Debt market

M.D. COLLEGE TYFM DEBT MARKET

B.COM (FINANCIAL MARKETS) Page | 1

CHAPTER 1: OVERVIEW OF FINANCIAL SYSTEM

[1.1] INTRODUCTION ON FINANCIAL SYSTEM

Economic growth and development of any country depends up on a well-knit financial

system. Financial system comprises a set of sub-systems of financial institutions financial

markets, financial instruments and services which help in the formation of capital. Thus a

financial system provides a mechanism by which savings are transformed into investments

and it can be said that financial system play an significant role in economic growth of the

country by mobilizing surplus funds and utilizing them effectively for productive purpose.

The financial system is characterized by the presence of integrated, organized and regulated

financial markets, and institutions that meet the short term and long term financial needs of

both the household and corporate sector. Both financial markets and financial institutions

play an important role in the financial system by rendering various financial services to the

community. They operate in close combination with each other.



The word "system", in the term "financial system", implies a set of complex and

closely connected or interlined institutions, agents, practices, markets, transactions, claims,

and liabilities in the economy. The financial system is concerned about money, credit and

finance-the three terms are intimately related yet are somewhat different from each other.

Indian financial system consists of financial market, financial instruments and financial

intermediation.



[1.2] Components Of Indian Financial System:

The following are the four main components of Indian Financial system are:

� Financial Institutions.

� Financial Markets.

� Financial Instruments/Assets/Securities.

� Financial Services.



� Financial Institutions:

Financial institutions are the intermediary who facilitates smooth functioning of

the financial system by making investors and borrowers meet. They mobilize savings

of the surplus units and allocate them in productive activities promising a better rate of

return. Financial institutions also provide a service to entities seeking advises on

various issues ranging from restructuring to diversification plans. They provide whole

range of services to the entities who want to raise funds from the markets elsewhere.

Financial institutions act as financial intermediaries because they act as middlemen

between savers and borrowers. Were these financial institutions may be of Banking or

Non-Banking institutions.

� Financial Markets:

Finance is a prerequisite for modern business and financial institutions play a

vital role in economic system. It's through financial markets the financial system of an

economy works. The main functions of financial markets are:

• To facilitate creation and allocation of credit and liquidity.

• To serve as intermediaries for mobilization of savings.

• To assist process of balanced economic growth.

• To provide financial convenience.

� Financial Instruments/Assets/Securities:

Another important constituent of financial system is financial instruments. They

represent a claim against the future income and wealth of others. It will be a claim

against a person or an institution, for the payment of the some of the money at a

specified future date.



� Financial Services:

Efficiency of emerging financial system largely depends upon the quality and

variety of financial services provided by financial intermediaries. The term financial

services can be defined as "activities, benefits and satisfaction connected with sale of

money that offers to users and customers, financial related value".



[1.3] INDIAN FINANCIAL MARKET

A Financial Market can be defined as the market in which financial assets are

created or transferred. As against a real transaction that involves exchange of money

for real goods or services, a financial transaction involves creation or transfer of a

financial asset. Financial Assets or Financial Instruments represents a claim to the

payment of a sum of money sometime in the future and /or periodic payment in the

form of interest or dividend. Financial market is broadly divided into 4 parts:

� Money Market:

The money market ifs a wholesale debt market for low-risk, highly-liquid,

short-term instrument. Funds are available in this market for periods ranging from a

single day up to a year. This market is dominated mostly by government, banks and

financial institutions.

� Capital Market:

The capital market is designed to finance the long-term investments. The

transactions taking place in this market will be for periods over a year.

� Forex Market:

The Forex market deals with the multicurrency requirements, which are met by

the exchange of currencies. Depending on the exchange rate that is applicable, the

transfer of funds takes place in this market. This is one of the most developed and

integrated market across the globe.

� Credit Market:

Credit market is a place where banks, FIs and NBFCs purvey short, medium

and long-term loans to corporate and individuals.



CHAPTER 2:OVERVIEW OF DEBT MARKET

[2.1] INTRODUCTION OF DEBT MARKET

The capital market comprises of equities market and 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. Debt market is a market for the issuance, trading and settlement in fixed income

securities of various types. The debt market is any market situation where trading debt

instruments take place. Examples of debt instruments include mortgages, promissory notes,

bonds, and Certificates of Deposit. A debt market establishes a structured environment where

these types of debt can be traded with ease between interested parties.

The debt market often goes by other names, based on the types of debt instruments

that are traded. In the event that the market deals mainly with the trading of municipal and

corporate bond issues, the debt market may be known as a bond market. If mortgages and

notes are the main focus of the trading, the debt market may be known as a credit market.

When fixed rates are connected with the debt instruments, the market may be known as a

fixed income market.

Debt market refers to the financial market where investors buy and sell debt securities,

mostly in the form of bonds. These markets are important source of funds, especially in a

developing economy like India. India debt market is one of the largest in Asia. Like all other

countries, debt market in India is also considered a useful substitute to banking channels for

finance. The most distinguishing feature of the debt instruments of Indian debt market is that

the return is fixed. This means, returns are almost risk-free. This fixed return on the bond is



often termed as the 'coupon rate' or the 'interest rate'. Therefore, the buyer (of bond) is giving

the seller a loan at a fixed interest rate, which equals to the coupon rate.

Indian debt market can be broadly classified into two categories, namely debt instruments

issued by Central or State Governments and debt instruments issued by Public and Private

Sector. Different instruments issued have some prominent features in respect of period of

maturity and the investors for such instruments.



A list of the structure of Indian debt market is given below:-

Who Issues Type of Instruments Maturity Periods Who Invests

Central

Government

Zero Coupon Bonds;

Coupon Bearing GOI

securities.

