Debt Market

CHAPTER 1
DEBT MARKET
1.1-MEANING
The debt market is a financial market where participants can issue new debt, known as
the primary market, or buy and sell debt securities, known as the Secondary market, usually in the form
of bonds. A debt market is also known as a fixed income market as debt instruments pay fixed returns.
Fixed income securities of various types and features are issued and traded in this market. 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 securities 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.

1.2-DEFINITION
The market for trading debt instruments
The environment in which the issuance and trading of debt securities paying a guaranteed yield
occurs and facilitates the transfer of capital from savers to the issuers or organizations requiring
capital for government projects, business expansions and ongoing operations.

Debt Market

1.3-CLASSIFICATION OF DEBT MARKET ON THE BASIS OF INSTRUMENTS

TRADED

DEBT
MARKETS

BOND
MARKET

CREDIT
MARKET

FIXED INCOME
MARKET

Debt market is called by different names based on the types of debt instruments traded.

Bond Market: In the event that the market deals mainly with the trading of government, semigovernment, municipal and corporate bond issues, the debt market may be known as a bond

market.
Credit Market: Where asset-backed mortgages and promissory notes are the main focus of the

trading, the debt market may be known as a credit market.

Fixed Income Market: When fixed rates are connected with the debt instruments, the market is
known as a fixed income market.
Generally, the instruments traded in the Bond and Credit market also have fixed income rates and

hence, come under Fixed Income Market. Amongst the above classification the Bond Market with fixed
rate instruments is highly traded in by the retail as well as wholesale investors. Hence, debt markets are
simultaneously called as the Bond Market as well as Fixed Income Market.

1.4-SECTORS OF THE BOND MARKET

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Debt Market

BOND
MARKET

INTERNAL
BOND MARKET

Domestic
Bond Market

EXTERNAL BOND
MARKET

Foreign
Bond Market

From the perspective of a country the Bond Market is classified into two markets.

Internal Bond Market: The internal bond market of a country is also known as the National
Bond Market. It is divided into the domestic bond market and foreign bond market. The domestic
bond market is where issuers domiciled in the country issue bonds and where those bonds are
subsequently traded.
The foreign bond market is where issuers not domiciled in the country are issued and traded. For
example, in India the foreign bond market is the market where the bonds are issued by nonIndian entities and then subsequently traded. Bonds in the foreign sector of a bond market have
nicknames and can be denominated in any currency.
Issuers of foreign bonds include central governments and their subdivisions, corporations and
supranational. A Supranational is an entity is formed by two or more central governments to
promote economic development of member countries, through international treaties.

Foreign bonds must comply with the security laws in the country where they are issued. Foreign
bonds issued in India must meet same legal requirements as complied with by the domestic bond
issuers.

Debt Market

External Bond Market: The external bond market includes bonds with the following
distinguishing features:
They are underwritten by an international syndicate.
At issuance, they are offered simultaneously to investors in a number of countries.
They are issued outside the jurisdiction of any single country.
They are in unregistered form.
The external bond market is referred to as the international bond market, the offshore bond
market, or, more popularly as the Eurobond market. Eurobonds are classified based on the
currency in which the issue is denominated.

Debt Market

CHAPTER 2
EVOLUTION OF DEBT MARKETS
2.1-GLOBAL HISTORY
Between 1915 and 1917, the United States Treasury bond market began as a way to fund plans
for World War I. Money for the war was financed by a rise in taxes and through the sale of war bonds,
called Liberty Bonds. Over $21 billion dollars were raised in bonds that would come due in full
(matured) after the war. However, the government did not have enough to cover the debt when it came
due, so more money was raised to pay off the first debt rolled over into bills due in less than one year,
and notes due in under ten years, and bonds due in ten to thirty years. These amounts were paid off
regularly until borrowings were increased during the Great Depression at the end of the 1920s.
The United States Treasury issued subscription bonds where the public signed up for a set
interest payment coupon and maturity price until 1929. Demand for government bonds and other
investments became so great that the Treasury set up auctions which became a regular event. They were
important because the yields in each maturity were used to as a 'risk free rate' for credit purposes. From
this point onward, government bonds were systematically created which had a secure annual interest
percentage.
Over the years, government bonds have become available to foreign governments. As the foreign
governments began to have a surplus of trade with the U.S., they became holders of United States debt.
As deficits rose during World War II and the Vietnam War, the debt markets and the rise of debt-related
investments has dominated financial markets. Most trading in the bond market occurs over-the-counter
(through organized electronic trading networks or groups), and is composed of the primary market
through which debt securities are issued and sold by borrowers to lenders, and the secondary market
through which investors buy and sell previously issued debt securities amongst themselves. Although the
stock market often commands more media attention, the bond market is actually many times larger and
it is even more vital to the ongoing operation of the public and private sectors.

