Fixed Income Instruments in India

Fixed Income Instruments in India
SUMMER INTERNSHIP
Report
On
“Fixed income
Instruments in India”
SUBMITTED TO: SUBMITTED BY:

Executive Director Deepak Singh (06-j1-121)
Jagjit Singh PGDBM (2006-08)
INSTITUTE OF MARKETING AND MANAGEMENT

Marketing Tower, B-11, Qutub Institutional Area,
New Delhi-110016
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“Fixed Income Instrument in India” is my attempt to gather maximum possible

information about fixed income securities at one place. This report is based on
secondary research from websites and newspapers. I have tried to cover most of
the well known fixed income instruments available in Indian financial market.
This report is based on the information latest by July 2007. Motive of preparing
this report is collect brief information on various fixed income instruments as
most of the people don’t have any information about these instruments.
It is a wide topic and it is not easy to touch all the aspects of fixed income
instrument in detail as well as the secondary market for government securities
and corporate bonds is not fully developed in India.
Thank you,
Deepak Singh
deepaksjyala@hotmail.com
deepaksjyala@gmail.com
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TABLE OF CONTENTS
1. Executive Summary
2. Objective
3. Methodology
4. Fixed Income Instruments
4.1) Introduction
4.2) Why Invest in Fixed Income Instruments?
4.3) Risk in Fixed Income Instruments
4.4) Returns
5. Debt Market
6. Structure of Indian Debt Market
7. Regulators (RBI & SEBI)
8. Government Securities
9. Essential terms
10. Features of Government Securities
11. Auction of Securities
12. Central Government Securities
12.1) Treasury Bills
12.2) Dated Securities
12.3) Zero coupon Bonds
12.4) Partly Paid Stock
12.5) Floating Rate Bonds
12.6) Capital Indexed Bonds
12.7) Coupon Bearing Bonds
12.8) Govt. with call and put option
12.9) Strips
13. Zero Coupon Yield Curve
14. State Government Securities
14.1) State Development Loan
14.2) Coupon Bearing Bonds
15. Mandated Investments in Govt. Securities
16. Benefits of Investing in Govt. Securities
17. Public Sector Bonds
17.1) Govt. Guaranteed Bonds
17.2) PSU Bonds
17.3) Commercial Papers
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17.4) Debentures
18. Private Sector Bonds
18.1) Corporate Bonds
18.2) Corporate Debentures
18.3) Inter-Corporate Deposits
18.4) Certificate of Deposits
18.5) SPN
18.6) Commercial Papers
18.7) Floating Interest Rate
18.8) Zero Coupon Bond
19. Other Fixed Income Instruments
19.1) Company fixed Deposits
19.2) Employee’s Provident Fund
19.3) Mutual Funds
19.4) Guilt Funds
19.5) Bank Fixed Deposits
19.6) Other Prominent Govt. Schemes
a) Public Provident Fund
b) National Savings Schemes Account, 1992 (Discont.)
c) National savings Certificates (viii) Issue
d) Post Office Monthly Income Scheme
e) Post Office Recurring Deposits Scheme
f) Post Office Savings Account
g) Post Office Time Deposit Schemes
h) Kisan Vikas Patra
i) RBI Relief Bonds
j) Deposit Scheme for Retiring Employees of PSUs
k) Deposit Scheme for Retiring Govt. Employees-89
l) Indira Vikas Patra (Discontinued)
20. Other important information
21. Liquidity Vs Return
22. Risk Vs Return
23. Suggestions for investors
24. Limitations of study
25. References/Bibliography
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1. EXECUTIVE SUMMARY
Savings are essential requirements for any individual. There are lots of
options available to invest in variety of securities based on individual’s
profile in terms of age, income, liquidity requirement and risk tolerance
level. At every age investment portfolio should comprise of both fixed and
variable income instruments.
This report addresses ‘Fixed Income Instruments’ which are one of the
important parts of every investors saving portfolio.
Fixed income instruments are basically obligations undertaken by the issuer

of the instrument as regards to the repayment of interest and principal (At
predetermined intervals of time), which the issuer would pay to the legal
owner of the instrument. . The time of maturity and amount to be received
on maturity are known in advance. Bonds, debentures, fixed deposits, and
small savings schemes (National Savings Certificate and Kisan Vikas Patra
among others) are some of the variants.
Fixed income instruments can be arranged into 4 sections namely –

1. Government Securities
2. Public Sector Bonds
3. Private Sector Bonds
4. Others (like PPF, Kisan Vikas patra, post office etc.)
The bond market in India is dominated by government bonds. Nearly 90% of

total domestic bonds outstanding are government issuances (i.e. Treasury
bills, notes and bonds), squeezing out corporate and other marketable debt
securities
PSU bonds have been consistently performing better than corporate bonds.
Government bonds constitute almost 35% of GDP where as Corporate bonds
constitute nearly 2% of the total GDP of India.
As far as risk is concerned fixed income bonds like government Securities
are considered risk free investments where as corporate bonds, debentures
etc varies from a range of low to moderate risk.
The very basic considerations of an investor while investing his money are
how to maximize one's returns? What will he get? and what are the risks
involved in investing in a particular investment?
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Attribute wise summary of financial instruments:
PRODUCTS RETURN LIQUIDITY RISK
EQUITY HIGH HIGH HIGH
Co. DEBENTURES MODERATE LOW MODERATE
Co. FDs MODERATE LOW HIGH
BANK DEPOSITS LOW HIGH LOW
PPF MODERATE MODERATE LOW
LIFE INSURANCE LOW LOW LOW
MUTUAL FUNDS HIGH HIGH LOW
RBI BONDS MODERATE LOW LOW
GOVT. SECURITIES MODERATE MODERATE LOW
GUILT FUNDS MODERATE HIGH MODERATE
RBI REFLIEF BOND HIGH LOW LOW
Risk Vs Return:
LOW MODERATE HIGH
Co. Fixed deposits Equity, RBI

HIGH
relief bonds,
Co. debentures, Real estate MODERATE

Guilt funds
Bank deposits, PPF, RBI bonds, Mutual funds

Life insurance Govt. Securities (fixed income LOW
part)
The desirability of any investment depends not only on its promising or

expected return but also on the risk exposure of the investment constitutes an
important element of investment decisions of the investors.
For different investors this market has different investment options with
variable liquidity and returns. Now investor can opt for best option
according to his/her preferences.
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2. OBJECTIVE
To collect information of various fixed income instruments.
In India most of the people don’t have sufficient information about various fixed
income instruments those are available for investment.
Objective of study is divided into two parts these are –
a) To collect information about various fixed income instruments

available in India.
b) Study of liquidity, Risk and Return in each instrument.
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3. RESEARCH METHODOLOGY
This project report is wholly based on personal discussion and research from
websites. Objective of report was fully executed with the help of secondary
data available on net.
The data collection and data analysis is done with the help of following
methods
1. Data collection:
Secondary Methods: - Journals, Corporate reports, News papers and related
websites.
2. Data analysis:
Data classification and analysis is being done with the help of various
statistical tools such as charts, tables and graphical methods such as pie
charts, bar charts, area charts etc.
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4.) 'Fixed Income' Instruments’

4.1) Indian market
Indian Capital Markets comprise of the Equities Market and the Debt Markets.
Debt Markets are markets for the issuance, trading and settlement in fixed income
securities of various types and features. Fixed income securities can be issued by
almost any legal entity like Central and State Governments, Public Bodies,
Statutory corporations, Banks and Institutions and Corporate Bodies.
Introduction to Fixed Income Instruments
Fixed Income securities are one of the most innovative and dynamic instruments
evolved in the financial system ever since the inception of money. Based as they
are on the concept of interest and time-value of money, Fixed Income securities
personify the essence of innovation and transformation, which have fueled the
explosive growth of the financial markets over the past few centuries.
Fixed Income securities offer one of the most attractive investment opportunities
with regard to safety of investments, adequate liquidity, flexibility in structuring a
portfolio, easier monitoring, long term reliability and decent returns. They are an
essential component of any portfolio of financial and real assets, whether in form
of pure interest bearing bonds, innovative and varied type of debt instruments or
asset-backed mortgages and securitized instruments.
Fixed income instruments are basically obligations undertaken by the issuer of the
instrument as regards to repayment of interest and principal (At predetermined
intervals of time), which the issuer would pay to the legal owner of the instrument.
Fixed Income instruments are essentially of two types.
 Tradable. E.g. A debenture

 Non-Tradable. E.g. A bank deposit
4.2) Why Invest in Fixed Income?
Fixed-income instruments in India typically include company bonds, fixed

deposits and government schemes. The reasons for investing in fixed income
option are mentioned below.
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 Low risk tolerance
One of the key benefits of fixed-income instruments is low risk i.e. the relative
safety of principal and a predictable rate of return (yield). If your risk tolerance
level is low, fixed-income investments might suit your investment needs better.
But remember that these still have risks associated and are explained later.
 Need for returns in the short-term

Investment in equity shares is recommended only for that portion of your wealth
for which you are unlikely to have a need in the short-term, at least five-years.
Consequently, the money that you are likely to need in the short-term (for capital
or other expenses), should be invested in fixed-income instruments.
 Predictable versus Uncertain Returns

Returns from fixed-income instruments are predictable i.e. they offer a fixed rate
of return. In comparison, returns from shares are uncertain. If you need a certain
predictable stream of income, fixed-income instruments are recommended.
Before you decide to invest in fixed-income instruments, evaluate your needs from
three key perspectives - risk, returns and liquidity. Match the investment options
with your financial needs.
4.3) Risk
There are two types of risks associated with investments in Fixed Income Options.
a) Interest Rate Risk

The price of the fixed income options are effected inversely by the interest rates.
So, if the interest rates go up then the price of the existing bonds goes down and
vice versa. The risk becomes important if you are interested in trading in the
bonds and are not likely to hold till maturity.
b) Credit Risk
Credit risk refers to the possibility that the issuer fails to pay what is owed
(principal and/or interest). Evaluate the credit ratings assigned by rating agencies
like Moody’s, Standard & Poor, CRISIL, ICRA and CARE to find corporate
bonds/ fixed deposits that match your risk tolerance level.
Please note that it is not mandatory for non-finance companies to get a credit
rating for their fixed deposit schemes. Hence, it is advisable to see if the company
has a credit rating for any other debt instrument while evaluating fixed deposit
schemes.
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Also, one should understand the relation between credit rating of a company and
the coupon (interest rate) which it promises. A low credit rating company would
promise higher coupon than a company which has high credit rating as the risk
involved in lending to low credit rated company is higher and the investor has to
be compensated for the same.
So, in case of fixed income option, investor should not get allured by the returns
alone and should look into the underlying risks as well.
Generally the government bonds are considered the safest as there is sovereign
guarantee attached. But at the same time some countries are considered more
reliable than others hence, in such a case the credit ratings of the country comes in
to play. Hence, an emerging market government bonds would pay higher coupon
than those issued by developed countries.
4.4) Returns
Return calculations should consider effective yield, interest rate expectations and
taxes.
a) Calculate effective yield

Calculate the post-tax effective yield for each instrument for comparison.
Effective yield is the IRR (Internal Rate of Return) of the fixed-income
instrument.
For e.g. for an instrument that pays 14% monthly interest, the effective annual
yield works out to 14.93%. This is definitely more attractive than an instrument
that pays 14% annually.
b) Consider interest rate (and inflation) expectations

Once you invest in a fixed-income instrument, your investment is committed,
more often than not, for the specified period of time.
During this period, if interest rates increase, you will not benefit from this rise.
Hence, your effective return from this investment will be lower than if you had the
flexibility to invest at a higher interest rate.
So, if you expect interest rates to increase, invest only in short-term instruments,
and vice versa.
c) Don’t forget taxes

While calculating your interest yield remember to include post-tax interest
receipts. For investors in high-tax brackets, tax-free government bonds/ schemes
might be more attractive.
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Mutual funds present an alternative avenue to invest in fixed income instruments
at zero tax liability on the income received.
Tenure & Liquidity

The tenure of the fixed income instrument is important as the returns get
influenced by the tenure. For example, the interest rate risk we discussed above, if
the interest rate rises then the existing bond with longer tenure will witness higher
fall in price than one with shorter tenure.
Fixed-income instruments are normally illiquid as the secondary market for these
instruments is not yet developed in India. Make sure you carefully evaluate the
potential liquidity, exit route and penalties of the instrument before you invest.
How to Buy?
Worldwide the secondary market for fixed income instruments is more developed
than in India. There are no open exchanges in India to trade debt and in case you
wish to trade in bonds then your broker will have to find buyer and sellers for
you.
- Company bonds/ debentures

