emerging markets bond index plus (embi+) jpmorgan

Emerging Markets ResearchBond IndexJ.P. Morgan Securities Inc.December 2004

Emerging Markets Bond Index Plus (EMBI+)Rules and Methodology

• The EMBI+ was created in response to investor demand for a liquidemerging markets debt benchmark

• The EMBI+ is a traditional, market-capitalization weighted indexcomprised of USD-denominated Brady bonds, Eurobonds, and tradedloans issued by sovereign entities

• Daily historical levels are available from December 31, 1993

OverviewThe JPMorgan Emerging Markets Bond Index Plus (EMBI+) is our mostliquid US-dollar emerging markets debt benchmark, and tracks totalreturns for actively traded external debt instruments in emerging markets.Included in the EMBI+ are US-dollar denominated Brady bonds,Eurobonds, and traded loans issued by sovereign entities.

The EMBI+ provides investors with a definition of the market for liquidemerging markets sovereign debt and its traded instruments. It segmentsfurther the universe of emerging markets as defined by the morecomprehensive EMBI Global and EMBI Global Diversified, by placing astrict liquidity requirement rule for inclusion. Other differences ininclusion rules apply. (Please refer to the methodology piece EMBI Globaland EMBI Global Diversified: Rules and Methodology for moreinformation on the EMBI Global/Diversified).

To be deemed an emerging market by the EMBI+, a country must be ratedBaa1/BBB+ or below by Moody’s/S&P rating agencies. This criterion,along with the liquidity ranking rule, carves out a basket of liquid bonds,each capable of being bought and sold at short notice, and quoted daily byseveral market makers at relatively low bid/offer spreads. The EMBI+ istransparent and timely, representing opportunities available to investors inthis market. It is geared toward managers of index funds who strictlyadhere to the performance and portfolio changes of the index.

www.morganmarkets.com

Gloria M. Kim(1-212) [email protected]

The certifying analyst(s) is indicated by the notation “AC.” See last page of thereport for analyst certification and important legal and regulatory disclosures.

Index inclusion selection processWe adhere to a strict set of rules for selecting countries and instruments forinclusion in the EMBI+. To be included in the EMBI+, bonds must meet botheligibility and liquidity requirements. When a bond meets both requirements, itis added to our indices; when it does not, it is dropped. Instruments that satisfyall the following defined criteria will be eligible for inclusion in the EMBI+:

1. Instrument type2. Issuer type classification;3. Currency denomination;4. Credit rating criteria;5. Current face amount outstanding;6. Remaining time until maturity;7. Legal jurisdiction;8. Settlement method;9. Quantifiable source of cash flow return; and10. Liquidity Ranking.

Emerging Markets ResearchEmerging Markets Bond Index Plus

Gloria M. Kim (1-212) 834-4153 Jennie Byun (1-212) 834-4029 Alvin Ying (1-212) [email protected] [email protected] [email protected]

2 December 2004

Table 1: EMBI indices at a glanceInclusion criteria EMBI+ EMBI Global EMBIG Diversified

Country requirements Rated Baa1/BBB+ Low/Middle income for Low/Middle income foror under by two consecutive years two consecutive years

Moody’s/S&P as per World Bank as per World Bank

Instrument requirementsMinimum issue size $500 million $500 million $500 million

Maturity requirement At least 2.5 years At least 2.5 years At least 2.5 yearsfor initial entry until maturity until maturity until maturity

Maturity requirement At least 1 year At least 1 year At least 1 yearto maintain inclusion until maturity until maturity until maturity

Liquidity criteria Must pass a series of Daily available pricing Daily available pricingliquidity tests (a minimum from an interdealer from an interdealer

bid/ask price and specific number broker or JPMorgan broker or JPMorganof interdealer broker quotes)

Face amt. constrained No No Yes

Includes quasi-sovereigns No Yes Yes

Table 2: Other JPMorgan indicesIndex IncludesLatin Eurobond Index (LEI) Latin American USD-denominated sovereign and corporate

bonds

Russia Corporate Bond Index (RUBI) Russian corporate bonds denominated in USD

JPMorgan Asia Credit Index (JACI) Asian USD-denominated sovereign and corporate bonds

EURO EMBIG/Diversified EURO-denominated sovereign and quasi-sovereign bonds

Emerging Local Markets Index Plus (ELMI+) Money market instruments within emerging marketsdenominated in local currency

Dow Jones CDX.EM Credit default swaps: a liquid, diversified basket of emergingmarket sovereign CDS



December 2004 3

Instrument TypeThe EMBI+ includes both fixed and floating-rate instruments, as well ascapitalizing/amortizing bonds or loans. Bonds or loans with embedded optionsand warrants are eligible for inclusion if a) the options/warrants are attached toinstruments that would otherwise be included in the index and b) the quotationconvention (as recommended by the Emerging Markets Traders Association) isfor instrument prices to be quoted cum options or warrants. Convertible bondsare not eligible for inclusion into the index.

Issuer type classificationThe EMBI+ contains only bonds or loans issued by sovereign entities fromindex-eligible countries. Quasi-sovereigns are not eligible for the EMBI+ evenif the entity is 100% owned by the government. Instruments issued bymunicipalities or provinces are also not eligible for inclusion.

Instruments will not be eligible for inclusion in the index if their credit has beenimproved by a) giving security over commercial receivables or b) giving aguarantee from a guarantor which is not a subsidiary of the eventual obligor orthe parent company/beneficiary of the issuer of the instrument. For thepurposes of clarification, bonds that are secured in part by US Treasuries (e.g.Brady bonds) are eligible for inclusion.

