OBJECTIVES OF THE STUDY

To study and understand the concept of financial system.

To study the concept of global and Indian financial market.

To understand the concept of debt market and various tools and instruments available to raise funds in debt market by issuers point of view.

To study and invest funds in different instruments available in debt market.

To understand the advantages, disadvantages and scope of debt market.

To identify the profitability, efficiency and growth rate of the debt market.

To analyze the statistical data of debt market.

pg. 1

SRNO

TOPIC PAGENO

1. CHAPTER 1

OVERVIEW OF FINANCIAL SYSTEM

3 TO9

2. CHAPTER 2

OVERVIEW OF DEBT MARKET

10 TO 23

3. CHAPTER 3REGULATORS OF DEBT MARKET

24 TO35

4. CHAPTER 4OVERVIEW OF BONDS

36 TO54

5. CHAPTER 5VALUATION OF BONDS

55 TO58

6. CHAPTER 6STATISTICAL DATA

59 TO 63

7. CHAPTER 7CONCLUSION

64 TO 66

8. CHAPTER 8BIBLOGRAPHY

67 TO68

pg. 2

CHAPTER 1

OVERVIEW OF FINANCIAL SYSTEM

pg. 3

[1.1] INTRODUCTION ON FINANCIAL SYSTEM

Economic growth and development of any country depends up on a well-knit financial system. Financial system comprises a set of sub-systems of financial institutions financial markets, financial instruments and services which help in the formation of capital. Thus a financial system provides a mechanism by which savings are transformed into investments and it can be said that financial system play an significant role in economic growth of the country by mobilizing surplus funds and utilizing them effectively for productive purpose.

The financial system is characterized by the presence of integrated, organized and regulated financial markets, and institutions that meet the short term and long term financial needs of both the household and corporate sector. Both financial markets and financial institutions play an important role in the financial system by rendering various financial services to the community. They operate in close combination with each other.

The word "system", in the term "financial system", implies a set of complex

and closely connected or interlined institutions, agents, practices, markets,

transactions, claims, and liabilities in the economy. The financial system is

concerned about money, credit and finance-the three terms are intimately

related yet are somewhat different from each other. Indian financial system

consists of financial market, financial instruments and financial intermediation.

pg. 4

[1.2] Components Of Indian Financial System:

The following are the four main components of Indian Financial system are:

Financial Institutions.

Financial Markets.

Financial Instruments/Assets/Securities.

Financial Services.

pg. 5

Financial Institutions:

Financial institutions are the intermediary who facilitates smooth

functioning of the financial system by making investors and borrowers

meet. They mobilize savings of the surplus units and allocate them in

productive activities promising a better rate of return. Financial

institutions also provide a service to entities seeking advises on various

issues ranging from restructuring to diversification plans. They provide

whole range of services to the entities who want to raise funds from the

markets elsewhere. Financial institutions act as financial intermediaries

because they act as middlemen between savers and borrowers. Were

these financial institutions may be of Banking or Non-Banking

institutions.

Financial Markets:

Finance is a prerequisite for modern business and financial

institutions play a vital role in economic system. It's through financial

markets the financial system of an economy works. The main functions

of financial markets are:

To facilitate creation and allocation of credit and liquidity.

To serve as intermediaries for mobilization of savings.

To assist process of balanced economic growth.

To provide financial convenience.

Financial Instruments/Assets/Securities:

pg. 6

Another important constituent of financial system is financial

instruments. They represent a claim against the future income and

wealth of others. It will be a claim against a person or an institution, for

the payment of the some of the money at a specified future date.

Financial Services:

Efficiency of emerging financial system largely depends upon the

quality and variety of financial services provided by financial

intermediaries. The term financial services can be defined as "activities,

benefits and satisfaction connected with sale of money that offers to

users and customers, financial related value".

[1.3] INDIAN FINANCIAL MARKET

pg. 7

A Financial Market can be defined as the market in which financial

assets are created or transferred. As against a real transaction that

involves exchange of money for real goods or services, a financial

transaction involves creation or transfer of a financial asset. Financial

Assets or Financial Instruments represents a claim to the payment of a

sum of money sometime in the future and /or periodic payment in the

form of interest or dividend. Financial market is broadly divided into 4

parts:

Money Market:

The money market ifs a wholesale debt market for low-risk,

highly-liquid, short-term instrument. Funds are available in this market

for periods ranging from a single day up to a year. This market is

dominated mostly by government, banks and financial institutions.

Capital Market:

The capital market is designed to finance the long-term

investments. The transactions taking place in this market will be for

periods over a year.

Forex Market:

pg. 8

The Forex market deals with the multicurrency requirements,

which are met by the exchange of currencies. Depending on the

exchange rate that is applicable, the transfer of funds takes place in this

market. This is one of the most developed and integrated market across

the globe.

Credit Market:

Credit market is a place where banks, FIs and NBFCs purvey short,

medium and long-term loans to corporate and individuals.

pg. 9

CHAPTER 2OVERVIEW OF DEBT

MARKET

[2.1] INTRODUCTION OF DEBT MARKET

pg. 10

The capital market comprises of equities market and 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. Debt market is a market for the issuance, trading and settlement

in fixed income securities of various types. The debt market is any market

situation where trading debt instruments take place. Examples of debt

instruments include mortgages, promissory notes, bonds, and Certificates of

Deposit. A debt market establishes a structured environment where these

types of debt can be traded with ease between interested parties.

The debt market often goes by other names, based on the types of debt

instruments that are traded. In the event that the market deals mainly with the

trading of municipal and corporate bond issues, the debt market may be

known as a bond market. If mortgages and notes are the main focus of the

trading, the debt market may be known as a credit market. When fixed rates

are connected with the debt instruments, the market may be known as a fixed

income market.

Debt market refers to the financial market where investors buy and sell

debt securities, mostly in the form of bonds. These markets are important

source of funds, especially in a developing economy like India. India debt

market is one of the largest in Asia. Like all other countries, debt market in

India is also considered a useful substitute to banking channels for finance. The

most distinguishing feature of the debt instruments of Indian debt market is

pg. 11

that the return is fixed. This means, returns are almost risk-free. This fixed

return on the bond is often termed as the 'coupon rate' or the 'interest rate'.

Therefore, the buyer (of bond) is giving the seller a loan at a fixed interest rate,

which equals to the coupon rate.

