Bond Market

Presented By: Ms Arleen Afonso

Topics to be discussed
What are bond markets?

Segmentation of the bond market

Participants in the bond market Instruments traded in the bond market Measures to strengthen market infrastructure
NDS (Negotiated Dealing System) CCIL (Clearing Corporation of India Ltd)

Topics to be discussed
What are bond markets? Segmentation of the bond market Participants in the bond market Instruments traded in the bond market Measures to strengthen market infrastructure NDS (Negotiated Dealing System) CCIL (Clearing Corporation of India Ltd)

Debt Market???
Debt Market, also known as the fixed income

securities market. The oldest market to have emerged in the world. In India, debt markets play a vital role as they enable the government and the corporate to channelize the nations financial resources for the infrastructural, industrial growth of the country.
At the same time, provide investors with a safe avenue to invest their funds in.

What are bonds???

A long-term debt security issued by

corporations and governments offering fixed interest payments periodically for a period of more than one year.
Holding a bond does not represent ownership

Difference between bonds and debentures

The debt securities issued by the Central and

State government are known as bonds.

The debt securities issued by private corporate

enterprises are known as debentures.

However, the two terms are often used

interchangeably.
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Features of Bonds
Issue date: The date on which an investor buys

the bond is called the issue date.

Principal: The amount that the investor invests in

the bond is called the principal amount. It is also called as the par value or face value.

Features of bonds
Typically the face value of bonds in the Indian

bond market is Rs. 100

The name of the bond signifies the various

features of the bond.

Coupon
Coupon refers to the periodic interest payments

made by the issuer of the bond (i.e. the borrower of the money) to the subscriber (i.e. the lender).
The coupons are specified directly as a fixed

percentage of the principal amount or

Floating rate

Debt Market Segmentation

Private Corporate Debt Market
Public sector undertaking bond market Government securities market Government securities is the principal segment of

the debt market

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Participants in the Debt Market

Central & State Governments Primary Dealers Public Sector Undertakings Corporates Banks

Mutual Funds
Insurance Companies FIIs

PF (Provident Funds & Pension Funds)

Charitable Institutions and Trusts
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Types of Instruments traded in the Debt Market

Market Segment Government Securities Issuer Central Government Instruments Zero Coupon Bonds, Coupon Bearing Bonds, Treasury Bills, Floating Rate Bonds, STRIPS, Govt. Dated Securities Coupon Bearing Bonds, Floating Rate Bonds Government Guaranteed Bonds, Debentures

State Government Public Sector Government Bonds Agencies/ Statutory Bodies Public Sector Units Private Sector Bonds
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PSU Bonds, Taxable & Tax-free, Debentures, Commercial Paper, Deep Discount Bonds. Debentures, Bonds, Commercial Paper, Floating Rate Bonds, Secured Premium Notes, Zero Coupon Bonds, Inter- Corporate Deposits CDs, Debentures, Bonds

Corporates

Banks

Zero Coupon Bond

No coupon payments are made. These bonds are issued at a discount to their

face value.
The effective return that the investor earns is the

difference between the face value minus the discounted value of the bond.
Also called as a Deep Discount Bond
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Floating Rate Bonds

The rate at which coupon is paid changes

periodically.
It is tied to a benchmark rate like a particular

Government security.
A few floating rate bonds also have caps and

floors.
These are also called as Range Notes, as they

move within a certain range.

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Callable & Puttable Bonds

Callable bonds:
The issuer can redeem or repay the principal

amount to the investor before the original maturity date

Also called as bonds embedded with options

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Advantages to the Issuer

Whenever the rates fall below the rate that the

issuer has offered, the issuer can repay the bond and issue a new bond at the lower rates.
Thus the company has to pay less for the same

amount of money that it borrows.

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Disadvantages to the Investor

Investor loses an opportunity to stay invested in a

security that pays higher returns even when the rates have dropped.
The investor is also faced by reinvestment risk. The rates offered for the callable bonds are

slightly higher that those offered in regular bonds.

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Puttable bonds:
The put option gives the investor the right to ask

for redemption or repayment of the face value

and retire the bond before the original maturity

date.
This option will be exercised by the investor when

the rates rise above the rates that they are offered in the existing bond investment
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Advantages to the Investor

The advantage to the investor is that when the

rates rise above the rates currently offered to him,

he can ask for repayment of the principal and

reinvest the money in a bond that offers the current high rate.

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Disadvantages to the Issuer

The disadvantage to the issuer is that, this will

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expose him to re-pricing risk. The issuer will now have to re-issue the bond, offering a higher coupon rate. To compensate the issuer for this, rate offered by the issuer for puttable bonds are lower than regular bonds. The Central Government has issued a bond with embedded option of both the call and put. This gives both the government and the bondholder the right to retire the bond.