Debt Market

2.2-INDIAN HISTORY
Towards the eighteenth century, the borrowing needs of Indian Princely States were largely met
by Indigenous bankers and financiers. The concept of borrowing from the public in India was pioneered
by the East India Company to finance its campaigns in South India (the Anglo French wars) in the
eighteenth century. The debt owed by the Government to the public, over time, came to be known as
public debt. The endeavors of the Company to establish government banks towards the end of the 18th
Century owed in no small measure to the need to raise term and short term financial accommodation
from banks on more satisfactory terms than they were able to garner on their own.

Borrowing for financing railway construction and public works such irrigation canals was first
undertaken in 1867. The First World War saw a rise in India's Public Debt as a result of India's
contribution to the British exchequer towards the cost of the war. The provinces of British India were
allowed to float loans for the first time in December, 1920 when local government borrowing rules were
issued under section 30(a) of the Government of India Act, 1919. Only three provinces viz., Bombay,
United Provinces and Punjab utilised this sanction before the introduction of provincial autonomy.
Public Debt was managed by the Presidency Banks, the Comptroller and Auditor-General of India till
1913 and thereafter by the Controller of the Currency till 1935 when the Reserve Bank commenced
operations.
Interest rates varied over time and after the uprising of 1857 gradually came down to about 5%
and later to 4% in 1871. In 1894, the famous 3 1/2 % paper was created which continued to be in
existence for almost 50 years. When the Reserve Bank of India took over the management of public debt
from the Controller of the Currency in 1935, the total funded debt of the Central Government amounted
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Debt Market

to Rs 950 crores of which 54% amounted to sterling debt and 46% rupee debt and the debt of the
Provinces amounted to Rs 18 crores.

2.3-PHASES OF PUBLIC DEBT IN INDIA

Upto 1867: When public debt was driven largely by needs of financing campaigns.
1867- 1916: When public debt was raised for financing railways and canals and other such

purposes.
1917-1940: When public debt increased substantially essentially out of the considerations of

provincial autonomy.
1940-1946: When because of war time inflation, the effort was to mop up as much as possible of

the current war time incomes

1947-1951: Represented the interregnum following war and partition and the economy was
unsettled. Government of India failed to achieve the estimates for borrowings for which credit

had been taken in the annual budgets.

1951-1985: When borrowing was influenced by the five year plans.
1985-1991: When an attempt was made to align the interest rates on government securities with
market interest rates in the wake of the recommendations of the Chakraborti Committee Report.

2.4-TALKING TECHINALLY: POST 1990s

Before the 1990s, the government securities market was characterised by administered interest
rates, high Statutory Liquidity Ratio (SLR) requirements that led to the existence of captive investors in
banks, and the absence of a liquid and transparent secondary market. The coupon rates offered on
government securities were not market related.
Reforms in the government securities (G-Sec) market were undertaken as a part of the overall
structural reform process that was initiated in 1991-92 and were aimed at redressing many of these
infirmities.

The first phase in the reform of the G-Sec market were aimed at creating an enabling policy
environment and included:
The elimination of automatic monetization
Transition to market-related interest rates
Reduction in SLR requirement to the then statutory minimum level of 25 per cent.

The second phase of reforms in the G- Sec market was directed towards institutional
development to enhance market activity, settlement and safety. These reforms included:
Establishment of a Delivery versus Payment system, to reduce settlement risk.
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Debt Market

Institution of the system of Primary Dealers (PDs).

Formation of market bodies such as Fixed Income Money Market and Derivatives
Association of India (FIMMDA) and Primary Dealers Association of India (PDAI).
Instrument diversification was also seriously attempted during this phase of reforms to
meet the diverse funding and hedging needs of participants.
Floating Rate Bonds (FRBs) introduced during this phase did not evoke much response.
Capital Indexed bonds (CIB) were first issued in 1997 but there were no further issuances
mainly due to the lack of an enthusiastic response from the market participants, both in
primary and secondary markets.

The third phase of reforms in the G-Sec market is aimed at enhancing liquidity and efficiency.
Some of the important initiatives that were taken during this phase are:
Introduction of repo/ reverse repo operations in government securities to facilitate
participants to manage short term liquidity mismatches.
Operationalisation of the Negotiated Dealing System (NDS), an automated electronic
trading platform.
Establishment of the Clearing Corporation of India Limited (CCIL) for providing an
efficient and guaranteed settlement platform.
Introduction of trading of G-secs in stock exchanges.
Introduction of OTC and exchange-traded derivatives to facilitate hedging of interest rate
risk.
Introduction of Real Time Gross Settlement System (RTGS) which addresses settlement
risk and facilitates liquidity management.
Adoption of a modified Delivery-versus-Payment mode of settlement which provides for
net settlement of both funds and securities legs.
Announcement of an indicative auction calendar for Treasury Bills and dated securities.