Indian debt market can be broadly classified into two categories, namely debt

instruments issued by Central or State Governments and debt instruments

issued by Public and Private Sector. Different instruments issued have some

prominent features in respect of period of maturity and the investors for such

instruments.

A gist of the structure of Indian debt market is given below:-

pg. 12

Who Issues Type of Instruments Maturity Periods Who Invests

Central Government

Zero Coupon Bonds; Coupon Bearing GOI securities.

1 year to 30 years

Banks, Insurance and PF Trusts, RBI, Mutual Funds, Individuals

Central Government Treasury Bills 91 days and 364

days

Banks, Insurance and PF Trusts, RBI, Mutual Funds, Individuals

State Government Coupon Bearing State Govt securities 5 years to 10 years

Banks, Insurance and PF Trusts

Government Enterprises & PSU Bonds

Govt guaranteed bonds 5 years to 10 years

Banks, Insurance, PF Trusts and  Individuals

PSU PSU Bonds, Zero coupon bonds 5 years to 10 years

Banks, Insurance, PF Trusts, Corporate amd, Individuals

Private Sector Corporates Debentures and Bonds 1 year to 12 years

Banks, Corporate, Mutual Funds and Individuals

Private and Public Sector Corporates Commercial Paper 15 days to 1 year

Banks, Corporate, Mutual Funds, Financial Institutions and Individuals

Banks and Fis Certificate of Deposits 15 days to 3 years Banks and Corporate

[2.2] CLASSIFICATION OF DEBT MARKET

pg. 13

The instruments traded can be classified into the following segments

based on the characteristics of the identity of the issuer of these securities:

Market

Segment

Issuer Instruments

Government

Securities

Central Government Zero Coupon Bonds, Coupon Bearing

Bonds, Treasury Bills, STRIPS

State Governments Coupon Bearing Bonds.

Public Sector

Bonds

Government

Agencies / Statutory

Bodies

Govt. Guaranteed Bonds, Debentures

Public Sector Units PSU Bonds, Debentures, Commercial Paper

Private Sector

Bonds

Corporates Debentures, Bonds, Commercial Paper,

Floating Rate Bonds, Zero Coupon Bonds,

Inter-Corporate Deposits

Banks Certificates of Deposits, Debentures,

Bonds

Financial Institutions Certificates of Deposits, Bonds

Indian debt market can be classified into two categories:

Government Securities Market (G-Sec Market): It consists of central

and state government securities. It means that, loans are being taken by

the central and state government. It is also the most dominant category

in the India debt market.

pg. 14

Bond Market: It consists of Financial Institutions bonds, Corporate

bonds and debentures and Public Sector Units bonds. These bonds are

issued to meet financial requirements at a fixed cost and hence remove

uncertainty in financial costs.

[2.3] IMPORTANCE OF DEBT MARKET

The key role of the debt markets in the Indian Economy stems from the

following reasons:

Efficient mobilization and allocation of resources in the economy.

Financing the development activities of the Government.

pg. 15

Transmitting signals for implementation of the monetary policy.

Facilitating liquidity management in tune with overall short term and

long term objectives.

Reduction in the borrowing cost of the Government and enable

mobilization of resources at a reasonable cost.

Provide greater funding avenues to public-sector and private sector

projects and reduce the pressure on institutional financing.

Enhanced mobilization of resources by unlocking illiquid retail

investments like gold.

Development of heterogeneity of market participants.

Assist in development of a reliable yield curve and the term structure of

interest rates.

Since the Government Securities are issued to meet the short term and

long term financial needs of the government, they are not only used as

instruments for raising debt, but have emerged as key instruments for

internal debt management, monetary management and short term

liquidity management.

pg. 16

[2.4] ADVANTAGES OF DEBT MARKET

The following are the advantages of debt market:

The biggest advantage of investing in Indian debt market is its assured

returns. The returns that the market offer is almost risk-free (though

there is always certain amount of risks, however the trend says that

return is almost assured).

Safer are the government securities. On the other hand, there are

certain amounts of risks in the corporate, FI and PSU debt instruments.

However, investors can take help from the credit rating agencies which

rate those debt instruments. The interest in the instruments may vary

depending upon the ratings.

Another advantage of investing in India debt market is its high liquidity.

Banks offer easy loans to the investors against government securities.

Greater safety and lower volatility as compared to other financial

instruments.

Variations possible in the structure of instruments like Index linked

Bonds, STRIPS.

Higher leverage available in case of borrowings against G-Secs.

No TDS on interest payments.

pg. 17

Example: Tax exemption for interest earned on G-Secs. up to Rs.3000/-

over and above the limit of Rs.12000/- under Section 80L (as amended in

the latest Budget).

Greater diversification opportunities adequate trading opportunities

with continuing volatility expected in interest rates the world over.

[2.5] DISADVANTAGES OF DEBT MARKET

pg. 18

As there are several advantages of investing in India debt market, there

are certain disadvantages as well.

As the returns here are risk free, those are not as high as the equities

market at the same time. So, at one hand you are getting assured

returns, but on the other hand, you are getting less return at the same

time.

Retail participation is also very less here, though increased recently.

There are also some issues of liquidity and price discovery as the retail

debt market is not yet quite well developed.

Debt securities usually have much smaller relative price changes than

stocks or commodities. Traders in debt securities must take larger

positions to achieve the same level of profits. It is not uncommon for

individual stocks or even stock indexes to move two percent or more

during a trading day. Debt securities may move two percent over several

weeks or a month. Even with ten-to-one leverage, trading debt

securities requires the trader to use much larger position sizes than a

stock market trader.

The debt trading markets are dominated by hedge funds and the trading

desks of large financial institutions. These traders have access to

information and capital that is difficult or impossible for the individual

trader to obtain. By the time the small trader gets the news that these

large players are trading on, it may be too late to profit from the news.

pg. 19

Traders in corporate debt securities trade high-yield or junk bonds to

earn the higher interest rates these bonds pay. The trader can also achieve

capital gains if the issuing corporation gets an upgrade in its credit rating. The

downside of high yield bonds is a bankruptcy and total loss of the principal

invested.

