Nasdaq Iceland Bond Indices 01 April 2015


 Bethany Hillary Nash
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1 Nasdaq Iceland Bond Indces 01 Aprl Fxed duraton Indces Introducton Nasdaq Iceland (the Exchange) began calculatng ts current bond ndces n the begnnng of They were a response to recent changes n Treasury bond ssuance as well as restructurng by the Housng Fnancng Fund (HFF) n the summer of These changes resulted n many of the largest and most actve bond seres beng excluded from the Exchange s prevous ndces, whch were desgned for zerocoupon bonds. Summary Lke ther predecessors, the bond ndces have a fxed duraton, whle the most sgnfcant changes from the prevous method are prncpally the followng: () () () The ndces cover a larger porton of the bond market than dd the earler ndces. In addton to zerocoupon bonds, bonds wth equal nstalments, annutes and coupon bonds are also elgble for ncluson n the ndces. Both bonds lsted at clean prce and drty prce wll be admssble. The changes mean that HFF bonds and all benchmark Treasury bond classes can be consdered for ncluson n the the Exchange s ndces. There can now be more than two bonds n each ndex at any pont n tme, whle ths was prevously lmted to two bonds at a tme. As a result of these changes, the bond ndces wll reflect a larger porton of the market, reducng the lkelhood of extraordnary prce movements n one bond class substantally affectng the ndces. The defnton of the new ndces s broader than that of the prevous ones. The former ndces were lmted to ndvdual bond classes, such as Tbonds and Housng Bonds, whereas the current ndces contan governmentguaranteed, ndexed and nonndexed bonds of varyng maturtes. The ndces wll therefore not be as senstve as the prevous ndces to the ssuers' choce of the type of bonds they
2 ssue,.e. ther choce between the types of payment (such as zerocoupon, annuty or coupon bonds), on the one hand, and between ndexed and nonndexed classes, on the other. Indces The followng ndces are calculated for governmentguaranteed bonds and blls: Name Code Duraton ISIN OMXI 10year ndexed OMXI10YI 10years IS OMXI 10year nonndexed OMXI10YNI 10 years IS OMXI 5year ndexed OMXI5YI 5 years IS OMXI 5year nonndexed OMXI5YNI 5 years IS OMXI 1year nonndexed OMXI1YNI 1 year IS OMXI 3month nonndexed OMXI3MNI 3 months IS The ndces have been calculated snce n the begnnng of 2005 apart from OMXI5YI, whch was ntroduced n December 2005, and OMXI10YNI, whch was ntroduced n February Hstorcal seres have been constructed extendng back to the begnnng of 1998 except the seres for the OMXI10YNI ndex whch only extends back to the begnnng of The 1year ndex wll nclude both bonds and blls to attan the oneyear duraton. Due to shortage of governmentguaranteed shortterm securtes, the Exchange decded to use threemonth REIBOR nterest rates on the nterbank market n ISK for nterpolaton of OMXI3MNI from and ncludng March 1 untl and ncludng June In February 2011, followng the Natonal Debt Management s frst ever ssuance of a 20year nomnal treasury bond, the Exchange started calculatng a new 10year nonndexed bond ndex (OMXI10YNI). Values for OMXI10YNI were calculated back to the begnnng of 2011 but the ndex had varable duraton untl the new 20year bond became elgble n the ndex on February 1 st. 2(9)
3 Elgble securtes The general rule for the earler ndces, of consderng benchmark governmentguaranteed bonds, wll generally contnue to apply. Benchmark bond classes and blls are generally elgble for ncluson n the ndces on the fourth day of tradng. In constructng hstorcal ndex seres, predatng the tme of formal benchmark classes of the Treasury and HFF, the marketablty of bonds, manly as reflected by tradng volume, s taken nto consderaton. If the benchmark system s elmnated n the future, the Exchange wll announce ts response specfcally; such a response wll am at havng "benchmarkequvalent" classes n the ndces and reflect the (probable) tradng volume. The Exchange also reserves the rg to respond to other specal