1.9% to 2%. The Federal Reserve’s effective policy rate has
fallen from 6.5% in 2000 to around 0.08% currently. Benchmark rates in the euro area and
Japan have been in negative territories in the past few years. Declines in government-bond
yields and central banks’ policy rates have fed through to lower loan rates and yields on
corporate bonds
As a result, even though global debt has rocketed over the years, the world’s interest costs,
as a share of GDP, are well below the peak attained in the 1980s. In the US for instance,
they stood at 12% of GDP in 2021, compared with 27% in 1989 (chart 5).
4
stood at 12% of GDP in 2021, compared with 27% in 1989

5
Global Bond Market Outstanding
$285 Trillion in 2021

6
 Why Corporates have a Bias for Debt Over Equity?

Most countries that levy taxes on corporate profits treat debt more favorably than equity,
largely because they allow interest payments, like other costs, to be deducted from tax
bills. That gives companies a huge incentive to borrow, rather than to fund themselves
through equity. With a lower equity base, it is easier to generate a higher return on
equity.
In America, Britain, Germany and Japan, debt-based finance is taxed at rates that are
3.8% - 6% lower than those on equity investments. The result is more indebtedness than
would otherwise have been the case.
For example, a bank that has $50 billion in gross profits and $40 billion in interest
payments (assuming full deduction for interest) and a corporate-tax rate of 20%, would
pay tax of only $2 billion (20% of $50 -$40), and have an incentive to rack up debt.
Most of the debt for USA, Japan, China, France, Italy , Germany among other OECD
countries is internally held and in the county’s respective currency
 Global Bond Markets: 2021
1) Total capitalization of world bond markets is put at $119 trillion by end of 2021, compared
to total capitalization of world stock markets of around $90 trillion, i.e. the global bond
markets are 32% bigger than the global stock markets .

2) The US bond market constitutes around 43% of the global bond market, followed by bonds
issued by the EU (27%), Japan (13%), and Emerging Markets (12%).

3) In the US, around 45% of total bonds outstanding are corporate bonds (including mortgage
bonds) capitalized at $23 trillion.

4) Corporates in the US depend more on the fixed income market for their funding
requirements than they do on bank loans. In Europe and the emerging countries, banks
continue to play a more important role in financing debt than the bond markets.

8
4) The Covid-19 pandemic has added $24 trillion to the build-up of global debt (both bank
loans and bonds) raising it to a record of $281 trillion, and world debt-to-GDP ratio surged
last year to over 355%. Government borrowing to support programs for the unemployed and
small businesses have accounted to 50% of the increase, with corporate borrowing, both
from banks and the fixed income market, accounting for the balance.

5) The surge in issuance of bonds globally over the past few years was also due to corporates
and governments taking advantage of historically low rates: yields on 10 year US treasuries
traded below 1.5% during most of 2019/2020 before rising to 1.75% by the end of 2021 and
to less than 2% recently. Yields on 10- year German and Japanese government bonds stayed
close to zero or negative through out the 2019-2021 period.

6) Quantitative easing (QE) in 2020 and 2021 in the US and the EU brought forth higher
bond prices (lower yields). In the recent round of QE, Governments have actively bought
treasuries, as well as, highly rated corporates bonds. The search for yield encouraged pension
funds and other institutional investors to buy higher yielding emerging market bonds, leading
to lower yields and more issuance of emerging market bonds including from countries in the
MENA region. 9
7) All this could soon change. The era of super-cheap money is ending. Central banks are
battling a surge in inflation. Those in some emerging economies have started raising interest
rates: Brazil’s central bank raised rates by 1.5% in early February 2022, its third consecutive
such increase. The Bank of England delivered its second interest-rate rise so far this year.
The Fed has signaled that it will put rates up as soon as March, and investors expect four
0.25% increases this year.

8) Real borrowing costs for governments, though still negative in many places, are inching
up. In America the yield on the five-year Treasury Inflation Protected Security (TIPS), which
hovered around -1.7% for much of 2021, now stands at 2.86%.

9)The Economist estimates that households, companies, financial firms and governments

worldwide paid $10.2 trillion in interest in 2021, equivalent to 12% of GDP. The global
interest rate bill could exceed $16 trillion by 2026 , equivalent to 15% of projected GDP of
that year. By way of comparison, the five-year Treasury yield has risen by 1% since spring
2021.
10
 Sovereign Bonds Issued in the MENA Region in 2020 and Returns Since Issuance till end 2020
Bond Currency Size (million) Issue Date Issue Price Price Return since Issuance
(2-Jan-21) (Capital Gain)

Qatar 4.4% ,2050 USD 5,000 16-Apr-20 100.0 127.50 27.50%

Abu Dhabi 3.875% ,2050 USD 4,000 16-Apr-20 96.14 119.06 23.85%

Saudi Arabia 4.5% ,2060 USD 3,000 22-Apr-20 99.08 121.75 22.88%

Qatar 3.75% ,2030 USD 3,000 16-Apr-20 99.81 117.45 17.67%

Abu Dhabi 2.5% ,2025 USD 3,000 16-Apr-20 99.21 106.89 7.75%

Abu Dhabi 3.125% ,2030 USD 3,000 16-Apr-20 99.60 112.73 13.18%

Saudi Arabia 3.75% ,2055 USD 2,750 3-Feb-20 98.28 105.52 7.37%

Saudi Arabia 2.9% ,2025 USD 2,500 22-Apr-20 99.81 107.89 8.09%

Saudi Aramco 3.25% ,2050 USD 2,250 24-Nov-20 99.05 98.61 -0.44%

Saudi Aramco 3.5% ,2070 USD 2,250 24-Nov-20 98.83 98.49 -0.35%

Saudi Aramco 2.25% ,2030 USD 2,000 24-Nov-20 99.41 100.89 1.49%

Abu Dhabi 0.75% ,2023 USD 2,000 2-Sep-20 99.76 100.31 0.55%

UAE 3.95% ,2050 USD 2,000 21-May-20 100.00 116.46 16.46%

Qatar 3.4% ,2025 USD 2,000 16-Apr-20 99.69 110.31 10.65%

 Sovereign and Corporate Bonds in the MENA Region : Top Gainers & Losers (Capital Gain/Loss) in 2020
Annual Annual
Price Price
Gainers Currency Change on Losers Currency Change on
2-Jan-21 end 2019 2-Jan-21 end 2019
DPW 4.7% ,2049 USD 114.7 15.3% Emirates REIT 2.125% ,2022 USD 54.6 -48.9%
Saudi Electricity 5.06% ,2043 USD 126.2 12.4% Bank Dhofar 5.519% ,Perp USD 84.8 -16.3%
ACWA 5.95% , 2039 USD 118.3 12.0% Odea Bank 7.625% ,2027 USD 62.3 -15.2%
Abu Dhabi 3.125% ,2049 USD 104.4 10.8% Natl Bank Oman 6.651% ,Perp USD 96.9 -5.6%
Saudi Aramco 4.375% ,2049 USD 118.0 10.2% Albaraka 9.371% ,2025 USD 100.3 -5.3%
Qatar 4.817% 2049 USD 133.2 10.2% Iraq 6.752% ,2023 USD 97.8 -5.2%
Saudi Arabia 4.625% ,2047 USD 120.1 9.9% ADES Int. (UAE) 8.625% ,2024 USD 100.8 -3.8%
Jordan 7.375% ,2047 USD 117.6 9.9% Oil & Gas 7.625% ,2024 USD 112.3 -3.5%
TAQA 6.5% ,2036 USD 147.2 9.5% Bahrain 7.5% ,2047 USD 117.4 -3.5%
Emirates SembCorp (Power) 4.45% ,2035 USD 117.7 7.7% Linklease Finance (UAE) 9% ,2023 USD 103.0 -3.4%