[2.6] INSTRUMENTS OF DEBT MARKET

There are various types of debt instruments available that one can find

in Indian debt market. They are as follows:

pg. 20

Government Securities:

It is the Reserve Bank of India that issues Government Securities

or G-Secs on behalf of the Government of India. These securities have a

maturity period of 1 to 30 years. G-Secs offer fixed interest rate, where

interests are payable semi-annually. For shorter term, there are Treasury

Bills or T-Bills, which are issued by the RBI for 91 days, 182 days and 364

days.

Corporate Bonds:

These bonds come from PSUs and private corporations and are

offered for an extensive range of tenures up to 15 years. There are also

some perpetual bonds. Comparing to G-Sec, corporate bonds carry

higher risks, which depend upon the corporation, the industry where the

corporation is currently operating, the current market conditions, and

the rating of the corporation. However, these bonds also give higher

returns than the G-Sec.

Certificate of Deposit:

These are negotiable money market instruments. Certificate of

Deposits (CDs), which usually offer higher returns than Bank term

deposits, are issued in demat form and also as a Usance Promissory

Notes. There are several institutions that can issue CDs. Banks can offer

CDs which have maturity between 7 days and 1 year. CDs from financial

institutions have maturity between 1 and 3 years. There are some

agencies like ICRA, FITCH, CARE, CRISIL etc. that offer ratings of CDs. CDs

are available in the denominations of Rs 1 Lac and in multiple of that.

pg. 21

Commercial Papers:

There are short term securities with maturity of 7 to 365 days. CPs

are issued by corporate entities at a discount to face value.

Treasury Bills:

Treasury bills are short-term instruments issued by the RBI on

behalf of the government to tide over short term liquidity shortfalls. The

instruments are issued by government to raise short term funds to

bridge seasonal or temporary gaps between its receipts (revenue &

capital) and expenditure. They form the most important segment of the

money market not only in India but all over the world as well.

Bonds:

A bond is a debt security in which authorized issuer owes the

holder a debt and it is obligated to repay the principle and interest rate

(coupon) at a later date or maturity date. It is a financial contract which

pledge to repay a specified or fixed amount of money with the interest

paid to the lender upon maturity of the contract.

[2.7] PLAYERS IN DEBT MARKET

Players in debt market are similar to players in most financial markets

and are essentially either buyers (debt issuer) of funds or sellers (institution) of

funds and often both.

Players include:

Institutional investorspg. 22

Governments

Traders

Individuals

Banks

Because of the specificity of individual bond issues, and the lack of liquidity in

many smaller issues, the majority of outstanding bonds are held by institutions

like pension funds, banks and mutual funds. In the United States, approximately

10% of the market is currently held by private individuals.

CHAPTER 3pg. 23

REGULATORS OF DEBT MARKET

[3.1] INTRODUCTION

Indian Debt Market has been subject to regulations by two authorities, RBI and SEBI. The dual control used to create overlapping of jurisdiction and thereby confusion. In a notification issued by the Government on March, 2, 2000 the areas of responsibility between RBI and SEBI have been clearly defined.

The RBI now regulates contracts for the sale and purchase of Government securities, gold related securities, money market securities and ready forward contract in debt securities.

pg. 24

SEBI regulates all mutual fund, including money market mutual funds. It also regulates the stock markets and the member brokers of the stock exchange. Further it regulates the listing and trading mechanism of the debt instruments. The issue of corporate debts is also under the regulation of SEBI.

The issuance of debt instruments by the government is regulated by the Government Securities Act 2006. The issuance of corporate securities is regulated by the SEBI Guidelines for disclosure and Investor protection.

The Government Securities Act, 2006 was enacted by the Parliament in August 2006. The RBI made Government Securities Regulation, 2007 to carry out the purpose of the Government Securities Act, 2006. The Act and the Regulations are applicable to Government securities created and issued by the Central and the State Government.

pg. 25

[3.2] Reserve Bank of India The Reserve Bank of India was established on April 1, 1935 in accordance with the provisions of the Reserve Bank of India Act, 1934.The Central Office of the Reserve Bank was initially established in Calcutta but was permanently moved to Mumbai in 1937. The Central Office is where the Governor sits and where policies are formulated. Though originally privately owned, since nationalization in 1949, the Reserve Bank is fully owned by the Government of India.

Role of RBI in Debt Market

1. Issuer Of Debt Instruments :Government securities are issued through auctions conducted by the RBI. Auctions are conducted on the electronic platform called the NDS – Auction platform. Commercial banks, scheduled urban co-operative banks, Primary Dealers, insurance companies and provident funds, who maintain funds account (current account) and securities accounts (SGL account) with RBI, are members of this electronic platform.

2. Started the Banking Ombudsman Scheme:The Scheme is introduced with the object of enabling resolution of complaints relating to certain services rendered by banks and to facilitate the satisfaction or settlement of such complaints.

3. Determines the investment of commercial banks in debt:RBI decides amount of investment of commercial bank in debt instrument.

pg. 26

[3.3] GOVERNMENT SECURITIES ACT, 2006:

‘Government security’ means a security created and issued by the Government for the purpose of raising a public loan or for any other purpose as may be notified by the Government in the Official Gazette.

A Government security may be issued in the form of:

a. A Government promissory note,b. A bearer bond payable to bearer,c. A stock or d. A bond

A stock means a Government security:a. Registered in the books of the RBI for which a stock certificate is issued;

orb. Held at the credit of the holder in the SGL account including the CSGL

account maintained in the books of the RBI

The transfer of the Government securities shall be made in such form and in such manner as may be prescribed.

[3.4] GOVERNMENT SECURITIES ACT, 2007 pg. 27

This Act made by the Reserve Bank of India to carry out the purpose of the Government Securities Act. These regulations provide for transfer of Government securities held in different forms.

1. Government security held in the form of Government Promissory Notes is transferable by endorsement and delivery.

2. Government securities held in the form of A Stock Certificate, SGL account including the CSGL account & Bond Ledger Account are transferable, before maturity, by execution of forms - III, IV & V respectively appended to the Government Securities Regulations.

3. A bearer bond is transferable by delivery and the person in possession of the bond shall be deemed to be the owner of the bond.

4. Government securities held in SGL account including the CSGL account or bond ledger account shall also be transferable by execution of a deed in an electronic form under digital signature.

[3.5] Securities and Exchange Board of India

pg. 28

The Securities and Exchange Board of India was enacted on April 12, 1992 in accordance with the provisions of the Securities and Exchange Board of India Act, 1992.