crcumstances and wll gve specfc notce of any actons n such cases. The frst step n ths drecton was mplct n the calculaton of hstorcal ndex values at the ndces ntroducton, snce Housng Authorty Bonds and Housng Bonds were excluded after 1 July Ths acton was justfed on the grounds that these were bonds whch were n the process of dsappearng from the market, and ther prce formaton was not nearly as effcent as prevously. Tradng n these bonds had fallen sharply and agreements wth market makers provded only for bds and not offers. In Aprl 2015 the Exchange started to use prce nformaton for Treasury blls from the Government Debt Management s auctons n addton to prces from the secondary market. Ths was deemed necessary because trades n Treasury blls had become sporadc and therefore nsuffcent prce nformaton was avalable on the secondary market for use n the ndces. Aucton prces are only used for Treasury blls and thus all prce nformaton for other bonds comes solely from the secondary market. Apart from ths, the ndces are revewed monthly n accordance wth the followng rules, whch nclude a number of aspects borrowed from the rules of Oslo Børs. 3(9)
4 1. Bonds can be consdered for ncluson n an ndex f ther duraton falls wthn the perod 1 : [duraton of the ndex * (1 + duraton of the ndex), duraton of the ndex * (1 + duraton of the ndex)] For example: For the 1Y ndex, bonds wth a duraton of 0 to 2 years are elgble For the 5Y ndex, bonds wth a duraton of 2 to 8 years are elgble, For the 10Y ndex, bonds wth a duraton of 4.5 to 15.5 years are elgble. The 3month ndex devates slgly form ths rule. From the begnnng of 1998 untl 28th of February 2006 only government guaranteed blls wth a duraton under 1 year were elgble (nstead of 0.9 years had the rule above appled). As of June 1, 2006, ths rule contnues to apply but wth the addton that nonndexed Treasury bonds wth a duraton of 1 year or lower are also elgble. Furthermore, at the same tme the rules were changed n order to ncrease the probablty that the ndex wll have a fxed duraton. The rules were changed n such a manner that f the stuaton arses that no elgble securty wth duraton above three months and less than or equal to one year exsts, then the governmentguaranteed securty wth the shortest duraton among those wth duraton above one year wll be selected. Stll, securtes wth a duraton of more than two years do not qualfy. 2. Wherever possble, bonds of both longer and shorter duraton than that of the ndex should be chosen. Thus bonds outsde of the duraton ntervals ndcated above can be consdered f necessary to ensure that the ndex ncludes duratons both longer and shorter than the desgnated ndex duraton. 3. If bonds wth duratons on both sdes of the ndex duraton are not avalable, only one bond shall be chosen for the ndex,.e. the bond wth a duraton closest to the ndex 1 When determnng the elgblty of a bond, ts duraton s rounded to one decmal place. 4(9)
5 duraton. Only under such crcumstances s the ndex duraton varable and wll dffer from ts reference duraton. 4. Elgblty for ndces based on the duraton rules descrbed n steps 1 and 2 above s determned on the 20th of each month (or the frst tradng day followng f the 20th s not a tradng day). 2 The duraton of the bonds as of that date (based on closng yeld that day) s used as reference. Changes under these rules take effect as of the 1 st of the followng month. Please note that ths rule, however, does not prevent new benchmark classes from becomng elgble earler for the ndces, as t apples to classes whch had already been ssued on the last date of revew. As prevously mentoned, new benchmark classes become elgble on the fourth day of tradng. Calculaton of ndex wegs Calculaton of the weg of each bond n the ndex s done n two steps: () All bonds n the ndex wth a duraton less than the ndex duraton are placed n one group (portfolo 1) and all bonds exceedng the ndex duraton n another (portfolo 2). The wegs of bonds n each group s determned usng a normal dstrbuton, wth the mean equal to the ndex duraton and standard devaton equal to 0.25 * (1 + ndex duraton). In partcular, wegs of a bond n portfolo k (k = 1 or 2) s: where 1 F z (1) n k F z s the weg of bond F (.) s the cumulatve probablty functon for the aforementoned normal dstrbuton, 2 The rule descrbed n step 3 has an mmedate effect on the day all elgble bonds are on one sde of the ndex target duraton. 5(9)
