AFE Course - Fixed Income Investments Report: Bond Analysis

This report undertakes a comprehensive analysis of a fixed income investment, specifically focusing on a bond issued by Australian Post. The report begins with an introduction to the company and the chosen bond, including its key features and general bond details. It then delves into the valuation of the bond, calculating its full price, accrued interest, and clean price. The subsequent sections explore interest rate risk, utilizing Macaulay duration and convexity calculations to assess the bond's sensitivity to interest rate changes. Furthermore, the report includes an approximate modified duration analysis. Finally, the report concludes with a credit analysis, evaluating the issuer's capacity through an examination of industry structure using Porter's Five Forces model, considering factors like bargaining power of customers and suppliers, threat of entry, and threat of substitute products or services. References used in the report are also included.

Fixed Income Investments

Contents
Introduction.................................................................................................................................................4
Main Body...................................................................................................................................................6
2. Valuation.............................................................................................................................................6
3. Interest risk..........................................................................................................................................8
4. Explanation........................................................................................................................................13
5. Credit Analysis:..................................................................................................................................13
References.................................................................................................................................................15

Introduction
This is the report which consists various bonds of Australian Post. The main business operations
is to provide courier services throughout Australia. As, this has provided various ways for
people, businesses and communities in order to link with each other and the plant. It offers
application inspection, foreign currency, forms validation, safe drop, money transfer and other
associated services in Australia. There are various bonds that have been issued by the Australian
Post, an Australian based company. The concerned company is a government based and
successfully gaining competitive advantage over its rival firms and accordingly has achieved
dominant position in the related sector. This report consists of the bond description of the cited
company along with the valuation of the bond securities and its interest risk with credit analysis.
Australian Post issued bond at the issued price of 99.606 with the coupon rate of 5% in order to
meet the financial needs of the company. The amount was raised funds from the market
AUD$500,000. Hereunder, various details are mentioned as under:
General bond details (Security information) of
Australian Postal Corp
Name of the company Australian Postal Corp
Market issue Domestic MTN
Issue price 99.606
Coupon rate 5%
Maturity date 13/11/2020
Series MTN
Coupon frequency Semi-annually
Par amount 100000
Type Fixed
Category Unsecured

The above table indicates the general details of the bond. Accordingly, after going through the
above table, the reader or user of the report will clearly get an idea regarding the nature and
characteristics of the bond of the concerned nation, i.e., Australian Postal Corp.
Ratings of bond issued by Australian Postal Corp
Credit rating agency Rating assigned
Moody's NA
S & P AA-
Composite NR
It is imperative to first calculate the yield on the corresponding bond which will help to arrive at
the duration of the bond (including the Macaulay duration). There are different aspects of the
calculating or arriving at the current value of bond.
(Issuer information) of bond issued by Australian
Postal Corp
Name of date Date
Pricing date 1/11/2013
Interest accrual date 13/11/2013
1st Settle date 13/11/2013
1st coupon date 13/05/2014
It has been observed that yield to maturity is negligible since there is a high variation between
the issue price and par amount (Hasan, 2015). Also, the current yield is approx. 1%. For the ease
of calculation, both the yield to maturity and current yield has been taken to be 1%. The yield of
maturity has been determined considering the present value of cash inflows that will arise
throughout the duration of the bond. Such inflow normally arises in the form of coupon
payments and the redeemable value or generally face value of the bond.

In the given case since the coupon payment is semi-annually; all the interest payments that will
be made half-yearly have been duly considered (Lily, et. al., 2014).
Taking the current yield to be 1%, the Macaulay duration comes out to be 6.13 years. This
indicates that the initial cost of the bond will be recovered within the specified duration or period
of 6.13 years on the condition that the coupon rate is 5%, and the yield is 1%. In the same
manner, Macaulay duration is determined by the weighted average of duration or tenure of the
bond or by weighted average period to maturity.
Main Body
2. Valuation
To determine the security’s full price which is the price to pay for trading the bond is calculated
below. The valuation part is also include the clean price which is the price quoted by the dealers
in the bond market and at the time of settlement date the accrued interest is also accumulated.
2.1 Full price of the Bond
Coupon
Dates
Coupon Coupon Time to
Receipt(15/180
)
PV of CF Time
Weighted CF
13/05/2019 2.5 .50 0.083 2.439 1.2195
13/11/2019 2.5 1 1.083 2.379 2.379
13/05/2020 2.5 1.5 2.083 2.321 3.4815
13/11/2020 2.5 2 3.083 2.265 4.53