Companies issue bonds and debentures through public issues that are open only
for a limited period of time. Application forms for these issues are available with
primary market brokers.
- Company fixed deposits

Fixed deposit schemes from companies are typically open round the year, unless
they have exceeded their collection limits. Even in such cases, companies accept
renewal from existing fixed deposit holders.
- Government schemes
You can invest in RBI bonds directly through the Reserve Bank of India or
through a broker. Bit this option is not open for Non Resident Indians. Investments
in other government schemes can normally be made through nationalized banks
and post offices.
- Fixed income mutual funds

Fixed-income and money market mutual funds offer investors an exposure to
fixed-income instruments. Open-ended mutual funds are available round the year
and can be easily purchased/ sold on any business day.
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5.) DEBT MARKET:
Debt market as the name suggests is where debt instruments or bonds are traded.
The most distinguishing feature of these instruments is that the return is fixed i.e.
they are as close to being risk free as possible, if not totally risk free. The fixed
return on the bond is known as the interest rate or the coupon rate. Thus, the buyer
of a bond gives the seller a loan at a fixed rate, which is equal to the coupon rate.
Debt Markets are therefore, markets for fixed income securities issued by:
 Central and State Governments
 Municipal Corporations
 Entities like Financial Institutions, Banks, Public Sector Units, and Public
Ltd. companies.
The money market also deals in fixed income instruments. However, difference
between money and bond markets is that the instruments in the bond markets have
a larger time to maturity (more than one year). The money market on the other
hand deals with instruments that have a lifetime of less than one year.
6.) MARKET MICRO STRUCTURE:
It is necessary to understand microstructure of any market to identify processes,

products and issues governing its structure and development. In this section a
schematic presentation is attempted on the micro-structure of Indian corporate
debt market so that the issues are placed in a proper perspective. Figure gives a
bird’s eye view of the Indian debt market structure.
Figure - The Structure of the Indian Debt Market
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REGULATORS
SEBI, RBI, DCA
MARKET SEGMENT ISSUERS INSTRUMENTS INVESTORS
GOI dated RBI

securities,
Central Govt Treasury Bills,
THE State Govt. DFIs
SOVERIGN securities
ISSUER State Govt Index bonds, zero
coupon bonds
BANKS
Govt. Agencies Govt. Guaranteed PENSION

& Stat. Bodies Bonds/ FUND
Debentures
THE PSU Bonds,
PUBLIC PSUs FIIs
Debentures, CP
SECTOR
Comm. Banks/ CD, Debentures, CORPORATES

DFIs Bonds
INDIVIDUALS
Bonds, Debentures,
Corporates Commercial Paper
(CP) SPNs,
Floating PROVIDENT
THE Rate Notes FCDs, FUNDS
PRIVATE PCDs, ZCBs
SECTOR INSURANCE
COS.,
Pvt. Sect. Banks Bonds, Debentures, TRUSTS,
CPs MUTUAL
and CDs FUNDS
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The instruments traded can be classified into the following segments

based on the characteristics of the identity of the issuer of these
securities:
Segment Issuer Instruments

Treasury Bills, Dated Securities, Zero
Coupon Bonds, Coupon Bearing bonds,
Central
Government Partly paid Stocks, Capital Index
Government
Bonds, Floating Rate Bonds, Inflation
Index Bonds, STRIPS
Government
Public
Agencies / Govt. Guaranteed Bonds, Debentures
Sector
Statutory Bodies
Public Sector PSU Bonds, Debenture, Commercial

Units Paper
Debentures, Bonds, Commercial Paper,

Private Corporate Floating Rate Bonds, Zero Coupon
Bonds, Inter-Corporate Deposits
Banks Certificate of Deposits, Bonds
Financial
Certificate of Deposits, Bonds
Institutions
The Government Securities are referred to as Statutory Liquid Ratio (SLR)
securities, as they are eligible securities for the maintenance of the SLR by the
Banks.
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7.) REGULATORS
RBI:
The Reserve Bank of India is the main regulator for the Money Market. Reserve
Bank of India also controls and regulates the G-Secs Market. Apart from its role as
a regulator, it has to simultaneously fulfill several other important objectives viz.
managing the borrowing program of the Government of India, controlling
inflation, ensuring adequate credit at reasonable costs to various sectors of the
economy, managing the foreign exchange reserves of the country and ensuring a
stable currency environment.
RBI controls the issuance of new banking licenses to banks. It controls the manner
in which various scheduled banks raise money from depositors. Further, it controls
the deployment of money through its policies on CRR, SLR, priority sector
lending, export refinancing, guidelines on investment assets etc.
Another major area under the control of the RBI is the interest rate policy. Earlier,
it used to strictly control interest rates through a directed system of interest rates.
Each type of lending activity was supposed to be carried out at a pre-specified
interest rate. Over the years RBI has moved slowly towards a regime of market
determined controls.
SEBI:
Regulator for the Indian Corporate Debt Market is the Securities and Exchange
Board of India (SEBI). SEBI controls bond market and corporate debt market in
cases where entities raise money from public through public issues.
It regulates the manner in which such moneys are raised and tries to ensure a fair
play for the retail investor. It forces the issuer to make the retail investor aware, of
the risks inherent in the investment, by way and its disclosure norms. SEBI is also
a regulator for the Mutual Funds, SEBI regulates the entry of new mutual funds in
the industry. It also regulates the instruments in which these mutual funds can
invest. SEBI also regulates the investments of debt FIIs.
Apart from the two main regulators, the RBI and SEBI, there are several other
regulators specific for different classes of investors, eg the Central Provision Fund
Commissioner and the Ministry of Labour regulate the Provident Funds.
Religious and Charitable trusts are regulated by some of the State governments of
the states, in which these trusts are located.
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8.) GOVERNMENT SECURITIES
Government securities (G-secs) or gilts are sovereign securities, which are issued
by the Reserve Bank of India (RBI) on behalf of the Government of India (GOI).
The GOI uses these funds to meet its expenditure commitments.
Definition of Government securities

The Government securities are included in the definition of securities in the
Securities Contracts (Regulation) Act, 1956 (SCRA) and mean a security created
and issued by the Central Government or a State Government for the purpose of
raising a public loan in a form specified in the Public Debt Act 1944.
Permitted Exchanges:
NSE, BSE and OTCEI.
9.) Essential terms one should be aware of before investing in

Government Securities --
An individual must be aware about the following terms associated with
Government Securities:
 Coupon: The 'Coupon' denotes the rate of interest payable on the security.
E.g. a security with a coupon of 7.40% would draw an interest of 7.40% on
the face value.
 Interest Payment Dates (IP dates): The dates on which the coupon
(interest) payments are made are called as the IP dates.
 Last Interest Payment Date (LIP Date): LIP date refers to the date on
which the interest was last paid.
 Accrued Interest: Accrued interest is the interest charged at the coupon

rate from the Last Interest Payment to the date of settlement. Accrued
Interest for a security depends upon its coupon rate and the number of days
from its LIP date to the settlement date.
 Day count convention

The market uses quite a few conventions for calculation of the number of
days that has elapsed between two dates. The ultimate aim of any
convention is to calculate (days in a month)/(days in a year). The
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conventions used are as below. We take the example of a bond with Face
Value 100, coupon 12.50%, last coupon paid on 15th June, 2000 and traded
for value 5th October, 2000.
 A/360(Actual by 360)
In this method, the actual number of days elapsed between the two dates is
divided by 360, i.e. the year is assumed to have 360 days.
 A/365 (Actual by 365)

divided by 365, i.e. the year is assumed to have 365 days.
 A/A (Actual by Actual)

divided by the actual days in the year.
 30/360-Day Count: A 30/360-day count says that all months consist of 30

days. i.e. the month of February as well as the month of March is assumed
to have thirty days.
 Yield: Yield is the effective rate of interest received on a security. It takes

into consideration the price of the security and hence differs as the price
changes, since the coupon rate is paid on the face value and not the price of
purchase.
The concept can be best understood by the following example:
 A security with a coupon of 7.40%:
 If purchased at Rs. 100 the yield will be 7.40%
 If purchased at Rs. 200 the yield becomes 3.70%.
 If purchased at Rs. 50 the yield becomes 14.80%
 Thus it is seen that higher the price lesser will be the yield and vice-
a-versa.
 The yield will be equal to the coupon rate if and only if the security
is purchased at the face value (Par).
 Yield to Maturity (YTM): YTM implies the effective rate of interest

received if one holds the security till its maturity. This is a better parameter
to see the effective rate of return as YTM also takes into consideration the
time factor.
 Holding Period Yield (HPY): HPY comes into the picture when an
investor does not hold the security till maturity. HPY denotes the effective
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yield for the period from the date of purchase to the date of sale.
 Clean Price: Clean Price denotes the actual price of the security as
determined by the market.
 Dirty Price: Dirty Price is the price that is obtained when the accrued
interest is added to the Clean Price.
 Shut Period: The government security pays interest twice a year. This
interest is paid on the IP dates. One working day prior to the IP date, the
security is not traded in the market. This period is referred to as the 'Shut
Period'.
 Face Value: The Face Value of the securities in a transaction is the number
of Government Security multiplied by Rs.100 (face Value of each
Government Security). Say, a transaction of 5000 Government Security
will imply a face value of Rs. 5,00,000 (i.e. 5000 * 100)
 "Cum-Interest" and "Ex-Interest"

Cum-interest means the price of security is inclusive of the interest accrued
for the interim period between last interest payment date and purchase date.
Security with ex-interest means the accrued interest has to be paid
separately
 Trade Value: The Trade Value is the number of Government Security

multiplied by the price of each security.
 Primary Dealers & Satellite Dealers

Primary Dealers can be referred to as Merchant Bankers to Government of
India, comprising the first tier of the government securities market. Satellite
work in tandem with the Primary Dealers forming the second tier of the
market to cater to the retail requirements of the market.
These were formed during the year 1994-96 to strengthen the market
infrastructure and put in place an improvised and an efficient secondary
government securities market trading system and encourage retailing of
Government Securities on large scale.
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10.) FEATURES OF A GOVERNMENT SECURITY -
A Government Security has the following features:

 The face value of all the securities is Rs.100.
 Interest is paid on a semi-annual basis i.e. every 6 months. i.e. A security
with a coupon of 7.40% will draw an interest payment of Rs 3.70 every six
months.
 Accrued Interest is always calculated on a 30/360-day count.
Thus a Government of India (GOI) security 8.07% 2017 would imply a security
carrying a coupon rate of 8.07%, payable semi-annually on the face value of
Rs.100, and maturing in the year 2017.
 Demat account for trading in Government Securities –

Government Securities can be held in the same demat a/c used for equities.
 The market lot and the tick size in the retail G-Sec market –
The market lot is 10 (i.e. minimum face value of Rs.1000). The tick size is
one paisa.
 The settlement cycle on the exchanges -

The settlement in G-Sec would take place either on a T+0, T+1 or T+2
basis. Where 'T' stands for the trade date, and '0', '1', '2' implies the number
of business days. i.e. On a given week having no holidays (As per the Stock
exchange list) a trade taking place on Monday with T+0 cycle will be
settled on Monday, a trade taking place on Saturday with T+1 cycle will be
settled the next Monday and so on.
 Effect of shut period on trading in stock exchanges

In case of a security going into the shut period on the WDM, it would be
suspended on the exchanges 1 working day prior to the IP date.
For e.g. say a security's IP date is 28th Jan 2005, the security would in go
the shut period on 27th Jan 2005 in the Wholesale Debt market.
 Intra-day short selling permitted

An individual can do intra-day short sales.
 Quoting of Government Securities on the stock exchanges

The prices will be quoted on a dirty price (clean price + accrued interest)
basis.
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 Interest Rate risk : Interest rate risk, market risk or price risk are
essentially one and the same. Theses are typical of any fixed coupon
security with a fixed period-to-maturity. This is on account of an inverse
relation between price and interest. As interest rates rise, the price of a
security will fall. However, this risk can be completely eliminated incase an
investor's investment horizon identically matches the term of the security.
 (Re-investment risk) : This risk is again akin to all those securities, which
generate intermittent cash flows in the form of periodic coupons. The most
prevalent tool deployed to measure returns over a period of time is the
yield-to-maturity (YTM) method. The YTM calculation assumes that the
cash flows generated during the life of a security is re-invested at the rate of
the YTM. The risk here is that the rate at which the interim cash flows are
re-invested may fall thereby affecting the returns.
 Default risk : This kind of risk in the context of a Government security is

always zero. However, these securities suffer from a small variant of
default risk i.e., maturity risk. Maturity risk is the risk associated with the
likelihood of the government issuing a new security in place of redeeming
the existing security. In case of Corporate Securities it is referred to as
Credit Risk.
 What factors determine interest rates?