Where financing vehicles are used, bonds or loans may be included in theEMBI+ if either 1) the financing vehicle or bond is guaranteed by an index eligibleissuer or 2) the transaction is structured as a pass-through where the creditor ofthe financing vehicle has full recourse to the underlying loan or bond between thefinancing vehicle and the final obligor, which itself must be an index eligible issuer.

In order to avoid double counting of index instruments, a bond or loan that isissued by a financing vehicle is only eligible for inclusion into the EMBI+ if theunderlying loan or bond is not itself included in the index.

Currency denominationOnly those instruments denominated in US dollars are considered for inclusion.Instruments denominated in US dollars where the amount of coupon orredemption payment is linked to an exchange rate are not eligible for inclusion.Prior to 1998, external-currency denominated instruments other than US-dollar, aswell as corporates, were allowed in the EMBI+, but have since then been removed.

Credit rating criteriaEligible instruments are determined by the rating assigned by Moody’s andS&P to the bond’s originating country. Since the EMBI+ covers external-currencydebt, we have defined emerging markets countries according to the ability to repayexternal-denominated debt. A country must be rated Baa1/BBB+ or below inits long-term foreign currency rating for its instruments to enter and remain in theindex. When a country receives a rating of A-/A3 or higher from both Moody’sand S&P, it is dropped from the EMBI+ at the next month-end rebalancing.

Current face amount outstandingOnly issues with current face amount outstanding of $500 million or more willbe considered for inclusion.

If an issue’s current face outstanding falls below this requirement (due to eithera debt retirement by the sovereign or the amortization of principal), the issuewill be removed from the index at the next month-end rebalancing date. Thereverse also holds true. Existing issues that, through reopenings, increase insize to satisfy our minimum current face outstanding requirement are thenconsidered for inclusion in the index at the next month-end rebalancing date.

Time until maturityA bond can only be added to the EMBI+ as long as its remaining life is greaterthan 2 1/2 years at the time at which it satisfies our inclusion criteria. Once anissue is added to the EMBI+, it may remain there up until 12 months prior tomaturity, assuming it continues to meet our inclusion criteria.

An instrument that has been dropped from the EMBI+ is not eligible to re-enterthe EMBI+ for 12 months. Such a step further ensures that the composition ofeach index is not subject to temporary liquidity trends.

Legal JurisdictionEffective May 31, 2002, inclusion into the EMBI+ is limited to issues with legaljurisdiction that is domestic to a G7 country. Local law instruments or bondsthat do not fall under G7 jurisdiction are not eligible for the index.

Settlement CriteriaInstruments in the EMBI+ must be able to settle internationally (either throughEuroclear or another institution domiciled outside the issuing country).

Quantifiable source of cash flow returnJPMorgan reserves the right to exclude from the composition of the EMBI+ anydebt instrument that it considers to have a cash flow structure from whichverifiable daily returns or other statistics (i.e. yield, spreads) cannot be calculated.

Liquidity Ranking Once the eligibility requirements are met, liquidity criteria are applied to theremaining universe of instruments. We look at three attributes to determineliquidity ratings: (1) size of the issue, (2) average monthly bid/ask spread, and(3) number of designated brokers providing daily quotes. The following tablesummarizes our liquidity ratings:

Rating Definition

L1 $2 billion face amount outstanding minimum, average bid/ask spread <= 3/8 point, and quoted by100% of all designated brokers

L2 $1 billion face amount outstanding minimum, average bid/ask spread < = 3/4 point, and quoted byat least 1/2 of the designated brokers

L3 $500 million face amount outstanding minimum, average bid/ask spread <= 1 1/2 points, andquoted by at least 1/4 of the designated brokers

L4 $500 million face amount outstanding minimum, average bid/ask spread <= 3 points, and quotedby at least 1 designated broker

L5 $500 million face amount outstanding minimum, average bid/ask spread => 3 points, and notquoted by any designated brokers



4 December 2004



December 2004 5

For a bond to be added to the EMBI+, it must be rated:

• L1 for 1 month, or

• L2 or higher for 3 consecutive months, or

• L3 or higher for 6 consecutive months.

For a bond to be dropped from the EMBI+, it must be rated:

• L4 for 6 consecutive months, or

• L5 for 1 month.

Timing of the addition of new issuesA new issue that meets the EMBI+ admission requirements is added to the indexon the first month-end business date after its issuance, provided its issue date fallsbefore the 15th of the month. A new issue whose issue date falls on or after the15th of the month is added to the index on the last business day of the next month.

There are two exceptions to the rule. The first exception applies to a new issuethat is released as part of a debt exchange program. For example, assume acountry exchanges a portion of its outstanding debt for a new issue after the15th of the month. At the month-end rebalancing date immediately followingthis event, the amount of debt retired in this exchange would be removed fromthe EMBI+,and the new issue would be added to the index (provided officialexchange results are made available in a timely manner).

The second exception concerns Reg S securities. An instrument that is issuedpurely in reliance on Regulation S of the U.S. Securities Act of 1933 and notpursuant to Rule 144A will be ineligible for inclusion in the EMBI Indices untilit is seasoned (that is, until the expiration of the relevant Regulation S restrictedperiod). The date at which the seasoning restriction is lifted will effectively bethe new “issue” date, at which point the 15th of the month rule will apply.

In extreme cases, an intra-month rebalancing can occur, where the EMBI+ isrebalanced before the end of the month. An intra-month rebalancing istriggered when:

• More than $6 billion of the face amount of EMBI+ bonds are exchanged, or

• More than 2/3 of the face amount of any one of the most liquid (identified asbonds with an L1 rating) index bonds is exchanged

Please refer to the Intra-Month Rebalancing Methodology, dated May 31, 2001for precise details on the mechanics behind intra-month rebalancings.

