Description
In finance, a bond is an instrument of indebtedness of the bond issuer to the holders. It is a debt security, under which the issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay them interest (the coupon) and/or to repay the principal at a later date, termed the maturity
Bond
…..Not
James Bond….But Yes, James Bond of Finance
What are Bonds ? A bond is a debt security, by which you are lending money to a government, municipality, corporation, or other entity known as the issuer. In return for the loan, the issuer promises to pay you a specified rate of interest during the life of the bond and to repay the face value of the bond (the principal) when it matures or becomes due.
Why Invest in Bonds?
Because bonds typically have a predictable stream of payments and repayment of principal, many people invest in them to preserve and increase their capital or to receive dependable interest income.
What is meant by the term Face Value? Securities are generally issued in denominations of 10, 100 or 1000. This is known as the Face Value or Par Value of the security.
What is the Coupon rate of the Security ? The Coupon rate is simply the interest rate that every debenture/Bond carries on its face value and is fixed at the time of issuance. For example, a 10% p.a coupon rate on a bond/debenture of Rs 100 implies that the investor will receive Rs 10 p.a. The coupon can be payable monthly, quarterly, half-yearly, or annually or cumulative on redemption. What is Interest Rate ? Bonds pay interest that can be fixed, floating or payable at maturity. Most debt securities carry an interest rate that stays fixed until maturity and is a percentage of the face (principal) amount. Typically, investors receive interest payments semiannually. For example, a Rs.1000 bond with an 8% interest rate will pay investors Rs.80 a year, in payments of Rs.40 every six months. When the bond matures, investors receive the full face amount of the bond—Rs.1, 000.
What do you mean by the Maturity of the bond ?
Securities are issued for a fixed period of time at the end of which the principal amount borrowed is repaid to the investors. The date on which the term ends and proceeds are paid out is known as the Maturity date. It is specified on the face of the instrument. Maturity ranges are often categorized as follows: · Short—term notes: maturities of up to five years
· Intermediate notes/bonds: maturities of five to 12 years · Long—term bonds: maturities of 12 or more years
What is redemption and what are the various Redemption Features?
On reaching the date of maturity, the issuer repays the money borrowed from the investors. This is known as Redemption or Repayment of the bond/debenture. · Call Provisions: Some bonds have redemption, or “call” provisions that allow or require the issuer to repay the investors? principal at a specified date before maturity. Bonds are commonly “called” when prevailing interest rates have dropped significantly since the time the bonds were issued.
· Puts: Conversely, some bonds have “puts,” which allow the investor the option of requiring the issuer to repurchase the bonds at specified times prior to maturity. Investors typically exercise this option when they need cash for some purpose or when interest rates have risen since the bonds were issued. They can then reinvest the proceeds at a higher interest rate.
What is the Yield on a Bond ?
Yield is the return you actually earn on the bond—based on the price you paid and the interest payment you receive. There are basically two types of bond yields you should be aware of: current yield and yield to maturity or yield to call.
What is Current Yield ? Current yield is the annual return on the amount paid for the bond and is derived by dividing the bond?s interest payment by its purchase price. If you bought at Rs.1, 000 and the interest rate is 8% (Rs.80), the current yield is 8% (Rs.80 ÷ Rs.1, 000). If you bought at Rs.800 and the interest rate is 8% (Rs.80), the current yield is 10% (Rs.80 ÷ Rs.800).
Current Yield is the coupon divided by the Market Price and gives a fair approximation of the present yield.
Therefore, Current Yield = Coupon of the Security(in %) x Face Value of the Security (viz. 100 in case of GSecs.)/Market Price of the Security Eg: Suppose the market price for a 10.18% G-Sec 2012 is Rs.120. The current yield on the security will be (0.1018 x 100)/120 = 8.48%
What is dividend yield ? Dividend yield is dividend to price ratio. It is the percentage calculated by dividing dividend per share by price per share. Dividend yield is used to calculate the earning on investment (shares) considering only the returns in the form of total dividends declared by the company during the year. Dividend Yield = Interim + Final Dividend X 100 Market Price of the share E.g.: For a company for FY10, Interim dividend = Rs. 2 per share Final dividend = Rs. 3 per share Share price = Rs. 50 Dividend yield = 2 + 3 50 Dividend yield =10%
What is Yield to Maturity/Yield to Call ? Yield to maturity and yield to call, tell you the total return you will receive by holding the bond until it matures or is called. It also enables you to compare bonds with different maturities and coupons. Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield), plus any gain (if you purchased the bond below its par, or face, value) or loss (if you purchased it above its par value). Yield to call is calculated the same way as yield to maturity, but assumes that a bond will be called and that the investor will receive face value back at the call date.
What is record date/shut period?
G-Sec/Bonds/Debentures keep changing hands in the secondary market. Issuer pays interest to the holders registered in its register on a certain date. Such date is known as record date. Securities are not transferred in the books of issuer during the period in which such records are updated for payment of interest etc. Such period is called as shut period.
What is a Debenture? A Debenture is a debt security issued by a company (called the Issuer), which offers to pay interest in lieu of the money borrowed for a certain period. In essence it represents a loan taken by the issuer who pays an agreed rate of interest during the lifetime of the instrument and repays the principal normally, unless otherwise agreed, on maturity. These are long-term debt instruments issued by private sector companies. These are issued in denominations as low as Rs 1000 and have maturities ranging between one and ten years.
