CHAPTER 1: INTRODUCTION

1) FINANCIAL MARKET IN INDIA

2) DEBTS MARKET
3) DEBT INSTRUMENT – DEFINITION, HISTORY,
UNDERSTANDING,FEATURES, IMPORTANCE, ADVANRAGES,
DISADVANTAGES PRESENT USE
4) SEBI
FINANCIAL MARKETS IN INDIA

Financial markets in India comprise the money market Government securities market,
capital market, insurance market, and the foreign exchange market. Recently, the
derivatives market has also emerged1 . With banks having already been allowed to
undertake insurance business, bane assurance market has also emerged in a big way.
Till the early 1990s most of the financial markets were characterized by controls over
the pricing of financial assets, restrictions on flows or transactions, barrier to entry,
low liquidity and high transaction costs. These characteristics came in the way of
development of the markets and allocative efficiently of resources channeled through
them. From 1991 onward, financial market reforms have emphasized the
strengthening of the price discovery process easing restrictions on transactions,
reducing transaction costs and enhancing systemic liquidity. 5.1 Classification of
Financial Markets 2 Financial markets are classified in different ways, which are
given below: 1. On the Basis of Claim on Financial Assets. 2. On the Basis of
Maturity of the claims. 3. On the basis of Existing claim or New Claim. 4. On the
Basis of Domicile.

A. On the Basis of Claim on financial Assets: The claims traded in a financial market
may be for either a fixed amount or a residual amount. Based on claim on financial
assets, financial markets are following two types: Equity market and Debt Market.

B. On the Basis of Maturity of the Claims4 : Another way of classifying financial

markets is on the basis of maturity/period of the claims. Based on this, financial
markets are following two types: Money market and Capital market.

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D. On the Basis of Domicile6 : Another way of classifying financial markets is on the
basis of domicile. Based on domicile way of classifying financial markets is on the
basis of domicile. Based on domicile financial markets can be divided into two viz.
International Market and Domestic Market.

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 DEBT MARKET

India never had a Junk Bond King like Michael Milken of the US who became
famous for packaging high-risk, high-yield bond bundles and selling them. At the
peak of his career in 1980s, he was reportedly earning hundreds of millions of dollars
a year by creating a junk bond market. In 1989 though he got indicted for securities
fraud and sentenced to several years in prison. After serving his sentence and coming
out of prison, Milken had refashioned himself as a financial consultant and
philanthropist.

However, as is becoming apparent, India does have a flourishing junk bond market
though it never had someone like Milken to package it and sell it and popularise it.
Also, they might be junk bonds in their characteristics, but they are not called that -
instead they go by the far more staid name of high-yield bonds or high-yield debt.
And the appetite for them has been quite high, as evidence points out.

There are of course some differences between Indian companies that issue them and
the generally accepted class of junk bonds in the US. In India, quite a few high yield
bonds were not considered particularly risky - the paper was largely issued by big,
reputed brand names, and were often initially graded with triple A or equivalent credit
ratings.

There were other kinds too - clearly high-risk bonds with low credit ratings that were
issued, but most of these were generally marketed to overseas investors. These were
high yield bonds that were recognised as high risk as well. A Reuters report suggests
that issuance of such bonds by Indian companies in global markets hit a record high in
2019, the last peak being in 2014.

However, there is a crucial difference here. Quite a few of these bonds - which have
varying tenures - have essentially been issued by very well-known and reputed
companies in India. In many cases, they offer a higher yield to global investors but are
still low cost funds for these companies as borrowing from the Indian market would
have been costlier. One big commodity company and another big steel manufacturer
raised big funds using this route. The sheer difference between Indian interest rates
and interest rates in the US allows Indian companies to offer better yield, even after

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factoring in exchange rate risks, to global investors while still accessing cheaper funds
than they would have otherwise.

But, it is the other kind of junk bonds that is far more interesting. These are bonds and
papers issued by top notch corporate and banking and financial names, which turned
sour almost overnight. There was a huge appetite for these bonds in the domestic
market itself because these companies and organisations were considered too solid
and too big to fail. Credit rating agencies were often behind the curve when it came to
downgrading their debt. And in some cases, the rating downgrade happened only after
a default had taken place or after the bad news about an impending default or a
company's deteriorating finances came to light. In most cases, the credit rating of the
debt went from triple A or equivalent to junk status overnight.

This is what has made the Indian corporate paper market so dangerous. Bankers,
mutual funds and others who had happily subscribed to these papers under the
impression that they were investing or loaning to rock solid securities found out one
day suddenly that the paper had turned junk. Fitch, for example, has decided to
downgrade the ratings for ICICI and Axis Banks to junk status. Zee group debt used
to be considered gold plated because of the group's overall functioning until their
infrastructure bets turned sour. Dewan Housing's chairman and managing director
Kapil Wadhawan was considered a star manager till fairly recently because of the way
he had grown the organisation - until the music stopped suddenly. IL&FS of course
was in a class by itself - often considered a quasi government organisation and an
infrastructure funding company par excellence until it came out that it had been
fudging its accounts for a long, long time.

