Japan Bond Indices Handbook
CROSS-ASSET

Global Markets Research
The Nomura Bond Performance Index, or NOMURA-BPI, has been widely used byinstitutional investors in Japan and other countries as a benchmark for measuring bondperformance and is now a leading bond market index in Japan. Nomura Securities hasdeveloped the NOMURA-BPI/Ladder as a benchmark index with stable duration, whichcharts the performance of laddered JGBs. Furthermore, indices of inflation-linked JGBs
(JGBi) and 15yr floating-rate JGBs (CMT) have risk-return profiles that are different fromfixed-coupon bonds.

11 June 2019
Visit Themes and Trades website forstrategic cross asset ideas.

Research analysts
Japan Bond IndicesIn this document, we introduce each index, including the basic facts related to bonds,
corresponding to the Plan-Do-See approach used for pension investment management,
breaking this down into three viewpoints – Plan: Know the Index; Do: Invest the Index;
and See: Review Index Investing.
In the first section, "Plan", we provide an overview of the domestic bond market andintroduce characteristic features of each index with an emphasis on duration and yields
that are of critical importance to bond investment.

Hiroe Fukasawa - NSC
hiroe.fukasawa@nomura.com+81 3 6703 3934
Hiroshi Iso - NSC
idx_mgr@jp.nomura.com+81 3 6703 1744
Taiki Sekiya - NSC
idx_mgr@jp.nomura.com+81 3 6703 3892

In the next section, "Do", we introduce the composition of each index, the characteristics
of turnover rates and risk indicators, which are important for index investing.
In the final section, "See", we provide the results of the decomposition of the returns ofeach index as a reference for reviewing fund performance, which is indispensable to risk
management.

We hope this document helps your index investing in fixed income.

Production Complete: 2019-06-11 07:00 UTC

See Appendix A-1 for analyst certification, important disclosures and the status of non-US analysts.

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Contents
1.

Introduction ............................................................................................................................... 3

2.

Plan: Know the Index ................................................................................................................ 4

2.1 The Domestic Bond Market and Index (Overview of the Domestic Bond Market) ......................................... 4
2.2 Bond Returns .................................................................................................................................................. 5
2.3 Historical Performance of the Total Index ...................................................................................................... 7
2.4 NOMURA-BPI, NOMURA-BPI/Extended ....................................................................................................... 8
2.5 NOMURA-BPI/Ladder................................................................................................................................... 10
2.6 NOMURA J-TIPS Index ................................................................................................................................ 11
2.7 NOMURA CMT Index ................................................................................................................................... 15

3.

Do: Invest the Index ................................................................................................................ 18

3.1 NOMURA-BPI ............................................................................................................................................... 18
3.2 NOMURA-BPI/Ladder................................................................................................................................... 26

4.

See: Reviewing Index Investing .............................................................................................. 28

4.1 NOMURA-BPI ............................................................................................................................................... 28
4.2 NOMURA J-TIPS Index ................................................................................................................................ 31

Appendix A-1 ............................................................................................................................................ 33

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1. Introduction
Nomura Securities’ Quantitative Research Center publishes the NOMURA-BPI,
NOMURA-BPI/Ladder, NOMURA J-TIPS Index and NOMURA CMT Index. Nomura
Securities’ Index Operations Dept. (IOD) is the Administrator of these indices. Eachindex is meant to be used as:A tool for determining investment policies (asset allocation strategies);A tool for determining a “manager structure”;

An investment management benchmark;

A tool for portfolio risk management;

An investment performance indicator; and

A tool for risk management for each issue.

When making use of various indices as policy benchmarks or managers’ benchmarks, it
is essential for both asset owners and fund managers to have an understanding of thenature of these indices.
This is because it is important for the asset owner to manage his or her assets inaccordance with his or her investment objectives in determining asset allocation tounderstand the risk/return characteristics of investment assets and/or the benchmarks.
By contrast, the fund manager is also required to invest funds in accordance with thebenchmarks set for the fund.
Hence, the composition of the index, the sector and degree of risk to which it is exposed,
and understanding the characteristics of the constituents of the index portfolio, are all
essential information.

In this document, we introduce each index, including the basic facts related to bonds,
corresponding to the Plan-Do-See approach used for pension investment management,
breaking this down into three viewpoints – Plan: Know the Index; Do: Invest the Index;
and See: Review Index Investing.
In the first section, "Plan", we provide an overview of the domestic bond market andintroduce characteristic features of each index with an emphasis on duration and yieldthat are of critical importance to bond investment.
In the next section, "Do", we introduce the composition of each index, the characteristics
of turnover rates and risk indicators, which are important for index investing.
In the final section, "See", we provide the results of the decomposition of the returns ofeach index as a reference for reviewing fund performance, which is indispensable to risk
management.

Please note that, while the rules for calculating each index have been previously
published as a handbook, starting with the publication of NOMURA-BPI's rule book
"NOMURA- BPI Index Rulebook" in February 2018, we have published a series of rulebooks on indices including the NOMURA-BPI/Ladder and the NOMURA J-TIPS Index.
Please refer to these rule books and to our web page(http://qr.nomura.co.jp/en/index.html) for the rules for each index. Furthermore, the data
and the analytical contents for the various indices are also summarized in this document,
which is designed to provide explanatory material.

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2. Plan: Know the Index
2.1 The Domestic Bond Market and Index (Overview of theDomestic Bond Market)
First, we briefly detail the composition of the domestic bond market. Fig. 1 shows therelationship between the remaining years to maturity (more than 1 year remaining),yields and the outstanding amounts (face value) of the securities in the domestic bondmarket. The size of each bubble represents the total outstanding amount by one year
intervals with the remaining years to maturity.
Fig. 1:Domestic bond market bubble map (28 December 2018)

Source: Nomura

Note:
1.Each item is summed up as follows:“JGBs”: NOMURA-BPI JGB“Agencies”: NOMURA-BPI Municipals, Government Guaranteed bonds and Bank Debentures“Credit”: NOMURA-BPI/Extended Corporate bonds and Samurai bonds and ABS“MBS”: NOMURA-BPI MBS“TIPS”: NOMURA J-TIPS Index“CMT”: NOMURA CMT Index“Others”: Publicly offered domestic bonds other than above1 with remaining years to maturity more than 1 year.
2.The yields for “CTM” and “Others” are treated as 0.
3.The remaining years to maturity are calculated taking into consideration early redemption, which is weighted
average life.

Fig. 1 shows the following characteristics of the domestic publicly offered bond market asat the end of December 2018:

Outstanding amount

The longer the years to maturity, the less the amount tends to be if the remaining
years to maturity are more than 10 years.



There are very few credit bonds with remaining years to maturity in excess of 20
years.

1 It meets floating bonds, corporates bonds with rated lower than BB and so on.

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The outstanding amount of "Others" is small, and the proportion of floating-ratebonds and corporate bonds with ratings of BB or lower is extremely small.

YieldsThe yield curves for government bonds, government-guaranteed bonds, local
government bonds and bank debentures are nearly flat with the remaining years tomaturity less than seven years.
Yields on “credit” tend to rise as the number of years remaining to maturity increase.

2.2 Bond Returns
It is difficult to make direct comparisons with the prices of specific bonds. This is because
different coupon levels may lead to different price levels if issuance periods are different
even if they have the same issuer and the same number of years remaining to maturity.
It is therefore more common, in the case of ordinary fixed-rate bonds, to evaluate suchbonds in terms of yield rather than price. The yield falls (rises) when the price of the bondrises (falls), and so yield is a very important concept in considering bond returns.
Modified duration (hereinafter referred to as duration) is the price sensitivity to a change
in yield, and is also a very important concept when considering bond returns. For regular
fixed-rate bonds, the return can be almost entirely explained by duration and compound
yield.2

Furthermore, the yield on government bonds tends to rise as the number of years
remaining to maturity increases (with the prolongation of duration). Therefore, for JGBs
(Japanese Government Bonds) the level of the yield is expected to be roughly equal by
matching the duration. In other words, JGBs that have roughly equivalent duration canbe expected to have almost the same price volatility, and so substitution between issues
is relatively easy.
By contrast, bonds other than government bonds such as corporate bonds, the level ofthe yield differs for each issuer even with the same duration level. This is because the T
spread, which is a yield added to the government bond yield, reflects factors such as theissuer's default risk and liquidity risk. Therefore, the T spread shows different types of
movement from that of interest rates, the yields of government bonds, and so the asset
owner/manager often monitors bond risks by breaking yields further down into interest
rate and the T spread. The following shows the impact of duration and T spreads on the
returns of each index.