Role of SEBI

1. Regulating the business in stock exchanges and any other securities markets;

2. Registering and regulating the working of stock brokers, sub-brokers, share transfer agents, bankers to an issue, trustees of trust deeds, merchant bankers and such other intermediaries who may be associated with securities markets in any manner;

3. Registering and regulating the working of the depositories, custodians of securities, foreign institutional investors, credit rating agencies and such other intermediaries.

4. Registering and regulating the working of venture capital funds and collective investment schemes, including mutual funds;

5. Promoting and regulating self-regulatory organizations.

6. Prohibiting fraudulent and unfair trade practices relating to securities markets;

7. Promoting investors' education and training of intermediaries of securities markets;

8. Prohibiting insider trading in securities;9. Regulating substantial acquisition of shares and take-

over of companies;10.Calling for information from, undertaking inspection,

conducting inquiries and audits of the intermediaries and self- regulatory organizations in the securities market;

pg. 29

[3.6] SEBI (DISCLOSURE AND INVESTOR PROTECTION) GUIDELINES, 2000

SEBI has issued Securities and Exchange Board of India (Disclosure and Investor Protection) Guidelines in 2000

SEBI GUIDELINES

A. For Issue of Debt Instruments

The issuer making a public issue or rights issue of debt securities shall appoint one or more debenture trustees in accordance with the provisions of Section 117B of the Companies Act, 1956.

The issuer making a public issue or rights issue of debt securities shall appoint one or more Merchant Bankers.

The issuer shall enter into an arrangement with a depository registered with the SEBI for dematerialization of the debt securities that are proposed to be issued to the public.

The issuer shall give an option to the subscribers to receive the debt securities either in the physical form or in dematerialized form.

A trust deed shall be executed by the issuer in favor of the debenture trustees before filling of offer document with the Registrar of Companies and the Designated Stock Exchange.

pg. 30

B. Advertisements of Public Issues:

The issuer company shall make an advertisement in an English national Daily with wide circulation, one Hindi National newspaper and a regional language newspaper with wide circulation at the place where the registered office of the issuer is situated

At the time of filing of the offer document with the Registrar of Companies.

Issue Opening Date, Issue Closing Date.

And contain the minimum disclosures as per Schedule IV.

C. Requirement of Credit Rating

No public issue or Rights issue shall be made unless credit rating from a credit rating agency has been obtained.

For a public or rights issue greater than or equal to Rs. 100 crores two ratings from two different credit rating agencies shall be obtained.

Where credit rating has been obtained from more than one credit rating agencies, all credit ratings, shall be disclosed.

All credit ratings obtained during the three years for any listed security of the issuer company shall be disclosed in the offer document.

pg. 31

D. Requirement of Debenture Trustee

In case of issue of debentures having maturity more than 18 months, the issuer shall appoint a Debenture Trustee.

The name of the debenture trustee must be stated in the offer document.

A trust deed must be executed by the issuer company in favor of the trustee within six months of the closure of the issue.

Trustees of the debenture issue shall be vested with the power for protecting the interest of the debenture holders.

E. Debenture Redemption Reserve (DRR)

A company has to create Debenture Redemption Reserve (DRR) in case of issue of debentures with maturity of more than 18 months.

The DRR should be created in accordance with the following provisions:

• Company shall create DRR equivalent to 50% of the amount of debenture issue before debenture redemption commences.

• Withdrawal from DRR is permitted only after 10% of the debenture liability has been actually redeemed by the company.

• The requirement of creation of DRR shall not be applicable in case of issue of debt instruments by infrastructure companies.

F. Distribution of Interest

pg. 32

In the case of existing issuers, prior permission of the lead institution for declaring interest exceeding 20% or as per the loan covenants is necessary if the issuer does not comply with institutional condition.

In case of New companies, distribution of interest shall require approval of the trustees to the issue and lead institution, if any

Interest may be distributed out of profit of particular years only If residual profits after transfer to debenture redemption reserve are

inadequate to distribute reasonable interest, issuer may distribute interest out of general reserve.

G. Other Provisions

No company shall issue Fully Convertible Debentures having conversion period of more than 36 months, unless conversion is made optional with “Put” and “Call” option.

No issue of debentures by any issuer company shall be made for acquisition of shares or providing loan.

Premium amount and time of conversion shall be determined by the issuer company.

The interest rate for debentures can be freely determined by the issuer company.

pg. 33

[3.7] SEBI (ISSUE AND LISTING OF DEBT SECURITIES) REGULATIONS, 2008Issue and Listing of Debt Securities was Implemented by SEBI & has simplified the Debt market and given it structure.

A. Issue Requirements for Public Issues

Electronic Issuance:An issuer proposing to issue debt securities to the public through the online system of the designated stock exchange should comply with the relevant application requirements as may be specified by SEBI.

Price Discovery through Book Building:The issuer may determine the price of debt securities in consultation with the lead merchant banker. The issue may be at fixed price or the price may be determined through the book building process in accordance with the procedure as may be specified by SEBI.

Minimum Subscription:The issuer may decide the amount of minimum subscription which it seeks to raise by issue of debt securities and disclose the same in the offer document. In the event of non-receipt of minimum subscription all application moneys received in the public issue shall be refunded to the applicants.

Listing of Debt Securities:An issuer desirous of issuing debt securities to the public has to make an application for listing to one or more recognized stock exchanges in terms of Sections 73(1) of the Companies Act , 1956. The issuer has to comply with the conditions of listing of such debt securities as specified in the Listing Agreement with the Stock exchanges where such debt securities are sought to be listed.

pg. 34

B. Continuous Listing Conditions :

1. All the issuers making public issues of debt securities issued on private placement basis should comply with the conditions of listing specified in the respective agreement for debt securities.

2. Every rating obtained by an issuer should be periodically reviewed by the registered credit rating agency and any revision in the rating shall be promptly disclosed by the issuer to the stock exchange where the debt securities are listed.