What are the different types of debentures? Debentures are divided into different categories on the basis of Convertibility of the instrument and security .On the basis of convertibility, debentures are classified into: · Non Convertible Debentures (NCD) : These instruments retain the debt character and can not be converted in to equity shares · Partly Convertible Debentures (PCD) : A part of these instruments are converted into Equity shares in the future at notice of the issuer. The issuer decides the ratio for conversion. This is normally decided at the time of subscription. · Fully convertible Debentures (FCD) : These are fully convertible into Equity shares at the issuer's notice. The ratio of conversion is decided by the issuer. Upon conversion the investors enjoy the same status as ordinary shareholders of the company. · Optionally Convertible Debentures (OCD) : The investor has the option to either convert these debentures into shares at price decided by the issuer/agreed upon at the time of issue.
On the basis of Security, debentures are classified into: · Secured Debentures : These instruments are secured by a charge on the fixed assets of the issuer company. So if the issuer fails on payment of the principal or interest amount, his assets can be sold to repay the liability to the investors · Unsecured Debentures: These instrument are unsecured in the sense that if the issuer defaults on payment of the interest or principal amount, the investor has to be along with other unsecured creditors of the company.
What are the main features of G-Secs and T-Bills in India? All G-Secs in India currently have a face value of Rs.100/- and are issued by the RBI on behalf of the Government of India. All G-Secs are normally coupon (Interest rate) bearing and have semi-annual coupon or interest payments with a tenor of between 5 to 30 years. This may change according to the structure of the Instrument. Eg: a 11.50% GOI 2005 security will carry a coupon rate(Interest Rate) of 11.50% p.a. on a face value per unit of Rs.100/- payable semi-annually and maturing in the year 2005.
Treasury Bills Treasury Bills are the instruments of short term borrowing by the Central/State govt. They are promissory notes issued at discount and for a fixed period. These were first issued in India in 1917. Objectives :-These are issued to raise funds for meeting expenditure needs and also provide outlet for parking temporary surplus funds by investors. Investors :-Treasury bills can be purchased by any one (including individuals) except State govt. These are issued by RBI and sold through fortnightly or monthly auctions at varying discount rate depending upon the bids. Denomination :-Minimum amount of face value Rs.1 lac and in multiples there of. There is no specific amount/limit on the extent to which these can be issued or purchased. Maturity :- 91 days and 364 days. Rate of interest :-Market determined, based on demand for and supply of funds in the money market. Other features :• These are highly liquid and safe investment giving attractive yield. • Approved assets for SLR purposes and DFHI is the market maker in these instruments and provide (daily) two way quotes to assure liquidity. • RBI sells treasury bills on auction basis (to bidders quoting above the cut-off price fixed by RBI) every fortnight by calling bids from banks, State Govt. and other specified bodies. They account for 3-4 % of the daily trading volumes.
What factors determine interest rates? When we talk of interest rates, there are different types of interest rates - rates that banks offer to their depositors, rates that they lend to their borrowers, the rate at which the Government borrows in the bond/G-Sec, market, rates offered to small investors in small savings schemes like NSC rates at which companies issue fixed deposits etc. The factors which govern the interest rates are mostly economy related and are commonly referred to as macroeconomic. Some of these factors are:
· Demand for money · Government borrowings · Supply of money · Inflation rate · The Reserve Bank of India and the Government policies which determine some of the variables mentioned above.
Who Regulates Indian G-1- and Debt Market? RBI: The Reserve Bank of India is the main regulator for the Money Market. Reserve Bank of India also controls and regulates the G-Secs Market. Another major area under the control of the RBI is the interest rate policy. Earlier, it used to strictly control interest rates through a directed system of interest rates. Each type of lending activity was supposed to be carried out at a pre-specified interest rate. Over the years RBI has moved slowly towards a regime of market determined controls. SEBI: Regulator for the Indian Corporate Debt Market is the Securities and Exchange Board of India (SEBI). SEBI controls bond market and corporate debt market in cases where entities raise money from public through public issues.
What is the Debt Market ? The Debt Market is the market where fixed income securities of various types and features are issued and traded. Debt Markets are therefore, markets for fixed income securities issued by Central and State Governments, Municipal Corporations, Govt. bodies and commercial entities like Financial Institutions, Banks, Public Sector Units, Public Ltd. companies and also structured finance instruments. What is the Money Market ?
The Money Market is basically concerned with the issue and trading of securities with short term maturities or quasi-money instruments. The Instruments traded in the money-market are Treasury Bills, Certificates of Deposits (CDs), Commercial Paper (CPs), Bills of Exchange and other such instruments of short-term maturities (i.e. not exceeding 1 year with regard to the original maturity)
Why should one invest in fixed income securities?
