risk & return analysis - bonds market in pakistan
TRANSCRIPT
RISK & RETURN ANALYSIS OF BOND MARKET IN PAKISTAN
Faculty Advisor:Ms. Tazeen Arsalan
Researchers:Abdul Hadi Khanani
Armoghan MoinQandeel Fatima Memon
Samra JavedSyed Jahanzeb Haider
Yamna ShumasZoya Talat
OBJECTIVES OF THE STUDY
To Analyze The Risk And Return Of Bond Market
in Pakistan
To Analyze The Factors
affecting Return on Bond
Market in Pakistan
OUTLINE Introduction Bond Market Importance Bond Market in Pakistan Bond Timeline & History Future Prospect Literature Review Methodology Findings Discussions
DEFINITIONSBondsA bond is a debt investment in which an investor loans money to an entity (typically corporate or governmental) which borrows the funds for a defined period of time at a variable or fixed interest rate. Owners of bonds are debt holders, or creditors, of the issuer.
Bond Market:The bond market – also called the debt market or credit market – is a financial market in which the participants are provided with the issuance and trading of debt securities.
IMPORTANCE OF BOND MARKETSBUYERS ISSUERSSteady income Cost EffectiveSmall investors Competition to banksDiversification Alternative means of raising debt
capital
Central Banks issue bonds to:• develop infrastructure of the country
• Invest to earn return
• To monitor currency value
• to control money supply, and subsequently
• To control inflation
BENEFITS OF BOND MARKET ON ECONOMY
Avenue to investDirect competition to banksGood indicator of wider macro-
level signalsMoney supply is absorbedInflation is controlledImprovement in currencyForeign portfolio investment
NEED FOR DEBT MARKET Microeconomic Role
• Local Borrowing – Elimination of maturity mismatch
• Foreign Borrowing – Twin Mismatch (Maturity, FOREX Risk)• Facilitates Development of Risk
Management Instruments Macroeconomic Role
• Alternative Source of Borrowing• Credit Risk Dispersion• Risk – Possible Contagion Effect
TYPES OF BONDS2)Government bonds
• Pakistan Investment Bonds
• US Special Dollar Bonds
• WAPDA Bonds
• National Saving Bonds
• Sukuk
1)Corporate Bonds
Engro Bonds
HISTORY OF BOND MARKET IN PAKISTAN
1960 To cover non-banking segment, Prize Bonds were introduced followed by various NSS Schemes.
1990s Market based Government Securities came into existence.
1992 Introduction of long term paper (FIB).Long term yield curve emerged giving opportunity to the corporate to come up with instruments.
1995 Foundation of the corporate bond market was laid with the first issue of Term Final Certificates (TFC).
2000 Introduction of Pakistan Investment Bonds. (PIBs).
Long term instruments gained momentum.
SBP introduced selective Primary Dealer System (PD).
2001 KIBOR/KIBID rates were introduced to provide inter-bank call money curve.
2001-05 Corporate Bond market was vibrant, adding approximately PKR 65 Billion issuance or 98% of total issuance to date.
2005 SBP issued guidelines on Forward Rate Agreement (FRA), Interest Rate Swaps (IRS) and Currency Options.
2007 Introduction of Engro bonds of Rs 4 billion.
2008 Introduction of GoP Ijara Sukuk.
2009-10 The Government raised Rs. 64.31 billion, as against the target of Rs. 60 billion, through the auctions of Pakistan Investment Bonds (PIBs).
A total of four tranches of GoP Ijara Sukuk had been issued.
Bond Automated Trading System (BATS), a new debt market platform was introduced. It allows electronic order entry and matching facility, which will provide a more efficient and transparent way to trade debt market securities.
April 12, 2009 KSE and MUFAP joined hands for the development corporate debt marketTrading – KSE, Settlement – NCC, Custodian – CDCTFCs to be traded through BATS in the first phaseGovernment securities to be traded in the 2nd phase
2010-11 Development of an electronic fixed income trading platform provided by Bloomberg called E-BOND : Electronic Bond Trading Platform.
2012 According to SBP and SECP, the domestic bonds outstanding were 30 percent of the GDP, which mostly consisted of government bonds, as the corporate bonds market was less developed.
2014 Pakistani bonds revived investor interest Corporate market came under investors focus.
Pakistan rose $2 billion through Euro Bonds.