Effect of duration on returns
If other conditions are same, duration is longer for long-term bonds, and so pricesensitivity to yield fluctuations also increases. We show the difference in the standard
deviation of return (the so-called risk) owing to the difference in duration by using
NOMURA-BPI/Ladder. Fig. 2 shows the average duration and standard deviation ofmonthly returns of the NOMURA-BPI/Ladder. Although the standard deviation formonthly yield differences is also provided, those of the NOMURA-BPI/Ladder do notdiffer much, but the level of the standard deviation of the monthly return is greatly
different. As duration gets longer, fluctuations in the return are larger by comparison withfluctuations in yield differences.

2

It is difficult to explain the return completely by duration alone, which is a coefficient of the linear approximation
to yield change, as the price changes nonlinearly in response to a yield change. By considering convexity, it ispossible to explain the return more precisely, but the influence is small compared with duration.

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Fig. 2: Average duration and standard deviation of monthly returns

Source: Nomura
Note:
1 Based on monthly returns in Feb 2009-Dec 2018. Standard deviation data are annualized.
2 The standard deviation for monthly yield differences is calculated using yield differences between the end of
previous month and the end of the month in the period from end-Feb-2009 to end-Dec-2018 and annualized,
which are multiplied by the square root of 12.

Effect of T Spreads on Returns
Fig. 3 shows the relationship between average T spreads and returns on indices with thesame duration level but different T spread levels. We have focused on the average
return level (red circle) and have also provided the level of 1 standard deviation. As theaverage T spread is higher, the average return tends to rise. However, as the T spreadincreases, the standard deviation also tends to rise. In this calculation period, thestandard deviation was larger for the sub-index with a AAA rating than for the sub-index
with a AA rating. This is mainly due to the performance of some electric powercompanies, which were included in the sub-index with a AAA rating at the time, which
experienced very large fluctuations at the time of the Great East Japan Earthquake ofMarch 2011.

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Fig. 3: Average spread and average return

6.0

Annualized average monthly return(%)
BPI Corp
mid A

5.0

4.0

1 standard
deviation

3.0

BPI Corp
mid AAA
Average return

2.0
BPI Corp
mid AA

1.0

0.0
Average T spread (bp)

-1.0
0

20

40

60

80

100

Source: Nomura
Note: Based on monthly returns in Jan 2009-Dec 2018. Average return data are annualized.
”mid”- term means 3 years or more and less than 7 years.

2.3 Historical Performance of the Total Index
In Fig. 4, we show the historical performance of the cumulative investment return index(= total index) for each index. These indices are rebased such that the value as of endMarch 2004 is 100.
Fig. 4: Movements in the total index for each index
Total index
140

CMT

J-TIPSBPI

Ladder 10yr

130

120

110

100

90

80
(yy/mm)Source: Nomura
Note: Shows monthly index values in Mar 2004-Dec2018. Each index is rebased so that end-Mar 2004 = 100.

Fig. 5 shows duration of the NOMURA-BPI had increased from around 5 years since thebeginning of 2004. This level of duration is same as the NOMURA-BPI/Ladder, which isshown in Fig. 9. Furthermore, there has been no big credit event. Hence, theperformance of NOMURA-BPI and NOMURA-BPI/Ladder 10yr has moved in a similar
direction, but diverged along with duration lengthening of NOMURA-BPI. In addition, the7Nomura | Japan Bond Indices Handbook

11 June 2019

the NOMURA J-TIPS Index’s weaker performance has been caused by a fall in the
expected inflation rate with a widening gap between supply and demand during thefinancial crisis in 2008.

2.4 NOMURA-BPI, NOMURA-BPI/extended
In section 2.2 we explained that the return on plain fixed-income bonds can be explained
almost entirely by duration and yield. In other words, these two points are essential forknowing the characteristics of the index. In this chapter, we introduce the characteristics
of each index focusing on duration and yield, specifically the weight for the remaining
years to maturity and the sectors. In addition, we also introduce the outstanding amounts
to gauge market liquidity.

DurationFirst, we show changes in the NOMURA-BPI's duration levels in Fig. 5.
Fig. 5: Changes in NOMURA-BPI duration and comparison of weight by remaining
years to maturity
Duration
10
9
8
7
6
5
4

16/01

13/01

10/01

07/01

04/01

01/01

98/01

95/01

3

(yy/mm)Source: Nomura
Note: Shows the end of month duration level in Jan 1995-Dec 2018.

Fig. 5’s pie chart shows, duration is prolonged with the increase in the weighting of superlong-term bonds.

Compound yield
We show the NOMURA-BPI's compound yield (Fig. 6) and T spread levels (Fig. 7), andits components at each point in time.

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Fig. 6: NOMURA-BPI compound yield and expected return
4.5

(%)

4.0

Compound yield
Expected return(Assumption that yield curve and T spread are unchanged)

3.5
3.0
2.5
2.0
1.5
1.0

0.5
0.0
-0.5

Source: Nomura
Note:
1 Shows the end of month compound yield in Jan 1996-Dec 2018.
2 Shows the end of month expected return in Jan 2006-Dec 2018.

Because the Bank of Japan (BOJ) introduced a negative interest rate policy in February
2016, the compound yield on the NOMURA-BPI also became negative at the time, but at
end-December 2018, it became positive. As the expected returns in Fig. 6 show
(assuming the yield curve and the T spread are the same as in the current situation ),even if the compound yield of the NOMURA-BPI becomes negative, because of thepositive yield curve there is a return by roll-down effect, and so the expected return is notnecessarily negative, and has been higher than the compound yield.

T spread
As of September 2018, the impact of credit spreads on the NOMURA-BPI was notparticularly large, with JGBs having an 80% weighting in the index, but at the time of theLehman brothers shock in 2008 and the Great East Japan Earthquake of 2011, volatility
in the T spread had a great influence on NOMURA-BPI’s performance. To better
understand the risk characteristics of the NOMURA-BPI therefore, it is also necessary tolook at the level of the T spread.

Fig. 7 shows a breakdown of the contribution to the T spread movements of the
NOMURA-BPI by sector.
Fig. 7: Contributions to NOMURA-BPI T spread by sector

Source: Nomura
Note: Shows the end of month T spreads in Oct 2001-Dec 2018.

In the NOMURA-BPI the biggest contributor to the T spread is the corporate bond sector.
Furthermore, in risk management, fluctuations in the T spread are important when the T
spread is widening, and at such times there is a rising contribution from samurai bonds.
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Samurai bonds are the highest T spread sector in the NOMURA-BPI. This is because
these bonds are exposed not only to credit risks and liquidity risks that exist in thecorporate bond sector, but also to risks relating to the country to which the issuer
belongs. For this reason, these bonds are susceptible to credit crunches and concerns
about the stability of the financial system, as was evident in 2008 when the T spreadwidened significantly. Fig. 8 shows historical data for the T spreads of corporate bonds
and samurai bonds.

Fig. 8: Changes in the T spread for corporate bonds and samurai bonds

Source: Nomura
Note: Shows the end of month T spread in Oct 2001-Dec 2018.

Both indices showed a significant widening of the T spread at the time of the 2008
Lehman brothers shock.
There was a steep widening in the corporate bond sector in 2002. It is because thesequence of defaults at retail companies and many financial institutions caused
increased wariness among investors. Besides, the corporate bond sector experienced
the great widening owing primarily to the Great East Japan Earthquake of March 2011.
There was no big widening in the samurai bond sector in 2002 and 2011, while the T
spread of the corporate bond sector was wide. By contrast, the T spread of the samurai
bond sector was widening because of the European debt crisis in early 2010 in contrast
with the stable T spread of the corporate bond sector.

2.5 NOMURA-BPI/Ladder
Duration
We have already mentioned that in choosing a bond index the level of duration is a key
factor that directly influences the level of return, nevertheless there is a problem called
moving targets that affect not just the NOMURA-BPI, but also market indices in general.
The moving target problem refers to the fact that levels of duration and credit risk
fluctuate greatly according to the composition of the outstanding amounts in terms ofremaining years to maturity of the market and the weighting of JGBs. Using indices with
unclear duration levels in the future as benchmarks will result in uncertain future risk
levels for benchmarks.
The NOMURA-BPI/Ladder was developed as a means of solving this moving target
problem. The NOMURA-BPI/Ladder is an index for the laddered portfolio of JGBs withno credit risk. There are four types of indices for 5, 10, 20, and 30 years. Duration is
maintained at a stable level because an equal amount of the par value (JPY10bn) is
evenly distributed according to remaining years to maturity. Furthermore, by combining
these four indices, a customised benchmark in terms of duration can also be provided.
Fig. 9 shows the changes in the duration.

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Fig. 9: Changes in duration for the NOMURA-BPI/Ladder
15

Duration

14
13
12
11
10
9

8
7
6
5
4
3
2
1
0
1993/09

1996/07

1999/06

Ladder 5years

2002/04

2005/02

2007/12

Ladder 10years

2010/10

Ladder 20years

2013/09

2016/07

Ladder 30years

Source: Nomura
Note: Shows the daily duration in Sep 30 1993-Dec 28 2018 as for Ladder10years, in Jan 6 1997-Dec 28 2018 as for
Ladder 20years, in Jan 4 2005-Dec 28 2018 as for Ladder 5years, in Jan 5 2009-Dec 28 2018 as for Ladder 30 years.

