what is the debt market? l the debt market is the market where fixed income securities of various...

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