Fixed Income securities offer a predictable stream of payments by way of interest and repayment of principal at the maturity of the instrument. The debt securities are issued by the eligible entities against the moneys borrowed by them from the investors in these instruments. Therefore, most debt securities carry a fixed charge on the assets of the entity and generally enjoy a reasonable degree of safety by way of the security of the fixed and/or movable assets of the company. *The investors benefit by investing in fixed income securities as they preserve and increase their invested capital and also ensure the receipt of regular interest income. *The investors can even neutralize the default risk on their investments by investing in Govt. securities, which are normally referred to as risk-free investments due to the sovereign guarantee on these instruments. *The prices of Debt securities display a lower average volatility as compared to the prices of other financial securities and ensure the greater safety of accompanying investments.
*Debt securities enable wide-based and efficient portfolio diversification and thus assist in portfolio risk-mitigation.
*Tax exemption for interest earned on G-Secs. up to Rs.3000/- over and above the limit of
What are the different types of instruments, which are normally traded in this market? The instruments traded can be classified into the following segments based on the characteristics of the identity of the issuer of these securities:
Market Segment
Issuer
Instruments Zero Coupon Bonds, Coupon Bearing Bonds, Treasury Bills, STRIPS Coupon Bearing Bonds. Govt. Guaranteed Bonds, Debentures PSU Bonds, Debentures, Commercial Paper Debentures, Bonds, Commercial Paper, Floating Rate Bonds, Zero Coupon Bonds, Inter-Corporate Deposits Certificates of Deposits, Debentures, Bonds Certificates of Deposits, Bonds
Government Securities
Central Government State Governments
Public Sector Bonds
Government Agencies / Statutory Bodies Public Sector Units
Private Sector Bonds
Corporates
Banks Financial Institutions
What are the different types of risks with regard to debt securities? The following are the risks associated with debt securities:
Default Risk: This can be defined as the risk that an issuer of a bond may be unable to make timely payment of interest or principal on a debt security or to otherwise comply with the provisions of a bond indenture and is also referred to as credit risk.
Interest Rate Risk: can be defined as the risk emerging from an adverse change in the interest rate prevalent in the market so as to affect the yield on the existing instruments. A good case would be an upswing in the prevailing interest rate scenario leading to a situation where the investors' money is locked at lower rates whereas if he had waited and invested in the changed interest rate scenario, he would have earned more. Reinvestment Rate Risk: can be defined as the probability of a fall in the interest rate resulting in a lack of options to invest the interest received at regular intervals at higher rates at comparable rates in the market. The following are the risks associated with trading in debt securities: Counter Party Risk: is the normal risk associated with any transaction and refers to the failure or inability of the opposite party to the contract to deliver either the promised security or the sale-value at the time of settlement. Price Risk: refers to the possibility of not being able to receive the expected price on any order due to a adverse movement in the prices
What is the trading structure in the Wholesale Debt Market?
The Debt Markets in India and all around the world are dominated by Government securities, which account for between 50 - 75% of the trading volumes and the market capitalization in all markets. Government securities (G-Secs ) account for 70 - 75% of the outstanding value of issued securities and 90-95% of the trading volumes in the Indian Debt Markets. State Government securities & Treasury Bills account for around 3-4 % of the daily trading volumes. The trading activity in the G-Sec. Market is also very concentrated currently (in terms of liquidity of the outstanding G-Secs .) with the top 10 liquid securities accounting for around 70% of the daily volumes. Who are the main investors of Govt. Securities in India? Traditionally, the Banks have been the largest category of investors in G-secs accounting for more than 60% of the transactions in the Wholesale Debt Market. The Banks are a prime and captive investor base for G-secs as they are normally required to maintain 25% of their net time and demand liabilities as SLR but it has been observed that the banks normally invest 10% to 15% more than the normal requirement in Government Securities because of the following requirements:*Risk Free nature of the Government Securities *Greater returns in G-Secs as compared to other investments of comparable nature
How interest rates and bonds prices are related ? You must have heard or read often that when Interest rates fall, bond prices go up and when interest rates rise, bond prices go down. Also in many articles you would have read a term “Interest rate Risk”, but always wondered why its is a “risk”.
Let me give you a simple example . Suppose in the market the interest rates are around 10% , Now Sudhir lends Rs 1,000 to Ashish for 1 yr at the interest rate of 10% , which means Sudhir will get Rs 100 as interest next year plus his initial 1,000 of principle , so Sudhir will get back total Rs 1,100 at the end of 1 yr. Now suppose they sign a paper where all these terms and conditions are written and we call this paper as “BOND” . Who ever has this bond at the end can go to Ashish and get Rs 1,100 by giving them that BOND paper. Now imagine two situations where interest rates move up and down and a third person called Tanuj wants to buy the bonds after interest rates has moved. Lets see how bond prices move in both the cases here.