It is all these that makes the Indian debt market more dangerous than perhaps the
bond market in the US. It will take some time before the current crisis settles down.

Increasing the Liquidity in Corporate Bond Market has been a major agenda for the
Government and for the Capital market authorities for long now. Various efforts in
the forms of reforms, change in guidelines and making availability of the required
infrastructure has been made in the direction but still the efforts does not seem to give
the expected results when it comes to the participation retails investors in Corporate

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Bond Market India. . One of the major reasons of the non-participation has been lack
of sufficient awareness on the part of retail Investors. This paper tries to measure the
awareness level about the Corporate Bonds and also the reasons for the non-
participation of the retail investors in the Primary and Secondary Markets of
Corporate Bond Market, with the help of data collected and its statistical analysis.

The bond market (also debt market or credit market) is a financial market where

participants can issue new debt, known as the primary market, or buy and sell
debt securities, known as the secondary market. This is usually in the form of bonds,
but it may include notes, bills, and so on.

Its primary goal is to provide long-term funding for public and private expenditures.
The bond market has largely been dominated by the United States, which accounts for
about 39% of the market. As of 2017, the size of the worldwide bond market (total
debt outstanding) is estimated at $100.13 trillion, according to Securities Industry and
Financial Markets Association (SIFMA).

The bond market is part of the credit market, with bank loans forming the other main
component. The global credit market in aggregate is about 3 times the size of the
global equity market. Bank loans are not securities under the Securities and Exchange
Act, but bonds typically are and are therefore more highly regulated. Bonds are
typically not secured by collateral (although they can be), and are sold in relatively
small denominations of around $1,000 to $10,000. Unlike bank loans, bonds may be
held by retail investors. Bonds are more frequently traded than loans, although not as
often as equity.

Nearly all of the average daily trading in the U.S. bond market takes place
between broker-dealers and large institutions in a decentralized over-the-
counter (OTC) market.[2] However, a small number of bonds, primarily corporate
ones, are listed on exchanges. Bond trading prices and volumes are reported on
FINRA's Trade Reporting and Compliance Engine, or TRACE.

An important part of the bond market is the government bond market, because of its

size and liquidity. Government bonds are often used to compare other bonds to
measure credit risk. Because of the inverse relationship between bond valuation and
interest rates (or yields), the bond market is often used to indicate changes in interest
rates or the shape of the yield curve, the measure of "cost of funding". The yield on

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government bonds in low risk countries such as the United States or Germany is
thought to indicate a risk-free rate of default. Other bonds denominated in the same
currencies (U.S. Dollars or Euros) will typically have higher yields, in large part
because other borrowers are more likely than the U.S. or German Central
Governments to default, and the losses to investors in the case of default are expected
to be higher. The primary way to default is to not pay in full or not pay on time.

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 DEFINITION

In most of the countries, the debt market is more popular than the equitymarket. This i
s due to the sophisticated bond instruments that have return-reaping assets as their und
erlying. In the

US, for instance, the corporatebonds (like mortgage bonds) became popular in the 198
0s. However, inIndia, equity markets are more popular than the debt markets due to th
edominance of the government securities in the debt markets.Moreover, the governme
nt is borrowing at a pre-announced coupon ratetargeting a captive group of investors, 
such as banks. This, coupled withthe automatic monetization of fiscal deficit, prevente
d the emergence of adeep and vibrant government securities market.The bond markets 
exhibit a much lower volatility than equities, and allbonds are priced based on the sam
e macroeconomic information. Thebond market liquidity is normally much higher tha
n the stock marketliquidity in most of the countries. The performance of the market fo
r debt isdirectly related to the interest rate movement as it is reflected in theyields of g
overnment bonds, corporate debentures, MIBOR-relatedcommercial papers,and non-
convertible debentures

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 HISTORY

The debt is one of the most critical components in the financial system of any
economy and acts as the fulcrum of a modern financial system.The debt market in
most developed countries is many times bigger than the other financial markets
including the equity market. The US bond market is more than $13.5 trillion in size
with a turnover exceeding $500 billion daily representing the largest securities market
in the world. The size of the world bond markets is close to US $31.4 trillion which is
nearly equivalent to the total GDP of all countries in the world.The total size of the
Indian debt market is currently estimated to be in the range of US $92 billion to US
$100 billion. India’s debt market accounts for approximately 30 percent of its GDP.
The Indian bond market measured by the estimated value of bonds outstanding is next
only to the Japanese and Korean bond markets in Asia. The Indian debt market, in
terms of volume, is larger than the equity market. In terms of daily settled deal, the
debt and the forex markets market currently (2001-02) command a volume of Rs
25,000 crore against a meager Rs 1,200 crore in the equity markets (including equity
derivatives).

