Presentation

Indian Debt Market
SBI Mutual Fund

Praloy Majumder
Kolkata
February 1-2,2008
Session One
Role of a financial
system….
• Financial system is one of the most important
inventions of the modern society.
• Its primary task is to move scarce loanable funds from
those who save to those who borrow to buy goods and
services and to make investments in new equipment
and facilities so that the overall economy can grow
and increase the standard of living enjoyed by the
citizens.
• Without the financial system and the funds it supplies,
each of us would lead a much less enjoyable life.
Role of a financial
system….
• The financial system determines both the cost of credit and how much
credit will be available to pay for the thousands of different goods and
services we purchase daily.
• The happening in this system has a powerful impact in the health of the
overall economy.
– For example, when credit becomes more costly and less available, total spending
for goods and services falls resulting in the increase in unemployment. This will in
turn reduce the growth and which will force the business houses to cut back the
production and lay off workers.
– In contrast, when the cost of credit declines the loanable funds become more
readily available and this will increase the total spending in the economy. This will
in turn creates more jobs and the economy growth accelerates.
Flow of income,payments and production
in the economic system
Flow of Expenditure
For consumption and
taxes
Flow of production
Of Goods and
Producing Services
Consuming
Units Units
( Mainly (Mainly
Business Household
Govt.
Flow of Productive s)
Services
Flow of Income
Entities in an Economy…
Entity Savings Investments
Household Current Income- Purchase of assets

Current ( durable) goods
Expenditure
Business Retained Purchase of Assets
firm Earning+Non
Cash Expenses
Government Current Income- Spending on
Current Building ,
Expenditure Maintaining of
Public facilities
Functions of Market ..
• Savings Function ;
• Wealth Function;
• Liquidity Function;
• Credit Function;
• Payment Function;
• Risk Function;
• Policy Function;
Types of Financial Markets
within the Financial
System
• The financial markets can be classified in different ways.
One way of classifying this is to classify in respect of
maturity of the instruments. Accordingly, the financial
markets can be classified into two main parts. They are
– Money Market
– Capital Market
• Money Market : This is defined as that financial market
where the maturity period of financial instruments
issued or traded is up to one year .
• Capital Market : This is defined as that financial market
where the maturity period of financial instruments
issued or traded is more than one year.
Financial Markets
F i n a n c i a l M a r
M o n e y C a p i t a l
N e g o tN i ao bn l e N e gD o e t bi at b le E q u i t y
G o v Nt o n GP r o i mv tS a e r cy o n d
Financial Assets…..
• Financial Asset is a claim against the
income or wealth of a business firm,
household or unit of government,
represented usually by a certificate,
receipt, or other legal document, and
usually created by the lending of
money. Familiar examples include
stocks, bonds, insurance policies and
deposits held in a bank.
Characteristics of financial
assets
• It promises future return
• It has a store value.
• Its physical form is not relevant.
• Its cost of transportation is very
low.
• It is fungible.
Creation Process of
Financial Asset
• Let us consider a two unit system
consisting of house hold and business
firm.
• We also assume that the system is
closed i.e. no external transactions with
other units are possible.
• The financial position of two units are
shown in the next two slides:
Creation Process of Financial
Asset-Balance sheet of a house
Liability
hold Asset
Net Worth 300000 Cash 50000
Furniture 70000
Clothes 25000
Automobile 140000
Other Asset 15000
Total 300000 Total 300000

Creation Process of Financial Asset-
Balance sheet of a business firm
Liability Asset
Furniture 60000
Plant & 225000
Machinery
Automobile 75000
Inventory 75000
Other Asset 25000

Creation of Financial Asset
• Now let us assume a situation that the business
firm requires a plant and machinery whose cost
is Rs 50000.
• The business firm can take decision to finance
these assets either through external borrowing
or from internal resources.
• In the case of funding the assets from internal
resources, the maximum it can use is to use the
cash balance of Rs 40000/- and the remaining
amount has to be borrowed from the other unit
of the system i.e. from the household.
• Now let us assume that the business firm decides to
borrow only Rs 10000/-
• Under this circumstance, the cash balance of the
house hold unit will decrease by Rs 10000/- while
there will be corresponding increase of the financial
assets of the same amount.
• In the case of the business firm’s balance sheet, the
assets under plant and machinery head by Rs
50000/- while its cash balance will be reduced by Rs
40000/- and there will be increase in liability under
the borrowing category of Rs 10000/-.
Balance sheet of a house hold
Liability Asset

Financial Asset 10000
Furniture 70000
Clothes 25000
Automobile 140000
Other Asset 15000
Balance sheet of a business firm
Liability Asset
Net Worth 500000 Cash
Financial 10000 Furniture 60000

Liability
Plant & 275000
Machinery
Automobile 75000
Inventory 75000
Other Asset 25000

• There is a financial asset in one system and there is a financial
liability in the other system and the amount is identical.
• In the case of real asset, here it is in the form of plant and
machinery , the increase is Rs 50000/- in the assets side under
this head but there is no corresponding increase of identical
amount in the balance sheet of that unit or the other unit
• This leads us to draw the following conclusion:
• Total Financial Asset = Total Financial Liability
• Since , Total Asset = Total Liability
– Total Financial Assets+ Total Real Asset = Total Financial
Liability +Total Net Worth
– Total Real Assets = Total Net Worth
• This implies that the increase in net worth is funding the increase in
real assets.
• So the increase in net worth is more important for economic growth
of the country.
• If this is so, the pertinent question is how the financial assets or
financial liability is relevant in the overall economic activity.
• Though real assets are funded by net worth of the system, the
creation of real assets requires funds and this fund is provided by the
house holds from their net worth or from the net worth of the
business units.
• These funds are channelised through the financial assets and
liabilities from the household units and business firms to business
firms , house hold units and governments for creation of real assets.
Without the financial systems and financial markets, the movement
of the fund is impossible.
Evolution of Financial
Transaction
• All financial transactions perform at least one basic
function- movement of scarce fund from those who
save and lend to those who wish to borrow and
invest.
• However, the transfer of funds from savers to
borrowers can be accomplished in at least three
different ways . We label these methods of fund
transfer as
• Direct Finance
• Semi direct Finance
• Indirect Finance
Direct Finance
• In the direct finance, borrower and lender
meet each other and exchange funds in
return for financial assets
• One such example is the borrowal of money
from one individual from another in exchange
of promissory notes ( signed by the borrower)
against money ( given by the lender) .
• The process is explained below with the help
of the following diagram:
Direct Finance
Flow of Fund
Borrowers Lenders
(deficit budget (surplus budget
unit) unit)
Primary Security
Direct Finance- Limitations
• Both borrower and lender must meet each
other to carry out the transaction. So cost of
searching/information is high.
• Both borrower and lender must agree to
exchange exactly identical amount of money
that is difficult.
• Lender must have faith on the security issued
by the borrower, which is also difficult to
achieve.
Semi direct Finance
• In this type of finance , some
individuals and business houses
become security brokers and
dealers whose essential function is
to bring surplus and deficit budget
units together.
• The process reduces information
costs.
Semi Direct Finance
Primary Security
Primary Security
Security brokers, Lenders

Borrowers dealers and (surplus
(deficit budget investment budget unit)
unit) bankers
Flow of Funds Flow of Funds

Semi Direct Finance-
Improvement over Direct
Finance
• Information cost for participants is reduced to a
great extent .The requirement of exact amount
of money involved is eliminated as dealers can
split up securities and sale in smaller lots
• Both dealers and brokers help in the
development of the secondary market.
Semi Direct Finance-
Limitations
• In this process also , the lender has
to accept the security offered by
the borrower as an acceptable
security.
Indirect Finance
• The limitations of both direct and semi direct
finance can be removed in the Indirect
Finance .
• In this form of finance, one financial
intermediary comes in between lenders and
borrowers.
• The financial intermediaries performs the
following functions:
Indirect Finance
• The financial intermediary accepts money from the surplus
budget unit in the form of deposits. In return of the money
deposited, the financial intermediary issues secondary
security.
• Since most of the financial intermediaries are regulated by
financial regulations in terms of financial strength, lenders
are more willing to accept this secondary security as gains
the primary securities issued by the borrower himself.
• The financial intermediary finds out the deficit budget
units for giving loans and collects money from the
borrowing unit. The information and searching cost are
reduced.
Indirect Finance
Primary Security Secondary Security
Financial Lenders
Borrowers Intermediaries (surplus
(deficit budget (Banks,Financial budget unit)
unit) Institutions)
Flow of Funds Flow of Funds

Financial
Disintermediation
• In the process of financial
disintermediation , the role of financial
intermediary has been eliminated and
the borrowers can raise the fund
directly from the lender with the help of
either public issue or private placement
of securities.
• This can be performed with the help of
stock exchanges
Financial Securities
• As we have seen that Financial
Securities are issued by the borrower to
the lender .
• A financial instrument or security
contains some short of commitment
promised by the borrower to the lender.
• When we talk about the financial
commitment we mean two things :
– Amount to be Repaid;
– Time of Repayment ;
• As per as amount is considered ,

financial security intends to pay
more than the amount taken from
the lender.
• This excess amount is called return
to be paid to the lender.
• As per as the time is considered ,
financial security intends to define
the time of repayment.
• Depending on the nature of commitment mentioned
in the financial instrument the security can be
broadly classified as Debt and Equity Security.
• In the case of Debt security, the borrower promises to
pay a fixed amount of return which is called as
( coupon, interest etc ) as per a fixed time frame.
• In the case of Debt security, the repayment amount
and time is not dependent on the projected
performance of the borrower.
• An example would clear this doubt.
• When a borrower raises Rs 10000/- in the form of a 5 year
debenture at a coupon rate of 12% to be paid annually , it
implies that the borrower ( which is also called issuer ) would
pay Rs 1200/- each year for 5 years and then after 5 years it
would repay Rs 10,000 .
• Even if the company does not earn any profit it has to pay
this amount and this repayment is not linked to profit or
earning of the company .
• This means that the borrower has lower amount of
repayment flexibility and that is why riskiness of the
company goes up with debt.
• In the case of Equity Security the borrower is not committing
neither in terms of amount of payment nor in terms of time of
payment at the time of issuing financial securities.
• The timing and amount of payment is linked to the profit or
earning of the company .
• In the case of equity the borrower has more flexibility of
payment .
• Since nothing comes free, the borrower has to pay something
more to the equity holder for enjoying this flexibility of
repayment.
• Borrower’s cost of equity is high compared to that of cost of
debt.
Debt Versus Equity
Debt Equity
Time of Repayment Fixed Not Fixed
Amount of Repayment Fixed Not Fixed
Repayment Not dependent on Dependent on

commitment performance of the performance of the
Company company
Relative Riskiness of More Less
the borrower
Riskiness of the Less More
investor
Expected Return of Less More
the investor
Debt Versus Equity
• Debt can be raised in the form of loan and in the form of
marketable financial securities which is also called as
Debenture.
• In the case of loan the lender would not be able to realise
the money till the borrower pays.
• In the case of debenture , the lender would be able to
realise the money even before the borrower pays as it
has a theoretical secondary market.
• However, in practise , there is not much of difference
between loan and debenture market.
Debt Versus Equity
• In the case of equity market people can invest directly in
the market by way of small amount of investment.
• However, if people wants to invest in the debt market it has
to invest in large amount .
• Moreover, the information is not widely distributed with
respect to debt market and people awareness need to be
created more in the debt market.
• In the case of debt market , the retail debt market is hardly
existing where as in the case of equity market retail equity
market is already existing.
Debt Versus Equity
• The return in debt market is less volatile as there
is a clear cut linkage between the price of the
debt security and the variable which would
change the price of the security.
• However in the case of equity market the return
is highly volatile as there is no clear cut linkage
can be established between the variables and the
price of the equity security.
Different types of Debt Market
Debt
Market
Domestic Foreign
Loan Loan Investment

Investment
Loan
Domestic Foreign
Short Term Short Long

Long Term
Term Term
Investment
Domestic Foreign
Long Short Long

Short
Term Term Term
Term
Session Two
Money Market
• Money Market is a market where the
remaining maturity of the financial security is
less than one year.
• This market is characterised by high degree of
safety as only selected issuers have access to
this market.
• The default rate on this market is non existing.
• The money market consists of several types of
instruments issued by private and
government bodies.
• These are discussed in the next slide.
Money Market Instruments
Money
Market
Negotiable Non
Negotiable
Money Market
• The following instruments are
negotiable money market instruments :
– Treasury Bill
– Commercial Paper
– Certificate of Deposits
– Bills Discounted
– Government of India Securities ( GOI) of
less than 1 year maturity
Money Market
• The following instruments are non
negotiable money market instruments :
– Fixed Deposits of maturity of less than 1 year;
– Call Money Borrowing Receipt
– Notice Money Borrowing Receipt
– Repo Borrowing Receipt
– MIBOR linked debentures
Call money market
• Under borrowing we are having :
– Call Money Borrowing
– Notice Money Borrowing
– Term Money Borrowing ;
• In all the three cases this would be over the
telephone market.
• The bank which is having surplus would lend
to banks which are requiring funds .
• The tenure is overnight for call money, more
than 1 days to up to 14 days for notice money
and more than 14 days for term money.
Call money market
• The borrowing is unsecured and
interest rate is market determined.
• Call money is used mainly to meet
Cash Reserve maintenance .
• CRR is the cash reserve ratio.
• The CRR is maintained on the Net
Demand and Time Liabilities of the
banking system.
Call money market
• Participants in the call money include the
following as both lenders and buyers :
– Banks ;
– Primary Dealers ;
• However there are prudential limit which has
been imposed on both outstanding borrowing
and lending transactions in call/notice money
market for banks and PDs.
Prudential norms on Call
money market
Participants Borrowing Lending
Scheduled CommercialOn a fortnightly averageOn a fortnight basis this