1 year to 30 years

Banks, Insurance

and PF Trusts, RBI,

Mutual Funds,

Individuals

Central

Government Treasury Bills 91 days and 364 days

Banks, Insurance

and PF Trusts, RBI,

Mutual Funds,

Individuals

State Government Coupon Bearing State

Govt securities 5 years to 10 years

Banks, Insurance

and PF Trusts

Government

Enterprises &

PSU Bonds

Govt guaranteed bonds 5 years to 10 years

Banks, Insurance,

PF Trusts and

Individuals

PSU PSU Bonds, Zero

coupon bonds 5 years to 10 years

Banks, Insurance,

PF Trusts, Corporate

and,

Individuals

Private Sector

Corporates Debentures and Bonds 1 year to 12 years

Banks, Corporate,

Mutual Funds and



Individuals

Private and Public

Sector Corporates Commercial Paper 15 days to 1 year

Banks, Corporate,

Mutual Funds,

Financial

Institutions and

Individuals

Banks and

Finance Certificate of Deposits 15 days to 3 years

Banks and

Corporate



[2.2] CLASSIFICATION OF DEBT 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

Government

Securities

Central Government Zero Coupon Bonds, Coupon Bearing

Bonds, Treasury Bills, STRIPS

State Governments Coupon Bearing Bonds.

Public Sector

Bonds

Government

Agencies / Statutory

Bodies

Govt. Guaranteed Bonds, Debentures

Public Sector Units PSU Bonds, Debentures, Commercial

Paper

Private Sector

Bonds

Corporates Debentures, Bonds, Commercial Paper,

Floating Rate Bonds, Zero Coupon Bonds,

Inter-Corporate Deposits

Banks Certificates of Deposits, Debentures,

Bonds

Financial Institutions Certificates of Deposits, Bonds



Indian debt market can be classified into two categories:

� Government Securities Market (G-Sec Market): It consists of central and state

government securities. It means that, loans are being taken by the central and state

government. It is also the most dominant category in the India debt market.

� Bond Market: It consists of Financial Institutions bonds, Corporate bonds and

debentures and Public Sector Units bonds. These bonds are issued to meet financial

requirements at a fixed cost and hence remove uncertainty in financial costs.



[2.3] IMPORTANCE OF DEBT MARKET

The key role of the debt markets in the Indian Economy stems from the following reasons:

� Efficient mobilization and allocation of resources in the economy.

� Financing the development activities of the Government.

� Transmitting signals for implementation of the monetary policy.

� Facilitating liquidity management in tune with overall short term and long term

objectives.

� Reduction in the borrowing cost of the Government and enable mobilization of

resources at a reasonable cost.

� Provide greater funding avenues to public-sector and private sector projects and

reduce the pressure on institutional financing.

� Enhanced mobilization of resources by unlocking illiquid retail investments like gold.

� Development of heterogeneity of market participants.

� Assist in development of a reliable yield curve and the term structure of interest rates.

Since the Government Securities are issued to meet the short term and long term

financial needs of the government, they are not only used as instruments for raising

debt, but have emerged as key instruments for internal debt management, monetary

management and short term liquidity management.



[2.4] ADVANTAGES OF DEBT MARKET

The following are the advantages of debt market:

� The biggest advantage of investing in Indian debt market is its assured returns. The

returns that the market offer is almost risk-free (though there is always certain amount

of risks, however the trend says that return is almost assured).

� Safer are the government securities. On the other hand, there are certain amounts of

risks in the corporate, FI and PSU debt instruments. However, investors can take help

from the credit rating agencies which rate those debt instruments. The interest in the

instruments may vary depending upon the ratings.

� Another advantage of investing in India debt market is its high liquidity. Banks offer

easy loans to the investors against government securities.

� Greater safety and lower volatility as compared to other financial instruments.

� Variations possible in the structure of instruments like Index linked Bonds, STRIPS.

� Higher leverage available in case of borrowings against G-Secs.

� No TDS on interest payments.

Example: Tax exemption for interest earned on G-Secs. up to Rs.3000/- over and

above the limit of Rs.12000/- under Section 80L (as amended in the latest Budget).

� Greater diversification opportunities adequate trading opportunities with continuing

volatility expected in interest rates the world over.



[2.5] DISADVANTAGES OF DEBT MARKET

As there are several advantages of investing in India debt market, there are certain

disadvantages as well.

� As the returns here are risk free, those are not as high as the equities market at the

same time. So, at one hand you are getting assured returns, but on the other hand, you

are getting less return at the same time.

� Retail participation is also very less here, though increased recently. There are also

some issues of liquidity and price discovery as the retail debt market is not yet quite

well developed.

� Debt securities usually have much smaller relative price changes than stocks or

commodities. Traders in debt securities must take larger positions to achieve the same

level of profits. It is not uncommon for individual stocks or even stock indexes to

move two percent or more during a trading day. Debt securities may move two percent

over several weeks or a month. Even with ten-to-one leverage, trading debt securities

requires the trader to use much larger position sizes than a stock market trader.

� The debt trading markets are dominated by hedge funds and the trading desks of large

financial institutions. These traders have access to information and capital that is

difficult or impossible for the individual trader to obtain. By the time the small trader

gets the news that these large players are trading on, it may be too late to profit from

the news.



� Traders in corporate debt securities trade high-yield or junk bonds to earn the higher

interest rates these bonds pay. The trader can also achieve capital gains if the issuing

corporation gets an upgrade in its credit rating. The downside of high yield bonds is a

bankruptcy and total loss of the principal invested.



[2.6] INSTRUMENTS OF DEBT MARKET

There are various types of debt instruments available that one can find in Indian debt

market. They are as follows:

� Government Securities:

It is the Reserve Bank of India that issues Government Securities or G-Secs on

behalf of the Government of India. These securities have a maturity period of 1 to 30

years. G-Secs offer fixed interest rate, where interests are payable semi-annually. For

shorter term, there are Treasury Bills or T-Bills, which are issued by the RBI for 91

days, 182 days and 364 days.

� Corporate Bonds:

These bonds come from PSUs and private corporations and are offered for an

extensive range of tenures up to 15 years. There are also some perpetual bonds.

Comparing to G-Sec, corporate bonds carry higher risks, which depend upon the

corporation, the industry where the corporation is currently operating, the current

market conditions, and the rating of the corporation. However, these bonds also give

higher returns than the G-Sec.

