INDIANFINANCIALMARKETS&SERVICES

UNIT4MONEYMARKETS&

DEBTMARKETININDIA

MONEYMARKET:LECTURE4-TYPESOFBONDS- GOVERNMENT SECURITIES: Appraisal, Issue

Procedure, Secondary market, Tradingmechanism

TYPESOFBONDSA.   FIXEDRATEBONDS

–  Thesearebondsonwhichthecouponrateisfixedfortheentirelife(i.e.tillmaturity)ofthebond

– MostGovernmentbonds in Indiaare issuedas fixed ratebonds.

–  Forexample–8.24%GS2018wasissuedonApril22,2008foratenorof10yearsmaturingonApril22,2018.

•  Coupon on this security will be paid half-yearly at 4.12% (halfyearlypaymentbeinghalfof theannualcouponof8.24%)ofthefacevalueonOctober22andApril22ofeachyear.

TYPESOFBONDSB.   FLOATINGRATEBONDS(FRB)

-  FRBsaresecuritieswhichdonothaveafixedcouponrate.

-  Thecouponisre-setatpreannouncedintervals(say,everysixmonthsoroneyear)byaddingaspreadoverabaserate.

-  FRBswerefirstissuedinSeptember1995inIndia.

-  Forexample,aFRBwasissuedonDecember21,2009foratenorof11years,thusmaturingonDecember21,2020.

-  Thebaserateonthebondforthecouponpaymentswasfixedat3.79%beingtheweightedaveragerateof implicityieldon182-dayTreasuryBillsduringtheprecedingthreeauctions.

-  Inthebondauctioncouponforthefirstsixmonthswasfixedat4.8557%

TYPESOFBONDSC.ZEROCOUPONBONDS

-  Zerocouponbondsarebondswithnocouponpayments.-  However, like T- Bills, they are issued at a discount and

redeemedatfacevalue.-  The Government of India had issued such securities in the

nineties,Ithasnotissuedzerocouponbondsafterthat.D.CAPITALINDEXEDBONDS

-  These are bonds, the principal of which is linked to anaccepted index of inflation with a view to protecting thePrincipalamountoftheinvestorsfrominflation.

-  A 5 year capital indexed bond,was first issued in December1997whichmaturedin2002.

TYPESOFBONDSE.   INFLATIONINDEXEDBONDS(IIBS)

•  IIBsarebondswhereinbothcouponflowsandPrincipalamountsareprotectedagainstinflation.

•  The inflation index used in IIBs may beWhole Sale Price Index(WPI)orConsumerPriceIndex(CPI).

•  Globally,IIBswerefirstissuedin1981inUK.•  In India, Government of India through RBI issued IIBs (linked toWPI)inJune2013.

•  Sincethen,theywereissuedonmonthlybasis(onlastTuesdayofeachmonth)tillDecember2013.

•  Based on the success of these IIBs, Government of India inconsultation with RBI issued the IIBs (CPI based) exclusively fortheretailcustomersinDecember2013.

TYPESOFBONDSF.   BONDSWITHCALL/PUTOPTIONS

•  Bonds can also be issued with features of optionality wherein the issuer canhavetheoptiontobuy-back(calloption)ortheinvestorcanhavetheoptiontosellthebond(putoption)totheissuerduringthecurrencyofthebond.

•  Itmaybenotedthatsuchbondmayhaveputonlyorcallonlyorbothoptions.

•  ThefirstG-Secwithbothcallandputoptionviz.6.72%GS2012wasissuedonJuly18,2002foramaturityof10yearsmaturingonJuly18,2012.

•  Theoptionality on the bond could be exercised after completion of five yearstenurefromthedateofissuanceonanycoupondatefallingthereafter.

•  TheGovernmenthas the right tobuy-back thebond (call option) at par value(equal to the facevalue)while the investorhas the right to sell thebond (putoption)totheGovernmentatparvalueonanyofthehalf-yearlycoupondatesstartingfromJuly18,2007.