Saudi Telecom Co 3.89% ,2029 USD 114.4 7.1% Boubyan 6.75% ,Perp USD 100.9 -3.2%
Alpha Star (UAE Real Estate) 6.625% ,2023 USD 99.6 6.6% Warba 6.5% ,Perp USD 102.8 -2.9%
SABIC 4.5% ,2028 USD 118.6 6.4% ABG Sukuk 7.875% ,Perp USD 99.6 -2.5%
Aldar 3.875% , 2029 USD 108.5 6.1% Emirates 1.564% ,2025 USD 98.2 -2.4%
Ooredoo(Qatar Tel.) 3.75% ,2026 USD 111.9 6.1% DIB Sukuk 6.75% ,Perp USD 100.8 -2.4%
Kuwait 3.5% ,2027 USD 113.7 5.9% DPW 2.375% ,2026 EUR 104.8 -2.4%
Egypt 6.588% ,2028 USD 110.1 5.7% Kuwait Projects 5% ,2023 USD 104.1 -2.3%
MAF 3.933% ,2030 USD 108.0 5.6% Ahli United 5.5% ,Perp USD 100.8 -2.0%
RAK 3.094% ,2025 USD 106.5 5.2% Dubai 5.591% ,2021 USD 102.4 -1.9%
Sovereign Bonds Issued in the MENA Region in 2021 and Returns Since Issuance till end 2021
Bond Currency Size (Million) Issue Date Issue Price Price (10-Feb-21) Return since Issuance
Qatar 4.4%, 2050 USD 5,000 16-Apr-20 100 115.52 15.52%
Abu Dhabi 3.875%, 2050 USD 4,000 16-Apr-20 96.14 108.17 12.51%
Saudi Arabia 4.5%, 2060 USD 3,000 22-Apr-20 99.08 112.63 13.68%
Qatar 3.75%, 2030 USD 3,000 16-Apr-20 99.81 108.57 8.78%
Abu Dhabi 2.5%, 2025 USD 3,000 16-Apr-20 99.21 101.73 2.54%
Abu Dhabi 3.125%, 2030 USD 3,000 16-Apr-20 99.6 105.28 5.70%
Saudi Arabia 3.75%, 2055 USD 2,750 3-Feb-20 98.28 98.81 0.54%
Saudi Arabia 2.9%, 2025 USD 2,500 22-Apr-20 99.81 102.68 2.88%
Saudi Aramco 3.25%, 2050 USD 2,250 24-Nov-20 99.05 89.79 -9.35%
Saudi Aramco 3.5%, 2070 USD 2,250 24-Nov-20 98.83 88.32 -10.63%
Saudi Aramco 2.25%, 2030 USD 2,000 24-Nov-20 99.41 94.19 -5.25%
Abu Dhabi 0.75%, 2023 USD 2,000 2-Sep-20 99.76 98.9 -0.86%
UAE 3.95%, 2050 USD 2,000 21-May-20 100 107.05 7.05%
Qatar 3.4%, 2025 USD 2,000 16-Apr-20 99.69 104.03 4.35%
 Sovereign and Corporate Bonds in MENA : Top Gainers & Losers in 2021
Gainers Currency Price (12-Feb-22) Annual Change
on end 2020 Losers Currency Price (12-Feb-22) Annual
Change on
end 2020

DPW 4.7% ,2049 USD 102.15 15.30% Emirates REIT 5.125% ,2022 USD 79.75 -50.20%
Saudi Electricity 5.06% ,2043 USD 112.9 12.24% Bank Dhofar 5.519% ,Perp USD 94.83 -16%
ACWA 5.95% , 2039 USD 112.98 11.93% Odea Bank 7.625% ,2027 USD 78.37 -14.92%
Abu Dhabi 3.125% ,2049 USD 94.58 10.58% Albaraka 9.371% ,2025 USD 101.19 -5.33%
Qatar 4.817% 2049 USD 122.51 10.48% Iraq 6.752% ,2023 USD 101.35 -5.33%
Audi Aramco 4.375% ,2049 USD 106.22 10.18% Bahrain 7.5% ,2047 USD 96.56 -3.56%

Saudi Arabia 4.625% ,2047 USD 110.7 10.17% Linklease Finance (UAE) 9% ,2023 USD 101.48 -3.56%
Jordan 7.375% ,2047 USD 96.43 9.76% Oil & Gas 7.625% ,2024 USD 107.16 -3.52%
TAQA 6.5% ,2036 USD 136.58 9.13% DPW 2.375% ,2026 EUR 103.11 -2.70%

Emirates SembCorp (Power) 4.45% ,2035 USD 113.81 7.90% Warba 6.5% ,Perp USD 100.35 -2.69%
Saudi Telecom Co 3.89% ,2029 USD 106.52 7.13% Emirates 1.506% ,2025 USD 100.45 -2.67%
SABIC 4.5% ,2028 USD 109.46 6.17% Kuwait Projects 5% ,2023 USD 100.03 -2.04%
Ooredoo(Qatar Tel.) 3.75% ,2026 USD 105.53 5.96% Ahli United 5.5% ,Perp USD 99.36 -2%
Kuwait 3.5% ,2027 USD 106.04 5.92% ABG Sukuk 7.875% ,Perp USD 100.6 -1.85%
Aldar 3.875% , 2029 USD 104.14 5.79%
Egypt 6.588% ,2028 USD 93.59 5.76%

Alpha Star (UAE Real Estate) 6.625% ,2023 USD 101.88 5.66%
MAF 3.933% ,2030 USD 104.68 5.28%
RAK 3.094% ,2025 USD 102.2 5.03%
 MENA Bond Market: 2021
Debt Capital Markets (DCM) in the MENA region totaled $132 billion in 2021, with 152
issuances, down by 12% in proceeds compared to 2020.
Corporate debt recorded a total of $65.7 billion, equivalent to 61% of total DCM proceeds
and the highest annual total since records began in 1980, with the balance of 49% or $41.8
billion issued by sovereign governments of the region.
The UAE was the top nation for DCM activity in 2021, with $32.4 billion in related proceeds
followed by Saudi Arabia with $25.3 billion.
The financial industry was the top-issuing industry of 2021 with $44.3 billion in proceeds.
The largest deal of the year was the bond sale from state energy company Qatar Petroleum
Corp raising $11 billion in June 2021.
MENA bond issuance is likely to decline in 2022 because of higher oil prices and revenues,
which would reduce the financing needs of the region’s oil exporting countries. About 40% of
MENA’s sovereign gross borrowing in 2021 will go towards refinancing maturing debt.

