Debt

Markets

Introduction
Debt instruments are contracts in which
one party lends money to another on predetermined terms with regard to rate of
interest to be paid by the borrower to the
lender, the periodicity of such interest
payment, and the repayment of the
principal amount borrowed (either in
installments or in bullet).

Evolution of
Debt Market in
India

dian Economic Crisis 1991

Pre-liberalization 1947-1991:

Socialism
Industrialization under state monitoring
Foreign trade restrictions (import tariffs, export
taxes and quantitative restrictions,foreign direct
investment(FDI) upper limit, restrictions on
technology transfer, export obligations and
government approvals)
Economic intervention
Elaborate licenses, regulations (commonly
referred to asLicense Raj)

Debt Market in India before

Liberalization:

Control on pricing of assets, administered interest

rates (Rates not market related)
Segmentation of markets and barriers to entry
Limited number of players
High transactions cost
High Statutory Liquidity Ratio (SLR) requirements
The absence of a liquid and transparent
secondary market

Economic Crisis 1990s

Large and growing fiscal imbalances over the

1980s
Financial Repression
Investors withdrew on low sentiments
Import bill swelled, exports slumped
Balance of payments problems
Rupee Depreciation
Defending the currency by expending foreign
reserves

Theeconomic liberalization in India

Opening for international trade and foreign investment

(Globalization)
Deregulation
Initiation ofPrivatization
Inflation-controlling measures
Private sector enterpriseand competition
Setting up of a comprehensive system of primary dealers
Adoption of DVP system for settlement of government
securities transactions
Abolition of tax deduction at source on government
securities (Tax reforms)
Permission for FIIs to Hedge their foreign currency risk in
the forward market
Introduction of Treasury bills of varying maturities
Placing investments of banks in preference
shares/debentures/bonds of corporate outside the five per
cent limit
Recommendation that the Government borrowings at

The main objective of the government was to transform

theeconomic systemfrom socialismto capitalism so as to
achieve high economic growth andindustrializethe nation.

Financial Markets
A financial market is a market in which people and entities can
trade financial securities, commodities, and other fungible
items of value at low transaction costs and at prices that
reflect supply and demand.

Financial markets facilitate:

The raising of capital (in the capital markets)

The transfer of risk (in the derivatives markets)
Price discovery (Demand and supply equilibrium)
The transfer of liquidity (in the money markets)
International trade (in the currency markets)

Types of Financial
Markets

Money Market
The money market can be defined as a
market for short term money and financial
assets that are near substitutes for money.

Money Market
Instruments

 Call Money or Notice Money

Amount borrowed for very short period, more than one day
up to 14 days.
Enables banks and institutions to even out their day to day
deficits and surpluses of money
Needed to adjust CRR requirement for Banks
Completely inter-bank market, only specified financial
institutions & MFs allowed to access call money market
Interest rates are market determined
Participants of call money market need to maintain current
account with RBI

 Bill Market
Bills of exchange can be rediscounted by the banks in bills
market
RBI introduced the Bills Market Scheme (BMS) in 1952 &
New Bill Market Scheme (NBMS) in 1970 to promote the bill
market in India
Precaution on bills regarding Accommodation bills,
Credibility of the parties, Completeness of the bill,
Dishonor of the bill, Stamped bill

 Certificate of Deposits
Marketable receipt of funds deposited in a bank for a fixed
period issued in form of promissory notes
They are negotiable and marketable bearing specific face
value and maturity
CD can be registered or bearer
They are liquid and risk free

 Commercial Papers
Short term negotiable unsecured promissory note
Issued by Private sector, public sector and non banking
company
Maturity period of a minimum 30 days to max 364 days
Direct commercial papers (without intermediary, issued
directly to the investors) or Dealer papers (dealer or
merchant banker issues on behalf of the company &
advisory service)

 Ready Forward Contracts

Agreement to sell and repurchase the same security and
vice versa
Sellers perspective of transaction is Repo and buyers
perspective is Reverse Repo
Only RBI approved parties and the securities are allowed
to repo and reverse repo trade
Highly useful for banks to maintain SLR & CRR

 Treasury Bills Market

Short term and lowest risk instrument
Issued at a pre-fixed day (14 & 91-day T Bill every Friday,
182 & 364-day T bill every alternate Wednesday) and a
fixed amount
Governments borrowing instrument
Yield is based on bids received at the auction