� Certificate of Deposit:

These are negotiable money market instruments. Certificate of Deposits (CDs),

which usually offer higher returns than Bank term deposits, are issued in demat form

and also as a Usance Promissory Notes. There are several institutions that can issue

CDs. Banks can offer CDs which have maturity between 7 days and 1 year. CDs from

financial institutions have maturity between 1 and 3 years. There are some agencies

like ICRA, FITCH, CARE, CRISIL etc. that offer ratings of CDs. CDs are available in

the denominations of Rs 1 Lac and in multiple of that.



� Commercial Papers:

There are short term securities with maturity of 7 to 365 days. CPs are issued by

corporate entities at a discount to face value.

� Treasury Bills:

Treasury bills are short-term instruments issued by the RBI on behalf of the

government to tide over short term liquidity shortfalls. The instruments are issued by

government to raise short term funds to bridge seasonal or temporary gaps between its

receipts (revenue & capital) and expenditure. They form the most important segment

of the money market not only in India but all over the world as well.

� Bonds:

A bond is a debt security in which authorized issuer owes the holder a debt and

it is obligated to repay the principle and interest rate (coupon) at a later date or

maturity date. It is a financial contract which pledge to repay a specified or fixed

amount of money with the interest paid to the lender upon maturity of the contract.



[2.7] PLAYERS IN DEBT MARKET

Players in debt market are similar to players in most financial markets and are

essentially either buyers (debt issuer) of funds or sellers (institution) of funds and often both.

Players include:

• Institutional investors

• Governments

• Traders

• Individuals

• Banks

Because of the specificity of individual bond issues, and the lack of liquidity in many smaller

issues, the majority of outstanding bonds are held by institutions like pension funds, banks

and mutual funds. In the United States, approximately 10% of the market is currently held by

private individuals.



CHAPTER 3: REGULATORS OF DEBT MARKET

[3.1] INTRODUCTION

Indian Debt Market has been subject to regulations by two authorities, RBI and SEBI. The

dual control used to create overlapping of jurisdiction and thereby confusion. In a

notification issued by the Government on March, 2, 2000 the areas of responsibility

betweenRBI and SEBI have been clearly defined.

The RBI now regulates contracts for the sale and purchase of Government securities, gold

related securities, money market securities and ready forward contract in debt securities.

SEBI regulates all mutual fund, including money market mutual funds. It also regulates the

stock markets and the member brokers of the stock exchange. Further it regulates the listing

and trading mechanism of the debt instruments. The issue of corporate debts is also under the

regulation of SEBI.

The issuance of debt instruments by the government is regulated by the Government

Securities Act 2006. The issuance of corporate securities is regulated by the SEBI Guidelines

for disclosure and Investor protection.

The Government Securities Act, 2006was enacted by the Parliament in August 2006. The

RBI made Government Securities Regulation, 2007 to carry out the purpose of the

Government Securities Act, 2006. The Act and the Regulations are applicable to

Government securities created and issued by the Central and the State Government.



[3.2] Reserve Bank of India

The Reserve Bank of India was established on April 1, 1935 in accordance with the

provisions of the Reserve Bank of India Act,1934.The Central Office of the Reserve Bank

was initially established in Calcutta but was permanently moved to Mumbai in 1937. The

Central Office is where the Governor sits and where policies are formulated. Though

originally privately owned, since nationalization in 1949, the Reserve Bank is fully owned

by the Government of India.

Role of RBI in Debt Market

1. Issuer Of Debt Instruments :

Government securities are issued through auctions conducted by the RBI.

Auctions are conducted on the electronic platform called the NDS – Auction

platform. Commercial banks, scheduled urban co-operative banks, Primary

Dealers, insurance companies and provident funds, who maintain funds

account (current account) and securities accounts (SGL account) with RBI,

are members of this electronic platform.

2. Started the Banking Ombudsman Scheme:

The Scheme is introduced with the object of enabling resolution of

complaints relating to certain services rendered by banks and to facilitate

the satisfaction or settlement of such complaints.

3. Determines the investment of commercial banks in debt:

RBI decides amount of investment of commercial bank in debt

instrument.



[3.3] GOVERNMENT SECURITIES ACT, 2006:

‘Government security’ means a security created and issued by the Government for the

purpose of raising a public loan or for any other purpose as may be notified by the

Government in the Official Gazette.

A Government security may be issued in the form of:

a. A Government promissory note,

b. A bearer bond payable to bearer,

c. A stock or

d. A bond

A stock means a Government security:

a. Registered in the books of the RBI for which a stock certificate is issued; or

b. Held at the credit of the holder in the SGL account including the CSGL account

maintained in the books of the RBI

The transfer of the Government securities shall be made in such form and in such manner as

may be prescribed.



[3.4] GOVERNMENT SECURITIES ACT, 2007

This Act made by the Reserve Bank of India to carry out the purpose of the Government

Securities Act. These regulations provide for transfer of Government securities held in

different forms.

1. Government security held in the form of Government Promissory Notes is transferable

by endorsement and delivery.

2. Government securities held in the form of A Stock Certificate, SGL account including

the CSGL account & Bond Ledger Account are transferable, before maturity, by

execution of forms - III, IV & V respectively appended to the Government Securities

Regulations.

3. A bearer bond is transferable by delivery and the person in possession of the bond

shall be deemed to be the owner of the bond.

4. Government securities held in SGL account including the CSGL account or bond

ledger account shall also be transferable by execution of a deed in an electronic form

under digital signature.



[3.5] Securities and Exchange Board of India

The Securities and Exchange Board of India was enacted on April 12, 1992 in accordance

with the provisions of the Securities and Exchange Board of India Act, 1992.

Role of SEBI

1. Regulating the business in stock exchanges and any other securities

markets;

2. Registering and regulating the working of stock brokers, sub-

brokers, share transfer agents, bankers to an issue, trustees of trust

deeds, merchant bankers and such other intermediaries who may be

associated with securities markets in any manner;

3. Registering and regulating the working of the depositories,

custodians of securities, foreign institutional investors, credit rating

agencies and such other intermediaries.

4. Registering and regulating the working of venture capital funds and

collective investment schemes, including mutual funds;

5. Promoting and regulating self-regulatory organizations.

6. Prohibiting fraudulent and unfair trade practices relating to

securities markets;

7. Promoting investors' education and training of intermediaries of

securities markets;

8. Prohibiting insider trading in securities;

9. Regulating substantial acquisition of shares and take-over of

companies;

10. Calling for information from, undertaking inspection, conducting

inquiries and audits of the intermediaries and self- regulatory

organizations in the securities market.



