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Types of Instrument Government Se Urities Publi Se Tor Onds Private Se 1 | Page BINU D PANDEY 09819589314 DEBT MARKET What is debt market? A market where fixed income securities of various types and features are issued and traded is known as a ³debt market´. Fixed income securities include securities issued by central and state governments, municipal, corporations, government bodies and commercial bodies such as financial institutions, banks, public sector units, public limited companies, etc. The securities are structured in nature. Advantages of debt market: To investor:Steady income, Safety, Risk free To financial system: Types of instruments that are traded in the debt market include the following: Types of Instrument Government Publi Se tor Private Se urities onds Se tor onds Debt Instruments: Debt instruments are contracts in which one party lends money to another on pre- determined terms with regard to rate of interest to be paid by the borrower to the lender, the periodicity of such interest payment, and the repayment of the principal amount borrowed (either in installments or in bullet). In the Indian securities markets, we generally use the term µbond¶ for debt instruments issued by the Central and State governments and public sector organizations, and the term µdebentures¶ for instruments issued by private corporate sector. The principal features of a bond are: a) Maturity b) Coupon c) Principal Maturity of a bond refers to the date on which the bond matures, or the date on which the borrower has agreed to repay (redeem) the principal amount to the lender. The borrowing is extinguished with redemption, and the bond ceases to exist after that date. ¢ £ 2 | P a g e B ¡ P A N D E Y 09819589314 Term t mat rit refers t t e number of years remaining for t e bond to mature. Term to maturity of a bond changes every day, from the date of issue of the bond until its maturity. Coupon Rate refers to the periodic interest payments that are made by the borrower (who is also the issuer of the bond) to the lender (the subscriber of the bond) and the coupons are stated upfront either directly specifying the number (e.g.8%) or indirectly tying with a benchmark rate (e.g.M BOR+0.5%). Coupon rate is the rate at which interest is paid, and is usually represented as a percentage of the par value of a bond. Principal is the amount that has been borrowed, and is also called the par value or face value of the bond. The coupon is the product of the principal and the coupon rate. Typical face values in the bond market are Rs. 100 though there are bonds with face values of Rs. 1000 and Rs.100000 and above. All Government bonds have the face value of Rs.100 In many cases, the name of the bond itself conveys the key features of a bond. For example a GS CG2008 11.40% bond refers to a Central Government bond maturing in the year 2008, and paying a coupon of 11.40%. Since Central Government bonds have a face value of Rs.100, and normally pay coupon semi annually, this bond will pay Rs. 5.70 as six- monthly coupon, until maturity, when the bond will be redeemed. The term to maturity of a bond can be calculated on any date, as the distance between such a date and the date of maturity. It is also called the term or the tenor of the bond. For instance, on February 17, 2004, the term to maturity of the bond maturing on May 23, 2008 will be 4.27 years. The general day count convention in bond market is 30/360European which assumes total 360 days in a year and 30 days in a month. Generally bonds with tenors of 1-5 years are called short-term bonds; Bonds with tenors ranging from 4 to 10 years are medium term bonds and above 10 years are long term bonds. In India, the Central Government has issued up to 30 year bonds. PARTICIPANTS IN THE DEBT MARKETS: Debt markets are pre-dominantly wholesale markets, with dominant institutional investor participation. The market participants in the debt market are: 1. Central Government, 2. Reserve Bank of India, 3. Primary dealers, 4. State Governments, municipalities and local bodies, 5. Public sector units 6. Corporate treasuries 7. Public sector financial institutions 8. Banks 3 | P a g e B ¤ NU D PANDEY 09819589314 9. Mutual funds 10. Foreign Institutional Investors 11. Provident funds 12. Charitable Institutions, Trusts and Societies What is SGL? SGL Stand for µSubsidiary General Ledger¶ account, it is facility provided by RBI to large banks and financial institutions to hold their investment in government securities and treasury bills in the electronic book-entry form. Such institution can settle their trades for securities held in SGL through a ³Delivery-Versus-Payments´ (DVP) mechanism, which ensures movement of funds and securities simultaneously. A. Classification on the basis of Variability of Coupon Q1) Zero coupon bond:A zero-coupon bon (also called a iscount bon or eep discount bond) is a bond bought at a price lower than its face value, with the face value repaid at the time of maturity. It does not make periodic interest payments, or have so-called "coupons," hence the term zero-coupon bond. When the bond reaches maturity, its investor receives its par (or face) value. Examples of zero-coupon bonds include government bonds and savings bonds. Zero coupon bonds may be long or short term investments. Long-term zero coupon maturity dates typically start at ten to fifteen years. The bonds can be held until maturity or sold on secondary bond markets. Short-term zero coupon bonds generally have maturities of less than one year and are called bills. The U.S. Treasury bill market is the most active and liquid debt market in the world. In such a bond, no coupons are paid. The bond is instead issued at a discount to its face value, at which it will be redeemed. There are no intermittent payments of interest. When such a bond is issued for a very long tenor, the issue price is at a steep discount to the redemption value. Such a zero coupon bond is also called a deep discount bond. The effective interest earned by the buyer is the difference between the face value and the discounted price at which the bond is bought. No inflow of cash and No payment of interest. There are also instances of zero coupon bonds being issued at par, and redeemed with interest at a premium (interest= Re-purchase ± Issue price) Q2) Floating rate bonds:Bond whose interestamountfluctuates in step with the market interest rates, or some other externalmeasure. Price of floating rate bonds remains relatively stable because neither a capital gain nor a capital loss occurs as marketinterest rates go up or down. Instead of a pre-determined rate at which coupons are paid, it is possible to structure bonds, where the rate of interest is re-set periodically, based on a benchmark rate. Such bonds whose coupon rate is not fixed, but reset with reference to a benchmark rate, are called floating rate bonds 4 | P a g e B ¥ NU D PANDEY 09819589314 Coupon rate in some of these bonds also have floors and caps Interest rates are not fixed Example: IDBI issued a 5 year floating rate bond, in July 1997, with the rates being reset semi-annually with reference to the 10 year yield on Central Government securities and a 50 basis point mark-up. In this bond, every six months, the 10-year benchmark rate on government securities is ascertained. The coupon rate IDBI would pay for the next six months is this benchmark rate, plus 50 basis points. The coupon on a floating rate bond thus varies along with the benchmark rate, and is reset periodically. Q3) Treasury Strips: Treasury strips are more popular in the United States and not yet available in India. Also known as Separate Trading of Registered Interest and Principal Securities, government dealer firms in the United States buy coupon paying treasury bonds and use these cash flows to further create zero coupon bonds. Dealer firms then sell these zero coupon bonds, each one having a different maturity period, in the secondary market. In the United States, government dealer firms buy coupon paying treasury bonds, and create out of each cash flow of such a bond, a separate zero coupon bond. We do not have treasury strips yet in the Indian markets. RBI and Government are making efforts to develop market for strips in governmentsecurities. A. Classification on the Basis of Variability of Maturity Q4) Callable bonds: A callable bond (also called redeemable bond) is a type of bond (debt security) that allows the issuer of the bond to retain the privilege of redeeming the bond at some point before the bond reaches the date of maturity. The issuer of a callable bond has the right (but not the obligation) to change the tenor of a bond (call option). The inclusion of this feature in the bond¶s structure provides the issuer the right to fully or partially retire the bond, and is therefore in the nature of call option on the bond. The issuer may redeem a bond fully or partly before the actual maturity date. These options are present in the bond from the time of original bond issue and are known as embedded options. A call option is either a European option or an American option. Under an European option, the issuer can exercise the call option on a bond only on the specified date, whereas under an American option, option can be exercised any time before the specified date.
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