TYPESOFBONDS

G.   SPECIALSECURITIES:–  Under themarketborrowingprogramme, theGovernmentof India

alsoissues,fromtimetotime,specialsecuritiesto•  entities like Oil Marketing Companies, Fertilizer Companies, the Food

Corporation of India, etc. (popularly called oil bonds, fertiliser bonds andfoodbondsrespectively)

•  ascompensationtothesecompaniesinlieuofcashsubsidies.•  Thesesecuritiesareusuallylongdatedsecuritiesandcarrymarginallyhigher

coupon(spreadofabout20-25bps)overtheyieldofthedatedsecuritiesofcomparablematurity.

–  These securities are, however, not eligible SLR securities but areeligibleascollateralformarketrepotransactions.

–  Thebeneficiaryentitiesmaydivestthesesecuritiesinthesecondarymarket to banks, insurance companies / Primary Dealers, etc., forraisingfunds.

TYPESOFBONDSH.STRIPS–SEPARATETRADINGOFREGISTEREDINTERESTANDPRINCIPALOFSECURITIES

•  STRIPSarethesecuritiescreatedbywayofseparatingthecashflowsassociatedwitharegularG-Seci.e.eachsemi-annualcouponpaymentandthefinalprincipalpaymenttobereceivedfromtheissuer,intoseparatesecurities.

•  TheyareessentiallyZeroCouponBonds(ZCBs).

•  However,theyarecreatedoutofexistingsecuritiesonlyandunlikeothersecurities,arenotissuedthroughauctions.

•  Securitiesrepresentfuturecashflows(periodicinterestandprincipalrepayment)ofanunderlyingcouponbearingbond.

•  BeingG-Secs,STRIPSareeligibleforSLR.

TYPESOFBONDSH. STRIPS – SEPARATE TRADING OF REGISTERED INTEREST AND PRINCIPAL OFSECURITIES…contd.

•  In India, currentlydatedsecurities (other thanFRBs, IIBsandspecial securities)havingtheircoupondueonJan2andJul2areeligibleforSTRIPPING.

•  For example, when ₹100 of the 8.24%GS2018 is stripped, each cash flow ofcoupon (₹ 4.12 each half year) will become a coupon STRIP and the principalpayment(₹100atmaturity)willbecomeaprincipalSTRIP.

•  These cash flows are traded separately as independent securities in thesecondarymarket.

TYPESOFBONDSH.STRIPS:PROS

•  STRIPSinG-Secsensureavailabilityofsovereignzerocouponbonds–  Facilitate the development of a market determined zero coupon

yieldcurve(ZCYC)

•  Provideinstitutionalinvestorswithanadditionalinstrumentfortheirassetliabilitymanagement(ALM)

•  Havezeroreinvestmentrisk,beingzerocouponbonds,theycanbeattractivetoretail/non-institutionalinvestors.

TYPESOFBONDSH.STRIPS–PROCEDURALASPECTS.

•  Theprocessof stripping/ reconstitutionofG-secs is carriedoutat–  RBI,PublicDebtOffice(PDO)intheCBSpackageofRBIi.e.E-Kuber–  throughanyof thePrimaryDealer at theoptionof theholderat any time

fromthedateofissuanceofaG-Sectillitsmaturity

•  Physicalsecuritiesarenoteligibleforstripping/reconstitution

•  Minimumamountofsecuritiesthatneedstobesubmittedforstripping/reconstitutionis₹1crore(FaceValue)andinmultiplesthereof

•  TheyarecurrentlytradableinbothOTCmarketandonNDS-OM

TYPESOFBONDSI.   SOVEREIGNGOLDBOND(SGB):

–  Uniqueinstruments,pricesofwhichare linkedtocommoditypricevizGold.

–  Denominated inmultiplesofgram(s)ofgoldwithabasicunitof1gram

–  ThetenoroftheSGBisforaperiodof8yearswithexitoptionfrom5thyeartobeexercisedontheinterestpaymentdates

–  SGBs are restricted for sale to resident Indian entities includingindividuals,HUFs,trusts,Universities,charitableinstitutions

TYPESOFBONDSI.   SOVEREIGNGOLDBOND(SGB):(contd.)