In the post reforms era, a fairly well segmented debt market has emerged comprising:

1.Private corporate debt market

2. Public sector undertaking bond market and

3. Government securities market

The government securities market accounts for more than 90 percent of the turnover
in the debt market. It constitutes the principal segment of the debt market.The Indian
debt market has traditionally been a wholesale market with participation restricted to
few institutional players – mainly banks. The banks were the major participants in the
government securities market due to statutory requirements. The turnover in the debt
markettoo was quite low a few hundred crores till the early 1990s. The debt market
was fairly underdeveloped due to the administrated interest rate regime and the
availability of investment avenues which gave a higher rate of return to investors.

In the early 1990s, the government needed a large amount of money for investment in
development and infrastructure projects. The government realized the need of a
vibrant, efficient and healthy debt market and undertook reform measures. The

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Reserve Bank put in substantial efforts to develop the government securities market
but its two segments, the private corporate debt market and public sector undertaking
bond market, have not yet fully developed in terms of volume and liquidity.It is debt
market which can provide returns commensurate to the risk, a variety of instruments
to match the risk and liquidity preferences of investors, greater safety and lower
volatility.

Hence the debt market has a lot of potential for growth in the future. The debt market
is critical to the development of a developing country like India which requires a large
amount of capital for achieving industrial and infrastructure growth.

Regulation of Debt Market: The Reserve Bank of India regulates the government
securities market and money market while the corporate debt market comes under the
purview of the Securities Exchange and Board of India (SEBI).In order to promote an
orderly development of the market, the government issued a notification on March 2,
2000 delineating the areas of responsibility between the Reserve Bank and SEBI. The
contracts for sale and purchase of government securities, gold related securities,
Money market securities and securities derived from these securities and ready
forward contracts in debt securities shall be regulated by the Reserve Bank. Such
contracts, if executed on the stock exchanges shall, however, be regulated by SEBI in
manner that is consistent with the guidelines issued by the Reserve Bank.

Link between Money Market and Debt Market:The money market is market dealing
in short term debt instruments (up to one year) while the debt market is a market for
long term instruments (more than one year) The money market supports the long term
debt market by increasing the liquidity of securities. A developed money market is a
prerequisite of the development of a debt market.

Characteristics of Debt Market:

The characteristics of an efficient debt market are a competitive market structure, low
transaction costs, a strong and safe market infrastructure and a high level of
heterogeneity among market participants.

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 UNDERSTANDING DEBT INSTRUMENTS

Any type of instrument primarily classified as debt can be considered a debt

instrument. Debt instruments are tools an individual, government entity, or business
entity can utilize for the purpose of obtaining capital. Debt instruments provide capital
to an entity that promises to repay the capital over time. Credit cards, credit lines,
loans, and bonds can all be types of debt instruments.

Typically, the term debt instrument primarily focuses on debt capital raised by
institutional entities. Institutional entities can include governments and both private
and public companies. For financial business accounting purposes, the Financial
Accounting Standards Board’s Generally Accepted Accounting Principles (GAAP)
and the International Accounting Standards Board’s International Financial Reporting
Standards (IFRS) may have certain requirements for the reporting of different types of
debt instruments on an entity’s financial statements.

The issuance markets for institutionalized entities varies substantially by the type of
debt instrument. Credit cards and credit lines are a type of debt instrument an
institution can use to obtain capital. These revolving debt lines usually have simple
structuring and only a single lender. They are also not typically associated with a
primary or secondary market for securitization. More complex debt instruments will
involve advanced contract structuring and the involvement of multiple lenders or
investors, usually investing through an organized marketplace.

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 FEATURES OF DEBT INSTRUMENTS

The features of the instruments are:

Safety of the principal amount

Guaranteed returns for the investors.

Some of these instruments also qualify for tax rebates under Section 80C.

Currently 8-9% interest per annum are quoted for medium to long-term deposits
whereas it is 6-7% returns for short-term deposits

Nowadays, many banks provide funds sweep-in /sweep-out facility where a balance
beyond a certain limit automatically gets converted into a fixed deposit and banks pay
the fixed deposit interest on it. This can be an option for a short-term horizon.

There are three main features of debt instruments

Maturity

Coupon

Principal

Maturity
Maturity refers to the date on which the bond matures. It is the date on which the
borrower agrees to repay the principal amount. Term-to-maturity refers to the number
of years remaining for the bond to mature. It changes every day from the date of the
issue to the maturity of the bond. It is also called the tenure or term of the bond.

