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What is the Debt Market?What is the 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. (www.besindia.com,FAQ)
ROLE OF A HEALTHY CORPORATE DEBT
For the issuer: low cost funds Alternative means of raising
debt For the investor: portfolio
diversification Efficient pricing of credit
risk
Definition of a Bond
A bond is a security that obligates the issuer to make specified interest and principal payments to the holder on specified dates. Coupon rate Face value (or par) Maturity (or term)
Bonds are sometimes called fixed income securities.
Types of Bonds
Pure Discount or Zero-Coupon Bonds Pay no coupons prior to maturity. Pay the bond’s face value at maturity.
Coupon Bonds Pay a stated coupon at periodic intervals prior to maturity. Pay the bond’s face value at maturity.
Perpetual Bonds (Consols) No maturity date. Pay a stated coupon at periodic intervals.
Bond Issuers
Government Financial Institutions Countries Corporations
Government Bonds
Treasury Bills (Gilts) No coupons (zero coupon security) Face value paid at maturity Maturities up to one year
Treasury Notes Coupons paid semiannually Face value paid at maturity Maturities from 2-10 years
Government Bonds
Treasury Bonds Coupons paid semiannually Face value paid at maturity Maturities over 10 years The 30-year bond is called the long bond.
Government Bonds
No default risk. Considered to be riskfree. Exempt from state and local taxes. Sold regularly through a network of primary dealers. Traded regularly in the over-the-counter market.
Corporate Bonds
Secured Bonds (Asset-Backed) Secured by real property Ownership of the property reverts to the bondholders upon
default.
Common Features of Corporate Bonds
Convertible bonds Callable bonds Sinking funds
Bond Ratings
Moody’s S&P Quality of Issue
Aaa AAA Highest quality. Very small risk of default.
Aa AA High quality. Small risk of default.
A A High-Medium quality. Strong attributes, but potentiallyvulnerable.
Baa BBB Medium quality. Currently adequate, but potentiallyunreliable.
Ba BB Some speculative element. Long-run prospectsquestionable.
B B Able to pay currently, but at risk of default in thefuture.
Caa CCC Poor quality. Clear danger of default .
Ca CC High specullative quality. May be in default.
C C Lowest rated. Poor prospects of repayment.
D - In default.
Valuing Zero Coupon Bonds
What is the current market price of a U.S. Bond that matures in exactly 5 years and has a face value of £1,000. The yield to maturity is rd=7.5%.
1000
1075565
.£696.
Bond Yields and PricesThe case of zero coupon bonds
Consider three zero-coupon bonds, all with » face value of F=100» yield to maturity of r=10%, compounded annually.
We obtain the following table:
Bond 1 Bond 2 Bond 3Time / Bond value 10% $90.91 $75.13 $62.09
1 100 0 02 0 03 100 04 05 100
Suppose the yield would drop suddenly to 9%, or increase to 10%. How would prices respond?
Bond prices move up if the yield drops, decrease if yield rises Prices respond more strongly for higher maturities
The Impact of Price Responses
Yield Bond 1 Bond 2 Bond 31 Year 3 Year 5 Year
10% $90.91 $75.13 $62.099% $91.74 $77.22 $64.99
% change 0.91% 2.70% 4.46%11% $90.09 $73.12 $59.35
% change -0.91% -2.75% -4.63%
Relationship Between Bond Prices and Yields
Bond prices are inversely related to interest rates (or yields). A bond sells at par only if its coupon rate equals the coupon
rate A bond sells at a premium if its coupon is above the coupon
rate. A bond sells a a discount if its coupon is below the coupon
rate.
Bond Prices and Yields
Bond Price
F
c Yield
Longer term bonds are moresensitive to changes in interestrates than shorter term bonds.
DEBT MARKET IN INDIADEBT MARKET IN INDIADEBT MARKET
IN INDIA
GovernmentSecurities Market
Corporate Debt Market
Market for PSU Bonds
Private Sector
Bonds
Main features of the Indian Main features of the Indian corporate debt marketcorporate debt market
Relative size and importance
Private placements Preference for rated paper
Reasons for Dominance of Reasons for Dominance of Private PlacementPrivate Placement
The dominance of private placement in total issuances is attributable to the following factors:
Tailor made deals mandatory lengthy issuance procedure
for public issues the information disclosure
requirements, listing of bonds on stock exchange was
not required. lower issuance costs.
Structure of corporate Structure of corporate debt market in indiadebt market in india
Market Micro Structure
Primary Corporate Debt Primary Corporate Debt MarketMarket
Market structure consists of :Market structure consists of : Issuers,Issuers, Instruments,Instruments, Processes, Processes, Investors, Investors, Rating agencies ,Rating agencies , Regulatory environment. Regulatory environment.
IssuersIssuers Indian Debt Market has almost all possible variety of
issuers as is the case in many developed markets:- Large private sector corporate Public sector undertakings (union as well as
state) Financial institutions Banks Medium and small companies. Thus the spectrum appears to be complete.