When we talk of interest rates, there are different types of interest rates - rates that
banks offer to their depositors, rates that they lend to their borrowers, the rate at
which the Government borrows in the bond/G-Sec, market, rates offered to small
investors in small savings schemes like NSC rates at which companies issue fixed
deposits etc.
The factors which govern the interest rates are mostly economy related and are
commonly referred to as macroeconomic. Some of these factors are:
1) Demand for money
2) Government borrowings
3) Supply of money
4) Inflation rate
5) The Reserve Bank of India and the Government policies which determine some
of the variables mentioned above.
 What is a Repo trade and how is it different from a normal buy or sell
transaction?
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An outright Buy or sell transaction is a one where there is no intended reversal of
the trade at the point of execution of the trade. The Buy or sell transaction is an
independent trade and is in no way connected with any other trade at the same or a
later point of time. A Ready Forward Trade (which is normally referred to as a
Repo trade or a Repurchase Agreement) is a transaction where the said trade is
intended to be reversed at a later point of time at a rate which will include the
interest component for the period between the two opposite legs of the
transactions.
So in such a transaction, one participant sells securities to other with an agreement
to purchase them back at a later date. The trade is called a Repo transaction from
the point of view of the seller and it is called a Reverse Repo transaction from
point of view of the buyer. Repos therefore facilitate creation of liquidity by
permitting the seller to avail of a specific sum of money (the value of the repo
trade) for a certain period in lieu of payment of interest by way of the difference
between the two prices of the two trades. Repos and reverse repos are commonly
used in the money markets as instruments of short-term liquidity management and
can also be termed as a collateralized lending and borrowing mechanism. Banks
and Financial Institutions usually enter into reverse repo transactions to manage
their reserve requirements or to manage liquidity.
 What are the type of transactions which take place in the market?
The following two types of transactions take place in the Indian markets:
 Direct transactions between banks and other wholesale market participants
which account for around 25% of the Wholesale Market volumes: Here the
Banks and the Institutions trade directly between themselves either through
the telephone or the NDS system of the RBI.
 Broker intermediated transactions, which account for around 70-75% of the
trades in the market. These brokers need to be members of a Recognized
Stock Exchange for RBI to allow the Banks, Primary Dealers and
Institutions to undertake dealings through them.
 What are the three modules in the GILT system?

GILT permits trading in the Wholesale Debt Market through the three following
avenues:
 Order Grabbing System - which provides for active interaction between the
market participants in keeping with the negotiated deal structure of the
market.
 Negotiated Deal Module - This permits the reporting of trades undertaken
by the market participants through the members of the Exchange.
 Cross Deal Module - permitting reporting of trades undertaken by two
different market participants through a single member of the Exchange.
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11.) AUCTION OF SECURITIES:
Auction is a process of calling of bids with an objective of arriving at the market

price. It is basically a price discovery mechanism. There are several variants of
auction. Auction can be price based or yield based. In securities market we come
across below mentioned auction methods.
(a) French Auction System: After receiving bids at various levels of yield
expectations, a particular yield level is decided as the coupon rate. Auction
participants who bid at yield levels lower than the yield determined as cut-off get
full allotment at a premium. The premium amount is equivalent to price equated
differential of the bid yield and the cut-off yield. Applications of bidders who bid
at levels higher than the cut-off levels are out-right rejected. This is primarily a
Yield based auction.
(b) Dutch Auction Price: This is identical to the French auction system as
defined above. The only difference being that the concept of premium does not
exist. This means that all successful bidders get a cut-off price of Rs. 100.00 and
do not need to pay any premium irrespective of the yield level bid for.
(c) Private Placement: After having discovered the coupon through the auction
mechanism, if on account of some circumstances the Government / Reserve Bank
of India decides to further issue the same security to expand the outstanding
quantum, the government usually privately places the security with Reserve Bank
of India. The Reserve Bank of India in turn may sell these securities at a later date
through their open market windiow albeit at a different yield.
(d) On-tap issue: Under this scheme of arrangements after the initial primary
placement of a security, the issue remains open to yet further subscriptions. The
period for which the issue remains open may be sometimes time specific or
volume specific.
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THE TERM GOVERNMENT SECURITIES INCLUIDES:-
 Central Government Securities

 State Government Securities
 Treasury Bills
Issuer Instruments
Central Government Treasury Bills, Dated Securities, Zero Coupon

Bonds, Coupon Bearing bonds, Partly paid
Stocks, Capital Index Bonds, Floating Rate
Bonds, Inflation Index Bonds, STRIPS
State Governments State Government loans, Coupon bearing

bonds,
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12.) SECURITIES ISSUED BY CENTRAL GOVERNMENT -
Issuer Instruments
Central Government Treasury Bills, Dated Securities, Zero Coupon

Bonds, Coupon Bearing bonds, Partly paid Stocks,
Capital Index Bonds, Floating Rate Bonds,
Inflation Index Bonds, STRIPS
12.1) TREASURY BILLS:
In the short term, the lowest risk category instruments are the Treasury Bills (TBs)
issued by Central government. RBI on behalf of central government issues them at
a prefixed day and for a fixed amount. The TBs are issued with varying maturity
usually not exceeding more than one year.
They are issued for different maturities viz. 14-day, 28 days (announced in Credit
policy but yet to be introduced), 91 days, 182 days and 364 days. 14 days T-Bills
had been discontinued recently. 182 days T-Bills were not re-introduced.
TREASURY
BILLS
91-Day T-Bill 182-Day T-Bill 364- Day T Bill
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 91-Day T-Bill-- (Tenor is of 91 days) Its auction is on every Wednesday of

the week and issued on following Friday. The notified amount for this auction
is Rs. 500 crore.
 182-Day T- Bill-- (Tenor is of 182 days) Its auction is on every alternate

Wednesday (which is not a reporting week) and issued on Friday. The notified
amount for this auction is Rs. 500 crore.
 364-Day T- Bill-- (Tenor is of 364 days) Its auction is on every alternate

Wednesday (which is a reporting week) and issued on Friday. The notified
amount for this auction is Rs. 1000 crore.
These Bills are now issued for only two tenures, namely 91 days and 364 days.
A considerable part of the central government's borrowing happens through
Treasury Bills of various maturities. Based on the bids received at the auctions,
RBI decides the cut off yield and accepts all bids below this yield.
Banks are the major investors in these instruments as they can park their
short-term surpluses and also since it forms part of their SLR investments. Besides
banks other investors in TBs are insurance companies, primary dealers, mutual
funds, FIs and FIIs.
These TBs, which are issued at a discount, can be traded in the market.
Most of the time, unless the investor requests specifically, they are issued not as
securities but as entries in the Subsidiary General Ledger (SGL), which is
maintained by RBI. The transactions cost on TBs are non-existent and trading is
considerably high in each bill, immediately after its issue and immediately before
its redemption.
The yield on TBs is mainly dependent on the rates prevalent in Call/Notice

market. Low yield on TBs, generally a result of high liquidity in banking system
as indicated by low call rates, would divert the funds from this market to other
markets. This would be particularly so, if banks already hold the minimum
stipulated amount (SLR) in government paper.
12.2) DATED SECURITIES

Government paper with tenor beyond one year is known as dated security. At
present, there are Central Government dated securities with a tenor up to 30 years
in the market. These securities generally carry a fixed coupon (interest) rate and
have a fixed maturity period. e.g. an 11.40% GOI 2008 G-sec. In this case 11.40%
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is the coupon rate and it is maturing in the year 2008. The salient features of Dated
Securities are:
 These are issued at the face value.

 The rate of interest and tenure of the security is fixed at the time of issuance
and does not change till maturity.
 The interest payment is made on half yearly rest.
 On maturity the security is redeemed at face value.
Auction/Sale: - Dated securities are sold through auctions. Fixed coupon

securities are sometimes also sold on tap that is kept open for a few days.
Announcement: - A half yearly calendar is issued in case of Central Government

dated securities, indicating the amounts, the period within which the auction will
be held and the tenor of the security, which is made available on Reserve Bank’s
website. The Government of India and the Reserve Bank also issue a press release
to announce the sale, a few days (normally a week) before the auction.
Amount: - Subscriptions can be for a minimum amount of Rs.10,000 and in

multiples of Rs.10,000.
Where are the sales held?

Auctions are conducted electronically on PDO-NDS system. The bids are
submitted by the members on PDO-NDS system both on their own behalf as well
as on behalf of their clients.
Payment: - The payment by successful bidders is made on the issue date, as

specified in the auction notification, usually the working day following the auction
day.
12.3) ZERO COUPON BONDS
Zero Coupon Bonds (ZCBs) were introduced on January 17, 1994. ZCBs, which
do not have regular interest(coupon) payments like traditional bonds, are sold at a
discount and redeemed at par on final maturity. The ZCBs were beneficial, both to
the Government because of the deferred payment of interest and to the investors
because of the lucrative yield and absence of reinvestment risk. These securities
are issued at a discount to the face value and redeemed at par. i.e. they are issued
at below face value and redeemed at face value.
The salient features of Zero Coupon Bonds are:
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 The tenure of these securities is fixed.
 No interest is paid on these securities.
 The return on these securities is a function of time and the discount to face
value.
12.4) PARTLY PAID STOCK
Par tly paid stock was introduced on November 14, 1994 whereby payment for the
Government stock was made in four equal monthly instalments. Designed for
institutions with regular flow of investible resources requiring regular investment
avenues, this instrument attracted good market response and was actively traded.
There was, however, only one more issue of partly paid stock on June 24, 1996
In these securities the payment of principal is made in installments over a given
period of time.
The salient features of Partly Paid Stock are:
 These types of securities are issued at face value and the principal amount
is paid in installments over a period of time.
 The rate of interest and tenure of the security is fixed at the time of issuance
and does not change till maturity.
 The interest payment is made on half yearly rest.
 These are redeemed at par on maturity.
12.5) FLOATING RATE BONDS
Floating Rate Bonds (FRBs) were first issued on September 29, 1995 but were
discontinued after the first issuance due to lack of market enthusiasm. They were
reintroduced on November 21, 2001 on demand from market participants, with
some modification in the structure. Although there was initially an overwhelming
market response to these issuances, FRBs were discontinued due to the waning
market interest reflected in the partial devolvement in the last two auctions on the
Reserve Bank and PDs. Erosion in the market interest for FRBs at that time was,
inter alia, due to strong credit pick-up and low secondary market liquidity in
FRBs.
These types of securities have a variable interest rate, which is calculated as a

fixed percentage over a benchmark rate. The interest rate on these securities
changes in sync with the benchmark rate.
The salient features of Floating Rate Bonds are:
 These are issued at the face value.
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 The interest rate is fixed as a percentage over a predefined benchmark rate.
The benchmark rate may be a bank rate, Treasury bill rate etc.
 The interest payment is made on half yearly rests.
 The security is redeemed at par on maturity, which is fixed.
12.6) CAPITAL INDEXED BONDS

A capital indexed bond (CIB) was issued on December 29, 1997 with a maturity
of 5 years. The bond provided for inflation hedging for the principal, while the
coupons of the bond were not protected against inflation. The issue of this bond
met with lackluster response, both in the primary and the secondary markets due to
the limited hedging against inflation. Therefore, there were no subsequent
issuances. An attempt is being made to reintroduce these bonds and towards this
end, a discussion paper was also widely circulated in May 2004. The proposed
modified structure of the CIB would be in line with the internationally popular
structure, which offers inflation linked returns on both the coupons and principal
repayments at maturity. The inflation protection for the coupons and the principal
repayment on the bond would be provided with respect to the Wholesale Price
Index (WPI) for all commodities (1993-94=100).
These securities carry an interest rate, which is calculated as a fixed percentage

over the wholesale price index. The salient features of Capital Indexed Bonds are:
 These securities are issued at face value.
 The interest rate changes according to the change in the Wholesale price
index, as the interest rate is fixed as a percentage over the wholesale price
index.
 The maturity of these securities is fixed and the interest is payable on half
yearly rests.
 The principal redemption is linked to the Wholesale price index.
Inflation linked bonds:

A bond is considered indexed for inflation if the payment of coupons is indexed by
reference to the change in the value of a general price or wage index over the term
of the instrument. The options are that either the interest payments are adjusted for
inflation or the principal repayment or both.
Out of the existing measures of inflation in India, viz., Consumer Price