2015 Pakistan issued $500 million Euro Bonds.
October 2016 Pakistan rose $1 billion through Sukuk bonds.
PROBLEMS IN BOND MARKET OF PAKISTAN
High administration cost Lack of Technological developments –
transparency and liquidity Weak Market Infrastructure Expectations of inflation and frequent
devaluation of PKR hindered the foreign investment
Lack of Benchmark in the market – Valuation problems (PIB 3,5, 10 years)
Inactive Secondary Market, absence of central price discovery mechanics/platform
RECOMMENDATIONSThe role of SBP needs to be changed.Mandatory for SBP to list it. Weak policies and unplanned structure needs mass improvement.Administration costs can be easily and effectively handled.Develop it to avoid monopoly.Need for Technological developments – transparency and liquidity
Title Author Year Sample ResultA Study on the Impact of Selected Monetary, Fiscal, Economic Variables on the Indian Bond Market
Dr. R. Himachalapathy, Rakshitha
2015 Country: India
Sample: Govt bonds
Time Span: 2005 to 2015
Significant relationship between yield rates and bank rate, repo rate, reverse repo, Index of Industrial Production, Wholesale Price Index and GDP
Positive relationship between yield rates and bank rate, repo rate, reverse repo rate, Index of Industrial Production, Wholesale Price Index and GDP
Information Content of Yield Spread: Economic Growth of Malaysia
Joanne Yen-Ei Keki and Kim-Leng Goh
2015 Country: Malaysia
Sample: 10 year Malaysian govt security and 3 month T-Bills
Time Span:1997 to 2012
Significant relationship between yield spread and economic activity
Positive Relationship between yield and economic factors
Title Author Year Sample ResultA Comparative Analysis of Returns of Various Financial Asset Classes in South Africa, A Triumph of Bonds
C. Auret and R. Vivian
2014 Country: South Africa
Sample: Equities, bonds and cash in South Africa
Time Span: 1986 to 2013
No significant relationship between the returns of equities over long bonds even before adjusting for risk
Exchange Rate Risk and Local Currency Sovereign Bond Yields in Emerging Markets
Blaise Gadanecz, Ken Miyajima, Chang Shu
2014 Country: 20 economies
Sample: 5 year local currency sovereign bonds of 20 economies
Time Span: 2005 to 2013
Significant relationship between exchange rate risk of emerging market economies and local currency sovereign bond yields
Positive relationship
Title Author Year Sample ResultThe Interest rate Effects on Government Debt Maturity
Jagjit S Chadha, Philip Turner and Zampolli
2013 Country: US
Sample: 5 & 10 year T-Bills
Time Span: 1976 to 2006
Significant relationship between dividend yield, CPI and GDP
Positive relationship
An Empirical Analysis of the Performance of the Ghana Stock Exchange and Treasury Bills
Samuel Antwi
2012 Country: Ghana
Sample: Annual returns of the Ghana Stock Exchange all-share index and Treasury bill
Time Span: 1990 to 2010
Significant relationship between risk and return of equity market and significant relationship between risk and return of debt market.
Positive relationship
Title Author Year Sample ResultThe Impact of Changes in Financial and Macroeconomics Variable on Term Structure of Interest Rates in Malaysia
Ong Tze San, Lai Yoke and Heng
2012 Country: Malaysia
Sample: One and 10 year Malaysian govt securities
Time Span:1997 to 2009
Money supply and current account have significant relationship on bond yield
Money supply has a positive relationship with bond yield, whereas current account has a negative relationship with bond yield
Fiscal Deficits, Public Debt, and Sovereign Bond Yields
Baldacci and Kumar
2010 Country: 31 advanced and emerging market economies
Sample: Fiscal deficit and government debt in 31 countries
Time Span: 1980 to 2008
Higher deficits and public debt lead to a significant increase in long-term interest rates
Positive relationship between large fiscal deficits and public debts and sovereign bond yields
Factors Influencing Yield Spreads of the Malaysian Bonds
Norliza Ahmad and Joriah Muhammad
2009 Country: Malaysia
Sample: Govt securities and corporate bonds
Time Span: 2001 to 2008
CPI and interest rates have a significant relationship with the yield spread of Malaysian Government Securities
Positive relationships
Interviews Literature Review
RESEARCH TECHNIQUE
QUALITATIVE
QUANTITATIVE
Regression of Bonds’ Data & External Factors’ data run on Stata
VARIABLES
PIB 3, 5 & 10 YEAR BONDSDEPENDENT VARIABLE
INDEPENDENT VARIABLES
Standard Deviation Interest Rate Fiscal Deficit Gross Domestic Product Exchange Rate
REGRESSION MODELThe following regressions are performed in our
study-
Pooled Fixed Random
Four models are developed to check the relationship.