Banks basis,borrowing should not exceed 25%
outstanding should notof their capital fund.
exceed 100 % of capitalHowever daily maximum
funds . Howeverlimit would be 50%.
maximum daily
borrowing can be 125% .
Primary Dealers 200% of NOF 25% of NOF

Cash Reserve Ratio
• Cash Reserve Ratio is a ratio which is linked to the Net
Demand and Time Liabilities of the banking system.
• When bank raises resource in the form of deposits , it is
appearing on the liability side of the bank balance sheet.
• Out of the total liability , certain liability is categorized as
Demand and Time Liability .
• This entire DTL of a bank can be segregated into DTL to Others
( I ) and DTL to Banks (II) .
• The fund raised by DTL is used for creating assets in the form
of loans and advances.
Cash Reserve Ratio
• Out of the loans and advances, certain loans and
advances can be made to other banks and this is
called Inter Bank Asset ( III).
• The NDTL is calculated by the following formula :
– NDTL= I+II-III if II-III >0,
– NDTL= I if II-III <0.
• Let us take an example:
– Suppose bank borrowing as on a Reporting Friday is Rs 1200
crores in the form DTL out of which DTL from Banking System
is Rs 400 crores and Rs 800 crores is from the others.
– Out of the proceed of Rs 1200 crores, Rs 200 crores had been
given as loan to another two banks.
– NDTL is Rs 800 cr+Rs 400 cr- Rs 200 cr = Rs 1000 cr.
Cash Reserve Ratio
• If the CRR is 7% , then the bank has to
maintain an average balance of Rs 70 crores in
the form of bank balance with RBI for the next
fortnight.
• This RBI balance would appear in the asset
side of the bank.
• This is the money impounded by the central
bank of a country.
• The higher the CRR , the lower would be the
money supply.
Central Bank , Money Supply and
Credit
• Money Stock Determination : Before understanding the
central bank’s role on money supply and credit, let us
first defined different nomenclature of money.
• Depending on the ease of conversion into cash and the
different level of maturity of the economy, the money
component is arrived at. Presently there are four types of
money component:
• M1 = Currency with Public + Demand Deposit
• M2 =M1+Post Office Demand Deposit
• M3 = M1+ Time Deposit of Bank
• M4 = M3 + Time Deposit of Post Office
Money Stock Measures
Notes in Circulation 1
Circulation of Rupee Coins2
Circulation of Small Coins 3 Currency with the Public =

(1+2+3-4)
Cash in Hand with Banks 4
Demand Deposits with5

Bank
Other Deposits with RBI 6 Deposit Money with the Public
( 5+6)
M1 =(1+2+3-4)+( 5+6)
Post Office Savings Bank7

Deposits
Credit
• If you see the components of different money, as we move
downward the liquidity decreases and the interest bearing
component increases.
• Among all the money , Reserve Bank of India (RBI) gives the
most importance to M3 ,because this is the component of money
which can be changed by RBI policy.
• So we shall concentrate mainly on the M3. If one looks at the
component of M3 which is also called the broad money , it
consists mostly of deposits at bank which the RBI does not
control directly.
• However RBI through a process can determine the money
supply and this should be one of the major roles of the RBI.
Credit
• Let us define money supply as the following :
– M3 = Cp +BD
– Where Cp = Currency with the Public; BD= Bank
deposit
• The behavior of both the public and the bank affects
the money supply .
– The public’s demand for currency affects the
currency component and
– its demand for bank deposits affects the deposit
component.
Credit
• The RBI has a part in determining the money supply. The
interactions among the actions of the public, the banks and the
RBI determine the money supply.
• The three variables which summarize the behaviour of the
public, he banks and the RBI in the money supply process are
the currency deposit ratio, the reserve ratio and the stock of
high power money.
• The Currency Deposit Ratio : The payment habits of the public
determine how much money is held relative to deposits. The
currency deposit ratio is affected by the cost and convenience
of obtaining cash. It can be assumed that currency deposit ratio
is independent of interest rates and constant.
Credit
• The Reserve Deposit Ratio: Bank reserves consist of
notes and coin held by banks and deposits the banks
hold at the RBI. Bank holds reserves to meet a) the
demands of their customers for cash and b) payments
their customers make by checks that are deposited in
other banks.
• If we denote re the ratio of bank reserves to deposits,
or the reserve deposit ratio, the reserve deposit ratio is
less than 1. This is because the bank would hold more
amount out of its deposit into other assets and less
amount in the form of reserve. The re is determined by
two sets of consideration.
Credit
• First, the RBI sets minimum reserve
requirements. Reserves has to be held against
deposits. The banks may also want to hold
excess reserves beyond the level of required
reserves. In deciding how much excess reserve
to hold, the following factors are the
determining factors
Credit
• The market interest rate i, the higher the market
interest rate lower would be the excess reserve,
• The volatility of the deposits,σ , the higher the volatility,
the higher would be the excess reserve.
• The reserve requirement, rR, the higher the reserve
requirement higher would be the deposit reserve ratio.
• The discount rate iD, the higher the discount rate, the
higher would be the deposit reserve ratio
Credit
• High Powered Money : High power money
consists of currency and banks deposits with
the RBI. Part of the currency is held by the
public .The remaining currency is held by
banks as part of their reserves. The RBI’s
control over monetary base is the main
through which it determines the money
supply.
•
Credit-Money Multiplier
• We develop a simple approach to money stock determination, using as
the key variables the currency deposit ratio, the reserve deposit ratio,
and high powered money.
• The approach is organized around the supply of and demand for high
powered money.
• The RBI can control the supply of high powered money
• The total demand for high powered money comes from the public who
want to use it as currency, and the banks which need its reserves.
• Before going into the details , we want to think briefly about the
relationship between the money stock and the stock of high powered
money.
• At the top of the following figure, we show the stock of high powered
money .At the bottom we show the stock of money. They are related by
the money multiplier .The money multiplier is the ratio of the stock of
money to the stock of high powered money .
Currency Reserves High Powered Money
Money Stock
Currency Deposits
• The precise relationship among the money stock ,M, the stock of
high powered money ,H, the reserve deposit ratio,re, and the
currency deposit ratio,cu is derived as follows :
– M= [(1+cu)/(re+cu)]H
• Where [(1+cu)/(re+cu)] is called as money multiplier.

• It is clear that money multiplier is larger the smaller the reserve
ratio re.
• The money multiplier is larger smaller the currency deposit ratio.
• The RBI tries to control the money supplier by controlling the high
power money.
RBI Balance Sheet
Liability Asset
Currency- with public (Cp) Gold and Foreign Exchange
With Bank (Cb ) (FXRBI )
Bank Deposit at RBI (D) Reserve Bank Loans given to

Govt( LGRBI )
Bank (LBRBI )
Commercial Sector (LC RBI
)
Other Deposits (OD) Other Assets (NO RBI )
Other Nonmoneytary
Liability(OLRBI )
Total Liability Total Asset
High Power Money
• H = Cp +(Cb ) +D+OD =(FXRBI )+ ( LGRBI )+ (LBRBI )+ (LC RBI
)+ (NO RBI )-(OLRBI )
• Cp=(FXRBI )+ ( LGRBI )+ (LBRBI )+ (LC RBI
)+ (NO RBI )-(OLRBI )- (Cb ) –D-OD
• Components of Reserve Money :
– Currency in circulation
• Currency with Public
• Currency with Bank
– Bank Deposits with RBI
– Other Deposits with RBI
• Sources of Reserve Money :
– Net FX Assets with RBI
– Net Credit of RBI
• Govt
• Bank
• Commercial Sector
– Govts Currency Liability to Public
– Net Non Monetary Liability
Bank Balance Sheet
Liability Asset
Public Deposit with Bank (BD) Gold and Foreign Exchange (FXB)
Bank Loans given to

Govt( BGB)
Commercial Sector (BC B)
Cash Balance with Bank (Cb)
Other Nonmoneytary Bank Deposit with RBI (D)

Liability(OLB)
Other Assets (NO B )

Total Liability Total Asset
Broad Money M3
• M3= Cp +BD
• Putting the value of BD from the previous slide ,
we get
• M3= Cp +(FXB)+ ( BGB)+ (BCB)+Cb+D+ (NO B )-(OLB)
• Now ,putting the value of Cp from RBI Balance sheet , we
get :
• M3=(FXRBI )+ ( LGRBI )+ (LBRBI )+ (LC RBI )+ (NO RBI )-
(OLRBI )- (Cb ) –D-OD + +(FXB)+ ( BGB)+ (BCB)
+Cb+D+ (NO B )-(OLB)
T Bills
• Central Government issues T Bills for meeting the intra year mis-
match in cash flows.
• The tenure of T Bill can be of 7, 14,28,91,182 and 364 days
maturity .
• Since the T Bill is issued by Government , it would indicate the risk
free rate for that maturity and helps the market to determine the
Risk Free Yield Curve.
• RBI is the lead manager to the issue which on behalf of Central
Government carries out the borrowing process.
• At the start of the year, RBI announces the calendar of borrowing
under the T Bill scheme and accordingly the market discount this
information and the same is reflected in the market interest rate.
T Bills
• T Bill is issued on the basis of auction process which
can be of uniform type ( Dutch auction ) or differential
price ( French auction ).
• T Bill can be issued on the basis of competitive as well
as non competitive bidding .
• In the case of non competitive bidding the bidder
needs not to mention the interest rate as the interest
rate applicable for the competitive bidder would be
awarded to the non competitive bidder.
T Bills
• T Bills are mostly issued in the D Mat form and the amount is
credited in the SGL account or CSGL account as the case
may be . This would help to eliminate the process of bad
delivery and fraudulent transaction.
• T Bills are usance promissory note issued at a discount to the
face value . It is also a negotiable instrument which increases
the liquidity of the security at the hand of the investor.
• The pricing of the T Bill is calculated as follows :

P = FV /[ 1+(r*d/36500) ]
• Where FV is the face value and r is the discount rate
appropriate to the maturity of the instrument which is d.
T Bills
• Since T Bills is considered as an eligible security for SLR
investment , the main investors are Banks.
• Besides the maturity of the instrument is also less and it
helps the banks to comply to the Asset Liability
Management norms.
• Besides Banks, T Bills can be purchased by Individuals,
Proprietorship Firm, Partnership Firm, Private Limited
Company , Public Limited Company , NRI, FIIS ( subject
to the debt market guidelines as applicable from time to
time )
Commercial Paper …
• Instrument
– Commercial Paper ( CP) is an unsecured money market instruments
issued in the form of a promissory note. Introduced in India in the year
1990 as per recommendation of the Vagul Committee.
• Who can issue CP :
– Corporates fulfilling certain criteria
• TNW as per the latest audited balance sheet should be not less than Rs 4
crores
• Company has sanctioned working capital limit by bank/s or all India
financial institutions
• The borrowal company is classified as Standard Assets by the Financial
Institutions and banks
– Primary Dealers ( PD) and Satellite Dealers ( SD) and All India
Financial Institutions ( FI) that have been permitted to raise short-term
resources under the umbrella limit fixed by RBI
• Rating Requirements :
– Mandatory for all participants . Rating to be obtained from
either CRISIL, ICRA,CARE,FITCH or any other rating agencies
as specified by RBI
– The minimum credit rating should be P-2 of CRISIL or such
equivalent by other agencies. The issuers shall ensure at the
time of issuance of CP that the rating is current and has not
fallen due for review.
• Maturity : CP can be issued for maturities between a
minimum of 15 days and a maximum of up to one year
form the date of issue. The maturity date of CP should not
go beyond the date up to which the credit rating of the
issuer is valid.
• Denominations : CP can be issued in denominations of Rs 5
lacs or multiples thereof.
• Limit and Amount of issue of CP :
– CP can be issued as a Stand Alone product. The aggregate amount of CP from an issuer
shall be within the limit as approved by its Board of Directors or the quantum indicated
by the Credit Rating Agency for the specified rating , which ever is lower.
– An FI can issue CP within the overall umbrella limit fixed by RBI i.e. Issue of CP
together with other instruments viz. term money borrowing,term deposits,certificate of
deposits and inter corporate deposits should not exceed 100 percent of its net owned
fund as per the latest audited balance sheet.
– The total amount of CP proposed to be issued should be raised within a period of two
weeks from the date on which the issuer opens the issue for subscription. CP may be
issued on a single date or in parts in different dates provided that in the latter case,
each CP shall have the same maturity date.
– Every CP issue should be reported to Chief General Manager, IECD, RBI through the
Issuing and Paying Agent within three days from the date of completion of the issue as
per the prescribed format.
• Investment in CP :
– CP may be issued to and held by individuals,banking companies,other corporate bodies
registered or incorporated or unincorporated bodies ,Non- Resident Indians ( NRIs) and
Foreign Institutional Investors (FII). However ,investments by FIIs would be within the
limits set for their investments by SEBI.
• Mode of Issuance :
– CP can be issued either in the form of a promissory note or in a dematerialised form
through any depositories approved by and registered with SEBI . Presently , banks and
others excepting companies and individuals can invest in CP only in Demat Forms
– The CP will be issued at a discounted price to a face value as may be determined by
the issuer . No issuer shall have the issue of CP underwritten or co-accepted.
• Payment of CP: The initial investor shall pay the discounted value of the CP by
means of a crossed account payee cheque to the account of the Issuer through
IPA. On maturity of CP, when the CP is held in physical form, the holder of the CP
shall present the instruments through IPA to Issuer . In case of demat, it is
redeemed through the depository and receive payment from IPA.
• Procedure for Issuance :
– Every issuer must appoint an IPA for issuance of CP.
– The issuer should disclose to potential investors its
financial positions as per the standard market practice.
– After the exchange of deal confirmation between the
investor and the issuer , issuing company shall issue
physical certificates to the investor or arrange for
crediting the CP to the investor’s account with a
depository
– Investor shall be given a copy of IPA certificate to the
effect that the issuer has a valid agreement with the IPA
and documents are in order.
• Role and responsibilities :
– Issuer : Issuer would ensure the strict compliance of the guidelines
stipulated by RBI or any other statutory bodies
– IPA :
• IPA would ensure that the issuer has a minimum credit rating as
stipulated by the RBI and amount mobilised through issuance of CP is
within the quantum indicated by CRA for the specified rating.
• IPA has to verify all documents submitted by the issuer viz.copy of board
resolution,signatures of authorised executants and issue a certificate that
documents are in order.
• It should also certify that it has a valid agreements with the issuer.
• Hold the certified copies of the original documents in its custody.
• Role and responsibilities :
– Credit Rating Agencies ( CRA)
• SEBI guideline for the rating would be applicable
• CRA should clearly indicate the date for review of the
rating
• CRA should also mention the amount of the issue size.
• Stamp duty :
– If routed through the bank 0.05% of the face value
upfront
– If placed directly 0.25% of the face value payable
upfront
Certificate of Deposits …
• Instrument
– Certificate of Deposits ( CD) is an Usance Promissory
Note used for raising funds for Banks and Financial
Institutions .
• Who can issue CD :
– All scheduled commercial banks( excluding Regional
Rural Banks ) .
– Select Financial Institutions ( FI) that have been
permitted to raise short-term resources under the
umbrella limit fixed by RBI.
• Rating Requirements :Rating is not mandatory /compulsory
• Maturity :
– CD issued by a Bank : Bank can issue CD for a period of not less than 15 days
and not exceeding one year from the date of issue.
– CD issued by a Financial Institutions : Financial Institutions can issue CD for a
period not less than 1 year and not exceeding 3 years from the date of issue.
( Maturity date for CD is the final date of payment and no delays of grace are
allowed. The renewal of CD is not permitted with retrospective effect and no
overdue interest is payable on CD) .
• Denominations : CD can be issued in denominations of Rs 1 lac ( 1 unit ) of
Maturity Value ( MV) /Face Value ( FV). The minimum marketable lot for a
CD , whether in physical or demat form will be Rs 1 lakh and in multiples of
Rs 1 lakh.
• Discount : As per the current RBI guidelines, CD should be
issued at a discount to the face value. The parties to
contract are free to determine the discount rate.
• Reserve Requirements : Banks have to maintain CRR and
SLR on the issue price of the CD
• Transferability : CDs held in physical form will be freely
transferable by endorsement and delivery . CD held in the
demat form can be transferred as per the procedure
applicable to other demat securities. There is no lock in
periods for CDs.
• Loan/Premature payments : Banks/FIs cannot

