Debt Bond Market

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    Presented By:

    Ms Arleen Afonso

    Bond Market

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    Topics to be discussed

    What are bond markets?

    Segmentation of the bond market

    Participants in the bond market

    Instruments traded in the bond market Measures to strengthen market infrastructure

    NDS (Negotiated Dealing System)

    CCIL (Clearing Corporation of India Ltd)

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    Topics to be discussed

    What are bond markets?

    Segmentation of the bond market

    Participants in the bond market

    Instruments traded in the bond market

    Measures to strengthen market infrastructure NDS (Negotiated Dealing System)

    CCIL (Clearing Corporation of India Ltd)

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    Debt Market???

    Debt Market, also known as the fixed income

    securities market.

    The oldest market to have emerged in the world.

    In India, debt markets play a vital role

    as they enable the government and the

    corporate to channelize the nations financial

    resources for the infrastructural, industrial growth

    of the country.

    At the same time, provide investors with a safe

    avenue to invest their funds in.4

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    What are bonds???

    A long-termdebt security issued bycorporations and governments offering fixedinterest payments periodically for a period ofmore than one year.

    Holding a bond does not represent ownership

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    Difference between bonds and

    debentures

    The debt securities issued by the Central and

    State government are known as bonds.

    The debt securities issued by private corporate

    enterprises are known as debentures.

    However, the two terms are often used

    interchangeably.

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    Features of Bonds

    Issue date: The date on which an investor buysthe bond is called the issue date.

    Principal: The amount that the investor invests inthe bond is called the principal amount. It is also

    called as the par value orface value.

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    Features of bonds

    Typically the face value of bonds in the Indian

    bond market is Rs. 100

    The name of the bond signifies the various

    features of the bond.

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    Coupon

    Coupon refers to the periodic interest payments

    made by the issuer of the bond (i.e. the borrower

    of the money) to the subscriber (i.e. the lender).

    The coupons are specified directly as a fixed

    percentage of the principal amount or

    Floating rate

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    Debt Market Segmentation

    Private Corporate Debt Market

    Public sector undertaking bond market

    Government securities market

    Government securities is the principal segment of

    the debt market

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    Participants in the Debt Market

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    Central & State Governments Primary Dealers

    Public Sector Undertakings

    Corporates

    Banks

    Mutual Funds

    Insurance Companies

    FIIs PF (Provident Funds & Pension Funds)

    Charitable Institutions and Trusts

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    Types of Instruments traded in the Debt

    Market

    MarketSegment

    Issuer Instruments

    Government

    Securities

    Central Government Zero Coupon Bonds, Coupon Bearing Bonds,

    Treasury Bills, Floating Rate Bonds, STRIPS,

    Govt. Dated Securities

    State Government Coupon Bearing Bonds, Floating Rate Bonds

    Public Sector

    Bonds

    Government

    Agencies/ Statutory

    Bodies

    Government Guaranteed Bonds, Debentures

    Public Sector Units PSU Bonds, Taxable & Tax-free, Debentures,

    Commercial Paper, Deep Discount Bonds.

    Private

    Sector

    Bonds

    Corporates Debentures, Bonds, Commercial Paper,

    Floating Rate Bonds, Secured Premium

    Notes, Zero Coupon Bonds, Inter- Corporate

    Deposits

    Banks CDs, Debentures, Bonds

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    Zero Coupon Bond

    No coupon payments are made.

    These bonds are issued at a discount to their

    face value.

    The effective return that the investor earns is thedifference between the face value minus the

    discounted value of the bond.

    Also called as a Deep Discount Bond

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    Floating Rate Bonds

    The rate at which coupon is paid changesperiodically.

    It is tied to a benchmark rate like a particularGovernment security.

    A few floating rate bonds also have caps and

    floors.

    These are also called as Range Notes, as theymove within a certain range.

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    Callable & Puttable Bonds

    Callable bonds:

    The issuer can redeem or repay the principal

    amount to the investor before the original maturity

    date

    Also called as bonds embedded with options

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    Advantages to the Issuer

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    Whenever the rates fall below the rate that the

    issuer has offered, the issuer can repay the bond

    and issue a new bond at the lower rates.

    Thus the company has to pay less for the same

    amount of money that it borrows.

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    Disadvantages to the Investor

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    Investor loses an opportunity to stay invested in a

    security that pays higher returns even when the

    rates have dropped.

    The investor is also faced by reinvestment risk.

    The rates offered for the callable bonds areslightly higher that those offered in regular bonds.

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    Puttable bonds:

    The put option gives the investor the right to ask

    for redemption or repayment of the face value

    and retire the bond before the original maturity

    date.

    This option will be exercised by the investor when

    the rates rise above the rates that they are

    offered in the existing bond investment

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    Advantages to the Investor

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    The advantage to the investor is that when the

    rates rise above the rates currently offered to him,he can ask for repayment of the principal and

    reinvest the money in a bond that offers the

    current high rate.

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    Disadvantages to the Issuer

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    The disadvantage to the issuer is that, this willexpose him to re-pricing risk.

    The issuer will now have to re-issue the bond,

    offering a higher coupon rate. To compensate the issuer for this, rate offered by

    the issuer for puttable bonds are lower thanregular bonds.

    The Central Government has issued a bond withembedded option of both the call and put.

    This gives both the government and thebondholder the right to retire the bond.

