Bond Markets Some Interesting Features Kandarp mehta Icfaian business school, ahmedabad

Yield Curve of Indian Bonds A plot of the yield (YTM) on various debt instruments against the time to maturity. This is known as the yield curve Under normal circumstances, bonds with longer time to maturity will offer a greater return as there is a far greater element of uncertainty and therefore, risk (high risk-high return) Understanding the forces that shape the yield curve, investors can make qualified decisions in selecting bonds The yield curve’s slope changes as various factors affect the pricing of debt market instruments For example take a yield curve that is flat instead of the normal upward sloping curve. In such a scenario, if you were confident that normalcy would return to the markets, you should sell long-term bonds and buy short-term bonds Source: Debt to Date,SHCIL,Issue no.14

Factors Affecting Yield Curve The monetary policy Economic growth Fiscal Policy inflation fact-sheet India Asian Bond Markets - Some Signals

Monetary Policy Tight Monetary policy Selling of bonds Reduction in price of Bonds Yield Curve steepens Liberal Monetary policy Buying of bonds Increase in price of Bonds Yield Curve Flattens Interest rates also have a negative relationship with the slope of the yield curve

Poor Economic Condition Lower / poor allocation of capital Banks saddled with surplus funds Surplus money diverted to Debt Market Economic Growth Increase in Bond prices / Reduced Yields Sudden increase in Bond Market Turnover which is largely attributable to Value increase should not be perceived is revival of Economy. It may be a “False-Boom”.

Fiscal Policy Higher Fiscal Deficit Higher interest rates Steep yield curve Lower Fiscal Deficit Lower interest rates Flat yield curve Precarious Financial Situation Short Term Rates > Long Term rates Steep and negatively sloped yield curve Improving Economic Situation Short Term Rates < Long Term rates Positively sloped yield curve (Degree of slope will depend upon intensity of expectations)

Inflation Inflation affects both the long term and the short term yields. Increase in inflation Real Rate of Return declines Expected yield goes up to cover up the decline Yield curve will be flattened

Fact sheet India Poor run at equity markets made debt markets more attractive. However, it remains to be seen whether the demand is more of short-term instrument or for long-term instruments.

Fact sheet - India (Contd…) Gross fiscal deficit (Q1 - FY 02) - Rs 422 bn Gross fiscal deficit (Q1 - FY 01) - Rs 251 bn (68% increase) Reason for the increase over 40% drop in revenue receipts - caused by a 54% dip in corporate tax collections - which was on account of lower earnings by the corporate This clearly points to the slowing economy. Also, the actual expenditure of the government at Rs 651 bn was higher by 14% compared to 1QFY01

Fact sheet - India (contd..) Try to make inferences from the data given below

Asian Bond Markets

Crisis Barometer

The Last Word... “For creation of a stable, strong and liquid Bond market, it is essential for any country to construct a reliable and stable Yield Curve”. –Robert Becker (McKinsey)