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DEBT MARKETS
DEBT MARKETS:-

The debt market is the market where debt instruments are traded. Debt
instruments are assets that require a fixed payment to the holder, usually
with interest. Examples of debt instruments include bonds (government or
corporate) and mortgages

DEBT:-

A debt generally refers to money owed by one party, the borrower or debtor,
to a second party, the lender or creditor. Debt is generally subject to
contractual terms regarding the amount and timing of repayments of
principal and interest.

DEBENTURES:-

DEFINITION of 'Debenture'

A type of debt instrument that is not secured by physical assets or collateral.

Debentures are backed only by the general creditworthiness and reputation
of the issuer. Both corporations and governments frequently issue this type
of bond in order to secure capital. Like other types of bonds, debentures are
documented in an indenture.

TYPES OF DEBENTURES:-

The major types of debentures are as follows:

1.)Types Of Debentures On The Basis Of Record Point Of View

a. Registered Debentures
These are the debentures that are registered with the company. The amount
of such debentures is payable only to those debenture holders whose name

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appears in the register of the company.

b. Bearer Debentures
These are the debentures which are not recorded in a register of the
company. Such debentures are transferable merely by delivery. Holder of
bearer debentures is entitled to get the interest.

2. Types Of Debentures On The Basis Of Security

a. Secured Or Mortgage Debentures

These are the debentures that are secured by a charge on the assets of the
company. These are also called mortgage debentures. The holders of secured
debentures have the right to recover their principal amount with the unpaid
amount of interest on such debentures out of the assets mortgaged by the
company.

b. Unsecured Debentures
Debentures which do not carry any security with regard to the principal
amount or unpaid interest are unsecured debentures. These are also called
simple debentures.

3). Types Of Debentures On The Basis Of Redemption

a. Redeemable Debentures
These are the debentures which are issued for a fixed period. The principal
amount of such debentures is paid off to the holders on the expiry of such
period. These debentures can be redeemed by annual drawings or by
purchasing from the open market.

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b. Non-redeemable Debentures
These are the debentures which are not redeemed in the life time of the
company. Such debentures are paid back only when the company goes to
liquidation.

4). Types Of Debentures On The Basis Of Convertibility

a. Convertible Debentures
These are the debentures that can be converted into shares of the company
on the expiry of pre-decided period. The terms and conditions of conversion
are generally announced at the time of issue of debentures.

b. Non-convertible Debentures
The holders of such debentures cannot convert their debentures into the
shares of the company.

5.) Types Of Debentures On The Basis Of Priority

a. First Debentures
These debentures are redeemed before other debentures.

b. Second Debentures
These debentures are redeemed after the redemption of first debentures.

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CLASSIFICATION OF DEBT MARKETS:-

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.

BONDS-THE BOND MARKET:-

The bond market is where debt securities are issued and traded. The bond
market primarily includes government-issued securities and corporate debt
securities, and it facilitates the transfer of capital from savers to the issuers
or organizations that requires capital for government projects, business
expansions and ongoing operations. The bond market is alternatively
referred to as the debt, credit or fixed-income market. Although the bond
market appears complex, it is really driven by the same risk and return
tradeoffs as the stock market. Most trading in the bond market occurs over
the counter through organized electronic trading networks and is composed
of the primary market (through which debt securities are issued and sold by
borrowers to lenders) and the secondary market (through which investors
buy and sell previously issued debt securities among themselves). Although
the stock market often commands more media attention, the bond market is
actually many times bigger and is vital to the ongoing operation of the public
and private sectors.

The bond market can essentially be broken down into three main groups:
issuers, underwriters and purchasers.

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

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up of governments, banks and corporations. The biggest of these issuers is

the government, which uses the bond market to help fund a country's
operations. 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. The final major issuer is the corporate bond market, which
issues debt to finance corporate operations.

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
transacted in one offering. As a result, a lot of work needs to be done to
prepare for the offering, such as creating a prospectus and other legal
documents. In general, the need for underwriters is greatest for the
corporate debt market because there are more risks associated with this
type of debt.

The final players in the bond market are those who buy the debt. Buyers
basically include every group mentioned as well as any other type of
investor, including the individual. 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. For example, Japan is a major holder of U.S.
government debt.

Getting bond quotes and general information about a bond issue is

considerably more difficult than researching a stock or a mutual fund. There
is not a lot of individual investor demand for the information; most bond

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information is available only through higher level tools that are not
accessible to the average investor.

In most cases, if you have a brokerage account, you will have access to that
firm's research tools, which may include bond quotes and other information.
Your brokerage is therefore the first place that you should look for bond
information. However, there are also free tools available online that provide
some basic information such as the bond's current price, coupon rate, yield
to maturity (YTM), bond rating and other pertinent information. Online
services can be limited, however, if they do not give you the volume of
bonds that trade hands or a bid-ask spread, making it difficult to measure
the true price of the bond.

ADVANTAGES OF DEBT MARKET:-

The biggest advantage of investing in 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 debt market is its high liquidity. Banks

offer easy loans to the investors against government securities.

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DISADVANTAGES OF DEBT MARKET:-

As there are several advantages of investing in 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 INSTRUMENTS:-

A paper or electronic obligation that enables the issuing party to raise funds
by promising to repay a lender in accordance with terms of a contract. Types
of debt instruments include notes, bonds, certificates, mortgages, leases or
other agreements between a lender and a borrower.

FEATURES OF DEBT INSTRUMENT:-

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Each debt instrument has three features: Maturity, coupon and principal.

Maturity: Maturity of a bond refers to the date, on which the bond matures,
which is the date on which the borrower has agreed to repay the principal.
Term-to-Maturity refers to the number of years remaining for the bond to
mature. The Term-to-Maturity changes everyday, from date of issue of the
bond until its maturity. The term to maturity of a bond can be calculated on
any date, as the distance between such a date and the date of maturity. It is
also called the term or the tenure of the bond.

Coupon: Coupon refers to the periodic interest payments that are made by
the borrower (who is also the issuer of the bond) to the lender (the
subscriber of the bond). Coupon rate is the rate at which interest is paid, and
is usually represented as a percentage of the par value of a bond.

Principal: Principal is the amount that has been borrowed, and is also called
the par value or face value of the bond. The coupon is the product of the
principal and the coupon rate.

The name of the bond itself conveys the key features of a bond. For example,
a GS CG2008 11.40% bond refers to a Central Government bond maturing in
the year 2008 and paying a coupon of 11.40%. Since Central Government
bonds have a face value of Rs.100 and normally pay coupon semi-annually,
this bond will pay Rs. 5.70 as six- monthly coupon, until maturity.

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TYPES OF DEBT INSTRUMENTS:-

Bond

A bond, also sometimes called a fixed-income security, is a type of debt

instrument that memorializes a loan made by an investor to a corporate or
government entity. The loan is to be paid back over a period of time with a
fixed interest rate and is often secured to fund projects.

Types of bonds:-

Government Bonds :-
In general, fixed-income securities are classified according to the length of
time before maturity. These are the three main categories:

Bills - debt securities maturing in less than one year.

Notes - debt securities maturing in one to 10 years.

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Bonds - debt securities maturing in more than 10 years.

Marketable securities from the U.S. government - known collectively as

Treasuries - follow this guideline and are issued as Treasury bonds, Treasury
notes and Treasury bills (T-bills). Technically speaking, T-bills aren't bonds
because of their short maturity. (You can read more about T-bills in our
Money market. All debt issued by Uncle Sam is regarded as extremely safe,
as is the debt of any stable country. The debt of many developing countries,
however, does carry substantial risk. Like companies, countries can default
on payments.

Muncipal bonds:-
Municipal bonds, known as "munis", are the next progression in terms of risk.
Cities don't go bankrupt that often, but it can happen. The major advantage
to munis is that the returns are free from federal tax. Furthermore, local
governments will sometimes make their debt non-taxable for residents, thus
making some municipal bonds completely tax free. Because of these tax
savings, the yield on a muni is usually lower than that of a taxable bond.
Depending on your personal situation, a muni can be a great investment on
an after-tax basis.

Corporate Bonds:-
A company can issue bonds just as it can issue stock. Large corporations
have a lot of flexibility as to how much debt they can issue: the limit is
whatever the market will bear. Generally, a short-term corporate bond is less
than five years; intermediate is five to 12 years, and long term is over 12
years.

Corporate bonds are characterized by higher yields because there is a higher

risk of a company defaulting than a government. The upside is that they can

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also be the most rewarding fixed-income investments because of the risk the
investor must take on. The company's credit quality is very important: the
higher the quality, the lower the interest rate the investor receives.

Zero-Coupon Bonds
This is a type of bond that makes no coupon payments but instead is issued
at a considerable discount to par value. For example, let's say a zero-coupon
bond with a $1,000 par value and 10 years to maturity is trading at $600;
you'd be paying $600 today for a bond that will be worth $1,000 in 10 years.