If an announcement is made for a bond to be called, it is removed the monthendprior to its call date on the basis of having less than 12 months remaining untilmaturity. If an announcement is not made in time for the bond to be removedthe prior monthend, it will be removed the first monthend following theannouncement, unless the amount to be called triggers an Intra-monthrebalancing (rules above).

Index weighting methodsThe weight of each instrument in the EMBI+ is determined by dividing the issue’smarket capitalization by the total market capitalization for all instruments in theindex. The result represents the weight of the issue expressed as a percentage ofthe EMBI+. Country weights for the EMBI+ are easily calculated by aggregatingthe weights of the instruments for each country. The market capitalization ofeach issue is calculated by multiplying its face amount outstanding by its bid-side settlement price. Face amounts outstanding for each issue are updated ateach month-end in order to reflect market events—such as reopenings orbuybacks—that have increased or decreased the issue’s available supply.

Daily Production of the EMBI+

The EMBI+ is produced every business day of the year. Business days arebased on the US bond market calendar set by the Emerging Markets TradersAssociation (EMTA).

Pricing on regular business daysThe EMBI+ is priced at 3:00pm Eastern Standard Time (EST) every business dayof the year as defined by the US bond market calendar. Composite instrumentsare priced using the best market bid (highest) and the best market ask (lowest)indicated by the following emerging market broker screens: Eurobrokers,Garban, GFI, Tullet & Tokyo, and Tradition. For instruments where there is not avalid price available at 3:00pm EST, the last available valid price is obtained fromthe market. As a last resort, if there are no valid market prices for an instrument,JPMorgan traders are asked to provide a market bid and ask. For thoseinstruments where pricing is not available on a regular basis, the compositionmethodology ensures that such instruments are excluded from the EMBI+.

Early closesWhen the US bond market closes early, typically before market holidays orwhen EMTA recommends an early close, prices of EMBI+ instruments arecaptured at the latest possible time to reflect an active closing market. Theliquidity of the EMBI+ is somewhat determined by whether internationalmarkets are open. On certain international holidays when the capital markets ofmany countries are closed, the liquidity of the EMBI+ diminishes and the indexis closed early to accurately reflect market prices.



6 December 2004



December 2004 7

Where to find the EMBI+

Daily EMBI+ results can be found in the following places:

• MorganMarkets (morganmarkets.com): Contains downloadable files ofdaily country and instrument returns, statistics, and compositions, as well asdata series of historical index levels and sovereign spreads.

• Dataquery on MorganMarkets: Allows clients to view, manipulate anddownload user-specific queries. Access Dataquery via MorganMarketswebsite from Tools > Business Tools.

• Reuters: Page <EMBI01> offers a directory of results for all JPMorganemerging markets bond indices; pages <EMBI19>and <11EMJ> displayclosing and real-time levels for the EMBI+, respectively.

• Bloomberg: Page <JPMX> is the directory page for all JPMorgan EMBIindices and their closing levels; options 4 and 5 display closing index levelsand statistics; page <JPME3> displays real-time levels for the EMBI+.

• JPMorgan’s monthly Emerging Markets Bond Index Monitor contains indexreturns, statistics, and composition updates for all of our emerging markets indices.

Custom Index BuilderJPMorgan has also made available the Custom Index Builder (viaMorganMarkets > Tools). This on-line tool allows clients to create customizedindices based on the following categorization:

• country selection • fixed versus floating rate-type

• maturity buckets • performing versus non-performing status

• credit ratings • collateralized and uncollateralized profile

Clients can choose to fix their custom portfolio weights or let it float on amarket-cap weighted basis. Using the JPMorgan Custom Index Builder,investors can hone in on the specific sectors applicable to their portfolios orevaluate potential investment scenarios with ease.



8 December 2004

Appendix: Instrument and index totalreturn calculationsThe following is a description of our methodology for calculating returns (total,price, and interest returns). Section I describes single-instrument returns.Section II describes index total returns. Section III describes yields and spreadcalculations for single instruments and the index as a whole.

The total return calculation for a single instrument is a means of representingthe economic benefit of holding the specific security. In its simplest form, it isbased on the “cash in/cash out” notion—i.e., what is paid for the security at theinitial purchase versus what is received at its sale. Of course, most fixed incomesecurities pay some form of coupon along the way, and some pay amortizations.For the calculation of individual instrument total returns, this cash is reinvestedin the instrument when received. However, when the instrument is part of aportfolio whose allocations are based on market capitalization (in the case ofthe EMBI+), the use of this market capitalization weighting scheme in effectcauses this cash to be proportionately reinvested in the other instruments thatmake up the portfolio.

The means of calculating the total return on a basket containing variousinstruments is an extension of the single-instrument total return framework. Tohold a “passive” portfolio, one would buy the instruments in the sameproportions in which they comprise the EMBI+. Each proportional amount is afunction of both the amount of the instrument outstanding (based on publiclyavailable information) and its settlement price. These two factors, whenmultiplied together, equal the asset’s market capitalization.

I. Single-instrument returnThe total return on a performing instrument is measured from one trade day tothe next using the following generalized equation:

This equation captures the three main components of a fixed income asset’svalue: price, cash flow (coupon and/or amortization) and currency. Thesecomponents are represented by:

Effective settlement value; primarily a function of the effectivesettlement price but also of the ex-coupon and ex-amortization rules[see equation (2) below]

If applicable, the coupon payment to which a holder on trade date t isentitled on value date v(t); determined by the instrument structure,ex-coupon conventions, and holiday calendar

1FX

FX

ESV

AMCESVtr

1ti,

ti,

1)s(t

v(t)v(t)s(t)t −×

++=

−−

( )tsESV

1.