–  Priceofbondatthetimeof issueisfixedinIndianRupeesonthebasisofthe previous week’s (Monday–Friday) simple average of closing price ofgoldof999puritypublishedbytheIndiaBullionandJewellersAssociationLtd.(IBJA)

–  The redemption pricewill be in Indian Rupees based on previousweek’s(Monday-Friday) simple average of closing price of gold of 999 puritypublishedbyIBJA

–  Investorsarecompensatedatafixedrateperannumpayablesemi-annuallyontheinitialvalueofinvestment

–  SGBs are eligible for SLR, can be used as collateral for loans and aretradeableonstockexchanges

ADVANTAGESOFG-SECs•  Besidesprovidingareturnintheformofcoupons(interest),G-Secsoffer

the maximum safety as they carry the Sovereign’s commitment forpaymentofinterestandrepaymentofprincipal.

•  Theycanbeheldinbookentry,i.e.,dematerialized/scriplessform,thus,obviatingtheneedforsafekeeping

•  G-Secsareavailableinawiderangeofmaturitiesfrom91daystoaslongas 40 years to suit the duration of varied liability structure of variousinstitutions.

•  G-Secs can be sold easily in the secondary market to meet cashrequirements.

ADVANTAGESOFG-SECs…contd.•  G-Secscanalsobeusedascollateraltoborrowfundsintherepomarket.

•  Securities such as State Development Loans (SDLs) and Special Securities (Oilbonds,UDAYbondsetc)provideattractiveyields.

•  Thesettlementsystemfor trading inG-Secs,which isbasedonDeliveryversusPayment(DvP),isaverysimple,safeandefficientsystemofsettlement.–  TheDvPmechanismensures transfer of securities by the seller of securities

simultaneouslywithtransferoffundsfromthebuyerofthesecurities,therebymitigatingthesettlementrisk.

•  G-Secpricesarereadilyavailableduetoaliquidandactivesecondarymarketandatransparentpricedisseminationmechanism.

STATEDEVELOPMENTALLOANS(SDLs)

•  StateGovernmentsalsoraiseloansfromthemarketwhicharecalledSDLs.

•  SDLs are dated securities issued through normal auction similar to the auctionsconductedfordatedsecuritiesissuedbytheCentralGovernment

•  Interest is serviced at half-yearly intervals and the principal is repaid on thematuritydate.

•  Likedatedsecurities issuedbytheCentralGovernment,SDLs issuedbytheStateGovernmentsalsoqualifyforSLR.

–  TheyarealsoeligibleascollateralsforborrowingthroughmarketrepoaswellasborrowingbyeligibleentitiesfromtheRBIundertheLiquidityAdjustmentFacility(LAF).

•  State Governments have also issued special securities under “Ujjwal DiscomAssurance Yojna (UDAY) Scheme for Operational and Financial Turnaround ofPowerDistributionCompanies(DISCOMs)”

ISSUEPROCEDUREOFG-SECs•  G-SecsareissuedthroughauctionsconductedbyRBI

•  AuctionsareconductedontheelectronicplatformcalledtheE-Kuber,theCoreBankingSolution(CBS)platformofRBI

•  Commercial banks, scheduled UCBs, Primary Dealers,insurance companies and provident funds, who maintainfunds account (current account and securities accounts(Subsidiary General Ledger (SGL) account) with RBI, aremembersofthiselectronicplatform

ISSUEPROCEDUREOFG-SECs…contd.

•  Members of E-Kuber can place their bids in the auctionthroughthiselectronicplatform

•  Non-E-Kuber members including non-scheduled UCBs canparticipate in the primary auction through scheduledcommercialbanksorPDs

•  Forthispurpose,theUCBsneedtoopenasecuritiesaccountwithabank/PD–suchanaccountiscalledaGiltAccount.–  A Gilt Account is a dematerialized account maintained with a

scheduledcommercialbankorPD.