Loan

A loan is a debt instrument where one party, the lender, gives another party,
the borrower, money, property, assets or materials goods on the basis of a
promise by the borrower that the loan will be repaid with interest and finance
charges. Loans may be an open-ended credit line with a limit, such as with
credit cards, or they may be a specific one-time loan, such as a loan to buy a
car. For larger loans, lenders may require that the loan be secured by
collateral property.

TYPES OF LOANS:-

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Loan types vary because each loan has a specific intended use. They can
vary by length of time, by how interest rates are calculated, by when
payments are due and by a number of other variables.

Student loans:-
Student loans are offered to college students and their families to help cover
the cost of higher education. There are two main types of student loans:
those offered by the federal government, and those offered by private
lenders. Federally funded loans are better, as they typically come with lower
interest rates and more borrower-friendly repayment terms.

Mortgage:-

Mortgages are loans distributed by banks to allow consumers to buy homes

they cant pay for upfront. A mortgage is tied to your home, meaning you
risk foreclosure if you fall behind on loan payments. Mortgages have among
the lowest interest rates of any loans.

Auto loans:

Like mortgages, auto loans are tied to your property. They can help you
afford a vehicle, but you risk losing the car if you miss payments. This type of
loan may be distributed by a bank or by the car dealership directly. While
loans from the dealership may be more convenient, they often cost more
overall.

Personal loans:-

Personal loans can be used for any personal expenses and dont have a
designated purpose. This makes them an attractive option for people with
outstanding debts, such as credit card debt, who want to reduce their
interest rates by transferring balances. Like other loans, personal loan terms
depend on your credit history.

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Loans of Veterans:-

The Department of Veterans Affairs (VA) has lending programs available to

veterans and their families. With a VA-backed home loan, money does not
come directly from the administration. Instead, the VA acts as a co-signer
and effectively vouches for you, helping you earn higher loan amounts with
lower interest rates.

Small business loans:-

Small business loans are granted to entrepreneurs and aspiring

entrepreneurs to help them start or expand a business. The best source of
small business loans is the U.S. Small Business Administration (SBA), which
offers a variety of loan types depending on each businesss needs.

Payday loans:-

Payday loans are short-term, high-interest loans designed to bridge the gap
from one paycheck to the next. They are predominantly used by repeat
borrowers living paycheck to paycheck. Because of the loans high costs, the
government strongly discourages their use.

Borrowing from retirement and Life insurance:-

Those with retirement funds or life insurance plans may be eligible to borrow
from their accounts. This option has the benefit that you are borrowing from
yourself, making repayment much easier and less stressful. However, in
some cases, failing to repay such a loan can result in tax consequences.

Consolidated Loans:-

A consolidated loan is a loan meant to simplify your finances. It is a loan that

pays off all or several of your other loans and debts, particularly credit card
debt. It means fewer monthly payments and lower interest rates.

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Consolidated loans are typically in the form of second mortgages or personal

loans.

Borrowing from friend and family;-

Borrowing money from friends and relatives is an informal type of loan. This
isnt always a good option, as it may strain a relationship. To protect both
parties, its a good idea to sign a basic promissory note.

Whenever you decide to borrow money whether it is to pay the bills or buy
a luxury item make sure you understand the agreement fully. Know what
type of loan youre receiving and whether it is tied to any of your belongings.

Also, familiarize yourself with your repayment terms: what your monthly
obligation will be, how long you have to repay the loan and the
consequences of missing a payment. If any part of the agreement is unclear
to you, dont hesitate to ask for clarifications or adjustments.

Mortgage

A mortgage is a secured lien or loan on residential property. The loan is

secured by the associated property. More specifically, if the borrower fails to
pay, the lender can take the property to fulfill the outstanding debt.

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TYPES OF MORTGAGE LOANS:-

There are many types of mortgages used worldwide, but several factors
broadly define the characteristics of the mortgage. All of these may be
subject to local regulation and legal requirements.

interest:

Interest may be fixed for the life of the loan or variable, and change at
certain pre-defined periods; the interest rate can also, of course, be
higher or lower.

term:

Mortgage loans generally have a maximum term, that is, the number of
years after which an amortizing loan will be repaid. Some mortgage loans
may have no amortization, or require full repayment of any remaining
balance at a certain date, or even negative amortization.

payment amount and frequency:

The amount paid per period and the frequency of payments; in some
cases, the amount paid per period may change or the borrower may have
the option to increase or decrease the amount paid.

prepayment:

Some types of mortgages may limit or restrict prepayment of all or a

portion of the loan, or require payment of a penalty to the lender for
prepayment.

The two basic types of amortized loans are the fixed rate mortgage (FRM)
and adjustable-rate mortgage (ARM) (also known as a floating rate or
variable rate mortgage). In some countries, such as the United States, fixed

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rate mortgages are the norm, but floating rate mortgages are relatively
common. Combinations of fixed and floating rate mortgages are also
common, whereby a mortgage loan will have a fixed rate for some period, for
example the first five years, and vary after the end of that period.

In a fixed rate mortgage, the interest rate, remains fixed for the life (or
term) of the loan. In case of an annuity repayment scheme, the
periodic payment remains the same amount throughout the loan. In
case of linear payback, the periodic payment will gradually decrease.

In an adjustable rate mortgage, the interest rate is generally fixed for a

period of time, after which it will periodically (for example, annually or
monthly) adjust up or down to some market index. Adjustable rates
transfer part of the interest rate risk from the lender to the borrower,
and thus are widely used where fixed rate funding is difficult to obtain
or prohibitively expensive. Since the risk is transferred to the borrower,
the initial interest rate may be, for example, 0.5% to 2% lower than the
average 30-year fixed rate; the size of the price differential will be
related to debt market conditions, including the yield curve.

Lease

A lease is an agreement between an owner of property and a tenant or

renter. A lease is a type of loan instrument because it secures a regular

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rent payment from the tenant to the owner, thereby creating a secured
long-term debt.

TYPES OF LEASE:-

Finance Lease and Operating Lease:

Finance lease, also known as Full Payout Lease, is a type of lease wherein the
lessor transfers substantially all the risks and rewards related to the asset to
the lessee. Generally, the ownership is transferred to the lessee at the end of
the economic life of the asset. Lease term is spread over the major part of
the asset life. Here, lessor is only a financier. Example of a finance lease is
big industrial equipment.

On the contrary, in operating lease, risk and rewards are not transferred
completely to the lessee. The term of lease is very small compared to
finance lease. The lessor depends on many different lessees for recovering
his cost. Ownership along with its risks and rewards lies with the lessor. Here,
lessor is not only acting as a financier but he also provides additional
services required in the course of using the asset or equipment. Example of
an operating lease is music system leased on rent with the respective
technicians.

Sale And Lease Back and Direct Lease:

In the arrangement of sale and lease back, the lessee sells his asset or
equipment to the lessor (financier) with an advanced agreement of leasing
back to the lessee for a fixed lease rental per period. It is exercised by the
entrepreneur when he wants to free his money, invested in the equipment or
asset, to utilize it at whatsoever place for any reason.

On the other hand, direct lease is a simple lease where the asset is
either owned by the lessor or he acquires it. In the former case, the lessor

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and equipment supplier are one and the same person and this case is called
bipartite lease. In bipartite lease, there are two parties. Whereas, in the
latter case, there are three different parties viz. equipment supplier, lessor,
and lessee and it is called tripartite lease. Here, equipment supplier and
lessor are two different parties.

Single Investor Lease and Leveraged Lease:

In single investor lease, there are two parties lessor and lessee. The lessor
arranges the money to finance the asset or equipment by way of equity or
debt. The lender is entitled to recover money from the lessor only and not
from the lessee in case of default by lessor. Lessee is entitled to pay the
lease rentals only to the lessor.

Leveraged lease, on the other hand, has three parties lessor, lessee and
the financier or lender. Equity is arranged by the lessor and debt is financed
by the lender or financier. Here, there is a direct connection of the lender
with the lessee and in case of default by the lessor; the lender is also entitled
to receive money from lessee. Such transactions are generally routed
through a trustee.

Domestic and International Lease:

When all the parties of the lease agreement reside in the same country, it is
called domestic lease.

International lease are of two types Import Lease and Cross Border Lease.
When lessor and lessee reside in same country and equipment supplier stays
in different country, the lease arrangement is called import lease. When the
lessor and lessee are residing in two different countries and no matter where
the equipment supplier stays, the lease is called cross border lease.

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TERM LOAN:

Generally, bank loans are short-term in nature, while bonds are very long-
term. An intermediate type of loan exists that is referred to as a term loan.
Term loans are particularly important to medium-sized firms; those that have
become too big to obtain all of their financing from their commercial bank,
but are not large enough to issue publicly-traded bonds. The typical term
loan is also of medium duration, typically between five and fifteen years.