( )tvC



December 2004 9

If applicable, the amortization to which a holder on trade date t isentitled on value date v(t); determined by the instrument structure,ex-amortization conventions, and holiday calendar

Foreign currency exchange rate for currency i measured in U.S.dollars per unit of foreign currency. Since the EMBI+ currentlycontain only U.S. dollar-denominated instruments, currency does notcontribute to the indices’ daily returns.

t Trade date; all index instruments trade on a New York holiday calendar

v(t) Value date for trade date t; date used to calculate accrued interest,which usually, but not always, coincides with the settlement date

s(t) Settlement date for trade date t; date on which cash transaction occurs

The effective settlement value can be calculated as follows:

where:

Effective settlement price, which is the price paid for a bond that istraded on trade date t and settled on settlement day s(t). The settlementdate is determined by the settlement convention of the bond andholiday calendar for the settlement convention; in short, the amount ofmoney, including accrued interest, etc., owed at the settlement date.

Ex-coupon placeholder; in some markets, market conventiondesignates a date that begins an “ex-period,” ending on the couponpayment date, during which a seller of the bond is entitled to keepthe upcoming coupon. This ex-period is usually 30 days. In effect,the coupon is stripped from the bond, such that the current buyer isno longer buying the rights to the coupon, and therefore the ESP paidby the buyer should be reduced by the amount of the foregonecoupon. For the total return, however, it is imperative to maintain thecontinuity of the traded asset – i.e., the bond should be“reconstituted” to its cum-payment before the ex-structure. To dothis, we account for the value this coupon represents to the seller viaan ex-coupon placeholder. Intuitively, the placeholder is an amountrepresenting the value of the next coupon discounted to thesettlement date of the transaction and is calculated as:

C Coupon amount to be paid at the end of the ex-period

Lt One-month Libor, used as the cash rate for the discounting

ds,t Number of days from settlement to the next coupon

( )tvAM

ti,FX

( )tsESP

( )tvxc

v(t)v(t)s(t)s(t) xamxcESPESV ++=

360tds,

t

v(t)

)L(1

Cxc

+

=

2.



10 December 2004

xamv(t) Ex-amortization placeholder; this concept is completely analogous tothe ex-coupon placeholder and is calculated in the same way:

The ex-coupon and ex-amortization placeholders are carried in both thenumerator and the denominator of the total return formula and effectively ceaseto exist when the ex-period elapses.

Although this equation is sufficient for the generalized concept of total return,complexities stem from the determination of the effective settlement price andthe treatment of interim cash flows. Therefore, below we describe thedifferences between instrument types, then show how these differences areincorporated into the generalized equation.

Effective settlement prices, ESPs(t)Effective settlement price is the instrument’s settlement “price”—i.e., theamount of money owed at settlement. ESP calculations translate the quotedprice into this settlement price, taking into account appropriate quotationconventions and settlement practices.

The quotation and settlement of USD-denominated bonds in the emergingmarkets currently follow guidelines set by two different groups. Brady bondsand Eurobonds follow standard international settlement, set by the InternationalSecurities Markets Association (ISMA). Price quoting conventions areoverseen, but not set by, the Emerging Markets Traders Association (EMTA);EMTA members also agree upon trading and settlement practices for loans.

There currently are two settlement practices used for instruments in the EMBI+:standard international settlement and loan settlement. The standardinternational settlement period was seven calendar days through June 1, 1995,and became three business days on June 7, 1995. Loan settlement follows anEMTA prescribed “batch settlement” process, whereby trades executed duringspecified time periods all settle on single pre-determined settlement dates.

Two types of price-quoting distinctions apply: the clean versus dirty pricingconvention and the current versus original face pricing convention.

Clean versus dirty quote conventionsThe clean-dirty distinction refers to whether an instrument’s quoted price isinclusive of accrued interest or not. Since the effective settlement price refersto all money paid at settlement, if a bond is quoted clean, the accrued interestthrough the value date owed at settlement must be added to the instrument’s price.

360tds,

t

v(t)

)L(1

AMxam

+

=



December 2004 11

Current face versus original face value quote conventionsThe current face-original face value distinction applies to amortizing andcapitalizing bonds; it refers to whether a bond’s quoted price is for a currentface amount of 100 or for the original face value of the bond, which may reflectthe fact that the instrument has amortized to an amount less than 100 or hascapitalized to an amount greater than 100. Since effective settlement pricerefers to the money actually paid at settlement, which is based on the currentoutstanding face value of the bond, an adjustment is made to the bond’s quotedprice on a current-face basis to adjust it to an original-face basis. Table 3shows the pricing conventions of instruments in the EMBI+.

Table 3: Price quoting conventions for EMBI+ instrumentsCurrent Face Original face

Clean (without accrued interest) Bradys, Euros, NoneMoroccan Tranche A

Dirty (with accrued interest) Argentine defaulted debt

For example, a bond that is trading at par but has just amortized 10% wouldtrade at a price of 100 on a current-face basis, but at a price of 90 on an original-face basis. Also, a bond that is trading at par and has just capitalized 10%would trade at 100 on a current-face basis and 110 on an original-face basis.

The adjustment from a current-face to an original-face basis is achieved byusing a “balance” scalar, Bv(t), which keeps track of the remaining balance of abond after capitalizations and amortizations. For bonds that have amortizedfrom par, the balance scalar will be between 0 and 1, starting at 1 at issue anddecreasing to 0 at the final amortization (maturity) of the bond. For bonds thatcapitalize, the number rises starting at 1, as determined by the capitalizationrates of the bond. This balance scalar strictly follows the quoting conventionsof a bond and is not necessarily related to the balance of outstanding bonds astracked by an issuer.