Index (CPI), GDP deflator and the Wholesale Price Index (WPI), the WPI emerges
as the best index for the CIB. Thus, the WPI for All commodities (1993-94=100)
released by the Office of the Economic Adviser, Ministry of Commerce and
Industries, Government of India would be taken as the index for measuring the
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inflation rate for the proposed bonds. However, for the purpose of inflation
protection the monthly average of WPI (average of weeks) as worked out by the
Reserve Bank of India, instead of WPI at the last week of the month, would be
used as it smoothens the weekly variability in WPI and its effect on the market
price of the bonds.
12.7) COUPON BEARING BOND

“Coupon bearing bond”- A bond that pays fixed cash flow every year, until it
matures at date T when it also pays the face value of the bond.
Eg: B1 with face value of Rs.100, maturity T = 5
and annual cash flow of Rs.10 looks like:
(10, 1), (10, 2), (10, 3), (10, 4), (110, 5)
12.8) Government securities with embedded call and put options

were introduced in July 2002 for a 10-year maturity using uniform price based
auction method. On these securities, the Government has the discretion to exercise
the ‘call option’, after giving a notice of two months, whereby the securities may
be prematurely redeemed at par on or after completion of five years tenure from
the date of issuance of securities on any coupon payment date falling thereafter.
The holders of the Government stock also have the discretion to exercise ‘put
option’ whereby premature redemption may be made under the same conditions as
the call option. There was only one issuance of this instrument.
12.9) STRIPS
STRIPS is the acronym for Separate Trading of Registered Interest and Principal
Securities. Stripping is the process of separating a standard coupon-bearing bond
into its individual coupon and principal components. In an official STRIPS market
for the Government securities, these stripped securities i.e., the newly created zero
coupon bonds remain the direct obligations of the Government and are registered
in the books of the agent meant for this purpose. Thus the mechanics of stripping
neither impacts the direct cost of borrowing nor change the timing or quantum of
the underlying cash flows; stripping only facilitates transferring the right to
ownership of individual cash flows
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Advantages:
STRIPS would facilitate the availability of zero coupon bonds (ZCBs) to the
investors and traders. They provide the most basic cash flow structure thus
offering the advantage of more accurate matching of liabilities without
reinvestment risk and a precise management of cash flows. Thus to some investors
who set the incoming inflows against an actuarial book (eg. Insurance companies),
STRIPS offer excellent investment choices. Apart from the advantages they offer
to low risk investors like pension funds and insurance companies, STRIPS offer
much greater leverage to hedge funds, since the zero coupon bonds are more
volatile than the underlying coupon bearing bonds. Last but not the least, STRIPS
offer an excellent scope to construct a zero yield curve for the sovereign bond
market.
Fungibility
An important feature of the STRIPS market is that the coupon STRIPS of the same
date from different stocks are fungible - meaning that they are just not identical
but exchangeable. Thus when a few coupon bearing bonds sharing the same
coupon payment dates are stripped, it may not be possible to distinguish the
coupon STRIPS created out of all these bonds. All STRIPS will have a unique
code number to identify. Going by the same logic, these coupon STRIPS could be
used to complete the reconstitution of any of those original coupon bearing bonds
whose coupon payment dates fall on the same date (provided the purchaser holds
all the other coupon and principal STRIPS).
Minimum Reconstitutable and Strippable amount

For operational convenience the size of coupon STRIPS and principal STRIPS
should be in whole paise so as to allow reconstitution. For example, for a 11.99
per cent Government stock, 2009, it will not be possible to reconstitute to, say, an
amount of Rs.500, since the necessary coupon STRIPS would be Rs.29.975.
Across the Stocks, it would be possible to reconstitute if the standard minimum
coupon strip is Rs.1,000. Accordingly, the minimum strippable amount could be
either kept at Rs.1,000 or Rs.10,000 and be increased in similar multiples.
Trading and pricing

There are two things that determine the prices of STRIPS viz., (i) the market
mechanism of supply and demand and (ii) the prices of the underlying strippable
and similar non-strippable stocks. Since STRIPS are the component parts of the
underlying stock from which they are created, theoretically, the price of any
strippable stock should be exactly equal to the sum of the prices of all its
component parts.
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13.) ZERO COUPON YIELD CURVE
The yield to maturity for coupon bonds is capable of several algebraically

equivalent definitions A straight forward definition of yield to maturity is the
single discount rate that equates the bond’s cash flows to the market price of the
bond. But a coupon paying bonds can be viewed as a combination of separate
bonds of varying maturities (of the coupons and the principal). From this point of
view , it is reasonable to ask what the rate of interest on each of these loans are. In
general any bond can be represented by an equation of the form:
P= C1/(1+0F1) + C1/{(1+0F1)(1+1F2)} +C1/{(1+0F1)(1+1F2)(1+2F3)} + …….
Where iFr = Discount rate for cash flows at the end of r period ( i.e. the cash flow
r-i periods from i th period. ). The rates represented by F’s are also known as
forward rates and they are related to the zero coupon rates (i.e. the rate at which a
single cash flow at any point of time in the future is discounted) by the following
equation:
(1+ rk )k = (1+ri)i x (1+ iFk)(k-i) where rk is the k period discount rate and r1=0F1
The point that is to be emphasized about the zero coupon rates are that they are
unique for a given period . To illustrate , if we say that the 6 monthly zero coupon
rate is 9.63%, then all cash flows for any bonds 6 months from now have to be
discounted by 9.63% i.e. zero coupon discount rates are period specific and not
bond specific. A zero coupon curve is the great invisible reality of the of the fixed
income markets and it solves the bulk of the pricing problems in fixed income
markets (ignoring default risk).
The pricing of securities based on Yield to Maturity (YTM) suffers from the
defect that although a security represents a series of cash flows occurring at
different points of time, they are discounted at the same rate. Hence the YTM can
be regarded as a weighted average discount rate for forward rates where the
weights are the corresponding cash flows . Since the cash flows of a bond is
unique, so is its YTM. In fact, if the forward curve is sharply upward sloping, the
YTM of a low coupon security should be more than a high coupon security of
identical tenor. This coupon effect, as it is known, is totally missed if the decisions
are based on YTM. With the introduction of STRIPS, the pricing of the primary
market offerings have also to be oriented towards zero coupon valuation method
so as to address the problems of valuation arising out of YTM methodology.
Who can strip and reconstitute

Stripping/reconstitution may be allowed to be performed by only a limited number
of intermediaries along with the debt manager on the specific requisition from the
holders.
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Role of Government Securities Yield Curve as a Public Good-

Yield curve, also known as term structure of interest rates, is the representation of
zero coupon yields of a series of maturities at a point of time. It is constructed by
plotting the yields against the respective maturity periods of benchmark fixed-
income securities. The yield curve is a measure of market’s expectations of future
interest rates, given the current market conditions. Securities issued by the
Government are considered risk-free, and as such, their yields are often used as the
benchmarks for fixed-income securities with the same maturities.
Graphic Representation of a Normal Yield Curve
The difference between short and long ends of the yield curve (spread) determines
the shape of the curve which is an important indicator of the expected performance
of the economy and inflation. Since the government securities yield curve
represents the risk-free interest rates, it is used for pricing other instruments of
various maturities. The yield
The difference between short and long ends of the yield curve (spread) determines
the shape of the curve which is an important indicator of the expected performance
of the economy and inflation. Since the government securities yield curve
represents the risk-free interest rates, it is used for pricing other instruments of
various maturities. The yield curve has informational value to bond issuers for
pricing as well as timing of their issue depending on the expected performance of
the economy. Investors can also use the curve in choosing the right tenor of
investment. For overseas investors, expected performance of different countries
could be compared by looking at the respective yield curves to make investment
decisions.
Most other interest rates are measured on the basis of the government securities
yield curve, viz., credit curve and swap curve. Similarly pricing of other financial
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instrument uses the government securities yield curve in some form or the other.
Thus, the yield curve acts as a kind of public good that is used constantly by
participants in the financial system.
The efficiency of the yield curve as a public good is enhanced under the following
two conditions. First, macroeconomic volatility, especially inflation volatility,
must be low so that a nominal yield curve is informative about the real cost of
borrowing. Second, the government must issue a sufficient volume of debt. Yield
is described as an apparatus which allows abstraction of irrelevant factors and
focuses on factors relevant for interest rate risk on portfolios (Krstic and
Marinkovic,1997).
The fact that the yield curve acts as a public good enjoins upon all participants, in
particular the regulators, the responsibility of ensuring that it is free from any
undesirable and manipulative influence, as this would lead to a loss in its
informational value and result in market inefficiency brought about by incorrect
pricing of other financial instruments.
One of the key features of development of the government securities market

is the evolution of yield curve over a reasonably long period. The upward sloping
yield curve, which is considered to be the usual term structure, may reflect either
the presence of interest rate risk premium or the so called Hicksian liquidity
premiums, or it may simply reflect the market’s anticipation about the upward
trend in the general level of interest rates over the period. Theoretical analysis
confirms that in an efficient market, yield curve will solely depend upon the
market’s response to collective beliefs about future interest rate movements, i.e.,
interest rates derived from the prevailing term structure of interest rates are correct
forecast of future interest rates. Thus, development of the government securities
market is essential for establishing the risk-free benchmarks in financial markets
and ensuring their functioning in an efficient manner.
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14.) SECURITIES ISSUED BY STATE GOVERNMENT -
Issuer Instruments
State Governments State Government loans/State

Development loan, coupon bearing
bond
14.1) State Government Securities/State Development loans

These are securities issued by the state governments and are also known as State
Development Loans (SDLs). The issues are also managed and serviced by the
Reserve Bank of India.
The tenor of state government securities is normally ten years. State government
securities are available for a minimum amount of Rs.10,000 and in multiples of
Rs.10,000. These are available at a fixed coupon rate. The auctions for State
Government securities are held electronically on PDO-NDS module.
Nine State Governments announce auctions of

State Development Loans 2017 for Rs.3482.129 crore on June 19 2007
State government debt issuances are largely long-term and in the local currency, as
states are not permitted to issue debt in foreign currencies directly. The typical
long-term debt is a 25-year fixed-rate loan with a five-year grace period. Two of
the main debt types are loans against small savings, which are subscribed by the
public, and market loans, which are bought by banks.
14.2) Coupon bearing bond
“Coupon bearing bond” A bond that pays fixed cash flow every year, until it
matures at date T when it also pays the face value of the bond.
Eg: B1 with face value of Rs.100, maturity T = 5
and annual cashflow of Rs.10 looks like:
(10, 1), (10, 2), (10, 3), (10, 4), (110, 5)
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15.) MANDATED INVESTMENTS IN GOVERNMENT

SECURITIES:
Banks are the largest investors in government securities. In terms of the SLR
provisions of the Banking Regulation Act, 1949, banks are required to maintain a
minimum of 25 per cent of their net demand and time liabilities (NDTL) in liquid
assets such as cash, gold and unencumbered government securities or other
approved securities as Statutory Liquidity Ratio (SLR). The minimum SLR
stipulation for scheduled urban co-operative banks (UCBs) is the same as for
scheduled commercial banks (SCBs) from April 1, 2003. However, for non-
scheduled UCBs, the minimum SLR requirement is 15 per cent for banks with
NDTL of over Rs.25 crore and 10 per cent for the remaining non-scheduled
UCBs. The minimum SLR stipulation for regional rural banks (RRBs) is the same
as for SCBs. From April 1, 2003, the coverage under the SLR has also been made
akin to SCBs. All deposits with sponsor banks, which were earlier considered as
part of the SLR, were to be converted into approved securities on maturity in order
to be reckoned for the SLR purpose. Recently, the Banking Regulation
Amendment Act, 2007 has removed the floor limit of 25 per cent for SLR for
scheduled banks.
The second largest category of investors in the government securities market is the
insurance companies. According to the stipulations of the Insurance Regulation
and Development Authority of India (IRDA), all companies carrying out the
business of life insurance should invest a minimum of 25 per cent of their
controlled funds in government securities. Similarly, companies carrying on
general insurance business are required to invest 30 per cent of their total assets in
government securities and other guaranteed securities, of which not less than 20
per cent should be in Central Government securities. For pension and general
annuity business, the IRDA stipulates that 20 per cent of their assets should be
invested in government securities.
The non-Government provident funds, superannuation funds and gratuity funds

are required by the Central Government from January 24, 2005 to invest 40 per
cent of their incremental accretions in Central and State government securities
and/or units of gilt funds regulated by the Securities and Exchange Board of India
(SEBI) and any other negotiable securities fully and unconditionally guaranteed by
the Central/State Governments. The exposure of a trust to any inpidual gilt fund,
however, should not exceed five per cent of its total portfolio at any point of time.
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Non-banking financial companies (NBFCs) accepting public deposits are required
to maintain 15 per cent of such outstanding deposits in liquid assets, of which not
less than 10 per cent should be maintained in approved securities, including
government securities and government guaranteed bonds. Investment in
government securities should be in dematerialised form, which can be maintained
in Constituents’ Subsidiary General Ledger (CSGL) Account of a SCB/Stock
Holding Corporation of India Limited (SHCIL). In order to increase the security
and liquidity of their deposits, residuary non-banking companies (RNBCs), are
required to invest not less than 95 per cent of their aggregate liability to depositors
(ALD) as outstanding on December 31, 2005 and entire incremental deposits over
this level in directed investments, which include government securities, rated and
listed securities and debt oriented mutual funds. From April 1, 2007, the entire
ALD is required to be invested in directed investments only.
Measures were taken to promote voluntary holding of government securities

among other investor categories. For this purpose, specialised institutions were
developed. The Discount and Finance House of India (DFHI), set up in April
1988, primarily for developing the money market, was also allowed to participate
in the government securities market. In order to develop an efficient institutional
infrastructure for an active secondary market in government securities and public
sector bonds, the Securities Trading Corporation of India (STCI) commenced its
operations in June 1994. With the introduction of the PD system, both DFHI and
STCI later transformed themselves into PDs.
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16.) BENEFITS OF INVESTING IN A GOVERNMENT