SCHEDULEOFISSUEOFG-SECs•  RBI, in consultationwith theGovernmentof India, issuesan

indicativehalf-yearlyauctioncalendar–  Containing informationabouttheamountofborrowing,therangeof

the tenor of securities and the period duringwhich auctionswill beheld

•  NotificationandaPressCommuniquegivingexactparticularsof the securities, viz., name, amount, type of issue andprocedureofauctionare issuedby theGovernmentof Indiaaboutaweekpriortotheactualdateofauction

ISSUEPROCEDUREOFG-SECs..contd.

•  RBIplacesthenotificationandaPressReleaseonitswebsiteand also issues advertisements in leading English and Hindinewspapers

•  Information about auctions is also available with selectbranchesofpublicandprivatesectorbanksandthePDs

•  Auction for dated securities is conducted on Friday forsettlement on T+1 basis (i.e. securities are issued on nextworkingdayi.e.Monday)

SDL&RBI

•  In terms of Sec. 21A (1) (b) of the Reserve Bank ofIndiaAct,1934,theRBImay,byagreementwithanyState Government undertake the management ofthepublicdebtofthatState

•  Accordingly, the RBI has entered into agreementswith29StateGovernmentsandoneUnionTerritory(UT of Puducherry) formanagement of their publicdebt

FLOATATIONOFSDLs.•  Under Article 293(3) of the Constitution of India (Under

section 48A of Union territories Act, in case of UnionTerritory)–  a State Government has to obtain the permission of theCentralGovernmentforanyborrowingaslongasthereisanyoutstandingloanthattheStateGovernmentmayhavefromtheCentre

•  Market borrowings are raised by the RBI on behalf of theStateGovernments–  to the extent of the allocations under the Market Borrowing

Programmeas approvedby theMinistry of Finance in consultationwiththePlanningCommission

FLOATATIONOFSDLs…contd.•  Before every auction, respective state governments issue specific

notifications indicating details of the securities being issued in theparticularauction.–  RBI places a press release on its website and also issues

advertisementsinleadingEnglishandvernacularnewspapersoftherespectivestates

•  Currently,SDLauctionsareheldonsecondandfourthTuesdayseverymonth.

•  AsincaseofCentralG-Secs,auctionisheldontheE-kuberPlatform.

•  10% of the notified amount is reserved for the retail investors under the non-competitivebidding

REPURCHASEOFG-SECs•  Repurchase(buyback)ofG-SecsisaprocesswherebytheGovernmentof

India and State Governments buy back their existing securities, byredeemingthemprematurely,fromtheholders.

•  Theobjectivesofbuybackcanbe

–  Reductionofcost(bybuyingbackhighcouponsecurities),–  Reductioninthenumberofoutstandingsecurities–  ImprovingliquidityintheG-Secsmarket(bybuyingbackilliquidsecurities)–  Infusionofliquidityinthesystem–  Effectivecashmanagementbyutilisingthesurpluscashbalances.

•  Fore.g.Repurchaseof twosecurities (7.59%2016worth₹ 9351.563crand7.02%2016worth₹6177.419cr)wasdonethroughreverseauctiononFebruary22,2016.

REPURCHASEOFG-SECs..contd•  StateGovernmentsgenerallybuy-backtheirhighcoupon(highcost

debt) bearing securities to reduce their interest outflows in thetimeswheninterestratesshowafallingtrend

•  Statesalsoretiretheirhighcostdebtpre-maturelyinordertofulfillsome of the conditions put by international lenders like AsianDevelopmentBank,WorldBanketc.tograntthemlowcostloans

•  Governmentsmake provisions in their budget for buying back ofexistingsecurities

•  Buyback can be done through an auction process (generally ifamount is large)orthroughthesecondarymarketroute, i.e.NDS-OM(ifamountisnotlarge)

MARKET SEGMENT

PRIMARY MARKET

SECONDARY MARKET

TRADINGING-SECs:SECONDARYMARKETFORGOVERNMENTSECURITIES

ThereisanactivesecondarymarketinG-Secs

Thesecuritiescanbe

bought/soldinthe

secondarymarketeither

through:

NegotiatedDealingSystem-OrderMatching(NDS-OM)(anonymousonlinetrading)