Debt Market

CHAPTER 3
STRUCTURE OF INDIAN DEBT MARKET

Source: http://www.scribd.com/doc/28143890/Presentation-on-Indian-Debt-Market

3.1-MARKET SEGMENTS

MARKET
SEGMENTS

GOVERNMENT
SECURITIES

PUBLIC
SECTOR

CORPORATE
DEBT
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Debt Market

Government Securities: The market for Government Securities comprises the Centre, State and
State-sponsored securities. The market for government securities is the oldest and most dominant
in terms of market capitalisation, outstanding securities, trading volume and number of
participants. It not only provides resources to the government for meeting its short term and long
term needs, but also sets benchmark for pricing corporate paper of varying maturities and is used
by RBI as an instrument of monetary policy. The instruments in this segment are fixed coupon
bonds, commonly referred to as dated securities, treasury bills, floating rate bonds, zero coupon

bonds and inflation index bonds.

Public Sector: The issues by government sponsored institutions like Development Financial
Institutions, as well as the infrastructure-related bodies and the PSUs, who make regular forays
into the market to raise medium-term funds, constitute the public sector segment of debt markets.
The gradual withdrawal of budgetary support to PSUs by the government since 1991 has
compelled them to look at the bond market for mobilising resources. The preferred mode of issue
has been private placement, barring an occasional public issue. Banks, financial institutions and
other corporates have been the major subscribers to these issues. The tax-free bonds, which
constitute over 50% of the outstanding PSU bonds, are quite popular with institutional players.

Corporate Debt: The market for corporate debt securities has been in vogue since early
1980s.Until 1992 interest rate on corporate bond issuance was regulated and was uniform across
credit categories. In the initial years, corporate bonds were issued with sweeteners in the form
of convertibility clause or equity warrants. Most corporate bonds were plain coupon paying
bonds, though a few variations in the form of zero coupon securities, deep discount bonds and
secured promissory notes were issued. After the de-regulation of interest rates on corporate
bonds in 1992, we have seen a variety of structures and instruments in the corporate bond
markets, including securitized products, corporate bond strips, and a variety of floating rate
instruments with floors and caps. In the recent years, there has been an increase in issuance of
corporate bonds with embedded put and call options. The major part of the corporate debt is
privately placed with tenors of 1-12 years.

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Debt Market

Market Capitalization of WDM Securities (September 2011)

Others; 12%
PSU Bonds; 6%
T-Bills; 6%
Government Securities; 59%
State Loans; 17%

Source: NSE-WDM Segment.

3.2-DEBT INSTRUMENTS

Dated Government Securities: Dated government securities are long-term securities that carry
a fixed or floating coupon (interest rate), which is paid on the face value, payable at fixed time
periods (usually half-yearly). The tenor of dated securities can be up to 30 years.
The Public Debt Office (PDO) of the Reserve Bank of India acts as the registry / depository of
Government securities and deals with the issue, interest payment and repayment of principal at maturity.
Most of the dated securities are fixed coupon securities.

The nomenclature of a typical dated fixed coupon Government security contains the following features - coupon,
name of the issuer, maturity and face value. For example, 7.49% GS 2017 would mean:
Coupon
Name of Issuer
Date of Issue
Maturity
Coupon Payment Dates
Minimum Amount of issue/ sale

7.49% paid on face value

Government of India
April 16, 2007
April 16, 2017
Half-yearly (October 16 and April 16) every year
Rs.10,000

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Debt Market

Treasury Bills: Treasury bills (T-bills) are money market instruments, i.e., short-term debt
instruments issued by the Government of India, and are issued in three tenors91 days, 182
days, and 364 days. The T-bills are zero coupon securities and pay no interest. They are issued at
a discount and are redeemed at face value on maturity.
Treasury bills are zero coupon securities and pay no interest. They are issued at a discount and
redeemed at the face value at maturity. For example, a 91 day Treasury bill of Rs.100/- (face
value) may be issued at say Rs. 98.20, that is, at a discount of say, Rs.1.80 and would be
redeemed at the face value of Rs.100/-. The return to the investors is the difference between the
maturity value or the face value (that is Rs.100) and the issue price. The Reserve Bank of India
conducts auctions usually every Wednesday to issue T-bills. Payments for the T-bills purchased
are made on the following Friday. The 91 day T-bills are auctioned on every Wednesday. The
Treasury bills of 182 days and 364 days tenure are auctioned on alternate Wednesdays. T-bills of
of 364 days tenure are auctioned on the Wednesday preceding the reporting Friday while 182 Tbills are auctioned on the Wednesday prior to a non-reporting Fridays. The Reserve Bank
releases an annual calendar of T-bill issuances for a financial year in the last week of March of
the previous financial year. The Reserve Bank of India announces the issue details of T-bills
through a press release every week.