grant loans against CDs. Banks/FI s can not buy-
back their own CDs before maturity. No
premature cancellation of the CD is allowed.
• IPA : Appointment of IPA for issue and
redemption of CDs is not required.
• Investors : CDs can be issued to individuals
( other than
minors),corporations,banks,companies,trusts,fun
ds,associations etc, Non Resident Indians( NRIs) .
• Mode of Issuance :
– CD can be issued either in the form of a promissory note or in a
dematerialised form through any depositories approved by and
registered with SEBI . Presently , banks and others accepting
companies and individuals can invest in CP only in Demat Forms
– The CD will be issued at a discounted price to a face value as may be
determined by the issuer .
• Holiday Convention :
– The CD , being Usance Promissory Notes ( UPN) , provisions of NI Act
( Sec 25) would be applicable.
– Scheduled holiday : Where the maturity date of CD falls on a holiday
declared under the NI Act , it would be payable on the immediate
preceding working day. The place of payment for the purpose of
interpretation of Sec 25 would be the place where the CD is payable
as stated on the CD ( physical) or as stated in ISIN Circular.
• Holiday Convention :
– Unscheduled holiday :
• Primary Market Issuance : Where the 1St leg of the transaction could not be
performed because of the above event, the contract would be deemed to
have been done for settlement on the following working day for the same
period/original duration and at the same rate.
• Secondary Market Trade : In case of secondary market deals contract would
be performed on the following working day at contracted rate of yield
( actual price to be worked as per market convention ).
• Redemption : CDs due for redemption would be redeemed by the respective
issuers by paying day/s interest at contracted interest/ discount rate,if the
holder is the first investor. If CD is held by transferee , the issuer would pay
the investor /holder in due course on the face value of the CD at the
previous days MIBOR rate.
• Secondary market transactions in CD

:Secondary market transactions would take
place in the manner they are taking place in
case of other debt instruments and would be
without recourse to the transferors. The main
features of secondary market trades are :
– The seller of CD must possess the CD at the time of
contract
– No forward sale contracts are allowed as per the
current guidelines of RBI.
Borrowings in the form of
Repurchase
• When banks lend it has given the money to borrower with a
definite term.
• The borrower would pay back after the term.
• If in between the depositor wants money , the bank has to
raise separate resources as the borrower would pay as per the
originally agreed terms.
• When it is raising such separate sources, bank have to search
for such lenders who are willing to lend .
• This process is eased if there is always a lender available
which would lend in such situation provided banks provide the
original instruments issued by borrower ( bank’s customer).
Borrowings in the form of
Repurchase
• Out of several borrowers which is
appearing as assets of bank balance
sheet, certain asset would qualify for
such facility .
• This is called repurchase agreement.
• Banks can raise fund from dedicated
lender by providing such eligible assets
to meet the temporary requirement.
• This is explained in the next slide.
Concept of Repurchase Facility
Depositor Bank Borrower
Dep RBI Dep Lend
Dedicated
Depositor Bank
Lender
Dep Lend
Repo RBI
Concept of Repurchase Facility
Repo Lend
Dedicated
Depositor Bank Lender
Repo RBI
Borrower
Bill Discounting …
• Once the assessment of the fund based working capital limit is
carried out , the company can avail this fund based working
capital amount either through a single product under loan
component or through a combination of different product under
loan component or through a combination of different products
under loan and investment component.
• Bill discounting is a product where a part of the receivable can
be financed. Once the assessment of the company is carried out,
a portion of the assessed limit representing part of the
receivable can be financed through bill discounting mode.
• When a company sales goods on credit, receivable is
generated in the books of accounts of the company.
This receivable is of two types :

• Open Account sales : Under this process only sales
invoice and other sales related documents are drawn
by the seller.
• Bills Receivable : Under this process, not only all the
documents associated with the open account sales are
drawn but also a Bills of Exchange is drawn. A typical
Bills of Exchange would look like as follows :
Bills of Exchange
Rs ______________/- Date:
Please Pay ________________ ( Payee) or Order a sum of Rs -
(Rupees ________________only ) on 90 days ( Credit Period) from the
date of this document.
---------------------------- ---------------------------
( Name & Address of ( Name &
Address of
Drawee) Drawer)
• To improve the cash flow, the seller can get the fund from
the Payee, immediately on submission of bills of exchange
to a bank .The bank would send it for acceptance to the
drawee and drawee accepts the bills of exchange to pay on
due date.
• On receipt of acceptance from the drawee, the bank would
pay to the drawer immediately.
• On due date the bank would collect the money from the
drawee. Since the bill of exchange is a negotiable
instrument, protection under Negotiable Instrument Act is
available to the payee. In many cases , the credit
enhancement of bills of exchange can be increased with the
help of a LC.
• A close scrutiny of the above mentioned bills of exchange would reveal
the following :

• It is an order given by the drawer of the bill of exchange to the drawee
to pay to a party after certain days. Here the drawer is generally the
seller and the drawee is generally the purchaser. The payee is the
bank from whom the seller gets the credit under bill discounting scheme.
• Under normal circumstances, the seller would get the payment after 90
days from the buyer.This is the credit period extended by the seller to
the buyer. This is also called the usance period of bills of exchange.
Bills Discounting …
• Now a days, this method of financing became very
much popular for Small and Medium Enterprise (SME)
financing. Many large company outsourced their
production facility to SMEs. These SMEs may not be
financially strong enough to attract very competitive
interest rate from the bank. The bank enters into
arrangement where the large company which is the
buyer of goods of SME would accept the Bills of
Exchange drawn by the SME and in that case the
exposure is shifted on the Large Company. Under this
mechanism , SME can get very finer interest rate.
FCNR(B) Loan..
NRI
FX
Deposits
To NRI
Pays back
Converts
FX into Rs Repays in FX
Indian Indian
Bank Converts Bank
Rs into FX
Repays in Rs
Lends Rs
Rupee FX
Lends in
Asset FX Asset
FCNR(B) Loans
FX
Assets
Investment
Loan to
In
Customer
Banks
Bills Discounting …
• Now a days, this method of financing became very
much popular for Small and Medium Enterprise (SME)
financing. Many large company outsourced their
production facility to SMEs. These SMEs may not be
financially strong enough to attract very competitive
interest rate from the bank. The bank enters into
arrangement where the large company which is the
buyer of goods of SME would accept the Bills of
Exchange drawn by the SME and in that case the
exposure is shifted on the Large Company. Under this
mechanism , SME can get very finer interest rate.
Disadvantage of
Commercial Paper ..
• When a company raises the fund through CP , it
will pay discount rate which is depended on the
money market rate at the date of issuance. For
example, a company wants to raise Rs 5 crores
through CP ( having a rating of P1+) for 90 days
on 1st September 2005, the discount rate to be
paid on the CP would depend on the call money
rate or MIBOR rate prevailing on 1st September
2005.This discount rate is fixed for the company
for the entire tenure of 90 days from 1st
September 2005.
Disadvantage of
Commercial Paper
• For example if the call money rate is 5%
p.a. and a P1+ CP would attract a discount
rate of 0.75% above the MIBOR rate , then
the discount rate to be paid by the
company would be 5.75% p.a. for 90 days
from 1st September 2005.
• Now if the call money rate goes down to
4.75% on September 15th 2005 , if the
company could have raised the fund at
that point of time at an interest rate of
5.50% p.a. for 90 days.
MIBOR Linked Debenture
• The benefits of daily movement of interest
rate would be possible in the case of
MIBOR linked debentures. Under this
instruments, a company can raise working
capital where the interest rate is
compounded on a daily basis based on the
closing MIBOR rate prevailing at the close
of each day
Session Three
Money Market Mutual
Fund
• Money Market Mutual Funds are mutual
funds which invest specifically in Money
Market Instruments.
• By this time, all of us know what are the
money market instruments . So these
are the funds which are created to
invest in these instruments.
• These funds are conservative compared
to other type of mutual funds.
Money Market Mutual
Fund
• If one investor buys such fund from
a large fund house , it is very
unlikely that the value of the fund
would drop.
• If there is any shortfall, the amount
is so small that the large fund would
make up such value.
• At the same time , the interest rate
is more than the bank deposit rate.
Money Market Mutual
Fund
• Since the minimum amount is quite
large for money market instrument ( in
case of CP , CD etc) , small investors
would not be able to invest .
• Besides for those instruments also
where the minimum amount is small but
tradable volume would not be
available.
• The transaction cost is also higher .
Money Market Mutual
Fund
• While investing Money Market Mutual
Fund , one has to look for yield.It tells
you what your money would earn within
the investment period.
• The second characteristics is the
minimum lock in period of the fund and
the minimum amount of withdrawal of
the fund.
Money Market Mutual
Fund
• Starting Minimum : In the Money Market
Mutual Fund , different funds are having
different starting minimum. However it
is not related to the yield directly as
many starting minimum fund can have
lesser return than a fund which is
having lower starting minimum.
Money Market Mutual
Fund
• Broadly there are two types of money market funds.
The first one is for the institutional investors and the
second one is for retail investors.
• Institutional money funds are basically held by
governments, institutional investors and businesses
etc. They sell in bulk and large sums of money are
parked in institutional money funds. The largest
institutional money market mutual fund, AIM money
market fund has invested $31 billion in US treasury
bills and corporate debts.
Money Market Mutual
• Retail money
Fund
market funds are more often than not
used for parking money temporarily such as at stock
brokers' firms.
• The size of the retail money market funds is nearly
half of all the money funds.
• The usual retail money fund investment portfolio is
commercial papers and US T-Bills like short term
debts and with some focused funds such as tax free
funds, government only funds and non government
mutual funds.
Money Market Mutual
Fund
• The advantages with retail money
market funds are you can withdraw
money even in smaller denominations
like $ 500 by drawing a check like you
do with your bank account. You also
have the option of a very simplified
redemption to exercise.
Money Market Mutual
• Money market funds
Fund
like the general funds and other
stocks and securities are rated by Standard & Poor
and Moody's rating agencies. So, check for the
ratings of your short listed funds. (example: 'A1' by
S&P and 'P1' by Moody's) .
• Look for the kind of instrument your mutual funds are
utilizing their assets to purchase. Some funds limit
their activities to purchasing, say US treasury bills. US
T-Bills command highest safety points from both the
rating agencies.
Money Market Mutual
Fund
• In almost all the cases, the NAVs of money market
mutual funds are fixed at $ 1.00. And look for the
minimum initial purchase when you are not sure so
that you will not get your money blocked
unnecessarily when your fund doesn't perform to
expectation.
• Normally these instruments are sold on no load. If
you want to minimize your cost out go, go for tax
free funds. Keep in mind to evaluate whether the low
returns of tax free funds are worth while buying in
comparison to taxable funds with high returns,
especially when you are investing more than
moderate amounts.
Money Market Mutual
Fund
• Reading the prospectus might reveal a point or two on the management and their
expense ratio too. A top ranking mutual fund may perform well but their expenses
can be sky high at the same time.
• There are three instances when Money Market Mutual Fund , because of their
Liquidity , are particularly suitable investments.
• First, money market mutual funds offer a convenient parking place for cash
reserves when an investor is not quite ready to purchase an individual stock ,
bond or normal mutual fund for his or her long-term portfolio holdings. Money
market mutual funds offer ultimate safety and liquidity. This means that investor
will have an expected sum of cash at the very moment that they need it.
Money Market Mutual
Fund
• Secondly, an investor holding a basket of mutual funds from a single
fund company may occasionally want to transfer assets from one fund
to another.
• If, however, the investor wants to sell a fund before deciding on
another fund to purchase, a money market mutual fund offered by the
same fund company may be a good place to park the proceeds of sale.
• Then, at the appropriate time, the investor may exchange his or her
money market mutual fund holdings for shares of the other funds in
the fund family.
Money Market Mutual
• Thirdly, to benefit
Fund
their clients, brokerage firms
regularly use money market mutual funds to provide
cash management services. Putting a client's dormant
cash into money market mutual funds will earn the
client an extra percentage point (or two) in annual
returns above those earned by other possible
investments.
Money Market Mutual
Fund
• Money market mutual funds may contain a specific type of money market
security or a combination of securities across a wide spectrum. That said,
most funds adopt a specific investment philosophy that relates to a
particular money market instrument.
• One particular type of fund limits its asset purchases to treasury securities.
Another class of money market funds purchases both U.S. government
securities and investments in various government-sponsored enterprises.
The third and largest class of money market mutual funds invests solely in
privately issued money market securities that offer the highest degree of
security, such as those rated "A1" by S&P or "P1" by Moody's.
•
Introduction
• Complicated subject
• Theoretically correct measures are
difficult to construct
• Different statistics or measures are
appropriate for different types of
investment decisions or portfolios
• Many industry and academic measures
are different
• The nature of active management
leads to measurement problems
Dollar- and Time-Weighted
Returns
Dollar-weighted returns
• Internal rate of return considering the cash
flow from or to investment
• Returns are weighted by the amount
invested in each stock
Time-weighted returns
• Not weighted by investment amount
• Equal weighting
Dollar-Weighted Return
Period Cash Flow
0 -50 share purchase
1 +2 dividend -53 share purchase
2 +4 dividend + 108 shares sold
Internal Rate of Return:

− 51 112
− 50 = +
(1 + r ) (1 + r ) 2
1
r = 7.117%
Time-Weighted Return
53 − 50 + 2
r1 = = 10%
50
54 − 53 + 2
r2 = = 5.66%
53
Simple Average Return:

(10% + 5.66%) / 2 = 7.83%
Averaging Returns
Arithmetic Mean: Text Example Average:
n
rt
r =∑ (.10 + .0566) / 2 = 7.81%
t =1 n
Geometric Mean: Text Example Average:

1/ n
 n

r =  ∏ (1 + rt ) −1 [ (1.1) (1.0566) ]1/2 - 1
 t =1  = 7.83%
Comparison of Geometric
and Arithmetic Means
• Past Performance - generally the
geometric mean is preferable to
arithmetic
• Predicting Future Returns-
generally the arithmetic average is
preferable to geometric
– Geometric has downward bias
Abnormal Performance
What is abnormal?
Abnormal performance is measured:
• Benchmark portfolio
• Market adjusted
• Market model / index model adjusted
• Reward to risk measures such as the
Sharpe Measure:
E (rp-rf) / σ p
Factors That Lead to
Abnormal Performance
• Market timing
• Superior selection
– Sectors or industries
– Individual companies
Risk Adjusted
Performance: Sharpe
1) Sharpe Index
rp - r f
σp
rp = Average return on the portfolio
rf = Average risk free rate

= Standard deviation of portfolio
σ p return
M2 Measure
• Developed by Modigliani and Modigliani
• Equates the volatility of the managed
portfolio with the market by creating a
hypothetical portfolio made up of T-bills
and the managed portfolio
• If the risk is lower than the market,
leverage is used and the hypothetical
portfolio is compared to the market
M2 Measure: Example
Managed Portfolio: return = 35% standard
deviation = 42%
Market Portfolio: return = 28% standard
deviation = 30% T-bill return = 6%
Hypothetical Portfolio:
30/42 = .714 in P (1-.714) or .286 in T-bills
(.714) (.35) + (.286) (.06) = 26.7%
Since this return is less than the market, the
managed portfolio underperformed
Risk Adjusted
Performance:
2) Treynor
Treynor Measure rp - rf
ßp
ßp = Weighted average for

portfolio
Risk Adjusted
Performance:
3) Jensen’sJensen
Measure
α p= rp - [ rf + ßp ( rm - rf) ]
α p = Alpha for the portfolio
ßp = Weighted average Beta
rm = Avg. return on market index port.
Appraisal Ratio
Appraisal Ratio = ap /
s(ep)
Appraisal Ratio divides the alpha of
the portfolio by the nonsystematic
risk
Nonsystematic risk could, in theory,
be eliminated by diversification
Which Measure is
Appropriate?
It depends on investment assumptions
1) If the portfolio represents the entire
investment for an individual, Sharpe Index
compared to the Sharpe Index for the market.
2) If many alternatives are possible, use the
Jensen α or the Treynor measure
The Treynor measure is more complete
because it adjusts for risk
Limitations
• Assumptions underlying measures

limit their usefulness
• When the portfolio is being actively
managed, basic stability requirements
are not met
• Practitioners often use benchmark
portfolio comparisons to measure
performance
Market Timing
Adjusting portfolio for up and

down movements in the
market
• Low Market Return - low ßeta
• High Market Return - high ßeta
Performance Attribution
• Decomposing overall performance
into components
• Components are related to specific
elements of performance
• Example components
– Broad Allocation
– Industry
– Security Choice
– Up and Down Markets
Process of Attributing
Performance
to Components
Set up a ‘Benchmark’ or ‘Bogey’
portfolio
• Use indexes for each component
• Use target weight structure
Process of Attributing
Performance
to Components
• Calculate the return on the ‘Bogey’
and on the managed portfolio
• Explain the difference in return based
on component weights or selection
• Summarize the performance
differences into appropriate
categories
Formula for Attribution
n n
rB = ∑wBi rBi & rp = ∑w pi rpi
i =1 i =1
n n
rp − rB = ∑w pi rpi − ∑wBi rBi =
i =1 i =1
n
∑( w
i =1
pi pi r − wBi rBi )
Where B is the bogey portfolio and p is the managed portfolio

Session Four
Government of India Accounts
G o v t o f I n d i a A c c
R e c e i p t E x p e n d
8 = 1 + 4 1 6 = 9 + 1
R e v e n u e C Ra pe ci t ea il p R t N e o c ne i Pp t l aP n l a n
1 4 9 1 3
T a xN o Rn e T c O a o x tv h e Be r yr o R ro R r f eo e L cw v Ceo e i n i a a np g n p ut R s i e t e a A v l C e A/ C a n
2 3 5 6 7 1 0 1 2 1 4 1 5
I n Ot e t r h e e s rt s
1 1
Government of India Account
• 17.Revenue Expenditure – 10+14

• 18.Capital Expenditure –12+15
• 19.Revenue Deficit –17-1
• 20.Fiscal Deficit –[16-(1+5+6)]
• Gross Primary Deficit –20-11
How to Bridge the Fiscal Deficit
• The Fiscal Deficit of the Central Government can

be met by the followings:
– Market Borrowing
– Small Savings ,EPF,PF
– RBI Bond
– External Borrowings
• In India, like any other developed economy, the
majority of the fiscal deficit is met by Market
Borrowing. Before going into the details of
market borrowing let us also examine the other
sources of borrowing as mentioned above .
• Small Savings ,EPF : By small savings , we mean NSCs
,EPF and other borrowings. Since small savings are major
source of mobilization of funds for state government , the
interest rate of such scheme should be kept at higher
level so that state can mobilize money under this
scheme. Besides of social implications, interest rate on
such borrowing cannot be reduced to a great extent.
Take the example of recent EPF downgrade of interest
rate.
• If Government borrows from this route, the cost of fund
would be higher and interest outgo would be higher. At
present it constitutes about 25% of fiscal deficit in a
particular year.
• RBI Bond: This is an important tool for bridging fiscal
deficit. This is for due to two reasons :
– This does not raise the Money Level as compared to
direct market borrowing.So inflationary potential is
lower.
– The cost can be kept lower and the adverse effect on
interest rate would be minimum for an individual
investor because the concentration of wealth is
significantly lower compared to market borrowing .
• But the negative point is that it is difficult to raise such a
huge money at a short period of one year .
• External Borrowing : Generally external borrowing comes
with lots of strings attached and it is politically debatable
issues too.
Market Borrowing to Bridge the
Fiscal Deficit
Due to all these factors , the government meets the fiscal deficit
•
mainly by market borrowing.At present about 70% of the total fiscal
deficit is met by market borrowing.
• On behalf of Government of India, RBI carries out the borrowing .That
is why it is called the Merchant Banker of the Government .
• Govern of India can Issue securities through following methods:
– Issue of Securities through Auction
– Issue of Securities with pre announced coupon rates
– Issue of Securities through TAP sale
– Issue of Securities by conversion of T Bills /dated securities
– Issue of Securities by any other mode.
Market Borrowing by Auction
•
Process
Under the auction process, the RBI announces the
borrowing programme . Generally , at the beginning of the
year , the RBI announces its borrowing programme.
• The sequence of events is as follows :
– The Government Presents Annual Budget in which Fiscal
Deficit is prescribed- generally in the last week of Feb
– The RBI announces monetary policy for the year in the
month of April so that its desired monetary policy is in
sync with the fiscal policy as announced in the budget.
– The RBI announces borrowing programme in the month
of April it self.
– The announcement of borrowing calendar prevents any
volatile movement in interest rate – as explained in the
Rational Expectation theory.
Process
• Under the Auction process, the total amount is notified
by press release.
• The total amount can be categorized under two heads :
– Competitive Bidding
– Non Competitive Bidding
• At the time of announcement of bidding , the total
amount under the non competitive bidding is announced.
The unsubscribed amount of non competitive bidding
amount can be converted into competitive bidding for
allocation.
• In the case of non competitive bidding , bidders would
only bid for the amount. The award would be allotted as
per the best price principle.
Process
• The auction process can be of two types,
depending on the type of quotation put at
the time of bidding, e.g.
– Yield Based Auction
– Price Based Auction
• In the case of Yield Based auction, the
bidder would bid for coupon.
• In the case of Price Based auction, the
bidder would bid for price.
Market Borrowing by Yield Based
Auction Process
• Under this scheme, the bidder would bid for the
coupon .For example, if RBI announces that it will
conduct borrowing for Rs 1500 crores under yield based
auction for issuance of securities of 20 years of
maturity .
• The bidders say A,B,C – the three banks would bid as
follows :
– A Bids for Rs 800 crores at 5.75% p.a.
– B Bids for 1000 crores at 5.80% p.a.
– C Bids for 1200 crores at 5.82 % p.a.
• Now RBI decides to give coupon of 5.74% p.a.
• In this case the amount would be devolved on RBI and
no body would be allotted.
Auction Process
• The bidders say A,B,C – the three banks would bid as
follows :
• In this case the amount of Rs 800 crores would be
subscribed by A, but the question would be at what
coupon rate. The rate quoted by A is 5.75% p.a. and
RBI wants to give 5.76% p.a.If it is French Auction ( as
mentioned at the time of bidding announcement) , A
would get coupon at 5.75% p.a.If the process of
auction is Dutch, A would get 5.76% p.a.
Auction Process
The bidders say A,B,C – the three banks would bid as follows :
•
• In this case the amount of Rs 800 crores would be subscribed
by A, but the question would be at what coupon rate. The rate
quoted by A is 5.75% p.a. and RBI wants to give 5.80% p.a.If it
is French Auction ( as mentioned at the time of bidding
announcement) , A would get coupon at 5.75% p.a. The
remaining amount of Rs 700 crores would be given to B at
5.80%. If the process of auction is Dutch, A would get 5.80%
p.a., the amount would be proportionate and so does B.
Auction Process
Suppose at the time of bidding the amount for non
•
competitive bidding is kept at 5% of the issue size.
• In such case the amount to be allotted to non competitive
bidder is Rs 75 crores.
• If the non competitive bid amount is Rs less than Rs 75
crores , the shortfall can be added to Competitive amount
and allotted to competitive bidder.
• But if the non competitive bid amount is more than Rs 75
crores, the proportionate allotment would be given to non
competitive bidder.
• The coupon would be on the basis of auction and best
price principal.
Market Borrowing by Price Based
Auction Process
• In the case of Price based auction process, the press
release mentions about the auction process and the
bidders are asked to quote as per price .
• Similarly, it is also of two types -french type of
auction ( differential price ) and dutch type of
auction ( uniform price ) .
• In the case of french auction, the bidder would be
awarded at or above the cut off price as per the bid
amount. In the case of uniform auction, the bidder
would be awarded at the cut off price.
• The price based mechanism is more scientific as it is
tantamount to re issue of securities. So the liquidity
increases and this can lead to the strips mechanism.
Market Borrowing by Pre announced
coupon rates
• Under this method of borrowing, the coupon on