Fig. 9 shows that duration is generally stable. Note that the NOMURA-BPI/Ladder 20yr
has fewer issues than other NOMURA-BPI/Ladder because the NOMURA-BPI/Ladder
20yr only includes the issues whose redemption timing is September. Hence, please pay
attention to the tendency for duration extension as reconstitution is large.
In addition, the level of NOMURA-BPI/Ladder 30yr duration became longer in the former
part of 2016. It was not caused by the reconstitution, but by the characteristic of fixedincome bonds that the level of duration becomes longer as the yield falls. Usually this
impact is not so big, but this feature was marked especially in the NOMURA-BPI/Ladder
30yr when interest rates fell steeply in the former part of 2016.

2.6 NOMURA J-TIPS Index
As the name implies, inflation-linked government bonds (JGBi) are bonds whose
principal and interest payments, on a nominal basis, change in line with the consumer
price level. The NOMURA J-TIPS Index is an index for JGBi (with or without principal
guaranteed). Although the issuance of JGBi without principal guaranteed, which werefirst issued in 2004, was suspended temporarily in 2008, JGBi with principal guaranteed(deflation floor) were subsequently issued in October 2013 and, as of 2018, periodic
issuance has continued. Along with this, the NOMURA J-TIPS Index was also broken
down into two sectors – with or without-deflation floor in November 2013.

YieldsIn Section 2.2 we described why there was a need to refer to the (nominal) yield inconsidering the nominal bond price. Similarly, yield is also an important concept for JGBi.
However, in JGBi, both nominal yield and real yield need to be considered, and the
NOMURA J-TIPS Index also defines these two types of yield. In this section, we
introduce these two types of yield and also show actual changes.
The definitions of each symbol are as follows.
𝐷𝑃:

Dirty price unadjusted for inflation

𝐴𝐷𝑃:

Dirty price adjusted for inflation𝑡𝑖:Number of years until 𝐶𝐹𝑖 Occurs

𝑇:

Number of years until redemption cash flow occurs

𝐶𝐹𝑖:

Real cash flow for the 𝑖th period

𝐷𝐹(𝑡)

:

Discount factor (nominal) for time 𝑡𝐼𝑅(𝑡𝑜𝑑𝑎𝑦):Index ratio, as of today
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𝜋:

11 June 2019

Break-even inflation rate𝑛

Nominal compound yield𝑟

Real compound yield

First, nominal yields are the actual payment amount. The nominal price of a JGBi with adeflation floor is expressed as follows using nominal future cash flow and nominal
discount factors.

𝐴𝐷𝑃 = ∑ 𝐼𝑅(𝑡𝑜𝑑𝑎𝑦) 𝐶𝐹𝑖 (1 + 𝜋)𝑡𝑖 𝐷𝐹(𝑡𝑖 ) + 𝐼𝑅(𝑡𝑜𝑑𝑎𝑦) 𝑚𝑎𝑥 {100 × (1 + 𝜋)𝑇 ,𝑖

100} 𝐷𝐹(𝑇)
𝐼𝑅(𝑡𝑜𝑑𝑎𝑦)(2.1)

Here, the dirty price adjusted for inflation excluding the effect of the indexation coefficient𝐼𝑅(𝑡𝑜𝑑𝑎𝑦) , which indicates the level of fluctuation for the CPI from the time of issuance(dividing both sides by 𝐼𝑅(𝑡𝑜𝑑𝑎𝑦) ), is transformed into an equation (2.2).

𝐷𝑃 = ∑𝑖 𝐶𝐹𝑖 (1 + 𝜋)𝑡𝑖 𝐷𝐹(𝑡𝑖 ) + 𝑚𝑎𝑥 {100 × (1 + 𝜋)𝑇 , 𝐼𝑅100
(𝑡𝑜𝑑𝑎𝑦)} 𝐷𝐹(𝑇)(2.2)

The equation (2.2) is based on the real price, that is the price unadjusted for inflation, at
the time of investment, and future cash flows are considered on a nominal basis basedon the time of investment. Specifically, we evaluate the nominal future cash flow
𝐶𝐹𝑖 (1 + 𝜋)𝑡𝑖 with the nominal discount factor 𝐷𝐹𝑖 at each point in time. The break-even
inflation rate 𝜋 (hereinafter referred to as "BEI") added is considered to represent the
average expected inflation rate from investment time to maturity.
Furthermore, when the equation (2.2) is expressed by the nominal compound yield 𝑛, it
becomes the following equation (2.3).
𝑛 −2𝑡𝑖𝐷𝑃 = ∑𝑖 𝐶𝐹𝑖 (1 + 𝜋)𝑡𝑖 (1 + 2 )+ 𝑚𝑎𝑥 {100 × (1 + 𝜋)𝑇 , 𝐼𝑅100
(𝑡𝑜𝑑𝑎𝑦)𝑛 −2𝑇} (1 + 2 )(2.3)

Considering future cash flows on a real basis, we can calculate the real compound yield𝑟 using the following equation (2.4).
𝐷𝑃 = ∑𝐶𝐹𝑖
𝑟 2𝑡𝑖(1 + 2)(2.4)

Fig. 10 shows the transition of the nominal compound yield of the NOMURA J-TIPS
Index and the BEI. The nominal compound yield here is the sum of the real compound
yield and the BEI.

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Fig. 10: Changes in the nominal compound yield and the BEI for NOMURA J-TIPS Index
5
4(%)
Nominal compound yield(Real compound yield + BEI)
Price risefactor of an
inflationlinked bond

BEI
3
2
1
0
-1
-2

Price fall
factor of an
inflationlinked bond

-3

-4

Source: Nomura
Note: Shows daily nominal yield and BEI in Apr 1 2004-Dec 28 2018.

As Fig. 10 shows, the rise in the BEI may lead to a rise in the price of JGBi, and a
decline in the nominal compound yield may lead to a price rise in JGBi.
Fig. 11 shows the change in real compound yields.

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Fig. 11: Change in the real compound yield for NOMURA J-TIPS Index

Source: Nomura
Note: Shows daily real yield in Apr 1 2004-Dec 28 2018

Fig. 11 shows that the real compound yield, that is the real price, has fluctuatedsignificantly, along with changes in BEI.

Duration
The duration of the NOMURA J-TIPS Index is calculated as real price sensitivity to realcompound yield changes. Fig. 12 shows changes in the outstanding amount, along withchanges in duration.
Fig. 12: Changes in duration and the outstanding amount for NOMURA J-TIPS Index

12

Outstanding
amount(Tri. Yen)

Without deflation floorWith deflation floor

10

Duration (right)
9

10

8

7

8

6

6

5
4

4

3
2

2

1

0
2004/040
2006/04

2008/04

2010/04

2012/04

2014/04

2016/04

2018/04

Source: Nomura
Note: Shows the end of month outstanding amount and duration in Apr 2004-Dec 2018.

During the temporary suspension of JGBi issuance from 2007 to 2012, the constituentsof the NOMURA J-TIPS Index were unchanged, so duration was shortened. Thereafter,
owing to the exclusion of issues that had less than one year remaining to maturity andthe inclusion of issues with deflation floors, duration has increased since June 2013.
Please also refer to Chapter 3 as for duration extension of index portfolio.

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2.7 NOMURA CMT Index
The 15yr floating-rate JGB, CMT, which is included in the NOMURA CMT Index has thecharacteristics of one whose coupon rate is revised semi-annually according to market
interest rates. Fig. 13 shows this concept. The coupon rate of the CMT is determined bysubtracting the fixed value (usually expressed as α) from the reference rate (thecompound yield of the average accepted bid of the 10yr JGB auction, which is held six
months before the coupon payment month). The reference rate changes every six
months. The spread α is determined by the CMT auction, and does not change until
redemption. The coupon rate of the CMT has a zero floor, the effect of which cannot be
overlooked particularly in the recent low yield environment.

Fig. 13: Reference rate of JGB floaters and cash flow (conceptual figure)Max(Y14.5-α, 0)/2+100
Y14

10yr JGB yield(reference rate)

Y15

Y0
α

α

Y0.5

Max(Y0-α, 0)/2

Y14.5
α

Y1

α

Max(Y14-α, 0)/2

Max(Y0.5-α, 0)/2

Present 6 months 1 year
time
later
later

…

…

…

…

14.5 years 15 years
later
later

Source: Nomura
Note: Yt stands for the reference rate at the time t and αstands for the spread between reference rate and coupon rate.

Outstanding amountFirst, we show the trend in the outstanding amount of the NOMURA CMT Index.
Fig. 14: Change in the outstanding amount for NOMURA CMT Index
Outstanding amount(Tri. Yen)

50
45
40

35
30
25
20

15
10
5
0
2001/1 2003/1 2005/1 2007/1 2009/1 2011/1 2013/1 2015/1 2017/1
Source: Nomura
Note: Shows the end of month outstanding amount in Jan 2001-Dec 2018.