15
Historically there has been an inverse relationship between crude oil prices and
issuance of government bonds from the Gulf countries.

16
 Largest Bonds Issued in the MENA Region in 2021 and Returns Since Issuance
Bonds Country Currency Coupon (%) Size Issue Date Issue Price Price (7-Feb-21) Return since Issuance

Saudi Arabia, Kingdom Of (Government), 2028 SAU SAR 1.97 16,664,000,000 21/01/2021 100 96.34 -3.7%
Saudi Arabia, Kingdom Of (Government), 2033 SAU SAR 2.55 14,884,381,000 21/01/2021 100 94.72 -5.3%
Saudi Arabia, Kingdom Of (Government), 2031 SAU SAR 2.8 12,787,800,000 18/03/2021 100 98.74 -1.3%
Saudi Arabia, Kingdom Of (Government), 2031 SAU SAR 2.6 11,111,700,000 17/06/2021 100 96.93 -3.1%
Saudi Arabia, Kingdom Of (Government), 2029 SAU SAR 2.43 9,783,353,000 19/08/2021 100 97.37 -2.6%
Saudi Arabia, Kingdom Of (Government), 2036 SAU SAR 3.21 5,015,004,000 19/08/2021 100 97.47 -2.5%
Qatar Petroleum, 2051 QAT USD 3.3 4,000,000,000 12/07/21 100 100 0.0%
Qatar Petroleum, 2031 QAT USD 2.25 3,500,000,000 12/07/21 98.937 95.89 -3.1%
Qatar Petroleum, 2041 QAT USD 3.125 3,500,000,000 12/07/21 99.631 96.46 -3.2%
Saudi Arabia, Kingdom Of (Government), 2033 SAU USD 2.25 2,750,000,000 02/02/21 99.105 95.07 -4.1%
Emirate Of Abu Dhabi, 2028 UAE USD 1.625 2,000,000,000 02/06/21 99.664 96.58 -3.1%
United Arab Emirates (Government),2061 UAE USD 3.25 2,000,000,000 19/10/2021 100 97.32 -2.7%
Emirate Of Abu Dhabi, 2031 UAE USD 1.875 1,750,000,000 15/09/2021 99.178 95.8 -3.4%
Oman Government International Bond, 2031 OMN USD 6.25 1,750,000,000 25/01/2021 100 105.99 6.0%
Egypt, Arab Republic Of (Government), 2031 EGY USD 5.875 1,500,000,000 16/02/2021 100 84.76 -15.2%
Egypt, Arab Republic Of (Government) , 2061 EGY USD 7.5 1,500,000,000 16/02/2021 100 78.08 -21.9%
Qatar Petroleum, 2026 QAT USD 1.375 1,500,000,000 12/07/2021 99.905 96.41 -3.5%
QNB Finance Ltd, 2026 QAT USD 3.15 1,500,000,000 04/02/21 100 99.19 -0.8%
Emirate Of Abu Dhabi, 2051 UAE USD 3 1,250,000,000 15/09/2021 100 94.2 -5.8%
Saudi Arabia, Kingdom Of (Government) , 2051 SAU USD 3.25 1,250,000,000 17/11/2021 97.931 94.34 -3.7%
Egypt, Arab Republic Of (Government) , 2027 EGY USD 5.8 1,125,000,000 30/09/2021 100 94.57 -5.4%
Egypt, Arab Republic Of (Government) , 2033 EGY USD 7.3 1,125,000,000 30/09/2021 100 88.76 -11.2%
Abu Dhabi Ports Company , 2031 UAE USD 2.5 1,000,000,000 06/05/21 97.922 96.47 -1.5%
DAE Funding 2024 UAE USD 1.55 1,000,000,000 22/06/2021 99.427 97 -2.4%
MDGH , 2051 UAE USD 3.4 1,000,000,000 07/06/21 100 100.6 0.6%
United Arab Emirates (Government) , 2031 UAE USD 2 1,000,000,000 19/10/2021 97.94 96.64 -1.3%
United Arab Emirates (Government) , 2041 UAE USD 2.875 1,000,000,000 19/10/2021 96.985 96.32 -0.7%