such securities will be announced before the date
of floatation and the securities would be issued at
par.
• In case the total subscription exceeds the
aggregate amount offered for sale in respect of a
fixed coupon security, the RBI may make partial
allotment to all the applicants.
• The RBI can accept the excess amount by
exercising the green shoe option as mentioned in
the notification.
Market Borrowing by Issue of
Securities through tap sale
• This is carried out by RBI for reduction of cost of
borrowing for government.
• At the time of original auction process, the bidders
expect higher interest rate while RBI does not want to
pay the higher interest rates.
• RBI takes the devolved amount in its books and then
when market conditions improve , it sales the
securities through its windows. In the process the cost
is reduced.
• Under this method, no aggregate amount is indicated
in the notification in respect of securities sold on
tap.Sale of such securities may be extended to more
than one day and the sale may be closed at any time
during the banking hours on any day.
Market Borrowing by Issue of
Securities through conversion of T
Bills/dated securities
• The holders of T Bills or certain specified
maturities and holders of specified
dated securities are provided an options
to convert the respective treasury
bills/dated securities at specified price
into new securities offered for sale.
• The new securities could be issued on
an auction /pre announced basis.
Different Types of GOI Securities
• Government of India may issue the following
securities from time to time:
– Securities with Fixed Coupon Rate
– Securities with Variable Coupon Rate
– Zero Coupon Bond
– Securities for which subscription is received in
specified amounts.
– Securities for which repayment is made in
specified installments.
– Securities with Embeded Derivatives ( e.g. Call
and Put Options).
– Securities with any other features in the
specific notification.
GOI Securities –Fixed Coupon
• The securities will carry a specific
coupon rate remaining fixed during the
term of the security and payable
periodically.
• Issue of security may be at a discount,
at par or at a premium to the face
value.
• Redemption of security would be at par.
GOI Securities –Variable Coupon
• The security will carry a coupon rate which will vary
according to the change in the Base Rate to which it is
related. The description of the base rate and the
manner in which the coupon rate is linked to the base
rate will be announced in the specific notification.
• The coupon rate may be subject to a floor or cap, if
any, as the case may be, as prescribed in the specific
notification.
• Where the base rate is pre announced and the security
is issued at par, the method of issue in respect of
securities/bonds with variable coupon rate will be as
announced in the Specific Notification.
GOI Securities –Zero Coupon Bonds
• Zero Coupon bonds are issued at a discount and
redeemed at par.No interest payment is made on
such bonds at periodic intervals before maturity.
• On the basis of bids received through tenders , the
RBI will determine the cut off price at which
tenders for purchase of Zero Coupon Bonds will be
accepted at the auction.
• All such bids , which are found to be lower than
the said cut off price, will be rejected.
•
GOI Securities –Where payment is
received or made in instalments
• The securities are issued either by

auction or by pre announcing a
coupon rate.
• The special feature of the securities is
that either the payment for securities
is received in specified instalments or
the repayment of the securities is
made in specified instalment as
notified in the Specific Notification
relating to the issue of security.
GOI Securities –with embedded
derivatives
• Government Securities may be issued with

embedded derivative features, for
example Call and Put Options.
• The government security may be repaid at
the option of the Govt of India, before the
specified redemption date , where a call
option is specified in the specific
notification relating to the issue of a
Government Security .
Government of India Securities
…
• Eligibility for Investment
• Investment can be made by any person including
firms,companies,Corporate bodies,institutions, State
Governments, Provident Funds and Trusts, Non Resident
Indians, Overseas Corporate Bodies ( OCB) , FII registered
with SEBI and approved BY RBI .
• Minimum Subscription : Goi Sec will be used for a minimum
amount of Rs 10000/- and in multiples thereafter
• Procedure for application : Application should be made in
prescribed forms ( stipulated by RBI) . For FIIs, NRI and OCB
, they should submit the application through the designated
branch of bank as stipulated by RBI .
…
• Procedure for application :Application should be submitted to the
office of the Reserve Bank of India or any other Institution as
notified for this purpose before the close of banking hours on the
specified dates.
• Payment for Goi Sec : Payment for the Goi Sec shall be made by
the applicants/investors on such dates as mentioned in the specific
notification by means of cash or cheque drawn on RBI , Mumbai or
any other specified office of RBI or Banker’s Pay order or by
authority to debit their current account or by electronic fund
transferor by any other means as specified by RBI
• Form of Security : Goi Se will be issued to the investors by credit to
their SGL or CSGL account of the institutions as specified by them ,
maintained with the RBI or by credit to their Bond ledger account
maintained with RBI or with any institutions authorized by RBI or
in the form of Stock Certificates
Government
Payment of Interest :
of India Securities …
•
Payment of interest will be made on Public Debt Offices of the
–
RBI or any other offices as notified by RBI from time to time.
• Repayment of Goi Sec :
– The Goi Sec will be paid at PDO of the RBI or any other institution
at which they are registered at the time of repayment.
– The Goi Sec may be repaid at the option of Govt of India , before
the specified redemption date , where a call option is specified at
the time of issuance of security .
– Same for the Investor if put option is there
– The security will be paid on the redemption date specified in the
notification if put or call option is not specified.
Government of India Securities …
• Transferability
– It can be renewed , sub divided , consolidated , converted
and transferred .
– The conversion is subject to the restriction with respect to
the forms in which Govt Securities shall be issued
– The transfer of securities by FII will be subject to SEBI
regulations and those of NRI and OCBs will be subject to
RBI guidelines
• Laws applicable in regard to Goi Sec :
– It should be dealt with Public Debt Act 1944, Public Debt
Rules 1946.
– Tax Laws prevalent in India
– Any disputes should be settled by the Courts in India
Government of India Securities …
• Participation of RBI : RBI may also if it
considers appropriate to do so participate in
the auction as a non competitor or subscribe
to the Goi Sec in other issues. Allotment of
securities to RBI will be at the cut off
price/yield emerging in the auction or any
other price/yield decided by the Government
• Modes of issue of Goi Security : Govt of India
may issue from time to time under the
following methods.
…
• One applicant may submit more than one bid at different rates of
yield or prices but for each different rates of yields and prices one
has to submit separate application forms.
• The yield or price is fixed depending on the type of auction
– In case of Uniform price auction competitive bids offered with rates up to
and below or the prices up to and above are offered at the maximum rate
or minimum price. Bids quoted higher than the maximum yield or lower than
the minimum rate are not accepted.
– In case of multiple price auction competitive bids offered with rates up to
and below the maximum yield / prices up to and above the minimum
prices are allotted as per the yield or price of the bids received.
Classification of Investment …
• The entire investment portfolio of the FIs will be classified
under three categories:
– ‘Held to Maturity’
– ‘Available for Sale’
– ‘Held for Trading’
• The securities acquired by the FIs with the intention to hold
them till maturity will be classified under Held to Maturity.
• The securities acquired by the FIs with the intention to trade
by taking advantage of the short-term price/ interest rate
movements etc. will be classified under Held for Trading
• The securities, which do not fall within the above two
categories, will be classified under Available for Sale.
Bond Characteristics
• Face or par value
• Coupon rate
– Zero coupon bond
• Compounding and payments
– Accrued Interest
• Indenture
Provisions of Bonds
• Secured or unsecured
• Call provision
• Convertible provision
• Put provision (putable bonds)
• Floating rate bonds
• Sinking funds
Bond Pricing
T
PB = ∑ C t t + ParValue T
(1+ r )
T
t =1 (1+ r )
PB = Price of the bond

Ct = interest or coupon payments
T = number of periods to maturity
y = semi-annual discount rate or the semi-annual
yield to maturity
Solving for Price: 10-yr, 8%
Coupon Bond,
Face = $1,000
20
1 1000
P = 40∑ +
t =1 ( 1.03)
t 20
(1.03)
P = $1,148.77
Ct = 40 (SA)
FV = 1000
T = 20 periods
r = 3% (SA)
Prices and Coupon Rates
Price
Yield
Yield to Maturity
• Interest rate that makes the
present value of the bond’s
payments equal to its price.
Solve the
T
bond formula for r
PB = ∑ C t
+
ParValue T
(1+r )
T
t =1 (1+r )
t
Yield to Maturity Example
35 20
1000
950 = ∑ +
(1+r )
T
(1+r )
t
t=1
10 yr Maturity Coupon Rate = 7%

Price = $950
Solve for r = semiannual rate r = 3.8635%
Yield Measures
Bond Equivalent Yield
7.72% = 3.86% x 2
Effective Annual Yield
(1.0386)2 - 1 = 7.88%
Current Yield
Annual Interest / Market Price
$70 / $950 = 7.37 %
Realized Yield versus YTM
• Reinvestment Assumptions
• Holding Period Return
– Changes in rates affects returns
– Reinvestment of coupon payments
– Change in price of the bond
Holding-Period Return:
Single Period
HPR = [ I + ( P0 - P1 )] / P0
where
I = interest payment
P1 = price in one period
P0 = purchase price
Holding-Period Example
CR = 8% YTM = 8% N=10 years
Semiannual Compounding P0 = $1000
In six months the rate falls to 7%
P1 = $1068.55
HPR = [40 + ( 1068.55 - 1000)] / 1000
HPR = 10.85% (semiannual)
Holding-Period Return:
Multiperiod
• Requires actual calculation of
reinvestment income
• Solve for the Internal Rate of
Return using the following:
– Future Value: sales price + future
value of coupons
– Investment: purchase price
Default Risk and Ratings
• Rating companies
– Moody’s Investor Service
– Standard & Poor’s
– Duff and Phelps
– Fitch
• Rating Categories
– Investment grade
– Speculative grade
Factors Used by Rating
Companies
• Coverage ratios
• Leverage ratios
• Liquidity ratios
• Profitability ratios
• Cash flow to debt
Protection Against Default
• Sinking funds
• Subordination of future debt
• Dividend restrictions
• Collateral
Default Risk and Yield
• Risk structure of interest rates
• Default premiums
– Yields compared to ratings
– Yield spreads over business cycles
Managing Fixed Income
Securities: Basic
Strategies
• Active strategy
– Trade on interest rate predictions
– Trade on market inefficiencies
• Passive strategy
– Control risk
– Balance risk and return
Bond Pricing Relationships
Bond Coupon Maturity Initial

YTM
A 12% 5 Years 10%
B 12% 30 Years 10%
C 3% 30 Years 10%
D 3% 30 Years 6%
Bond Bond Bond Bond

A B C D
Price at 10% YTM 1075.82 1188.54 340.12 587.06
Price at 11% YTM 1036.96 1086.94 304.50 503.64

(ABC) and 7% (D)
Price at 9% 1116.69 1308.21 383.58 692.55

YTM(ABC) and 5%
(D)
B
s eci r p
gat necr eP
C
Changes in Yield to Maturity D
• Inverse relationship between price
and yield.
• An increase in a bond’s yield to
maturity results in a smaller price
decline than the gain associated
with a decrease in yield.
• Long-term bonds tend to be more
price sensitive than short-term
bonds.
Bond Bond Bond Bond

A B C D
Decrease in Price -38.86 -101.60 -35.62 -83.42

due to increase in
Yield
Increase in Price due 40.87 119.67 43.46 105.50
to decrease in yield
% Change -3.61% -8.55% -10.47% -14.21%
% Change 3.80% 10.07% 12.78% 17.97%

(cont’d)
• As maturity increases, price
sensitivity increases at a
decreasing rate.
• Price sensitivity is inversely related
to a bond’s coupon rate.
• Price sensitivity is inversely related
to the yield to maturity at which the
bond is selling.
Duration
• A measure of the effective maturity of a bond.
• The weighted average of the times until each payment is received, with the weights
proportional to the present value of the payment.
• Duration is shorter than maturity for all bonds except zero coupon bonds.
• Duration is equal to maturity for zero coupon bonds.
Duration: Calculation
t
wt = CF t (1 + y ) Price
T
D = ∑t ×wt
t =1
CF t =Cash Flow for period t

Duration Calculation:
Example using Table 16.3
8% Time Payment PV of CF Weight C1 X
Bond years (10%) C4
.5 40 38.095 .0395 .0197
1 40 36.281 .0376 .0376
1.5 40 34.553 .0358 .0537
2.0 1040 855.611 .8871 1.7742
sum 964.540 1.000 1.8852