Coupon
Coupon Rate refers to the periodic payment of interest made by the issuer of the bond
to the lender of the bond. Coupons are declared either by stating the number
(example: 8%) or with a benchmark rate (example: MIBOR+0.5%). It is usually
represented as a percentage of the face value or the par value of the bond.

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 Principal
It is the amount which is borrowed. It is the face or the par value of the bond. The
product of the coupon rate and principal is the coupon.

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, when the
bond will be redeemed.

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 tenor of the bond.
For instance, on February 17, 2004, the term to maturity of the bond maturing on May
23, 2008 will be 4.27 years. The general day count convention in bond market is
30/360European which assumes total 360 days in a year and 30 days in a month.
There is no rigid classification of bonds on the basis of their term to maturity.
Generally bonds with tenors of 1-5 years are called short-term bonds; bonds with
tenors ranging from 4 to 10 years are medium term bonds and above 10 years are long
term bonds. In India, the Central Government has issued up to 30 year bonds.

Main features of debt securities

2.7 Debt securities should display all, or most, of the following quantitative
characteristics:

 an issue date, on which the debt security is issued;

 an issue price, at which investors buy the debt securities when first issued;

 a redemption (or maturity) date, on which the final contractually scheduled

repayment of the principal is due;5

 a redemption price or face value,6 which is the amount to be paid by the issuer

to the holder at maturity;

 an original maturity, which is the period from the issue date until the final
contractually scheduled payment;

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 a remaining (or residual) maturity, which is the period from the reference date
until the final contractually scheduled payment;

 the coupon rate that the issuer pays to the holders, which may be fixed
throughout the life of the debt security or vary with inflation, interest rates or asset
prices;7

 the coupon dates, on which the issuer pays the coupon to the securities’
holders, and

 the issue price, redemption price, and coupon rate may be denominated (or
settled) in either domestic currency or foreign currencies.
2.8 Qualitative features of debt securities include:

 the documents specifying the rights of debt securities issuers, in the form of
indentures or covenants. The terms of contracts may be changed only with great
difficulty, with amendments to the governing document generally requiring approval
by a majority vote of the debt securities’ holders; and

 the default risk attached to debt securities, which is the creditworthiness of

individual debt securities issues assessed by credit rating agencies. For further details

Borderline cases

Negotiable loans
Debt securities may include loans that have become negotiable de facto, but only if
there is evidence of secondary market trading, including the existence of market
makers, and frequent quotations of the instrument, such as provided by bid-offer
spreads (2008 SNA 11.65). These debt securities result from the conversion of loans,
with the recording of two financial transactions, that is, liquidation of the loan and
creation of the new debt security.

Private placements
Debt securities also include private placements. Private placements of debt securities
involve an issuer selling debt securities directly to a small number of investors.

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Typically, the creditworthiness of private placements are not assessed by credit rating
agencies, and as the securities are generally not resold or re-priced, their secondary
market is shallow. However, to the extent that some private placements can be (and
are) traded among investors, the criterion of negotiability for debt securities is met.

Structured debt securities

Debt securities that combine different features of financial instruments pose
challenges with respect to their classification. This is particularly the case for so-
called structured debt securities, which are a sub-set of structured securities.
2.12 A structured debt security typically combines a debt security, or a basket of debt
securities, with a financial derivative, or a basket of financial derivatives. This
financial derivative, or the basket, is typically embedded in and therefore inseparable
from the debt security. When the debt security and financial-derivative components of
a financial instrument are separable from each other they should be classified
accordingly, but if they cannot be separated then the instrument should be valued and
classified according to its primary characteristics (BPM6 5.83 (d)), either as a debt
security or financial derivative. For further details on structured debt securities,
see Annex 1.

Islamic debt securities

Debt securities also encompass financial instruments governed by Islamic rules and
principles (Sharī’ah). Islamic finance uses financial instruments that are backed by
returns from a non-financial asset and earn a variable rate of return tied to the
performance of the asset, or returns that are not specified before the investment is
made, but shared on the basis of a pre-agreed ratio of actual earnings. Islamic debt
securities are distinguished from equity securities by two categories of criteria. The
first category comprises criteria used to differentiate conventional debt securities from
equity securities. The second category comprises additional criteria used to
distinguish Islamic debt securities from equity securities. These criteria and other
details concerning Islamic debt securities are outlined in Annex 2.

Preferred shares
2.14 Preferred shares8 typically rank higher than ordinary equity securities. They may
carry superior voting rights to ordinary equity securities or no voting rights at all.