SECURITY-
The Benefits of investing in a Government Security are:

1. Safety: The Zero Default Risk is the greatest attraction for investments in
Government Securities. It enjoys the greatest amount of security possible, as the
Government of India issues it. Hence they are also known as Gilt-Edged Securities
or 'Gilts'.
2. Fixed Income: During the term of the security there is likely to be fluctuations
in the Government Security prices and thus there exists a price risk associated with
investment in Government Security. However, the return on the holding of
investment is fixed if the security is held till maturity and the effective yield at the
time of purchase is known and certain. In other words the investment becomes a
fixed income investment if the buyer holds the security till maturity.
3. Convenience: Government Securities do not attract deduction of tax at source

(TDS) and hence the investor having a non-taxable gross income need not file a
return only to obtain a TDS refund.
4. Simplicity: To buy and sell Government Securities all an individual has to do

is call his / her Equity Broker and place an order. If an individual does not trade in
the Equity markets, he / she has to open a demat account and then can commence
trading through any Equity broker.
5. Liquidity: Government Security when actively traded on exchanges will be

highly liquid, since a national trading platform is available to the investors.
6. Diversification Government Securities are available with a tenor of a few

months up to 30 years. An investor then has a wide time horizon, thus providing
greater diversification opportunities.
Factors that affect the price of a Government Security –

These are the factors which affect the price of the securities –
 Demand and supply
 Economic conditions.
 General money market conditions including the position of money
supply, in the economy.
 Interest rates prevalent in the market and the rates of new issues.
 Credit quality of the issuer.
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17.) PUBLIC SECTOR BONDS -

Public Sector Government Agencies / Govt. Guaranteed Bonds,
Statutory Bodies Debentures
Public Sector Units PSU Bonds, Debenture,

Commercial Paper
17.1) GOVT. GUARANTEED BONDS:

Introduction
State Governments have been issuing a large amount of guarantees and letters of
comfort on behalf of public sector undertakings (PSUs) at the State level, co-
operative societies and State Cooperative Banks (StCBs) for the purpose of public
investment, particularly in resource-intensive infrastructure sector and for
promotion of rural development, to enable the PSUs to mobilise resources.
Lenders/investors in State guaranteed papers:
A. Banking Entities
a) Commercial Banks
b) Rural Co-operative Banks
c) Urban Co-operative Banks
B. Financial Institutions
a) National Bank for Agriculture and Rural Development (NABARD)
b) National Housing Bank (NHB)
c) Small Industries Development Bank of India (SIDBI)
d) Life Insurance Corporation of India (LIC)
e) Housing and Urban Development Corporation (HUDCO)
f) Rural Electrification Corporation (REC)
g) Power Finance Corporation (PFC)
h) Other Public Financial Institutions (PFIs)
C. Others
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a) Public and Private Sector Provident Funds (PFs);
b) Charitable Trusts
c) National Co-operatives Development Corporation (NCDC)
d) Non-Banking Financial Corporations (NBFCs)
GUARANTEE FEE
Table 2: Structure of Guarantee Fee/Commission in Some Indian States:

March 2001
(per cent of guaranteed amount)
Sl.No States Structure of Guarantee Fee
1 Andhra 0.5% to 2%
Pradesh
2 Karnataka A floor fee of 1 per cent
3 Rajasthan 0.1 to 1 per cent
4. Orissa  0.02% - 0.5% for Cooperative institutions,

housing, local bodies and state PSEs
 1% for other guarantees and bonds;
 NABARD and other agriculture related
guarantees are exempted
5 Gujarat 1%, some state PSEs are exempt while 0.25% is

charged for open market borrowing that forms part
of the state annual plan.
6 West A floor of 1 % is kept, but rises with greater

Bengal default perception of the project
7 Kerala 0.75 per cent
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8 Mizoram No Guarantee fee is charged
9 Punjab 2 % for term loans, 1/8% for procurement

agencies
The Reserve Bank has also organized a workshop on 'Risk Evaluation on State
Guarantees' to help State Government officials to analyse the risk of defaults on
State Government guarantees.
17.2) PSU BONDS
Public Sector Undertaking Bonds (PSU Bonds): These are Medium or long
term debt instruments issued by Public Sector Undertakings (PSUs). The term
usually denotes bonds issued by the central PSUs (i.e. PSUs funded by and under
the administrative control of the Government of India). Most of the PSU Bonds
are sold on Private Placement Basis to the targeted investors at Market Determined
Interest Rates. Often investment bankers are roped in as arrangers to this issue.
Most of the PSU Bonds are transferable and endorsement at delivery and are
issued in the form of Usance Promissory Note.
In case of tax free bonds, normally such bonds accompany post dated interest
cheque / warrants.
17.3) COMMERCIAL PAPERS
It was introduced in India in 1990 with a view to enabling highly rated corporate
borrowers/ to diversify their sources of short-term borrowings and to provide an
additional instrument to investors. Subsequently, primary dealers and satellite
dealers were also permitted to issue CP to enable them to meet their short-term
funding requirements for their operations.
CPs are negotiable short-term unsecured promissory notes with fixed maturities,
issued by well rated companies generally sold at a discount basis. These are
basically instruments evidencing the liability of the issuer to pay the holder in due
course a fixed amount (face value of the instrument) on the specified due date.
ISSUER: Corporates and primary dealers (PDs), and the all-India financial
institutions (FIs) that have been permitted to raise short-term resources under the
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umbrella limit fixed by Reserve Bank of India are eligible to issue CP.
Rating Requirement
The minimum credit rating shall be P-2 of Credit Rating Information Services of
India Ltd (CRISIL) or such equivalent rating by other agencies. Like
- Investment Information and Credit Rating Agency of India Ltd. (ICRA) or
- Credit Analysis and Research Ltd. (CARE) or
- FITCH Ratings India Pvt. Ltd. or such other credit rating agencies as may be
specified by the Reserve Bank of India from time to time, for the purpose.
Maturity
CP can be issued for maturities between a minimum of 7 days and a maximum up
to one year from the date of issue.
Denominations
CP can be issued in denominations of Rs.5 lakh or multiples thereof. Amount
invested by a single investor should not be less than Rs.5 lakh (face value).
Limits and the 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, whichever
is lower. Banks and FIs will, however, have the flexibility to fix working capital
limits duly taking into account the resource pattern of companies' financing
including CPs.
Issuing and Paying Agent (IPA)

Only a scheduled bank can act as an IPA for issuance of CP.
Investment in CP
CP may be issued to and held by individuals, banking companies, other corporate
bodies registered or incorporated in India and unincorporated bodies, Non-
Resident Indians (NRIs) and Foreign Institutional Investors (FIIs)..
Mode of Issuance
CP can be issued either in the form of a promissory note or in a dematerialised
form through any of the depositories approved by and registered with SEBI. CP
will be issued at a discount to face value as may be determined by the issuer. No
issuer shall have the issue of CP underwritten or co-accepted.
17.4) Debenture (please refer to private sector)
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18.) PRIVATE SECTOR -
Private Corporate Debentures, Bonds, Commercial

Paper, SPN, Floating Rate Bonds,
Zero Coupon Bonds, Inter-
Corporate Deposits
Banks Certificate of Deposits, Bonds
Financial Certificate of Deposits, Bonds

Institutions
The Indian Corporate Bond Market
18.1)) CORPORATE BONDS

Corporate bonds are debt securities issued by private and public corporations.
Companies issue corporate bonds to raise money for a variety of purposes, such as
building a new plant, purchasing equipment, or growing the business. When one
buys a corporate bond, one lends money to the "issuer," the company that issued
the bond. In exchange, the company promises to return the money, also known as
"principal," on a specified maturity date. Until that date, the company usually pays
you a stated rate of interest, generally semiannually. While a corporate bond gives
an IOU from the company, it does not have an ownership interest in the issuing
company, unlike when one purchases the company's equity stock.
Yields
Yield is a critical concept in bond investing, because it is the tool used to measure
the return of one bond against another. It enables one to make informed decisions
about which bond to buy. In essence, yield is the rate of return on bond
investment. However, it is not fixed, like a bond’s stated interest rate. It changes to
reflect the price movements in a bond caused by fluctuating interest rates. The
following example illustrates how yield works.
 You buy a bond, hold it for a year while interest rates are rising and then
sell it.
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 You receive a lower price for the bond than you paid for it because, no one
would otherwise accept your bond’s now lower-than-market interest rate.
 Although the buyer will receive the same amount of interest as you did and
will also have the same amount of principal returned at maturity, the
buyer’s yield, or rate of return, will be higher than yours, because the buyer
paid less for the bond.
 Yield is commonly measured in two ways, current yield and yield to
maturity.
Current yield
 The current yield is the annual return on the amount paid for a bond,
regardless of its maturity. If you buy a bond at par, the current yield equals
its stated interest rate. Thus, the current yield on a par-value bond paying
6% is 6%.
 However, if the market price of the bond is more or less than par, the
current yield will be different. For example, if you buy a Rs. 1,000 bond
with a 6% stated interest rate at Rs. 900, your current yield would be 6.67%
(Rs. 1,000 x .06/Rs.900).
Yield to maturity
It tells the total return you will receive if you hold a bond until maturity. It also
enables you to compare bonds with different maturities and coupons. Yield to
maturity includes all your interest plus any capital gain you will realize (if you
purchase the bond below par) or minus any capital loss you will suffer (if you
purchase the bond above par).
Valuation of Corporate Bonds

Corporate bonds tend to rise in value when interest rates fall, and they fall in value
when interest rates rise. The inverse relationship between bonds and interest
rates—that is, the fact that bonds are worth less when interest rates rise and vice
versa can be explained as follows :-
 When interest rates rise, new issues come to market with higher yields than
older securities, making those older ones worth less. Hence, their prices go
down.
 When interest rates decline, new bond issues come to market with lower
yields than older securities, making those older, higher-yielding ones worth
more. Hence, their prices go up.
 As a result, if one sells a bond before maturity, it may be worth more or less
than it was paid for.
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Market preference for high rated bonds:
Investors in corporate debt instruments are excessively safety conscious as could
be noted form the fact that there is hardly any demand for paper which is rated
below AA or its equivalent by the rating companies. World over any paper rated
BBB (or its equivalent) and above is considered as investment grade, except that
the interest rate to be paid on BBB has to be high enough to compensate for the
risk attached to it in relation to the highest rated paper. Basically it is a question of
risk-reward matrix with higher risk being compensated by higher return. Globally
there is considerable demand for debt paper which is rated below AA. In fact the
maturity of the market is often judged by the skill of the investors to factor
riskreward matrix in their investment decision so that they do not miss the high
return opportunities that may exist in the case of BBB rated paper. Judged from
this matrix it is clear that Indian debt market is yet to mature. This is indicated by
the analysis of the outstanding bond issues with reference to their rating values
assigned to them by the recognized rating agencies. Over 82percent of the debt
paper is AA and above, as demand for other investment grade paper is not large
enough. The majority of institutional investors by amount in the corporate debt
paper are banks which are all the while in favour of highly rated paper while at the
same extending loans to not so well rated corporate clients. Thus most of the
banks adopt an asymmetric credit evaluation methodology when they are willing
to provide loan to a client but unwilling to invest in the debt paper issued by the
borrower if the debt paper is not rated very highly by the rating agencies. It is
hoped that as the corporate debt market grows in size and becomes deep, liquid,
and broad-based investors will start understanding the risk-reward matrix much
more intelligently. Institutional investors will start to appreciate increasingly the
risk-adjusted returns and the arbitrage that the market provides. Table III-4A and
III-4B give the outstanding corporate debt in the market in terms of rating class,
issue sizes and no. of issues.
Corporate Bonds- Outstanding Issues (Aug 25, 2005)