 Money Market Mutual Funds

The fund portfolio consists of various short term market
instruments
Small-scale investor actively take part in the money
markets
Minimum lock-in period is 15 days

 Credit Cards
Monetary instrument that enables the card holder to
obtain goods and service without actual payment at the
time of purchase
Credit can be availed for a period of 30 to 45 days
The card carried a pre-determined limit up to which the
holder can spend

Debt Market
Debt market is where debt instruments or
bonds are traded. The most distinguishing
feature of these instruments is that the
return is fixed i.e. they are as close to being
risk free as possible, if not totally risk free.
The fixed return on the bond is known as the
interest rate or the coupon rate.

Debt Market
Instruments

 Government Securities / Gilt-edged

Securities
Issued by Central Government, State government and
Quasi-Government agencies
Government securities have maturities ranging from 3
20 years
Typically held by banks, financial institutions, insurance
companies, provident funds mainly because of certain
statutory compulsions

 Savings Bonds
Public Sector Undertaking Bonds

 Private Sector Debentures

Instruments raised by the company for raising long term
debt
Typically secured by a charge on immovable properties
They carry maturity period and coupon rate
Debentures may have convertible clause (option to
convert the debentures into equity shares)
Debentures may have call & put option

 Preference Shares
Represent hybrid security (combination of equity shares
and debentures)
Carry fixed rate of dividend
Dividend payable only out of distributable profits
Dividend is generally cumulative and tax-exempt
May be redeemable

There are three main segments in

the debt markets in India

Government Securities
Public Sector Units (PSU) bonds and
Corporate securities

Indian Debt Market Structure

Risks Associated with Fixed Income

Securities
Interest Rate Risk - The market value of the securities is
inversely affected by movements in interest rates.

Price Risk - The price received on secondary market

(premature exit) depends on the level of interest rates, time
to term, credit quality of the issuer and liquidity.

Liquidity Risk - the risk that an investor will be unable to

sell securities due to lack of demand and thus must sell them
at a substantial loss and/or incur substantial transaction
costs in the sale process.

Reinvestment Risk the risk that the income and/or

principal repayments must be invested at lower rates,
especially with callable securities.

Prepayment Risk - Prepayment risk is the risk that the

Purchasing Power Risk - Investors often focus on the real

rate of return, or the actual return minus the rate of inflation.
Rising inflation has a negative impact on real rates of return
because inflation reduces the purchasing power of both
investment income and principal.

Credit Risk - The safety of the fixed income investor's

principal depends on the issuer's credit quality and ability to
meet its financial obligations, such as payment of coupon
and repayment of principal at maturity. A change in either
the issuer's credit rating or the market's perception of the
issuer's business prospects will affect the value of its
outstanding securities.

Default Risk - The risk of default is the risk that the issuer
will not be able to make interest payments and/or return the
principal at maturity.

REGULATORS
The Securities Contracts Regulation Act (SCRA) defines the
regulatory role of various regulators in the securities market.

The RBI regulates the money market segment of the debt

products (CPs, CDs) and the Government securities market.

The non Government bond market is regulated by the SEBI. The

SEBI also regulates the stock exchanges and hence the
regulatory overlap in regulating transactions in Government
securities on stock exchanges have to be dealt with by both the
regulators (RBI and SEBI) through mutual cooperation.

The RBIs Regulatory Role

Licensing
Prescribing capital requirements
Monitoring governance
Setting prudential regulations to ensure solvency and
liquidity of the banks
Prescribing lending to certain priority sectors of the
economy
Regulating interest rates in specific areas
Setting appropriate regulatory norms related to income
recognition, asset classification, provisioning, investment
valuation, exposure limits and the like
Initiating new regulation

SEBI

The regulator for the Indian corporate debt market is the

Securities and Exchange Board of India (SEBI). SEBI controls
the bond market in cases where entities, especially corporates,
raise money from public through public issues.
It regulates the manner in which money is raised and to ensure
a fair play for the retail investor. It forces the issuer to make the
retail investor aware of the risks inherent in the investment and
its disclosure norms. SEBI is also a regulator for the mutual
funds and regulates the entry of new mutual funds in the
industry. It also regulates the instruments in which these
mutual funds can invest. SEBI also regulates the investments of
FIIs.