Duration/Price
Relationship
Price change is proportional to
duration and not to maturity.
∆ P/P = -D x [∆ (1+y) / (1+y)
D* = modified duration
D* = D / (1+y)
∆ P/P = - D* x ∆ y
Rules for Duration
Rule 1 The duration of a zero-coupon bond equals
its time to maturity.
Rule 2 Holding maturity constant, a bond’s
duration is higher when the coupon rate is lower.
Rule 3 Holding the coupon rate constant, a bond’s
duration generally increases with its time to
maturity.
Rule 4 Holding other factors constant, the duration
of a coupon bond is higher when the bond’s yield
to maturity is lower.
Rules for Duration (cont’d)
Rules 5 The duration of a level
perpetuity is equal
(1 +y) to:
y
Rule 6 The duration of a level

annuity is 1equal
+y to:
T
−
y (1 + y ) T − 1
Rules for Duration (cont’d)
Rule 7 The duration for a corporate
bond is equal to:
1 + y (1 + y ) + T (c − y )
−
y c[(1 + y ) T − 1] + y
Duration and Convexity
Price
Pricing Error
from convexity
Duration
Yield
Convexity
• Convexity :
– 1/ P*(1+y)2*∑[CFt/(1+y)t (t2+t)]
Session Five
Corporate Bonds
• Corporate bonds are the fixed income
instrument issued by Corporations
other than the Government.
• There are broadly two types of
institutions which issue corporate
bonds namely Private Sector
Companies and Public Sector
Companies.
Corporate Bonds
• Under the case of Public Sector Undertaking ( PSU) two
types of bonds can be issued , namely Tax Free Bond
and Taxable Bond.
• In the case of tax free bonds the interest is tax free and
in the case of taxable bond , the interest is taxable at
the issue of the receiver of interest. The bonds issued by
PSU companies are also popularly known as PSU Bonds.
• In the case of other companies namely Private Sector
Companies ( which consist of both Private and Public
Limited companies ) some times these bonds are also
called as Debentures .
Corporate Bonds
• Besides these companies one of the other major players
in the bond market is the bank and financial institutions .
• Banks continuously issue bonds to shore up its Tier II
capital which is required for meeting its capital adequacy
ratio. Similar principle is applicable for Financial
Institutions.
• Though a mature bond market is must for overall
development of the economy as company uses
leverages to raise more capital , yet in India bond market
has not developed to that extent.
• However, there are enough opportunities to invest in the
bond in the retail segment.
Issue Process
• Passing of necessary resolution in the General Meeting and
Board Meeting.
• Obtaining the necessary credit rating.
• Creation of security for the said bonds/debentures through
appointment of debenture trustees.
• Appointment of advisors and investment bankers for issue
management ;
• Finalisation of the initial terms of the issue;
• Preparation of the offer document ( in the case of Public
Issue ) and Investment Memorandum ( in the case of
Private Issue ) ;
• SEBI approval of offer document for Public Issue;
Issue Process
• Listing agreement with Stock Exchanges.
• Offer the issue to prospective investors /and or Book Builders.
• Acceptance of application money /advance deposits for the
issue;
• Allotment of the issue ;
• Issue of letter of allotment and certificates/depository
confirmation ;
• Collect final amounts from the investors;
• Refund excess money /interest on application money;
Debenture Trustee
• No Company can issue Prospectus or Letter of Offer to
Public unless it has appointed one or more debenture
trustees for such debentures in accordance with the
provisions of the Companies Act 1956.
• The names of the Debenture Trustees would be mentioned
in the offer document and also in all subsequent periodical
communications sent to the debenture holders.
• A trust deed shall be executed by the issuer Company in
favour of the debenture trustees within three months of
the closure of the issue.
Offer Document
• Draft offer document would be
filed to the SEBI, in the prescribed
format. In the case of Private
Placement , Investment
memorandum would be submitted
to the prospective investors;
Creation of Debenture
Redemption Reserves
( DRR)
• A company has to create Debenture Redemption Reserves
( DRR) in case of issue of debenture in the maturity as prescribed
in the SEBI DIP guidelines and Indian Companies Act, 1956.
• A company shall create DRR to the tune of 50% of the
redemption amount before the debenture redemption
commences.
• Withdrawal from DRR is permitted only after at least 10% of the
debenture liability has accurately been redeemed by the
company . The creation of DRR would not be applicable for
debenture to be issued by Infrastructure Companies .
Creation of Debenture
Redemption Reserves
( DRR)
• A company has to create Debenture Redemption Reserves
( DRR) in case of issue of debenture in the maturity as prescribed
in the SEBI DIP guidelines and Indian Companies Act, 1956.
• A company shall create DRR to the tune of 50% of the
redemption amount before the debenture redemption
commences.
• Withdrawal from DRR is permitted only after at least 10% of the
debenture liability has accurately been redeemed by the
company . The creation of DRR would not be applicable for
debenture to be issued by Infrastructure Companies .
Credit Rating
• No Company can make Public Issue or
Rights Issue of the debenture unless it
has obtained credit rating from at least
two rating agencies and the rating must
be investment grade and the same is
disclosed in the offer document.
• In the case of Private Placement, QIB
insists on the ratings.
Term of Debenture
• The terms of the debenture is mentioned in the offer
document. In the case of Public Issue the face value
is 100.
• In the case of issuance the debentures may be
clubbed for a single investors , however the
investors can ask for split of the debentures and the
same can be issued to the investors separately with
minimum number of 1.
• In the case of private placement no such minimum
paid up value is there and generally it is Rs 10 lacs.
Term of Debenture
• In the case of fixed interest instrument , the
interest is paid as a certain percentage of the
face value of the instrument.
• The interest is due from the deemed date of
allotment and deemed date of allotment is
mentioned in the offer document.
• In case of floating rate instruments , the interest
rate would start from the beginning of the
period and it would be applicable till the end of
the period.
Term of Debenture
• Companies are required to pay investors ,
interest on application money that is received
from the date of realizations of this amount, to
the date immediately preceding the deemed
allotment at the applicable coupon rate of the
debenture.
• In case of applications that have been rejected or
allotted in part, for the unallotted interest as
mentioned above would be paid within 3 weeks
of the issue closure , on the refundable
application money.
Redemption
• Debenture can be hold either in the Physical
form or in the demat form .
• In the case of the physical form, the physical
debenture would have to be surrendered to
the company and the Company’s liability
will be extinguished once the debenture has
been redeemed .
• Debentures in the demat form are
discharged on payment of redemption
amounts to the registered debenture
holders as intimated by the depository.
Session Six
Immunization
• Banks are having a natural mismatch between assets and
liabilities maturity structure.
• Moreover, banks investments are predominantly in the
debt instruments.
• So banks assets are prone to interest rate risk.
• So Banks need to protect its asset from this risk.
• Let us take an example that a bank takes a deposit of Rs
10,000/- from a depositor where it is contracted to pay 8%
and both the interest and principal would be paid back
after 5 years.
• After 5 years , the bank is supposed to pay Rs 10000
(1.08)5=Rs 14693.28 years
Immunization
• Suppose bank wants to fund this obligation with Rs 10000 of 8% annual
coupon bonds , selling at par value with six years to maturity.
• As long as interest rate remains 8% , the bank funds its obligations.
• If interest rate changes, two offsetting influences will affect the ability of
the fund to grow to the targeted value of Rs 14,693.28.
• If interest rate rises, the fund will suffer a capital loss , impairing its
ability to satisfy its obligations. However, at a higher investment rate,
reinvested coupon will grow at a faster rate, offsetting the capital loss.
• Fixed income investors face two offsetting types of rate risk:
– Price risk
– Reinvestment risk
Immunization
• Increase in interest rate causes capital
losses but at the same time increase the
rate at which the coupon is reinvested.
• If the portfolio duration is chosen
appropriately, these two effects will cancel
out exactly.
• For a horizon equal to portfolios duration,
price risk and reinvestment risk exactly
cancels out.
Immunization
Payment No Years Remaining Accumulated Value of
until obligation Invested Amount
A .Interest remains at 8%
1 4 800(1.08)4=1088.39
2 3 800(1.08)3=1007.77
3 2 800(1.08)2= 933.12
4 1 800(1.08)1=864.00
5 0 800(1.08)0=800.00
5 0 10,800/(1.08)
=10000.00
Total 14693.28
B .Interest falls to 7 %
1 4 800(1.07)4=1048.64
2 3 800(1.07)3= 980.03
3 2 800(1.07)2= 915.92
4 1 800(1.07)1=856.00
0
Immunization
Payment No Years Remaining Accumulated Value of

until obligation Invested Amount
C .Interest increases to 9 %
1 4 800(1.09)4=1129.27
2 3 800(1.09)3=1036.02
3 2 800(1.09)2= 950.48
4 1 800(1.09)1=872.00
5 0 800(1.09)0=800.00
5 0 10,800/(1.09) =9908.26
Total 14696.02
Immunization
Accumulated value of
Invested Fund
t* D* Time
Immunization
• As the time passes on the duration of the asset profile
changes .
• This brings the importance of rebalancing the portfolio.
• The manager must rebalance the portfolio continuously
to keep the duration of the portfolio equal to the maturity
profile of the liability.
• This is so because duration generally decreases less
rapidly than does maturity.
• So even if the portfolio is immunized at the beginning ,
the maturity and duration fall in different
rate,necessitating the rebalancing of the portfolio.
Immunization
• There are many shortcomings in immunization technique :
• It assumes that the portfolio yield curve is flat.
• In the case of an upward sloping yield curve, the appropriate
rate need to be taken from the yield curve.
• Next is the parallel shift in yield curve. In case on non parallel
shift in yield curve immunization technique would not be able to
protect the portfolio from the interest rate risk.
• The immunization does not address the inflation issues at all.
Cash Flow Matching and
Dedication
• In case of cash flow matching, the obligations are first
found out for a particular period and then cash flows
are matched by forming a portfolio.
• Once matching is carried out, the portfolio need not be
immunized.
• When matching is done for the entire investment
horizon, it is called dedication technique.
• But getting bonds to follow the cash flow matching and
dedication technique is very difficult.
Active Bond Management
Technique
There are two ways for active bond management technique.
•
– Interest rate forecasting : it tries to anticipate movements across
the entire spectrum of the fixed income markets.
– Identification of relative mis pricing within fixed income markets
• Both the techniques would generate abnormal returns only if
the analyst’s information or insight is superior to that of the
market.
• Empirical evidences do not support that individual possesses
better knowledge than that of the market.
Bond Swap
• This belong to the active bond management
technique.
• Bond swap means replacement of one types
of bonds with that of another.
• There are fives types of bond swaps :
– The substitution swap
– The intermarket spread swap
– The rate anticipation swap
– The pure yield swap
– The tax swap
Different types of bonds
Swap
• The substitution swap is an exchange of one bond for a nearly identical
substitute. The substituted bonds should be of essentially equal
coupon,maturity, quality,call feature ,sinking fund provisions etc. This
swap would be motivated by a discrepancy between the prices of the
bonds represents a profit opportunity.
• The Intermarket spread swap is pursued when an investor believes that
the yield spread between two sectors of the bond markets is out of line.
For example if the current spread between the corporate and
government bond market is considered too wide and is expected to
narrow, the investor will shift from government bond to corporate bond.
Different types of bonds
Swap
• The rate anticipation swap is pegged to interest rate
forecasting.If the investor views that interest rate is
likely to decrease, it would replace shorter duration
bond with longer duration bond .
• The pure yield swap is aimed to earn the higher yield.
This strategy involves replacement of lower yield
bond with higher yield.
• The tax swap is to exploit some tax benefits by
adjusting capital loss from future gains – the facilities
available with some selected securities.
Horizon Analysis
• The analysts using this approach selects a
particular holding period and predicts the yield
curve at the end of the period.
• Then bond’s end of period price is calculated
from the yield curve.
• Then the analysts add the coupon income and
the perspective capital gain of the bond to
arrive at the total return on bond in the
horizon period.
Horizon Analysis
• Suppose a 20 year maturity ,10% coupon bond
currently yields 9% and sells at Rs 1092.01.
• An analyst with a 5 year time horizon would be
concerned about the bond’s price and the value of
reinvested coupon five years hence.
• At that time the bond will have 15 years maturity ,
so the analyst will predict the yield on 15 years
maturity at the end of 5 year period to determine
the bond’s expected price .
• If the yield is expected to be 8% , the bond’s end of
period price will be
– 50 * Annuity Factor ( 4% ,30)+1,000 PV Factor ( 4%,30)=
Rs 1172.92
Horizon Analysis
• The capital gain on this bond will be Rs 80.91 .
• Meanwhile the coupon paid by the bond will be reinvested over
the five year period.
• The analyst must predict a reinvestment rate at which the
invested coupons can earn interest.
• Suppose the assumed rate is 4% per half year period.
• If all the coupons are reinvested at this rate,the value of the ten
semiannual coupon payments with accumulated interest rate at
the end of the five year will be Rs 600.31.
• The total return proved by the bond over the holding period is
Rs 681.82/Rs 1092.01 i.e. 62.4% .
• The analyst repeats this procedure for many securities and
select the ones promising superior holding period return.
Contingent Immunization
• It is mixed passive –active strategy .
• Suppose that the interest rate at present is 10% per annum and a
manager’s portfolio is worth Rs 10 million right now.
• At current rate the manager can lock in via conventional immunization
techniques, a future portfolio value of Rs 12.1 million after 2 years.
• Now suppose that the manager wants to pursue active management
but is willing to risk losses only to the extent that the terminal value of
the portfolio would not drop lower than Rs 11 million.
• Because only Rs 9.09 million ( Rs 11million/1.10 ) is required to
2
achieve this minimum acceptable terminal value , and the portfolio is

currently worth Rs 10 million , the manager can afford to risk some
losses at the outset and might start off with an active strategy rather
than immediately immunizing.
• The key is to calculate the value of the fund required to
lock in via immunization a future value of Rs 11 million at
current rates.
• If T denotes the time left until the horizon date and r is
the market interest rate at any particular point of time ,
then the value of the fund necessary to guarantee an
ability to reach the minimum amount of terminal value is
Rs 11 million/(1+r)T, because this size portfolio if
immunized will fetch Rs 11 million.
• This value becomes the trigger point.
• When the actual portfolio value dips to the trigger point ,
active management will cease.
• Contingent upon reaching the trigger , an immunization
strategy is initiated .
Rs in Million
Portfolio
Value
Trigger Point
t* t
Horizon
Rs in Million
Portfolio
Value
t* t
Horizon
Interest Rate SWAP
• Consider a three-year swap initiated on March
1,1999 ,in which company B agrees to pay to
company A an interest rate of 5% per annum on a
notional principle of $ 100 million .
• In return company A agrees to pay to Company B
the six-month LIBOR rate on the same notional
principal.
• We assume the agreement specifies that payments
are to be exchanged every six months and the 5%
interest rate is quoted with semi annual
compounding.
• This is represented diagrammatically in the next
slide :
Interest Rate SWAP
5.0%
Company A Company B
LIBOR
Cash Flows to Company B
Date LIBOR rate Floating Fixed Cash Net Cash
( %) Cash Flow Flow Paid Flow
Received
1.3.1999 4.20
1.9.1999 4.80 +2.10 -2.50 -0.40
1.3.2000 5.30 +2.40 -2.50 -0.10
1.9.2000 5.50 +2.65 -2.50 +0.15

