Fixed Income Securities

Debt Market : How it works ?

Session -1

By: Vivek Rajvanshi

Session Plan
Session

Topic

Details

1-2-3

Fixed Income Products

Introduction to the properties and features of fixed

income products; yield, duration & convexity; yield
curves & forward rates; zero coupon bonds. Popular
models for the spot rate.

4-5-6

Investment Management

Mean-Variance Portfolio; Market timing and stock

selection abilities of managers; Black-Litterman Model

7-8

Stochastic Calculus

9-10

Options Pricing

Introduction to martingales, Brownian motion, Ito

integrals and Itos formula, in both the uni-variate and
multi-variate case.
Black-Scholes PDE: simple European calls and puts:
put-call parity. The PDE for pricing commodity and
currency options. Discontinuous payoffs Binary and
Digital options.
2

Why Debt Market?

Asset Classes
Which asset classes are used by the managers to
allocate funds for the investment perspective?
Instruments or Promissory Notes, featuring:
Issuer
Maturity date
Face value
Example:
T-bills, Bonds, CDs etc.

Why we need such instruments for financing?

4

Advantages of Bonds over Stocks

Bonds, a more conservative investment instrument
than stocks, offer some attractive features:

Safety
Reliable income
Potential for capital gains
Diversification (especially for an otherwise all-equity
portfolio)

Safety of Bonds
The safety of bonds derives mainly from two things:
Bondholders are in line ahead of both preferred and
common stockholders for payment. Thus, if a firm falls on
hard times, it must first pay its bondholders while
stockholders may see dividends cut.
In the event that a company skips a payment or violates
covenants of the indenture, the creditors may force it into
bankruptcy to protect the value of their investment.
Stockholders have no such right.

Reliability of Income
Most bonds are fixed-income securities. As such, they
promise a fixed set of interest payments and the return of
the principal at maturity.
Investors can count on receiving their interest payments in
full and on time, except in the event of severe financial
distress. Common stockholders can never be sure of the
exact amount (and sometimes the exact timing) of
dividends.

Bonds that are callable do not offer as much reliability,

though it is still far better than stocks.

Why Government/Corporates Issues Debt

Securities?

How Government Finance Fiscal Deficit

Gross fiscal deficit FY 2012-13 (RE)
5,20,925 (5.2 per cent of GDP)

Financing
Market Borrowings Issuance of Dated Securities
Repayments
New borrowing

Net Issuance of T-bills

External Assistance (ADB etc.)

Securities against Small Savings (NSC etc.)

Source: Controller General of Accounts (CGA), www.cga.nic.in

All figures in Rs. crore

How Government finance Fiscal Deficit

Central Government Outstanding Debt at End-Mar 2013
Outstanding (Rs.
Variable
Cr)
A. Public Debt
40,83,040
1. Internal Debt
37,18,633
Marketable
(a) Treasury Bills
2,99,763
(i) 91-days Treasury Bills
1,05,096
(ii) 182-days Treasury Bills
64,196
(iii) 364-days Treasury Bills
1,30,471
(iv) Cash Management Bills
0.0
(b) Dated Securities
30,60,713
Non-marketable
(i) 14-days Treasury Bills
88,316
(ii) Securities Issued to NSSF (RD, NSC, PPF)
2,07,294
(iii) Compensation and other bonds
30,157
(iv) Securities issued to International Financial Institutions
32,389
2. External Debt

3,64,407

Source: Min of Fin, GoI, www.finmin.nic.in

Figures are in crore

(%)

91.08%
7.34%
2.57%
1.57%
3.20%
0.00%
74.96%
8.77%

8.92%

10

How Firms Finance Themselves

Internal financing
Retained earnings
Depreciation

(31%)
(21%)
(10%)

External financing

Issuing new equity

Bank loans
Issuing bonds
Foreign borrowings
Current liabilities

(68%)
(14%)
(18%)
(04%)
(03%)
(25%)

Source: Banerji et al. (2012) New thinking on corporate bond

market in India

11

Debt Route a Big Hit

IPO in debt was introduced in 2009
Provide a better source of funds to corporations,
especially when market sentiments are bad in equity
market
IPO offering
FY09
FY10
FY11
FY12
FY13
FY14

Equity
2034
46941
46182
23989
8663
6528

Debt
1500
2500
9431
35611
16980
42383

Source: RBI Annual Report & Handbook of Statistics, SEBI

12

Indian Debt Market: How it Works?