Case 1 : Interest rates go down Suppose interest rates in market falls to 9% because of government policies or some other reasons (in our country RBI keeps change interest rates). Which means now if a person lends Rs 1,000 to some one, he can get only 9% as interest. But Sudhir has a special bond! , which actually gives 10% return (also called as coupon rate) and not 9%. He is getting 1% more than what a new bond in market will give. Now if Tanuj comes to Sudhir and wants to buy this Bond from Sudhir, Will Sudhir give this bond at 1,000 ? No , This bond is worth more now, because this bond is giving more than what a normal bond in market can provide. What will be price Sudhir can charge from Tanuj ? It?s very simple maths. If Tanuj goes to market and invests 1,000 , He will get 1,090 at the end of the year because interest rates are at 9% only. So how much should Tanuj pay for the bond Sudhir is holding as he will get Rs 1,100 with that bond. It?s a simple calculation => To get 1,090 at maturity , Tanuj has to pay 1,000 in current condition. so .. => To get Rs 1 at maturity, Tanuj has to pay 1,000/1,090 in current condition. => To get Rs 1,110 at maturity, Tanuj has to pay 1,100 * 1,000/1,090 today = Rs 1,009.2 (approx). Which means as Sudhir bond is giving 1,100 at the end , Its worth 1009.2 because interest rates moved down ! . So Sudhir?s bond commands a premium of Rs 9.2 . You can see that 9% of 1,009.2 is equal to 90.8 and 1009.2 + 90.8 = Rs 1,100 which completes the equation
Case 2 : Interest rates go up In the same manner suppose interest rates move up to 12% in market from initial 10% . Now if a person lends Rs 1,000 to someone , he can get 1,120 at the end . Now Sudhir?s bond is actually giving less than the new bonds in market . Why will some one pay 1,000 to Sudhir to get 1,100 at the maturity , when they can lend the same money in market to get 1,120 at maturity , which is Rs 20 more . So now if a person has to buy Sudhir?s bond they will pay a less price (discount) . Using the same process you saw above you can find out that the new value of bond will be 982.2 => To get 1,120 at maturity , Tanuj has to pay 1,000 in current condition. so .. => To get Rs 1 at maturity, Tanuj has to pay 1,000/1,120 in current condition.
=> To get Rs 1,110 at maturity, Tanuj has to pay 1,100 * 1,000/1,120 today = Rs 982.2 (approx).
What is Commercial Paper (CP) ? Commercial Paper (CP) is an unsecured money market instrument issued in the form of a promissory note. It was introduced in India in 1990. Why it was introduced? It was introduced in India in 1990 with a view to enabling highly rated corporate borrowers/ to diversify their sources of short-term borrowings and to provide an additional instrument to investors. Subsequently, primary dealers and satellite dealers were also permitted to issue CP to enable them to meet their short-term funding requirements for their operations. Who can issue CP? Corporates, primary dealers (PDs) and the All-India Financial Institutions (FIs) are eligible to issue CP. Is there any rating requirement for issuance of CP? And if so, what is the rating requirement? Yes. All eligible participants shall obtain the credit rating for issuance of Commercial Paper either from Credit Rating Information Services of India Ltd. (CRISIL) or the Investment Information and Credit Rating Agency of India Ltd. (ICRA) or the Credit Analysis and Research Ltd. (CARE) or the FITCH Ratings India Pvt. Ltd. or such other credit rating agency (CRA) as may be specified by the Reserve Bank of India from time to time, for the purpose. The minimum credit rating shall be P-2 of CRISIL or such equivalent rating by other agencies.
What is the minimum and maximum period of maturity prescribed for CP? CP can be issued for maturities between a minimum of 15 days and a maximum up to one year from the date of issue. In what denominations a CP that can be issued? CP can be issued in denominations of Rs.5 lakh or multiples thereof. Who can invest in CP? Individuals, banking companies, other corporate bodies registered or incorporated in India and unincorporated bodies, Non-Resident Indians (NRIs) and Foreign Institutional Investors (FIIs) etc. can invest in CPs. However, amount invested by single investor should not be less than Rs.5 lakh (face value).However, investment by FIIs would be within the limits set for their investments by Securities and Exchange Board of India (SEBI. Whether CP is always issued at a discount? Yes. CP will be issued at a discount to face value as may be determined by the issuer.
CERTIFICATE OF DEPOSITS This scheme was introduced in July 1989, to enable the banking system to mobilise bulk deposits from the market, which they can have at competitive rates of interest. We can compare certificate of deposits with treasury bills as they are short term, tradable, discounted bonds. But the difference is T-Bills are issued by government and CDs are issued by banks, financial institutions. The lender of a CD could be another bank, corporate or financial institution. Who can issue :-Scheduled commercial banks (except RRBs) and All India Financial Institutions within their `Umbrella limit?. Some features of CDs in India *Maturity period is Minimum 7 days Maximum: 12 Months for CDs issued by banks. For CDs issued by Financial institutions maturity is minimum 1 year and maximum 3 years. *Minimum amount to invest in a CD is Rs1 lakh *Loan against collateral of CD is not permitted (It?s possible in „sight fixed deposits?) *Premature withdrawal is not allowed (can be sold to other investors) *Interest rate can be fixed or floating *They are issued at a discount to face value like zero coupon bonds
Inter-corporate Deposits (ICDs) Inter-Corporate Deposits refers to unsecured short term funding raised by corporates from other corporates. This is a form of disintermediated financing, where corporates with surplus funding directly lend to those in need of funding of such funds and thereby save on the spreads that banks would have charged in borrowing from one to lend to the other. Rates on ICDs would higher than those in the Certificate of Deposit (CD) market. The tenor of ICD may range from 1 day to 1 year, but the most common tenor of borrowing is for 90 days. Only Limited Companies can issue ICDs . Minimum is Rs. 1,00,000/- and maximum ,no limit.
doc_782890241.pptx
In finance, a bond is an instrument of indebtedness of the bond issuer to the holders. It is a debt security, under which the issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay them interest (the coupon) and/or to repay the principal at a later date, termed the maturity
Bond
…..Not
James Bond….But Yes, James Bond of Finance
What are Bonds ? A bond is a debt security, by which you are lending money to a government, municipality, corporation, or other entity known as the issuer. In return for the loan, the issuer promises to pay you a specified rate of interest during the life of the bond and to repay the face value of the bond (the principal) when it matures or becomes due.