[3.6] SEBI (DISCLOSURE AND INVESTOR PROTECTION)

GUIDELINES, 2000

SEBI has issued Securities and Exchange Board of India (Disclosure and Investor

Protection) Guidelines in 2000

SEBI GUIDELINES

A. For Issue of Debt Instruments

• The issuer making a public issue or rights issue of debt securities shall appoint one or

more debenture trustees in accordance with the provisions of Section 117B of the

Companies Act, 1956.

• The issuer making a public issue or rights issue of debt securities shall appoint one or

more Merchant Bankers.

• The issuer shall enter into an arrangement with a depository registered with the SEBI

for dematerialization of the debt securities that are proposed to be issued to the public.

• The issuer shall give an option to the subscribers to receive the debt securities either in

the physical form or in dematerialized form.

• A trust deed shall be executed by the issuer in favor of the debenture trustees before

filling of offer document with the Registrar of Companies and the Designated Stock

Exchange.



B. Advertisements of Public Issues:

� The issuer company shall make an advertisement in an English national Daily with

wide circulation, one Hindi National newspaper and a regional language newspaper

with wide circulation at the place where the registered office of the issuer is situated

� At the time of filing of the offer document with the Registrar of Companies.

� Issue Opening Date, Issue Closing Date.

� And contain the minimum disclosures as per Schedule IV.

C. Requirement of Credit Rating

� No public issue or Rights issue shall be made unless credit rating from a credit rating

agency has been obtained.

� For a public or rights issue greater than or equal to Rs. 100 crores two ratings from

two different credit rating agencies shall be obtained.

� Where credit rating has been obtained from more than one credit rating agencies, all

credit ratings, shall be disclosed.

� All credit ratings obtained during the three years for any listed security of the issuer

company shall be disclosed in the offer document.



D. Requirement of Debenture Trustee

� In case of issue of debentures having maturity more than 18 months, the issuer shall

appoint a Debenture Trustee.

� The name of the debenture trustee must be stated in the offer document.

� A trust deed must be executed by the issuer company in favor of the trustee within six

months of the closure of the issue.

� Trustees of the debenture issue shall be vested with the power for protecting the

interest of the debenture holders.

E. Debenture Redemption Reserve (DRR)

� A company has to create Debenture Redemption Reserve (DRR) in case of issue of

debentures with maturity of more than 18 months.

� The DRR should be created in accordance with the following provisions:

• Company shall create DRR equivalent to 50% of the amount of debenture issue

before debenture redemption commences.

• Withdrawal from DRR is permitted only after 10% of the debenture liability has

been actually redeemed by the company.

• The requirement of creation of DRR shall not be applicable in case of issue of

debt instruments by infrastructure companies.



F. Distribution of Interest

� In the case of existing issuers, prior permission of the lead institution for declaring

interest exceeding 20% or as per the loan covenants is necessary if the issuer does not

comply with institutional condition.

� In case of New companies, distribution of interest shall require approval of the trustees

to the issue and lead institution, if any

� Interest may be distributed out of profit of particular years only

� If residual profits after transfer to debenture redemption reserve are inadequate to

distribute reasonable interest, issuer may distribute interest out of general reserve.

G. Other Provisions

� No company shall issue Fully Convertible Debentures having conversion period of

more than 36 months, unless conversion is made optional with “Put” and “Call”

option.

� No issue of debentures by any issuer company shall be made for acquisition of shares

or providing loan.

� Premium amount and time of conversion shall be determined by the issuer company.

� The interest rate for debentures can be freely determined by the issuer company.



[3.7] SEBI (ISSUE AND LISTING OF DEBT SECURITIES)

REGULATIONS, 2008

Issue and Listing of Debt Securities was Implemented by SEBI & has simplified the

Debt market and given it structure.

A. Issue Requirements for Public Issues

� Electronic Issuance:

An issuer proposing to issue debt securities to the public through the online system of

the designated stock exchange should comply with the relevant application

requirements as may be specified by SEBI.

� Price Discovery through Book Building:

The issuer may determine the price of debt securities in consultation with the lead

merchant banker. The issue may be at fixed price or the price may be determined

through the book building process in accordance with the procedure as may be

specified by SEBI.

� Minimum Subscription:

The issuer may decide the amount of minimum subscription which it seeks to raise by

issue of debt securities and disclose the same in the offer document. In the event of

non-receipt of minimum subscription all application moneys received in the public

issue shall be refunded to the applicants.



� Listing of Debt Securities:

An issuer desirous of issuing debt securities to the public has to make an application

for listing to one or more recognized stock exchanges in terms of Sections 73(1) of the

Companies Act , 1956. The issuer has to comply with the conditions of listing of such

debt securities as specified in the Listing Agreement with the Stock exchanges where

such debt securities are sought to be listed.

B. Continuous Listing Conditions:

1. All the issuers making public issues of debt securities issued on private

placement basis should comply with the conditions of listing specified in the

respective agreement for debt securities.

2. Every rating obtained by an issuer should be periodically reviewed by the

registered credit rating agency and any revision in the rating shall be promptly

disclosed by the issuer to the stock exchange where the debt securities are listed.

3. Any changes in rating should be promptly disseminated to investor.

4. Debenture trustee should disclose the information to the investors and the

general public by issuing a press release.