Fixed Rate Bonds: These are bonds on which the coupon rate is fixed for the entire life of the
bond. Most government bonds are issued as fixed rate bonds. In finance, a fixed rate bond is a
type of debt
instrument bond with a fixed coupon (interest) rate, as opposed to a floating rate
note. A fixed rate bond is a long term debt paper that carries a predetermined interest rate. The
interest rate is known as coupon rate and interest is payable at specified dates before bond
maturity. Due to the fixed coupon, the market value of a fixed-rate bond is susceptible to
fluctuations in interest rates, and therefore has a significant amount of interest rate risk. That
being said, the fixed-rate bond, although a conservative investment, is highly susceptible to a loss
in value due to inflation. The fixed-rate bonds long maturity schedule and predetermined coupon
rate offers an investor a solidified return, while leaving the individual exposed to a rise in the
consumer price index and overall decrease in their purchasing power.
The coupon rate attached to the fixed-rate bond is payable at specified dates before the bond
reaches maturity; the coupon rate and the fixed-payments are delivered periodically to the
investor at a percentage rate of the bonds face value. Due to a fixed-rate bonds lengthy maturity
date, these payments are typically small and as stated before are not tied into interest rates.
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Debt Market

For example 8.24%GS2018 was issued on April 22, 2008 for a tenor of 10 years maturing on
April 22, 2018. Coupon on this security will be paid half-yearly at 4.12% (half yearly payment
being the half of the annual coupon of 8.24%) of the face value on October 22 and April 22 of
each year.

Floating Rate Bonds: Floating rate bonds are securities that do not have a fixed coupon rate. The
coupon is re-set at pre-announced intervals (say, every 6 months, or 1 year) by adding a spread
over a base rate. In the case of most floating rate bonds issued by the Government of India so far,
the base rate is the weighted average cut-off yield of the last three 364-day Treasury bill auctions

preceding the coupon re-set date, and the spread is decided through the auction.
For example, a Floating Rate Bond was issued on July 2, 2002 for a tenor of 15 years, thus
maturing on July 2, 2017. The base rate on the bond for the coupon payments was fixed at 6.50%
being the weighted average rate of implicit yield on 364-day Treasury Bills during the preceding
six auctions. In the bond auction, a cut-off spread (markup over the benchmark rate) of 34 basis
points (0.34%) was decided. Hence the coupon for the first six months was fixed at 6.84%

Zero Coupon Bonds: Zero coupon bonds are with no coupon payments. Like T-Bills, they are
issued at a discount to the face value. The Government of India issued such securities in the 90s;
it has not issued zero coupon bonds after that. Zero-coupon bonds may not reach maturity for
decades, so it is important to make sure that any bonds purchased have been issued by
creditworthy entities. Some of them are issued with provisions that permit them to be paid out
(called)

before

maturity.

Also, the bonds' daily prices fluctuate on the open markets, so investors who sell them prior to
maturity may receive more or less money than they originally paid for the bonds. Of course, if
held until maturity, the payout will be predetermined and does not change.

Certificate of Deposit: The term Certificate of Deposit or CD refers to money market instruments
of relatively short duration or savings accounts that pay a fixed rate of interest until a given
maturity date. Also, funds placed in a Certificate of Deposit usually cannot be withdrawn prior to
maturity or they can perhaps only be withdrawn with advanced notice and/or by having a penalty

assessed
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. Commercial Paper in India is a new
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Debt Market

addition to short-term instruments in Indian Money market since 1990 onward. The introduction
of Commercial paper as the short-term monetary instrument was the beginning of a reform in
Indian Money market on the background of trend of Liberalization which began in the world
economy during 1985 to 1990. A commercial paper in India is the monetary instrument issued in
the form of promissory note.[1] It acts as the debt instrument to be used by

large corporate

companies for borrowing short-term monetary funds in the money market. An introduction of
Commercial Paper in Indian money market is an innovation in the Financial system of India.
Prior to injection of Commercial Paper in Indian money market i.e. before 1990, the corporate
companies had to depend upon the crude and traditional method of borrowing working capital
from the commercial banks by pledging the inventory of raw materials asCollateral security. It
involved more loss of time for the borrowing companies in availing the short-term funds for dayto-day production activities. The commercial paper has become effective instrument for these
corporate companies to avail the short-term funds from the money market within shortest
possible time limit by avoiding the hassles of direct negotiation with the commercial banks for
availing the short-term loans.

Debentures/Corporate Debt: Sec.2 (12) of Indian Companies Act, 1956 defines debenture as

"debenture includes debenture stock bonds and any other securities of a company, whether

constituting a charge on the assets of the company or not.