CMT issuance has been suspended since 2008, and the outstanding amount of the
NOMURA CMT Index has been decreasing since 2014.

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DurationIn the case of plain fixed-rate bonds, we said yields and duration would explain the returnalmost completely. However, for floating-rate bonds with variable coupon rates, yields
cannot be defined in the first place, and it is also difficult to calculate duration, which isthe price sensitivity to yield fluctuations. Therefore, to calculate the interest rate risk offloating-rate government bonds, concepts such as effective duration and key rate
duration, which are price sensitive to changes in the spot rate instead of yields, are used.
Effective duration is the price sensitivity to a parallel shift in the spot rate, and the key
rate duration is the concept of decomposing effective duration, representing pricesensitivity to a change in the spot rate in a specific term, not in all terms. The NOMURACMT Index also defines the effective duration and the key rate duration.3

Fig. 15 gives the results of comparing the effective duration of each issue that makes up
the NOMURA CMT Index with JGBs of the same remaining years to maturity.
Fig. 15: The effective duration of CMT and BPI JGB

Effective duration
5

4

3

2

1

CMT

BPI JGB

0

1

2

3

4
5
Remaining years to maturity (year)

Source: Nomura
Note: As of 28 Dec 2018. BPI JGB is represented by the sub-indices regarding one year intervals with the remaining years
to maturity

The effective duration of CMT is small when compared with JGBs of similar remaining
years at maturities of two-and-a-half years or more. This does not mean the degree of
price change with respect to the change in the interest rate is smaller than that of JGBs,
but is because they have negative sensitivity (the price rises when interest rates rise)depending on terms.
Specifically, it can be shown by the shape of key rate duration, which is the pricesensitivity to a change in the spot rate in each term. Fig. 16 shows key rate duration of
the CMT (due for maturity in September 2023) and the 5yr JGB(due for maturity in May2023) that has the approximately the same number of remaining years to maturity as theselected CMT.

3

Effective duration can explain price change for plain fixed-rate bonds, and we also calculate the value of theeffective duration on a daily basis for the NOMURA-BPI. However, in the case of a plain fixed-rate bond, as themost impactful cash flow occurs at the time of the maturity of the bond, there is no significant difference between
the effective duration and the (modified) duration.

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Fig. 16: Key rate duration of CMT and fixed rate bonds

4

Reflects the price falls due to thedecrease in the present value on a timeof redemption when the market interest
rate rises

Key rate duration

3

Reflects the price rises dueto the increase in the
expected coupon rate whenthe market interest rate rises

2
5year JGB

CMT

1

0
Remaining years to matuarity

-1
0yr

1yr

2yr

3yr

4yr

5yr

6yr

7yr

8yr

9yr 10yr 11yr 12yr 13yr 14yr 15yr 16yr

Source: Nomura
Note: As of 28 Dec 2018

In Fig. 16, the sensitivity of the CMT is negative when it is near the term of 13 years.
Unlike plain fixed-rate bonds, for the CMT, the sensitivity on this term reflects price rises
owing to the increase in the expected coupon rate when the market interest rate rises.
Key rate duration of the NOMURA CMT Index, which is an average of the key rate
duration of each issue weighted by the total market value including accrued income, isshown in Fig. 17.

Fig. 17: Key rate duration of NOMURA CMT index

0.9

Key rate duration

0.8
0.7

0.6
0.5

0.4
0.3
0.2
0.1
0.0
-0.1

Remaining years to matuarity-0.2
0yr 1yr 2yr 3yr 4yr 5yr 6yr 7yr 8yr 9yr 10yr 11yr 12yr 13yr 14yr 15yr 16yr
Source: Nomura
Note: As of 28 Dec 2018

Fig. 17 shows negative key rate duration focused on 12yr as of 28 December 2018.

The CMT, in contrast with ordinary fixed-rate government bonds, has issues whose pricedeclines are restrained by higher coupon rates in an environment of rising market
interest rates. However, Fig. 16 and Fig. 17 show whether the interest rate at the time of
maturity changes or the interest rate at the time of evaluating the reference rate changes
will have a different impact on the arbitrage price than the ordinary fixed-rate government
bond.

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3. Do: Invest the Index
When using index investing, it is also important to understand the constituents of theindex from various viewpoints and know the characteristics of the individual issues which
are included or excluded on reconstitution, not only to understand the overall picturesuch as the level of duration and yield. We will describe these issues in this chapter.

3.1 NOMURA-BPI
Composition of corporate bond sector, and samurai bond sector
When tracking the NOMURA-BPI, we generally use a stratified sampling method
because of the constraints on face amounts relative to the AUM and liquidity. To use astratified sampling method, it is needed to match the weightings, duration, compound
yield and T spread levels of each category of the portfolio and the benchmark for
management. And the category must be divided up such that the issues in each category
have the almost the same risk/return characteristics. Fig. 18 shows the number ofissuers for each sector of the NOMURA-BPI.
Fig. 18: NOMURA-BPI, Number of issuers by sector (28 December 2018)
JGBs

Municipals

GovernmentBank
Guaranteeddebentures
bonds

Corporatebonds

Samurai
bonds

MBS

ABS

1

62

15

334

43

1

46

1

Source: Nomura

Further, we show the composition, in slightly greater detail, of the corporate bond sector
and the samurai bond sector, both of which include a variety of issues.

As mentioned in Chapter 2, the T spread level plays an important role in affecting bondreturns. Additionally, the rating level is very important information as it will help withknowing the T spread. Fig. 19 and Fig. 20 show the value by rating category for
NOMURA-BPI/Extended corporate bonds and samurai bonds, including BBB equivalents.
For the definition of the highest rating, please refer to the "NOMURA-BPI Index
Rulebook".

Fig. 19: Outstanding amount of NOMURA-BPI/extended corporate bonds classified by
the highest rating

BBB
0.8TriYen
2%

AAA
5.3Tri Yen
10%
A
16.6Tri Yen
31%AA
30.3Tri Yen
57%

Source: Nomura
Note: As of 28 Dec 2018

The weight of AA and A sectors is large in the NOMURA-BPI/extended corporate bonds.

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Fig. 20: Outstanding amount of NOMURA-BPI/extended samurai bonds classified by thehighest ratings

BBB
0.6Tri Yen
10%

AAA
0.1Tri Yen
2%AA
2.1Tri Yen
34%

A
3.3Tri Yen
54%

Source: Nomura
Note: As of 28 Dec 2018

In the NOMURA-BPI/extended samurai bonds, the weight of the AAA sector is smaller
and the BBB sector is larger relative to the NOMURA-BPI/extended corporates.

Basically, the T spread reflects corporate creditworthiness and the average T spread of
the index is often explained using the weighted average credit rating with the outstanding
amount as shown above. By contrast, however, when unusual events occur such as theGreat East Japan Earthquake, the T spread may change significantly for certain
industries. For this reason, it is important to show the composition by industry. Fig. 21
shows the face value of the corporate bond sector by industry.

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Fig. 21: Outstanding amount of NOMURA-BPI Corporate bonds classified by sector

Telecom
1.2Tri Yen
2%

Food
1.2Tri Yen
2%
Chemical
1.3Tri Yen
3%

Other
7.8Tri Yen
15%

FILP Agency
Bonds
16.8Tri Yen
32%

Wholesale
1.3Tri Yen
3%
Electronics
1.6Tri Yen
3%
Real estate
2Tri Yen
4% Other financial
sector
3.6Tri Yen
7%

Bank
3Tri Yen
6%

Transportation
4.4Tri Yen
8%Electricity andGas
7.8Tri Yen
15%

Source: Nomura
Note: As of 28 Dec 2018

Fig. 21 shows that the weight of FILP agency bonds and others sector such as theelectricity and gas sector are large and 85% of the pie chart is made up of the 11 highest
industry categories.

Duration extension
In tracking portfolios, it is important to match interest rate sensitivity. In the NOMURABPI, issues with years remaining to maturity of less than one year are excluded on amonthly basis. When issues with short remaining years to maturity are excluded from theportfolio, the average duration of that portfolio extends. This extension is particularlymarked at the end of months when large amounts of JGBs are excluded. To
demonstrate this fact, past trends are shown separately for each factor of inclusion andexclusion. The methods for calculating the inclusion factor and exclusion factor are as
follows.

exclusion factor = 𝐷𝑘𝑒𝑒𝑝 (𝑒𝑜𝑚) − 𝐷(𝑒𝑜𝑚)inclusion factor = 𝐷𝑝𝑙 (𝑒𝑜𝑚) − 𝐷𝑘𝑒𝑒𝑝 (𝑒𝑜𝑚)Note that𝐷(𝑡):Duration that is a weighted average with market value amount (incl.
accrued interest) for the constituents of the current month index
portfolio at time 𝑡

𝐷𝑘𝑒𝑒𝑝 (𝑡):Duration that is a weighted average with market value amount (incl.
accrued interest) for the constituent both of the current and next monthindex portfolio at time 𝑡

𝐷𝑝𝑙 (𝑡):Duration that is a weighted average with market value amount (incl.
accrued interest) for the constituents of the next month index portfolio
at time 𝑡𝑒𝑜𝑚:

The end of the last business day of the current month.