3. Any changes in rating should be promptly disseminated to investor.

4. Debenture trustee should disclose the information to the investors and the general public by issuing a press release.

pg. 35

CHAPTER 4OVERVIEW OF BONDS

[4.1] INTRODUCTION OF BONDSpg. 36

In finance, a bond is a debt security, in which the authorized issuer owes

the holders a debt and, depending on the terms of the bond, is obliged to pay

interest (the coupon) and/or to repay the principal at a later date, termed

maturity. A bond is a formal contract to repay borrowed money with interest

at fixed intervals. Thus a bond is like a loan: the issuer is the borrower (debtor),

the holder is the lender (creditor), and the coupon is the interest. Bonds

provide the borrower with external funds to finance long-term investments, or,

in the case of government bonds, to finance current expenditure. Certificates

of deposit (CDs) or commercial paper are considered to be money market

instruments and not bonds. Bonds must be repaid at fixed intervals over a

period of time. Bonds and stocks are both securities, but the major difference

between the two is that (capital-) stockholders have an equity stake in the

company (i.e., they are owners), whereas bondholders have a creditor stake in

the company (i.e., they are lenders). Another difference is that bonds usually

have a defined term, or maturity, after which the bond is redeemed, whereas

stocks may be outstanding indefinitely. An exception is a consol bond, which is

a perpetuity (i.e., bond with no maturity).A number of bond indices exist for

the purposes of managing portfolios and measuring performance, similar to

the S&P 500 or Russell Indexes for stocks. The most common American

benchmarks are the (ex) Lehman Aggregate, Citigroup BIG and Merrill Lynch

Domestic Master. Most indices are parts of families of broader indices that can

be used to measure global bond portfolios, or may be further subdivided by

maturity and/or sector for managing specialized portfolios.

[4.2] PLAYERS OF BOND MARKET

The bond market can essentially be broken down into three main groups:

pg. 37

Issuers:

The issuers sell bonds or other debt instruments in the bond market to

fund the operations of their organizations. This area of the market is

mostly made up of governments, banks and corporations. The biggest of

these issuers is the government, which uses the bond market to fund a

country's operations, such as social programs and other necessary

expenses. The government segment also includes some of its agencies

such as Fannie Mae, which offers mortgage-backed securities. Banks are

also key issuers in the bond market and they can range from local banks

up to supranational banks such as the European Investment Bank, which

issues debt in the bond market. The final major issuer is the corporate

bond market, which issues debt to finance corporate operations.

Underwriters:

The underwriting segment of the bond market is traditionally made up

of investment banks and other financial institutions that help the issuer

to sell the bonds in the market. In general, selling debt is not as easy as

just taking it to the market. In most cases, millions - if not billions - of

dollars are being transacted in one offering. As a result, a lot of work

needs to be done - such as creating a prospectus and other legal

documents - in order to sell the issue. In general, the need for

underwriters is greatest for the corporate debt market because there

are more risks associated with this type of debt.

Purchasers: The final players in the market are those who buy the debt

that is being issued in the market. They basically include every group

mentioned as well as any other type of investor, including the individual.

pg. 38

Governments play one of the largest roles in the market because

they borrow and lend money to other governments and banks.

Furthermore, governments often purchase debt from other countries if

they have excess reserves of that country's money as a result of trade

between countries.

Example: Japan is a major holder of U.S. government debt.

pg. 39

[4.3] FEATURES OF BOND

The most important features of a bond are:

Nominal, principal or face amount:

The amount on which the issuer pays interest, and which, most

commonly, has to be repaid at the end of the term. Some structured

bonds can have a redemption amount which is different to the face

amount and can be linked to performance of particular assets such as a

stock or commodity index, foreign exchange rate or a fund. This can

result in an investor receiving less or more than his original investment

at maturity.

Issue price:

The price at which investors buy the bonds when they are first

issued, which will typically be approximately equal to the nominal

amount. The net proceeds that the issuer receives are thus the issue

price, less issuance fees.

Maturity date:

The date on which the issuer has to repay the nominal amount.

As long as all payments have been made, the issuer has no more

obligations to the bond holders after the maturity date. The length of

time until the maturity date is often referred to as the term or tenor or

maturity of a bond. The maturity can be any length of time, although

debt securities with a term of less than one year are generally

designated money market instruments rather than bonds. Most bonds

have a term of up to thirty years. Some bonds have been issued with

pg. 40

maturities of up to one hundred years, and some even do not mature at

all. In the market there are three groups of bond maturities:

Short term (bills): maturities up to one year;

Medium term (notes): maturities between one and ten years;

Long term (bonds): maturities greater than ten years.

Coupon:

The interest rate that the issuer pays to the bond holders.

Usually this rate is fixed throughout the life of the bond. It can also vary

with a money market index, such as LIBOR, or it can be even more

exotic. The name coupon originates from the fact that in the past,

physical bonds were issued which had coupons attached to them. On

coupon dates the bond holder would give the coupon to a bank in

exchange for the interest payment.

Indentures and Covenants:

An indenture is a formal debt agreement that establishes the

terms of a bond issue, while covenants are the clauses of such an

agreement. Covenants specify the rights of bondholders and the duties

of issuers, such as actions that the issuer is obligated to perform or is

prohibited from performing. In the U.S., federal and state securities and

commercial laws apply to the enforcement of these agreements, which

are construed by courts as contracts between issuers and bondholders.

The terms may be changed only with great difficulty while the bonds are

outstanding, with amendments to the governing document generally

requiring approval by a majority (or super-majority) vote of the

bondholders.

Coupon dates:

pg. 41

The dates on which the issuer pays the coupon to the bond

holders. In the U.S. and also in the U.K. and Europe, most bonds are

semi-annual, which means that they pay a coupon every six months.

Optionality:

Occasionally a bond may contain an embedded option; that is, it

grants option-like features to the holder or the issuer.

Call ability:

Some bonds give the issuer the right to repay the bond before

the maturity date on the call dates; see call option. These bonds are

referred to as callable bonds. Most callable bonds allow the issuer to

repay the bond at par. With some bonds, the issuer has to pay a

premium, the so called call premium. This is mainly the case for high-

yield bonds. These have very strict covenants, restricting the issuer in its

operations. To be free from these covenants, the issuer can repay the

bonds early, but only at a high cost.

Put ability:

Some bonds give the holder the right to force the issuer to repay the

bond before the maturity date on the put dates; see put option. (Note:

"Putable" denotes an embedded put option; "Puttable" denotes that it

may be put.)

[4.4] TYPES OF BOND

pg. 42

After you decide to invest in bonds, you then need to decide what kinds of

bond investments are right for you. Most people don’t realize it, but the bond

market offers investors a lot more choices than the stock market.