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They may entitle their holders to a dividend that is paid out prior to any dividends to
ordinary equity holders and they may be convertible into ordinary equity securities.
Only preferred shares that pay a fixed income and do not provide for participation in
the distribution of the residual value of a corporation on its dissolution are classified
as debt securities.
Depository receipts
2.15 Depository receipts allow a non-resident institutional unit to introduce its debt or
equity securities into another market in a form more readily acceptable to the
investors in that market. A resident deposit-taking corporation will purchase the
underlying securities and then issue receipts in a currency more acceptable to the
investor. These instruments are classified according to the underlying financial
instrument backing them, that is, as debt securities or equity securities. This is
because the “issuer” (the deposit-taking corporation) does not take the underlying
securities onto its balance sheet, but rather acts as a facilitator. The non-resident
debtor is the issuer of the underlying securities (External Debt GuideAppendix I).
Securities repurchase agreements
2.16 A securities repurchase agreement is an arrangement involving the provision of
securities in exchange for cash with a commitment to repurchase the same or similar
securities at a fixed price either on a specified future date, or with an “open” maturity.
Securities lending with cash collateral and sell / buy-backs are terms for different
arrangements with the same economic effect as a securities repurchase agreement.
Economic ownership of the securities provided as collateral under securities lending
arrangements, including a securities repurchase agreement, is considered not to have
changed because the cash recipient (the seller of the securities) is still subject to all
market risks (and also obtains all the benefits). Therefore, transactions involving
repurchase agreements and securities lending do not include new debt securities
issues, but rather the incurrence of collateralised loans. Hence, these transactions are
excluded from debt securities statistics.

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 IMPORTANCE

 The key role of the debt markets in the Indian Economy stems from the following
reasons:  Financing the development activities of the Government.Efficient
mobilization and allocation of resources in the economy. Transmitting signals for
implementation of the monetary policy.  Facilitating liquidity management in tune
with overall short term and long term objectives. Reduction in the borrowing cost of
the Government and enable mobilization of resources at a reasonable cost. Provide
greater funding avenues to public-sector and private sector projects and reduce the
pressure on institutional financing.  Enhanced mobilization of resources by unlocking
illiquid retail investments like gold. Development of heterogeneity of market
participants. Assist in development of a reliable yield curve and the term structure of
interest rates. Since the Government Securities are issued to meet the short term and
long term financial needs of the government, they are not only used as instruments for
raising debt, but have emerged as key instruments for internal debt management,
monetary management and short term liquidity management.

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TYPES OF INSTRUMENTS

Debt Instruments are obligation of issuer of such instrument as regards certain future
cash flow representing Interest & Principal, which the issuer would pay to the legal
owner of the Instrument. Debt Instruments are of different types like Bonds,
Debentures, Commercial Papers, Certificates of Deposit, Government Securities (G -
Secs) etc. The Government Securities (G-Secs) market is the oldest and the largest
element of the Indian debt market in terms of market capitalization, trading volumes
and outstanding securities. The G-Secs market plays a very important role in the
Indian economy as it provides the benchmark for determining the level of interest
rates in the country through the yields on the government securities which are treated
as the risk-free rate of return in any economy.

The reserve Bank of India has allowed Primary Dealers, Banks and Financial
Institutions in India to do transactions in debt instruments among themselves or with
non-bank clients. Debt instruments provide fixed return known as coupon rate. Retail
investors would have a natural preference for fixed income returns and especially so
in the present situation of increasing volatility in the financial markets. Now, retail
investors are also showing keen interest in Debt Instruments particularly in the
Central Government Securities (G-secs).For an individual investor G-secs are one of
the best investment options as there is zero default risk and lower volatility.

There are different kinds of Debt Instruments available in India such as:

 Bonds
 Certificates of Deposit
 Commercial Papers
 Debentures
 FD
 G - Secs (Government Securities)
 National savings Certificate (NSC)

BONDS
A Bond is simply an 'IOU' in which an investor agrees to lend money to a company or
government in exchange for a predetermined interest rate. If a business wants to

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expand, one of its options is to borrow money from individual investors. The
company issues bonds at different interest rates and sells them to the public. Investors
purchase them with the understanding that the company will pay back their original
principal with some interest that is due by a set date (this is known as the "maturity").
The interest a bondholder earns depends on the

STRENGTH OF THE CORPORATION.

For example, a blue chip is more stable and has a lower risk of defaulting on its debt.
Sometimes some big companies issue bonds and they may only pay 7% interest, but
some other small companies may pay you 10%. A general rule of thumb when
investing in bonds is that "the higher the interest rate, the riskier the bond."