6 z s the number of standard devatons (absolute value) the duraton of a bond s from the duraton of the ndex, and n k s the number of bonds n group k. () The wegs of the portfolos on each sde of the ndex duraton are determned n the followng manner: If dp 1 s the duraton of portfolo 1, dp 2 s the duraton of portfolo 2 and d ndex s the duraton of the ndex, the weg of portfolo 1 s: d ndex d p2 p1 (2) d d p1 p2 and the weg of portfolo 2 s (3) p2 1 p1 The wegh of bond n the ndex s thus w * (4) pk f the bond s n portfolo k (k = 1 or 2) The duraton of portfolo k s found usng the followng formula: n d pk d (5) 1 where d s the duraton of bond. 6(9)
7 Index calculaton The ndex value s calculated usng the followng formula: I t I P H 1 (6) n t t t wt 1 Pt 1 jt 1 where I t = the ndex value on day t, w t = the weg of bond n the ndex on day t, P t = the drty prce, or settlement prce, of bond on day t, j t1 = an adjustment factor for nterest payments and nstalments. Ths s the amount of the cash flow (the sum of nstalments and nterest) on day t, H t = an adjustment factor reflectng the renvestment of called bonds (Housng Bonds). Ths s 0 except on the redempton date of called bonds, when the adjustment factor s gven a dfferent value f the yeld on date t dffers from the bond s nomnal yeld. Ths value depends upon the proporton of bonds called and the yeld on the call date (see below for more detals). All bonds are thus placed n the ndex formula on a comparable prce bass,.e. usng the drty prce for all of them, whch makes the prce n the formula dffer from the quoted market prce for both HFF bonds and some classes of Treasury bonds, where the quoted market prce s the clean prce. The adjustment factor j n the equaton denomnator results from the fact that on a cash flow exdate, and holdng other thngs constant, the drty prce (settlement prce) falls by the amount of ths cash flow. Adjustment for Housng Bonds 7(9)
8 A specal adjustment s made to the calculaton of ndces ncludng Housng Bonds on the redempton date for called Housng Bonds. The reason for ths s that the redempton prce dffers from the market prce of the bonds f ther nomnal nterest rate dffers from the yeld on the date of redempton. Wthout ths adjustment the ndex ncludng such bonds would underestmate (overestmate) the change n value of the underlyng asset portfolo when the redempton prce s hgher (lower) than the market prce of the bond n queston. We can take an example where a% of the class concerned s redeemed on date t. Snce the nomnal nterest rate dffers from the bond s market yeld, the value of the called bonds s a% * (P t + b) and not P t (b > 0 f the nomnal nterest rate s lower than the market yeld and b < 0 f the nomnal nterest rate s hgher than the yeld). Ths makes the adjustment coeffcent H t a% * b (7) Index yeld calculaton The ndces yeld s calculated by consderng the weged cash flow of the underlyng bonds. The calculated yeld s only meant to ndcate the yeld level of the relevant segment of the fxedncome market and s therefore for nformatonal purposes only. The ndex values are not based on the calculated yeld. The weged average prce of the ndex s gven by: n 1 w t P, (8) t where P : the prce of bond at tme t, t w : the weg of bond at tme t, t : the weged average prce of the consttuents of ndex h at tme t. The ndex s yeld s obtaned through the followng formula: 8(9)
9 T n st 1 w CF st 1 y t s / 360, (9) where CF : the cash flow from bond at tme s, s y : the yeld of ndex h at tme t. The quantty st s calculated accordng to the 30/360 day count rule. 9(9)
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