Bahrain, Kingdom Of (Government) , 2033 BHR USD 5.25 1,000,000,000 25/01/2021 100 91.96 -8.0%
Bahrain, Kingdom Of (Government) , 2034 USD 5.625 1,000,000,000 18/11/2021 100 92.53 -7.5%
 Largest Bonds Issued in the MENA Region in 2021 and Returns Since Issuance
Bonds Country Currency Coupon (%) Size Issue Date Issue Price Price (7-Feb-21) Return since Issuance
NBK SPC Ltd KWT USD 1.625 1,000,000,000 15/09/2021 99.518 95.44 -4.1%
Oman Government International Bond OMN USD 7 1,000,000,000 25/01/2021 96.959 100.54 3.7%
Ooredoo International Finance Ltd QAT USD 2.625 1,000,000,000 08/04/21 98.922 98.21 -0.7%
QNB Finance Ltd QAT USD 1.375 1,000,000,000 26/01/2021 99.501 95.95 -3.6%
Saudi Arabia, Kingdom Of (Government) SAU EUR 0 1,000,000,000 03/03/21 100.171 99.05 -1.1%
Abu Dhabi National Energy Company UAE USD 2 750,000,000 29/04/2021 99.799 96.51 -3.3%
Abu Dhabi National Energy Company UAE USD 3.4 750,000,000 29/04/2021 100 102.51 2.5%
Emirates Nbd Bank Pjsc UAE USD 4.25 750,000,000 27/05/2021 100.5 101.38 0.9%
Sharjah, Emirate Of UAE USD 3.625 750,000,000 10/03/21 100 93.86 -6.1%
Egypt, Arab Republic Of (Government) EGY USD 3.875 750,000,000 16/02/2021 100 91.88 -8.1%
Egypt, Arab Republic Of (Government) EGY USD 8.75 750,000,000 30/09/2021 100 85.32 -14.7%
OQ SAOC OMN USD 5.125 750,000,000 06/05/21 100 100.83 0.8%
Equate Petrochemical Bv KWT USD 2.625 700,000,000 28/04/2021 99.898 97.03 -2.9%
NBK Tier 1 Ltd KWT USD 3.625 700,000,000 24/02/2021 100 97.5 -2.5%
CBQ Finance Ltd QAT USD 2 700,000,000 12/05/21 99.745 97.54 -2.2%
Oryx Funding Ltd OMN USD 5.8 600,000,000 03/02/21 100 103.91 3.9%
Emirates Telecommunications Group Co UAE EUR 0.375 500,000,000 17/05/2021 99.738 97.7 -2.0%
Emirates Telecommunications Group Co UAE EUR 0.875 500,000,000 17/05/2021 98.392 97.21 -1.2%
Mdgh Gmtn (Rsc) Ltd UAE USD 2.5 500,000,000 03/06/21 99.719 96.84 -2.9%
Sharjah, Emirate Of UAE USD 4.375 500,000,000 10/03/21 94.036 89.69 -4.6%
Bahrain, Kingdom Of (Government) BHR USD 4.25 500,000,000 25/01/2021 100 96.92 -3.1%
Bahrain, Kingdom Of (Government) BHR USD 4.25 500,000,000 25/01/2021 100 97.11 -2.9%
Bahrain, Kingdom Of (Government) BHR USD 6.25 500,000,000 25/01/2021 100 90.49 -9.5%
Bahrain, Kingdom Of (Government) BHR USD 6.25 500,000,000 25/01/2021 100 89.6 -10.4%
Bank Muscat Saog OMN USD 4.75 500,000,000 17/03/2021 100 103.33 3.3%
Commercial Bank Psqc QAT USD 4.5 500,000,000 03/03/21 100 100.95 1.0%
Doha Finance Ltd QAT USD 2.375 500,000,000 31/03/2021 99.738 98.58 -1.2%
Saudi Arabia, Kingdom Of (Government) SAU EUR 0.625 500,000,000 03/03/21 99.817 96.01 -3.8%
Energean Plc EGY USD 6.5 450,000,000 18/11/2021 100 97.63 -2.4%
National Bank Of Oman OMN USD 8 300,000,000 01/04/21 100 103.99 4.0%
Ahli Bank Qpsc QAT USD 4 300,000,000 17/02/2021 100 99.02 -1.0%
Oman Arab Bank Saog OMN USD 7.625 250,000,000 04/06/21 100 103.96 4.0%
 Largest Bonds Issued in the MENA Region in 2021 and Returns Since Issuance
Egypt, Arab Republic Of (Government) EGY EGP 0 19,775,100,000 20/07/2021 100 97.88 -2.1%
Saudi Arabia, Kingdom Of (Government) SAU SAR 1.97 16,664,000,000 21/01/2021 100 96.34 -3.7%
Saudi Arabia, Kingdom Of (Government) SAU SAR 2.55 14,884,381,000 21/01/2021 100 94.72 -5.3%
Saudi Arabia, Kingdom Of (Government) SAU SAR 2.8 12,787,800,000 18/03/2021 100 98.74 -1.3%
Saudi Arabia, Kingdom Of (Government) SAU SAR 2.6 11,111,700,000 17/06/2021 100 96.93 -3.1%
Saudi Arabia, Kingdom Of (Government) SAU SAR 2.43 9,783,353,000 19/08/2021 100 97.37 -2.6%
Saudi Arabia, Kingdom Of (Government) SAU SAR 3.21 5,015,004,000 19/08/2021 100 97.47 -2.5%
Qatar Petroleum QAT USD 3.3 4,000,000,000 12/07/21 100 100 0.0%
Qatar Petroleum QAT USD 2.25 3,500,000,000 12/07/21 98.937 95.89 -3.1%
Qatar Petroleum QAT USD 3.125 3,500,000,000 12/07/21 99.631 96.46 -3.2%
Saudi Arabia, Kingdom Of (Government) SAU USD 2.25 2,750,000,000 02/02/21 99.105 95.07 -4.1%
Emirate Of Abu Dhabi UAE USD 1.625 2,000,000,000 02/06/21 99.664 96.58 -3.1%
United Arab Emirates (Government) UAE USD 3.25 2,000,000,000 19/10/2021 100 97.32 -2.7%
Emirate Of Abu Dhabi UAE USD 1.875 1,750,000,000 15/09/2021 99.178 95.8 -3.4%
Oman Government International Bond OMN USD 6.25 1,750,000,000 25/01/2021 100 105.99 6.0%
Oman Sovereign Sukuk Saoc OMN USD 4.875 1,750,000,000 15/06/2021 100 105.67 5.7%
Egypt, Arab Republic Of (Government) EGY USD 5.875 1,500,000,000 16/02/2021 100 84.76 -15.2%
Egypt, Arab Republic Of (Government) EGY USD 7.5 1,500,000,000 16/02/2021 100 78.08 -21.9%
Qatar Petroleum QAT USD 1.375 1,500,000,000 12/07/2021 99.905 96.41 -3.5%
Qnb Finance Ltd QAT USD 3.15 1,500,000,000 04/02/21 100 99.19 -0.8%
Emirate Of Abu Dhabi ARE USD 3 1,250,000,000 15/09/2021 100 94.2 -5.8%
Saudi Arabia, Kingdom Of (Government) SAU USD 3.25 1,250,000,000 17/11/2021 97.931 94.34 -3.7%
Egypt, Arab Republic Of (Government) EGY USD 5.8 1,125,000,000 30/09/2021 100 94.57 -5.4%
Egypt, Arab Republic Of (Government) EGY USD 7.3 1,125,000,000 30/09/2021 100 88.76 -11.2%
Abu Dhabi Ports Company Pjsc UAE USD 2.5 1,000,000,000 06/05/21 97.922 96.47 -1.5%
Dae Funding Llc UAE USD 1.55 1,000,000,000 22/06/2021 99.427 97 -2.4%
Mdgh Gmtn Bv UAE USD 3.4 1,000,000,000 07/06/21 100 100.6 0.6%
United Arab Emirates (Government) UAE USD 2 1,000,000,000 19/10/2021 97.94 96.64 -1.3%
United Arab Emirates (Government) UAE USD 2.875 1,000,000,000 19/10/2021 96.985 96.32 -0.7%
Bahrain, Kingdom Of (Government) BHR USD 5.25 1,000,000,000 25/01/2021 100 92.37 -7.6%
Bahrain, Kingdom Of (Government) BHR USD 5.25 1,000,000,000 25/01/2021 100 91.96 -8.0%
Bahrain, Kingdom Of (Government) BHR USD 5.625 1,000,000,000 18/11/2021 100 92.53 -7.5%
 MENA Bond Market: 2021
1. Among the best performing dollar denominated bonds issued from the region in 2021 and
up to 12 February 2022, were the Omani bonds, both the sovereign government bonds
and the corporate bonds issued by Bank Muscat and Oman Arab Bank. Oman Government
sovereign bond on its $1.75 billion , coupon 6.25% maturing 2031, recorded a price
increase of 6% (excluding coupons). Abu Dhabi National Energy Company on its $750,000
bond coupon 3.5% recorded a price increase of 2.5%.
2. Among the worst performing dollar denominated bonds issued from the region in 2021
and up to 7 February 2021 , were Egypt Government Sovereign bonds maturing 2031,
2033, and 2061, these recorded capital losses of -15.2%, -11.1% and -21.9% respectively .
Bahrain Government Sovereign bonds maturing 2033 and 2034 recorded capital losses of
-8% and -7.5% respectively. Saudi Government Sovereign bond maturing 2033 recorded
capital losses of -5.3%. Aramco 2070 (-10.3%) and 2050 (-9.35%).
3. The largest deals from MENA in 2021 were dominated by sovereign issuers including
Bahrain (13.8 billion) , Qatar Petroleum ($11 billion billion), Egypt ($3 billion) and the
Saudi Riyal Denominated Sovereign bonds (SR 53.596 billion equivalent to $14.3 billion).

