DEBT MARKETS1

2 INTRODUCTION What is a debt market? A part of the capital market A place where trading in Debt Instruments takes place Is also known as a ‘fixed income market as debt instruments pay fixed returns Impact of the debt market on the economy? Opportunity for investors to diversify their investment portfolio Improved transparency because of stringent disclosure norms and auditing requirements Less risk compared to the equity markets. This leads to inflow of funds in the economy Increased funds for implementation of government development plans. The government can raise funds at lower costs by issuing government securities

THE STRUCTURE OF INDIAN DEBT MARKET DEBT MARKETS3

4 Platform’s For Debt Market Primary Debt Market Secondary Debt Market Issuer’s Instruments Investors Rating agencies Trading Platform Clearing and Settlement Mechanism Instrument’s Investor’s

REGULATION’S FOR DEBT MARKET SARFAESI Act,2002 Securities and Exchange Board of India,1992. Companies Act, 1956 Securities Contracts (Regulation) Act, 1956 Depositories Act, 1996 Fixed-Income and Money Market Dealers’ Association DEBT MARKETS5

MARKET PARTICIPANTS IN THE DEBT MARKET Central Governments Reserve Bank of India Primary Dealers State Governments Public Sector Units Corporate treasuries Public Sector Financial Institutions Banks Foreign Institutional Investors Charitable Institutions, Trusts and Societies DEBT MARKETS6

7 DEBT INSTRUMENTS

DEBT MARKETS8 SHORT TERM INSTRUMENTS Treasury Bills Fixed deposit Certificates of Deposits Commercial Paper Bills Rediscounting schemes LONG TERM INSTRUMENTS Government of India dated securities (GOISECs) Inflation linked bonds Zero coupon bonds State government securities (state loans) Public Sector Undertaking Bonds (PSU Bonds) Corporate debentures Bonds of Public Financial Institutions (PFIs)

TREASURY BILLS Promissory notes of the central government and therefore qualify as being free of credit risks Issued to meet short term funding requirements of the government account with Reserve Bank Sale is by auction. Any individual, corporate, bank, primary dealer or other entity is free to buy T-Bill Denominations of 91, 182 and 364 days CERTIFICATE OF DEPOSIT (CD) Similar to CPs except that the issuer is a bank Minimum amount of a CD can be Rs. 1 lakh and maturity between 7 days and 1 year Financial Institutions can issue CDs only for maturities between 1 and 3 years No premature cancellation of CD is allowed DEBT MARKETS9

COMMERCIAL PAPER (CP) Promissory notes issued by the corporate sector for raising short term funds Sold at a discount to face value Maturity can range between a minimum of 7 days and a maximum of 1 year CPs are required to be rated and the minimum rating eligibility is P2 Every CP issue has an Issuing and Paying Agent (IPA), which has to be a scheduled bank Stamp duty is currently payable on CP issues, depending on the maturity and who the initial buyer is BILLS REDISCOUNTING SCHEME The RBI introduced the Bills Market Scheme (BMS) in 1952 which was later modified into the New Bills Market Scheme (NBMS) Under this scheme commercial banks can rediscount the bills which were originally discounted by them with approved institutions (viz., Commercial Banks, Development Financial Institutions, Mutual Funds, Primary Dealers etc.) DEBT MARKETS10

GOVERNMENT OF INDIA DATED SECURITIES (GOISECS) GOISECs are issued by the Reserve Bank of India on behalf of the Government of India. These form a part of the borrowing program approved by Parliament in the Finance Bill each year (Union Budget) They have maturity ranging from 1 year to 30 years GOISECs are issued through the auction route. The RBI pre specifies an approximate amount of dated securities that it intends to issue through the year INFLATION LINKED BONDS These are bonds for which the coupon payment in a particular period is linked to the inflation rate at that time - the base coupon rate is fixed with the inflation rate. Investors are often loath to invest in longer dated securities due to uncertainty of future interest rates. The idea behind these bonds is to make them attractive to investors by removing the uncertainty of future inflation rates, thereby maintaining the real value of their invested capital. DEBT MARKETS11