Totals 10 9.404 11.61
Where:
FV (face value of the bond): $100
PMT (Coupon payment per period): $2.5
t (It is the time to the next coupon payment): 15 days
T (Duration between two coupon payments): 180 days
r (required rate of return per period): 2.3925%
For Australia Post, 5% bond 13/11/2020, the full price is $9.404
2.2 Accrued Interest
Accrued interest is the total accumulated interest on the bond from the last coupon payment.
Accrued interest is calculated by using the below:
Where,
t: (180-15) = 165 days accrued from the last coupon payment.
T: Total number of days between coupon payments.
PMT: Coupon payment semi-annually
Accrued Interest = 2.5*165/180
Accrued Interest = 2.2917
2.3 Clean Price
The clean price of the bond would be derived by deducting accrued interest with full price of the
bond.

i.e., $9.404 - $2.2917 = $7.112
3. Interest risk
3.1 Macaulay Duration
Coupon
Dates
Coupon Coupon Time to
Receipt(15/180
)
PV of CF Time
Weighted CF
13/05/2019 2.5 .50 0.083 2.439 1.2195
13/11/2019 2.5 1 1.083 2.379 2.379
13/05/2020 2.5 1.5 2.083 2.321 3.4815
13/11/2020 2.5 2 3.083 2.265 4.53
9.40 11.61
Macaulay Duration: PV of CF/Time Weighted CF.
=11.61/9.40=1.23 half yearly
By converting into full years then this would be 1.23/2= 0.615 whole years.

3.2 Convexity
Coupon
Dates
Coupo
n
Coupo
n
Time to
Receipt(15/18
0)
PV of
CF
(t^2+t) (t^2+t)(PV of
CF)
13/05/201
9
2.5 0.5 0.083 2.439 0.08988
9
0.219239271
13/11/201
9
2.5 1 1.083 2.379 2.25588
9
5.366759931
13/05/202
0
2.5 1.5 2.083 2.321 6.42188
9
14.90520437
13/11/202
0
2.5 2 3.083 2.265 12.5878
9
28.51156859
9.4 21.3555
6
49.00277216

Semi-annual convexity is 49
3.3 Approximate modification duration:
This is an extension of Macaulay Duration is a kind of adjusted tool which enable to assess the
sensitivity of a bond to change in interest rates efficiently. This is an optional method to calculate
duration of percentage points enhancing or diminishing using the bond value.
By considering gain and /or decrease of 10 basis points, AMD is calculated as shown as under:
PV+(Increase in rate by 10bps)
Where R= (4.785+.10)/2= 0.0244
Coupon Dates Coupon Coupon Time to
Receipt(15/180
)
PV of CF
13/05/2019 2.5 .50 0.083 2.439

13/11/2019 2.5 1 1.083 2.379
13/05/2020 2.5 1.5 2.083 2.321
13/11/2020 2.5 2 3.083 2.265
9.40
PV- (decrease in rate by 10bps)
Where, R= (4.785+0.1)/2 = 0.234
Coupon Dates Coupon Coupon Time to
Receipt(15/180
)
PV of CF
13/05/2019 2.5 .50 0.083 2.439
13/11/2019 2.5 1 1.083 2.379
13/05/2020 2.5 1.5 2.083 2.321
13/11/2020 2.5 2 3.083 2.16
9.30
Therefore,
Where,

PV0 9.40
PV1 9.30
Change 1 in Yield is 0.001 or 0.1%
Approximate convexity: As calculated above 3.2, there need not to divide by 2. It is because of
incorporation of coupon rate payments and yield to maturity in calculation in the bond price.