EQUATION Model (1 – All Bonds,
2 – Three Year PIBs 3 – Five Year PIBs 4 – Ten Year PIBs)
Bond Yields = f (Risk, fiscal deficit, interest rate, exchange rate, GDP)
OR
Y = βo + β1X1(Risk) + β2X2(Fiscal Deficit) + β3X3(GDP) +β4X4(Interest Rate) + β5X5(Exchange Rate)
There exists a Positive relationship between Risk and bond yield.
There exists a positive relationship between interest rate and bond yield.
There exists a negative relationship between exchange rate and bond yield.
There exists a negative relationship between GDP and bond yield.
There exists a positive relationship between fiscal deficit and bond yield.
Hypothesis
DESCRIPTIVE OF MODEL 1(ALL BONDS)
VariableMean Standard
DeviationMin Max Observations
Yield overall 11.30100. 1.807156. 7.622. 13.474. N = 33
between 0.388582. 10.925. 11.701. n = 3
within 1.778202. 7.998. 13.782. T = 11
Risk overall 0.05345. .2E49259 -0.349. 0.744. N = 33
between 0.020821. 0.033. 0.074. n = 3
within 0.214231. -0.370. 0.723. T = 11
Interest Rate
overall 0.06585. 0.018400. 0.026. 0.087. N = 33
between 0.000000. 0.066. 0.066. n = 3
within 0.018400. 0.026. 0.087. T = 11
Exchange Rate
overall 0.06446. 0.058037. -0.005. 0.161. N = 33
between 0.000000. 0.064. 0.064. n = 3
within 0.058037. -0.005. 0.161. T = 11
Gross overall 0.04156. 0.018332. 0.016. 0.077. N = 33
Domestic between 0.000000. 0.000. 0.042. n = 3
Product within 0.018332. 0.016. 0.077. T = 11
Fd Overall 0.05645. 0.014642. 0.033. 0.082. N = 33
between 0.000000. 0.056. 0.056. n = 3
within 0.014642. 0.033. 0.082. T = 11
Independent Variables
Coef. Std. Err.
T P>t Coef. Std. Err. T P>t Coef. Std. Err. z P>z
Risk 3.9274. 0.721 5.44 0.000 4.21470.553816 7.61 0.000 3.927356 0.721953 5.44 0.000
Interest
Rate 81.8439 16.49 4.96 0.000 86.08312.61:639 6.83 0.000 81.84388 16.49433 4.96 0.000
Exchange
Rate -4.3706. 2.442 -1.79 0.085 -4.57271.86271 -2.45 0.021 -4.3706 2.442986 -1.79 0.074
Gross
Domestic
Product-24.1592. 14.57 -1.66 0.108 -21.491
11.124 -1.93 0.065 -24.1592 14.57399 -1.66 0.097
Fiscal
Deficit 11.8870. 11.46 1.04 0.308 11.791 8.736152 1.35 0.189 11.89698 11.46075 1.04 0.299
_cons
6.2719. 1.665 3.77 0.001 5.8835 1.272432 4.62 0.000 6.271927 1.665641 3.77 0.000
Pooled Regression Fixed Effect Random Effect
Adj R square 0.898 R square R squareWithin 0.9433 Within 0.9428Overall 0.8975 Overall 0.8980
F test 47.53 F test 83.2
Model 1 (All bonds included)
MODEL 2 ( 3 YEAR PIB BOND)
Independent Variables
Coef. Std. Err. T P>t
Risk 4.1242. 1.015386 4.06 0.010
Gross Domestic Product
-32.7755. 24.33905 -1.35 0.236
Interest Rate 96.6465. 28.1523 3.43 0.019
Exchange Rate -6.3025. 4.282961 -1.47 0.201
Fiscal Deficit 7.7628. 19.86533 0.39 0.712
_cons 5.5210. 2.8443616 1.94 0.110
Pooled Regression
Adj R square 0.9502
F test 19.08
MODEL 3 ( 5 YEAR PIB BOND)
Independent Variables
Coef. Std. Err. T P>t
Risk 5.058. 0.8662832 5.84 0.002
Interest Rate 99.17184 - 18.60818 5.33 0.003
Exchange Rate-5.195. 2.655264
1.96 0.108
GDP-13.354. 16.17758
0.83 0.447
Fiscal Deficit 12.648. 12.40545 1.02 0.355
_cons 4.601.202 1.87641 2.45 0.058
Pooled Regression
Adj R square 0.9502
F test 19.08
MODEL 4 ( 10 YEAR PIB BOND)
Pooled Regression
Adj R square 0.9937
F test 316.78
Independent Variables
Coef. Std. Err. T P>t
Risk 6.327. 0.4194798 15.08 0.000
Gross Domestic Product