CHAPTER 4: OVERVIEW OF BONDS

[4.1] INTRODUCTION OF BONDS

In finance, a bond is a debt security, in which the authorized issuer owes the holders a

debt and, depending on the terms of the bond, is obliged to pay interest (the coupon) and/or

to repay the principal at a later date, termed maturity. A bond is a formal contract to repay

borrowed money with interest at fixed intervals. Thus a bond is like a loan: the issuer is the

borrower (debtor), the holder is the lender (creditor), and the coupon is the interest. Bonds

provide the borrower with external funds to finance long-term investments, or, in the case of

government bonds, to finance current expenditure. Certificates of deposit (CDs) or

commercial paper are considered to be money market instruments and not bonds. Bonds

must be repaid at fixed intervals over a period of time. Bonds and stocks are both securities,

but the major difference between the two is that (capital-) stockholders have an equity stake

in the company (i.e., they are owners), whereas bondholders have a creditor stake in the

company (i.e., they are lenders). Another difference is that bonds usually have a defined

term, or maturity, after which the bond is redeemed, whereas stocks may be outstanding

indefinitely. An exception is a console bond, which is a perpetuity (i.e., bond with no

maturity).A number of bond indices exist for the purposes of managing portfolios and

measuring performance, similar to the S&P 500 or Russell Indexes for stocks. The most

common American benchmarks are the (ex) Lehman Aggregate, Citigroup BIG and Merrill

Lynch Domestic Master. Most indices are parts of families of broader indices that can be

used to measure global bond portfolios, or may be further subdivided by maturity and/or

sector for managing specialized portfolios.



[4.2] PLAYERS OF BOND MARKET

The bond market can essentially be broken down into three main groups:

� Issuers:

The issuers sell bonds or other debt instruments in the bond market to fund the

operations of their organizations. This area of the market is mostly made up

of governments, banks and corporations. The biggest of these issuers is

the government, which uses the bond market to fund a country's operations, such

as social programs and other necessary expenses. The government segment also

includes some of its agencies such as Fannie Mae, which offers mortgage-

backed securities. Banks are also key issuers in the bond market and they can

range from local banks up to supranational banks such as the European Investment

Bank, which issues debt in the bond market. The final major issuer is the corporate

bond market, which issues debt to finance corporate operations.

� Underwriters:

The underwriting segment of the bond market is traditionally made up of investment

banks and other financial institutions that help the issuer to sell the bonds in the

market. In general, selling debt is not as easy as just taking it to the market. In most

cases, millions - if not billions - of dollars are being transacted in one offering. As a

result, a lot of work needs to be done - such as creating a prospectus and other legal

documents - in order to sell the issue. In general, the need for underwriters is greatest

for the corporate debt market because there are more risks associated with this type of

debt.



� Purchasers: The final players in the market are those who buy the debt that is being

issued in the market. They basically include every group mentioned as well as any

other type of investor, including the individual. Governments play one of the largest

roles in the market because they borrow and lend money to other governments and

banks. Furthermore, governments often purchase debt from other countries if

they have excess reserves of that country's money as a result of trade

between countries.

Example: Japan is a major holder of U.S. government debt.



[4.3] FEATURES OF BOND

The most important features of a bond are:

� Nominal, principal or face amount:

The amount on which the issuer pays interest, and which, most commonly, has

to be repaid at the end of the term. Some structured bonds can have a redemption

amount which is different to the face amount and can be linked to performance of

particular assets such as a stock or commodity index, foreign exchange rate or a fund.

This can result in an investor receiving less or more than his original investment at

maturity.

� Issue price:

The price at which investors buy the bonds when they are first issued, which

will typically be approximately equal to the nominal amount. The net proceeds that the

issuer receives are thus the issue price, less issuance fees.

� Maturity date:

The date on which the issuer has to repay the nominal amount. As long as all

payments have been made, the issuer has no more obligations to the bond holders after

the maturity date. The length of time until the maturity date is often referred to as the

term or tenor or maturity of a bond. The maturity can be any length of time, although

debt securities with a term of less than one year are generally designated money

market instruments rather than bonds. Most bonds have a term of up to thirty years.

Some bonds have been issued with maturities of up to one hundred years, and some

even do not mature at all. In the market there are three groups of bond maturities:

� Short term (bills): maturities up to one year;

� Medium term (notes): maturities between one and ten years;

� Long term (bonds): maturities greater than ten years.



� Coupon:

The interest rate that the issuer pays to the bond holders. Usually this rate is

fixed throughout the life of the bond. It can also vary with a money market index, such

as LIBOR, or it can be even more exotic. The name coupon originates from the fact

that in the past, physical bonds were issued which had coupons attached to them. On

coupon dates the bond holder would give the coupon to a bank in exchange for the

interest payment.

� Indentures and Covenants:

An indenture is a formal debt agreement that establishes the terms of a bond

issue, while covenants are the clauses of such an agreement. Covenants specify the

rights of bondholders and the duties of issuers, such as actions that the issuer is

obligated to perform or is prohibited from performing. In the U.S., federal and state

securities and commercial laws apply to the enforcement of these agreements, which

are construed by courts as contracts between issuers and bondholders. The terms may

be changed only with great difficulty while the bonds are outstanding, with

amendments to the governing document generally requiring approval by a majority (or

super-majority) vote of the bondholders.

� Coupon dates:

The dates on which the issuer pays the coupon to the bond holders. In the U.S.

and also in the U.K. and Europe, most bonds are semi-annual, which means that they

pay a coupon every six months.

� Optionality :

Occasionally a bond may contain an embedded option; that is, it grants option-

like features to the holder or the issuer.



� Call ability:

Some bonds give the issuer the right to repay the bond before the maturity

date on the call dates; see call option. These bonds are referred to as callable bonds.

Most callable bonds allow the issuer to repay the bond at par. With some bonds, the

issuer has to pay a premium, the so called call premium. This is mainly the case for

high-yield bonds. These have very strict covenants, restricting the issuer in its

operations. To be free from these covenants, the issuer can repay the bonds early, but

only at a high cost.

� Put ability:

Some bonds give the holder the right to force the issuer to repay the bond before the

maturity date on the put dates; see put option. (Note: "Puttable" denotes an embedded

put option; "Puttable" denotes that it may be put.)



[4.4] TYPES OF BOND

After you decide to invest in bonds, you then need to decide what kinds of bond

investments are right for you. Most people don’t realize it, but the bond market offers

investors a lot more choices than the stock market.

Depending on your goals, your tax situation and your risk tolerance, you can choose

from municipal, government, corporate, mortgage-backed or asset-backed securities and

international bonds. Within each broad bond market sector you will find securities with

different issuers, credit ratings, coupon rates, maturities, yields and other features. Each one

offers its own balance of risk and reward.