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Fig. 22: Extension of duration as for NOMURA-BPI
Extension of duration

0.25

0.20

0.15

0.10

0.05

0.00

-0.05
2017/012017/04

Inclusion factor

2017/072017/10

2018/012018/04

2018/072018/10

Exclusion factor

Source: Nomura
Note: Shows month-end duration extension in Jan 2017-Dec 2018

As Fig. 22 shows, duration tends to extend greatly owing to exclusion factors at the endof February, May, August and November every year. This is because JGBs that haveyears remaining to maturity of less than one year in the NOMURA-BPI are excluded fromthe index in response to redemptions of JGBs concentrated in the months of March,June, September and December.
It is worth noting that none of the inclusion/exclusion factors had been negative until the
inclusion factor posted a negative value at the end of May 2018 for the first time and was
also negative at the end of August and November 2018. The duration of the NOMURABPI has been extending year by year, and as a result, the above mentioned 𝐷𝑘𝑒𝑒𝑝 (𝑡)exceeded the average duration of the issues to be incorporated.

Turnover rate
We provide the turnover rate of the index portfolio which is useful for calculatingtransaction costs. The turnover rate is the sum of the sell turnover rate and buy turnoverrate, and each turnover rate is calculated using the follows.
Sell turnover rate = Exclusion amount of the index portfolio in the current month÷ Total amount of the index portfolio in the current month
Buy turnover rate = Inclusion amount of the index portfolio in the next month÷ Total amount of the index portfolio in the next month21

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Fig. 23: Turnover rate of the NOMURA-BPI

5%

Sell turnover

Buy turnover

4%

3%

2%

1%

0%

Source: Nomura
Note: Shows month-end turnover rate in Jan 2014-Dec 2018

We can see that sell turnover rates are large at the end of February, May, August andNovember every year, along with the redemptions of a large amount of JGBs. The sell
turnover rate at the end of March 2014 was relatively large. This is because retail bonds
were excluded from the NOMURA-BPI in accordance with revising the inclusion criteria.

In addition, Fig. 24 shows the turnover rate of the NOMURA-BPI corporates in the light offunds benchmarked by the NOMURA-BPI corporates.

Fig. 24: Turnover rate of the NOMURA-BPI corporate bonds

9%

Sell turnover

Buy turnover

8%
7%
6%
5%
4%
3%
2%
1%
0%

Source: Nomura
Note: Shows month-end turnover rate in Jan 2014-Dec 2018

Unlike NOMURA-BPI JGBs, the turnover rate of NOMURA-BPI corporate bonds do nothave distinctive features. The turnover rate of the NOMURA-BPI corporate bonds isaround 3%.

Portfolio tracking
Up to now, we have provided information to help with tracking the NOMURA-BPI
precisely but, depending on the level of acceptable tracking error and financial
constraints, there may be cases where we consider using slightly more simplified
management. In this section, we show simulation results on the extent that tracking ispossible with JGBs, interest rate swaps and JGB futures.

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11 June 2019

Fig. 25: Summary of the tracking method(1)Current 10yr JGBs
(2)Current 2+5+10+20yr
JGBs(3)Five JGBs

Rebalance
frequency
MonthlyMonthly

Risk indicator for matching
Duration
Duration of sub-indices for remaining
years to maturity
Duration of sub-indices for remaining
years to maturity
Duration of sub-indices for remaining
years to maturity
Standard deviation based on daily
return over latest 60 business days
Maximizing compound yield based on
the constraints to limit the difference
between risk indicators of the tracking
portfolio and the NOMURA-BPI towithin a set range

Every 6months(4)2+5+10+20yr Interest
rate swaps(5)JGB futures

Monthly(6)JGBs with around 30
issues by optimization
methodMonthlyMonthly

Source: Nomura(1)Tracking using current 10yr JGBs
The holding amount is determined at the end of every month so that duration of the
tracking portfolio equals that of the NOMURA-BPI.
Fig. 26: Tracking using current JGBs (10yr)
2.5%

Un-annualized Return

2.0%
1.5%

1.0%
0.5%
0.0%
-0.5%
-1.0%

-1.5%
-2.0%
2014/01

2015/01

2016/01
diff

BPI

2017/012018/01

Current 10yr JGBs

Source: Nomura
Note: Shows month-end un-annualized return in Jan 2014-Dec 2018(2)Tracking using current 2+5+10+20yr JGBs
Holding amounts are determined so that the modified duration of the tracking portfolio
matches that of the NOMURA-BPI in its breakdown by remaining maturity (1-3yrs, 3-7yrs,
7-11yrs, 11yrs +) at the end of every month.

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Fig. 27: Tracking using current 2+5+10+20yr JGBs
2.5%

Un-annualized Return

2.0%
1.5%
1.0%
0.5%
0.0%

-0.5%
-1.0%

-1.5%
-2.0%
2013/09

2014/09diff

2015/09
BPI

2016/092017/09

Current 2yr+5yr+10yr+20yr JGBs

Source: Nomura
Note: Shows month-end un-annualized return in Jan 2014-Dec 2018(3)Tracking using Five JGBs
We break down the NOMURA-BPI into five portfolios based on remaining maturity (13yrs, 3-7yrs, 7-11yrs, 11-25yrs, 25yrs +), and select one JGB issue whose duration issimilar to that included in the portfolio of the respective maturity. Note that portfolios arerebalanced every six months, and the rollover rate is lower than in the cases where
current issues are rolled over every month.
Fig. 28: Tracking using five JGBs
2.5%

Un-annualized Return

2.0%
1.5%
1.0%
0.5%
0.0%
-0.5%

-1.0%
-1.5%
-2.0%
2014/01

2015/01

2016/01diff

2017/01
BPI

2018/01

five JGBs

Source: Nomura
Note: Shows month-end un-annualized return in Jan 2014-Dec 2018

Even though the NOMURA-BPI includes around 7,000 issues in the calculation period,
from January 2014 to December 2018, we replicated the index portfolio with around a
15bp tracking error using only five JGBs by matching the duration of sub-indices for theremaining years to maturity.
You can expect to replicate the index portfolio effectively by making good use of risk
indicators.
(4)Tracking using interest rate swaps
The notional principal of interest rate swaps (for four types of maturity, 2yr, 5yr, 10yr, and20yr) is determined so that the interest rate sensitivity of swaps matches the modified
duration of the NOMURA-BPI in its breakdown by remaining maturity (1-3yrs, 3-7yrs, 711yrs, 11yrs and longer). Note that the portfolio is rebalanced monthly.

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Fig. 29: Tracking using interest rate swaps
2.5%

Un-annualized Return

2.0%
1.5%
1.0%

0.5%
0.0%
-0.5%
-1.0%
-1.5%

-2.0%
2014/01

2015/01

2016/01
diff

BPI

2017/012018/01

Interest rate swaps

Source: Nomura
Note: Shows month-end un-annualized return in Jan 2014-Dec 2018(5)Tracking using JGB futures
Holding amounts of JGB futures are determined using hedge ratios of JGB futurescontracts to the NOMURA-BPI. The hedge ratio is a regression coefficient of a simple
linear regression4 for the NOMURA-BPI monthly return using the JGB futures monthly
return, and the hedge ratio is calculated at the end of every month.
Fig. 30: Tracking using JGB futures
2.5%

Un-annualized Return

2.0%
1.5%
1.0%
0.5%
0.0%
-0.5%

-1.0%
-1.5%
-2.0%
2014/01

2015/01

2016/01
diff

BPI

2017/012018/01

JGB Futures

Source: Nomura
Note: Shows month-end un-annualized return in Jan 2014-Dec 2018(5)Tracking by the optimization method
Tracking using the optimization method requires determining the constraints of
optimization to align price movements of the portfolio and the NOMURA-BPI. Therefore,
selecting indicators that show the attributes of the portfolio is important. These indicators
include:Portfolio average duration,Portfolio average convexity,



Sector distributions by term remaining to maturity, type of issue, etc,

Average durations and average convexity within each sector,

4 A simple regression based upon daily returns over latest 60 business days.

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to note some examples.
Here, we consider selecting issues every month to maximize the compound yield tomaturity of the tracking portfolio, based on constraints to limit the difference between risk
indicators of the tracking portfolio and the NOMURA-BPI to within a set range. The
number of issues in the tracking portfolio is around 30. Fig. 31 shows the performance ofthe tracking portfolio and the NOMURA-BPI and the difference in performance.
Fig. 31: Tracking by optimization method
2.5%