Market Issue Market
No. of Market Market
Rating Class Share Size Cap (Rs.
Issues Share (%) Share (%)
(%) (Rs.Cr) Cr)
AAA/MAAA 955 61.61 92609 69.81 93872 69.68
AA+/LAA+/MAA+ 320 20.65 19605 14.78 19821 14.71
AA/LAA/MAA 175 11.29 13248 9.99 13692 10.16
AA-/LA- 31 2 1272 0.96 1322 0.98
A+/LA+ 16 1.03 1545 1.16 1559 1.16
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A/LAMA 16 1.03 1512 1.14 1529 1.13
A- 12 0.77 1063 0.8 1065 0.79
BBB+ 11 0.71 833 0.63 877 0.65
BBB/LBBB 8 0.52 722 0.54 25 0.54
B 6 0.39 257 0.19 257 0.19
Grand 1550 100 132666 100 134719 100
Rating Not Available 82 9906 9916
Source: NSE WDM segment
Table-III-4B: Corporate Bonds (Structured Obligations) -

Outstanding Issues (Aug 25, 2005)
Market Market Market Market

Rating No. of Issue Size
Share Share Cap (Rs. Share
Class Issues (Rs. Cr)
(%) (%) Cr) (%)
AAA 19 8.6 3116 12.83 3144 12.75
AA+ 6 2.71 175 0.72 175 0.71
AA 5 2.26 263 1.08 267 1.08
AA- 15 6.79 1700 7 1777 7.2
A+/LA+ 24 10.86 3042 12.53 3197 12.96
A/LA 136 61.54 12328 50.77 12671 51.37
A- 10 4.52 1900 7.82 2017 8.18
BBB+ 3 1.36 200 0.82 204 0.83
BBB 2 0.9 840 3.46 495 2.01
BB 1 0.45 718 2.96 718 2.91
Total 221 100 24282 100 24665 100
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18.2) CORPORATE DEBENTURES
A Debenture is a debt security issued by a company (called the Issuer), which
offers to pay interest in lieu of the money borrowed for a certain period. In essence
it represents a loan taken by the issuer who pays an agreed rate of interest during
the lifetime of the instrument and repays the principal normally, unless otherwise
agreed, on maturity.
These are long-term debt instruments issued by private sector companies. These
are issued in denomination as low as Rs. 1000 and have maturity ranging between
one and ten years. Long maturity debentures are rarely issued, as investors are not
comfortable with such maturities.
Debentures enable investors to reap the dual benefits of adequate security and
good returns. Unlike Fixed and Bank Deposit they can be transferred from one
party to another by using transfer form. Debentures are normally issued in
physical form. However, corporates/PSUs have started issuing debentures in
Demat form. Generally, debentures are less liquid as compared to PSU bonds and
their liquidity is inversely proportional to the residual maturity. Debentures can be
secured or unsecured.
Debentures are divided into different categories on the basis of:

1. Convertibility of the instrument
2. Security
1. Debentures can be classified on the basis of convertibility into:
a) Non-Convertible Debentures (NCD): This type of security retains all the

characteristic of a debt instruments and it cannot be converted into any other form
of security (mainly equity).
b) Partly Convertible Debentures (PCD): A part of this instrument can be
converted into Equity share in the future at the instance of issuer. The issuer
decides the ratio of the conversion at the time of subscription.
c) Fully convertible Debentures (FCD): These instruments are fully convertible
into Equity shares at the issuer's notice. The issuer decides the ratio of conversion.
Upon conversion the investors enjoy the same status as ordinary shareholders of
the company.
e) Optionally Convertible Debentures (OCD): The investor has the option to
either convert these debentures into shares at price decided by the issuer/agreed
upon at the time of issue.
2. On basis of Security, debentures are classified into:
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a) Secured Debentures: These instruments are secured by a charge on the fixed
assets of the issuing company. So if the issuer fails on payment of either the
principal or interest amount, his assets can be sold to repay the liability to the
investors. This is usually in the form of a first mortgage or charge on the fixed
assets of the company on a pari passu basis with other first charge holders like
financial institutions etc. Sometimes, the charge can also be a second charge
instead of a first charge. Most of the times the charge is created on behalf of the
entire pool of debenture holders by a trustee specifically appointed for the
purpose.
b) Unsecured Debentures: These instruments are unsecured in the sense that if

the issuer defaults on payment of the interest or principal amount, the investor has
to be along with other unsecured creditors of the company.
(18.3) INTER-CORPORATE DEPOSITS
Apart from CPs, corporates also have access to another market called the Inter
Corporate Deposits (ICD) market. An ICD is an unsecured loan extended by one
corporate to another. Existing mainly as a refuge for low rated corporates, this
market allows funds surplus corporates to lend to other corporates. Also the better-
rated corporates can borrow from the banking system and lend in this market. As
the cost of funds for a corporate in much higher than a bank, the rates in this
market are higher than those in the other markets. ICDs are unsecured, and hence
the risk inherent in high. The ICD market is not well organised with very little
information available publicly about transaction details.
(18.4) CERTIFICATE OF DEPOSITS
After treasury bills, the next lowest risk category investment option is the
certificate of deposit (CD) issued by banks and FIs.
Allowed in 1989, CDs were one of RBI's measures to deregulate the cost of funds
for banks and FIs.
The rates on these deposits are determined by various factors. Low call rates
would mean higher liquidity in the market. Also the interest rate on one-year bank
deposits acts as a lower barrier for the rates in the market.
Guidelines for Issue of Certificates of Deposit (CDs)

as Amended up to June 30, 2006
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Introduction
Certificates of Deposit (CDs) is a negotiable money market instrument and issued
in dematerialised form or as a Usance Promissory Note, for funds deposited at a
bank or other eligible financial institution for a specified time period.
Eligibility
CDs can be issued by (i) scheduled commercial banks excluding Regional Rural
Banks (RRBs) and Local Area Banks (LABs); and (ii) select all-India Financial
Institutions that have been permitted by RBI to raise short-term resources within
the umbrella limit fixed by RBI.
Aggregate Amount
 Banks have the freedom to issue CDs depending on their requirements.
 An FI may issue CDs within the overall umbrella limit fixed by RBI, i.e., issue
of CD together with other instruments, viz., term money, term deposits,
commercial papers and inter-corporate deposits should not exceed 100 per cent
of its net owned funds, as per the latest audited balance sheet.
Minimum Size of Issue and Denominations

Minimum amount of a CD should be Rs.1 lakh, and in the multiples of Rs. 1 lakh
thereafter.
Who can Subscribe

CDs can be issued to individuals, corporations, companies, trusts, funds,
associations, etc. Non-Resident Indians (NRIs) may also subscribe to CDs, but
only on non-repatriable basis which should be clearly stated on the Certificate.
Such CDs cannot be endorsed to another NRI in the secondary market.
Maturity
 The maturity period of CDs issued by banks should be not less than 7 days
and not more than one year.
 The FIs can issue CDs for a period not less than 1 year and not exceeding 3
years from the date of issue.
Discount/Coupon Rate
CDs may be issued at a discount on face value. Banks/FIs are also allowed to issue
CDs on floating rate basis provided the methodology of compiling the floating rate
is objective, transparent and market-based. The issuing bank/FI is free to
determine the discount/coupon rate.
Reserve Requirements
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Banks have to maintain the appropriate reserve requirements, i.e., cash reserve
ratio (CRR) and statutory liquidity ratio (SLR), on the issue price of the CDs.
Transferability
Physical CDs are freely transferable by endorsement and delivery. Dematted CDs
can be transferred as per the procedure applicable to other demat securities. There
is no lock-in period for the CDs.
Loans/Buy-backs
Banks/FIs cannot grant loans against CDs. Furthermore, they cannot buyback their
own CDs before maturity.
Format of CDs
Banks/FIs should issue CDs only in the dematerialized form. However, according
to the Depositories Act, 1996, investors have the option to seek certificate in
physical form. Accordingly, if investor insists on physical certificate, the bank/FI
may inform Financial Markets Department, Reserve Bank of India, Central Office,
Fort, Mumbai - 400001 about such instances separately.
(18.5) SPN
Secured Premium Notes (SPN) with Detachable Warrants: SPN which is issued
along with a detachable warrant, is redeemable after a notice period, say four to
seven years. The warrants attached to it ensure the holder the right to apply and get
allotted equity shares; provided the SPN is fully paid.
There is a lock-in period for SPN during which no interest will be paid for an
invested amount. The SPN holder has an option to sell back the SPN to the
company at par value after the lock in period. If the holder exercises this option,
no interest/ premium will be paid on redemption. In case the SPN holder holds its
further, the holder will be repaid the principal amount along with the additional
amount of interest/ premium on redemption in installments as decided by the
company. The conversion of detachable warrants into equity shares will have to be
done within the time limit notified by the company.
(18.6) Commercial Papers (Please refer to Public Sector Bond)
(18.7) Floating Interest rate (Please refer to Government securities part)
(18.8) Zero Coupon Bond (Please refer to Government securities part)
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19.) OTHER FIXED INCOME INSTRUMENTS:

1. Company Fixed Deposits
2. Employee’s Provident Fund
3. Mutual Funds
4. Guilt Funds
5. Bank Fixed Deposits
6. Other prominent government schemes
19.1) COMPANY FIXED DEPOSITS
Fixed Deposits in companies that earn a fixed rate of return over a period of time
are called Company Fixed Deposits. Financial institutions and Non-Banking
Finance Companies (NBFCs) also accept such deposits. Deposits thus mobilised
are governed by the Companies Act under Section 58A. These deposits are
unsecured, i.e., if the company defaults, the investor cannot sell the documents to
recover his capital, thus making them a risky investment option.
Benefits of investing in Company Fixed Deposits
 High interest.
 Short-term deposits.
 Lock-in period is only 6 months.
 No Income Tax is deducted at source if the interest income is up to Rs
5,000 in one financial year
 Investment can be spread in more than one company, so that interest from
one company does not exceed Rs. 5,000
Company Fixed Deposits have always offered interest which is 2-3% higher than
Bank Deposit rate, becaue they have to pay higher interest to banks for borrowing
money.
 interest payments
Interest is paid on monthly/quarterly/half yearly/yearly basis or on maturity,
and is sent either through cheque or through Electronic Clearing System
basis.
 TDS is deducted if the interest on fixed deposit exceeds Rs.5000/- in a

financial year.
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Which companies can accept a deposits ?
Companies registered under the Companies Act 1956, such as:
 Manufacturing Companies.
 Non-Banking Finance Companies.
 Housing Finance Companies.
 Financial Institutions.
 Government Companies.
Upto what limits can a company accept deposit?
A Non-Banking Non-Finance Company(Manufacturing Company) can accept

deposits subject to following limits.
 Upto 10% of the aggregate of paid-up share capital and free reserves if the
deposits are from shareholders or guaranteed by the directors.
 Otherwise upto 25% of the aggregate of paid-up share capital and free
reserves.
A Non-Banking Finance Company can accept deposits upto following limits:
 An Equipment Leasing Company can accept four times of its net owned
fund.
 A Loan or Investment Company can accept deposit upto one and half time
of its net owned funds.
Period of the deposit

Company Fixed Deposits can be accepted by a Manufacturing Company having
duration from 6 months to 3 years. Non-Banking Finance Companies can accept
deposit from 1 year to 5 years period. A Housing Finance Company can accept
deposit from 1 year to 7 years.
19.2) EMPLOYEE’S PROVIDENT FUNDS (EPF)
Employee’s Provident funds Act, 1952

