1MDB financial engineering demystified

1MDB financial engineering demystified. This is our simplified explanation of how parties could have profited from 1MDB deals. This is meant as an example or illustration only.

1. Parties making money by “playing” with the yield of bonds. The RM5 billion IMTN Malaysian Government guaranteed bonds

With the guarantee, the yield (or cost of borrowing) should be similar to other Malaysian Government papers, right? Not for 1MDB. At 6.68% p.a., the decision-makers committed 1MDB to a high-interest rate when they could have borrowed cheaply.

The bonds are first sold to the 1st subscriber (buyer) of the bonds at 6.68%. The 1st (called primary) subscriber then sells the bonds to other investors (secondary investors) at a yield similar to other Government guaranteed papers, say 5%. Remember, the credit is the same, ie. The government of Malaysia.

To adjust for the difference in yield (6.68% vs 5%), the price of the bonds go up. So say, the bonds were issued at RM87.92 to the 1st subscriber, the secondary investor now pays RM110 (for example) to the 1st subscriber, for an UPFRONT profit of RM22.08. Or over RM1 billion total profit!

In the meantime, 1MDB is stuck with paying 6.68% p.a. interest (an extra RM84 mil p.a. using the 5% example) for the next 30 years.