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How Much Should You Pay for CapitaMall Trust’s Retail Bonds?

Yesterday, CapitaMall Trust (SGX: C38U), a real estate investment trust that focuses on retail malls, announced that it would be offering S$150m worth of bonds to the general public in Singapore.

These bonds – termed as retail bonds – would mature in seven years and entitle its holders to a fixed annual interest payment of 3.08% with a half-yearly pay-out on February and August of each year.

Wilson Tan, chief executive of the REIT’s manager, a wholly-owned subsidiary of retail mall owner and manager CapitaMalls Asia (SGX: JS8), mentioned that the first series of 2-year retail bonds issued in 2011 “received strong interest from retail investors and was about 1.9 times subscribed.” So, if history is to be used as a judge, we might be seeing strong investor interest surface again with this new offering.

It would be easy to subscribe for the bonds – subscription opens at 9am today and would close at 12 noon on 18 Feb 2014 – as applications can be made via automated teller machines (ATMs), websites, and mobile banking interfaces of various banks that include DBS, OCBC, UOB, and Far Eastern Bank Limited.

From the coupon payments of the bond, it’s also obvious to see the returns that bond investors can get from the bonds. But here, a more interesting question arises – how much should you actually pay for those bonds if your goal is to have returns that could at least match inflation?

To answer that, we first have to understand that the value of money does not stay constant with time – a dollar 30 years ago could be used to purchase so much more goods and services than is possible now due to inflation.

This then leads us to the concept of the present value of money. Here’s what I have previously written on the topic:

“Suppose that we’re willing to give you S$20 either today or in 10 years. Most likely, you’d choose to have the money today. After all, there will likely be inflation over the next decade, so you’ll be able to have more chicken rice with that S$20 now than you’d be able to buy in 10 years.

Or perhaps you like money more than you like chicken rice so you decide to invest that S$20 in Singapore government 10-year bonds earning annual interest of around 2.5%. In 10 years, that S$20 will have grown to S$25.60. Thus, S$20 now is worth 28% more than S$20 in 10 years.

Now turn the question around. What is the present value of S$20 in 10 years? In other words, how much money would we need to leave in 2.5% bonds to have S$20 at the end of 10 years? The answer is S$15.62 (S$20 divided by 1.025 to the power of 10). 10 years in the future, you could consider an IOU for S$20 as worth only about S$15 today, because the discounted value of S$20 is S$16. In this case, 2.5% would be the discount rate.”

In our context here, if we assume that inflation is running at 3% a year, then a discount rate of 3% would be used if you’ll like your investment returns to match the rate of inflation. Here’s how the calculations work out based upon the minimum sum of S$2,000 that’s required for an investment into CapitaMall Trust’s retail bonds.

Discounted coupon payments

Year after purchase of bonds

Annual coupon payments
(not accounting for inflation)

Discount

Present value of annual coupon payments after accounting for 3% inflation

1

S$70.60

1.03

S$68.54

2

S$70.60

1.032

S$66.55

3

S$70.60

1.033

S$64.61

4

S$70.60

1.034

S$62.73

5

S$70.60

1.035

S$60.90

6

S$70.60

1.036

S$59.13

7

S$70.60

1.037

S$57.40

Discounted principal payments

Year after purchase of bonds

Principal payment
(not accounting for inflation)

Discount

Present value of principal payment after accounting for 3% inflation

1

1.03

2

1.032

3

1.033

4

1.034

5

1.035

6

1.036

7

S$2,000

1.037

S$1,626.18

So, if we sum up the present value of the principal and annual coupon payments in the two tables above, S$2,000 worth of bonds would have to be purchased at a price above S$2,066 for you to lose money in real, inflation-adjusted terms in a scenario where the inflation rate is at 3%. On the other hand, if you think inflation could hit 4% for prolonged periods of time in the future, then the present value of S$2,000 worth of CMT’s retail bonds would become S$1,944 (using a discount rate of 4%).

 

Inflation of 2%

Inflation of 3%

Inflation of 4%

Present Value of S$2,000 invested into CMT’s retail bonds

S$2,198

S$2,066

S$1,944

In other words, what you should pay for CMT’s retail bonds – or any other bond for the matter – is heavily affected by the rate of return you desire. And, if your goal’s to beat inflation, you would really have to form an outlook for the rate of inflation to pinpoint a proper discount rate for those bonds.

Of course, investors who choose to subscribe for the bonds during the application period would have no say over the price they’ll have to pay for the investment. But, there’s another choice investors can make with regard to the retail bond offering – they can choose not to participate if the returns being offered does not match up with what’s desired.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn’t own shares in any companies mentioned.