While banks will make term loans of up to five years, they generally
prefer to make only short-term loans. This is due to the nature of the source
of financing of banks. Banks financing generally comes from deposits, which
are short-term, so they do not want to make long-term loans. However,
some of their funds (equity and long-term certificates of deposit) are long-
term in nature and provide the means by which longer term loans can be
made.

DIFFERENT NEEDS,DIFFERENT LOANS:-

1. Personal Loans
These loans are offered by most banks, and the proceeds may be used for
virtually any expense (from buying a new stereo system to paying off a
common bill). Typically, personal loans are unsecured, and range anywhere
from a few hundred to a few thousand dollars. As a general rule, lenders will
typically require some form of income verification, and/or proof of other
assets worth at least as much as the individual is borrowing. The application
for this type of loan is typically only one or two pages in length. Approvals (or
denials) are generally granted within a few days.

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The downside is that the interest rates on these loans can be quite high.
According to the Federal Reserve, they range from about 10-12%. The other
negative is that these loans sometimes must be repaid within two years,
making it impractical for individuals looking to finance large projects.

In short, personal loans (in spite of their high interest rates) are probably the
best way to go for individuals looking to borrow relatively small amounts of
money, and who are able to repay the loan within a couple of years.

2. Credit Cards
When consumers use credit cards, they are essentially taking out a loan with
the understanding that it will be repaid at some later date. Credit cards are a
particularly attractive source of funds for individuals (and companies)
because they are accepted by many - if not most - merchants as a form of
payment.

In addition, to obtain a card (and, by extension, $5,000 or $10,000 worth of

credit), all that\'s required is a one-page application. The credit review
process is also rather quick. Written applications are typically approved (or
denied) within a week or two. Online / telephone applications are often
reviewed within minutes. Also in terms of their use, credit cards are
extremely flexible. The money can be used for virtually anything these days
from paying college tuition to buying a drink at the local watering hole. (To
find out more about this process, see The Importance of Your Credit Rating.

There are definitely pitfalls, however. The interest rates that most credit-card
companies charge range as high as 20% per year. In addition, a consumer is
more likely to rack up debt using a credit card (as opposed to other loans)
because they are widely accepted as currency and because it\'s
psychologically easier to hand someone a credit card than to fork over the
same amount of cash.

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3. Home-Equity Loans
Homeowners may borrow against the equity they\'ve built up in their house
using a home-equity loan. In other words, the homeowner is taking a loan
out against the value of his or her home. A good method of determining the
amount of home equity available for a loan would be to take the difference
between the home\'s market value and the amount still owing on the
mortgage.

The loan proceeds may be used for any number of reasons, but are typically
used to build home additions, or for debt consolidation. The interest rates on
home-equity loans are very reasonable as well. In addition, the terms of
these loans typically range from 15 to 20 years, making them particularly
attractive for those looking to borrow large amounts of money. But, perhaps
the most attractive feature of the home-equity loan is that the interest is
usually tax deductible.

The downside to these loans is that consumers can easily get in over their
heads by mortgaging their homes to the hilt. Furthermore, home-equity loans
are particularly dangerous in situations where only one family member is the
breadwinner, and the family\'s ability to repay the loan might be hindered by
that person\'s death or disability. Even a 1% increase in interest rates could
mean the difference between losing and keeping your home if you rely too
heavily on this style of loan.

4. Home-Equity Line of Credit

This line of credit acts as a loan and is similar to home-equity loans in that
the consumer is borrowing against his or her home\'s equity. However, unlike
traditional home-equity loans, these lines of credit are revolving, meaning
that the consumer may borrow a lump sum, repay a portion of the loan, and
then borrow again. It\'s kind of like a credit card that has a credit limit based
on your home\'s equity! These loans may be tax deductible and are typically

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repayable over a period of 10 to 20 years, making them attractive for larger

projects.

Because specific amounts may be borrowed at different points in time, the

interest rate charged is typically pegged to some underlying index such as
the "prime rate". This is both good and bad in the sense that at some times,
the interest rates being charged may be quite low. However, during period of
rising rates, the interest charges on outstanding balances can be quite high.

There are other downsides as well. Because the amount that can be
borrowed can be quite large (typically up to $500,000 depending upon a
home\'s equity), consumers tend to get in over their heads. These consumers
are often lured in by low interest rates, but when rates begin to rise, those
interest charges begin racking up and the attractiveness of these loans starts
to wane.

5. Cash Advances
Cash advances are typically offered by credit-card companies as short-term
loans. Other entities, such as tax-preparation organizations, may offer
advances against an expected IRS tax refund or against future income
earned by the consumer.

While cash advances may be easy to obtain, there are many downsides to
this type of loan. For example:

They are not typically tax deductible.

Loan amounts are typically in the hundreds of dollars, making them

impractical for many purchases, particularly large ones.

The effective interest rate charges and related fees can be very high.

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In short, cash advances are a fast alternative for obtaining money (funds are
typically available on the spot), but because of the numerous pitfalls, they
should be considered only as a last resort. (Learn more about cash advances
in Payday Loans Don\'t Pay)

6. Small Business Loans

The Small Business Administration (SBA) or your local bank typically extend
small business loans to would-be entrepreneurs, but only after they\'ve
submitted (and received approval for) a formal business plan. The SBA and
other financial institutions typically require that the individual personally
guarantee the loan, which means that they will probably have to put up
personal assets as collateral in case the business fails. Loan amounts can
range from a few thousand to a few million dollars, depending on the
venture.

While the term of the loan may vary from institution to institution, typically,
consumers will have between five and 25 years to repay the loans. The
amount of interest incurred from the loan depends on the lending institution
in which the loan is made. Keep in mind that borrowers can negotiate with
the lending institution with regard to the level of interest charged. However,
there are some loans on the market that offer a variable rate.

Small business loans are the way to go for anyone looking to fund a new or
existing business. However, be forewarned: getting a business plan approved
by the lending institution may be difficult. In addition, many banks are

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unwilling to finance "cash businesses" because their books (ie. tax records)
often do not accurately reflect the health of the underlying business.

MONEY MARKET INSTRUMENTS:-

The money market is the arena in which financial institutions make available
to a broad range of borrowers and investors the opportunity to buy and sell
various forms of short-term securities. There is no physical "money market."
Instead it is an informal network of banks and traders linked by telephones,
fax machines, and computers. Money markets exist both in the United States
and abroad.

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The short-term debts and securities sold on the money marketswhich are
known as money market instrumentshave maturities ranging from one day
to one year and are extremely liquid. Treasury bills, federal agency notes,
certificates of deposit (CDs), eurodollar deposits, commercial paper, bankers'
acceptances, and repurchase agreements are examples of instruments. The
suppliers of funds for money market instruments are institutions and
individuals with a preference for the highest liquidity and the lowest risk.

The money market is important for businesses because it allows companies

with a temporary cash surplus to invest in short-term securities; conversely,
companies with a temporary cash shortfall can sell securities or borrow funds
on a short-term basis. In essence the market acts as a repository for short-
term funds. Large corporations generally handle their own short-term
financial transactions; they participate in the market through dealers. Small
businesses, on the other hand, often choose to invest in money-market
funds, which are professionally managed mutual funds consisting only of
short-term securities.

TYPES OF MONEY MARKET INSTRUMENTS:-

Treasury bills

Treasury bills (T-bills) are short-term notes issued by the U.S. government.
They come in three different lengths to maturity: 90, 180, and 360 days. The
two shorter types are auctioned on a weekly basis, while the annual types

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are auctioned monthly. T-bills can be purchased directly through the auctions
or indirectly through the secondary market. Purchasers of T-bills at auction
can enter a competitive bid (although this method entails a risk that the bills
may not be made available at the bid price) or a noncompetitive bid. T-bills
for noncompetitive bids are supplied at the average price of all successful
competitive bids.

Federal agency notes

Some agencies of the federal government issue both short-term and long-
term obligations, including the loan agencies Fannie Mae and Sallie Mae.
These obligations are not generally backed by the government, so they offer
a slightly higher yield than T-bills, but the risk of default is still very small.
Agency securities are actively traded, but are not quite as marketable as T-
bills. Corporations are major purchasers of this type of money market
instrument.

Short term tax exempts

These instruments are short-term notes issued by state and municipal

governments. Although they carry somewhat more risk than T-bills and tend
to be less negotiable, they feature the added benefit that the interest is not
subject to federal income tax. For this reason, corporations find that the
lower yield is worthwhile on this type of short-term investment.

Certificate of deposit

Certificates of deposit (CDs) are certificates issued by a federally chartered

bank against deposited funds that earn a specified return for a definite
period of time. They are one of several types of interest-bearing "time
deposits" offered by banks. An individual or company lends the bank a

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certain amount of money for a fixed period of time, and in exchange the
bank agrees to repay the money with specified interest at the end of the
time period. The certificate constitutes the bank's agreement to repay the
loan. The maturity rates on CDs range from 30 days to six months or longer,
and the amount of the face value can vary greatly as well. There is usually a
penalty for early withdrawal of funds, but some types of CDs can be sold to
another investor if the original purchaser needs access to the money before
the maturity date.

