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DEBT MARKETS

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INTRODUCTION

What is a debt market?

• A part of the capital market• A place where trading in Debt Instruments takes place• Is also known as a ‘fixed income market as debt instruments pay fixed returns

Impact of the debt market on the economy?

• Opportunity for investors to diversify their investment portfolio• Improved transparency because of stringent disclosure norms and auditing requirements• Less risk compared to the equity markets. This leads to inflow of funds in the economy• Increased funds for implementation of government development plans. The government can raise funds at lower costs by issuing government securities

THE STRUCTURE OF INDIAN DEBT MARKET

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• Issuer’s

• Instruments

• Investors

• Rating agencies

• Trading Platform

• Clearing and Settlement Mechanism • Instrument’s

• Investor’s

REGULATION’S FOR DEBT MARKET

SARFAESI Act,2002

Securities and Exchange Board of India,1992.

Companies Act, 1956

Securities Contracts (Regulation) Act, 1956

Depositories Act, 1996

Fixed-Income and Money Market Dealers’ Association

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MARKET PARTICIPANTS IN THE DEBT MARKET Central Governments

Reserve Bank of India

Primary Dealers

State Governments

Public Sector Units

Corporate treasuries

Public Sector Financial Institutions

Banks

Foreign Institutional Investors

Charitable Institutions, Trusts and Societies

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DEBT INSTRUMENTS

DEBT INSTRUMENTS

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SHORT TERM INSTRUMENTS

• Treasury Bills

• Fixed deposit

• Certificates of Deposits

• Commercial Paper

• Bills Rediscounting schemes

LONG TERM INSTRUMENTS

• Government of India dated securities (GOISECs)

• Inflation linked bonds

• Zero coupon bonds

• State government securities (state loans)

• Public Sector Undertaking Bonds (PSU Bonds)

• Corporate debentures

• Bonds of Public Financial Institutions (PFIs)

TREASURY BILLS

• Promissory notes of the central government and therefore qualify as being free of credit risks

• Issued to meet short term funding requirements of the government account with Reserve Bank

• Sale is by auction. Any individual, corporate, bank, primary dealer or other entity is free to buy T-Bill

• Denominations of 91, 182 and 364 days

CERTIFICATE OF DEPOSIT (CD)

• Similar to CPs except that the issuer is a bank• Minimum amount of a CD can be Rs. 1 lakh and maturity between 7 days

and 1 year• Financial Institutions can issue CDs only for maturities between 1 and 3

years• No premature cancellation of CD is allowed

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COMMERCIAL PAPER (CP)

• Promissory notes issued by the corporate sector for raising short term funds• Sold at a discount to face value• Maturity can range between a minimum of 7 days and a maximum of 1 year• CPs are required to be rated and the minimum rating eligibility is P2• Every CP issue has an Issuing and Paying Agent (IPA), which has to be a

scheduled bank• Stamp duty is currently payable on CP issues, depending on the maturity

and who the initial buyer is

BILLS REDISCOUNTING SCHEME

• The RBI introduced the Bills Market Scheme (BMS) in 1952 which was later modified into the New Bills Market Scheme (NBMS)

• Under this scheme commercial banks can rediscount the bills which were originally discounted by them with approved institutions (viz., Commercial Banks, Development Financial Institutions, Mutual Funds, Primary Dealers etc.)

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GOVERNMENT OF INDIA DATED SECURITIES (GOISECS)

GOISECs are issued by the Reserve Bank of India on behalf of the Government of India. These form a part of the borrowing program approved by Parliament in the Finance Bill each year (Union Budget)

They have maturity ranging from 1 year to 30 years GOISECs are issued through the auction route. The RBI pre specifies an

approximate amount of dated securities that it intends to issue through the year

INFLATION LINKED BONDS

These are bonds for which the coupon payment in a particular period is linked to the inflation rate at that time - the base coupon rate is fixed with the inflation rate. Investors are often loath to invest in longer dated securities due to uncertainty of future interest rates. The idea behind these bonds is to make them attractive to investors by removing the uncertainty of future inflation rates, thereby maintaining the real value of their invested capital.

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ZERO COUPON BONDS

These are bonds for which there is no coupon payment. They are issued at a discount to face value with the discount providing the implicit interest payment.