1. DOMESTIC BONDS:

� Municipal bonds:

Municipal bonds are debt obligations issued by states, cities, counties and other

governmental entities, which use the money to build schools, highways, hospitals, sewer

systems, and many other projects for the public good. When you purchase a municipal bond,

you are lending money to a state or local government entity, which in turn promises to pay

you a specified amount of interest (usually paid semiannually) and return the principal to you

on a specific maturity date. Not all municipal bonds offer income exempt from both federal

and state taxes. There is an entirely separate market of municipal issues that are taxable at

the federal level, but still offer a state—and often local—tax exemption on interest paid to

residents of the state of issuance. Most of this municipal bond information refers to munis

which are free of federal taxes.



� Fixed Rate Bonds:

Bonds have a coupon that remains constant throughout the life of the bond.

� Floating Rate Notes (FRNs):

Bonds have a variable coupon that is linked to a reference rate of interest, such

as LIBOR or Euribor. For example the coupon may be defined as three month USD

LIBOR + 0.20%. The coupon rate is recalculated periodically, typically every one or

three months.

� High Yield Bonds:

Bonds that are rated below investment grade by the credit rating agencies. As

these bonds are more risky than investment grade bonds, investors expect to earn a

higher yield. These bonds are also called junk bonds.

� Zero-Coupon Bond:

A debt security that doesn't pay interest (a coupon) but is traded at a deep

discount, rendering profit at maturity when the bond is redeemed for its full face

value. Also known as an "accrual bond". Zero coupon bonds are sold at a substantial

discount from the face amount.

� Government Bonds:

It is the Reserve Bank of India that issues Government Securities or G-Secs on

behalf of the Government of India. These securities have a maturity period of 1 to 30

years. G-Secs offer fixed interest rate, where interests are payable semi-annually. For

shorter term, there are Treasury Bills or T-Bills, which are issued by the RBI for 91

days, 182 days and 364 days.



� Inflation Linked Bonds:

Bonds in which the principal amount and the interest payments are indexed to

inflation. The interest rate is normally lower than for fixed rate bonds with a

comparable maturity. However, as the principal amount grows, the payments increase

with inflation. The United Kingdom was the first sovereign issuer to issue inflation

linked Gilts in the 1980s. Treasury Inflation-Protected Securities (TIPS) and I-bonds

are examples of inflation linked bonds issued by the U.S. government.

� Other Indexed Bonds:

For example equity-linked notes and bonds indexed on a business indicator (income,

added value) or on a country's GDP.

� Asset-backed Securities:

Bonds whose interest and principal payments are backed by underlying cash

flows from other assets. Examples of asset-backed securities are mortgage-backed

securities (MBS's), collateralized mortgage obligations (CMOs) and collateralized

debt obligations (CDOs).

� Subordinated Bonds:

Bonds are those that have a lower priority than other bonds of the issuer in case

of liquidation. In case of bankruptcy, there is a hierarchy of creditors. First the

liquidator is paid, then government taxes, etc. The first bond holders in line to be paid

are those holding what is called senior bonds. After they have been paid, the

subordinated bond holders are paid. As a result, the risk is higher. Therefore,

subordinated bonds usually have a lower credit rating than senior bonds. The main

examples of subordinated bonds can be found in bonds issued by banks, and asset-

backed securities.



� Perpetual Bonds:

Bonds are also often called perpetuities or 'Perps'. They have no maturity date.

The most famous of these are the UK Consoles, which are also known as Treasury

Annuities or Undated Treasuries. Some of these were issued back in 1888 and still

traded today.



2. INTERNATIONAL BONDS:

Some companies, banks, governments, and other sovereign entities may decide to

issue bonds in foreign currencies as it may appear to be more stable and predictable than

their domestic currency. Issuing bonds denominated in foreign currencies also gives issuers

the ability to access investment capital available in foreign markets. The proceeds from the

issuance of these bonds can be used by companies to break into foreign markets, or can be

converted into the issuing company's local currency to be used on existing operations

through the use of foreign exchange swap hedges. Foreign issuer bonds can also be used to

hedge foreign exchange rate risk. Some foreign issuer bonds are called by their nicknames,

such as the "samurai bond." These can be issued by foreign issuers looking to diversify their

investor base away from domestic markets. These bond issues are generally governed by the

law of the market of issuance, e.g., a samurai bond, issued by an investor based in Europe,

will be governed by Japanese law. Not all of the following bonds are restricted for purchase

by investors in the market of issuance.

� Eurodollar bond, a U.S. dollar-denominated bond issued by a non-U.S. entity outside

the U.S.

� Yankee bond, a US dollar-denominated bond issued by a non-US entity in the US

market.

� Kangaroo bond, an Australian dollar-denominated bond issued by a non-Australian

entity in the Australian market.

� Maple bond, a Canadian dollar-denominated bond issued by a non-Canadian entity in

the Canadian market.

� Samurai bond, a Japanese yen-denominated bond issued by a non-Japanese entity in

the Japanese market.

� Uri dashi bond, a non-yen-denominated bond sold to Japanese retail investors.

� Shibosai Bond is a private placement bond in Japanese market with distribution

limited to institutions and banks.



[4.5] ISSUERS OF BONDS

Many entities issue bonds. The bond market separates bond issuers into categories

based on the similarities of these issuers and their characteristics. These major categories are:

supranational agencies (i.e. World Bank), national governments (i.e. Government of

Canada), provincial or state governments (i.e. Province of Ontario), municipal governments

(i.e. City of Edmonton) and corporate bonds (i.e. General Motors). Bonds are issued by

public authorities, credit institutions, companies and supranational institutions in the primary

markets. The most common process of issuing bonds is through underwriting. In

underwriting, one or more securities firms or banks, forming a syndicate, buy an entire issue

of bonds from an issuer and re-sell them to investors. The security firm takes the risk of

being unable to sell on the issue to end investors. Primary issuance is arranged by book

runners who arrange the bond issue, have the direct contact with investors and act as advisors

to the bond issuer in terms of timing and price of the bond issue.