PSU Bonds: PSU bonds are medium and long term obligations issued by public sector
companies where the Government shareholding is 51% and more. Most of PSU bonds are in
form of promissory notes transferable by endorsement and delivery. No stamp duty or transfer
deed is required at the time of transfer of bonds transferable by endorsement.

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Debt Market

Security-wise Distribution of Turnover (20102011)

Treasury Bills; 18%

Government
Securities; 54%
PSU/Institutional Bonds;
20%
Others; 8%

Source: NSE-WDM Segment.

3.3-PARCIPANTS IN DEBT MARKETS

Debt markets are pre-dominantly wholesale markets, with dominant institutional investor
participation. The investors in the debt markets concentrate in banks, financial institutions, mutual funds,
provident funds, insurance companies and corporates. Many of these participants are also issuers of debt
instruments.
The market participants in the debt market are:

Central Governments, raising money through bond issuances, to fund budgetary deficits and

other short and long term funding requirements.

Reserve Bank of India, as investment banker to the government, raises funds for the
government through bond and T-bill issues, and also participates in the market through open-

market operations, in the course of conduct of monetary policy.

Primary dealers, who are market intermediaries appointed by the Reserve Bank of India who
underwrite and make market in government securities, and have access to the call markets and

repo markets for funds.

State Governments, municipalities and local bodies, which issue securities in the debt markets

to fund their developmental projects, as well as to finance their budgetary deficits.

Public sector units are large issuers of debt securities, for raising funds to meet the long term
and working capital needs. These corporations are also investors in bonds issued in the debt
markets.
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Debt Market

Corporate treasuries issue short and long term paper to meet the financial requirements of the

corporate sector. They are also investors in debt securities issued in the market.
Public sector financial institutions regularly access debt markets with bonds for funding their
financing requirements and working capital needs. They also invest in bonds issued by other

entities in the debt markets.

Banks are the largest investors in the debt markets, particularly the Treasury bond and bill
markets. They have a statutory requirement to hold a certain percentage of their deposits
(currently the mandatory requirement is 25% of deposits) in approved securities (all government
bonds qualify) to satisfy the statutory liquidity requirements. Thus Bank Fixed Deposit
investments are indirect way of investing in Debt markets. They are arrangers of commercial
paper issues of corporates. They are also active in the inter-bank term markets and repo markets

for their short term funding requirements. Banks also issue CDs and bonds in the debt markets.
Mutual funds have emerged as another important player in the debt markets, owing primarily to
the growing number of bond funds that have mobilised significant amounts from the investors.
Most mutual funds also have specialised bond funds such as gilt funds and liquid funds. Mutual
funds are not permitted to borrow funds, except for very short-term liquidity requirements.
Therefore, they participate in the debt markets pre-dominantly as investors, and trade on their

portfolios quite regularly.

Foreign Institutional Investors are permitted to invest in Dated Government Securities and

Treasury Bills within certain specified limits.

Provident funds are large investors in the bond markets, as the prudential regulations governing
the deployment of the funds they mobilise, mandate investments pre-dominantly in treasury and

PSU bonds. Thus provident fund investments are indirect way of investing in Debt markets.
Charitable Institutions, Trusts and Societies are also large investors in the debt markets. They
are, however, governed by their rules and byelaws with respect to the kind of bonds they can buy
and the manner in which they can trade on their debt portfolios.

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Debt Market

Participant-wise Distribution of Turnover (20102011)

Indian Banks; 13%

Fis, MFs & Corporates; 2%

Trading Members; 54%

Foreign Banks; 27%
Primary Dealers; 4%

Source: NSE-WDM Segment.

3.4-REGULATORS OF DEBT MARKET

The Securities Contracts Regulation Act (SCRA) defines the regulatory role of various regulators
in the securities market. Accordingly, with its powers to regulate the money and Government securities
market, the RBI regulates the money market segment of the debt products (CPs, CDs) and the
Government securities market. The non Government bond market is regulated by the SEBI. It regulates
the manner in which money is raised and to ensure a fair play for the retail investor. It forces the issuer
to make the retail investor aware of the risks inherent in the investment and its disclosure norms The
SEBI also regulates the stock exchanges and hence the regulatory overlap in regulating transactions in
Government securities on stock exchanges have to be dealt with by both the regulators (RBI and SEBI)
through mutual cooperation. In any case, High Level Co-ordination Committee on Financial and Capital
Markets (HLCCFCM), constituted in 1999 with the Governor of the RBI as Chairman, and the Chiefs of
the securities market and insurance regulators, and the Secretary of the Finance Ministry as the
members, is addressing regulatory gaps and overlaps.