For example, in the case of bonds that trade with an ex-period foramortizations, the “ex-balance” follows the same convention. If the bond goesex-amortization 30 days before the coupon, on that date the seller retains theright to the coupon; therefore, the effective settlement price is lowered (jumpsdown) by the amount of the amortization, since the buyer is no longer entitledto it. For a bond trading on a current-face basis, this adjustment at settlement ismade via the Bv(t) scalar. This scalar is an important variable because it adjustsother variables affecting the effective settlement price. Accrued interest, forexample, is normally computed on a cash basis (i.e., coupon rate x day count),ignoring the current balance of the bond. Here, again, the scalar is used toadjust the accrued interest for the balance on the bond.

Because the balance scalar is determined independently (i.e., it is based solelyon the cash flow structure and quoting conventions for the bond), it can be usedto scale all other variables. The remainder of this description assumes that allnon-price variables have been appropriately adjusted and, therefore, defined onan original-face basis.



12 December 2004

With these concepts in mind, we can generalize the equation for the effectivesettlement price of performing instruments as follows:

where:

Bid price of a bond according to the quoting conventions of thebond’s market; total return is calculated on the bid side so as torepresent the “cash out” value of the bond on a given day

CO Current face/original face value indicator:1 = Bond quoted on a current-face basis (i.e., needs scaling ifapplicable); and0 = Bond quoted on an original-face value basis

Bv(t) Face balance scalar used to adjust for principal balance due, asdetermined by the cash-flow structure, and settlement and ex-balanceconventions

ACv(t) Accrued capitalization; for bonds that capitalize and are quoted on acurrent-face basis, an adjustment is made at settlement for the portionof the next capitalization that is not included in the quoted price.Since capitalization is a payment for principal (unlike accruedinterest, which is a payment for interest), the accrued capitalization,AC, is multiplied by the quoted price; AC is determined analogouslyto accrued interest (i.e., capitalization rate x day count convention)

CD Clean/dirty indicator:1 = Bond quoted on a clean basis; and0 = Bond quoted on a dirty basis

AIv(t) Current period’s coupon rate x day count convention; this iscalculated up to, but excluding, the value date, v(t). Althoughconventions covering accrued interest calculations can begeneralized, exceptions do apply.

Settlement and interest calculationsEMBI+ calculations take into account accrued interest conventions, settlementconventions, and ex-coupon/ ex-amortization conventions of each security andmarket.

Day-count basisIn general, the day-count basis will depend on whether a bond has a fixed orfloating rate. For fixed-rate bonds, it is usually 30/360, and for floating-ratebonds, it is usually either actual/360 or Treasury actual/actual. Exceptionsexist, which apply to certain Brady bonds.

{ }v(t)

Qtv(t)

v(t)Qts(t)

AI CDbp AC CO

1 0, CO if ,B1, CO if bpESP

×+××+

==×=

Qtbp

3.



December 2004 13

Coupon paymentDepending upon the specific debt instrument, coupons can be scheduledmonthly, quarterly, semiannually, or annually. How the coupon end-of-periodand pay dates are set vary from bond to bond. Several conventions apply tosituations in which the end of a coupon’s period falls on a weekend or holiday,as defined by EMTA. These conventions are detailed in Table 4.

Table 4: End-of-period conventionsIf a scheduled end-of-period (EOP) date falls on a weekend or holiday, the end of period:

EOP/Pay 1 Remains on that date, and the actual pay date is moved to the next business day.

EOP/Pay 2 And the actual pay date are moved to the next business day.

EOP/Pay 3 And the actual pay date are moved to the next business day, unless that pushes them to thenext calendar month, in which case they are moved to the preceding business day.

EOP/Pay 4 And the actual pay date are moved to the next business day, and all subsequent ends ofperiods are benchmarked from that day.

EOP/Pay 5 All hybrid cases of 1 through 4.

Coupon accrualGenerally, interest accrues from the previous coupon date (inclusive) to thesettlement date (exclusive). If a bond trades ex-coupon, negative accruedinterest will accrue from the ex-date to the coupon date.

Cash reinvestmentSince coupon income and amortization payments on performing instruments arereasonably certain, reinvestment is done on the date on which the value date forthe trade captures the next cash payment. This allows the investor to affect thereinvestment trade such that, when the trade settles, the cash payment is available.

Price and interest returnPrice return is the component of total return that follows just the pricemovement. Intuitively speaking, it is the original-face, clean-priced bond’sreturn, Pt(o,c). This bond’s return is calculated using variables already defined:

Price return, adjusted for currency, then is:

Finally, interest return is simply a residual of total return and price return:

{ }{ }1,0CD if ,AI 0, CD if xam

bp AC CO0,1CO if,B 1, CO if bpP

V(t)v(t)

Qtv(t)v(t)

Qt

CO,t

==−+

××+==×=4.

1FX

FX

P

AMPPr

1-ti,

ti,CO,

1-t

v(t)CO,

tt −×

+=

1Pr1tr

ir1t

tt +

+=+

5.

6.



14 December 2004

Treatment of non-performing instrumentsIn the event of an unexpected delay of or default on a payment, the specificcash flow would not be recognized until the payment is actually received. Thecalculation of an individual non-performing instrument’s return and theresulting index return would follow the settlement-cash flow entitlementconvention set by either EMTA or a similar market trade group.