The Employees Provident Funds and Miscellaneous Provisions Act, provides for
compulsory contributory fund for the future of an employee after his retirement or
for his dependents in case of his early death.
It extends to the whole of India except the State of Jammu and Kashmir and is
applicable to:
a. every factory engaged in any industry specified in Schedule 1 in
which 20 or more persons are employed;
b. every other establishment employing 20 or more persons or class of
such establishments which the Central Govt. may notify;
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c. any other establishment so notified by the Central Government even
if employing less than 20 persons.
EMPLOYEES ENTITLED
Every employee, including the one employed through a contractor (but excluding
an apprentice engaged under the Apprentices Act or under the standing orders of
the establishment and casual laborers), who is in receipt of wages upto Rs. 6,500
p.m., shall be eligible for becoming a member of the funds.
The condition of three months? continuous service or 60 days of actual work, for
membership of the scheme, has been done away with, w.e.f. 1.11.1990. Workers
are now eligible for joining the scheme from the date of joining the service.
TERM OF SCHEME
Every member of the Employees? Pension Fund Scheme shall continue to remain
the member till the earliest happening of any of the following events:
i. he attains the age of 58 years; or
ii. he avails the withdrawal benefit to which he is entitled vide para 14 of the
scheme; or
iii. he dies; or
iv. the pension is vested in him.
Every employer shall send to the Commissioner, within three months of the
commencement of the scheme, a consolidated return of the employees entitled to
become members of the new scheme.
EMPLOYER/S CONTRIBUTION
The employer is required to contribute the following amounts towards Employees?
Provident Fund and Pension Fund
a. In case of establishments? employing less than 20 persons or a sick
industrial (BIFR) company or ?sick establishments? or any establishment in
the jute, beedi, brick, coir or gaur gum industry. ?10% of the basic wages,
dearness allowance and retaining allowance, if any.
b. In case of all other establishments? employing 20 or more person-12% of
the wages, D.A., etc.
A part of the contribution is remitted to the Pension Fund and the remaining
balance continues to remain in Provident Fund account.
Where, the pay of an employee exceeds RS. 6500 p.m., the contribution payable to
Pension Fund shall be limited to the amount payable on his pay of RS. 6500 only,
however, the employees may voluntarily opt for the employer?s share of
contributions on wages beyond the limit of RS. 6500 to be credited to the Pension
Fund.
INTEREST
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The employer shall be liable to pay simple interest @ 12% p.a. on any amount due
from him under the Act, from the date on which it becomes due till the date of its
actual payment.
19.3) MUTUAL FUND
A Mutual Fund is a trust that pools the savings of a number of investors who share
a common financial goal. The money thus collected is then invested in capital
market instruments such as shares, debentures and other securities. The income
earned through these investments and the capital appreciation realised are shared
by its unit holders in proportion to the number of units owned by them. Thus a
Mutual Fund is the most suitable investment for the common man as it offers an
opportunity to invest in a diversified, professionally managed basket of securities
at a relatively low cost. The flow chart below describes broadly the working of a
mutual fund:
Mutual Fund Operation Flow Chart
Concept of Mutual Fund
Many investors with common financial

objectives pool their money
Investors, on a proportionate basis, get mutual

fund units for the sum contributed to the pool
The money collected from investors is invested

into shares, debentures and other securities by
the fund manger
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The fund manager realizes gains or losses, and

collects dividend or interest income
Any capital gains or losses from such

investments are passed on to the investors in
promotion of the number of units held by them
TYPES OF MUTUAL FUND SCHEMES

 By Structure
o Open - Ended Schemes
o Close - Ended Schemes
o Interval Schemes
 By Investment Objective
o Growth Schemes
o Income Schemes (√)
o Balanced Schemes
o Money Market Schemes (√)
 Other Schemes
o Tax Saving Schemes
o Special Schemes
 Index Schemes
 Sector Specfic Schemes
Association of Mutual Funds in India (AMFI)

With the increase in mutual fund players in India, a need for mutual fund
association in India was generated to function as a non-profit organisation.
Association of Mutual Funds in India (AMFI) was incorporated on 22nd August,
1995.
AMFI is an apex body of all Asset Management Companies (AMC) which has
been registered with SEBI. Till date all the AMCs are that have launched mutual
fund schemes are its members. It functions under the supervision and guidelines
of its Board of Directors.
Association of Mutual Funds India has brought down the Indian Mutual Fund
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Industry to a professional and healthy market with ethical lines enhancing and
maintaining standards. It follows the principle of both protecting and promoting
the interests of mutual funds as well as their unit holders.
 Income/Debt-oriented schemes (√)

These schemes are for investors who are in need of regular and a steady flow of
income stream. Investors get a fixed sum of money on a monthly, bi-annually or
on an annual basis depending on the options chosen by them while filling the
application form.
A good chunk of such scheme is invested in fixed income securities like corporate
debentures (debt instruments issued by companies like say Bajaj Auto that have a
high safety rating (lower risk of default) and are very much like fixed deposit
schemes of banks) and bonds issued by the Indian government as well as corporate
bonds (again like fixed deposits; a bond has a fixed tenure and a fixed rate of
interest known as coupon rate).
Though risks in these schemes is much lower than growth schemes the chances of
capital appreciation are also lesser. It is a moderate-risk, moderate-returns kind of
scheme.
Investors whose risk appetite is not very high can avail of these schemes. Though
not affected by wild fluctuations in the equity market the NAVs of income
schemes are sensitive to interest rates.
If interest rates go up the value of NAVs of income schemes go down. Their
NAVs and interest rates share an inverse relation. The current situation is the case
in point as interest rates are on an upward journey.
Again good for long-term investors as interest rate changes even out over a period
of 3-5 years.
Franklin Templeton Mutual Fund's FT India Monthly Income Plan and Canbank
Mutual fund's CANINCOME are examples of two such schemes.
 Money market schemes (√)

This scheme is for those investors who want to earn steady but assured income on
their surplus funds in the short-term.
This scheme basically aims to provide easy liquidity (investors can sell the units of
these schemes and get cash in lieu). Apart from that investors can rest assured that
the money they put in will not reduce in value, that is, it offers capital protection.
The assured income generated from such schemes is the icing on the cake.
Mutual funds offering this scheme invest their corpus in treasury bills (short-term
debt instrument offered by the government; say a 30-day fixed deposit offered by
a bank), certificates of deposit (same as fixed deposit schemes offered by
companies like say ACC), apart from a host of other short-term debt schemes of
the government.
56/90
This scheme offers highest security and least volatility. However, the returns are
lower along with high safety of your principal amount.
Fidelity Mutual Fund's Fidelity Short Term Income Fund and Franklin Templeton
Mutual Fund's Templeton India Liquid Plus are the examples of such money
market schemes.
19.4) GILT FUNDS
Gilt funds, as they are conveniently called, are mutual fund schemes floated by
asset management companies with exclusive investments in government
securities. The schemes are also referred to as mutual funds dedicated exclusively
to investments in government securities. Government securities mean and include
central government dated securities, state government securities and treasury bills.
The gilt funds provide to the investors the safety of investments made in
government securities and better returns than direct investments in these securities
through investing in a variety of government securities yielding varying rate of
returns gilt funds, however, do run the risk.. The first gilt fund in India was set up
in December 1998.
Liquidity Support
Eligibility
All gilt funds - public and private sector, open-ended or close- ended - are eligible
to avail liquidity support and other facilities from the Reserve Bank of India. The
gilt funds schemes should, however, have the approval of the Securities and
Exchange Board of India. It would be prudent for the gilt funds to submit an
advance copy of the draft offer document to the Reserve Bank of India for
preliminary scrutiny at the time of submitting the draft offer document to the
Securities and Exchange Board of India. This is to enable the Reserve Bank to
satisfy itself that the scheme proposed to be floated by the gilt funds is in
conformity with the Reserve Bank's guidelines for availing liquidity support from
the Reserve Bank of India.
Conditions
The Reserve Bank of India provides liquidity support by way of reverse repos
subject to the following terms and conditions:
i. Re-purchase agreements (reverse repos) with the Reserve Bank are
in eligible central government dated securities and treasury bills of
all maturities.
57/90
ii. The prices of the securities for reverse repo transactions are
determined by the Reserve Bank of India, at its discretion.
iii. The securities tendered by the gilt funds for reverse repos by the
Reserve Bank are in multiples of Rs. 10 lakh (face value).
iv. Gilt funds can avail the reverse repo facility for a maximum period
of 14 days at a time.
v. The repo rate is the Bank Rate.
vi. Liquidity support is made available at Mumbai only. The gilt funds,
however, are free to transmit the funds to other centers of the
Reserve Bank under its Remittance Facility Scheme.
vii. The gilt funds cannot use the funds raised through the reverse repos
facility for on-lending in the call/notice money market.
viii. The Reserve Bank reserves the right to partially accept or reject any
application for liquidity support without assigning any reason.
ix. The Reserve Bank can call for all relevant information from gilt
funds in regard to their operations and the gilt funds are required to
provide it.
19.5) BANK FIXED DEPOSIT
A fixed deposit is meant for those investors who want to deposit a lump sum of
money for a fixed period; say for a minimum period of 15 days to five years and
above, thereby earning a higher rate of interest in return. Investor gets a lump sum
(principal + interest) at the maturity of the deposit.
Bank fixed deposits are one of the most common savings scheme open to an
average investor. Fixed deposits also give a higher rate of interest than a savings
bank account. The facilities vary from bank to bank. Some of the facilities offered
by banks are overdraft (loan) facility on the amount deposited, premature
withdrawal before maturity period (which involves a loss of interest) etc. Bank
deposits are fairly safer because banks are subject to control of the Reserve Bank
of India.
Returns
The rate of interest for Bank Fixed Deposits varies between 4 and 11 per cent,
depending on the maturity period (duration) of the FD and the amount invested.
Interest rate also varies between each bank. A Bank FD does not provide regular
interest income, but a lump-sum amount on its maturity. Some banks have facility
to pay interest every quarter or every month, but the interest paid may be at a
discounted rate in case of monthly interest. The Interest payable on Fixed Deposit
58/90
can also be transferred to Savings Bank or Current Account of the customer. The
deposit period can vary from 15, 30 or 45 days to 3, 6 months, 1 year, 1.5 years to
10 years.
Duration Interest rate (%) per annum

15-30 days 4 -5 %
30-45 days 4.25-5 %
46-90 days 4.75--5.5 %
91-180 days 5.5-6.5 %
181-365 days 5.75-6.5 %
1-2 years 6-8 %
2-3 years 6.25-8 %
3-5 years 6.75-8
Advantages
Bank deposits are the safest investment after Post office savings because all bank
deposits are insured under the Deposit Insurance & Credit Guarantee Scheme of
India. It is possible to get a loans up to75- 90% of the deposit amount from banks
against fixed deposit receipts. The interest charged will be 2% more than the rate
of interest earned by the deposit. With effect from A.Y. 1998-99, investment on
bank deposits, along with other specified incomes, is exempt from income tax up
to a limit of Rs.12, 000/- under Section 80L. Also, from A.Y. 1993-94, bank
deposits are totally exempt from wealth tax. The 1995 Finance Bill Proposals
introduced tax deduction at source (TDS) on fixed deposits on interest incomes of
Rs.5000/- and above per annum.
How to apply?
One can get a bank FD at any bank, be it nationalised, private, or foreign. You
have to open a FD account with the bank, and make the deposit. However, some
banks insist that you maintain a savings account with them to operate a FD. When
a depositor opens an FD account with a bank, a deposit receipt or an account
statement is issued to him, which can be updated from time to time, depending on
the duration of the FD and the frequency of the interest calculation. Check deposit
receipts carefully to see that all particulars have been properly and accurately
filled in.
Fixed Deposits: Documentation (UTI Bank)
59/90
The following documents are required when applying for a Fixed Deposit
An Individual, Hindu  A valid passport or a valid driving

Undivided Family, Sole license
Proprietorship Concern  An introduction by any other bank or
an introduction by an UTI Bank
Savings Account holder for the last six
months
 A photograph
Trusts  Copy of the Trust Deed

 Copy of the registration certificate
 Copy of the Resolution of The
Trustees
 Authorising the members concerned to
open and operate the account
 Photographs of the members operating
the account
Associations / Clubs  Bye-laws of the Association

 Copy of the Resolution by the board
authorising the members concerned to
open and operate the account
 Photographs of the members operating
the account
Partnership Firm  Partnership Deed

 Letter from partners approving the
persons concerned to open and operate
the account
 Photographs of the persons operating
the account
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19.6) OTHER PROMINENET GOVERNMENT SCHEMES
The list of prominent government schemes available for

investors is given below.
 Public Provident Fund
 National savings Certificates (viii) Issue
 Post Office Monthly Income Scheme
 Post Office Recurring Deposits Scheme
 Post Office Savings Account
 Post Office Time Deposit Schemes
 Kisan Vikas Patra
 RBI Relief Bonds
 Depost Scheme for Retiring Employees of PSUs
 Deposit Scheme for Retiring Govt. Employees-89
 National Savings Schemes Account, 1992 (Discontinued)
 Indira Vikas Patra (Discontinued)
61/90
a) PUBLIC PROVIDENT FUND
Terms of Investment
Tax-free interest, highest post-tax fixed-income yield for individuals in high

tax bracket.
Annual rate of Interest 9.50%
Periodicity of interest payment Compounded annually
Effective annual yield 9.50% tax-free
Maturity period 15 years
Minimum Investment Amount Rs100 per annum
Maximum Investment Amount Rs60,000 per annum
Investment in multiples of Rs100
62/90
Availability
Eligibility Individuals or on behalf of minors, HUF, AOP, NRIs
Available at Selected post offices and banks
Tax Benefits
I.T. section
Sec. 88 for tax rebate
applicable
On sum invested 20% tax rebate, subject to a maximum investment of