4. Explanation
4.1 Duration:
With the change of interest rate, it measures the sensitivity of the value of the principal of a fixed
income investment like bonds and other secured or unsecured securities. Duration is expressed as
a number of years. Duration has an opposite relationship between rates of interest with bond
prices which shows in a convex curve slope.
In fixed income analysis, the yield duration analysis used is:
 Macaulay duration
 Modified and Money duration
 The price value of basis point
4.2 Convexity:
Convexity is the degree of the curve, in the relationship between bond prices and bond yields. It
shows how bond duration changes as the interest rate changes (Franco and Gerussi, 2013).
Convexity is mainly used as risk management tool which helps the investors in measuring and
managing the market risk to which a portfolio of bonds are exposed. The convexity increases
when the systematic risk increases in a portfolio and vice versa.
4.3 Interpretation:
This is indicated by the Macaulay’s duration which indicates that change in interest rate changes
the price of the bond by 0.615. This means that if there is variation in interest rate by 10bps, the
value of portfolio will have a change of 0.615.
5. Credit Analysis:
5.1 Capacity

Capacity is the ability of the issuer to avail the service of borrowed debts (Kang, 2012). The
issuer of the debt will observe the factors influencing the industry and then inspect the specific
company to whom the debt needs to be given.
A. Industry Structure
The analysis on industry structure is done by using “Porters Five Forces Model” which was
invented by Michael Porter. This model helps the issuer to measure the risk which will be face
by the industry at any point of time (Gardiner, Symons and Symons, 2014).
Bargaining power of customers:
In large service industries, buyers have a power of bargaining which impacts the sales and profits
of the industry in a negative manner (Jordan,et al., 2015). Australia Post is a government
company which keeps in mind the interest of the customers. Change in the pricing would impact
the company sales and the customers would look for other substitute product.
Bargaining power of suppliers:
In a service industry, Australia Post is a major company which offers reasonable services to their
customers and other suppliers. Being a service provider, Australia Post would have a so many
contracts with the suppliers who deliver courier, post, etc. on a timely manner. The supplier
bargaining power would impact the sales and profits of the company and it is the duty of
management of the company to provide commission, discount and other facilities to their
suppliers.
Threat of entry:
The entry of a new competitor is also impacts the company in negative manner. Australia post is
a government company which will be impact by the other private companies who is new in the
market and also offers reasonable services to their customers. This will impact the company
performance and sales also.
Threat of Substitute:

The substitute products or services will also impact the company’s performance in the market. It
will reduce the share in market. Australia Post should make a policy which reduce such situation
and also not impact the services which are provided in the market.

References
Hasan, R. K., (2015). Hedging Foreign Exchange Risk Exposure by Importer Companies.
International Journal of Economics, Finance and Management Sciences.
Lily, J., Kogid, M., Mulok, D., Sang, T, L., &Asid, R., (2014). Exchange Rate Movement and
Foreign Direct Investment in Asean Economies. Hindawi Publishing Corporation.
Malik, R., (2016). Challenges Posed by Foreign Exchange Exposures and Strategic Way-out.
International journal of management and economics invention.
Raja, Y.Y., &Ullah, N., (2014). Determinants of Foreign Exchange Markets. IOSR Journal of
Economics and Finance, vol.2.
Jordan, B. D., Miller, T. W., & Dolvin, S. D. (2015). Fundamentals of investments: valuation
and management. McGraw-Hill Education.
Namvar, E. (2014). An introduction to peer-to-peer loans as investments. Journal of Investment
Management First Quarter.
Gardiner, P., Symons, M. J., & Symons, G. (2014). U.S. Patent Application No. 14/198,222.
Kang, X. (2012). Commodity Investments: The Missing Piece of the Portfolio Puzzle?. Available
at SSRN 2153319.
Franco, C., & Gerussi, E. (2013). Trade, foreign direct investments (FDI) and income inequality:
Empirical evidence from transition countries. The Journal of International Trade &
Economic Development, 22(8), 1131-1160.