Why Invest in Bonds?
Because bonds typically have a predictable stream of payments and repayment of principal, many people invest in them to preserve and increase their capital or to receive dependable interest income.
What is meant by the term Face Value? Securities are generally issued in denominations of 10, 100 or 1000. This is known as the Face Value or Par Value of the security.
What is the Coupon rate of the Security ? The Coupon rate is simply the interest rate that every debenture/Bond carries on its face value and is fixed at the time of issuance. For example, a 10% p.a coupon rate on a bond/debenture of Rs 100 implies that the investor will receive Rs 10 p.a. The coupon can be payable monthly, quarterly, half-yearly, or annually or cumulative on redemption. What is Interest Rate ? Bonds pay interest that can be fixed, floating or payable at maturity. Most debt securities carry an interest rate that stays fixed until maturity and is a percentage of the face (principal) amount. Typically, investors receive interest payments semiannually. For example, a Rs.1000 bond with an 8% interest rate will pay investors Rs.80 a year, in payments of Rs.40 every six months. When the bond matures, investors receive the full face amount of the bond—Rs.1, 000.
What do you mean by the Maturity of the bond ?
Securities are issued for a fixed period of time at the end of which the principal amount borrowed is repaid to the investors. The date on which the term ends and proceeds are paid out is known as the Maturity date. It is specified on the face of the instrument. Maturity ranges are often categorized as follows: · Short—term notes: maturities of up to five years
· Intermediate notes/bonds: maturities of five to 12 years · Long—term bonds: maturities of 12 or more years
What is redemption and what are the various Redemption Features?
On reaching the date of maturity, the issuer repays the money borrowed from the investors. This is known as Redemption or Repayment of the bond/debenture. · Call Provisions: Some bonds have redemption, or “call” provisions that allow or require the issuer to repay the investors? principal at a specified date before maturity. Bonds are commonly “called” when prevailing interest rates have dropped significantly since the time the bonds were issued.
· Puts: Conversely, some bonds have “puts,” which allow the investor the option of requiring the issuer to repurchase the bonds at specified times prior to maturity. Investors typically exercise this option when they need cash for some purpose or when interest rates have risen since the bonds were issued. They can then reinvest the proceeds at a higher interest rate.
What is the Yield on a Bond ?
Yield is the return you actually earn on the bond—based on the price you paid and the interest payment you receive. There are basically two types of bond yields you should be aware of: current yield and yield to maturity or yield to call.
What is Current Yield ? Current yield is the annual return on the amount paid for the bond and is derived by dividing the bond?s interest payment by its purchase price. If you bought at Rs.1, 000 and the interest rate is 8% (Rs.80), the current yield is 8% (Rs.80 ÷ Rs.1, 000). If you bought at Rs.800 and the interest rate is 8% (Rs.80), the current yield is 10% (Rs.80 ÷ Rs.800).
Current Yield is the coupon divided by the Market Price and gives a fair approximation of the present yield.
Therefore, Current Yield = Coupon of the Security(in %) x Face Value of the Security (viz. 100 in case of GSecs.)/Market Price of the Security Eg: Suppose the market price for a 10.18% G-Sec 2012 is Rs.120. The current yield on the security will be (0.1018 x 100)/120 = 8.48%
What is dividend yield ? Dividend yield is dividend to price ratio. It is the percentage calculated by dividing dividend per share by price per share. Dividend yield is used to calculate the earning on investment (shares) considering only the returns in the form of total dividends declared by the company during the year. Dividend Yield = Interim + Final Dividend X 100 Market Price of the share E.g.: For a company for FY10, Interim dividend = Rs. 2 per share Final dividend = Rs. 3 per share Share price = Rs. 50 Dividend yield = 2 + 3 50 Dividend yield =10%
What is Yield to Maturity/Yield to Call ? Yield to maturity and yield to call, tell you the total return you will receive by holding the bond until it matures or is called. It also enables you to compare bonds with different maturities and coupons. Yield to maturity equals all the interest you receive from the time you purchase the bond until maturity (including interest on interest at the original purchasing yield), plus any gain (if you purchased the bond below its par, or face, value) or loss (if you purchased it above its par value). Yield to call is calculated the same way as yield to maturity, but assumes that a bond will be called and that the investor will receive face value back at the call date.
What is record date/shut period?
G-Sec/Bonds/Debentures keep changing hands in the secondary market. Issuer pays interest to the holders registered in its register on a certain date. Such date is known as record date. Securities are not transferred in the books of issuer during the period in which such records are updated for payment of interest etc. Such period is called as shut period.
