Corporate bond valuation : the Maltese scenario

Abstract

The performance of the equity markets during the past year and a half and concerns about responsible and proper accounting prompted by the Enron scandal have reduced the attractiveness of the equity markets with investors the world over. Conversely, as monetary authorities around the world have loosened monetary policy to boost economic recovery, the bond markets have done well. Investors have shied away from the equity markets so far and have turned to bond markets for investment opportunities. This trend has also been mirrored in the Maltese market where demand for bonds has been increasing as bond prices have reached record highs. New government and corporate issues have been increasing during the past twelve months. An environment of low interest rates and a banking sector wanting to reduce certain exposures have pushed corporate issuers to tap the Maltese capital market to raise funds. As the corporate bond market seems to flourish, we thought it opportune to provide a more detailed analysis of this market. We have attempted to estimate a value for each chosen corporate bond and compared the estimated value to the observed market price. This analysis has been compiled in the following manner: Chapter one provides an introduction to the Maltese corporate bond market detailing the characteristics of the market that are the most relevant for this dissertation. An overview of the methodology utilized to compile this study is also provided. This chapter concludes by highlighting the assumptions and limitations that were made in our study. A detailed review of the salient theory of bond valuation is presented in Chapter two. This chapter served as our reference for our later chapters where the valuation of bonds was undertaken. The chapter covers the main theory on bond valuation, relationship between yield, coupon, price and maturity, measures of bond return, measures of interest rate risk such as duration, modified duration and convexity.