The book runners' willingness to underwrite must be discussed prior to opening

books on a bond issue as there may be limited appetite to do so. In the case of Government

Bonds, these are usually issued by auctions, where both members of the public and banks

may bid for bond. Since the coupon is fixed, but the price is not, the percent return is a

function both of the prices paid as well as the coupon.



[4.6] BOND CREDIT RATING

In investment, the bond credit rating assesses the credit worthiness of a corporation's debt

issues. It is analogous to credit ratings for individuals and countries. The credit rating is a

financial indicator to potential investors of debt securities such as bonds. These are assigned

by credit rating agencies such as Moody's, Standard & Poor's, and Fitch Ratings to have

letter designations (such as AAA, B, CC) which represent the quality of a bond. Bond ratings

below BBB/Baa are considered to be not investment grade and are colloquially called junk

bonds.

Moody's S&P Fitch GRADE

Long-

term

Short-

term

Long-

term

Short-

term Long-term

Short-

term

AAA

P-1

AAA

A-1+

AAA

F1+

Prime

AA1 AA+ AA+

High grade AA2 AA AA

AA3 AA- AA-

A1 A+ A-1

A+ F1 Upper medium

grade A2 A A

A3 P-2

A- A-2

A- F2

BAA1 BBB+ BBB+ Lower medium

grade BAA2

P-3 BBB

A-3 BBB

F3 BAA3 BBB- BBB-

BA1

Not prime

BB+

B

BB+

B

Non-investment

grade

speculative

BA2 BB BB

BA3 BB- BB-

B1 B+ B+ Highly speculative



B2 B B

B3 B- B-

CAA1 CCC+

C CCC C

Substantial risks

CAA2 CCC Extremely

speculative

CAA3 CCC- In default with little

prospect for

recovery CA

CC

C

C D /

DDD / In default

• / • DD



CREDIT RATING AGENCIES:

� Credit rating agencies registered as such with the SEC are known as “Nationally

Recognized Statistical Rating Organizations.” The following firms are currently

registered as NRSROs: A.M. Best Company, Inc.; DBRS Ltd.; Egan-Jones Rating

Company; Fitch, Inc.; Japan Credit Rating Agency, Ltd.; LACE Financial Corp.;

Moody’s Investors Service, Inc.; Rating and Investment Information, Inc.; Real point

LLC; and Standard & Poor’s Ratings Services. Under the Credit Rating Agency

Reform Act, an NRSRO may be registered with respect to up to five classes of credit

ratings: (1) financial institutions, brokers, or dealers; (2) insurance companies; (3)

corporate issuers; (4) issuers of asset-backed securities; and (5) issuers of government

securities, municipal securities, or securities issued by a foreign government.

� S&P, Moody's, and Fitch dominate the market with approximately 90-95 percent of

world market share.

� The Development of Bond market in In Credit Rating Tiers

� Moody's assigns bond credit ratings of AAA,A A,A,BAA, BA, B, CAA, CA, C, with

WR and NR as withdrawn and not rated. Standard & Poor's and Fitch assign bond

credit ratings of AAA, AA, A, BBB, BB, B, CCC, CC, C, D.

As of October 16, 2009, there were 4 companies rated AAA by S&P: Automatic Data

Processing (NYSE:ADP)

Johnson & Johnson (NYSE:JNJ)

Microsoft (NASDAQ:MSFT)

ExxonMobil (NYSE:XOM)

� Moody's, S&P and Fitch will all also assign intermediate ratings at levels between AA

and CCC (e.g., BBB+, BBB and BBB-), and may also choose to offer guidance

(termed a "credit watch") as to whether it is likely to be upgraded (positive),

downgraded (negative) or uncertain (neutral).



Moody's Standard

& Poor's

Credit worthiness

AAA AAA Triple A = Credit risk almost zero

AA1 AA+ Safe investment, low risk of failure

AA2 AA "

AA3 AA- "

A1 A+ Safe investment, unless unforeseen events should occur in the

economy at large or in that particular field of business

A2 A "

A3 A- "

BAA1 BBB+ Medium safe investment. Occurs often when economy has

deteriorated. Problems may arise

BAA2 BBB "

BAA3 BBB- "

BA1 BB+ Speculative investment. Occurs often in deteriorated

circumstances, usually problematic to predict future

development

BA2 BB "

BA3 BB- "

B1 B+ Speculative investment. -Deteriorating situation expected

B2 B "

B3 B- "

CAA CCC High likelihood of bankruptcy or other business interruption

CAA CC "

C C "

D Bankruptcy or lasting inability to make payments most likely

WR Rating withdrawn

NR Not rated



Investment grade:

� A bond is considered investment grade or IG if its credit rating is BBB- or higher by

Standard & Poor's or Baa3 or higher by Moody's or BBB(low) or higher by DBRS.

Generally they are bonds that are judged by the rating agency as likely enough to meet

payment obligations that banks are allowed to invest in them.

� Ratings play a critical role in determining how many companies and other entities that

issue debt, including sovereign governments; have to pay to access credit markets, i.e.,

the amount of interest they pay on their issued debt. The threshold between

investment-grade and speculative-grade ratings has important market implications for

issuers' borrowing costs.

� Bonds that are not rated as investment-grade bonds are known as high yield bonds or

more derisively as junk bonds.

� The risks associated with investment-grade bonds (or investment-grade corporate

debt) are considered noticeably higher than in the case of first-class government

bonds. The difference between rates for first-class government bonds and investment-

grade bonds is called investment-grade spread. It is an indicator for the market's belief

in the stability of the economy. The higher these investment-grade spreads (or risk

premiums) are, the weaker the economy is considered.

� The debt market is much more popular than the equity markets in most parts of the

world. In India

� The reverse has been true. Nevertheless, the Indian debt market has transformed itself

into a much

� More vibrant trading field for debt instruments from the rudimentary market about a

decade ago.

� The sections below encompass the transformation of government and corporate debt

markets in

� India along with a comparison of the developments in equity market.



CHAPTER 5: VALUATION OF BONDS

[5.1] BOND VALUATION

At the time of issue a level coupon bond is usually sold for a price which is close to

its par value. After issue a bond is traded on the market at a price which reflects the current

level of interest rates and the degree of risk associated with the bond. Typically we are

interested in calculating either the market price that a bond should sell for, given that the

investor wants to obtain a particular market yield; or the effective yield (a.k.a. the

yield to maturity), given the price at which the bond is trading the value of a financial

security is the PV of expected future cash flows to value bonds we need to estimate future

cash flows (size and timing) and discount at an appropriate rate.