3.5-FINANCIAL SERVICES IN DEBT MARKETS

Credit Rating: A credit rating evaluates the credit worthiness of a debtor, especially a
business (company) or a government. It is an evaluation made by a credit rating agency of the
debtor's ability to pay back the debt and the likelihood of default.
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Debt Market

Credit ratings are determined by credit ratings agencies. The credit rating represents the credit
rating agency's evaluation of qualitative and quantitative information for a company or
government; including non-public information obtained by the credit rating agencies analysts.
Credit ratings are not based on mathematical formulas. Instead, credit rating agencies use their
judgment and experience in determining what public and private information should be
considered in giving a rating to a particular company or government. The credit rating is used by
individuals and entities that purchase the bonds issued by companies and governments to
determine the likelihood that the government will pay its bond obligations.
A poor credit rating indicates a credit rating agency's opinion that the company or government
has a high risk of defaulting, based on the agency's analysis of the entity's history and analysis of
long term economic prospects.
The credit rating agencies in India are CRISIL Ltd, Fitch Ratings India, ICRA Ltd, Credit
Analysis and Research (CARE) Ltd, SME Rating Agency of India(SMERA).
Debt Syndication: Debt syndication is an arrangement made between two or more
banks/financial institutions to provide the borrower a credit facility using common debt
documents. Debt syndication is the process of dispensing the money advanced in, generally a
large loan, to a number of enterprises or investors. It is general to use debt syndication when the
loan required, in order to fund a company or set aside a company from bankruptcy.
By employing debt syndication, several banks, investment firms or other companies share both
the profits and the risk of making a large loan. A decline in the number of available lenders has
complicated debt syndication. While banks are regularly the primary lenders, they can be
involved in deals with less outlay, thus reducing their risk.
Banks are likely to employ debt syndication, because they are more watchful about taking on
more risky investments. In fact banks may advance little money but act more as the principals in
arranging a deal between several investors. Banks frequently do not underwrite the entire loan,

since this would mean they would be advancing all initial risk for a large deal.
Investment Banking: An investment bank is a financial institution that assists individuals,
corporations and governments in raising capital by underwriting and/or acting as the client's
agent in the issuance of securities. Investment Banks may also provide ancillary services such

as market making, trading of fixed income instruments.

Debt Broking: A broker acts as an agent or intermediary for a buyer and a seller. The buyer,
seller, and broker may all be individuals, or one or more may be a business or other institution.
Broker is paid a commission for executing client orders on behalf of the clients. A floor
broker executes orders on the floor of the exchange, an upstairs broker handles retail customers
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Debt Market

and their orders. Broker is a person who acts as an intermediary between a buyer and seller,
usually charging a commission. A "broker" specializes in stocks, bonds, commodities,
or options acts

as

an agent and

must

be registered with

the

exchange

where

the securities are traded.

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Debt Market

CHAPTER 4
FEATURES AND RISKS OF FIXED INCOME SECURITIES
4.1-FEATURES

Maturity: Maturity of a fixed income security(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. Term to maturity, on the other hand, refers to the number of years remaining for the bond to
mature. Term to maturity of a bond changes every day, from the date of issue of the bond until its
maturity. 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. There is no
rigid classification of bonds on the basis of their term to maturity. 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.
Coupon Rate: 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. MIBOR+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.

Par Value: 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 coupons, until maturity, when the
bond will be redeemed.

4.2-RISKS

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Debt Market

As an integral part of a well-balanced and diversified portfolio, fixed income securities afford
opportunities for predictable cash flows to match investors individual needs, provide capital
preservation and may offset the volatility of the stock market. However, all investments have some
degree of risk. Some of the most common risks associated with fixed income securities.
Interest Rate Risk: The market value of the securities will be inversely affected by movements
in interest rates. When rates rise, market prices of existing debt securities fall as these securities
become less attractive to investors when compared to higher coupon new issues. As prices
decline, bonds become cheaper so the overall return, when taking into account the discount, can
compete with newly issued bonds at higher yields. When interest rates fall, market prices on
existing fixed income securities tend to rise because these bonds become more attractive when

compared to the newly issued bonds priced at lower rates.

Price Risk: Investors who need access to their principal prior to maturity have to rely on the
secondary market to sell their securities. The price received may be more or less than the original
purchase price and may depend, in general, on the level of interest rates, time to term, credit
quality of the issuer and liquidity. Among other reasons, prices may also be affected by current
market conditions, or by the size of the trade (prices may be different for 10 bonds versus 1,000
bonds), etc. It is important to note that selling a security prior to maturity may affect actual yield
received, which may be different than the yield at which the bond was originally purchased. This

is because the initially quoted yield assumed holding the bond to term.
Liquidity Risk: Liquidity risk is the risk that an investor will be unable to sell securities due to a
lack of demand from potential buyers, sell them at a substantial loss and/or incur substantial
transaction costs in the sale process. Broker/dealers, although not obligated to do so, may

provide secondary markets.

