Fixed Rate Treasury Notes Finance Essay

The Philippine domestic bond market consists of 2 types of bonds - short- and long-term bonds; mainly issued by the national government. The majority of bonds in the Philippine bond market are the Treasury notes and bonds. Though the corporate bonds make up a small percentage of the overall bond market, they have been steadily growing their share in the last few years.

Over the last 5 years, the Philippine fixed income market has put in efforts to bring structure and order into the bond market environment. However, more work is needed in the organization of the spot market as the market drivers and stakeholders consider it an important and necessary step in creating market structures that will bring robustness into the system.

As the credit rating of Philippines was upgraded recently by both S&P and Moody's, it has lent a favorable investment environment.

The interest rate is on a downward trend and the inflation is almost stable now. However as the country's economy grows, it's important to have the right monetary policies to be able to keep inflation in control. Hence the BSP recently cut the interest by 25 basis points to 3.75 percent in a bid to bring about a strong financial system combined with a balanced and sustainable growth in economy.

Methodology

Listed below are the considerations as well as the methodology that went behind selection of the bonds for investment purpose.

The most important criterion for selection was YTM.

Secondly, we looked at the maturity date of bonds to be before 2017, in line with the investment philosophy.

Thirdly, we calculated the Duration of bonds. Duration refers to the percentage change in the price of a bond caused by one percent change in yield. Hence it's a measure of resilience of the price of the bond to interest rate fluctuations. We wanted to calculate DV01 (percentage change in the price of a bond caused by one basis point change in yield) which is a better indicator as the market has become much more volatile in the last few years.

Weightages were assigned to these 3 criteria to arrive at a weighted average score for each bond that would help in selecting the top bonds for our portfolio.

Bonds with highest yields and the lowest duration made the cut for the portfolio.

For corporate bonds, we took into account the credit rating as well.

As seen earlier, the Government to Corporate bond ratio is 92:8. At the same time, the corporate bonds are also steadily increasing in volume. After studying the bonds, we decided to split our investment as 60% in Government bonds and 40% in corporate bond.

Recommendation

Based on the above criteria, we decided to split our investment as 60% in Government Bonds and 40% in corporate bonds. Below, is the portfolio of bonds we selected. Since the interest rates are expected to be low, the bonds with low duration should be traded on the secondary market and the bonds with high duration should be 'Held to Maturity'. Also, the liquidity will be more in case of low duration bonds.

 

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