8.071. 6.068317 1.33 0.241
Interest Rate 98.758. 6.831279 14.46 0.000
Exchange Rate -3.417. 0.8774736 -3.89 0.011
Fiscal Deficit 11.578. 4.201141 2.76 0.040
_cons 4.187. 0.6747056 6.21 0.002
HYPOTHESIS: YIELD HAS A POSITIVE RELATIONSHIP WITH STANDARD DEVIATION (RISK)
Results shows that as risk increase return increase
Risk is a measure of volatility
Bonds with high volatility risk have higher yield Bonds with low volatility have lower yield
PIBS are sovereign bonds, it doesn’t have liquidity, default risk.
HYPOTHESIS: YIELD HAS A POSITIVE RELATIONSHIP WITH STANDARD DEVIATION (RISK)
PIBs have inflation risk and interest rate risk
Coupon payments are fixed it doesn’t increase with inflation
YIELD HAS A POSITIVE RELATIONSHIP WITH INTEREST RATE
Interest rate is an important factor and affects returns of all investments
Increase in interest rate increase a return on bonds
Bond yield is directly correlated with interest rate as interest rate increases bond yield increase and coupon payment on bonds increase.
As interest rate increases the prices of previously issued bond decrease as new bonds would offer higher yield.
HYPOTHESIS: YIELD HAS A NEGATIVE RELATIONSHIP WITH GDP
According to academic theories increase in GDP is due to increase total investment
It increases demand pull inflation
To overcome demand pull inflation government increases interest rate which increase bond yield.
In Pakistan bond yield and GDP have negative relationship
HYPOTHESIS: YIELD HAS A NEGATIVE RELATIONSHIP WITH GDP
Pakistan has done huge borrowings from IMF and is moving towards new era of growth due to CPEC.
Foreigners and locals are investing huge amount of money in mega projects
Government is decreasing interest rate to encourage investment and discourage fixed deposits
It gives incentive to companies to invest in business leading to increase in investment component leading in increase in GDP.
HYPOTHESIS: YIELD HAS A NEGATIVE RELATIONSHIP WITH EXCHANGE RATE
Pakistan has done huge borrowing from IMF and World
Bank to overcome its fiscal deficit
Under current IMF program Pakistan is forced to devalue its local currency and decrease its interest rate
It would increase money supply in an economy and discourage deposits in saving account to encourage investment in an economy
The purpose is to increase growth through investment
HYPOTHESIS: YIELD HAS A POSITIVE RELATIONSHIP WITH FISCAL DEFICIT
Bond Yield and fiscal deficit has positive relationship
Fiscal deficit increases ,yield increase.
In Pakistan government tries to fill a gap of fiscal deficit by issuing debts
Fiscal deficit increase government increase an interest rate
It attracts investors to buy the extra debt and limit the money supply in economy
HYPOTHESIS: YIELD HAS A POSITIVE RELATIONSHIP WITH FISCAL DEFICIT
Banks heavily invest in T-Bills and PIBS. Same was happening in 2008.
Creates “Crowding Out” effect by borrowing more money and leaves less money for private sector
Higher interest rates also can reduce the private sector's demand for capital
It reduce the demand for commercial and retail borrowing
LIMITATIONS OF THE STUDY Only 3, 5 and 10 year PIB Bonds are included
in the study
The Research is done only on Pakistani Bonds.
Only 11 years of data is has been included i.e. 2005 to 2015.