ThroughOvertheCounter(OTC)andreportedonNDS-OM

NDS-OM-Web

A.NDS-OM•  In August, 2005, RBI introduced an anonymous screen

basedordermatchingmodulecalledNDS-OM

•  This is an order driven electronic system, where theparticipantscantradeanonymouslybyplacingtheirorderson the system or accepting the orders already placed byotherparticipants

•  Anonymity ensures a level playing field for variouscategoriesofparticipants

•  NDS-OMisoperatedbytheCCILonbehalfoftheRBI

A.NDS-OM….contd.•  Directaccess to theNDS-OMsystem is currentlyavailableonly to

selectfinancialinstitutions–  likeCommercialBanks,PrimaryDealers,wellmanagedandfinancially

soundUCBsandNBFCs,etc

•  Otherparticipantscanaccessthissystemthroughtheircustodiansi.e.withwhomtheymaintainGiltAccounts–  Thecustodiansplacetheordersonbehalfoftheircustomers

•  Advantagesincludepricetransparencyandbetterpricediscovery

•  Gilt Account holders have been given indirect access to thereportingmoduleofNDS-OMthroughcustodianinstitutions

B.OvertheCounter(OTC)/TelephoneMarket

•  In this market, a participant, who wants tobuyorsellaG-Sec,maycontactabank/PD/financial institutioneitherdirectlyor througha broker registered with SEBI and negotiatepriceandquantityofsecurity

•  Such negotiations are usually done ontelephone and a deal may be struck if bothcounterpartiesagreeontheamountandrate

B.OvertheCounter(OTC)/TelephoneMarket….contd.

•  Inthecaseofabuyer, likeanUCBwishingtobuyasecurity,thebank'sdealer(whoisauthorizedbythebanktoundertaketransactions in G-Secs)may get in touchwith othermarketparticipantsovertelephoneandobtainquotes–  Shouldadealbestruck,thebankshouldrecordthedetailsofthetradeinadealslip

•  The dealer must exercise due diligence with regard to thepricequotedbyverifyingwithavailablesources

•  All trades undertaken in OTC market are reported on theReportedsegmentofNDS-OM

C.NDS-OMWEB•  RBI has launchedNDS-OM-Webon June 29, 2012 forfacilitating direct participation of gilt account holders(GAH)onNDS-OM–  through their primary members (PM) (as risk controlleronlyandnothavinganyroleinpricingoftrade).

•  TheGAHhaveaccesstothesameorderbookofNDS-OMasthePM

•  GAH are in a better position to control their orders(place/modify/cancel/hold/release)andhaveaccesstorealtimelivequotesinthemarket

C.NDS-OMWEB..contd.•  Sincenotificationsofordersexecutedaswell asvarious queries are available online to theGAH,theyarebetterplacedtomanagetheirpositions

•  Web based interface that leverages on the giltaccounts alreadymaintainedwith the custodianBanks/PDs provides an operationally efficientsystemtoretailparticipants

•  JustlikeNDS-OM,RBIprovidesthisfacilityalsoatnocosttoitsusers

D.STOCKEXCHANGE•  AsadvisedbySEBI,thestockexchanges(likeNSE,BSE,MCX)havebeenaskedto

creatededicateddebtsegmentintheirtradingplatforms

•  Incompliancetothis,stockexchangeshavelauncheddebttrading(G-Secsasalsocorporatebonds)segmentwhichgenerallycatertotheneedsofretailinvestors.

•  Theprocess involvedintradingofG-Secs inDematforminstockexchanges isasfollows:–  The Gilt Account Holder (GAH), say XYZ provident fund, approaches his

custodian bank, (say ABC ), to convert his CSGL holdings (to the extent hewishestotrade,say₹10,000),intoDematform.

–  ABC reduces the GAH’s security balance by ₹ 10,000 and advises thedepositoryofstockexchange(NSDL/CSDL)toincreaseXYZ’sDemataccountby₹10,000.

–  ABCalsoadvisestoPDO,MumbaitoreduceitsCSGLbalanceby₹10,000andincreasetheCSGLbalanceofNSDL/CSDLby₹10,000

–  NSDL/CSDLincreasestheDematbalanceofXYZby₹10,000–  XYZcannowtradeinG-Seconstockexchange.