Reinvestment Risk: Downward trends in interest rates also create reinvestment risk, or the risk
that the income and/or principal repayments will have to be invested at lower rates.
Reinvestment risk is an important consideration for investors in callable securities. This
generally happens if the market rates fall low enough for the issuer to save money by repaying
existing higher coupon bonds and issuing new ones at lower rates. Investors will stop receiving

the coupon payments if the bonds are called.

Prepayment Risk: Similar to call risk, prepayment risk is the risk that the issuer may repay
bonds prior to maturity. This type of risk is generally associated with mortgage-backed securities.
Homeowners tend to prepay their mortgages at times that are advantageous to their needs, which
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Debt Market

may be in conflict with the holders of the mortgage-backed securities. If the bonds are repaid

early, investors face the risk of reinvesting at lower rates.

Purchasing Power Risk: Fixed income investors often focus on the real rate of return, or the
actual return minus the rate of inflation. Rising inflation has a negative impact on real rates of

return because inflation reduces the purchasing power of the investment income and principal.
Credit Risk: The safety of the fixed income investors principal depends on the issuers credit
quality and ability to meet its financial obligations, such as payment of coupon and repayment of
principal at maturity. Rating agencies assign ratings based on their analysis of the issuers
financial condition, economic and debt characteristics, and specific revenue sources securing the
bond. Issuers with lower credit ratings usually have to offer investors higher yields to
compensate for additional credit risk. A change in either the issuers credit rating or the markets
perception of the issuers business prospects will affect the value of its outstanding securities.

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Debt Market

CHAPTER 5
REASEARCH ANALYSIS
1) Do you invest in Fixed Income Securities?

% of Respondents

Yes; 100%

Interpretation:
We have 50 respondents.
All the respondents we came across had some of their investments providing them fixed
incomes.

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Debt Market

2) Gender:

% of Respondents

Female; 40%
Male; 60%

Interpretation:
Generally, in India, still, male take investment decisions for the investible surplus of the
family and household.

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Debt Market

3) Age Group

% of Respondents

Above 50; 10%

35-50; 17%

18-35; 73%

4) Annual Income

% of Respondents

Above 12lacs; 6%
6-12lacs; 20%
Below 3lacs; 44%

3-6lacs; 30%

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Debt Market

5) Objectives of Investment

% of Respondents

Liquidity; 14%
Yield; 36%

Security; 50%

Interpretation:
This clearly explains that people are primarily interested in security of their capital, then the
yield(returns), i.e., the appreciation to capital and lastly in the liquidity(marketability) of the
security.

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Debt Market

6) Benchmark Returns Expected

% of Respondents

Inflation Rate; 28%

Current Interest Rate; 51%
Sensex; 21%

Interpretation:
More than half of the investors are satisfied with the current interest rate; whilst one quarter
expect Inflation rate to be recovered by the investments and the remaining expect the returns that
SENSEX offers.

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Debt Market

7) Instruments invested in

% of Respondents

Others; 6%
Corporate Debentures; 5%
Corporate FDs; 6%
Bank FDs; 40%
Government Bonds/Debt; 6%
Employee Provident Fund; 9%
Public Provident Fund; 16%
Post Office FDs; 12%

Interpretation:
From the above analysis we recover that people mainly invest in the safest and easily accessible
instruments that provide them with fixed incomes and their principal on maturity.

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Debt Market

8) Proportion of Investment in Fixed Income Securities:

% of respondents

Above 50%; 18%

Below 25%; 52%

25-50%; 30%

Interpretation:
Half of the people we came across have a very small part of their investments, i.e., less than
25% in Fixed Income Securities; and very less (18%) have more than 50% of their
investments in Fixed Income Securities.

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Debt Market

9) Do you think the Fixed Income Markets will develop?

% of Respondents

No; 14%

Yes; 86%

Interpretation:
People in general are of the opinion that the Indian Fixed Income Markets will develop.