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    Convertible BondsA convertible option provides the investor with an

    option to convert the outstanding bond into equityof the company

    The number of shares allotted i.e. the conversionratio and the conversion price to be applied isspecified in the indentures (the terms andconditions) of the bond in the beginning

    Fully convertible bonds

    Partially convertible bonds

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    Secured Premium Notes

    SPN is a secured debenture redeemable at premium

    issued along with a detachable warrant

    Redeemable after a notice period of 4-7years

    The warrants attached to SPN gives the holder the

    right to apply and get allotted equity shares; provided

    the SPN is fully paid

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    Contd..

    There is a lock-in period for SPN

    The SPN holder has an option to sell back the

    SPN to the company

    The conversion of detachable warrants into equity

    shares will have to be done within the time limit

    notified by the company

    Eg-TISCO

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    STRIPS (Separate Trading for Registered

    Interest and Principal of Securities)

    STRIPS is a process of stripping a conventional

    coupon bearing security into a number of zero coupon

    securities which can be traded separately

    Split on the basis of Coupons and Principal

    repayment

    Easy calculation of yield

    Easy calculation of cash flows

    Free from default risk24

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    Government Dated Securities

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    Medium to long term obligations issued by RBI onbehalf of the Govt. to finance the deficit and

    development programs

    Predominantly coupon bearing & coupon is paid

    semi-annually

    Also issued at floating rate and as zero coupon

    bonds

    No TDS is applicable Eligible for SLR and highly liquid

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    Risks associated with Debt Securities Default Risk

    Interest Rate Risk

    Reinvestment Risk

    Risks associated with trading in Debt

    Securities Counter party risk

    Price risk

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    Segments of the Debt Market

    Primary Segment

    Fresh Issues

    Secondary Segment

    OTCEI

    WDM NSE

    BSE

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    Primary Issuance Process

    The issuance process for G-secs has undergonesignificant changes over the last few years:

    The introduction of the auction mechanism.

    Creation of the system of primary dealers.

    The introduction of non-competitive bids.

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    What is an auction mechanism?

    This is basically a price discovery mechanism.

    Used to discover the price of the govt. sec. being

    floated in the market.

    Auction is a process of calling of bids with an

    objective of arriving at the market price.

    RBI conducts the option on behalf of the govt.

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    RBI announces the auction of government securities

    through a press notification, and invites bids.

    The sealed bids are opened at an appointed time.

    Successful bidders are those that bid at the highest

    price.

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    The objectives of auction design are:

    Higher auction volumes that satisfy the target

    borrowing requirement.

    Broadening participation to ensure that bids are

    not concentrated and

    Ensuring efficiency through achieving the optimalcost of borrowing for the government.

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    Primary dealers

    They 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.

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    The objectivesof setting up thesystem of primary dealers are:

    To strengthen the infrastructure in the Gsecs market

    in order to make it vibrant, liquid and broad-based;

    To improve secondary market trading system.

    enhance liquidity and turnover and

    encourage voluntary holding of government

    securities among a wider investor base;

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    Non competitive bids

    The non competitive bids were introduced, with a

    view to expand the bond market and allow individual

    investors to invest in the G-secs.

    The allocation is according to the discretion of RBI,

    and the price is that discovered through the auction.

    The number of securities allocated here, is a

    percentage of the amount issue typically 5%.

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    Subsidiary General Ledger (SGL)

    account

    (SGL) account is a securities account maintained by

    banks, primary dealers and financial institutions with

    the RBI, to hold their investments in G secs. and

    T- bills in the electronic book entry form. These institutions can settle their trades for

    securities held in SGL through a delivery versus

    payment (DvP) mechanism, which ensures

    simultaneous movement of funds and securities.

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    Constituent Subsidiary General Ledger

    (CSGL)

    As individual investors do not have access to the

    SGL system, RBI has permitted such investors to

    open a account with any entity authorized by RBI forthis purpose and thus avail of the DvP settlement.

    RBI permits Clearing houses, banks and PDs to

    offer CSGL account facility to an investor who is

    interested in participating in the governmentsecurities market.

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    Features of CSGL Accounts

    CSGL account gets debited or credited on the sale

    or purchase of the securities ,similar to a bank

    account. The account holder receives a statement at periodic

    intervals showing the balance of securities in his

    account.

    All the securities are maintained in demat mode,which can be converted into physical mode

    whenever required by the Account Holder.

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    Trading Mechanism

    The trades on the Whole Sale Debt market (WDM)

    segment can be executed in the:

    Continuous market or

    Negotiated market.

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    Continuous market

    Here, orders entered by the trading members are

    matched by the trading system.

    For each order entering the trading system, thesystem scans for a probable match in the order

    books.

    On finding a match, a trade takes place.

    In case the order does not find a suitable counterorder in the order books, it is stored in the order

    books as a passive order.

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    Negotiated Market

    In the negotiated market, deals are negotiated

    between the two counter parties and are reported on

    the trading system for approval.

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    Negotiated Dealing System

    (NDS)

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    NDS

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    Provides an online electronic bidding facility in theprimary auctions of the Central/State Government

    securities, OMOs auctions

    It enables screen based electronic bidding &

    reporting of transactions

    Banks, financial institutions, Primary Dealers

    having SGL Accounts or current accounts are

    eligible to participate in NDS

    Members are expected to report all the trades

    negotiated outside the system for settlement

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    Clearing Corporation of India Ltd

    (CCIL)

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    CCIL

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    It is a clearing and settling agency in respect of alltrades

    NDS is integrated with CCIL

    All the transactions that take place on NDS are

    settled over CCIL

    All transactions upto Rs. 20 crore are to be

    settled through CCIL

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