Instruments Instruments
Till recently - plain vanilla bonds . Now- They include:
Partly convertible debentures (PCDs), Fully convertible debentures (FCDs), Deep discount bonds (DDBs), Zero coupon bonds (ZCBs), Bonds with warrants, Floating rate notes (FRNs) Bonds and secured premium notes (SPNs).
Important noteImportant note
The coupon rates mostly depend on tenure and credit rating. However, these may not be strictly correlated in all cases. The maturities of bonds generally vary in between one year to ten years. However, the median could be around four to five years. The maturity period by and large depends on outlook on interest rates. In expectation of falling interest rates environment, corporate, it is observed, mostly go to shorter term instruments while the opposite is true in case of possible hike in interest rates. For the past few years interest rates have been falling and short end issues are on the rise. This is one of the reasons that many corporate are reluctant to go for public issue route and listing of their securities.
Investors Investors
INDIA Diverse number of sophisticated/
institutional investors are required. Institutional Investors in India are
few in number and the variety also is limited .
Banks and financial institutions, by and large, do not take active interest in Corporate Debt Market
Rating agenciesRating agencies
India has a well developed Credit Rating Agency system and rating agencies are well experienced and regarded. By and large, their ratings do carry confidence in the market.
Structural Weaknesses in Structural Weaknesses in primary marketprimary market
Lack of large and diverse investors
Lack of dedicated intermediaries (Bond Manager)
Heavy tilt towards private placement
Secondary Corporate Debt Secondary Corporate Debt MarketMarket
Trading Platform
Clearing and Settlement Mechanism Instruments traded on WDM Investors in WDM Regulatory Environment
Continuous Automated Market
Negotiated Market
Trading PlatformTrading Platform
OTC – Bilateral Agreements
Stock exchange :- Stock exchange :- brokersbrokers
INDIAINDIA
NSE
WDM
TRADING SYSTEM
NEAT
Fully automated Screen Based Trading System
Trade simultaneously
Easy, efficient
Order driven system
Best buy
Best sell
Continuous Automated Continuous Automated MarketMarket
Buy Orders Sell OrdersMatching
NEAT-WDM system
participants can set up their counter-party exposure limits against all probable counter-parties
reduce/minimize the counter-party risk associated with the counter-party to trade
A trade does not take place if both the buy/sell participants do not invoke the counter-party exposure limit in the trading system.
Negotiated Market:Negotiated Market:
Trades are normally decided by the seller and the buyer Deals structured outside Deals disclosed to the market through NEAT-WDM
system. Buyers and sellers know each other No counter-party exposure limit needs to be invoked
Clearing and Settlement Clearing and Settlement MechanismMechanism
Participants
Exchange
Trades are settled gross Settlement is on a rolling basis Settlement periods- ranging from same
day (T+0) to a maximum of (T+2).
Primary responsibility
Monitor
Settlement
Settlement
Instruments traded on WDMInstruments traded on WDM
Government securities,Treasury Bills, Bonds
Issued by PSU’s/ corporate/ banks like Floating Rate Bonds, Zero Coupon Bonds, Commercial Paper, Certificate of Deposit, corporate debentures, State Government loans, SLR and Non-SLR bonds issued by financial institutions, units of mutual Funds and securitized debt by banks, financial institutions, corporate bodies, trusts and others.
Investors in WDMInvestors in WDM
Large investors and a high average trade value characterize this segment .
Till recently- purely informal market After WDM- Transparent Efficient Monitoring and surveillance
Regulatory EnvironmentRegulatory Environment
Regulations of SEBI Manner in which such moneys are raised fair play Make the retail investor aware of the risks
inherent in the investment Disclosure and Investor Protection (DIP)
Guidelines
BUSINESS GROWTH ON THE WDM SEGMENT
0.00
200000.00
400000.00
600000.00
800000.00
1000000.00
1200000.00
1400000.00
year
Rs.
(crs
)
Net traded value(Rs. Cr.)
Number of trades
Structural Weaknesses in Structural Weaknesses in secondary marketsecondary market
Absence of Clearing Corporation. Dedicated trading platform. Exclusive, well capitalized and
professional intermediaries. Lack of reliable and up to date information.
Reason for underdeveloped Reason for underdeveloped corporate debt marketcorporate debt market
Poor Quality Paper Inadequate liquidity Debt Versus equity : Cost and risks Incomplete access to information Interest rate structure Narrow investor base Lack of transparency in trades, Comprehensive regulatory
framework Lack of Debt Derivative Products Lack of Product Standardisation
Corporate debt market in India
Features
Less developed than Equity markets contrary to world markets
Liquidity mainly in Govt. securities and highly rated corporate papers (AAA and AA)
Primarily an over the counter (OTC) Market
Debt and equity markets in the World
BIBLIOGRAPHYBIBLIOGRAPHY
Working Paper No. 9 Corporate Debt Market in India: Key Issues and Some Policy Recommendations
www.bseindia.com www.bis.org/publ/bppdf/bispap26m.pdf www.rbi.org.in, reports, VII. Equity And Corporate
Debt Market