20
 Fixed Income Markets: Global and MENA issuance of bonds and
Sukuk ($billions )
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Global $3,100 $3,500 $3,700 $3,800 $4,500 $5,000 $5,600 $6,200 $6,500 $7,000 $8,300

MENA Total $37 $35 $32 $39 $38 $32 $76 $135 $123 $144 $150
-MENA $33 $32 $30 $35 $28 $25 $53 $95 $76 $77 $80
Sovereign

-MENA $4 $3 $2 $4 $10 $7 $23 $40 $47 $63 $70

Corporates

Total fixed income issuance in the region reached $150 billion in 2020, an increase of 4.3% on 2019
level. Corporate bonds accounted for 33% of the total, followed by sovereign bonds (32.7%), sovereign
Sukuk (20.6%), and corporate Sukuk (13.8%). Aggregate issuance (bonds and Sukuk) by governments
of the region amounted to $80 billion in 2020, or 53.3% of the total, while bonds and sukuk issued by
corporates (including government owned) reached $70 billion , or 46.7% of total

21
 Characteristics of MENA’s Fixed Income Markets
1. Around 90% of the total fixed income issuance in the region have so far been dollar
denominated, targeting mainly foreign investors seeking risk diversification and higher
returns. The aim of the sovereign issuers is reducing pressure on domestic liquidity and
tapping foreign sources of funding.
2. Trading in the secondary market remains limited, reflecting the buy and hold approach of
investors. Average daily trading volume does not exceed $300 million in 2021, compared to
$1.7 billion for stocks (75% of that in Saudi Arabia).
3. Local currency denominated corporate bond markets are still in their infancy. In the US,
close to 60% of the borrowing requirements of corporates come from bonds, in the region
bonds issued in local currencies do not exceed 5%. Corporates are still over dependent on
banks for their funding requirements.
4. MENA’s fixed income markets are in their early stages of development. Total amount of
outstanding dollar bonds and sukuk in the MENA region reached $132 billion in 2021, or
4.6% of the region’s GDP of $2,850 billion, compared to 40% for emerging markets and
103% for USA.
22
 Advantages of Having a Deep and Liquid Debt Market in the Region
1. Diversification of funding sources for corporates, reducing their overdependence on banks:
 During the financial crisis of 2008-2009, several wholesale banks in the region found it
difficult to fund themselves through the interbank market, or this funding source became
very expensive, forcing banks to limit their lending even to their best corporate clients.
 When corporates reach their credit ceiling with banks, even the best client would not be
able to borrow more than 10% of the bank’s Tier 1 capital.
2. Issuing bonds reduces debt service payment, especially in a rising interest rates scenario)
locking-in interest rates for 5- 10 years, and allowing the issuer to repay the principal upon
maturity (one bullet repayment) or usually refinance it by issuing a new bond.
3. Bonds will enhance the financial transparency of the issuer and improve his corporate
image. Usually, no collateral is needed to issue bonds (debentures). Only mortgage bonds
offer collateral.
4. Bonds provide long term sources of funding for banks, thus helping them to reduce the
mismatch in maturity between their assets and liabilities.

23
 Issuance and Placement of Corporate Bonds
Two investment banks will be involved in the issuance and custody of corporate bonds.
1) The Issuer investment Bank prepares the prospectus (information memorandum), price and
issue the bond either on:
a) Fully underwritten basis: The investment bank (IB) buys the bonds from the issuer at say
98:00 of face value, then it sells them to investors at say 100:00, making 2%. The IB may not
be able to place the whole amount issued, thus the bank is taking the risk of keeping part of
the bonds on its books.
b) Best effort basis: The IB gets a placement fee of say 1% on the amount he successfully
places at a price of 100:00 of face value. Of course the IB will do its best to place as many
bonds possible to capture a bigger placement fee. However, there is no guarantee to the
issuer that the whole amount will be successfully placed.
2) The Trustee Bank: Provides settlement and custody services to bond holders, including
paying coupon and principal, transfer agent when ownership changes in secondary market etc..
The custody fee is around 0.2% annually.
Secondary markets: where bonds are listed and traded, either on an Exchange (e.g., NYSE ,
Nasdaq Dubai), or Over-the-counter (OTC) market, among brokers
24
Bond rating is critical, Price of a bond Bond Credit Ratings
will drop if the issuer is downgraded.
The three major bond rating agencies
are Moody’s, Standard & Poor’s
(S&P), and Fitch

Bonds are rated by the perceived

default risk of the issuer, the
higher the risk of default the lower
the rating.

Bonds may be either investment

grade (AAA to BBB- by S&P) or
speculative/junk grade, (beginning
from BB+ to D by S&P).

Close to 45% of corporate bonds

issued globally are classified as
speculative/junk. Issuers rated CCC
and lower have accounted for 21% of
the junk issuance since 2008.
* Lebanon is currently rated D by S&P and Fitch.
 Restructuring Vs Rescheduling Vs Moratorium
1. A “credit event” is related to a specific issuer who has defaulted on his obligations. It includes
bankruptcy or insolvency of the issuer, failure to pay one or more contractual payments when
due (coupon/principal), or when the issuer breaches a major loan covenant. When a default
occurs, all the bonds outstanding for the issuer become due and payable immediately .
2. A restructuring occurs when the terms of the obligation are altered so as to make the new
terms less attractive to the debt holders than the original terms (hair cut). The terms that can
be changed would typically include: (1) a reduction of the interest rate, (2) a reduction in the
principal, (3) a change in the level of seniority of the obligation, etc.
3. A rescheduling does not alter the terms of the obligation other than lengthening the maturity
of the repayment schedule (e.g. the principal of a 5 year bond to be repaid say over a 10 year
period)
4. A moratorium is a temporary suspension on debt where the borrower does not have to make
any interest payment. The unpaid interest during the moratorium is then added to the
principal amount of the debt, with repayments resuming at the end of the moratorium period.
26
Debt Capital Markets
Money Markets Bond Market
(maturity less than 1 year) (maturity more than 1 year
 100 years or perpetuals)

Issuers: Issuers:
- Governments: T-bills - Governments: T-Bonds
- Corporates/Banks:
- Banks: CDs Corporate Bonds
- Corporates: CPs Convertible Bonds
Perpetual Bonds
Callable Bonds
CoCos (contingent
convertible bonds or prefunded
shares)

27
Characteristics and Pricing of Money Market Instruments
 

(e.g.  Discount Yield 5%)

If face value upon maturity is Pf

28
 Characteristics and Pricing of Bonds
1. Various interest rate measures:
- Coupon rate (% of face value paid semiannually)
- Required rate of return (ex-ante)
- Realized rate of return (ex-post)
2. Term structure of interest rate: The Yield Curve
- Longer maturities normally have higher yields ( maturity premium)
- Yield curve reflects the market’s expectations of future rates
3. The inverse non-linear relationship between the price of a bond and interest
rate is one of the most fundamental relationships in financial markets (Pb rises
when r declines).
4. Duration measures the degree of responsiveness (elasticity) of % change in price
of the bond due to a % change in interest rate (): capital Gain/Capital loss.
5. Government bonds are benchmarks for pricing corporate bonds. Yields on
corporate bonds are normally higher than those on their respective government
bonds of same maturity and same currency.