Large denomination (jumbo) CDs of $100,000 or more are generally

negotiable and pay higher interest rates than smaller denominations.
However, such certificates are only insured by the FDIC up to $100,000.
There are also eurodollar CDs; they are negotiable certificates issued against
U.S. dollar obligations in a foreign branch of a domestic bank. Brokerage
firms have a nationwide pool of bank CDs and receive a fee for selling them.
Since brokers deal in large sums, brokered CDs generally pay higher interest
rates and offer greater liquidity than CDs purchased directly from a bank.

Commercial paper

Commercial paper refers to unsecured short-term promissory notes issued by

financial and nonfinancial corporations. Commercial paper has maturities of
up to 270 days (the maximum allowed without SEC registration
requirement). Dollar volume for commercial paper exceeds the amount of
any money market instrument other than T-bills. It is typically issued by
large, credit-worthy corporations with unused lines of bank credit and
therefore carries low default risk.

Standard and Poor's and Moody's provide ratings of commercial paper. The
highest ratings are A1 and P1, respectively. A2 and P2 paper is considered
high quality, but usually indicates that the issuing corporation is smaller or

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more debt burdened than A1 and P1 companies. Issuers earning the lowest
ratings find few willing investors.

Unlike some other types of money-market instruments, in which banks act as

intermediaries between buyers and sellers, commercial paper is issued
directly by well-established companies, as well as by financial institutions.
Banks may act as agents in the transaction, but they assume no principal
position and are in no way obligated with respect to repayment of the
commercial paper. Companies may also sell commercial paper through
dealers who charge a fee and arrange for the transfer of the funds from the
lender to the borrower.

Bankers acceptance

A banker's acceptance is an instruments produced by a nonfinancial

corporation but in the name of a bank. It is document indicating that such-
and-such bank shall pay the face amount of the instrument at some future
time. The bank accepts this instrument, in effect acting as a guarantor. To be
sure the bank does so because it considers the writer to be credit-worthy.
Bankers' acceptances are generally used to finance foreign trade, although
they also arise when companies purchase goods on credit or need to finance
inventory. The maturity of acceptances ranges from one to six months.

Repurchase agreements

Repurchase agreementsalso known as repos or buybacksare Treasury

securities that are purchased from a dealer with the agreement that they will
be sold back at a future date for a higher price. These agreements are the
most liquid of all money market investments, ranging from 24 hours to
several months. In fact, they are very similar to bank deposit accounts, and
many corporations arrange for their banks to transfer excess cash to such
funds automatically.

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CRUSH SPREAD:-

The CRUSH spread study is a futures transaction that parallels the process of
producing bean oil (BO) and soymeal (SM) from soybeans (S). This study will
only work with S, BO, and SM contracts on a daily chart.

The CRUSH study is similar to the CRACK spread used for crude oil. Soybeans
are the raw material used to produce bean oil (BO) and soymeal (SM).
However, the ratio for this spread is 1:1:1. One bushel of soybeans produces
one unit of soymeal and one unit of bean oil. The products soybeans produce
are measured in liquid and dry weights. However, the end result from
processing soybeans into its chief products is a 1:1:1 ratio.

The basic calculation is a simple one that is made somewhat more

complicated because the quantities are given in different units of mass,
volume and price. Soybean contracts are quoted in cents per bushel, Bean
Oil is quoted in cents per pound and Soymeal is quoted in dollars per short
ton. Since the crushing process produces 11 pounds of oil per bushel of
soybeans, this price is converted to cents per bushel by multiplying by 11.
No price conversion is necessary because both trade in cents.

Soybean meal is quoted in dollars per short ton, a price conversion must be
made (dollars to cents), then a mass conversion must be made (short tons to
pounds) finally a conversion from mass to volume. First the price is multiplied
100 (dollars to cents,) next a short ton of Soybean meal is converted to
pounds by dividing by 2000 (short tons to pounds,) finally, since the crushing

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process produces 44 pounds of soybean meal per bushel of soybeans, the

price is converted to bushels by multiplying by 44. This is equivalent to
multiplying by 2.2 (2.2 = 100/2000*44). This results in the following
expression:

%S * 1 + %SM * 2.2 * 1 + %BO * 11 * 1

PURPOSE OF CRUSH SPREAD:-

The soybean processor will be interested in the crush spread as part of its
hedging strategy, traders as part of its risk management strategy,
speculators will look at the crush spread for trading opportunities.

Soybeans processors can use the crush spread in order to lock in a gross
profit margin, and cover the risk of adverse price fluctuation: inflation of
soybeans inputs and deflation of outputs such as soybean mean and
soybean oil.

Traders use soybean crush spreads as a risk management strategy by

"combining soybean, soybean oil and soybean meal futures positions, into a
single position". The spread position is then used to hedge the margin
between soybean futures, and soybean oil and meal futures".

CALCULATION OF CRUSH SPREAD:-

On average, one unit of soybeans produces 80% soybean meal, 18.3%

soybean oil, and 1.7% waste, though growing conditions affect oil yields. To
calculate the crush margin of one unit of soybeans, take the % value of the
soybean meal and oil futures (e.g., in CNY/metric ton purchased on the

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Dalian Commodity Exchange) and subtract the value of the soybeans (e.g., in
USD/bushel purchased on the Chicago Board of Trade)

Crush Margin = Soybean Meal x 80% + Soybean Oil x 18.3%

Soybeans

This requires making to conversionsfrom bushels to metric tons and from

USD to CNY. The unit of the crush margin is CNY/mt.

INTERPRETATION:-

The soybean crush spread represents the margin soybean processors might
capture by using the futures markets to hedge their positions. Analyze this
chart much like another spread chart. Do not forget seasonal factors that
might influence the price spread.

You are looking for overvalued and undervalued market conditions. Find the
predominant market trend. Watch for divergence between the products,
soybean oil and soybean meal, and the raw material, soybeans. Processors
try to maintain their margins in spite of market conditions and trends.

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The same analysis theory for a CRACK spread applies to the CRUSH spread. If
the spread for soybeans and its products (bean oil and soymeal) is narrow,
the profit potential leans in the direction of the bean oil and soymeal
contracts. This is a sign that the cost to process soybeans is too high to
produce any appreciable profit.

The opposite is true, however, if a large span appears. The processors push
to sell bean oil and soymeal to reap the profits. This aggressive push almost
guarantees that the product prices will be forced down to meet the soybean
prices.

CRACK SPREAD:-

Crack spread is a term used in the oil industry and futures trading for the
differential between the price of crude oil and petroleum products extracted
from it - that is, the profit margin that an oil refinery can expect to make by
"cracking" crude oil (breaking its long-chain hydrocarbons into useful shorter-
chain petroleum products.

In the futures markets, the "crack spread" is a specific spread trade involving
simultaneously buying and selling contracts in crude oil and one or more
derivative products, typically gasoline and heating oil. Oil refineries may
trade a crack spread to hedge the price risk of their operations, while
speculators attempt to profit from a change in the oil/gasoline price
differential.

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FACTORS AFFECTING CRACK SPREAD:-

One of the most important factors affecting the crack spread is the relative
proportion of various petroleum products produced by a refinery. Refineries
produce many products from crude oil, including gasoline, kerosene, diesel,
heating oil, aviation fuel, asphalt and others. To some degree, the proportion
of each product produced can be varied in order to suit the demands of the
local market. Regional differences in the demand for each refined product
depend upon the relative demand for fuel for heating, cooking or
transportation purposes. Within a region, there can also be seasonal
differences in demand for heating fuel versus transportation fuel.

The mix of refined products is also affected by the particular blend of crude
oil feedstock processed by a refinery, and by the capabilities of the refinery.
Heavier crude oils contain a higher proportion of heavy hydrocarbons
composed of longer carbon chains. As a result, heavy crude oil is more
difficult to refine into lighter products such as gasoline. A refinery using less
sophisticated processes will be constrained in its ability to optimize its mix of
refined products when processing heavy oil.

FUTURES TRADING:-

For integrated oil companies that control their entire supply chain from oil
production to retail distribution of refined products, there is a natural
economic hedge against adverse price movements. For independent oil
refiners which purchase crude oil and sell refined products in the wholesale
market, adverse price movements can present a significant economic risk.
Given a target optimal product mix, an independent oil refiner can attempt to
hedge itself against adverse price movements by buying oil futures and

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selling futures for its primary refined products according to the proportions of
its optimal mix.