A default will not force the removal of the affected instrument from the EMBI+.As long as the affected instrument continues to satisfy our inclusion criteria, itwill not be removed from the index.

II. Index total returnTo compute a daily index value, we need to know the following:

1. The list of instruments to be included and their amounts outstanding;

2. The daily total return of each instrument; and

3. The weight of each instrument as of the prior business day’s close.

The first factor, the list of instruments and amounts outstanding, comprisesparameters that are exogenous to the other factors and, therefore, changes to itshould not result in changes in value of the index. These “rebalancing” eventsare done to the index on the last business day of each month, such that theindex’s next month’s composition reflects the new instrument balance. When arebalancing event occurs, it is as if the investor sells the entire portfolio at theday’s closing bid-side prices, and then immediately reinvests the proceeds in thenew portfolio in proportion to the new market values based on the same closingbid-side prices. This results in a shift in the relative weights but not a change inthe overall portfolio value.

It is worth noting what is meant by the amount outstanding of an instrument.Recall that amortizations and capitalizations, where applicable, result inchanges to the amount outstanding. These changes are “passive,” however, andare already captured in the effective settlement price via the balance scalar.Therefore, the figure used in determining market value is the original amountoutstanding, plus or minus any “active” changes to the amount outstandingresulting from reopenings or buybacks (which we will refer to as N, the “numberof bonds”). Since this is an original-face-value concept, it is consistent with allour other variables, also defined in terms of original face value.



December 2004 15

The total return on day t, TRt, is the arithmetically weighted average of eachinstrument’s return from the period t-1 to t. The weights are market-capitalization weights from the prior business day, t-1:

In this equation, the “ith” bond’s dirty market-capitalization weight on day t-1is defined by:

where:

and:

L(t’) Instrument list on day t’

t’ Last rebalancing day

Ni,t’ Number of bonds (see above); usually equal to the amount outstanding,except for capitalizing or amortizing bonds

Each term in the summation in Equation 7 measures the percentage contributionof an instrument to the change in the index portfolio’s value between day t-1and day t.

Since each instrument’s weight is updated daily, it is possible to see how cashreinvestment is done. Because the effective settlement price of an instrumentdrops concurrently with its cash payment (the accrued interest, balance scalar,quoted price, or cash-promised variable drops, depending on the type ofinstrument), the instrument’s market-capitalization weight drops, raising therelative importance of the other instruments within the portfolio. This achievescross-index reinvestment. Since the scheduled cash flow causes theinstrument’s market capitalization and weight as a percentage of the index todrop, a simultaneous increase in the weight of the other instruments in the indexoccurs. As a result of this shift in instrument weights, from a mathematicalperspective cross-index investment of the cash flow is achieved.

Once the aggregate daily total return of the EMBI+ is known, it is then appliedto the index’s prior day closing level to arrive at the current day’s closing value:

It-1 The closing cumulative total return index level for the EMBI+ as of theprior business day (where December 31, 1993 = 100)

( )ti,

t'Li1t,t'i,t trmTR ×= ∑

∈−7.

( )

( )( )1tsi,

t'Lit'i,

1tsi,t'i,1t,t'i,

ESVN

ESVNm

−∈

−−

×

×=

∑

( )1m

t'Li1t,t'i, =∑

∈−

( )t1-tt 1II TR+×=8.



16 December 2004

Price and interest returnAll of the variables needed to calculate index price returns are defined above,except for one. This remaining variable represents the clean marketcapitalization, which is computed in an analogous way to the dirty marketcapitalization, but uses the clean-price concepts described earlier for bonds andloans, instead of the effective settlement price. Therefore, portfolio price returnis the weighted average—in which the weights are clean—of the price returnsof the constituent instruments. Interest return calculations continue to be basedon the same formula.

III. Yield and spread calculationsInstrument Level YieldBlended Yield to Maturity is simply the internal rate of return of the bondinstrument. Stripped Yield measures the pure issuer risk by stripping out anycollateralized cashflows from the instrument. In the case for uncollateralizedbonds the blended yield is equal to the stripped yield. Stripped yield is usuallyreferred to as Sovereign Yield for the Emerging Markets sovereign bonds and theEMBI indices. Embedded options are ignored for yield to maturity calculations.

Instrument Level SpreadSpread measures the credit risk premium over US Treasury bonds. The BlendedSpread is the regular Spread over Treasury. Spread over treasury is simply thedifference between the Yield to Maturity Bond and the Yield to Maturity of thecorresponding point on the US treasury spot curve. Since Yield to Maturity issimply the discount rate at which all present value of all future cashflows equalsthe market price of the bond, all cashflows are discounted at the same (flat) rate.

Spread Over Treasury is a poor measure of sovereign risk for Brady bonds. Allcashflows are discounted using the same rate, regardless of any collateral. Forcollateralized debt, this rate represents the return on blended and sovereign risk.For uncollateralized debt, this rate represents the return on pure sovereign risk.Therefore comparisons between collateralized and uncollateralized bonds orbonds with different amounts of collateral are distorted.

Stripped Spread is a better measure for these comparisons because it accountsfor collateral. In the calculation of stripped spread the value of collateralizedflows (if any) are ‘stripped’ from the bond. In the case of a bond with principalcollateral, the present value of the collateral is discounted using US TreasuryStrip rates and subtracted from the price of the bond. To calculate the StrippedSpread the zero curve is then parallel shifted upwards and used to discount theremaining unsecured flows until the present value of the cashflows equals theex-collateral price of the bond. The number of basis points the curve must beshifted upwards is called the Stripped Spread.



December 2004 17

Stripped Spread is the value of Z such that market value of portfolio equals

where

CFt cashflow at time t

Rt zero-coupon rate at the t- year point of the curve

This calculation is also valid for uncollateralized bonds.