29
  

5. If r = 0 then .
6. For every in the market there is a corresponding discount rate r that renders = PV or fair market
value.

30
 Negative Bond Yields

 
PV > FV (buying a bond at a premium e.g. paying 105 to receive 100 upon maturity)

b n

31
 Contingent Convertible Bonds (CoCos) Issued by Banks
 While convertible bonds give the holder the right but not the obligation to convert his
bond holdings into shares, holders of CoCos are obliged to convert their bonds into
shares when they are asked to do so. If the ratio of bank’s equity to weighted assets
drops below a certain predetermined level, the issuer may decide to convert its CoCos
into equity. This is why CoCos are called pre-funded equity.
 When times are good, CoCos behave like bonds paying coupon semi-annually and the
principal upon maturity. They have an active secondary market. But when banks issuing
CoCos experience losses that eat up equity, CoCos are converted into shares at the
conversion rate indicated in the prospectus (e.g. one bond into 25 shares)
 Banks prefer to issue CoCos instead of equity because interest paid on these bonds (an
expense item) lowers taxes, and makes it easier to generate higher returns on equity.
Investors are attracted to such an asset that offers a higher yield than bank bonds but
lower risk than bank preferred shares.
 Bond Market Indexes
Managed by major investment banks, e.g., Barclays, Merrill Lynch, J.P. Morgan Chase. These
market indexes reflect both the capital gain/loss on bonds plus the interest (coupon) income
earned prorated to the holding period. Changes in values of bond indexes can be used by bond
traders and fund managers as a benchmark to evaluate the performance of their bond
portfolios.
J.P. Morgan Chase Emerging Market Bond Index is the most used index to show changes in
emerging market bonds. J.P. Morgan added Saudi Arabia, Kuwait, UAE, Bahrain, and Qatar to its
emerging market fixed income indices starting 2019. Oman was already a part of the Index .
The weights for the 6 GCC countries are Saudi Arabia (3.1%), UAE (2.6%), Kuwait (0.8%), Qatar
(2.6%), Oman (2.6%) and Bahrain (2.1%) taking the total for the six GCC states to 13.8%.
Egypt’s sovereign bonds were added to JPMorgan's EM indexes on Jan. 31, 2022, with 1.63%
weight and a total of 12 bonds.  Egypt local sovereign bonds could attract inflows of up to $2.4
billion due to inclusion in the Index
The inclusion into J.P. Morgan EMBI index tracked by $360 billion of passive and active
investments is expected to bring up to $60 billion of additional inflows into the GCC and Egypt
bond portfolios
 Perpetual Bonds
In contrast with stocks, who do not have a specific maturity date, bonds usually have a specific
date when they mature (principal should be repaid), with the exception of perpetual bonds.
A perpetual bond is a fixed income security with no maturity date. Most of them have a call
option allowing the issuer to repay the bond after a specific time. Besides the callability
feature, the major drawback of perpetual bonds is that they subject investors to perpetual
credit risk exposure of the issuer, this is why only highly rated corporates and banks issue
perpetuals. These are liquid can be sold and bought in the secondary market and their major
benefit is that they pay a steady stream of interest payments forever (perpetuity).
Perpetual bonds function similarly to a fixed dividend paying stocks or preferred stocks. These
pay a fixed dividend as long as the company exists, i.e. the company is a going concern.
If not called, some purpetual bonds reset the coupon after every 5 years to the then prevaling
5 year US Treasury yield plus a prespecified spread such as 500 bp.
Similar to the price of a preferred share paying fixed dividend, the price of a perpetual bond Pb
is the fixed coupon payment divided by the discount rate.
Pb = D / r where D is the fixed annual coupon payment.
 Z-Spread (Zero Volatility Spread)
The Z-spread is the constant spread (constant %) when added to the spot rate of the treasury curve at the dates
when cash flows on the bond are received would make the price of a security equals to the present value of its
cash flows. In other words , each cash flow is discounted at the appropriate treasury spot rate plus the Z-spread
For coupon 1: use r1 spot rate for 6 months (risk free) + Z,
For coupon 2: use r2 spot rate for one year + Z, etc.
The Z-spread represents the additional risk the investor is taking in the form of credit risk and liquidity risk, it
also helps analysts discover if there is a discrepancy in the bond’s price that would lead to price volatility.
Because the Z-spread measures the constant spread that an investor will receive over the entirety of the treasury
yield curve , it gives a more realistic valuation of a security instead of using a single discount rate for the whole
duration. Investors look for bonds with low Z-spread.
To calculate the Z-spread, take the treasury spot rate at each maturity (every 6 months), add the constant Z-
spread to that rate and then use the combined rate as the discount rate to calculate the price of the bond. The Z-
spread is the rate added to the treasury spot rate at each coupon payment and FV that would render the price of
the bond equals its discounted future cash flows.
Pb = Coupon/2. + …………….Coupon/2+ FV If we have Pb , ri , coupon , FV, , we can solve for Z
{1 + (r1+z)/2} {1 + (rn+z)/2}2n
Where Pb is the current market price of bond, r spot treasury rate at each maturity, Z =Z spread
 Sinking Fund and Cross Default
Sinking Fund:
 Certain issuers, not highly rated, are required to pay an annual amount into a fund called
“sinking fund”, held at the trustee bank representing the bond holders. By the time the bond
approaches maturity, there would have been enough money accumulated over the years in
the sinking fund to repay the principal, thus reducing the risk of default.
 Since sinking funds reduces the probability of default, it is an attractive feature to bond
holders. Bonds with this feature have lower yields than bonds of same issuer and same
maturity but without a sinking fund.
Cross Default:
Cross default is a covenant included in all bond documents. It puts the bond issuer in default on
all its outstanding bonds if he fails to be current on any coupon or principal payment due on any
of his bonds. For example, when Lebanon failed to pay the interest and the principal due on its
November 2019 maturing bond, this triggered a cross default on all Lebanese Eurobonds
maturing in the years 2020 till 2030 . Thus cross default tends to have a domino effect where all
future bonds become due on the first default date, putting the issuer under severe pressure.
Bond Buyback

A bond buyback is a mechanism whereby the issuer repurchases its bonds from
bondholders in the open market. Similar to share buybacks, the principal of the
bond gets reduced by the amount bought back and the bonds tendered by
bondholders get cancelled.

Issuers buy back their bonds so that they can reduce their overall debt and thereby
interest expenses over time. Bond buyback is used as a liability management
strategy by the company issuing the bonds.