1.3.2001 5.60 +2.75 -2.50 +0.25
1.9.2001 5.90 +2.80 -2.50 +0.30
1.3.2002 6.40 +2.95 -2.50 +0.45

Cash Flows to Company B
Date LIBOR rate Floating Fixed Cash Net Cash
( %) Cash Flow Flow Paid Flow
Received
1.3.1999 4.20
1.9.1999 4.80 +2.10 -2.50 -0.40
1.3.2000 5.30 +2.40 -2.50 -0.10
1.9.2000 5.50 +2.65 -2.50 +0.15

1.3.2001 5.60 +2.75 -2.50 +0.25
1.9.2001 5.90 +2.80 -2.50 +0.30
1.3.2002 6.40 +102.95 -102.50 +0.45

Interest Rate SWAP
• If we see the previous slide we find out
the following interesting phenomena :
– Position of B is :
• Long on a Floating Rate Bond ;
• Short on Fixed Rate Bond;
– Position of A is :
• Long on a Fixed Rate Bond;
• Short on Floating Rate Bond;
Use of Interest Rate SWAP
• For Company B the swap could be used
to transform a floating rate loan into a
fixed rate loan.
• Suppose Company B has arranged to
borrow $
New Instruments for
Managing Interest Rate
• Interest rate derivativesRisk
are the instruments which are used to
manage Interest Rate Risk.
• One such instrument is the Inverse Floater.
• This is bond which pays lower coupon when interest rate rises.
– For example an Inverse Floater would pay coupon rate income equal to
10%minus the rate on one year T Bill Rate .If the T Bill rate is 4% then the
bond would pay coupon of 6% .
• If the T Bill rate increases to 7% then the bond would pay 3% of
par value : in addition , as other interest rates rise along with T
Bill rate , the bond price falls as well for the usual reason that
future cash flows are discounted at higher rates.
• Therefore there is a dual impact and this securities fair poorly
specially when interest rate rises.
New Instruments for
Managing Interest Rate
• Conversely it Risk
works very well when
interest rate falls.
Interest Rate Risk
Management
• With the help of interest rate swap one can manage the
interest rate movement.
• Collateralized Mortgage Obligation (CMO) is another tool with
which interest rate risk can be managed.
• In the case of CMO, Interest Only (IO) strips and Principle Only
(PO) strips would trade separately.
• PO securities exhibit very long effective duration – that is their
value is very sensitive to interest rate fluctuations. It performs
very well if the interest rate fall.
• IO securities fall when interest rate fall. It has negative
effective duration. This is good for an investor who is betting
an increase in interest rate.
Session Seven
What is a structured
finance
• A structured finance is a financial procedure to suit
the need of the borrower as per its specific
requirement.
• In many cases, a borrower may not get funding on a
plain vanilla method .However, by properly
structuring the process the borrower can be funded.
• Similarly by securitising the loans funding can be
arranged to meet the specific requirement of the
issuer of loan.
• Structured finance serves several purpose starting
from increase in fund flows in the system to risk
mitigation of the system.
Funding of a week
company
• In the case of plain vanilla lending, a lending
institution can lend to a borrower only if it can
meet the following criteria :
– Profitability : 10% of net sales .
– Current Ratio : 1.33
– Leverage Ratio : 1.75
• The lender from its internal model finds that
these are the parameters required at a
particular point of time to avoid delinquency.
• The main concern of the lender is to avoid
delinquency.
Funding of a week
company
• A Company has the following criteria :
– Profitability : 3% of net sales .
– Current Ratio : 1.03
– Leverage Ratio : 2.75
• The lender wants to finance this Company .
• The major concern for the lender is that if a company
can not meet the above criteria , there is a probability
that the Company would default.
• The lender can address this concern by entering into a
structured finance agreement with the company.
Funding of a week
company
• The lender sits with the company and analyses
the customer profile of the company .
• The lender rates these customers and segregate
the best rated customers from the rests.
• Now lender enters into agreement with the
borrower in such a way that these customers
would pay directly to the lender.
• The lender overcollateralise the installment by 2
to 3 times .
• This is an example of structured finance through
escrowing of receivable.
Securitisation
• It is used to mean a device of structured
financing where an entity seeks
– to pool together its interest in identifiable
cash flows over time;
– transfer the same to investors either with
or without the support of further
collaterals;
– and thereby achieve the purpose of
financing.
Requirement of
Securitisation
• Securitisation is used for fulfilling the
following purpose :
– It reduces the capital requirement imposed
by the regulator.
– It gives an opportunity of investors to suit
their requirement as per their subjective
risk preferences.
– It also reduces the risk of the system .
Terminology in
Securitisation
• The entity that securitises its assets is called the originator: the name
signifies the fact that the entity was responsible for originating the claims that
are to be ultimately securitised.
• There is no distinctive name for the investors who invest their money in the
instrument: therefore, they might simply be called investors.
• The claims that the originator securitises could either be
– existing claims, or existing assets (in form of claims), or
– expected claims over time. In other words, the securitised assets could be either
existing receivables, or receivables to arise in future. The latter, for the sake of
distinction, is sometimes called future flows securitisation, in which case the
former is a case of asset-backed securitisation.
• In US markets, another distinction is mostly common: between mortgage-
backed securities and asset-backed securities. This only is to indicate the
distinct application: the former relates to the market for securities based on
mortgage receivables, which in the USA forms a substantial part of total
securitisation markets, and securitisation of other receivables.
Terminology in
Securitisation
• Since it is important for the entire exercise to be a case of
transfer of receivables by the originator, not a borrowing on the
security of the receivables, there is a legal transfer of the
receivables to a separate entity. In legal parlance, transfer of
receivables is called assignment of receivables.
• An entity is created solely for the purpose of the transaction:
therefore, it is called a special purpose vehicle (SPV) or a
special purpose entity (SPE) or, if such entity is a company,
special purpose company (SPC).
• The originator transfers the assets to the SPV, which holds the
assets on behalf of the investors, and issues to the investors its
own securities. Therefore, the SPV is also called the issuer.
Terminology in
Securitisation
• These securities could either represent a direct claim of the
investors on all that the SPV collects from the receivables
transferred to it: in this case, the securities are called pass through
certificates or beneficial interest certificates as they imply
certificates of proportional beneficial interest in the assets held by
the SPV.
• Alternatively, the SPV might be re-configuring the cash flows by
reinvesting it, so as to pay to the investors on fixed dates, not
matching with the dates on which the transferred receivables are
collected by the SPV. In this case, the securities held by the
investors are called pay through certificates.
• The securities issued by the SPV could also be named based on their
risk or other features, such as senior notes or junior notes,
floating rate notes, etc.
Asset Backed Securities
( ABS)
Asset Backed Securities in a general sense
CDO
Mortgage ABS in a
Backed Narrower
Securities Sense
( MBS) •Credit Card
Residential •Equipment
Mortgage •Student Loan
CLO CBO
Commercial •Music Royalties Loan owned Bonds
Mortgage By Traded in the
Bank Market
Process of securitisation
Credit Originator /
Enhancer Servicer
Provides Credit Receives Loan sale Receives inflow
Enhancement Fund From reference
Transfer
Of Assets Issuer of
Trustee S.P.V. Underwriter
Principal Debt
And Interest Securities
Minus
Servicing Revenues from
Fees Debt Distribution
Securities Of
Disburses
Revenues to Debt Securities
Investors Investors
CDO
• In a Collateralised Debt Obligation ( CDO) structure, the issuer
repackages ( corporate or sovereign ) debt securities or bank
loans in to a reference portfolio ( the collateral) , whose proceeds
are subsequently sold to investors in the form of debt securities
with various levels of senior claim on this collateral.
• The issued securities are structured in so called senioritised credit
tranches, which denote a particular class of debt securities
investor may acquire when they invest in a CDO transaction.
• The tranching can be done by means of various structural
provisioning governing the participations of investors in the
proceeds and losses stemming from the collateral.
CDO
• Subparticipation is one of the most convenient vehicles for attaching
different levels of seniority to categories of issued securities, so that losses
are allocated to the lowest subordinate tranches before the mezzanine and
senior tranches are considered.
• This process of filling up the tranches with periodic losses bottom up
results in a cascading effect .
• Both interest and losses are allotted according to investor seniority.
• This prioritisation of claims and losses from the reference portfolio
guarantee that senior tranches carry a high investment grading ( AAA) ,
provided sufficient junior tranches have been issued to shield more senior
tranches from credit losses.
Types of CDO
• The classification of CDOs depends on possible variability in the
valuation of the collateral ex post the issuance of the securities.
• In Market value CDO , the allocation of payments to various tranches
depends on the mark to market returns on the reference portfolio
underlying the transactions.
• The market value form of CDO s is generally applied in cases of
distressed reference portfolio of bonds or loans such that the credit
and trading expertise of the originator of these assets might provide
grounds for arbitrage gains from the differences in prices between the
distressed assets on the bank books and their aggregate valuation
when bundled in a reference portfolio underlying securities.
Various form of structure
enhancement – Waterfall
CDO Tranches
AAA Senior Tranches
Portfolio
Payment A Mezzanine Tranches
X 1000 Made
BB Subordinated Tranches
Y 2000
Equity Tranches
Z 4000
Various form of structure
enhancement
• Over collateralisation : Volume of assets
is more than volume of issued notes.
• Excess Spread: Difference between
interest payment from assets and CDO
coupons are collected in an account.
• Guarantee by the originator.
• Insurance by the third party.
Credit Derivative
• Complexities in credit transactions warrant
invention of credit derivatives .
• In a fixed income securities , interest rate risk in
the form of duration, convexity are addressed by
Interest Rate Derivatives.
• Where as the remaining risk of debt security
i.e.default risk is addressed by credit derivatives.
• Besides several default like situation in the last
20 years prompted the innovation of such
products.
What is Credit Derivative ?
• Credit Derivatives are financial instruments designed to transfer
credit risk from one counterpart to another.
• Legal ownership of the reference obligation is usually not
transferred.
• Credit derivative can have the form of forwards,swaps and
options, which may be imbedded in financial assets such as
bonds and loans.
• Credit derivatives allow an investor to reduce or eliminate the
credit risk or to assume credit risk, expecting to profit from it.
• From a technical point of view , credit derivatives are financial
instruments whose value is derived from an underlying obligation
which is either a bond or loan.
Reason for increase in
Credit Derivative
Transaction
• The number of credit derivative transactions have
increased dramatically in recent years .The main
reasons for the rise of credit derivative are :
– The general desire to reduce risk in the financial markets ,
expressed by increased regulatory requirement
– An increase in personal bankruptcies and recent corporate
and sovereign bankruptcies, such as the Asian Financial
Crisis in 1997, Russia 1998, Argentina 2001 or Enron in
2002 and World Com 2002.
– An increase in the ability to value and risk manage credit
risk.
Types of Credit
Derivatives
Credit
Derivatives
Credit Synthetic
TROR
CDS Spread Structures
Product
Credit Default Swaps
• In a Credit Default Swap (CDS), the buyer
makes a periodic or upfront payment to the
seller of the default swap.
• The default swap seller promises to make a
payment in the event of default of a reference
obligation which is usually a bond or loan.
• More technically, a CDS can be viewed as a
put option on the reference obligation. The
default buyer owns this put, allowing him to
sell the reference obligation to the default
swap seller in case of default.
• Another important point is that the default
swap buyer has a short position in the credit
quality of the reference obligation. If the credit
quality and the price of the bond decrease, the
present value ( the premium if paid upfront )
of the default swap would increase.
• Thus the original premium paid by the buyer is
lower than the market price after the bond
price decrease. If desired, the default swap
buyer can sell the default swap at the higher
market premium with a profit.
• Using the same logic, the default swap seller
has a long position in the credit quality of the
reference obligation. If the credit quality and
the price of the bond increase, the present
value ( the premium if paid upfront ) of the
default swap would decrease.
• Thus the original premium received by the
buyer is higher than the market price after the
bond price price. If desired, the default swap
seller can buy back the default swap contract
at the lower market premium with a profit.
Credit Default Swaps-
Utilities
• Hedging : CDS can be used to reduce various types of risk
such as default risk, credit deterioration risk, and also other
types of risk such as market risk and operational risk.
• Yield enhancement: By assuming credit risk on reference
obligation yield can be enhanced.
• Convenience and cost reduction : A CDS allows a lender to
eliminate the credit exposure to a debtor without the
knowledge of the debtor , thus maintaining a good bank
debtor relationship.
• Arbitrage : Since default swap ( and other credit derivatives )
can be replicated with other financial instruments , arbitrage
opportunity may exist.
Terminology
• Buying a default swap or paying a fixed rate in a default swap
is also called as buying protection.
• Selling a default swap or paying a floating rate in a default
swap is called as selling protection or assuming risk.
• The default swap premium also called as fee,price or fixed
rate is often referred to as the default swap spread.
• Being long the default swap basis means buying the reference
obligation and buying protection.
• Being short the default swap basis means selling the reference
obligations and selling protection.
Features
• In a default swap the following terms have
to be agreed between a buyer and seller :
– The premium
– The reference obligations
– Its notional amount
– The maturity of swap
– The definition of the default event
– The type of settlement ( physical or cash)
Settlement
• The settlement in the default swap is either
in cash or in physical.
• Cash settlement is easier from an
administrative point of view.
• Cash Settlement : In case of cash
settlement , the cash paid from the default
swap seller to the default swap buyer incase
of default is usually determined as :
N*[ Reference Price-(Final Price+Accrued
Interest on reference obligation ) ]
Settlement , An example
• The notional amount of default swap is Rs 50,000,000. The
reference price is 100% and a dealer opinion poll
determines the final price of the reference bond as 35%.
The last coupon payment was 45 days ago and the bond
has an annual coupon of 9% . What is the cash settlement
amount in case of default of the reference bond ?
• It is =N*[ Reference Price-(Final Price+Accrued Interest on
reference obligation ) ]
• = 50,000,000*[100%-(35%+9%*45/360)]=Rs 31,937,500.
Settlement , An example
• In case of physical settlement amount
paid by the default swap seller to the
swap buyer is N*Reference Price where
as the buyer will deliver a bond from the
pre specified baskets.
Securitisation
• Securitisation is a process by which assets are sold to a
bankruptcy remote special purpose vehicle (SPV) in
return for an immediate cash payment.
• The cash flow from the underlying pool of assets is used
to service the securities issued by the SPV.
Securitisation thus follows a two stage process.
– In the first stage there is sale of single asset or pooling and sale
of pool of assets to a 'bankruptcy remote' special purpose
vehicle (SPV) in return for an immediate cash payment and
– in the second stage repackaging and selling the security
interests representing claims on incoming cash flows from the
asset or pool of assets to third party investors by issuance of
tradable debt securities.
Securitisation
• Banks’ exposures to a securitisation transaction are
referred to as “securitisation exposures”.
• Securitisation exposures include, but are not
restricted to the following:
– exposures to securities issued by the SPV,
– credit enhancement facility,
– liquidity facility,
– underwriting facility,
– interest rate or currency swaps and
– cash collateral accounts.
Securitisation – Definition
• Bankruptcy remote" means the unlikelihood
of an entity being subjected to voluntary or
involuntary bankruptcy proceedings,
including by the originator or its creditors;
• Credit enhancement" is provided to an SPV
to cover the losses associated with the pool
of assets. The rating given to the securities
issued by the SPV (PTCs) by a rating agency
will reflect the level of enhancement;
• A "first loss facility" represents the first level of financial support to a
SPV as part of the process in bringing the securities issued by the SPV to
investment grade. The provider of the facility bears the bulk (or all) of
the risks associated with the assets held by the SPV;
• A “second loss facility” represents a credit enhancement providing a
second (or subsequent) tier of protection to an SPV against potential
losses;
• "Liquidity facilities" enable SPVs to assure investors of timely payments.
These include smoothening of timing differences between payment of
interest and principal on pooled assets and payments due to investors;
• "Originator" refers to a bank that transfers from its balance
sheet a single asset or a pool of assets to an SPV as a part of a
securitisation transaction and would include other entities of
the consolidated group to which the bank belongs.
• "Securitisation" means a process by which a single performing
asset or a pool of performing assets are sold to a bankruptcy
remote SPV and transferred from the balance sheet of the
originator to the SPV in return for an immediate cash payment;
• "Service provider" means a bank that carries out on behalf of the
SPV
– (a) administrative functions relating to the cash flows of the underlying
exposure or pool of exposures of a securitization;
– (b) funds management; and
– (c) servicing the investors;
• "SPV" means any company, trust, or other entity constituted or
established for a specific purpose - (a) activities of which are limited
to those for accomplishing the purpose of the company, trust or
other entity as the case may be; and (b) which is structured in a
manner intended to isolate the corporation, trust or entity as the
case may be, from the credit risk of an originator to make it
bankruptcy remote;
• "SPV" means any company, trust, or other entity
constituted or established for a specific purpose –
– (a) activities of which are limited to those for
accomplishing the purpose of the company, trust or other
entity as the case may be; and
– (b) which is structured in a manner intended to isolate
the corporation, trust or entity as the case may be, from
the credit risk of an originator to make it bankruptcy
remote;
• Underwriting" means the arrangement
under which a bank agrees, before
issue, to buy a specified quantity of
securities in a new issue on a given date
and at a given price if no other
purchaser has come forward.
Securitisation – True Sale
• For enabling the transferred assets to be removed
from the balance sheet of the originator in a
securitisation structure, the isolation of assets or ‘true
sale’ from the originator to the SPV is an essential
prerequisite. In case the assets are transferred to the
SPV by the originator in full compliance with all the
conditions of true sale given below, the transfer would
be treated as a 'true sale' and originator will not be
required to maintain any capital against the value of
assets so transferred from the date of such transfer.
• The effective date of such transfer should be
expressly indicated in the subsisting
agreement. In the event of the transferred
assets not meeting the “true-sale” criteria the
assets would be deemed to be on the balance
sheet of the originator and accordingly the
originator would be required to maintain capital
for those assets. The criteria of true-sale that
have been prescribed below are illustrative but
not exhaustive.
• The sale should result in immediate legal separation of the
originator from the assets which are sold to the new owner
viz. the SPV .
• The originator should effectively transfer all risks/ rewards
and rights/ obligations pertaining to the asset and shall not
hold any beneficial interest in the asset after its sale to the
SPV.
• The originator shall not have any economic interest in the
assets after its sale and the SPV shall have no recourse to
the originator for any expenses or losses except those
specifically permitted under these guidelines.
• There shall be no obligation on the originator to re-purchase
or fund the re-payment of the asset or any part of it.
• An option to repurchase fully performing assets at the end
of the securitisation scheme where residual value of such
assets has, in aggregate, fallen to less than 10% of the
original amount sold to the SPV ("clean up calls") as allowed
vide paragraph 10 can be retained by the originator.
• The originator should be able to demonstrate that it has
taken all reasonable precautions to ensure that it is not
obliged, nor will feel impelled, to support any losses
suffered by the scheme or investors.
• The sale shall be only on cash basis and the consideration shall
be received not later than at the time of transfer of assets to the
SPV. The sale consideration should be market-based and arrived
at in a transparent manner on an arm's length basis.
• Provision of certain services (such as credit enhancement,
liquidity facility, underwriting, asset-servicing, etc.) and
assumption of consequent risks/ obligations by the originators as
specifically allowed in these guidelines would not detract from
the 'true sale' nature of the transaction, provided such service
obligations do not entail any residual credit risk on the assets
securitized or any additional liability for them beyond the
contractual performance obligations in respect of such services.
Securitisation – SPV
• SPV is a special purpose vehicle set up during the process
of securitisation to which the beneficial interest in the
securitised assets are sold / transferred on a without
recourse basis.
• The SPV may be a partnership firm, a trust or a company.
Any reference to SPV in these guidelines would also refer
to the trust settled or declared by the SPV as a part of the
process of securitisation.
• The SPV should meet the following criteria to enable the
originator to treat the assets transferred by it to the SPV
as a true sale and apply the prudential guidelines on
capital adequacy and other aspects with regard to the
securitisation exposures assumed by it.
Securitisation – SPV
• Any transaction between the originator and the SPV should be strictly on
arm’s length basis. Further, it should be ensured that any transaction with the
SPV should not intentionally provide for absorbing any future losses.
• The SPV and the trustee should not resemble in name or imply any connection
or relationship with the originator of the assets in its title or name.
• The SPV should be entirely independent of the originator. The originator
should not have any ownership, proprietary or beneficial interest in the SPV.
The originator should not hold any share capital in the SPV.
• The SPV should be bankruptcy remote and non-discretionary.
Session Seven
Investment of Mutual Fund
• A mutual fund may invest moneys
collected under any of its schemes only
in:
– securities ;
– money market instruments;
– privately placed debentures;
– securitised debt instruments, which are either
asset backed or mortgage backed securities;
– gold or gold related instruments
Investment of Mutual Fund
• Moneys collected under any
money market scheme of a mutual
fund shall be invested only in
money market instruments.
• Moneys collected under any gold
exchange traded fund scheme
shall be invested only in gold or
gold related instruments,
Borrowing of Mutual Fund
• The mutual fund shall not borrow except to meet
temporary liquidity needs of the mutual funds for the
purpose of repurchase, redemption of units or payment
of interest or dividend to the unit holders.
– Provided that the mutual fund shall not borrow more than 20
per cent of the net asset of the scheme and the duration of
such a borrowing shall not exceed a period of six months.
Borrowing of Mutual Fund
• The mutual fund shall not advance any loans for any
purpose.
• The mutual fund may lend securities in accordance
with the Stock Lending Scheme of the Board.
• Mutual funds may enter into underwriting agreement
after obtaining a certificate of registration in terms of
the Securities and Exchange Board of India
(Underwriters) Rules and Securities and Exchange
Board of India (Underwriters) Regulations, 1993
authorising it to carry on activities as underwriters.
Computation of Net Asset
Value
• Every mutual fund shall compute the Net Asset Value of each
scheme by dividing the net assets of the scheme by the
number of units outstanding on the valuation date.
• The Net Asset Value of the scheme shall be calculated and
published at least in two daily newspapers at intervals of not
exceeding one week.
• Provided that the Net Asset Value of any scheme for special
target segment or any monthly income scheme which are not
mandatorily required to be listed in any stock exchange
under regulation 32, may publish the Net Asset Value at
monthly or quarterly intervals as may be permitted by the
Board.
Pricing
• The price at which the units may be subscribed or sold and the
price at which such units may at any time be repurchased by the
mutual fund shall be made available to the investors.
• The mutual fund, in case of open-ended scheme, shall at least
once a week publish in a daily newspaper of all India circulation,
the sale and repurchase price of units.
• While determining the prices of the units, the mutual fund shall
ensure that the repurchase price is not lower than 93 per cent of
the Net Asset Value and the sale price is not higher than 107 per
cent of the Net Asset Value:
• Provided that the repurchase price of the units of a close ended
scheme shall not be lower than 95 per cent of the Net Asset
Value:
Pricing
• Provided further that the difference
between the repurchase price and the sale
price of the unit shall not exceed 7 per cent
calculated on the sale price:
• Provided further that no entry load shall
be charged by any close-ended scheme
after commencement of the Securities and
Exchange Board of India (Mutual Funds)
(Second Amendment) Regulations, 2006.
Thank You