ZERO COUPON BONDS These are bonds for which there is no coupon payment. They are issued at a discount to face value with the discount providing the implicit interest payment. STATE GOVERNMENT SECURITIES (STATE LOANS) These are issued by the respective state governments but the RBI coordinates the actual process of selling these securities. Each state is allowed to issue securities up to a certain limit each year. State Government issue such securities to fund their developmental projects and finance their budgetary defictis BONDS OF PUBLIC FINANCIAL INSTITUTIONS (PFIS) Apart from public sector undertakings, Financial Institutions are also allowed to issue bonds, that too in much higher quantum. DEBT MARKETS12

PUBLIC SECTOR UNDERTAKING BONDS (PSU BONDS) These are long term debt instruments issued by Public Sector Undertakings (PSUs). Typically, they have maturities ranging between 5-10 years and they are issued in denominations (face value) of Rs.1,000 each Most of these issues are made on a private placement basis to a targeted investor base at market determined interest rates. CORPORATE DEBENTURES These are long term debt instruments issued by private sector companies. These are issued in denominations as low as Rs.1,000 and have maturities ranging between one and ten years. A key feature that distinguishes debentures from bonds is the stamp duty payment. Debenture stamp duty is a state subject and the quantum of incidence varies from state to state. Transfer stamp duty remains high in many states and is probably the biggest deterrent for trading in debentures resulting in lack of liquidity. DEBT MARKETS13

BOND BASICS & VALUATION OF BONDS Bonds represent loans by investors to a company. BOND TERMINOLOGY Coupon Coupon rate Face (par) value Maturity date Yield YTM DEBT MARKETS14

PROCESS FOR ISSUING BONDS Company sets the maturity date and face value of the bonds Investment bankers set the coupon rate for the bonds Investment bankers find investors for the bonds and issue them in the primary market. Government Securities :- Uniform price Based or Dutch Auction Multiple/variable Price Based or French Auction The bonds become available in the secondary market. NDS – OM and WDM DEBT MARKETS15

Example What is the present value of a bond with a two-year maturity date, a face value of Rs.1,000, and a coupon rate of 6%? The current prevailing rate for similar issues is 5%. Inverse relationship :- As interest rates fall, bond prices rise As interest rates rise, bond prices fall DEBT MARKETS16

Relationship between prices & yield Yields Bond Prices Yields Bond Prices YTM= 10% Coupon = 10% Bond price = Rs100 Flat yield= 10% YTM  = 12% Bond price= Rs83 Flat yield= 12 % Example YTM= 12% Coupon = 10% Bond price = Rs 83 Flat yield= 12% YTM  = 10% Bond price= Rs100 Flat yield= 10 %

Par Coupon rate = Yield to maturity Discount Coupon rate < Yield to maturity Premium Coupon rate > Yield to maturity Price Interest rate relationship

Credit Spread DEBT MARKETS19

RISK ASSOCIATED WITH BONDS Interest rate risk Credit risk Reinvestment risk Sovereign risk Inflation risk DEBT MARKETS20

ADVANTAGES OF DEBT MARKET Assured returns High liquidity Credit rating agencies Flexibility of capital structure Tax deductible

DISADVANTAGES OF DEBT MARKET Less returns when compared to Equity market Not well developed in India. Exposed to interest rate risk. Less liquidity in many issues.

IMPACT ON THE ECONOMY Opportunity for investors to diversify their investment portfolio. Higher liquidity and control over credit. Less risk compared to the equity markets Government can raise funds at lower costs by issuing government securities.

DEBT VS EQUITY Equity :  Time and amount of repayment is uncertain and not fixed.  Repayment is also dependent on the performance of the company.  Returns are higher but also the risk for the investor is higher. DEBT :  Time and amount of repayment is fixed beforehand.  Repayment is not dependent on performance.  Risk is low and so is the returns.

GLOBAL SCENARIO..... At present, the size of the international bond market is about $45 trillion Chinese Bond Market at a growing stage with a turnover of about $40 billion USA, Britain and Euro zone are the leaders

FUTURE ESTIMATION OF INDIAN DEBT MARKET Four-fold increase in the size of India’s overall bond market, from about $400bn today, or around 45% of GDP, to about $1.5 trillion by 2016 in current Dollars, i.e. 55% of GDP at that time. If India were to proceed more aggressively on financial liberalisation, the size of the debt market would grow even faster

ISSUES AND RECOMMENDATIONS Issues :  Lack of sufficient investor base in terms of quantity as well as diversity.  Lack of awareness among investors. Recommendations:  Developing bond managers.  By enlarging number of investors.  Increasing awareness among the investors.

THANK YOU DEBT MARKETS28