13

Indian Debt Market: A Broad Classification

(1) Call/notice money market
"Call Money" means deals in overnight funds
"Notice Money" means deals in funds for 2 - 14 days
Term Money means deals in funds for 15 days-1 year
Products: T-bills , CDs ,Commercial Paper , CBLOs etc.

(2) Bond market

14

Indian Debt Market: A Broad Classification..contd

Bond market
1. Government Securities or Gilts
Issued by the central government to fund their fiscal deficit also
called direct dated securities
Indirect government securities
Issued by central government in lieu of subsidies
E.g., oil bonds, fertilizer bonds
Do not qualify for the statutory requirements

2. State development loans (SDL)

Issued by the state governments

3. Corporate Bonds
Issued by private and public sector companies

Examples: Zero coupon/deep discount bonds, fixed interest

bonds, floating rate bonds etc.
15

Participants
Banks
SLR Requirements (21.25%)

Insurance Companies
Regulatory requirements
LIC has to allocate 60% if its annual incremental investments in GSecs. while GIS and its subsidiaries - 40%

Provident Funds
Regulatory requirements
Percentage of their incremental accretions need to be invested
25% in GoI G-Secs., 15%- State Govt. Secs., 40% in PSU bonds and max of
10% in private sector debentures

16

Participants..contd
Primary Dealers (PDs)
Objectives
Strengthening institutional infrastructure
To make G-Secs. market more vibrant, liquid and broad based
To ensure the development of underwriting and market making
capabilities

Obligations

Annual bidding commitment- participate in securities auctions

Underwriting the primary issuance
Offering quotes (act as a market maker)
Providing market information to the Central Bank

Benefits
Access to call money market as borrower and lender
Extended liquidity support by RBI
17

Other Participants

Mutual funds
Trusts
Corporate Treasuries
PSUs Treasuries
FIIs

18

Holding Pattern of G-Securities

Category

Commercial Banks

7.53%
1.20%
2.78%

Insurance Companies

7.19%

34.50%

RBI
Bank-PDs

9.38%

Provident Funds
Cooperative Banks
Corporates

18.22%

Jun-13

Commercial Banks

34.50

Insurance Companies

19.20

RBI

18.22

Bank-PDs

9.38

Provident Funds

7.19

Cooperative Banks

2.78

Corporates

1.20

Others

7.53

Others
19.20%

Total

Source: RBI Bulletin

100.00

Data Source for FIMs

RBI
CCIL
FIMMDA
NSE & BSE
BIS
Bloomberg
Reuters
Debt Management Deptt, Ministry of Finance, GoI

20

Data Source for FIMs

http://www.smartmoney.com/bonds/
This site contains a good source for current rates, the current and past yield
curves, and explanations of how the shape of the yield curve can affect
economic performance. It also has a summary of current economic factors
that are influencing rates.
http://www.bondresources.com/
The site listed above has price and yield curve information and the ability
to chart Treasury securities over time.
http://www.bloomberg.com/markets
The site listed above has price and yield curve information and the ability
to chart Treasury securities over time.
http://www.investinginbonds.com
The site listed above has price and yield curve information and the ability
to chart Treasury securities over time.
http://www.stls.frb.org/
Historical information on interest rates and other economic factors are
available in the Federal Reserve Economic Data Base (FRED) at the
address shown above. Data in FRED can be downloaded in a spreadsheet
format.
21

Thank You!

22