Depending on your goals, your tax situation and your risk tolerance, you

can choose from municipal, government, corporate, mortgage-backed or asset-

backed securities and international bonds. Within each broad bond market

sector you will find securities with different issuers, credit ratings, coupon

rates, maturities, yields and other features. Each one offers its own balance of

risk and reward.

1. DOMESTIC BONDS:

Municipal bonds:

Municipal bonds are debt obligations issued by states, cities,

counties and other governmental entities, which use the money to build

schools, highways, hospitals, sewer systems, and many other projects for the

public good. When you purchase a municipal bond, you are lending money to a

state or local government entity, which in turn promises to pay you a specified

amount of interest (usually paid semiannually) and return the principal to you

on a specific maturity date.

Not all municipal bonds offer income exempt from both federal and state

taxes. There is an entirely separate market of municipal issues that are taxable

at the federal level, but still offer a state—and often local—tax exemption on

interest paid to residents of the state of issuance. Most of this municipal bond

information refers to munis which are free of federal taxes.

pg. 43

Fixed Rate Bonds:

Bonds have a coupon that remains constant throughout the life of

the bond.

Floating Rate Notes (FRNs):

Bonds have a variable coupon that is linked to a reference rate of

interest, such as LIBOR or Euribor. For example the coupon may be

defined as three month USD LIBOR + 0.20%. The coupon rate is

recalculated periodically, typically every one or three months.

High Yield Bonds:

Bonds that are rated below investment grade by the credit rating

agencies. As these bonds are more risky than investment grade bonds,

investors expect to earn a higher yield. These bonds are also called junk

bonds.

Zero-Coupon Bond:

A debt security that doesn't pay interest (a coupon) but is traded

at a deep discount, rendering profit at maturity when the bond is

redeemed for its full face value. Also known as an "accrual bond". Zero

coupon bonds are sold at a substantial discount from the face amount.

Government Bonds:

pg. 44

It is the Reserve Bank of India that issues Government Securities

or G-Secs on behalf of the Government of India. These securities have a

maturity period of 1 to 30 years. G-Secs offer fixed interest rate, where

interests are payable semi-annually. For shorter term, there are Treasury

Bills or T-Bills, which are issued by the RBI for 91 days, 182 days and 364

days..

Inflation Linked Bonds:

Bonds in which the principal amount and the interest payments

are indexed to inflation. The interest rate is normally lower than for fixed

rate bonds with a comparable maturity. However, as the principal

amount grows, the payments increase with inflation. The United

Kingdom was the first sovereign issuer to issue inflation linked Gilts in

the 1980s. Treasury Inflation-Protected Securities (TIPS) and I-bonds are

examples of inflation linked bonds issued by the U.S. government.

Other Indexed Bonds:

For example equity-linked notes and bonds indexed on a business

indicator (income, added value) or on a country's GDP.

Asset-backed Securities:

Bonds whose interest and principal payments are backed by

underlying cash flows from other assets. Examples of asset-backed

securities are mortgage-backed securities (MBS's), collateralized

mortgage obligations (CMOs) and collateralized debt obligations (CDOs).

Subordinated Bonds:

pg. 45

Bonds are those that have a lower priority than other bonds of the

issuer in case of liquidation. In case of bankruptcy, there is a hierarchy of

creditors. First the liquidator is paid, then government taxes, etc. The

first bond holders in line to be paid are those holding what is called

senior bonds. After they have been paid, the subordinated bond holders

are paid. As a result, the risk is higher. Therefore, subordinated bonds

usually have a lower credit rating than senior bonds. The main examples

of subordinated bonds can be found in bonds issued by banks, and

asset-backed securities.

Perpetual Bonds:

Bonds are also often called perpetuities or 'Perps'. They have no

maturity date. The most famous of these are the UK Consols, which are

also known as Treasury Annuities or Undated Treasuries. Some of these

were issued back in 1888 and still traded today.

2. INTERNATIONAL BONDS:

Some companies, banks, governments, and other sovereign entities may

decide to issue bonds in foreign currencies as it may appear to be more stable

and predictable than their domestic currency. Issuing bonds denominated in

pg. 46

foreign currencies also gives issuers the ability to access investment capital

available in foreign markets. The proceeds from the issuance of these bonds

can be used by companies to break into foreign markets, or can be converted

into the issuing company's local currency to be used on existing operations

through the use of foreign exchange swap hedges. Foreign issuer bonds can

also be used to hedge foreign exchange rate risk. Some foreign issuer bonds

are called by their nicknames, such as the "samurai bond." These can be issued

by foreign issuers looking to diversify their investor base away from domestic

markets. These bond issues are generally governed by the law of the market of

issuance, e.g., a samurai bond, issued by an investor based in Europe, will be

governed by Japanese law. Not all of the following bonds are restricted for

purchase by investors in the market of issuance.

Eurodollar bond, a U.S. dollar-denominated bond issued by a non-U.S.

entity outside the U.S.

Yankee bond, a US dollar-denominated bond issued by a non-US entity

in the US market.

Kangaroo bond, an Australian dollar-denominated bond issued by a

non-Australian entity in the Australian market.

Maple bond, a Canadian dollar-denominated bond issued by a non-

Canadian entity in the Canadian market.

Samurai bond, a Japanese yen-denominated bond issued by a non-

Japanese entity in the Japanese market.

Uridashi bond, a non-yen-denominated bond sold to Japanese retail

investors.

Shibosai Bond is a private placement bond in Japanese market with

distribution limited to institutions and banks.

pg. 47

[4.5] ISSUERS OF BONDS

pg. 48

Many entities issue bonds. The bond market separates bond issuers

into categories based on the similarities of these issuers and their

characteristics. These major categories are: supranational agencies (i.e. World

Bank), national governments (i.e. Government of Canada), provincial or state

governments (i.e. Province of Ontario), municipal governments (i.e. City of

Edmonton) and corporate bonds (i.e. General Motors). Bonds are issued by

public authorities, credit institutions, companies and supranational institutions

in the primary markets. The most common process of issuing bonds is through

underwriting. In underwriting, one or more securities firms or banks, forming a

syndicate, buy an entire issue of bonds from an issuer and re-sell them to

investors. The security firm takes the risk of being unable to sell on the issue to

end investors. Primary issuance is arranged by book runners who arrange the

bond issue, have the direct contact with investors and act as advisors to the

bond issuer in terms of timing and price of the bond issue.