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Debt Market

10) FALLING RUPEE HURTS DEBT MARKET: The falling rupee might continue to keep foreign
investors away from Indian debt in the near future. In the past month, these investors sold debt of Rs
18,345 crore ($3.19 billion) and the trend is likely to continue until the rupee shows stability. It has
plunged 7.1 per cent in the past month and is near its all-time (intra-day) low of Rs 58.99.
As compared to debt, equities have witnessed lower selling pressure. Foreign investors have sold equity
of only Rs 1,374 crore in June. Global uncertainties have seen them taking a breather from buying
Indian equities lately and lack of buying from domestic institutions has resulted in lacklustre markets.
Foriegn institutional investors (FIIs) are said to be taking a wait and watch approach, looking for cues
from
the
Fed's
meeting
tomorrow.
But it's the redemptions in the debt segment that has the government worried. Bond experts say the
biggest factor which has driven away foreign investors has been the volatile rupee. The cost of holding
domestic bonds has increased, as foreign investors pay more towards higher hedging due to the rising
foreign exchange risk. Foreign investors also see payouts from their Indian domestic holdings shrink
when
the
rupee
falls.
Indian debt yields are higher than in other emerging markets but the high returns might not be attractive
enough against a falling rupee. Says Kaustubh Kulkarni, head of local currency debt, Standard Chartered
India: The current market dislocation is temporary and is happening due to volatility in the forex
market. The rupee movement can significantly dent a bond investor's profit.
Emerging market bonds have seen sharp redemptions of about $4.5 billion in the past month as investors
worry the liquidity provided by the US Fed through its quantitative easing could taper off. Treasury
yields in the US have increased, sparking a further exodus from emerging markets. The difference in
yields between the US 10-year Treasury and the Indian 10-year G-sec has reduced from 5.46 per cent to
5.09
per
cent
in
the
past
month.
This has led to foreign investors rebalancing their debt portfolios towards developed markets. They were
also sitting on large bond gains due to the cut in interest rates in domestic markets. Says Kulkarni:
Foreign investors had made a decent amount of profit on the corporate bond front and this is why they
rebalanced. It's a relative value play that bond investors are looking at, after seeing forward yields and
local
bond
yields.
India's debt market share is less than five per cent of emerging markets debt; the impact of selling
Indian debt in the local market has hardly affected yields.

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Debt Market

As prices of bonds fall on heavy selling,

yields rise but since the past month, yields
have increased only marginally to 7.27 per
cent (from 7.11 per cent in May). Says
Neelkanth Mishra, India equity strategist,
Credit Suisse: India does not have a large
share of emerging market debt allocations
and is not benchmarked in emerging
market indices. Therefore, the impact in
India
has
been
less.

economies

if

it

offers

higher

yields

Experts reckon that many of these same

investors who have been selling would reexamine India as among the major
than
other
emerging-market
countries.

The Reserve Bank of India (RBI) is also largely expected to cut rates going forward, though it paused on
this in the latest credit policy. RBI was among the few central banks which had continued raising rates
when other emerging market countries, such as Brazil, were cutting these.
In its latest credit policy statement, RBI said: It is only a durable receding of inflation that will open up
the space for monetary policy to continue to address risks to growth. Analysts expect inflation to ease
due to lower commodity prices and, in the second half, expect RBI to cut rates by a further 50 basis
points.
The expected rate cut could attract foreign buyers, as they gain from rising bond prices. But for that to
happen, the rupee has to stabilise. Says Kulkarni: If the rupee stabilises, I don't see why foreigners
shouldn't be back in Indian bonds.

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Debt Market

11)What are the chief impediments to growth of Fixed Income Markets?

Lack of Public awareness is one of the major obstacle to growth.

The policies and regulations dont seem proper. RBI should control more stringently.
The Government of India is dependent on Inflation Rate. So public is not taking risk and is

investing where they generate Income plus Tax Benefit.

The interest rates and the fluctuations in it, and the liquidity aspects create uncertainty.
The interest rates are not able to beat inflation. Hence, inflation is posing a threat to growth and

investments.
The volatility in financial markets and the need to provide an anchor to investors against such

volatility.
Good rated products on less guaranteed returns. The rate of return should be market linked.
Government should come up with more lucrative & investor oriented schemes which is

currently lacking.
People invest more in equities due to high returns-high risks and youngsters are able to take

risks and there also exists Promotion and overdependence on stock market.
Lack of Government support to the market.
Growth of capital market as whole.
Less volume to the market. People dont know the power of Fixed Income Markets.
Financial Education. Subsidies on petrol to be revived for autos/food transport & benefits
transferred to common man. So that spending improves leading to economy revenues.

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Debt Market

CONCLUSION
The investor base has strengthened with the awareness of the need to investing and even creating
portfolios with significant amounts available for investing. Simultaneously, the Fixed Income Market
has grown.
People have started investing in various avenues available hence the proportion of their
investments in Fixed Income Securities is low. But, subsequently the capital markets as a whole has
grown on the basis of the creation of the investor base. The markets are enchasing on policy making and
other investor protection strategies making securities more tradable and liquid in the retail sector than
ever before.
Transparency and easy accessibility to the markets with introduction of financially engineered
instruments has led to volumes in the market. The corporate bond investments have seen a upsurge due
to role of credit rating and other financial services in the Fixed Income Sector.
Still, there is lot to go between a Bank FD and Post Office FD to G-Sec and other Fixed Income
Securities not only primarily in small towns but also in cities. Public awareness, availability of broking
services, reduction in minimum investment caps will bring out the actual potential of the Fixed Income
Market.

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