What is a Debenture? A Debenture is a debt security issued by a company (called the Issuer), which offers to pay interest in lieu of the money borrowed for a certain period. In essence it represents a loan taken by the issuer who pays an agreed rate of interest during the lifetime of the instrument and repays the principal normally, unless otherwise agreed, on maturity. These are long-term debt instruments issued by private sector companies. These are issued in denominations as low as Rs 1000 and have maturities ranging between one and ten years.
What are the different types of debentures? Debentures are divided into different categories on the basis of Convertibility of the instrument and security .On the basis of convertibility, debentures are classified into: · Non Convertible Debentures (NCD) : These instruments retain the debt character and can not be converted in to equity shares · Partly Convertible Debentures (PCD) : A part of these instruments are converted into Equity shares in the future at notice of the issuer. The issuer decides the ratio for conversion. This is normally decided at the time of subscription. · Fully convertible Debentures (FCD) : These are fully convertible into Equity shares at the issuer's notice. The ratio of conversion is decided by the issuer. Upon conversion the investors enjoy the same status as ordinary shareholders of the company. · Optionally Convertible Debentures (OCD) : The investor has the option to either convert these debentures into shares at price decided by the issuer/agreed upon at the time of issue.
On the basis of Security, debentures are classified into: · Secured Debentures : These instruments are secured by a charge on the fixed assets of the issuer company. So if the issuer fails on payment of the principal or interest amount, his assets can be sold to repay the liability to the investors · Unsecured Debentures: These instrument are unsecured in the sense that if the issuer defaults on payment of the interest or principal amount, the investor has to be along with other unsecured creditors of the company.
What are the main features of G-Secs and T-Bills in India? All G-Secs in India currently have a face value of Rs.100/- and are issued by the RBI on behalf of the Government of India. All G-Secs are normally coupon (Interest rate) bearing and have semi-annual coupon or interest payments with a tenor of between 5 to 30 years. This may change according to the structure of the Instrument. Eg: a 11.50% GOI 2005 security will carry a coupon rate(Interest Rate) of 11.50% p.a. on a face value per unit of Rs.100/- payable semi-annually and maturing in the year 2005.
Treasury Bills Treasury Bills are the instruments of short term borrowing by the Central/State govt. They are promissory notes issued at discount and for a fixed period. These were first issued in India in 1917. Objectives :-These are issued to raise funds for meeting expenditure needs and also provide outlet for parking temporary surplus funds by investors. Investors :-Treasury bills can be purchased by any one (including individuals) except State govt. These are issued by RBI and sold through fortnightly or monthly auctions at varying discount rate depending upon the bids. Denomination :-Minimum amount of face value Rs.1 lac and in multiples there of. There is no specific amount/limit on the extent to which these can be issued or purchased. Maturity :- 91 days and 364 days. Rate of interest :-Market determined, based on demand for and supply of funds in the money market. Other features :• These are highly liquid and safe investment giving attractive yield. • Approved assets for SLR purposes and DFHI is the market maker in these instruments and provide (daily) two way quotes to assure liquidity. • RBI sells treasury bills on auction basis (to bidders quoting above the cut-off price fixed by RBI) every fortnight by calling bids from banks, State Govt. and other specified bodies. They account for 3-4 % of the daily trading volumes.
What factors determine interest rates? When we talk of interest rates, there are different types of interest rates - rates that banks offer to their depositors, rates that they lend to their borrowers, the rate at which the Government borrows in the bond/G-Sec, market, rates offered to small investors in small savings schemes like NSC rates at which companies issue fixed deposits etc. The factors which govern the interest rates are mostly economy related and are commonly referred to as macroeconomic. Some of these factors are:
· Demand for money · Government borrowings · Supply of money · Inflation rate · The Reserve Bank of India and the Government policies which determine some of the variables mentioned above.
Who Regulates Indian G-1- and Debt Market? RBI: The Reserve Bank of India is the main regulator for the Money Market. Reserve Bank of India also controls and regulates the G-Secs Market. Another major area under the control of the RBI is the interest rate policy. Earlier, it used to strictly control interest rates through a directed system of interest rates. Each type of lending activity was supposed to be carried out at a pre-specified interest rate. Over the years RBI has moved slowly towards a regime of market determined controls. SEBI: Regulator for the Indian Corporate Debt Market is the Securities and Exchange Board of India (SEBI). SEBI controls bond market and corporate debt market in cases where entities raise money from public through public issues.
What is the Debt Market ? The Debt Market is the market where fixed income securities of various types and features are issued and traded. Debt Markets are therefore, markets for fixed income securities issued by Central and State Governments, Municipal Corporations, Govt. bodies and commercial entities like Financial Institutions, Banks, Public Sector Units, Public Ltd. companies and also structured finance instruments. What is the Money Market ?
The Money Market is basically concerned with the issue and trading of securities with short term maturities or quasi-money instruments. The Instruments traded in the money-market are Treasury Bills, Certificates of Deposits (CDs), Commercial Paper (CPs), Bills of Exchange and other such instruments of short-term maturities (i.e. not exceeding 1 year with regard to the original maturity)
Why should one invest in fixed income securities?