The book runners' willingness to underwrite must be discussed prior

to opening books on a bond issue as there may be limited appetite to do so. In

the case of Government Bonds, these are usually issued by auctions, where

both members of the public and banks may bid for bond. Since the coupon is

fixed, but the price is not, the percent return is a function both of the prices

paid as well as the coupon.

pg. 49

[4.6] BOND CREDIT RATINGIn investment, the bond credit rating assesses the credit worthiness of a

corporation's debt issues. It is analogous to credit ratings for individuals and

countries. The credit rating is a financial indicator to potential investors of debt

securities such as bonds. These are assigned by credit rating agencies such as

Moody's, Standard & Poor's, and Fitch Ratings to have letter designations (such

as AAA, B, CC) which represent the quality of a bond. Bond ratings below

BBB/Baa are considered to be not investment grade and are colloquially called

junk bonds.

Moody's S&P Fitch GRADELong-term Short-

termLong-term

Short-term Long-term Short-

termAAA

P-1

AAA

A-1+

AAA

F1+

PrimeAA1 AA+ AA+

High gradeAA2 AA AAAA3 AA- AA-A1 A+ A-1 A+ F1

Upper medium gradeA2 A AA3 P-2 A- A-2 A- F2

BAA1 BBB+ BBB+Lower medium gradeBAA2 P-3 BBB A-3 BBB F3

BAA3 BBB- BBB-BA1

Not prime

BB+

B

BB+

B

Non-investment gradespeculativeBA2 BB BB

BA3 BB- BB-B1 B+ B+

Highly speculativeB2 B BB3 B- B-

CAA1 CCC+

C CCC C

Substantial risksCAA2 CCC Extremely speculativeCAA3 CCC-

In default with littleprospect for recoveryCA

CCC

C

D /

DDD

/ In default / DD

CREDIT RATING AGENCIES:

pg. 50

Credit rating agencies registered as such with the SEC are known as

“Nationally Recognized Statistical Rating Organizations.” The following

firms are currently registered as NRSROs: A.M. Best Company, Inc.; DBRS

Ltd.; Egan-Jones Rating Company; Fitch, Inc.; Japan Credit Rating Agency,

Ltd.; LACE Financial Corp.; Moody’s Investors Service, Inc.; Rating and

Investment Information, Inc.; Real point LLC; and Standard & Poor’s

Ratings Services. Under the Credit Rating Agency Reform Act, an NRSRO

may be registered with respect to up to five classes of credit ratings: (1)

financial institutions, brokers, or dealers; (2) insurance companies; (3)

corporate issuers; (4) issuers of asset-backed securities; and (5) issuers

of government securities, municipal securities, or securities issued by a

foreign government.

S&P, Moody's, and Fitch dominate the market with approximately 90-95

percent of world market share.

The Development of Bond market in In Credit Rating Tiers

Moody's assigns bond credit ratings of Aaa, Aa, A, Baa, Ba, B, Caa, Ca, C,

with WR and NR as withdrawn and not rated. Standard & Poor's and

Fitch assign bond credit ratings of AAA, AA, A, BBB, BB, B, CCC, CC, C, D.

As of October 16, 2009, there were 4 companies rated AAA by S&P:

Automatic Data Processing (NYSE:ADP)

Johnson & Johnson (NYSE:JNJ)

Microsoft (NASDAQ:MSFT)

ExxonMobil (NYSE:XOM)

pg. 51

Moody's, S&P and Fitch will all also assign intermediate ratings at levels

between AA and CCC (e.g., BBB+, BBB and BBB-), and may also choose to

offer guidance (termed a "credit watch") as to whether it is likely to be

upgraded (positive), downgraded (negative) or uncertain (neutral).

Moody's

Standard &

Poor's

Credit worthiness

AAA AAA Triple A = Credit risk almost zeroAA1 AA+ Safe investment, low risk of failureAA2 AA "AA3 AA- "A1 A+ Safe investment, unless unforeseen events should occur in

the economy at large or in that particular field of businessA2 A "A3 A- "BAA1 BBB+ Medium safe investment. Occurs often when economy has

deteriorated. Problems may ariseBAA2 BBB "BAA3 BBB- "BA1 BB+ Speculative investment. Occurs often in deteriorated

circumstances, usually problematic to predict future development

BA2 BB "BA3 BB- "B1 B+ Speculative investment. -Deteriorating situation expectedB2 B "B3 B- "CAA CCC High likelihood of bankruptcy or other business interruptionCAA CC "C C "

D Bankruptcy or lasting inability to make payments most likelyWR Rating withdrawn[2]

NR Not rated[2]

Investment grade:

pg. 52

A bond is considered investment grade or IG if its credit rating is BBB- or

higher by Standard & Poor's or Baa3 or higher by Moody's or BBB(low)

or higher by DBRS. Generally they are bonds that are judged by the

rating agency as likely enough to meet payment obligations that banks

are allowed to invest in them.

Ratings play a critical role in determining how many companies and

other entities that issue debt, including sovereign governments; have to

pay to access credit markets, i.e., the amount of interest they pay on

their issued debt. The threshold between investment-grade and

speculative-grade ratings has important market implications for issuers'

borrowing costs.

Bonds that are not rated as investment-grade bonds are known as high

yield bonds or more derisively as junk bonds.

The risks associated with investment-grade bonds (or investment-grade

corporate debt) are considered noticeably higher than in the case of

first-class government bonds. The difference between rates for first-class

government bonds and investment-grade bonds is called investment-

grade spread. It is an indicator for the market's belief in the stability of

the economy. The higher these investment-grade spreads (or risk

premiums) are, the weaker the economy is considered.

The debt market is much more popular than the equity markets in most

parts of the world. In India

The reverse has been true. Nevertheless, the Indian debt market has

transformed itself into a much

More vibrant trading field for debt instruments from the rudimentary

market about a decade ago.

pg. 53

The sections below encompass the transformation of government and

corporate debt markets in

India along with a comparison of the developments in equity market.

pg. 54

CHAPTER 5VALUATION OF BONDS

[5.1] BOND VALUATION

At the time of issue a level coupon bond is usually sold for a price which

is close to its par value. After issue a bond is traded on the market at a price

which reflects the current level of interest rates and the degree of risk

pg. 55

associated with the bond. Typically we are interested in calculating either the

market price that a bond should sell for, given that the investor wants to

obtain a particular market yield; or the effective yield (a.k.a. the

yield to maturity), given the price at which the bond is trading the value of a

financial security is the PV of expected future cash flows to value bonds we

need to estimate future cash flows (size and timing) and discount at an

appropriate rate.