Following are allowed to issue bonds

- Governments
- Municipalities
- Variety of institutions
- Corporations
There are many types of bonds, each having diverse features and characteristics.
Bonds and stocks are both securities, but the major difference between the two is that
stockholders have an equity stake in the company (i.e., they are owners), whereas
bondholders have a creditor stake in the company (i.e., they are lenders). Another
difference is that bonds usually have a defined term, or maturity, after which the bond
is redeemed, whereas stocks may be outstanding indefinitely.

Returns in Bonds Returns is depends on the nature of the bonds that have been
purchased by the investor. Bonds may be secured or unsecured. Firstly, always check
up the credit rating of the issuing company before purchasing the bond. This gives
you a working knowledge of the company's financial health and an idea about the risk
considerations of the instrument itself. Interest payments depend on the health and
credit rating of the issuer. Therefore, it is essential to check the credit rating and
financial health of the issuer before loosening up the bond. If you do invest in bonds
issued by the top-rated Corporates, there is no guarantee that you will receive your
payments on time.

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Risks in Bonds In certain cases, the issuer has a call option mentioned in the
prospectus. This means that after a certain period, the issuer has the choice of
redeeming the bonds before their maturity. In that case, while you will receive your
principal and the interest accrued till that date, you might lose out on the interest that
would have accrued on your sum in the future had the bond not been redeemed.
Always remember that if interest rates go up, bond prices go down and vice-versa.

Buying and Holding of Bonds Investors can subscribe to primary issues of

Corporates and Financial Institutions (FIs). It is common practice for FIs and
corporates to raise funds for asset financing or capital expenditure through primary
bond issues. Some bonds are also available in the secondary market. The minimum
investment for bonds can either be Rs 5,000 or Rs 10,000. However, this amount
varies from issue to issue. There is no prescribed upper limit to your investment. The
duration of a bond issue usually varies between 5 and 7 years.

Selling of Bonds Selling bonds in the secondary market has its own drawbacks. First,
there is a liquidity problem which means that it is a tough job to find a buyer. Second,
even if you find a buyer, the prices may be at a sharp discount to its intrinsic value.
Third, you are subject to market forces and, hence, market risk. If interest rates are
running high, bond prices will be down and you may well end up incurring losses. On
the other hand, Debentures are always secured.

Liquidity of a Bond: Selling in the debt market is an obvious option. Some issues

also offer Put and Call option.

 In Put option, the investor has the option to approach the issuing entity after a
specified period (say, three years), and sell back the bond to the issuer.
 In Call option, the company has the right to recall its debt obligation after a
particular time frame.

DEBENTURE
A debenture is similar to a bond except the securitization conditions are different. A
debenture is generally unsecured in the sense that there are no liens or pledges on

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specific assets. It is defined as a certificate of agreement of loans which is given under
the company's stamp and carries an undertaking that the debenture holder will get a
fixed return (fixed on the basis of interest rates) and the principal amount whenever
the debenture matures. 

In finance, a debenture is a long-term debt instrument used by governments and large

companies to obtain funds. The advantage of debentures to the issuer is they leave
specific assets burden free, and thereby leave them open for subsequent financing.
Debentures are generally freely transferrable by the debenture holder. Debenture
holders have no voting rights and the interest given to them is a charge against profit.

DEBENTURES VS. BONDS

Debentures and bonds are similar except for one difference bonds are more secure
than debentures. In case of both, you are paid a guaranteed interest that does not
change in value irrespective of the fortunes of the company. However, bonds are more
secure than debentures, but carry a lower interest rate. The company provides
collateral for the loan. Moreover, in case of liquidation, bondholders will be paid off
before debenture holders. 

A debenture is more secure than a stock, but not as secure as a bond. In case of
bankruptcy, you have no collateral you can claim from the company. To compensate
for this, companies pay higher interest rates to debenture holders. All investment,
including stocks bonds or debentures carry an element of risk.

COMMERCIAL PAPERS

Commercial Paper (CP) is an unsecured money market instrument issued in the form
of a promissory note. It was introduced in India in 1990 with a view to enable highly
rated corporate borrowers/ to diversify their sources of short-term borrowings and to
provide an additional instrument to investors. Subsequently, primary dealers and
satellite dealers were also permitted to issue CP to enable them to meet their short-
term funding requirements for their operations. CP can be issued in denominations of

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Rs.5 lakh or multiples thereof. Amount invested by a single investor should not be
less than Rs.5 lakh (face value). It will be issued foe a duration of
30/45/60/90/120/180/270/364 days. Only a scheduled bank can act as an Issuing and
Paying Agent IPA for issuance of CP.