For simplicity, most refiners wishing to hedge their price exposures have
used a crack ratio usually expressed as X:Y:Z where X represents a number
of barrels of crude oil, Y represents a number of barrels of gasoline and Z
represents a number of barrels of distillate fuel oil, subject to the constraint
that X=Y+Z. This crack ratio is used for hedging purposes by buying X
barrels of crude oil and selling Y barrels of gasoline and Z barrels of distillate
in the futures market. The crack spread X:Y:Z reflects the spread obtained
by trading oil, gasoline and distillate according to this ratio. Widely used
crack spreads have included 3:2:1, 5:3:2 and 2:1:1. As the 3:2:1 crack spread
is the most popular of these, widely quoted crack spread benchmarks are the
"Gulf Coast 3:2:1" and the "Chicago 3:2:1".

Various financial intermediaries in the commodity markets have tailored their

products to facilitate trading crack spreads. For example, NYMEX offers
virtual crack spread futures contracts by treating a basket of underlying
NYMEX futures contracts corresponding to a crack spread as a single
transaction. Treating crack spread futures baskets as a single transaction has
the advantage of reducing the margin requirements for a crack spread
futures position. Other market participants dealing over the counter provide
even more customized products.

The following discussion of crack spread contracts comes from the Energy
Information Administration publication Derivatives and Risk Management in
the Petroleum, Natural Gas, and Electricity Industries: Refiners profits are
tied directly to the spread, or difference, between the price of crude oil and
the prices of refined products. Because refiners can reliably predict their
costs other than crude oil, the spread is their major uncertainty. One way in
which a refiner could ensure a given spread would be to buy crude oil futures
and sell product futures. Another would be to buy crude oil call options and

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sell product call options. Both of those strategies are complex, however, and
they require the hedger to tie up funds in margin accounts.

To ease this burden, NYMEX in 1994 launched the crack spread contract.
NYMEX treats crack spread purchases or sales of multiple futures as a single
trade for the purposes of establishing margin requirements. The crack spread
contract helps refiners to lock-in a crude oil price and heating oil and
unleaded gasoline prices simultaneously in order to establish a fixed refining
margin. One type of crack spread contract bundles the purchase of three
crude oil futures (30,000 barrels) with the sale a month later of two unleaded
gasoline futures (20,000 barrels) and one heating oil future (10,000 barrels).
The 3-2-1 ratio approximates the real-world ratio of refinery output2 barrels
of unleaded gasoline and 1 barrel of heating oil from 3 barrels of crude oil.
Buyers and sellers concern themselves only with the margin requirements for
the crack spread contract. They do not deal with individual margins for the
underlying trades.

An average 3-2-1 ratio based on sweet crude is not appropriate for all
refiners, however, and the OTC market provides contracts that better reflect
the situation of individual refineries. Some refineries specialize in heavy
crude oils, while others specialize in gasoline. One thing OTC traders can
attempt is to aggregate individual refineries so that the traders portfolio is
close to the exchange ratios. Traders can also devise swaps that are based
on the differences between their clients situations and the exchange
standards.

YIELD TO MATURITY:-

The Yield to maturity (YTM), book yield or redemption yield of a bond or other
fixed-interest security, such as gilts, is the internal rate of return(IRR, overall
interest rate) earned by an investor who buys the bond today at the market
price, assuming that the bond will be held until maturity, and that all coupon

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and principal payments will be made on schedule. Yield to maturity is the

discount rate at which the sum of all future cash flows from the bond
(coupons and principal) is equal to the price of the bond. The YTM is often
given in terms of Annual Percentage Rate (A.P.R.), but more usually market
convention is followed. In a number of major markets (such as gilts) the
convention is to quote annualised yields with semi-annual compounding (see
compound interest; thus, for example, an annual effective yield of 10.25%
would be quoted as 10.00%, because 1.05 x 1.05 = 1.1025.[

MAIN ASSUMPTION:- The main underlying assumptions used concerning the

traditional yield measures are:

The bond will be held to maturity.

All coupon and principal payments will be made on schedule.

All the coupons are reinvested at an interest rate equal to the yield-to-
maturity. However, the paper Yield-to-Maturity and the Reinvestment
of Coupon Payments says making this assumption is a common
mistake in financial literature and coupon reinvestment is not required
for YTM formula to hold.

The reason for the confusion is this: The YTM is equivalent to a price in
the market place. You can bid a 5% YTM on a bond. In that case each
cash flow will be discounted at that rate to give you a current number
price for a bond. However if you take that price for the bond and
annualize it at the YTM you will not get the same economic return as
you would get from buying and holding the bond. For example, the
paper cited above discounts the cash flows of a 5 year 5% coupon
bond at a YTM rate of 5% and shows that the current price is par.
However, if you buy a 5 year 5% coupon bond for $100 you would
gross $125 at maturity. However if you invest $100 at a rate of 5% for

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5 years you would gross: 100 * 1.05^5 = $127.63. The difference

between $127.63 and $125 is the reinvestment of the coupon
payments at 5%. Therefore if you want to compound the dollar amount
used to purchase a bond by the YTM, you will have to reinvest the
coupons at the YTM rate as well.

The yield is usually quoted without making any allowance for tax paid
by the investor on the return, and is then known as "gross redemption
yield". It also does not make any allowance for the dealing costs
incurred by the purchaser (or seller).

COUPON RATE VS YTM:

If a bond's coupon rate is less than its YTM, then the bond is selling at
a discount.

If a bond's coupon rate is more than its YTM, then the bond is selling at
a premium.

If a bond's coupon rate is equal to its YTM, then the bond is selling at
par.

VARIENTS OF YIELD TO MATURITY:-

As some bonds have different characteristics, there are some variants of

YTM:

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Yield to call (YTC): when a bond is callable (can be repurchased by the

issuer before the maturity), the market looks also to the Yield to call,
which is the same calculation of the YTM, but assumes that the bond
will be called, so the cashflow is shortened.

Yield to put (YTP): same as yield to call, but when the bond holder has
the option to sell the bond back to the issuer at a fixed price on
specified date.

Yield to worst (YTW): when a bond is callable, puttable, exchangeable,

or has other features, the yield to worst is the lowest yield of yield to
maturity, yield to call, yield to put, and others.

FORMULA WITH EXAMPLES:-

Example 1
Consider a 30-year zero-coupon bond with a face value of $100. If the bond
is priced at an annual YTM of 10%, it will cost $5.73 today (the present value
of this cash flow, 100/(1.1)30 = 5.73). Over the coming 30 years, the price will
advance to $100, and the annualized return will be 10%.

What happens in the meantime? Suppose that over the first 10 years of the
holding period, interest rates decline, and the yield-to-maturity on the bond
falls to 7%. With 20 years remaining to maturity, the price of the bond will be
100/1.0720, or $25.84. Even though the yield-to-maturity for the remaining
life of the bond is just 7%, and the yield-to-maturity bargained for when the
bond was purchased was only 10%, the return earned over the first 10 years

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is 16.25%. This can be found by evaluating (1+i) from the equation (1+i)10 =
(25.842/5.731), giving 1.1625.

Over the remaining 20 years of the bond, the annual rate earned is not
16.25%, but rather 7%. This can be found by evaluating (1+i) from the
equation (1+i)20 = 100/25.84, giving 1.07. Over the entire 30 year holding
period, the original $5.73 invested increased to $100, so 10% per annum
was earned, irrespective of any interest rate changes in between.

Example 2
You buy ABC Company bond which matures in 1 year and has a 5% interest
rate (coupon) and has a par value of $100. You pay $90 for the bond.

The current yield is 5.56% (5/90).

If you hold the bond until maturity, ABC Company will pay you $5 as interest
and $100 par value for the matured bond.

Now for your $90 investment, you get $105, so your yield to maturity is
16.67% [= (105/90)-1] or [=(105-90)/90].

INTEREST:- Interest is a fee paid by a borrower of assets to the owner as a

form of compensation for the use of the assets. It is most commonly the
price paid for the use of borrowed money, or money earned by deposited
funds.

When money is borrowed, interest is typically paid to the lender as a

percentage of the principal, the amount owed to the lender. The percentage
of the principal that is paid as a fee over a certain period of time (typically
one month or year) is called the interest rate. A bank deposit will earn
interest because the bank is paying for the use of the deposited funds.
Assets that are sometimes lent with interest include money, shares,
consumer goods through hire purchase, major assets such as aircraft, and

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even entire factories in finance lease arrangements. The interest is

calculated upon the value of the assets in the same manner as upon money.

Interest is compensation to the lender, for a) risk of principal loss, called

credit risk; and b) forgoing other investments that could have been made
with the loaned asset. These forgone investments are known as the
opportunity cost. Instead of the lender using the assets directly, they are
advanced to the borrower. The borrower then enjoys the benefit of using the
assets ahead of the effort required to pay for them, while the lender enjoys
the benefit of the fee paid by the borrower for the privilege. In economics,
interest is considered the price of credit.