Un-annualized Return

2.0%
1.5%
1.0%
0.5%
0.0%
-0.5%

-1.0%
-1.5%
-2.0%
2014/01

2015/01diff

2016/01
BPI

2017/012018/01

Portfolio by the Optimization Method

Source: Nomura
Note: Shows month-end un-annualized return in Jan 2014-Dec 2018

At the end of this section we summarize the results. The tracking errors for the portfolio
using interest rate swaps or JGB futures were relatively large because of the differencein risk characteristics. In this calculation period, we can replicate the NOMURA-BPI,
whose JGB weighting is 70-80%, using five JGBs with around a 15bp tracking error as
long as there is no big credit event.
Fig. 32: Tracking error as for each tracking portfolio
Tracking asset(method)

Tracking
error(1)Current 10yr JGBs (stratified sampling method)

66.3bp(2)Current 2+5+10+20yr JGBs(stratified sampling method)

21.8bp(3)Five JGBs(stratified sampling method)

13.1bp(4)Interest rate swaps 2+5+10+20yr

65.1bp(5)JGB Futures

133.3bp(6)JGBs around 30 issues(optimization method)

20.8bpSource: Nomura
Note: The calculation using annualized return in Jan 2014-Dec 2018.

3.2 NOMURA-BPI/Ladder
Change in number of issues
The NOMURA-BPI/Ladder is a cumulative investment return index that illustrates theperformance when investing in a laddered portfolio of JGBs. One key point to pay
particular attention to here is the number of issues increases or decreases depending on
the timing of the issuance of the new bonds. Fig. 33 shows an example for the
NOMURA-BPI/Ladder 30yr. As the NOMURA-BPI/Ladder is an index that always
includes bonds on a 10-billion-yen target basis, regardless of the issue amount, weremind you that it is an index that consists of equal-amount holdings.

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Fig. 33: An example of changes in the number of issues in the NOMURA-BPI/Ladder
30yr
Amount(100 Mil.JPY)

not included for Oct-2017
porfolio because of the issue on
Dec-20-2017

1000
Sep-20 Dec-20 Mar-20 Jun-20 Sep-20 Dec-20

redemption
2017
month

2018

Mar-20 Jun-20 Sep-20 Dec-20 Mar-20 Jun-20 Sep-20 Dec-20 Mar-20

2046

2047

2048

constituents for
Sep-2017 portfolio(61 issues)
constituents for
Oct-2017 portfolio(60 issues)

Source: Nomura

The issue that was redeemed on 20 September 2017 was included in the September
2017 index portfolio, and it was excluded at the end of September 2017 because of theredemption. After that, no new issues were included in the October 2017 index portfolio
and the number of issues in the NOMURA-BPI/Ladder 30yr decreased to 59 at the
beginning of October 2017. It is because there were no new JGBs issued in September
2017, whose redemption timings are in the latter part of FY2047 (Oct 2047-Mar 2048).
To carry out a completely passive investment, the redemption amounts for theredemption issue on 20 September 2017 need to be equally allocated to eachconstituent bond in the following month, and so it is necessary to prepare purchaseamounts by selling an equally allocated amount in the month in which bonds are newly
added. However, this method is not realistic because it inevitably results in an increasein transaction costs. For JGBs, there is always liquidity issues even without auctions, so
it may be worth considering a new index that encompasses a rule that it will include themost recently issued JGBs at such time that redemption amounts are available at theend of the month.5 Please contact us if you have any interest in such an index.

5 However, in such a case, there is a possibility that the redemption timing may not be as uniform as the
NOMURA-BPI/Ladder, and so the issues may not be aligned at equal intervals in terms of remaining years tomaturity, and so that the change in duration may become unstable.

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4. See: Reviewing Index Investing
To calculate the deviation factor between the actual result of the index investing and thereturn indicated by the index, it is necessary to know the factors of the return caused by
the index.
In this chapter, we show the results of the factor decomposition of the returns of various
indices.

4.1 NOMURA-BPI
As mentioned in Section 2.2, bond price changes are expressed in terms of changes inyield, and the yield is broken down into the interest rate and T spread. Furthermore, even
if the level of the interest rate or T spread do not change, bond estimated prices will rise
(if the yield is positive) over time. In addition, for MBS (mortgage-backed securities),
because of the existence of prepayment risk, with an embedded call option, a change involatility can explain price changes.
Here, we list four return factors:
 Time elapsedChanges in the yield curveChanges in T spreadChanges in volatility6

First, we dissect the change from the price of an individual bond at the end of last monthPt  1 to the price at the end of the current month P t  through the following four ways:Pt  1  P1 t :

Change in price due to time elapsed

P1 t   P2 t :

Change in price due to change in yield curve

P2 t   P3 t :

Change in price due to change in spreadP3 t   Pt :

Change in price due to change in volatility

Fig. 34: Price changes due to individual factors

Source: Nomura

In each of these calculation processes, only the related factor is changed. That is, theparameters outlined in Fig. 35 are used to calculate price P1t , P2 t , P3 t  and P t  .

6This indicates the impact that changes in swaption volatility have on bond prices when passed throughparameters.

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Fig. 35: Parameters used for calculating the prices
Yield curve
Swaption volatility

P1 t P2 t P3 t Pt 

T spreadPrevious monthPrevious monthPrevious month

Current monthPrevious monthPrevious month

Current monthPrevious month

Current month

Current month

Current month

Current month

Source: Nomura

Using these prices, un-annualized returns for individual factors of individual bonds arecalculated as the following.

Return due to time-elapsed factor: RTIME
With the passage of time, not only does price change from Pt  1 to P1 t  , interest
payments and principal redemption must also be considered.
RTIME F t  :

CF :
C

:

P1 F t   Pt  1F t  1  CFPt  1F t  1Remaining amount at time t
Interest payments and principal
redemption(  C / 100  F t  1  F t  1  F t  )Interest paid during month for JPY100 of face value

Return due to yield curve factors: RYC
RYC P2 t   P1 t F t 
Pt  1F t  1Return due to T spread factor: RSPREAD
RSPREAD 

P3 t   P2 t F t 
Pt  1F t  1Return due to volatility factor: RVOLRVOL 

Pt   P3 t F t 
Pt  1F t  1The return of the index is broken down by factor in the following procedure: 1) calculating
the returns for individual factors of individual bonds using the above methods, and 2)
calculating the weighted average of these returns by using the remaining amount of thebond as of the end of the previous month.
A dissection of the return results are shown below for the NOMURA-BPI, the NOMURABPI corporates, and the NOMURA-BPI MBS. Note that annualized data are shown in Fig.
36-38.

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Fig. 36: Return factor analysis of the NOMURA-BPI
Return(%)
25

Volatility factors

Spread factors

Yield factors

Time factors

20
15
10
5
0
-5
-10
-15
-20
2011/01

2012/01

2013/01

2014/01

2015/01

2016/012017/012018/01

Source: Nomura
Note: Shows month-end return in Jan 2011-Dec 2018

We see that in the NOMURA-BPI, of which up to 80% consists of JGBs, more than halfof the returns are due to the yield curve factor and the time elapsed factor. Furthermore,
the time elapsed factor decreased along with the downward shift in yields.

Fig. 37: Return factor analysis of the NOMURA-BPI corporates
Return(%)

Spread factors

15

Yield factors

Time factors

10
5
0
-5
-10
-15
-20
2011/01

2012/01

2013/01

2014/01

2015/01

2016/012017/012018/01

Source: Nomura
Note: Shows month-end return in Jan 2011-Dec 2018. Volatility factor is not calculated with Corporate bonds.

Fig. 37 shows that in the NOMURA-BPI corporates, there was the great impact on theindex return owing to the T spread factor after March 2011, when the Great East Japan
Earthquake occurred.

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Nomura | Japan Bond Indices Handbook

11 June 2019

Fig. 38: Return factor analysis of the NOMURA-BPI MBS
Return(%)
15

Volatility factors

Spread factors

Yield factors

Time factors

10
5
0
-5
-10
-15

-20
2011/01

2012/01

2013/01

2014/01

2015/01

2016/012017/012018/01

Source: Nomura
Note: Shows month-end return in Jan 2011-Dec 2018

Unlike other NOMURA-BPI sub-indices, the volatility factor is reflected in the NOMURABPI MBS. We have seen when the T spread factor has had a big impact between 2015
and 2016, along with the widening of the T spread caused by negative interest rate
policy.