STATE GOVERNMENT SECURITIES (STATE LOANS)

These are issued by the respective state governments but the RBI coordinates the actual process of selling these securities. Each state is allowed to issue securities up to a certain limit each year. State Government issue such securities to fund their developmental projects and finance their budgetary defictis

BONDS OF PUBLIC FINANCIAL INSTITUTIONS (PFIS)

Apart from public sector undertakings, Financial Institutions are also allowed to issue bonds, that too in much higher quantum.

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PUBLIC SECTOR UNDERTAKING BONDS (PSU BONDS)

These are long term debt instruments issued by Public Sector Undertakings (PSUs). Typically, they have maturities ranging between 5-10 years and they are issued in denominations (face value) of Rs.1,000 each

Most of these issues are made on a private placement basis to a targeted investor base at market determined interest rates.

CORPORATE DEBENTURES

These are long term debt instruments issued by private sector companies. These are issued in denominations as low as Rs.1,000 and have maturities

ranging between one and ten years. A key feature that distinguishes debentures from bonds is the stamp duty

payment. Debenture stamp duty is a state subject and the quantum of incidence varies from state to state. Transfer stamp duty remains high in many states and is probably the biggest deterrent for trading in debentures resulting in lack of liquidity.

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BOND BASICS & VALUATION OF BONDSBonds represent loans by investors to a company.

BOND TERMINOLOGY

Coupon

Coupon rate

Face (par) value

Maturity date

Yield

YTM

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PROCESS FOR ISSUING BONDSCompany sets the maturity date and face value of the

bondsInvestment bankers set the coupon rate for the bondsInvestment bankers find investors for the bonds and

issue them in the primary market.

Government Securities :-Uniform price Based or Dutch Auction Multiple/variable Price Based or French Auction The bonds become available in the secondary market.NDS – OM and WDM

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ExampleWhat is the present value of a bond with a

two-year maturity date, a face value of Rs.1,000, and a coupon rate of 6%? The current prevailing rate for similar issues is 5%.

Inverse relationship :-

As interest rates fall, bond prices rise

As interest rates rise, bond prices fallDEBT MARKETS 16

Yields

BondPrices

Yields

BondPrices

YTM = 10%Coupon = 10%Bond price = Rs100Flat yield = 10%---------------------------------YTM = 12%Bond price = Rs83Flat yield = 12 %

Example

YTM = 12%Coupon = 10%Bond price = Rs 83Flat yield = 12%---------------------------------YTM = 10%Bond price = Rs100Flat yield = 10 %

Par• Coupon rate = Yield to maturity

Discount

• Coupon rate < Yield to maturity

Premium

• Coupon rate > Yield to maturity

Price Interest rate relationship

Credit Spread

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RISK ASSOCIATED WITH BONDS

• Interest rate risk

• Credit risk

• Reinvestment risk

• Sovereign risk

• Inflation risk

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ADVANTAGES OF DEBT MARKETAssured returns

High liquidity

Credit rating agencies

Flexibility of capital structure

Tax deductible

DISADVANTAGES OF DEBT MARKET

Less returns when compared to Equity market

Not well developed in India.

Exposed to interest rate risk.

Less liquidity in many issues.

IMPACT ON THE ECONOMYOpportunity for investors to

diversify their investment portfolio.

Higher liquidity and control over credit.

Less risk compared to the equity markets

Government can raise funds at lower costs by issuing government securities.

DEBT VS EQUITYEquity :Time and amount of repayment is uncertain and not

fixed.Repayment is also dependent on the performance of

the company.Returns are higher but also the risk for the investor

is higher.

DEBT :Time and amount of repayment is fixed beforehand.Repayment is not dependent on performance.Risk is low and so is the returns.

GLOBAL SCENARIO.....At present, the size of the international bond

market is about $45 trillion

Chinese Bond Market at a growing stage with a turnover of about $40 billion

USA, Britain and Euro zone are the leaders

FUTURE ESTIMATION OF INDIAN DEBT MARKET

Four-fold increase in the size of India’s overall bond market, from about $400bn today, or around 45% of GDP, to about $1.5 trillion by 2016 in current Dollars, i.e. 55% of GDP at that time.

If India were to proceed more aggressively on financial liberalisation, the size of the debt market would grow even faster

ISSUES AND RECOMMENDATIONSIssues : Lack of sufficient investor base in terms of quantity as well as diversity. Lack of awareness among investors.Recommendations:Developing bond managers.By enlarging number of investors. Increasing awareness among the investors.

THANK YOUDEBT MARKETS 28