Interest is often compounded, which means that interest is earned on prior

interest in addition to the principal. The total amount of debt grows
exponentially, most notably when compounded at infinitesimally small
intervals, and its mathematical study led to the discovery of the number
However, in practice, interest is most often calculated on a daily, monthly, or
yearly basis, and its impact is influenced greatly by its compounding rate.

HISTORY

According to historian Paul Johnson, the lending of "food money" was

commonplace in Middle East civilizations as far back as 5000 BC. They
regarded interest as legitimate since acquired seeds and animals could
"reproduce themselves"; whilst the ancient Jewish religious prohibitions
against usury ( NeSheKh) were a "different view". On this basis, the Laws
of Eshnunna (early 2nd millennium BC) instituted a legal interest rate,

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specifically on deposits of dowry, since the silver being used in exchange for
livestock or grain could not multiply of its own.

The First Council of Nicaea, in 325, forbade clergy from engaging in usury
which was defined as lending on interest above 1 percent per month (12.7%
APR. Ninth century ecumenical councils applied this regulation to the laity.
Catholic Church opposition to interest hardened in the era of scholastics,
when even defending it was considered a heresy. St. Thomas Aquinas, the
leading theologian of the Catholic Church, argued that the charging of
interest is wrong because it amounts to "double charging", charging for both
the thing and the use of the thing.

In the medieval economy, loans were entirely a consequence of necessity

(bad harvests, fire in a workplace) and, under those conditions, it was
considered morally reproachable to charge interest.It was also considered
morally dubious, since no goods were produced through the lending of
money, and thus it should not be compensated, unlike other activities with
direct physical output such as blacksmithing or farming. For the same
reason, interest has often been looked down upon in Islamic civilization, with
most scholars agreeing that the Qur'an explicitly forbids charging interest.

Medieval jurists developed several financial instruments to encourage

responsible lending and circumvent prohibitions on usury, such as the
Contractum trinius.Of Usury, from Brant's Stultifera Navis (the Ship of Fools) ;
woodcut attributed to Albrecht Drer

In the Renaissance era, greater mobility of people facilitated an increase in

commerce and the appearance of appropriate conditions for entrepreneurs
to start new, lucrative businesses. Given that borrowed money was no longer
strictly for consumption but for production as well, interest was no longer
viewed in the same manner. The School of Salamanca elaborated on various
reasons that justified the charging of interest: the person who received a

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loan benefited, and one could consider interest as a premium paid for the
risk taken by the loaning party.

There was also the question of opportunity cost, in that the loaning party lost
other possibilities of using the loaned money. Finally and perhaps most
originally was the consideration of money itself as merchandise, and the use
of one's money as something for which one should receive a benefit in the
form of interest. Martn de Azpilcueta also considered the effect of time.
Other things being equal, one would prefer to receive a given good now
rather than in the future. This preference indicates greater value. Interest,
under this theory, is the payment for the time the loaning individual is
deprived of the money.

Economically, the interest rate is the cost of capital and is subject to the laws
of supply and demand of the money supply. The first attempt to control
interest rates through manipulation of the money supply was made by the
French Central Bank in 1847.

The first formal studies of interest rates and their impact on society were
conducted by Adam Smith, Jeremy Bentham and Mirabeau during the birth of
classic economic thought. In the late 19th century leading Swedish
economist Knut Wicksell in his 1898 Interest and Prices elaborated a
comprehensive theory of economic crises based upon a distinction between
natural and nominal interest rates. In the early 20th century, Irving Fisher
made a major breakthrough in the economic analysis of interest rates by
distinguishing nominal interest from real interest. Several perspectives on
the nature and impact of interest rates have arisen since then.

The latter half of the 20th century saw the rise of interest-free Islamic
banking and finance, a movement that attempts to apply religious law
developed in the medieval period to the modern economy. Some entire
countries, including Iran, Sudan, and Pakistan, have taken steps to eradicate

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interest from their financial systems altogetherRather than charging interest,

the interest-free lender shares the risk by investing as a partner in profit loss
sharing scheme, because predetermined loan repayment as interest is
prohibited, as well as making money out of money is unacceptable. All
financial transactions must be asset-backed and it does not charge any "fee"
for the service of lending.

TYPES OF INTEREST:- Simple interest is calculated only on the principal

amount, or on that portion of the principal amount that remains.

The amount of simple interest is calculated according to the following

formula:

where r is the period interest rate (I/m), B0 the initial balance and mt the
number of time periods elapsed.

To calculate the period interest rate r, one divides the interest rate I by the
number of periods mt.

For example, imagine that a credit card holder has an outstanding balance of
$2500 and that the simple interest rate is 12.99% per annum. The interest
added at the end of 3 months would be,

and they would have to pay $2581.19 to pay off the balance at this point.

If instead they make interest-only payments for each of those 3 months at

the period rate r, the amount of interest paid would be,

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Their balance at the end of 3 months would still be $2500.

In this case, the time value of money is not factored in. The steady payments
have an additional cost that needs to be considered when comparing loans.
For example, given a $100 principal:

Credit card debt where $1/day is charged: 1/100 = 1%/day = 7%/week

= 365%/year.

Corporate bond where the first $3 are due after six months, and the
second $3 are due at the year's end: (3 + 3)/100 = 6%/year.

Certificate of deposit (GIC) where $6 is paid at the year's end: 6/100

= 6%/year.

There are two complications involved when comparing different simple

interest bearing offers.

1. When rates are the same but the periods are different a direct
comparison is inaccurate because of the time value of money. Paying
$3 every six months costs more than $6 paid at year end so, the 6%
bond cannot be 'equated' to the 6% GIC.

2. When interest is due, but not paid, does it remain 'interest payable',
like the bond's $3 payment after six months or, will it be added to the
balance due? In the latter case it is no longer simple interest, but
compound interest.

A bank account that offers only simple interest, that money can freely be
withdrawn from is unlikely, since withdrawing money and immediately
depositing it again would be advantageous.

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Composition of interest rates

In economics, interest is considered the price of credit, therefore, it is also
subject to distortions due to inflation. The nominal interest rate, which refers
to the price before adjustment to inflation, is the one visible to the consumer
(i.e., the interest tagged in a loan contract, credit card statement, etc.).
Nominal interest is composed of the real interest rate plus inflation, among
other factors. A simple formula for the nominal interest is:

Where i is the nominal interest, r is the real interest and is inflation.

This formula attempts to measure the value of the interest in units of stable
purchasing power. However, if this statement were true, it would imply at
least two misconceptions. First, that all interest rates within an area that
shares the same inflation (that is, the same country) should be the same.
Second, that the lenders know the inflation for the period of time that they
are going to lend the money.

One reason behind the difference between the interest that yields a treasury
bond and the interest that yields a mortgage loan is the risk that the lender
takes from lending money to an economic agent. In this particular case, a
government is more likely to pay than a private citizen. Therefore, the
interest rate charged to a private citizen is larger than the rate charged to
the government.

To take into account the information asymmetry aforementioned, both the

value of inflation and the real price of money are changed to their expected
values resulting in the following equation:

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Here, it is the nominal interest at the time of the loan, r(t+1) is the real interest
expected over the period of the loan, (t+1) is the inflation expected over the
period of the loan and is the representative value for the risk engaged in
the operation.

CUMULATIVE OR COMPUND INTEREST RATES:-

The calculation for cumulative interest or compound interest is as follows:

Cumulative Interest or Compound Interest = A-P(1+r/100)n (n show

power), where

A= Absolute Value

P=Primary Value

r=rate of interest (rate may be quarterly,four monthly ,half yearly and

yearly)

n=number of terms in a year interest compounded (If interest is

compounded after 3 months then n=4; if interest is compounded after
4 months then n=3; if interest is compounded after 6 months then n=2
and if interest is compounded after 12 months or 1 year then n=1)

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CREDIT RATING

DEFINITION of 'Credit Rating'

An assessment of the credit worthiness of a borrower in general terms or

with respect to a particular debt or financial obligation. A credit rating can be
assigned to any entity that seeks to borrow moneyan individual,
corporation, state or provincial authority, or sovereign government. Credit
assessment and evaluation for companies and governments is generally
done by a credit rating agency such as Standard & Poors, Moodys or Fitch.
These rating agencies are paid by the entity that is seeking a credit rating for
itself or for one of its debt issues.

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History of Credit Ratings

Moody's was the first agency to issue publicly available credit ratings for
bonds, in 1909, and other agencies followed suit in the decades after. These
ratings didn't have a profound effect on the market until 1936, when a new
rule was passed that prohibited banks from investing in speculative bonds, or
those with low credit ratings, to avoid the risk. This practice was quickly
adopted by other companies and financial institutions, and relying on credit
ratings became the norm.

Why Credit Ratings Are Important?