At par: When a bond is selling at price = Par Value = $1,000 ]

This would happen when the coupon rate = YTM.

Discount Bond: When a bond is selling at price < Face Value

-- Coupon Rate < YTM.

Premium Bond: When a bond is selling at price > Face Value

-- Coupon rate > YTM.

[5.2] YIELD TO MATURITY

The yield to maturity is the discount rate which returns the market

price of the bond; it is identical to (required return) in the above equation.

YTM is thus the internal rate of return of an investment in the bond made at

the observed price. Since YTM can be used to price a bond, bond prices are

often quoted in terms of YTM. Yield refers to the percentage rate of return

paid on a stock in the form of dividends, or the effective rate of interest paid

pg. 56

on a bond or note. There are many different kinds of yields depending on the

investment scenario and the characteristics of the investment. The calculation

of YTM helps the investor in rational decision making. YTM serves as a cut off

point to the investor and enables him to determine whether he should or

should not invest in the given debt instrument. YTM represents the yield on

bond, provided the bond id held to maturity and the intermittent coupons are

reinvested at the same YTM rate. In other words, YTM assumes that investor

can reinvest the coupon received at same rate as YTM over the investment

horizon.

To achieve a return equal to YTM, i.e. where it is the required return on the

bond, the bond owner must:

Buy the bond at price P0,

Hold the bond until maturity, and

Redeem the bond at par.

Coupon yield:

The coupon yield is simply the coupon payment (C) as a percentage of the face

value (F).

Coupon yield = C / F

Coupon yield is also called nominal yield.

Current yield:

pg. 57

The current yield is simply the coupon payment (C) as a percentage of the

(current) bond price (P).

Current yield = C / P0.

Relationship:

The concept of current yield is closely related to other bond concepts,

including yield to maturity, and coupon yield. The relationship between yield

to maturity and the coupon rate is as follows:

When a bond sells at a discount, YTM > current yield > coupon yield.

When a bond sells at a premium, coupon yield > current yield > YTM.

When a bond sells at par, YTM = current yield = coupon yield amt.

pg. 58

CHAPTER 6STATISTICAL DATA

[6.1] STATISTICAL DATA ON DEBT MARKET

The following table gives us the information of last ten years bonds issued by

Public Sector Undertakings.

Bonds Issued by Public Sector Undertakings (Rupees crore)Year Tax-free Bonds Taxable Bonds Total (2+3)

1 2 3 4

2000-01 662.2 15969.4 16631.6

pg. 59

2001-02 274.2 14161.5 14435.7

2002-03 286.0 7243.0 7529.0

2003-04 5443.2 5443.2

2004-05 7590.6 7590.6

2005-06 4845.5 4845.5

2006-07 10325.1 10325.1

2007-08 13404.4 13404.4

2008-09 12839.8 12839.8

2009-10 29937.8 29937.8

It is analyzed that since 2003 till date there is no Tax Free Bonds issued

by public sector undertakings. It is also been interpreted that the value

of taxable bonds are increasing on yearly basis.

Debt-to-GDP and the Market :

Decades from now, when historians write about the current era, the

relationship between the stock market and the debt ratio will likely be a hot

topic — one that will encompass politics, economics, demographics and

cultural history. The first few decades after World War II witnessed an inverse

relationship between a rising market and shrinking debt ratio. But after the

decade of stagflation, the 18-year bull market that started in 1982 was

accompanied by a change in the debt relationship from inverse to tandem, as

the overlay below suggests. Those good times came at a cost — one that was

increasingly covered by debt.

pg. 60

pg. 61

Note that I've changed the color of the ratio from red (my usual color for debt)

to black to avoid any suggestion of political responsibly. Ultimately politics is

but one factor in the debt equation, which is driven by larger historical forces

(World Wars, the Great Depression and the Cold War) as well as profound

social, economic and cultural changes (e.g., trickle-down economics meets the

Boomer era of conspicuous consumption).

pg. 62

I've interpolated monthly values for the debt data in the market overlay so it

aligns properly with the monthly market data for the S&P Composite. Thus the

Office of Management and Budget (OMB) dot estimates in the top chart are

shown as a smooth rosy line in the second. That line represents the White

House OMB's six-year debt and GDP forecasts. Note that the curve becomes

less steep from 2012-2015. Let's hope this isn't a wishful view through rosy

colored glasses.

pg. 63

CHAPTER 7CONCLUSION

[6.1] CONCLUSION

After you decide to invest in bonds, you then need

to decide what kinds of bond investments are right for you.

Most people don’t realize it, but the bond market offers

investors a lot more choices than the stock market.

pg. 64

Depending on your goals, your tax situation and your

risk tolerance, you can choose from municipal, government,

corporate, mortgage-backed or asset-backed securities and

international bonds. Within each broad bond market sector

you will find securities with different issuers, credit ratings,

coupon rates, maturities, yields and other features. Each one

offers its own balance of risk and reward.

Individual investors as well as groups or corporate

partners may participate in a debt market. Depending on the

regulations imposed by governments, there may be very little

distinction between how an individual investor versus a

corporation would participate in a debt market. However,

there are usually some regulations in place that require that

any type of investor in debt market offerings have a

minimum amount of assets to back the activity. This is true

even with situations such as bonds, where there is very little

chance of the investor losing his or her investment.

One of the advantages to participating in a debt

market is that the degree of risk associated with the

investment opportunities is very low. For investors who are

focused on avoiding riskier ventures in favor of making a

pg. 65

smaller but more or less guaranteed return, going with bonds

and similar investments simply makes sense. While the

returns will never be considered spectacular, it is possible to

earn a significant amount of money over time, if the right

debt market offerings are chosen.

pg. 66

CHAPTER 8BIBLOGRAPHY

[7.1] BIBLOGRAPHY

BOOKS REFERRED:

DEBT MARKETS – SANDEEP GUPTA & SACHIN BHANDARKAR

WEBSITE

pg. 67

www.sebi.gov.in

www.investopedia.com

www.wikipedia.com

www.rbi.org.com

pg. 68