FEATURES OF COMMERCIAL PAPERS

Following are the important features of commercial papers

 They are unsecured debts of corporates and are issued in the form of
promissory notes, redeemable at par to the holder at maturity.
 Only corporates who get an investment grade rating can issue CPs, as per RBI
rules.
 It is issued at a discount to face value
 Attracts issuance stamp duty in primary issue
 Has to be mandatorily rated by one of the credit rating agencies
 It is issued as per RBI guidelines
 It is held in Demat form
 CP can be issued in denominations of Rs.5 lakh or multiples thereof. Amount
invested by a single investor should not be less than Rs.5 lakh (face value).
 Issued at discount to face value as may be determined by the issuer.
 Bank and FI’s are prohibited from issuance and underwriting of CP’s.
 Can be issued for a maturity for a minimum of 15 days and a maximum upto
one year from the date of issue.

Who can Issue Commercial Papers?

 Corporates and primary dealers (PDs)

 All-India financial institutions (FIs)

Maturity

 CP can be issued for maturities between a minimum of 7 days and a maximum

up to one year from the date of issue.

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Investment in CP

 CP may be issued to and held by individuals, banking companies, other

corporate bodies registered or incorporated in India and unincorporated
bodies, Non-Resident Indians (NRIs) and Foreign Institutional Investors
(FIIs). However, investment by FIIs would be within the limits set for their
investments by Securities and Exchange Board of India. Banks still continue
to be a major player in the CP market.

Mode of Issuance

 CP can be issued either in the form of a promissory note or in a dematerialized

form through any of the depositories approved by and registered with SEBI.
CP will be issued at a discount to face value as may be determined by the
issuer. No issuer shall have the issue of CP underwritten or co-accepted.

CERTIFICATE OF DEPOSIT

 A certificate of deposit or CD is a time deposit, a financial product commonly

offered to consumers by banks, thrift institutions, and credit unions. CDs are
similar to savings accounts in that they are insured and thus virtually risk-free;
they are "money in the bank". They are different from savings accounts in that
the CD has a specific, fixed term (often 3 months, 6 months, or 1 to 5 years),
and, usually, a fixed interest rate. It is intended that the CD be held until
maturity, at which time the money may be withdrawn together with the
accrued interest.

 Eligibility to issue CD

 Scheduled commercial banks excluding Regional Rural Banks (RRBs)

andLocal Area Banks

 All-India Financial Institutions that have been permitted by RBI to raise short-
term resources within the umbrella limit fixed by RBI.

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Who can subscribe
CDs can be issued to individuals, corporations, companies, trusts, funds, associations,
etc. Non- Resident Indians (NRIs) may also subscribe to CDs, but only on non-
repatriable basis which should be clearly stated on the Certificate. Such CDs cannot
be endorsed to another NRI in the secondary market.

Maturity

 The maturity period of CDs issued by banks should be not less than 7 days and
not more than one year.
 The FIs can issue CDs for a period not less than 1 year and not exceeding 3
years from the date of issue.

DISCOUNT/ COUPON RATE

CDs may be issued at a discount on face value. Banks/FIs are also allowed to issue
CDs on floating rate basis provided the methodology of compiling the floating rate is
objective, transparent and market-based. The issuing bank/FI is free to determine the
discount/coupon rate. The interest rate on floating rate CDs would have to be reset
periodically in accordance with a pre-determined formula that indicates the spread
over a transparent benchmark.
A bond's coupon rate can be calculated by dividing the sum of the security's annual
coupon payments and dividing them by the bond's par value. For example, a bond
issued with a face value of $1,000 that pays a $25 coupon semiannually has a coupon
rate of 5%. All else held equal, bonds with higher coupon rates are more desirable for
investors than those with lower coupon rates.
The coupon rate is the interest rate paid on a bond by its issuer for the term of the
security. The term "coupon" is derived from the historical use of actual coupons for
periodic interest payment collections. Once set at the issuance date, a bond's coupon
rate remains unchanged and holders of the bond receive fixed interest payments at a
predetermined time-frequency.

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KEY TAKEAWAYS

 A coupon rate is the yield paid by a fixed-income security.

 When a market ticks up and is more favorable, the coupon holder will yield
less than the prevailing market conditions as the bond will not pay more, as its
value was determined at issuance.

 The yield to maturity is when a bond is purchased on the secondary market, and
is the difference in the bond's interest payments, which may be higher or lower
than the bond's coupon rate when it was issued.
 Imp :-If the market rate turns lower than a bond's coupon rate, holding the
bond is advantageous, as other investors may want to pay more than the face
value for the bond's comparably higher coupon rate
 A bond issuer decides on the coupon rate based on prevalent market interest
rates, among others, at the time of the issuance. Market interest rates change
over time and as they move higher or lower than a bond's coupon rate, the
value of the bond increases or decreases, respectively.

A bond issuer decides on the coupon rate based on prevalent market interest rates,
among others, at the time of the issuance. Market interest rates change over time and
as they move higher or lower than a bond's coupon rate, the value of the bond
increases or decreases, respectively.
 