Credit ratings for borrowers are based on substantial due

diligence conducted by the rating agencies. While a borrower will strive to
have the highest possible credit rating since it has a major impact on interest
rates charged by lenders, the rating agencies must take a balanced and
objective view of the borrowers financial situation and capacity to
service/repay the debt.

A credit rating not only determines whether or not a borrower will be

approved for a loan, but also the interest rate at which the loan will need to
be repaid. Since companies depend on loans for many start-up and other
expenses, being denied a loan could spell disaster, and a high interest rate is
much more difficult to pay back. Credit ratings also play a large role in a
potential buyer's determining whether or not to purchase bonds. A poor
credit rating is a risky investment; it indicates a larger probability that the
company will not pay off its bonds. For more on why a high credit rating is
essential for a business.

It is important for a borrower to remain diligent in maintaining a high credit

rating. Credit ratings are never static, in fact, they change all the time based
on the newest data, and one negative debt will bring down even the best

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score. Credit also takes time to build up. If an entity has good credit but a
short credit history, that isn't seen as positively as the same quality of credit
but with a long history. Debtors want to know a borrower can maintain good
credit consistently over time.

Credit rating changes can have a significant impact on financial markets. A

prime example of this effect is the adverse market reaction to the credit
rating downgrade of the U.S. federal government by Standard & Poors on
August 5, 2011. Global equity markets plunged for weeks following the
downgrade.

Factors Affecting Credit Ratings and Credit Scores

There are a few factors credit agencies take into consideration when
assigning a credit rating for an organization. First, the agency considers the
entity's past history of borrowing and paying off debts. Any missed payments
or defaults on loans negatively impact the rating. The agency also looks at
the entity's future economic potential. If the economic future looks bright,
the credit rating tends to be higher; if the borrower does not have a positive
economic outlook, the credit rating will fall.

For individuals, the credit rating is conveyed by means of a numerical credit

score that is maintained by Equifax, Experian and other credit-reporting
agencies. A high credit score indicates a stronger credit profile and will
generally result in lower interest rates charged by lenders. There are a
number of factors that are taken into account for an individual's credit score,
including payment history, amounts owed, length of credit history, new
credit, and types of credit. Some of these factors have greater weight than
others. Details on each credit factor can be found in a credit report, which

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typically accompanies a credit score. For a more detailed description of each

credit factor.

Short-Term vs. Long-Term Credit Ratings

A short-term credit rating reflects the likelihood of the borrower defaulting

within the year. This type of credit rating has become the norm in recent
years, whereas in the past, long-term credit ratings were more heavily
considered. Long-term credit ratings predict the borrower's likelihood of
defaulting at any given time in the extended future.

Corporate credit ratings

Credit ratings that concern corporations are usually of a corporation's

financial instruments i.e. debt security such as a bond, but corporations
themselves are also sometimes rated. Ratings are assigned by credit rating
agencies, the largest of which are Standard & Poor's, Moody's and Fitch
Ratings. They use letter designations such as A, B, C. Higher grades are
intended to represent a lower probability of default.

Agencies do not attach a hard number of probability of default to each grade,

preferring descriptive definitions such as: "the obligor's capacity to meet its
financial commitment on the obligation is extremely strong," or "less
vulnerable to non-payment than other speculative issues ..." (Standard and
Poors' definition of a AAA rated and a BB rated bond respectively). However,
some studies have estimated the average risk and reward of bonds by rating.
One study by a rating service (Moody's) claimed that over a "5-year time
horizon" bonds it gave its highest rating (Aaa) to had a "cumulative default
rate" of just 0.18%, the next highest (Aa2) 0.28%, the next (Baa2) 2.11%,
8.82% for the next (Ba2), and 31.24% for the lowest it studied (B2). (See
"Default rate" in "Estimated spreads and default rates by rating grade" table

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to right.) Over a longer time horizon it stated "the order is by and large, but
not exactly, preserved".

Another study in Journal of Finance calculated the additional interest rate or

"spread" corporate bonds pay over that of "riskless" US Treasury bonds,
according to the bonds rating. (See "Basis point spread" in table to right.)
Looking at rated bonds from 197389, the authors found a AAA rated bond
paid only 43 "basis points" (or 43/100th of a percentage point) over a
Treasury bond (so that it would yield 3.43% if the Treasury yielded 3.00%). A
CCC-rated "junk" (or speculative) bond on the other hand, paid over 4% (404
basis points) more than a Treasury on average over that period.

Different rating agencies may use variations of an alphabetical combination

of lower and upper case letters, with either plus or minus signs or numbers
added to further fine tune the rating (see colored chart). The Standard &
Poor's rating scale uses upper case letters and pluses and minuses. The
Moody's rating system uses numbers and lower case letters as well as upper
case.

While Moody's, S&P and Fitch Ratings control approximately 95% of the
credit ratings business, they are not the only rating agencies. DBRS's long-
term ratings scale is somewhat similar to Standard & Poor's and Fitch Ratings
with the words high and low replacing the + and . It goes as follows, from
excellent to poor: AAA, AA(high), AA, AA(low), A(high), A, A(low), BBB(high),
BBB, BBB(low), BB(high), BB, BB(low), B(high), B, B(low), CCC(high), CCC,
CCC(low), CC(high), CC, CC(low), C(high), C, C(low) and D. The short-term
ratings often maps to long-term ratings though there is room for exceptions
at the high or low side of each equivalent.

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S&P, Moody's, Fitch and DBRS are the only four ratings agencies that are
recognized by the European Central Bank for the purposes of determining
collateral requirements for banks to borrow from the central bank. The ECB
uses a first, best rule among the four agencies that have the designated ECAI
status. That means that it takes the highest rating among the four - S&P,
Moody's, Fitch and DBRS - to determine haircuts and collateral requirements
for borrowing. Ratings in Europe have been under close scrutiny, particularly
the highest ratings given to countries like Spain, Ireland and Italy because it
affects how much banks can borrow against sovereign debt they hold.

A. M. Best rates from excellent to poor in the following manner: A++, A+, A,
A, B++, B+, B, B, C++, C+, C, C, D, E, F, and S. The CTRISKS rating
system is as follows: CT3A, CT2A, CT1A, CT3B, CT2B, CT1B, CT3C, CT2C and
CT1C. All these CTRISKS grades are mapped to one-year probability of
default.

rating
Moody's S&P Fitch
description

Long- Short- Long- Short- Long- Short-

term term term term term term

Aaa AAA AAA Prime

Aa1 AA+ AA+

A-1+ F1+
Aa2 AA AA High grade
P-1
Aa3 AA AA

A1 A+ A+
A-1 F1 Upper medium
A2 A A
grade
A3 A A-2 A
P-2 F2
Baa1 BBB+ BBB+ Lower medium

Baa2 P-3 BBB BBB F3 grade

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Baa3 BBB A-3 BBB

Ba1 BB+ BB+ Non-investment

Ba2 BB BB grade

Ba3 BB BB speculative
B B
B1 B+ B+

B2 B B Highly speculative

B3 B B

Caa1 CCC+ CCC+

Not
Caa2 CCC CCC Substantial risks
Prime
Caa3 CCC CCC
C C
Extremely
CC CC
Ca speculative

C C Default imminent

C RD DDD

/ SD D DD D In default

/ D D

Credit rating agencies

In addition to "the Big Three" of Moody's, Standard & Poor's, and Fitch
Ratings, other agencies and rating companies include (in alphabetical order):

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Agusto & Co. Nigeria, A. M. Best (U.S.), China Chengxin Credit Rating Group
(China), Shanghai Brilliance Credit Rating & Investors Service Co.,Ltd (China),
Credit Rating Agency Ltd (Zambia),Credit Rating Information and Services
Limited (Bangladesh), CTRISKS (Hong Kong), Dagong Europe Credit Rating
(Italy), DBRS (Canada), Dun & Bradstreet (U.S.), Egan-Jones Rating Company
(U.S.), Global Credit Ratings Co. (South Africa), HR Ratings (Mexico), PACRA
Limited (Pakistan) ICRA Limited (India), Japan Credit Rating Agency (Japan),
Levin and Goldstein (Zambia), Morningstar, Inc. (U.S.), Muros Ratings (Russia,
alternative rating company), Public Sector Credit Solutions (U.S., not-for
profit rating provider), Rapid Ratings International (U.S.), RusRating (Russia),
Universal Credit Rating Group (Hong Kong), Veda (Australia, previously
known as Baycorp Advantage), Wikirating (Switzerland, alternative rating
organization), Humphreys Ltd (Chile, previously known as Moodys Partner in
Chile), Credit Research Initiative (Singapore, non-profit rating provider).