If the bonds are trading cheaper than their face value, the issuer would find it
particularly attractive to buyback the bonds. Tender offers are a form of buyback
whereby the bondholders who opt to sell back their bonds to the issuer could get
either cash or new bonds of equivalent value at a specified price.
  Technical Default

A technical default is a non-compliance with technical requirements or

covenants in the bond’s offering memorandum or credit agreements.

This need not have anything to do with missing a scheduled payment but have
more to do with breaching specified conditions. These could include: 1) not
adhering to negative covenants which require not to dispose of any assets, 2)
changing the nature of business, 3) delaying publishing annual results, 4)
issuing more debt instruments, etc.

Thus, a technical default may still result in a full repayment of the bond upon
maturity. For example, if an issuer of a bond fails to deliver the financial results
by the deadline stipulated in the bond terms, it will be in technical default.
 
 Corporate Bond Quote: Example
Moody’s
Issuer S&P/
Name Symbol Coupon Maturity Fitch High Low Last Change Yield %
Philip ISIN Code
Morris PM39759464 2.625 % 3/06/2023 A2 /A /A 95.335 93.521 93.772 0.858% 3.38%
1) Issuer name and ticker symbol (this is the ISIN code that gives you all the
information needed on the bond and the issuer)
2) Coupon, annual rate of 2.625% (paid semiannually)
3) Maturity date: day, month and year (3rd of June 2023)
4) Bond rating by the three major rating agencies (Moody’s=A2, S&P=A and Fitch= A)
5) High, Low, and Last prices in decimal form as a percent of par value
◦ Yesterday’s high price was 95.335, it closed at 93.772, both below par of 100
6) Change: is the change from the prior day’s last price ( up 0.858%)
7) Yield (%): is the promised yield to maturity achieved using the last market price,
i.e. if bought at that price and held to maturity, the investor’s realized rate of
return on purchasing the bond would be 3.388%
Download the
App BondEvalue
Free for One
Month
 Calculating Accrued Interest
On settlement date (2 days after the trade), the buyer must pay the seller the purchase price of
the bond plus the interest accrued to the seller for the period when the last coupon payment
was made and up to the settlement date. Only from the settlement date onward, the bond
becomes the property of the buyer.
Example: You purchased a $10,000 bond on October 5, settlement October 7, coupon rate is
4.375%, the last coupon payment was made on May 15. The current ask price is 105:08.
1. Calculate the interest accrued to the seller
2. The clean price and the full or dirty price of the bond.

On October 7 you became the owner of the bond. Of course the coupon rate of 4.375% is the
annual rate paid on the bond (the investor receives half of that every 6 months). There are 184
days from May 15 (when the last coupon payment was made) and November 15 (when the next
coupon payment is due six months later)
 Calculating Accrued Interest
Solution:
1. The coupon is % of $10,000 = $218.75 paid every 6 months
The seller was owner of the bond for 144 days since the last coupon payment was made
on May 15 and till the settlement date on October 7 when the buyer becomes the owner
of the bond (16 days in May, 30 days in June, 31 days in July, 31 days in August, 30 days
in September, and 6 days in October)
Interest Accrued: $218.75 x = $171.19.
There are 184 days from May 15 till Nov 15.
2. Clean price Pb : 105:08 of $10,000 or 105.
1.052.5 x $10,000 = $10,525
Full price: $10,525 + $171.19 = $10,696.19
Open Market Operations: Determining Short Term Rates

Open Market Operations:

• Buying/Selling of T-bills to help set the Overnight Interbank Rates (Fed Funds
Rate)
• Trading of excess reserves between banks determines overnight interbank rate
or Fed Funds rate.
• The Central Bank can bring a lower interbank rate by increasing the supply of
excess reserves in the system through the buying of treasury bills from the
public ( injecting liquidity).
• Lower Interbank (Fed Funds) Rate would bring lower short term interest rates
and encourage more borrowing.

44
 Interbank or Fed Funds Rate
All banks are required to keep a certain percentage of their
deposits as required reserves with the central bank (Fed). No
interest earned on these reserves.
Some banks would have excess reserves that they are not yet D excess S excess
reserves
able to lend them out (S of excess reserves on the right side of reserves
the chart), others would have shortage of reserves, they need
to fund the loans they have (D of excess reserves on the left Overnight
Fed funds
side). rate, or
interbank
Banks with excess reserves would like to lend the reserves rates
overnight (that can be renewed) and make some interest on
them. Other banks would like to borrow reserves overnight to
fund the shortage in their loan book. Q excess
reserves
Fed funds/interbank is the equilibrium overnight
borrowing/lending rate of excess reserves between banks . The
Fed (central bank) interferes to set this overnight rate through
buying and selling of government securities (providing
additional excess reserves or withdrawing reserves from banks)
 Quantitative Easing(QE): Flattening of the Yield Curve
Quantitative easing defined by buying of longer maturity bonds to bring down lower long
term yields.
The Central Bank would buy longer maturity bonds (say 10 years) from the market at their
present value, thus reducing the supply of these bonds. The Fed started its QE in 2008 by
purchasing $85 billion worth of bonds monthly, later reduced to $65 billion then $55 billion…
then $5 billion (tapering of QE by 2014). Another QE has started March 2020, following the
spread of Covid-19, however this time around the Fed and the ECB are buying both treasury
bonds and highly rated corporate bonds
Price of 10 year bonds would rise
Yield on the 10 year bonds would decline
Flattening the yield curve

This should encourage long term borrowing (e.g. mortgages) and long term investments The
combined balance sheet of the Fed, BOE, ECB, Swiss National Bank, and BOJ rose from $2
trillion in 2007 to $18 trillion in 2018.
46
 Quantitative Easing (QE)
Up till the Financial crisis of 2008, the Fed and other 𝑃𝑏
central banks targeted short term rates (Fed Funds), 𝑆′
through selling and buying of short term securities but D 10 year T- S 10 year
never interfered with long term yields. bond T. Bonds

QE: withdrawing from the market billions worth of 10

year treasuries paying for it by issuing new checks
(printing money book entry). The QE program started 𝑃 10 𝑦
with $85 billion monthly in 2008, lowered it gradually to
$65 billion then $55 billion until it reached 0 in 2014
(tapering).
A total of $4.5 trillion worth of 10 year treasuries was
bought by the fed, reducing the supply in the 10 year
treasury market (S shifting to the left S1) the price of 10 Q 10 year
T-bonds
year treasuries moved up, i.e. yields on the 10 year T-
bonds dropped from 4.53% in 2007 to less than 2.5% in
2014. This had a huge positive impact on mortgage rates
and long term borrowing costs.
 The Fed and Covid-19 Crisis
In September 2019, the fed resumed an expansionary monetary policy with Fed funds
dropping gradually to 1.5% by the end of 2019 (from 2.5% in Dec. 2018) and reaching
0.01% by end of March 2020, as Covid-19 was spreading. Fed Funds rates were targeted
to be between 0.0% and 0.25% and are likely to stay at that level till March 2022,
possibly ending 2022 at 1.25% (four 0.25% raises).
A new quantitative easing program was also introduced in early 2020, where the Fed
started buying longer maturity bonds, paying for it by newly issued money (book entry)
crediting the account of banks selling bonds to the Fed. Yields on 10 year treasury
dropped from 2.5% in late 2019 to 1.75% by end of January 2022 and around 2%
recently. Yields on 10 year treasuries traded between 0.69% and 1.50% during most of
2021.
The Fed has started tapering (buying less monthly bonds from the market) in early 2022.