When investors buy a bond initially at face value and then hold the bond to maturity,
the interest they earn on the bond is based on the coupon rate set forth at the issuance.
For investors acquiring the bond on the secondary market, depending on the prices
they pay, the return they earn from the bond's interest payments may be higher or
lower than the bond's coupon rate. This is the effective return called yield to maturity.
For example, a bond with a par value of $100 but traded at $90 gives the buyer a yield
to maturity higher than the coupon rate. Conversely, a bond with a par value of $100
but traded at $110 gives the buyer a yield to maturity lower than the coupon rate.

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Reserve Requirements
Banks have to maintain the appropriate reserve requirements, i.e., cash reserve ratio
(CRR) and statutory liquidity ratio (SLR), on the issue price of the CDs.

Transferability
Physical CDs are freely transferable by endorsement and delivery. Dematted CDs can
be transferred as per the procedure applicable to other demat securities. There is no
lock-in period for the CDs.

Loans/Buy-backs
Banks/FIs cannot grant loans against CDs. Furthermore, they cannot buy-back their
own CDs before maturity.

ADVANTAGES OF DEBT
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  Control: Taking out a loan is temporary. The relationship ends when the debt
is repaid. The lender does not have any say in how the owner runs his business.
 Taxes: Loan interest is tax deductible, whereas dividends paid to shareholders
are not.
 Predictability: Principal and interest payments are stated in advance, so it is
easier to work these into the company's cash flow. Loans can be short, medium or
long term.

DISADVANTAGES OF DEBT

 Qualification: The company and the owner must have acceptable credit ratings
to qualify.
 Fixed payments: Principal and interest payments must be made on specified
dates without fail. Businesses that have unpredictable cash flows might have
difficulties making loan payments. Declines in sales can create serious problems
in meeting loan payment dates.
 Cash flow: Taking on too much debt makes the business more likely to have
problems meeting loan payments if cash flow declines. Investors will also see the
company as a higher risk and be reluctant to make additional equity investments.
 Collateral: Lenders will typically demand that certain assets of the company
be held as collateral, and the owner is often required to guarantee the
loan personally.

ASPECTS OF DEBT INSTRUMENTS

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five main aspects of debt instruments. The aspects are: 1. Interest Rate 2. Security 3.
Options 4. Tax Status5. Risk Weight.

Aspect1. Interest Rate:

Interest rate can be fixed or floating. Floating rates are variously linked with call rates,
bank rate or government security rate, though a firm reference note is not yet
available in the market. There are also instruments where interest rates are linked with
index of inflation so that real interest rate return stands protected.

Interest rate stated on the face of the debt instrument is called coupon rate. Some
debentures/bonds are issued with step-up coupons, where interest rate varies from
period to period within the maturity date – generally on an ascending scale from year
to year.

Aspect2. Security:
Debentures/bonds may be secured or unsecured. While conventionally, security is by
way of mortgage, or floating charge on fixed assets, some of the new instruments are
structured with charge on receivables (generally deposited in an escrow account)
pertaining to a specific activity or generated in a specific area. Clean instruments with
guarantee by government or parent company are also gaining popularity.

Securitised bonds are instruments with an underlying asset, income from which would
go to meet obligations under the bond, and are commonly issued through a special
purpose vehicle/ company. For instance, a bank may issue bonds representing all its
mortgage receivables through this route. Securitised bonds are preferred by the issuers
for credit enhancement and for obtaining liquidity from the existing assets.

Aspect 3. Options:
A debt instrument can have various options. Convertibility option refers to conversion
of debt into equity (always at the option of the investor if the conversion is to take
place after 18 months of issue), either in full or in part.

A put option is an option in favour of holder of the instrument to redeem the

investment on a particular date, or during a specified period, before maturity. Call

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option is the right of the issuer to prepay the debt (i.e., to call back the debt paper)
similarly before maturity date.

The options infuse flexibility into the debt issues so that the issuer/ holder can take
advantage of the prevailing market conditions.

Aspect 4. Tax Status:

Certain securities (e.g., in infrastructure sector) have been exempted from income
tax/capital gains tax. Pricing of such securities takes into account the tax exemption,
with the result that the cost of the issue is lower, while the holder would relatively
have higher pretax yields.

Bonds and debentures which are exempt from tax directly compete with redeemable
preference shares, as the dividend from the latter is also exempt from tax.

Aspect5. Risk Weight:

Bonds/debentures may also differ according to their risk weight for the purpose of
Banks’ capital adequacy requirement. For instance, SLR securities have negligible
capital requirements, while PSU Bonds of some financial institutions bear 20% risk
weight, while corporate bonds have been assigned 100% weight

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