Convertible Bonds
A convertible option provides the investor with an

option to convert the outstanding bond into equity of the company

The number of shares allotted i.e. the conversion

ratio and the conversion price to be applied is specified in the indentures (the terms and conditions) of the bond in the beginning
Fully convertible bonds
Partially convertible bonds
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Secured Premium Notes

SPN is a secured debenture redeemable at premium

issued along with a detachable warrant

Redeemable after a notice period of 4-7years The warrants attached to SPN gives the holder the

right to apply and get allotted equity shares; provided the SPN is fully paid

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Contd..
There is a lock-in period for SPN The SPN holder has an option to sell back the

SPN to the company

The conversion of detachable warrants into equity

shares will have to be done within the time limit notified by the company
Eg-TISCO
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STRIPS (Separate Trading for Registered Interest and Principal of Securities)

STRIPS is a process of stripping a conventional

coupon bearing security into a number of zero coupon securities which can be traded separately
Split on the basis of Coupons and Principal

repayment
Easy calculation of yield Easy calculation of cash flows
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Free from default risk

Government Dated Securities

Medium to long term obligations issued by RBI on

behalf of the Govt. to finance the deficit and development programs Predominantly coupon bearing & coupon is paid semi-annually Also issued at floating rate and as zero coupon bonds No TDS is applicable Eligible for SLR and highly liquid

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 Risks associated with Debt Securities

Default Risk
Interest Rate Risk Reinvestment Risk

Risks associated with trading in Debt

Securities
Counter party risk Price risk

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 Segments of the Debt Market

Primary Segment

Fresh Issues

Secondary Segment

OTCEI WDM NSE BSE

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Primary Issuance Process

The issuance process for G-secs has undergone significant changes over the last few years:

The introduction of the auction mechanism. Creation of the system of primary dealers. The introduction of non-competitive bids.

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What is an auction mechanism?

This is basically a price discovery mechanism.
Used to discover the price of the govt. sec. being

floated in the market.

Auction is a process of calling of bids with an

objective of arriving at the market price.

RBI conducts the option on behalf of the govt.
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 RBI announces the auction of government securities

through a press notification, and invites bids.

The sealed bids are opened at an appointed time. Successful bidders are those that bid at the highest

price.

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The objectives of auction design are:

Higher auction volumes that satisfy the target

borrowing requirement.
Broadening participation to ensure that bids are

not concentrated and

Ensuring efficiency through achieving the optimal

cost of borrowing for the government.

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Primary dealers
They are market intermediaries appointed by the

Reserve Bank of India who:

Underwrite

and securities, and

make

market

in

government

Have access to the call markets and repo markets for

funds.

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The objectives of setting up the system of primary dealers are:

To strengthen the infrastructure in the Gsecs market

in order to make it vibrant, liquid and broad-based;

To improve secondary market trading system. enhance liquidity and turnover and

encourage voluntary holding of government

securities among a wider investor base;

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Non competitive bids

The non competitive bids were introduced, with a

view to expand the bond market and allow individual investors to invest in the G-secs.
The allocation is according to the discretion of RBI,

and the price is that discovered through the auction.

The number of securities allocated here, is a

percentage of the amount issue typically 5%.

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Subsidiary General Ledger (SGL) account

(SGL) account is a securities account maintained by

banks, primary dealers and financial institutions with the RBI, to hold their investments in G secs. and T- bills in the electronic book entry form. These institutions can settle their trades for securities held in SGL through a delivery versus payment (DvP) mechanism, which ensures simultaneous movement of funds and securities.

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Constituent Subsidiary General Ledger (CSGL)

As individual investors do not have access to the

SGL system, RBI has permitted such investors to open a account with any entity authorized by RBI for this purpose and thus avail of the DvP settlement. RBI permits Clearing houses, banks and PDs to offer CSGL account facility to an investor who is interested in participating in the government securities market.

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Features of CSGL Accounts

CSGL account gets debited or credited on the sale

or purchase of the securities ,similar to a bank account. The account holder receives a statement at periodic intervals showing the balance of securities in his account. All the securities are maintained in demat mode, which can be converted into physical mode whenever required by the Account Holder.
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Trading Mechanism
The trades on the Whole Sale Debt market (WDM) segment can be executed in the: Continuous market or Negotiated market.

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Continuous market
Here, orders entered by the trading members are

matched by the trading system. For each order entering the trading system, the system scans for a probable match in the order books. On finding a match, a trade takes place. In case the order does not find a suitable counter order in the order books, it is stored in the order books as a passive order.
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Negotiated Market
In the negotiated market, deals are negotiated

between the two counter parties and are reported on the trading system for approval.

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Negotiated Dealing System (NDS)

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NDS
Provides an online electronic bidding facility in the

primary auctions of the Central/State Government securities, OMOs auctions It enables screen based electronic bidding & reporting of transactions Banks, financial institutions, Primary Dealers having SGL Accounts or current accounts are eligible to participate in NDS Members are expected to report all the trades negotiated outside the system for settlement
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Clearing Corporation of India Ltd (CCIL)

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CCIL
It is a clearing and settling agency in respect of all

trades NDS is integrated with CCIL All the transactions that take place on NDS are settled over CCIL All transactions upto Rs. 20 crore are to be settled through CCIL

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