Fixed Income securities offer a predictable stream of payments by way of interest and repayment of principal at the maturity of the instrument. The debt securities are issued by the eligible entities against the moneys borrowed by them from the investors in these instruments. Therefore, most debt securities carry a fixed charge on the assets of the entity and generally enjoy a reasonable degree of safety by way of the security of the fixed and/or movable assets of the company. *The investors benefit by investing in fixed income securities as they preserve and increase their invested capital and also ensure the receipt of regular interest income. *The investors can even neutralize the default risk on their investments by investing in Govt. securities, which are normally referred to as risk-free investments due to the sovereign guarantee on these instruments. *The prices of Debt securities display a lower average volatility as compared to the prices of other financial securities and ensure the greater safety of accompanying investments.
*Debt securities enable wide-based and efficient portfolio diversification and thus assist in portfolio risk-mitigation.
*Tax exemption for interest earned on G-Secs. up to Rs.3000/- over and above the limit of
What are the different types of instruments, which are normally traded in this market? The instruments traded can be classified into the following segments based on the characteristics of the identity of the issuer of these securities:
Market Segment
Issuer
Instruments Zero Coupon Bonds, Coupon Bearing Bonds, Treasury Bills, STRIPS Coupon Bearing Bonds. Govt. Guaranteed Bonds, Debentures PSU Bonds, Debentures, Commercial Paper Debentures, Bonds, Commercial Paper, Floating Rate Bonds, Zero Coupon Bonds, Inter-Corporate Deposits Certificates of Deposits, Debentures, Bonds Certificates of Deposits, Bonds
Government Securities
Central Government State Governments
Public Sector Bonds
Government Agencies / Statutory Bodies Public Sector Units
Private Sector Bonds
Corporates
Banks Financial Institutions
What are the different types of risks with regard to debt securities? The following are the risks associated with debt securities:
Default Risk: This can be defined as the risk that an issuer of a bond may be unable to make timely payment of interest or principal on a debt security or to otherwise comply with the provisions of a bond indenture and is also referred to as credit risk.
Interest Rate Risk: can be defined as the risk emerging from an adverse change in the interest rate prevalent in the market so as to affect the yield on the existing instruments. A good case would be an upswing in the prevailing interest rate scenario leading to a situation where the investors' money is locked at lower rates whereas if he had waited and invested in the changed interest rate scenario, he would have earned more. Reinvestment Rate Risk: can be defined as the probability of a fall in the interest rate resulting in a lack of options to invest the interest received at regular intervals at higher rates at comparable rates in the market. The following are the risks associated with trading in debt securities: Counter Party Risk: is the normal risk associated with any transaction and refers to the failure or inability of the opposite party to the contract to deliver either the promised security or the sale-value at the time of settlement. Price Risk: refers to the possibility of not being able to receive the expected price on any order due to a adverse movement in the prices
What is the trading structure in the Wholesale Debt Market?
The Debt Markets in India and all around the world are dominated by Government securities, which account for between 50 - 75% of the trading volumes and the market capitalization in all markets. Government securities (G-Secs ) account for 70 - 75% of the outstanding value of issued securities and 90-95% of the trading volumes in the Indian Debt Markets. State Government securities & Treasury Bills account for around 3-4 % of the daily trading volumes. The trading activity in the G-Sec. Market is also very concentrated currently (in terms of liquidity of the outstanding G-Secs .) with the top 10 liquid securities accounting for around 70% of the daily volumes. Who are the main investors of Govt. Securities in India? Traditionally, the Banks have been the largest category of investors in G-secs accounting for more than 60% of the transactions in the Wholesale Debt Market. The Banks are a prime and captive investor base for G-secs as they are normally required to maintain 25% of their net time and demand liabilities as SLR but it has been observed that the banks normally invest 10% to 15% more than the normal requirement in Government Securities because of the following requirements:*Risk Free nature of the Government Securities *Greater returns in G-Secs as compared to other investments of comparable nature
How interest rates and bonds prices are related ? You must have heard or read often that when Interest rates fall, bond prices go up and when interest rates rise, bond prices go down. Also in many articles you would have read a term “Interest rate Risk”, but always wondered why its is a “risk”.
Let me give you a simple example . Suppose in the market the interest rates are around 10% , Now Sudhir lends Rs 1,000 to Ashish for 1 yr at the interest rate of 10% , which means Sudhir will get Rs 100 as interest next year plus his initial 1,000 of principle , so Sudhir will get back total Rs 1,100 at the end of 1 yr. Now suppose they sign a paper where all these terms and conditions are written and we call this paper as “BOND” . Who ever has this bond at the end can go to Ashish and get Rs 1,100 by giving them that BOND paper. Now imagine two situations where interest rates move up and down and a third person called Tanuj wants to buy the bonds after interest rates has moved. Lets see how bond prices move in both the cases here.