4.2 NOMURA J-TIPS Index
As mentioned in Section 2.2, nominal JGBs and the rise in bond prices (positive bondreturns) have meant a decline in (nominal) yields. Conversely, for JGBi, when thenominal price of JGBi7 (inflation-adjusted prices) rises, whether expressed in terms of anincrease in the indexation coefficient or in the real price (that is to say, in the price before
inflation adjustment) rising (that is, there is a decrease in the real yield), it means that
one or the other of them is occurring. An increase in the indexation coefficient is caused
by a rise in the inflation rate that occurred from the past time to the valuation date, and a
decline in the real yield is due to a decrease in the nominal yield or to a rise in the BEI(break-even inflation), which is considered as the expected inflation rate, or is the resultof the existence of both these factors.
Here, we list four return factors:
 Changes in the past inflation rateTime elapsedChanges in nominal yieldChanges in BEI(expected inflation rate).

The definitions of each symbol are as follows.

7

The nominal price (price after inflation adjustment) of inflation-linked government bonds is expressed as the
product of the indexation coefficient and the real price (price before inflation adjustment). For this point, pleasealso refer to "Nomura Inflation-linked JGB Index: Index Construction Rule Book".

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Nomura | Japan Bond Indices Handbook

𝑅(𝑡)

:

Total return of NOMURA J-TIPS Index at time 𝑡

𝐷𝑃(𝑡)

:

Dirty price unadjusted for inflation at time 𝑡

𝐴𝐷𝑃(𝑡):

Dirty price adjusted for inflation at time 𝑡

𝐼𝑅(𝑡)

:

Index ratio at time 𝑡

𝑟(𝑡)

:

Real compound yield at time 𝑡

𝜋(𝑡)

:

Break-even inflation rate at time 𝑡

𝑛(𝑡)

:

Nominal compound yield at time 𝑡∆𝑡:Elapsed time between time 𝑡 − 1 and time 𝑡𝐷(𝑡)11 June 2019

Duration8 at time 𝑡

Note that each equation indicates as follows(1) Changes in the past inflation rate(2) Time elapsed(3) Changes in the nominal yield(4) Changes in the expected inflation rate.
Fig. 39 shows the result of the return decomposed into four factors.
Fig. 39: Return factor analysis of the NOMURA J-TIPS Index

Source: Nomura
Note: Shows month-end return in Jan 2011-Dec 2018. Total index is rebased so that end-Dec 2010 = 100.

We can see that the impact of the changes of the expected inflation rate was big when
the NOMURA J-TIPS Index performed well in 2004 and became worse in the latter halfof 2015 and the former half of 2016.

8

Unlike other chapters in this document, “Duration” in this chapter stands for duration, what we call Macaulay
duration, not modified duration. The definition of “duration” is placed in “NOMURA J-TIPS Index Rulebook”.

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Appendix A-1
Analyst Certification
We, Hiroe Fukasawa, Hiroshi Iso and Taiki Sekiya, hereby certify (1) that the views expressed in this Research report accuratelyreflect our personal views about any or all of the subject securities or issuers referred to in this Research report, (2) no part ofour compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in thisResearch report and (3) no part of our compensation is tied to any specific investment banking transactions performed by
Nomura Securities International, Inc., Nomura International plc or any other Nomura Group company.

Important Disclosures
Online availability of research and conflict-of-interest disclosures
Nomura Group research is available on www.nomuranow.com/research, Bloomberg, Capital IQ, Factset, Reuters and ThomsonOne.
Important disclosures may be read at http://go.nomuranow.com/research/globalresearchportal/pages/disclosures/disclosures.aspx or requested
from Nomura Securities International, Inc., or Instinet, LLC on 1-877-865-5752. If you have any difficulties with the website, please email
grpsupport@nomura.com for help.
The analysts responsible for preparing this report have received compensation based upon various factors including the firm's total revenues, aportion of which is generated by Investment Banking activities. Unless otherwise noted, the non-US analysts listed at the front of this report are
not registered/qualified as research analysts under FINRA rules, may not be associated persons of NSI or ILLC, and may not be subject to
FINRA Rule 2241 restrictions on communications with covered companies, public appearances, and trading securities held by a researchanalyst account.
Nomura Global Financial Products Inc. (“NGFP”) Nomura Derivative Products Inc. (“NDPI”) and Nomura International plc. (“NIplc”) areregistered with the Commodities Futures Trading Commission and the National Futures Association (NFA) as swap dealers. NGFP, NDPI, andNIplc are generally engaged in the trading of swaps and other derivative products, any of which may be the subject of this report.
ADDITIONAL DISCLOSURES REQUIRED IN THE U.S.
Principal Trading: Nomura Securities International, Inc and its affiliates will usually trade as principal in the fixed income securities (or in related
derivatives) that are the subject of this research report. Analyst Interactions with other Nomura Securities International, Inc. Personnel: The fixedincome research analysts of Nomura Securities International, Inc and its affiliates regularly interact with sales and trading desk personnel inconnection with obtaining liquidity and pricing information for their respective coverage universe.
Valuation methodology - Fixed Income
Nomura’s Fixed Income Strategists express views on the price of securities and financial markets by providing trade recommendations. Thesecan be relative value recommendations, directional trade recommendations, asset allocation recommendations, or a mixture of all three.
The analysis which is embedded in a trade recommendation would include, but not be limited to:• Fundamental analysis regarding whether a security’s price deviates from its underlying macro- or micro-economic fundamentals.
• Quantitative analysis of price variations.
• Technical factors such as regulatory changes, changes to risk appetite in the market, unexpected rating actions, primary market activity andsupply/ demand considerations.
The timeframe for a trade recommendation is variable. Tactical ideas have a short timeframe, typically less than three months. Strategic tradeideas have a longer timeframe of typically more than three months.
For the purposes of the EU Market Abuse Regulation, the distribution of ratings published by Nomura Global Fixed Income Research is asfollows:
53% have been assigned a Buy (or equivalent) rating; 50% of issuers with this rating were supplied material services* by the Nomura Group**.
0% have been assigned a Neutral (or equivalent) rating.
47% have been assigned a Sell (or equivalent) rating; 60% of issuers with this rating were supplied material services by the Nomura Group.
As at 3 April 2019.
*As defined by the EU Market Abuse Regulation**The Nomura Group as defined in the Disclaimer section at the end of this report

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Nomura | Japan Bond Indices Handbook

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11 June 2019

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Disclaimers required in Japan
Explanation on Ratings by Unregistered Rating Agencies
From the perspective of obtaining fairness and transparency in the market, registration system for credit rating agencies has been introduced
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In accordance with this, those financial instruments business operators utilizing ratings assigned by unregistered rating agencies (“Unregistered
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○Significance of Registration
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○Rating Agencies
Standard & Poor’s-Name of the rating agency group and registration number
Name of the rating agency group: S&P Global Ratings (S&P)
Name of the registered credit rating agency within the group and its registration number:
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Please refer to the Japanese website of S&P Global Ratings Japan Inc. at (http://www.standardandpoors.co.jp). Access「無登録格付け情報」(http://www.standardandpoors.co.jp/unregistered) under 「ライブラリ・規制関連」of the page.
-Assumptions, Significance and Limitation of Credit Ratings

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Credit ratings assigned by S&P are statements of opinion on the future credit quality of issuers or particular debts as of the date they are
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-Assumptions, Significance and Limitation of Credit Ratings
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and any estimated financial loss in the event of default. Credit ratings do not address any other risk, including but not limited to: liquidity risk,
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-Assumptions, Significance and Limitation of Credit Ratings
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as opinions on relative ranking of vulnerability to default, do not imply or convey a specific statistical probability of default.
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believes to be credible. Fitch conducts a reasonable investigation of the factual information relied upon by it in accordance with its ratings
methodology, and obtains reasonable verification of that information from independent sources, to the extent such sources are available for agiven security or in a given jurisdiction. The assignment of a rating to any issuer or any security should not be viewed as a guarantee of theaccuracy, completeness, or timeliness of the information relied on in connection with the rating or the results obtained from the use of suchinformation. If any such information should turn out to contain misrepresentations or to be otherwise misleading, the rating associated with that
information may not be appropriate. Despite any verification of current facts, ratings can be affected by future events or conditions that were notanticipated at the time a rating was issued or affirmed.
Please refer to “Definitions of Ratings and Other Forms of Opinion” on Fitch’s Japanese website for the explanation covering the details of theassumptions, significance and limitation of credit ratings.
This information is based on information Nomura has received from sources it believes to be reliable as of June 1, 2018, but it does notguarantee accuracy or completeness of the information. For details, please refer to its website above.
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Disclaimers required in Japan
Credit ratings in the text that are marked with an asterisk (*) are issued by a rating agency not registered under Japan’s Financial Instruments
and Exchange Act (“Unregistered Ratings”). For details on Unregistered Ratings, please contact the Research Product Management Dept. of
Nomura Securities Co., Ltd.
Investors in the financial products offered by Nomura Securities may incur fees and commissions specific to those products (for example,
transactions involving Japanese equities are subject to a sales commission (all figures on a tax-inclusive basis) of up to 1.404% of thetransaction amount or a commission of ¥2,808 for transactions of ¥200,000 or less, while transactions involving investment trusts are subject tovarious fees, such as commissions at the time of purchase and asset management fees (trust fees), specific to each investment trust). In
addition, all products carry the risk of losses owing to price fluctuations or other factors. Fees and risks vary by product. Please thoroughly read
the written materials provided, such as documents delivered before making a contract, listed securities documents, or prospectuses.
-----Transactions involving Japanese equities (including Japanese REITs, Japanese ETFs, and Japanese ETNs) are subject to a sales commissionof up to 1.404% of the transaction amount (or a commission of ¥2,808 for transactions of ¥200,000 or less). When Japanese equities arepurchased via OTC transactions (including offerings), only the purchase price shall be paid, with no sales commission charged. However,36Nomura | Japan Bond Indices Handbook