TOP 10 CREDIT RATING AGENCIES IN INDIA:-

Here is a list of top 10 credit rating agencies in India; these are the best
companies in credit rating industry providing risk assessment, ratings and
analytic solutions. Ranking process of these credit rating agencies in India is
frequently being updated by our expert team.
1 | Crisil Limited
Corporate office Mumbai, Maharashtra | Establishment 1987 |
Business Credit Rating, Risk & Policy Advisory | Website www.crisil.com
|
CRISIL headquartered at Mumbai is Indias largest and first credit rating
agency; and a global leader in research, ratings and risk & policy advisory
services. It is one of the top credit rating agency in India which has won
many prestigious awards in the credit rating category and had assessed
more than 61000 entities.

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2 | Credit Information Bureau India Limited -(CIBIL)

Corporate office Mumbai, Maharashtra | Establishment 2000 |
Business Credit Rating information | Website www.cibil.com |
CIBIL headquartered at Mumbai is an Credit Information Company which
maintains records of an individuals payments related to credit cards and
loans. The information about users credit cards and loans is later used by the
CBIL to generate Credit information reports which are used to approve loan
applications.

3 | Fitch Ratings India Private Ltd.

Corporate office New York, USA | Establishment 1913 |
Business Financial Information Services | Website www.fitchratings.com
|
Fitch Ratings, a Fitch Group company is a among the top credit rating
agencies in India incorporated in 1913 in New York, USA. Fitch Ratings
provides financial information services in more than 30 countries and has
over 2000 employees working at 50+ offices worldwide.
4| Equifax
Corporate office Atlanta, United States | Establishment 1899 |
Business Credit rating | Website www.equifax.co.in |
Equifax Inc started operations in 1899 and has managed to be among the
top credit rating agencies in India and at global level. Equifax Inc provides
information management services that process thousands of records of its
members which can be used by them for various purposes and to supply risk
management solutions, credit risk management and analysis, fraud
detection triggers, decision technologies, marketing tools etc.

5 | Credit Analysis & Research Ltd. (CARE)

Corporate office Mumbai, Maharashtra | Establishment 1993 |
Business Credit Rating | Website www.careratings.com |
CARE Ratings is second-largest among the credit rating agencies in India as

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far as Indian origin company is concerned. CAREs rating businesses can be

divided into various segments like for banks, IPO grading and sub-
sovereigns. Companys shareholders includes leading domestic banks and
financial institutions in India.

6| ICRA Limited
Corporate office Gurgaon, Haryana | Establishment 1991 |
Business Investment Information and Credit Rating | Website
www.icra.in |
ICRA limited is a joint venture between Moodys Investors and various
financial services companies is a part of ICRA group which was founded in
1991. It is a Credit rating agency listed on the National Stock Exchange and
Bombay Stock Exchange. ICRA has four subsidiaries ICRA Management
Consulting Services Ltd, ICRA Techno Analytics Ltd, ICRA Online Ltd, PT. ICRA
Indonesia and ICRA Lanka Ltd.
7| ONICRA
Corporate office Gurgaon, Haryana | Establishment 1993 |
Business Research, Risk & Ratings | Website www.onicra.com |
Onicra Credit Rating Agency is a Credit and Performance Rating company
based in Gurgaon and founded in 1993. Onicra is among the top 10 credit
rating agencies in India offering smart and innovative solutions like risk
assessment, analytical solutions and ratings to MSMEs, corporate and
individuals.

8| High Mark Credit Information Services

Corporate office Mumbai, Maharashtra | Establishment 2005 |
Business Financial Services | Website www.highmark.in |
High Mark Credit Information Services is a recognized credit rating company
in India. It provides bureau services, analytic solutions and risk management
to banks and financial institutions operating in Micro-finance, Retail
consumer finance, MSME, Rural & Cooperative Sectors.

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9|SME Rating Agency of India Ltd. (SMERA)

Corporate office -Mumbai, Maharashtra | Establishment 2005 |
Business | Website www.smera.in |
SMERA Ratings Ltd a Mumbai based company now expanded to 13 more
locations was founded in year 2005. SMERA a joint venture of SIDBI, several
private sector banks in the country and Dun & Bradstreet Information
Services India Pvt. Ltd. (D&B). Since 2005 SMERA rated over 23,000 MSMEs
pan India.
10| Brickwork Ratings India Private Ltd
Corporate office Bengaluru, Karnataka | Establishment 2007 |
Business | Website www.brickworkratings.com |
Brickwork Ratings was established in 2007 by Sangeeta Kulkarni as a credit
rating firm. ndThe company is registered with SEBI, RBI & NSIC and operates
in wide range of areas such as NCD, Bank Loan, Commercial paper, MSME
ratings. It is among the leading credit rating companies in India having
already rated Rs 200,000 crores of bonds and bank loans.

ADVANTAGES OF CREDIT RATING AGENCIES:-

(1) Lower cost of borrowing:

A company with highly rated instrumet has the opportunity to reduce the
cost of borrowing from the public by quoting lesser interest on fixed deposits
or debentures or bonds as the investors with low risk preference would come
forward to invest in safe securities though yielding marginally lower rate of
return.

(2) Wider audience for borrowing:

A company with a highly rated instrument can approach the investors

extensively for the resource mobilisation using the press media. Investors in
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different strata of the society could be attracted by higher rated instrument

as the investors understands the degree of certainty about timely payment
of interest and principal on a debt instrument with better rating.

(3) Rating as marketing tool:

Companies with rated instrument improve their own image and avail of the
rating as a marketing tool to create better image in dealing with its
customers feel confident in the utility products manufactured by the
companies carrying higher rating for their credit instruments.

(4) Reduction of cost in public issues:

A company with higher rated instrument is able to attract the investors and
with least efforts can raisefunds. Thus, the rated company can economise
and minimise cost of public issues by controlling expenses on media
coverage, conferences and other publicity stunts and gimmicks. Rating
facilitates best pricing and timing of issues.

(5) Motivation for growth:

Rating provides motivation to the company for growth as the promotors feel
confident in their own efforts and are encouraged to undertake expansion of
their operations or new projects.

With better image created though higher credit rating the company can
mobilise funds from public and instructions or banks from self assessment of

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its own status which is subject to self-discipline and self-improvement, it can

perceive and avoid sickness.

(6) Unknown issuer:

Credit rating provides recognition to a relatively unknown issuer while

entering into the market through wider investor base who rely on rating
grade rather than on name recognition.

(7) Benefits to brokers and financial intermediaries:

Highly rated instruments put the brokers at an advantage to make less

efforts in studying the companys credit position to convince their clients to
select an investment proposal.

This enables brokers and other financial intermediaries to save time, energy,
costs and manpower in convincing their clients about investment in any
particular instrument.

DIS-ADVANTAGES OF CREDIT RATING AGENCIES:-

(1) Biased rating and misrepresentations:

In the absence of quality rating, credit rating is a curse for the capital market
industry, carrying out detailed analysis of the company, should have no links
with the company or the persons interested in the company so that the
reports impartial and judicious recommendations for rating committee.The
companies having lower grade rating do not advertise or use the rating while
raising funds from the public. In such cases the investor cannot get
information about the riskness of instrument and hence is at loss.

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(2) Static study:

Rating is done on the present and the past historic data of the company and
this is only a static study. Prediction of the companys health through rating
is momentary and anything can happen after assignment of rating symbols
to the company.

Dependence for future results on the rating, therefore defeats the very
purpose of risk indicativeness of rating. Many changes take place in
economic environment, political situation, government policy framework
which directly affect the working of a company.

(3) Concealment of material information:

Rating Company might conceal material information from the investigating

team of the credit rating company. In such cases quality of rating suffers and
renders the rating unreliable.

(4) Rating is no guarantee for soundness of company:

Rating is done for a particular instrument to assess the credit risk but it
should not be construed as a certificate for the matching quality of the
company or its management. Independent views should be formed by the
user public in general of the rating symbol.

(5) Human bias:

Finding off the investigation team, at times, may suffer with human bias for
unavoidable personal weakness of the staff and might affect the rating.

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(6) Reflection of temporary adverse conditions:

Time factor affects rating, sometimes, misleading conclusions are derived.

For example, company in a particular industry might be temporarily in
adverse condition but it is given a low rating. This adversely affects the
companys interest.

(7) Down grade: Once a company has been rated and if it is not able to
maintain its working results and performance, credit rating agencies would
review the grade and down grade the rating resulting into impairiring the
image of the company.

(8) Difference in rating of two agencies:

Rating done by the two different credit rating agencies for the same
instrument of the same issuer company in many cases would not be
identical. Such differences are likely to occur because of value judgement
differences on qualitative aspects of the analysis in tow different agencies.

Conclusion

The debt market plays an important role in efficient

mobilization and allocation of resources in the economy,
financing the development activities of government,

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transmitting signals for implementation of monetary

policy, facilitating liquidity management in tune with
overall short term and long term objectives

BIBLOGRAPHY

The information was collected from internet, also particular books

of debt markets where refer for the collection of information.

www.google.com

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www.investopidia.com

www.wikipidea.com

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