Influential factors of pricing of Chinese national bonds

By | May 2, 2014

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1. Introduction of county selected: China 2
1.1 Economic facts 2
1.2 Justification for choosing this country 3
2. The chosen market: debt market 3
2.1 Essential features of debt market in China 4
2.2 Chosen instrument: China Government Bond 4
3. Pricing the chosen instrument 4
3.1 How is the chosen instrument priced? 4
3.2 How is it traded? 5
3.3 The market microstructure features of trading 6
3.4 Snapshot of pricing data 6
Reference 7

Chart 1 China GDP annual growth rate 2
Chart 2 The price records of the China Government Bond (10 Years) 3

Fin 8202

1. Introduction of county selected: China

We will choose China as the targeted country to be studied in order to facilitate our study and make it more focused as the financial markets are very much differentiated across different nations and regions.

1.1 Economic facts

Chart 1 China GDP annual growth rate
Source: tradingeconomics.com 2012

Chinese economic has been considered as one of the most vivid economies in the work in the past two decades since its implementation of the reform and opening up policy in the year of 1978. Though the double digit miracle seemed to be ended by the US led economic crisis in 2008, the economic growth slowed down but an approximately 8 per cent growth is maintained. As a matter of fact, according to official data, the GDP of the country increased by 8.9 per cent in the 4th Quarter, a steady but modest decline compared to 9.7 per cent in Q1, 9.5 per cent in Q2, and 9.1 per cent in Q3. And therefore the overall GDP growth for the single year of 2011 reached 9.2 per cent (wordpress.com 2012).

1.2 Justification for choosing this country

There are three major reasons that China is chosen as the country to be studied. First of all, China has been a member of WTO since 11 December 2001 (wto.org 2008). With also the growth of the trade volume with the major economies, China has been one important trade partner to many countries and therefore it is significant to study its financial market; secondly, it is expected that the financial market in the country would be completely open to international investors. And according to Xu (2011) international investment funds are already gearing up to fully grasp the lucrative opportunities offered by China’s financial market; China is one leading economy among the raising economies which have become very popular among the investors in particular during the most recent economic crisis and sovereignty debt crisis, and in fear of the impacts over the capital value, many investors are now prefer to invest in the raising economies and no doubt that China has become a key choice.

2. The chosen market: debt market

Debt market refers to the financial market where investors buy and sell debt securities, mostly in the form of bonds (Sasidharan 2011, p. 100). The debt market of China is chosen to be studied for several major reasons. First of all, since the beginning of 2001, the China’s debt market has developed continually and steadily in term of market size. According to the earlier data, in year of 2007, the issuance of bonds in the inter-bank market was over CNY 7.98 trillion with a year on year growth of 40 per cent (Barth, Tatom & Yago 2009, p. 552); secondly, debt market is in general consider as with less risk than the stock market. As the foreign investors are concerning about the risks in China and because of the less familiar with China, debt market is usually the first market where the foreign investors could have a try.

2.1 Essential features of debt market in China

There are some key features that describe the functioning of the debt market in China. First of all, the government bonds and central bank bonds have the largest issuing volumes and the annual volume of issuance of these two kinds is much bigger than those of the stock market and the corporate bond (Chan 2007). Secondly, as well known China has a strong central government and the strong power of the government is also seen in term of strict control of all kinds of bonds and the operation of all market venues and therefore the strong control by the government is one of the key features and there are a number of implications because of the influence of the government though these implications are not discussed in the study further.

2.2 Chosen instrument: China Government Bond

There are several factors behind the rationality of choosing the China government bound as the investment instrument. First of all, national debt or government debt is usually considered as one important investment in the investment portfolio for investors and as China becoming the second largest economic in the world, its national debt should receive sufficient attention from the foreign investors; secondly, government bonds are usually denominated in the country’s own currency, as mentioned above foreign investors are concerning about the risks in China and because of the less familiar with China, government bonds is the investment with least risk in the debt market of China.

3. Pricing the chosen instrument

3.1 How is the chosen instrument priced?

The national bond of China could be influenced by a number of factors in term of pricing. But still the price of the national bond is co-decided by the demand and the supply side factors. First of all, as above mentioned, China has a strong government; the issuance volume is decided by the government could have a strong impact over the pricing of the government bond, in particular when some government bonds come with fixed interest rate and the government could directly set the interest rate in a higher level to attract the domestic and international investors; secondly, the strong control of the government could also seen from the strong roll of the major stated owned banks. As known to us, China’s banking system is largely controlled by the four largest state owned banks though such state ownership is becoming weaker with the listing of these banks but so far the government could still press the banks in dealing with the national bond products; thirdly, the price of a debt product is also influenced by the bank interest rate and if the bank interest rate increased strongly and it would reduce the demand of the government bond; fourthly, as mentioned above the government bond has less risks, and therefore if people expect that there could be risks in the economy, they would prefer to buy in the government bond to resist such risks. As a result the expectation of the future economy would become important in pricing the national bond of China.

3.2 How is it traded?

The China Government Bond are traded in three markets which include inter-bank, exchange and also the most seen channel we know, the bank counter. While the government bond of China are traded in exchange, the trading of the government bond future is still banned though China is on track to reintroduce the trading of government bond futures which a major financial derivatives instrument banned 17 years according to the recent new report (wsj.com 2012). Nevertheless, in case of the government bond itself, it is traded widely.

3.3 The market microstructure features of trading

To the foreign investors, stock exchange is usually the market where they can trade the China national bond. In term of the trading process, there are five major steps: account opening, entrusting, making deals, deal clearance, ownership transferring. In another word, in order for foreign investors to trade the China national bond, investors have to open account with the security companies and build up the entrusting relationship with these security companies. In term of each transaction, investors could approach the security companies’ counter as well as through telephone entrusting and other ways to proceed the deals.

3.4 Snapshot of pricing data

Chart 2 The price records of the China Government Bond (10 Years)
Source: tradingeconomics.com 2012

From the above chart, we can see that China’s Government Bond Yield for 10 Year Notes rallied 4 basis points during the last 30 days which means it became more expensive for China to borrow money from investors though speaking from a whole year since September last year, the China’s Government Bond 10Y current price is not at its peak as it reached at about 3.4 in two separate time points as the above chart shows.

Reference

Barth, J. R., Tatom, J. A. & Yago, G. 2009, China’s Emerging Financial Markets: Challenges and Opportunities. London: Springer. p. 552

Chan, K. C. 2007. China’s Capital Markets: Challenges from WTO Membership. Cheltenham: Edward Elgar Publishing.

Sasidharan, K. 2011, Security Analysis & Portfolio Mgmt. New Delhi: Tata McGraw-Hill. p. 100

tradingeconomics.com 2012. China Government Bond 10Y. accessed on 12 Sep 2012 [online] available: http://www.tradingeconomics.com/china/government-bond-yield

Xu, L. 2011. China’s Economy in the Post-Wto Environment: Stock Markets. Cheltenham: Edward Elgar Publishing Limited.

wordpress.com 2012. BBC: China’s 2011 GDP Numbers. accessed on 12 Sep 2012 [online] http://chovanec.wordpress.com/2012/01/17/bbc-chinas-2011-gdp-numbers/

wto.org 2008. China and the WTO. accessed on 12 Sep 2012 [online] http://www.wto.org/english/thewto_e/countries_e/china_e.htm