SUMMARY OF STOCK & BOND RESULTS
Variables Stocks Bonds
Risk + +
Exchange Rate - -
Inflation - Not Applicable
Foreign Direct Investment + Not Applicable
Interest Rate + +
Money Supple + Not Applicable
GDP + -
Fiscal Deficit +
KNOW WHAT INVESTMENT PRODUCTS ARE AVAILABLE:
Ordinary shares of listed companies Unit trust schemes Mutual funds certificates Corporate bonds i.e., Term Finance
Certificates (TFCs) Government securities i.e., Federal
Investment Bonds(FIBs), Pakistan Investment Bond (PIBs) Special US Dollar Bonds
STRATEGIES FOR INVESTMENT.
Top down Bottom up Value or growth Large or small cap Ethical investment and technical analysis
TIPS FOR INVESTING WISELY
When trading in the Stock Market, one should avoid: Greed Making the same mistake twice Following the crowd Putting all your ‘eggs in one basket’ Using rumors as tips Emotions; being emotional can effect
reasoning Traders should use research backed by
fundamental reasoning. Impatience Over borrowing
IMPORTANT CONSIDERATIONS FOR INVESTORS
How Much Money Can You Afford to Invest?
How Do You Want to Invest?
YEARS WITH THE PRESENT ORGANIZATION
28%
25%15%
32%
Chart Title
0-1 years 1-5 year6-10 years more than 10 years
INCOME
20%
37%
15%
28%
Chart Title
Less than 25K Between 25K and 100KBetween 100K and 200K More than 200K
PROFESSION
17%
17%
17%17%
17%
17%
Chart Title
Student Doctor BrokerTeacher Investor Other (Please Specify)
WHY DO YOU THINK PEOPLE INVEST IN BOND MARKET?
Low risk High returns For diversification Other (Please Specify)
44
7
31
5
Chart Title
WHY DO YOU THINK CORPORATE DON’T ISSUE BONDS IN PAKISTAN?
No need of ad-ditional funds
Difficult to issue More cost involved Other (Please Specify)
13
32 31
6
IN WHICH SEGMENTS OF CAPITAL MARKET DO YOU INVEST?
Property Bond Market
Stock Market
Mutual Funds
Currency Other (Please Specify)
18
3
23
7
20
WHAT IS YOUR PORTFOLIO SIZE?
8%
17%
4%71%
Chart Title
Less than 100K Between 100K and 300KBetween 300K and 500K More than 500K
AMONG THE RISK-LESS FORMS OF INVESTMENTS (BANK DEPOSITS, NATIONAL SAVINGS CERTIFICATES), WHY DO YOU THINK THAT THE BOND MARKET IS THE LEAST DEVELOPED?
2217 19 18
0
IN YOUR OPINION, DOES BOND MARKET NEED FURTHER DEVELOPMENT BEFORE IT CAN START TO ATTRACT HIGH NET WORTH INVESTORS?
96%
4%
Chart Title
Yes No
WHAT MEASURES CAN BE TAKEN TO IMPROVE THE BOND MARKET IN PAKISTAN?
Majority said that the awareness is the key for improving the bond market
Another key factor would be proper regulatory body for maintaining transparency
WHY DO YOU THINK THERE IS A NEED FOR STRONG BOND MARKET?
Excess to extra funds for the issuer
Another investing option would be created for the investors
Bond markets are a source of funding
IF YOU CHOSE ‘BOND MARKET’, SPECIFY WHICH TYPE
Majority invested in government bonds as they are risk free in nature
Corporate bonds do not have much awareness
WHY DO YOU INVEST IN THE SEGMENTS WHICH YOU MARKED?
Majority responded higher returns being the most important reason for investing in any capital market
More then 80% of the respondents went with higher return being an important reason for the selection of their market
Other respondents also selected diversification as another reason for the selection of their capital market
WOULD YOU PREFER ALTERNATIVE FORMS OF INVESTMENTS OVER BONDS? SPECIFY THE REASON?
Majority of the respondents said they would prefer alternative forms of investments, specifically; mutual funds
Others preferred equity as it is more liquid
Lack of information about bonds was the reason of this preference
IN YOUR OPINION, SHOULD STEPS BE TAKEN TO INCREASE AWARENESS AMONG POTENTIAL BOND MARKET INVESTORS? IF YES, PLEASE SPECIFY THE STEPS
Majority said proper marketing campaigns should be introduced
Proper workshops should be held at institutes
Some suggested allocation of budget to regulatory bodies