For Emerging Markets sovereign bonds, the stripped spread is more commonlyknown as Sovereign Spread. Stripped spread is calculated using offer sideprices. Note that stripped spread of the index does NOT equal to the marketcap weighted average of individual bond spreads.

Composite level yields and spreadsThe calculation methodology for index level yields and spreads are the same asat the instrument level. Cashflows from all the individual bonds in the portfolioare added up to create a single “superbond”. The yield and spread for thissuperbond is then calculated as described above for the single instrument. Notethat the result will be different from the market capitalization weighted spreadderived from individual bonds in the portfolio.

IV. Other Index MetricsEffective Interest Rate (EIR) Duration: Measure of sensitivity of dirty pricewith respect to the US Interest Rates parallel shift. It approximately shows thepercentage change of dirty price if all US interest rates change by 100 bps.

Effective Spread Duration: Measure of sensitivity of dirty price with respectto the sovereign spread movement. It approximately shows the percentagechange of dirty price if stripped spread changes by 100 bps.

Average Life: Weighted average time of principal repayment. For non-amortizing bonds, the average life is equal to the years to maturity of the bond.

V. Credit QualityWith the launch of the EMBI Credit Subindices in April 2002, JPMorgancategorizes and calculates analytics on four distinct credit buckets: InvestmentGrade, BB, B and Residual (CCC+ and below) subindex. Where we publishindex statistics for ratings-based subindices, we take the higher of the S&P andMoody’s ratings to determine an instrument’s ratings category.

∑ [(CFt)/ (1+ Rt +Z)t]

JPMorgan Emerging Markets Research Contact InformationJoyce Chang, Global Head of Emerging Markets Research, Foreign Exchange, and Commodities (1-212) 834-4203

[email protected]

GLOBAL STRATEGY AND QUANTITATIVE ANALYSIS

EASTERN EUROPE, MIDDLE EAST AND AFRICA

If you would like to be included on our distribution list, or if your e-mail address has changed, please contact Susan [email protected].

Please visit http://www.morganmarkets.com to view our archives and find a wide range of analytical tools.

[email protected] MD, Strategy/Economics (Emerging Europe, (44-20) 7777-4627Russia and Turkey)

[email protected] VP, Strategy/Economics (Africa, Middle East) (44-20) 7777-3770

[email protected] VP, Strategy (EEMEA Local Markets) (44-20) 7777-0185

[email protected] Assoc., Strategy (EEMEA Local Markets) (44-20) 7777-4423

[email protected] VP, Strategy/Economics (Turkey, the (44-20) 7777-3672Balkans and North Africa)

[email protected] VP, Strategy (EEMEA FX) (44-20) 7777-3430

[email protected] Assoc., Strategy (EEMEA FX) (44-20) 7777-1214

[email protected] VP, Economics (Turkey, Bulgaria & the Baltics) (90-212) 326-8590

[email protected] Assoc, Economics (South Africa) (27-11) 507-0376

[email protected] Assoc, Economics (Russia, Bulgaria and (7-095) 937-7321Kazakhstan)

[email protected] Assoc., Economics (Hungary, Slovakia, (44-20) 7777-3981Poland, and Czech Republic)

[email protected] VP, Corporate Strategy (Emerging Europe (44-20) 7325-3522and Russia)

[email protected] Assoc., Corporate and Bank Strategy (44-20) 7325-7278(Emerging Europe and Russia)

LATIN AMERICA

[email protected] VP, Strategy/Economics (Brazil, Latin (1-212) 834-4685America Local Markets)

[email protected] Assoc, Strategy (Brazil Local Markets) (1-212) 834-4043

[email protected] VP, Strategy/Economics (Andean Region) (1-212) 834-4326

[email protected] Assoc, Strategy (Dominican Rep and LatAm) (1-212) 834-4308

[email protected] Assoc, Strategy (Mexico and Central America) (1-212) 834-4426

[email protected] MD, Strategy/Economics (Mexico and LatAm) (52-55) 5540-9558

[email protected] VP, Strategy/Economics (Argentina and Chile) (1-212) 834-4144

[email protected] Assoc, Economics (Mexico) (52-55) 55-40-9339

[email protected] VP, Economics (Brazil) (55-11) 3048-3634

[email protected] Assoc, Economics (Brazil) (55-11) 3048-3369

[email protected] Assoc, Economics (Argentina) (54-11) 4348-3405

[email protected] VP, Corporate Strategy (1-212) 834 4302

[email protected] VP, Corporate Strategy (1-212) 834-4711

[email protected] MD, Global Head of Quantitative Strategy (44-20) 7777-3020

[email protected] MD, Corporate Strategy (1-212) 834-4214

[email protected] VP, Corporate Strategy (Banks) (44-20) 7777-3582

[email protected] VP, Relative Value Strategy (1-212) 834-4439

[email protected] Assoc, Relative Value Strategy (1-212) 834-4210

[email protected] VP, Relative Value Strategy, (44-20) 7777-0070

[email protected] VP, Analytics (1-212) 834-7072

[email protected] VP, Index Management (1-212) 834-4153

[email protected] Assoc, Index Management (1-212) 834-4029



[email protected] Analyst, Analytics (1-212) 834-7037

[email protected] Assoc, Analytics (1-212) 834-7190

[email protected] VP, FX Strategist (1-312) 325-3164

EMERGING ASIA

[email protected] MD, Asian Economic Research (852) 2800-7000

[email protected] VP, Strategy/Economics (Emerging Asia and (65) 6882-2461the Philippines)

