Brady Bond Primer - Brady Valuation Methodology

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What is the street valuation methodology?

Brady Bonds carry three risk components:

1. The principal collateral in the form of US Treasury zero coupon principal guarantee.

2. The rolling interest guarantees comprised of securities on deposit with the Federal Reserve Bank.
(By convention no consideration is given to rights and warrants for valuation purposes)

  • Two approaches may be considered for valuation purposes:
  • Use option pricing or probability models to determine the probability of default or
  • Conservatively assume the debtor default and the guarantee used to pay the interest
  • Sovereign risk.

A procedure to value Brady Bonds considers individually the three distinct risk components for each class of bond:

1. The present value of PAR and DISCOUNT principal collateral derived from U.S. Treasury strip yield with comparable maturity.

2. Conservative valuation of the interest component as assumed serviced by the rolling guarantee:

  • For fixed coupon bonds use either the U.S. Treasury Bill or \"AAA\" rates corresponding to the first 2 or 3 coupon dates.
  • For floating coupon bonds compute the equivalent fixed-rate yield on a LIBOR based asset swap or forward rate basis.

3. Value the remaining non-collateralized cash flows

  • Compute the stripped yield or the IRR of the remaining cash flows

4. Sovereign risk is the implied stripped yield (non enhanced by the credit guarantees)

  • Considered as the current Brady bond market price less the value of principal and interest collateral.
  • A blended yield to maturity is the IRR of the bond\'s total cash flows (collaterilized and non-collaterized components)
  • The blended yield will usually be lower than the stripped yield since the value of the guarantees will raise a bond\'s price.

NOTE: for additional information continue with Brady Debt Issue Flavors