48
 Features of Duration
Duration is the weighted average time to maturity until repayment of the invested amount on a financial
security is complete. It is measured in years and it is less than the maturity of coupon bearing bonds.
It measures the sensitivity (or elasticity) of the price of a fixed income security to small changes in interest
rates. The higher the duration , the higher will be the change in bond prices for a given change in interest
rates.
In 2020, Austria issued 2.8 billion euro sovereign century bonds maturing in 2120 (100 years), at a coupon
of 0.85%, the bonds duration today is 69.9 years
Duration and coupon interest
◦ The higher the coupon or promised interest payment on the bond, the shorter its duration.
◦ Due to the fact that the larger the coupon or promised interest payment, the more quickly investors
receive cash flows on a bond and the higher are the present value weights of those cash flows in the
duration calculation. Zero coupon bond duration is its years to maturity
Duration and rate of return
◦ Duration decreases as the rate of return on the bond increases

Duration and maturity

◦ Duration increases with maturity, but at a decreasing rate

49
Duration Measured in Years ( cannot be negative)
Duration is the estimated percentage change in the bond’s price (capital
gain/loss) due to a small percentage change in interest rate. Because %
change in price moves in the opposite direction to the % change in
interest rates, then duration when calculated as such should come out to
be negative. This is why we take - Dur
To lower systematic risk associated with a sudden rise in interest rates,
lower duration of the portfolio
P  r 
  Dur  
P 1  r 
 Modified Duration
Modified duration (DurMod) is a more direct measure of bond prices to a change in
interest rate
It is defined as:
DurAnnual
DurMod 
(1  rperiod
) )

Using modified duration to predict price changes (capital gain/loss) due to a given
change in r ( not % change in r as in Duration).

ΔP
 DurMod  Δrannual
P
Duration is the Slope of the Curve
 Convexity and Duration
Convexity is the degree of curvature of the price-interest rate curve around some
interest rate level
◦ Convexity is desirable
◦ The greater the convexity of a security or portfolio, the more insurance or
protection an investor has against a sudden rise in interest rate and the greater the
capital gains after interest rate falls
◦ Convexity diminishes the error in capital gain/loss
◦ All fixed-income securities are convex
◦ As interest rates change, bond prices change at a non constant rate
 Stocks’ Duration
The longer you have to wait for coupon and principal payments, the longer the duration.
It is also a gauge of how much the price of a bond changes as interest rates shift (capital
gain/loss). The greater a bond’s duration, the more sensitive it is to a rise in interest
rates.

You can also think of equity investment in duration terms. Take the familiar price-
earnings ratio (PE) or the price paid by investors for a given level of stock market
earnings. The idea is that if a stock has a PE of 10, based on recent earnings, it would
take ten years to earn back the amount invested in the stock today (assuming earnings
stay constant). The PE is thus a crude measure of the stock’s duration.

Cash is by definition is the asset with the shortest duration. Were interest rates to go up
sharply, cash holders would get the benefit quickly even as other assets suffer. So as the
duration of your portfolio rises, it makes sense to raise your cash holdings too. Missing
out on some returns is the price you pay for mitigating duration risk.
Credit Default Swaps (CDS)

CDS is cost of protection against a possible default of a bond issuer.

Pays to AIG annually the CDS “spread” to buy

protection Default
Default
protection
protection
seller
buyer
In case of default AIG will pay the investor (AIG)
who bought the protection the face value of
the bond but not the remaining coupons

55
 Cont’d: Credit Default Swaps (CDS)
Insurance or CDS rates are higher for more risky borrowers:
Rates on 5 year CDS as of Feb 12, 2022
USA: 10.7 b.p. A Credit Default Swap (CDS) is a financial contract
Germany: 10.0 b.p between two counterparties that allows an investor to
Saudi Arabia: 55 b.p “swap” or offset the credit risk with another investor. CDS
acts like an insurance policy wherein the buyer makes
UAE(Dubai): 75 b.p.
regular payments to the seller to protect himself from an
Kuwait: 56 b.p. issuer default. In the event of a default, the buyer
Egypt: 520 b.p receives the face value of the bond or loan, from the
Iraq: 434 b.p seller of the CDS as per the agreement. CDS spreads are a
Bahrain: 295 b.p commonly used metric to track the market-priced
Morocco: 101 b.p creditworthiness of an issuer. A widening (increase) in
CDS spreads indicates a deterioration in creditworthiness
Lebanon: 25,000 b.p and vice-versa.
56
 The Mechanics of a Credit Default Swaps (CDS)
1. To explain the mechanics of a CDS we will assume that the reference entity is XYZ
corporation and that the issuer has only one bond issue outstanding. The underlying for the
CDS is $10 million par value of the XYZ bond issue. Assume that the swap fee or premium –
the payment made by the protection buyer to the protection seller – is 200 basis points.
2. The standard contract for a CDS calls for a quarterly payment of the fee or swap premium.
The day count convention used for CDS’s is actual/360. A day count convention of
actual/360 means that to determine the payment in a quarter, the actual number of days in
the quarter is used and 360 days are assumed for the year. Consequently, the swap
premium payment for a quarter is:

3. Notional amount x swap rate (in decimal) x actual number of days in a quarter/360

4. For example assume a CDS on a $10 million bond and 92 actual days in a quarter, with a
swap premium of 0.02 (200 b.p.), then the quarterly swap payment to be paid by the
protection buyer would be : $10,000,000 x 0.02 x 92/360 = $51,111.1

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2. In the absence of a credit event, the credit protection buyer (the one buying the CDs
insurance against default) will make a quarterly swap premium payment over the life of the
swap contract. If a credit event occurs, two things happen. First, there are no further
payments of the swap premium by the protection buyer to the protection seller. Second, a
termination value is determined for the swap should a credit event occur.
3. The procedure for computing the termination value depends on the settlement terms
specified in the swap agreement. This will be either physical settlement or cash settlement.
The market practice for settlement for single name CDS’s is physical delivery of the bond.
4. With physical settlement the protection buyer delivers a specified amount of the
bonds to the protection seller. The protection seller pays the protection buyer the face
value of the defaulting bonds.

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Mechanics of a Credit Default Swap with Physical Delivery

Cash Flows before a Credit Event

Protectio Protectio
n Buyer n Seller
Quarterly Swap Premium (e.g.
200 b.p.) determined by demand
and supply in the market

Cash Flows after a Credit Event

Discontinue payments of Quarterly

Protectio Swap Premium after the date of Protectio
n Buyer credit event
n Seller
Physical Delivery of Bonds to
the protection seller
Cash Equal to Face Value of defaulting Bonds

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