Fair Valuation of Corporate Bonds in Pakistan

However, the market experienced a significant setback in 2008 due to the financial crisis, which led to a large number of TFCs being deemed non-performing. As a result, there was a shift towards floating rate bonds from fixed rate bonds, as interest rate fluctuations made the latter vulnerable to price risk. In recent years, banks have been the most active issuers of corporate debt in the market, approaching the bond market for financing due to increasing capital requirements by regulators and Basel implementation. However, many large corporates are still reluctant to approach the debt market due to high costs of issuance and listing, as well as lengthy approval times by authorities. Additionally, investors refrain from the corporate bond market due to low liquidity in the secondary market and a lack of transparent pricing mechanisms. A major characteristic of corporate debt security is the credit risk associated with it. In Pakistan's bond market, the federal government is the largest borrower and commands a similar rate to the rate of return sought by banks for interbank borrowing and from top corporates. This results in investors seeking even higher returns on corporate debentures to account for higher credit risk. Large blue-chip corporates, on the other hand, usually get better financing terms from commercial banks based on their sound track record, and therefore avoid approaching the debt market for financing. The corporate bond market in Pakistan is lopsided towards bad assets, with many companies seeking financing through debt instruments being those for whom regular bank financing is difficult to obtain. This is supported by the fact that the market has a low liquidity level, with few investors participating in the secondary market. The lack of transparent pricing mechanisms also contributes to the market's inefficiencies, making it challenging for investors to make informed decisions. The current pricing methodology in the corporate bond market in Pakistan has several issues, including the lack of trading volumes, non-coverage of certain issues, and invisibility of the over-the-counter (OTC) market. The Mutual Funds Association of Pakistan (MUFAP) plays a crucial role in the pricing process, but its methods have limitations. An alternative pricing framework, such as the Bond Pricing Agency (BPA) concept, has been proposed to address these issues and improve the market's efficiency. The BPA framework involves a pricing methodology that takes into account various factors, including the bond's yield, maturity, and credit rating.