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Indian Debt Market

SBI Mutual Fund

Household Current Income- Purchase of assets

Net Worth 300000 Cash 50000

Total 300000 Total 300000

Net Worth 500000 Cash 40000

Other Asset 25000

Net Worth 300000 Cash 40000

Net Worth 500000 Cash

Financial 10000 Furniture 60000

Other Asset 25000

Total 510000 Total 510000

Security brokers, Lenders

Flow of Funds Flow of Funds

Flow of Funds Flow of Funds

• As per as amount is considered ,

Time of Repayment Fixed Not Fixed

Amount of Repayment Fixed Not Fixed

Repayment Not dependent on Dependent on

Loan Loan Investment

Short Term Short Long

Long Short Long

Scheduled CommercialOn a fortnightly averageOn a fortnight basis this

Primary Dealers 200% of NOF 25% of NOF

Circulation of Small Coins 3 Currency with the Public =

Demand Deposits with5

Post Office Savings Bank7

Currency Reserves High Powered Money

Bank Deposit at RBI (D) Reserve Bank Loans given to

Other Deposits (OD) Other Assets (NO RBI )

Bank Loans given to

Cash Balance with Bank (Cb)

Other Nonmoneytary Bank Deposit with RBI (D)

Other Assets (NO B )

• Loan/Premature payments : Banks/FIs cannot

• Secondary market transactions in CD

Depositor Bank Borrower

Dep RBI Dep Lend

Please Pay ________________ ( Payee) or Order a sum of Rs -

(Rupees ________________only ) on 90 days ( Credit Period) from the

date of this document.

Internal Rate of Return:

Simple Average Return:

Geometric Mean: Text Example Average:

rf = Average risk free rate

rf = Average risk free rate

ßp = Weighted average for

• Assumptions underlying measures

Adjusting portfolio for up and

Where B is the bogey portfolio and p is the managed portfolio

• 17.Revenue Expenditure – 10+14

• The Fiscal Deficit of the Central Government can

• Under this method of borrowing, the coupon on

• The securities are issued either by

• Government Securities may be issued with

PB = Price of the bond

10 yr Maturity Coupon Rate = 7%

Bond Coupon Maturity Initial

B 12% 30 Years 10%

Bond Bond Bond Bond

Price at 10% YTM 1075.82 1188.54 340.12 587.06

Price at 11% YTM 1036.96 1086.94 304.50 503.64

Price at 9% 1116.69 1308.21 383.58 692.55