� At par: When a bond is selling at price = Par Value = $1,000 ]

This would happen when the coupon rate = YTM.

� Discount Bond: When a bond is selling at price < Face Value

-- Coupon Rate < YTM.

� Premium Bond: When a bond is selling at price > Face Value

-- Coupon rate > YTM.



[5.2] YIELD TO MATURITY

The yield to maturity is the discount rate which returns the market price of the

bond; it is identical to (required return) in the above equation. YTM is thus the internal rate

of return of an investment in the bond made at the observed price. Since YTM can be used to

price a bond, bond prices are often quoted in terms of YTM. Yield refers to the percentage

rate of return paid on a stock in the form of dividends, or the effective rate of interest paid on

a bond or note. There are many different kinds of yields depending on the investment

scenario and the characteristics of the investment. The calculation of YTM helps the investor

in rational decision making. YTM serves as a cutoff point to the investor and enables him to

determine whether he should or should not invest in the given debt instrument. YTM

represents the yield on bond, provided the bond id held to maturity and the intermittent

coupons are reinvested at the same YTM rate. In other words, YTM assumes that investor

can reinvest the coupon received at same rate as YTM over the investment horizon.

To achieve a return equal to YTM, i.e. where it is the required return on the bond, the bond

owner must:

• Buy the bond at price P0,

• Hold the bond until maturity, and

• Redeem the bond at par.

Coupon yield:

The coupon yield is simply the coupon payment (C) as a percentage of the face value

(F).Coupon yield is also called nominal yield.

Coupon yield = C / F



Current yield:

The current yield is simply the coupon payment (C) as a percentage of the (current) bond

price (P).

Current yield = C / P0.

Relationship:

The concept of current yield is closely related to other bond concepts, including yield to

maturity, and coupon yield. The relationship between yield to maturity and the coupon rate is

as follows:

� When a bond sells at a discount, YTM > current yield > coupon yield.

� When a bond sells at a premium, coupon yield > current yield > YTM.

� When a bond sells at par, YTM = current yield = coupon yield amt.



CHAPTER 6: STATISTICAL DATA

[6.1] STATISTICAL DATA ON DEBT MARKET

The following table gives us the information of last ten years bonds issued by Public Sector

Undertakings.

Bonds Issued by Public Sector Undertakings(Rupees crore)

Year Tax-free Bonds Taxable Bonds Total (2+3)

1 2 3 4

2000-01 662.2 15969.4 16631.6

2001-02 274.2 14161.5 14435.7

2002-03 286.0 7243.0 7529.0

2003-04 5443.2 5443.2

2004-05 7590.6 7590.6

2005-06 4845.5 4845.5

2006-07 10325.1 10325.1

2007-08 13404.4 13404.4

2008-09 12839.8 12839.8

2009-10 29937.8 29937.8



It is analyzed that since 2003 till date there is no Tax Free Bonds issued by public

sector undertakings. It is also been interpreted that the value of taxable bonds are

increasing on yearly basis.

Debt-to-GDP and the Market:

Decades from now, when historians write about the current era, the relationship between the

stock market and the debt ratio will likely be a hot topic — one that will encompass politics,

economics, demographics and cultural history. The first few decades after World War II

witnessed an inverse relationship between a rising market and shrinking debt ratio. But after

the decade of stagflation, the 18-year bull market that started in 1982 was accompanied by a

change in the debt relationship from inverse to tandem, as the overlay below suggests. Those

good times came at a cost — one that was increasingly covered by debt.





Note that I've changed the color of the ratio from red (my usual color for debt) to black to

avoid any suggestion of political responsibly. Ultimately politics is but one factor in the debt

equation, which is driven by larger historical forces (World Wars, the Great Depression and

the Cold War) as well as profound social, economic and cultural changes (e.g., trickle-down

economics meets the Boomer era of conspicuous consumption).

I've interpolated monthly values for the debt data in the market overlay so it aligns properly

with the monthly market data for the S&P Composite. Thus the Office of Management and

Budget (OMB) dot estimates in the top chart are shown as a smooth rosy line in the second.

That line represents the White House OMB's six-year debt and GDP forecasts. Note that the

curve becomes less steep from 2012-2015. Let's hope this isn't a wishful view through rosy

colored glasses.



CHAPTER 7: CONCLUSION

[7.1] CONCLUSION

After you decide to invest in bonds, you then need to decide what kinds of bond

investments are right for you. Most people don’t realize it, but the bond market offers

investors a lot more choices than the stock market.

Depending on your goals, your tax situation and your risk tolerance, you can

choose from municipal, government, corporate, mortgage-backed or asset-backed securities

and international bonds. Within each broad bond market sector you will find securities with

different issuers, credit ratings, coupon rates, maturities, yields and other features. Each one

offers its own balance of risk and reward.

Individual investors as well as groups or corporate partners may participate in a debt

market. Depending on the regulations imposed by governments, there may be very little

distinction between how an individual investor versus a corporation would participate in a

debt market. However, there are usually some regulations in place that require that any type

of investor in debt market offerings have a minimum amount of assets to back the activity.

This is true even with situations such as bonds, where there is very little chance of the

investor losing his or her investment.

One of the advantages to participating in a debt market is that the degree of risk

associated with the investment opportunities is very low. For investors who are focused on

avoiding riskier ventures in favor of making a smaller but more or less guaranteed return,

going with bonds and similar investments simply makes sense. While the returns will never

be considered spectacular, it is possible to earn a significant amount of money over time, if

the right debt market offerings are chosen.



CHAPTER 8: BIBLOGRAPHY

[8.1]BIBLOGRAPHY

� BOOKS REFERRED:

DEBT MARKETS – SANDEEP GUPTA & SACHIN BHANDARKAR

� WEBSITE

www.sebi.gov.in

www.investopedia.com

www.wikipedia.com

www.rbi.org.com

Debt market

Education