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Nomura Securities may charge a separate fee for OTC transactions, as agreed with the customer. Japanese equities carry the risk of losses
owing to price fluctuations. Japanese REITs carry the risk of losses owing to fluctuations in price and/or earnings of underlying real estate.
Japanese ETFs carry the risk of losses owing to fluctuations in the underlying indexes or other benchmarks.
Transactions involving foreign equities are subject to a domestic sales commission of up to 1.026% of the transaction amount (which equals the
local transaction amount plus local fees and taxes in the case of a purchase or the local transaction amount minus local fees and taxes in thecase of a sale) (for transaction amounts of ¥750,000 and below, maximum domestic sales commission is ¥7,668). Local fees and taxes inforeign financial instruments markets vary by country/territory. When foreign equities are purchased via OTC transactions (including offerings),
only the purchase price shall be paid, with no sales commission charged. However, Nomura Securities may charge a separate fee for OTC
transactions, as agreed with the customer. Foreign equities carry the risk of losses owing to factors such as price fluctuations and foreignexchange rate fluctuations.
Margin transactions are subject to a sales commission of up to 1.404% of the transaction amount (or a commission of ¥2,808 for transactions of¥200,000 or less), as well as management fees and rights handling fees. In addition, long margin transactions are subject to interest on thepurchase amount, while short margin transactions are subject to fees for the lending of the shares borrowed. A margin equal to at least 30% of
the transaction amount (at least 33% for online transactions) and at least ¥300,000 is required. With margin transactions, an amount up toroughly 3.3x the margin (roughly 3x for online transactions) may be traded. Margin transactions therefore carry the risk of losses in excess of themargin owing to share price fluctuations. For details, please thoroughly read the written materials provided, such as listed securities documents
or documents delivered before making a contract.
Transactions involving convertible bonds are subject to a sales commission of up to 1.08% of the transaction amount (or a commission of¥4,320 if this would be less than ¥4,320). When convertible bonds are purchased via OTC transactions (including offerings), only the purchaseprice shall be paid, with no sales commission charged. However, Nomura Securities may charge a separate fee for OTC transactions, as
agreed with the customer. Convertible bonds carry the risk of losses owing to factors such as interest rate fluctuations and price fluctuations in
the underlying stock. In addition, convertible bonds denominated in foreign currencies also carry the risk of losses owing to factors such as
foreign exchange rate fluctuations.
When bonds are purchased via public offerings, secondary distributions, or other OTC transactions with Nomura Securities, only the purchaseprice shall be paid, with no sales commission charged. Bonds carry the risk of losses, as prices fluctuate in line with changes in market interest
rates. Bond prices may also fall below the invested principal as a result of such factors as changes in the management and financial
circumstances of the issuer, or changes in third-party valuations of the bond in question. In addition, foreign currency-denominated bonds also
carry the risk of losses owing to factors such as foreign exchange rate fluctuations.
When Japanese government bonds (JGBs) for individual investors are purchased via public offerings, only the purchase price shall be paid, withno sales commission charged. As a rule, JGBs for individual investors may not be sold in the first 12 months after issuance. When JGBs forindividual investors are sold before maturity, an amount calculated via the following formula will be subtracted from the par value of the bondplus accrued interest: (1) for 10-year variable rate bonds, an amount equal to the two preceding coupon payments (before tax) x 0.79685 will be
used, (2) for 5-year and 3-year fixed rate bonds, an amount equal to the two preceding coupon payments (before tax) x 0.79685 will be used.
When inflation-indexed JGBs are purchased via public offerings, secondary distributions (uridashi deals), or other OTC transactions with
Nomura Securities, only the purchase price shall be paid, with no sales commission charged. Inflation-indexed JGBs carry the risk of losses, as
prices fluctuate in line with changes in market interest rates and fluctuations in the nationwide consumer price index.The notional principal of
inflation-indexed JGBs changes in line with the rate of change in nationwide CPI inflation from the time of its issuance. The amount of the
coupon payment is calculated by multiplying the coupon rate by the notional principal at the time of payment. The maturity value is the amountof the notional principal when the issue becomes due. For JI17 and subsequent issues, the maturity value shall not undercut the face amount.
Purchases of investment trusts (and sales of some investment trusts) are subject to a purchase or sales fee of up to 5.4% of the transaction
amount. Also, a direct cost that may be incurred when selling investment trusts is a fee of up to 2.0% of the unit price at the time of redemption.
Indirect costs that may be incurred during the course of holding investment trusts include, for domestic investment trusts, an asset managementfee (trust fee) of up to 5.4% (annualized basis) of the net assets in trust, as well as fees based on investment performance. Other indirect costs
may also be incurred. For foreign investment trusts, indirect fees may be incurred during the course of holding such as investment company
compensation.
Investment trusts invest mainly in securities such as Japanese and foreign equities and bonds, whose prices fluctuate. Investment trust unit
prices fluctuate owing to price fluctuations in the underlying assets and to foreign exchange rate fluctuations. As such, investment trusts carry
the risk of losses. Fees and risks vary by investment trust. Maximum applicable fees are subject to change; please thoroughly read the writtenmaterials provided, such as prospectuses or documents delivered before making a contract.
In interest rate swap transactions and USD/JPY basis swap transactions (“interest rate swap transactions, etc.”), only the agreed transaction
payments shall be made on the settlement dates. Some interest rate swap transactions, etc. may require pledging of margin collateral. In someof these cases, transaction payments may exceed the amount of collateral. There shall be no advance notification of required collateral value or
collateral ratios as they vary depending on the transaction. Interest rate swap transactions, etc. carry the risk of losses owing to fluctuations inmarket prices in the interest rate, currency and other markets, as well as reference indices. Losses incurred as such may exceed the value ofmargin collateral, in which case margin calls may be triggered. In the event that both parties agree to enter a replacement (or termination)transaction, the interest rates received (paid) under the new arrangement may differ from those in the original arrangement, even if terms otherthan the interest rates are identical to those in the original transaction. Risks vary by transaction. Please thoroughly read the written materials
provided, such as documents delivered before making a contract and disclosure statements.
In OTC transactions of credit default swaps (CDS), no sales commission will be charged. When entering into CDS transactions, the protection
buyer will be required to pledge or entrust an agreed amount of margin collateral. In some of these cases, the transaction payments may exceed
the amount of margin collateral. There shall be no advance notification of required collateral value or collateral ratios as they vary depending on
the financial position of the protection buyer. CDS transactions carry the risk of losses owing to changes in the credit position of some or all of
the referenced entities, and/or fluctuations of the interest rate market. The amount the protection buyer receives in the event that the CDS is
triggered by a credit event may undercut the total amount of premiums that he/she has paid in the course of the transaction. Similarly, theamount the protection seller pays in the event of a credit event may exceed the total amount of premiums that he/she has received in thetransaction. All other conditions being equal, the amount of premiums that the protection buyer pays and that received by the protection seller
shall differ. In principle, CDS transactions will be limited to financial instruments business operators and qualified institutional investors.
No account fee will be charged for marketable securities or monies deposited. Transfers of equities to another securities company via the Japan
Securities Depository Center are subject to a transfer fee of up to ¥10,800 per issue transferred depending on volume.

Nomura Securities Co., Ltd.
Financial instruments firm registered with the Kanto Local Finance Bureau (registration No. 142)
Member associations: Japan Securities Dealers Association; Japan Investment Advisers Association; The Financial Futures Association ofJapan; and Type II Financial Instruments Firms Association.

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The Nomura Group manages conflicts with respect to the production of research through its compliance policies and procedures (including, but
not limited to, Conflicts of Interest, Chinese Wall and Confidentiality policies) as well as through the maintenance of Chinese Walls andemployee training.
Additional information regarding the methodologies or models used in the production of any investment recommendations contained
within this document is available upon request by contacting the Research Analysts listed on the front page. Disclosures information
is available upon request and disclosure information is available at the Nomura Disclosure web page:
http://go.nomuranow.com/research/globalresearchportal/pages/disclosures/disclosures.aspx
Copyright © 2019 Nomura Securities Co., Ltd. All rights reserved.

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