[email protected] VP, Strategy/Economics (Singapore, Thailand (65) 6882-2253and Taiwan)

[email protected] VP, Strategy (Asian local markets) (852) 2259-6208

[email protected] VP, Relative Value Strategy (852) 2800-8008

[email protected] VP, Economics (Malaysia, India and Indonesia) (65) 6882-2375

[email protected] VP, Economics (Korea) (82-2) 758-5509

[email protected] MD, Strategy/Economics (Greater China) (852) 2800-7006

[email protected] Assoc, Economics (China and Hong Kong) (852) 2800-7005

[email protected] Analyst, Strategy (Asian fx markets) (65) 6882-2216

[email protected] VP, Corporate Strategy (852) 2800-8001

[email protected] Assoc, Asian Strategy (852) 2800-8100

[email protected] Assoc, Economics (Indonesia and Philippines) (65) 6882-7143

J.P. Morgan SecuritiesIncorporated

270 Park AvenueNew York, N.Y. 10017Tel. (1-212) 270-6000

J.P. Morgan Europe Limited125 London Wall

London EC2Y 5AJTel. (44 20) 7777-2000

J.P. Morgan Securities(Asia Pacific) LimitedChater House, 26/F

8 Connaught Road CentralHong Kong

Tel. (852) 2800-1000

J.P. Morgan SecuritiesAsia Private Limited

Akasaka Park Building2-20 Akasaka 5-chome

Minato1`-ku,Tokyo 107-6151,

JapanTel. (813) 5573-1185

Analysts’ Compensation: The research analysts responsible for the preparation of this report receive compensation based upon various factors, including the quality and accuracy ofresearch, client feedback, competitive factors and overall firm revenues. The firm’s overall revenues include revenues from its investment banking and fixed income business units.

Principal Trading: JPMorgan and/or its affiliates normally make a market and trade as principal in fixed income securities discussed in this report.

Legal Entities: JPMorgan is the marketing name for JPMorgan Chase & Co. and its subsidiaries and affiliates worldwide. J.P. Morgan Securities Inc. is a member of NYSE and SIPC.JPMorgan Chase Bank, N.A. is a member of FDIC and is authorized and regulated in the UK by the Financial Services Authority. J.P. Morgan Futures Inc., is a member of the NFA. J.P.Morgan Securities Ltd. (JPMSL) is a member of the London Stock Exchange and is authorized and regulated by the Financial Services Authority. J.P. Morgan Equities Limited is amember of the Johannesburg Securities Exchange and is regulated by the FSB. J.P. Morgan Securities (Asia Pacific) Limited (CE number AAJ321) is regulated by the Hong KongMonetary Authority. JPMorgan Chase Bank, Singapore branch is regulated by the Monetary Authority of Singapore. J.P. Morgan Securities Asia Private Limited is regulated by the MASand the Financial Services Agency in Japan. J.P. Morgan Australia Limited (ABN 52 002 888 011/AFS Licence No: 238188) (JPMSAL) is a licensed securities dealer.

General: Information has been obtained from sources believed to be reliable but JPMorgan does not warrant its completeness or accuracy except with respect to any disclosures relativeto JPMSI and/or its affiliates and the analyst’s involvement with the issuer. Opinions and estimates constitute our judgment as at the date of this material and are subject to changewithout notice. Past performance is not indicative of future results. The investments and strategies discussed here may not be suitable for all investors; if you have any doubts you shouldconsult your investment advisor. The investments discussed may fluctuate in price or value. Changes in rates of exchange may have an adverse effect on the value of investments. Thismaterial is not intended as an offer or solicitation for the purchase or sale of any financial instrument. JPMorgan and/or its affiliates and employees may act as placement agent, advisoror lender with respect to securities or issuers referenced in this report.. Clients should contact analysts at and execute transactions through a JPMorgan entity in their home jurisdictionunless governing law permits otherwise. This report should not be distributed to others or replicated in any form without prior consent of JPMorgan.

U.K. and European Economic Area (EEA): Investment research issued by JPMSL has been prepared in accordance with JPMSL’s Policies for Managing Conflicts of Interest inConnection with Investment Research. This report has been issued in the U.K. only to persons of a kind described in Article 19 (5), 38, 47 and 49 of the Financial Services and MarketsAct 2000 (Financial Promotion) Order 2001 (all such persons being referred to as “relevant persons”). This document must not be acted on or relied on by persons who are not relevantpersons. Any investment or investment activity to which this document relates is only available to relevant persons and will be engaged in only with relevant persons. In other EEAcountries, the report has been issued to persons regarded as professional investors (or equivalent) in their home jurisdiction.

Australia: This material is issued and distributed by JPMSAL in Australia to “wholesale clients” only. JPMSAL does not issue or distribute this material to “retail clients.” The recipientof this material must not distribute it to any third party or outside Australia without the prior written consent of JPMSAL. For the purposes of this paragraph the terms “wholesale client”and “retail client” have the meanings given to them in section 761G of the Corporations Act 2001. Korea: This report may have been edited or contributed to from time to time by affiliatesof J.P. Morgan Securities (Far East) Ltd, Seoul branch.

Copyright 2004 JPMorgan Chase & Co. All rights reserved. Additional information available upon request. Revised November 12, 2004.

The analyst(s) denoted by an asterisk (“AC”) hereby certifies that: 1) all of the views expressed in this researchaccurately reflect his or her personal views about any and all of the subject securities or issuers; and 2) no part ofany of the analysts compensation was, is, or will be directly or indirectly related to the specific recommendationsor views expressed by the analyst(s) in this research.

emerging markets bond index plus (embi+) jpmorgan

Documents