Case 1 : Interest rates go down Suppose interest rates in market falls to 9% because of government policies or some other reasons (in our country RBI keeps change interest rates). Which means now if a person lends Rs 1,000 to some one, he can get only 9% as interest. But Sudhir has a special bond! , which actually gives 10% return (also called as coupon rate) and not 9%. He is getting 1% more than what a new bond in market will give. Now if Tanuj comes to Sudhir and wants to buy this Bond from Sudhir, Will Sudhir give this bond at 1,000 ? No , This bond is worth more now, because this bond is giving more than what a normal bond in market can provide. What will be price Sudhir can charge from Tanuj ? It?s very simple maths. If Tanuj goes to market and invests 1,000 , He will get 1,090 at the end of the year because interest rates are at 9% only. So how much should Tanuj pay for the bond Sudhir is holding as he will get Rs 1,100 with that bond. It?s a simple calculation => To get 1,090 at maturity , Tanuj has to pay 1,000 in current condition. so .. => To get Rs 1 at maturity, Tanuj has to pay 1,000/1,090 in current condition. => To get Rs 1,110 at maturity, Tanuj has to pay 1,100 * 1,000/1,090 today = Rs 1,009.2 (approx). Which means as Sudhir bond is giving 1,100 at the end , Its worth 1009.2 because interest rates moved down ! . So Sudhir?s bond commands a premium of Rs 9.2 . You can see that 9% of 1,009.2 is equal to 90.8 and 1009.2 + 90.8 = Rs 1,100 which completes the equation
Case 2 : Interest rates go up In the same manner suppose interest rates move up to 12% in market from initial 10% . Now if a person lends Rs 1,000 to someone , he can get 1,120 at the end . Now Sudhir?s bond is actually giving less than the new bonds in market . Why will some one pay 1,000 to Sudhir to get 1,100 at the maturity , when they can lend the same money in market to get 1,120 at maturity , which is Rs 20 more . So now if a person has to buy Sudhir?s bond they will pay a less price (discount) . Using the same process you saw above you can find out that the new value of bond will be 982.2 => To get 1,120 at maturity , Tanuj has to pay 1,000 in current condition. so .. => To get Rs 1 at maturity, Tanuj has to pay 1,000/1,120 in current condition.
=> To get Rs 1,110 at maturity, Tanuj has to pay 1,100 * 1,000/1,120 today = Rs 982.2 (approx).
What is Commercial Paper (CP) ? Commercial Paper (CP) is an unsecured money market instrument issued in the form of a promissory note. It was introduced in India in 1990. Why it was introduced? It was introduced in India in 1990 with a view to enabling highly rated corporate borrowers/ to diversify their sources of short-term borrowings and to provide an additional instrument to investors. Subsequently, primary dealers and satellite dealers were also permitted to issue CP to enable them to meet their short-term funding requirements for their operations. Who can issue CP? Corporates, primary dealers (PDs) and the All-India Financial Institutions (FIs) are eligible to issue CP. Is there any rating requirement for issuance of CP? And if so, what is the rating requirement? Yes. All eligible participants shall obtain the credit rating for issuance of Commercial Paper either from Credit Rating Information Services of India Ltd. (CRISIL) or the Investment Information and Credit Rating Agency of India Ltd. (ICRA) or the Credit Analysis and Research Ltd. (CARE) or the FITCH Ratings India Pvt. Ltd. or such other credit rating agency (CRA) as may be specified by the Reserve Bank of India from time to time, for the purpose. The minimum credit rating shall be P-2 of CRISIL or such equivalent rating by other agencies.
What is the minimum and maximum period of maturity prescribed for CP? CP can be issued for maturities between a minimum of 15 days and a maximum up to one year from the date of issue. In what denominations a CP that can be issued? CP can be issued in denominations of Rs.5 lakh or multiples thereof. Who can invest in CP? Individuals, banking companies, other corporate bodies registered or incorporated in India and unincorporated bodies, Non-Resident Indians (NRIs) and Foreign Institutional Investors (FIIs) etc. can invest in CPs. However, amount invested by single investor should not be less than Rs.5 lakh (face value).However, investment by FIIs would be within the limits set for their investments by Securities and Exchange Board of India (SEBI. Whether CP is always issued at a discount? Yes. CP will be issued at a discount to face value as may be determined by the issuer.
CERTIFICATE OF DEPOSITS This scheme was introduced in July 1989, to enable the banking system to mobilise bulk deposits from the market, which they can have at competitive rates of interest. We can compare certificate of deposits with treasury bills as they are short term, tradable, discounted bonds. But the difference is T-Bills are issued by government and CDs are issued by banks, financial institutions. The lender of a CD could be another bank, corporate or financial institution. Who can issue :-Scheduled commercial banks (except RRBs) and All India Financial Institutions within their `Umbrella limit?. Some features of CDs in India *Maturity period is Minimum 7 days Maximum: 12 Months for CDs issued by banks. For CDs issued by Financial institutions maturity is minimum 1 year and maximum 3 years. *Minimum amount to invest in a CD is Rs1 lakh *Loan against collateral of CD is not permitted (It?s possible in „sight fixed deposits?) *Premature withdrawal is not allowed (can be sold to other investors) *Interest rate can be fixed or floating *They are issued at a discount to face value like zero coupon bonds
Inter-corporate Deposits (ICDs) Inter-Corporate Deposits refers to unsecured short term funding raised by corporates from other corporates. This is a form of disintermediated financing, where corporates with surplus funding directly lend to those in need of funding of such funds and thereby save on the spreads that banks would have charged in borrowing from one to lend to the other. Rates on ICDs would higher than those in the Certificate of Deposit (CD) market. The tenor of ICD may range from 1 day to 1 year, but the most common tenor of borrowing is for 90 days. Only Limited Companies can issue ICDs . Minimum is Rs. 1,00,000/- and maximum ,no limit.
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