Rs60,000
On interest received Interest receipts totally tax-free
Liquidity
Premature
Available every year from 7th financial year
Withdrawal
Loan against
Available from 3rd financial year
investment
Transferability Not transferable to other persons. Transferable from

Bank to post office account
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b) NATIONAL SAVING CERTIFICATES (VIII) ISSUE
Terms of Investment
Investment amount as well as interest-accrued and reinvested qualify

for tax rebates
Periodicity of interest
Compounded semi-annually
payment
Effective annual yield 9.73%
Minimum Investment Amount

Rs100
Maximum Investment
No limit
Amount
Investment in multiples of Rs100/ Rs500/ Rs1,000/ Rs5,000/

Rs10,000
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Availability
Eligibility Individuals or on behalf of minors, trusts
Available at All head post offices and selected sub-post offices
Tax Benefits
I.T. section Sec. 88 for investment amount, eligible under Sec. 80L
applicable for interest earned
On sum invested Eligible for rebate upto a maximum of Rs60,000 under

Sec. 88
On interest Upto Rs12,000 under Sec. 80L. Interest accrued

received qualifies for rebate under Sec.88
Liquidity
Premature Withdrawal After end of 4 years
Loan against investment Can be pledged with banks for loan
Transferability Not allowed
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c) POST OFFICE MONTHLY INVESTMENT SCHEMES
Terms of Investments
Interest payable monthly, 10% bonus on maturity
Monthly
payment
Minimum Investment
Rs6,000
Amount
Maximum Investment Rs3,00,000 (single account), Rs6,00,000 (joint

Amount account)
Investment in multiples of Rs6,000
66/90
Availability
Eligibility Individuals
Tax Benefits
I.T. section applicable Eligible under Sec. 80L for interest earned
On sum invested No benefits
On interest received Upto Rs12,000 under Sec. 80L
Liquidity
Premature After 1 year at 5% discount, after 3 years no

Withdrawal discount for withdrawal
Loan against
Not available
investment
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d) POST OFFICE RECURRING DEPOSITS SCHEME
Terms of Investment
Recurring Deposit Scheme
Periodicity of interest payment Compounded quarterly
Minimum Investment Amount Rs10 per month
Maximum Investment Amount No limit
Investment in multiples of Rs5
68/90
Availability
Eligibility Individuals, trusts, welfare and

regiment funds
Available at All head post offices and selected

sub-post offices
Tax Benefits
I.T. section applicable Eligible under Sec. 80L for interest

earned
On interest received Upto Rs12,000 under Sec. 80L.
Liquidity
50% of the outstanding amount can
Premature Withdrawal
be withdrawn after 1 year.
Loan against investment Not available
Not allowed, extension of scheme for

Transferability another 5 years on a year-to-year
basis
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e) POST OFFICE SAVINGS SCHEME
Terms of Investment
Similar to a Bank Account, cheque facility available
Compounded annually
payment
Effective annual yield 4.5% tax-free
Maturity period Not applicable
Minimum Investment
Rs20
Amount
Maximum Investment Rs50,000 for individuals, no limit for other

Amount investors
Investment in multiples of Not applicable
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Availability
Eligibility All categories of investors
Tax Benefits
I.T. section applicable None
On interest received Interest is totally tax-free
Liquidity
Premature Withdrawal Cheque facility available, cheques are accepted

by scheduled banks
Loan against
Not available
investment
71/90
f) POST OFFICE TIME DEPOSITS SCHEME
Terms of Investment
Similar to a Fixed Deposit Scheme
Annual rate of 9%, 10%, 11% 11.5% for maturity periods of

Interest 1,2,3 and 5 years respectively
Compounded quarterly
payment
Effective annual yield 9.3%, 10.4%, 11.5% 12% for maturity periods of
1,2,3 and 5 years respectively
Maturity period Depends on option (see annual rate of

interest).Can vary between 1,2,3 and 5 years
Minimum Investment
Rs50
Amount
Maximum Investment
No limit
Amount
Investment in
Rs50
multiples of
72/90
Availability
Eligibility Individuals, trusts, welfare and regiment funds
Tax Benefits
I.T. section applicable Eligible under Sec. 80L for interest earned
On interest received Upto Rs12,000 under Sec.80L
Liquidity
Premature After 6 months, not eligible for interest for
Withdrawal accounts closed within 1 year
Loan against
After 1 year
investment
73/90
g) KISAN VIKAS PATRA
Terms of Investment
Money doubles in 6 & 1/2 years.
Compounded annually
payment
Maturity period 6 & 1/2 years
Minimum Investment Amount Rs100
Maximum Investment
No limit
Amount
Investment in multiples of Rs100/ Rs500/ Rs1,000/ Rs5,000/

Rs50,000
74/90
Availability
Eligibility Individuals, and on behalf of minors, trusts
Available at Post offices
Tax Benefits
On sum invested None
On interest received None
Liquidity
Premature Withdrawal Not Available
Loan against investment Not available
Transferability Not available
75/90
h) RBI RELIEF BOND
Terms of Investment
Tax-free interest. Issued as promissory notes.Regular and cumulative
schemes
Annual rate of
8.50%
Interest
Periodicity of interest Compounded semi-annually for cumulative

payment schemes, otherwise interest paid annually
Effective annual yield 8.50% for cumulative schemes
Minimum Investment
Rs10,000
Amount
Maximum Investment
No limit
Amount
Investment in
Rs1,000
multiples of
76/90
Availability
Eligibility Individuals, and on behalf of minors, HUF, NRIs
Available at Agents/ brokers affiliated to government/ RBI
Tax Benefits
On interest received Totally exempt from tax
Liquidity
Premature After 2 1/2 years, lower interest on premature
Withdrawal withdrawal
Loan against
Not available
investment
Transferability For promissory notes - by endorsement and

transfer; for stock certificate - by transfer
instrument with registration
77/90
i) DEPOSIT SCHEME FOR RETIRING EMPLOYEES OF PSUs
Terms of Investment
Interest on amounts invested within three months of retirement is totally
exempt from tax. Similar in nature to fixed deposit schemes
Periodicity of interest payment Compounded semi-annually
Minimum Investment Amount Rs1,000
Maximum Investment Amount Total retirement benefit
78/90
Availability
Eligibility Individuals retiring from service with PSUs
Available SBI branches & subsidiaries, selected nationalised branches,

at selected sub-post offices
Tax Benefits
Liquidity
Premature After 1 year but before 3 years with only one

Withdrawal withdrawal per year. Interest rate will be lower at 4%
p.a. against 9% from date of deposit to withdrawal.
Loan against
Not available
investment
79/90
j) DEPOSIT SCHEME FOR RETIRING GOVERNMENT
EMPLOYEES -89
Terms of Investment
Interest on amounts invested within three months of retirement is totally

exempt from tax.
Periodicity of interest payment Compounded semi-annually
Minimum Investment Amount Rs1,000
Maximum Investment Amount Total retirement benefit
80/90
Availability
Eligibility Individuals retiring from service with central/ state

government offices
Available SBI branches & subsidiaries, selected nationalised branches,

at selected sub-post offices
Tax Benefits
Liquidity
Premature After 1 year but before 3 years with only one
Withdrawal withdrawal per year. Interest rate will be lower at 4%
p.a. against 9% from date of deposit to withdrawal.
Loan against
Not available
investment
81/90
20) OTHER IMPORTANT INFORMATION:
 The bond market is dominated by government bonds. Government bond

issuances, resulting from persistently high fiscal deficits, as well as specific
regulatory requirements, have underpinned the supply and demand conditions
in India’s debt capital markets. Nearly 90% of total domestic bonds
outstanding are government issuances (i.e. Treasury bills, notes and bonds),
squeezing out corporate and other marketable debt securities (see chart).
Government issuance leads the local bond market

Domestic bonds outstanding, % of total
68%
Government bonds
Treasury bills
State loans
PSU bonds
Corporate bonds
4% 4%
3% Others
6% 15%
As of March 2006.
PSU = Public Sector Undertaking
Source: National Stock Exchange
 PSU bonds by far outweigh the size of private corporate bonds (see chart
below), reflecting a number of factors, foremost of which are the lists of
regulatory requirements for private issues. Regulatory oversight of the
segment falls under the purview of the Securities and Exchange Board of India
(SEBI).
82/90
Private corporate bonds outweighed by PSU bonds

Distribution of issuance, %
120
100
80
Private corporate bonds

60
PSU bonds
40
20
0
2004 2005 2006
As of end- March of the year.

Source: National Stock Exchange
 Government bond issuances rule the roost

The government bond segment is the oldest and largest component of the debt
market. Its size has taken off exponentially over the past decades, with the total
stock of debt outstanding at roughly USD 280 bn as of June 2006 4, increasing
three and a half times since 1995. This translates to roughly 35% of GDP, in line
with several large Asian economies and is not significantly lower than that of the
United States (see chart below).
83/90
A siz eable governm ent bond m arket % of GD P
50
45
40
35
30
2001
25
20 2005
15
10
5
0
T h ailan d C h in a So u th In d ia M alays ia USA
Ko r e a
Source: BIS
 Corporate bond market: A huge potential awaits

In contrast to the government bond market, the size of the corporate bond market
(i.e. corporate issuers plus financial institutions) remains very shallow (see chart
below), amounting to just USD 16.8 bn10, or less than 2% of GDP at the end of
June 2006. A well-developed corporate bond market would give companies
greater flexibility to define their optimum capital structure. By the same token,
investors would benefit from having a wider range of asset classes to diversify
their fixed income investments.
C o r p o r a te b o n d m a r k e t h a s y e t to d e v e lo p
% of G DP
50
45
40
35
30 2001
25
20 2005
15
10
5
0
In d ia C h in a T h a ila n d US A So u th M a la y s ia
Ko r e a
Source: BIS
84/90
21.) REVIEW OF INVESTMENT OPTIONS:
PRODUCTS RETURN LIQUIDITY RISK

EQUITY HIGH HIGH HIGH
Co. DEBENTURES MODERATE LOW MODERATE
Co. FDs MODERATE LOW HIGH
BANK DEPOSITS LOW HIGH LOW
PPF MODERATE MODERATE LOW
LIFE INSURANCE LOW LOW LOW
MUTUAL FUNDS HIGH HIGH LOW
RBI BONDS MODERATE LOW LOW
GOVT. SECURITIES MODERATE MODERATE LOW
GUILT FUNDS MODERATE HIGH MODERATE
RBI REFLIEF BOND HIGH LOW LOW
22.) LIQUIDITY Vs RETURNS: -
LOW MODERATE HIGH
Bank Guilt funds Equity,

HIGH
deposits mutual fund
PPF, Govt. Securities

MODERATE
Life RBI bond, Co. FDs, SSI, RBI relief

Insurance Co. debentures bond LOW
85/90
LIQUIDITY AND RETURNS: (suggestions)
 Low liquidity, Low returns

This investment option is suitable for those who do not want to take risk and
are satisfied with low returns and bank deposits are the good example of such
type of funds.
 Low liquidity, Moderate returns

An investor with this objective can invest in RBI Bonds, Co. FDs or Co.
debentures where he could expect moderate returns and low liquidity. Here
RBI bonds are low risky as compared to Company fixed deposits and Co.
debentures.
 Moderate liquidity, Moderate returns

Those investors who want moderate liquidity and moderate returns PPF and
Government securities are the good options. These investments are with
minimum locking period with impressive returns.
 High liquidity, High returns – (equity, mutual fund)

Growth equity and mutual funds schemes are the best options for the investors
with a high liquidity appetite along with a high return. These investment
options are highly attractive and fast money making machines.
23.) RISK AND RETURNS: -
Risk and return are two inseparable parts of an investment strategy. They have a
direct relation with each other. Higher the risks higher are the returns and vice
versa. The very basic considerations of an investor while investing his money are
how to maximize one's returns? What will he get? and what are the risks involved
in investing in a particular investment.
RISK VS RETURNS: -
86/90
LOW MODERATE HIGH
Co. Fixed deposits Equity, RBI

HIGH
relief bonds
Co. debentures, Real estate MODERATE

Guilt funds
Bank deposits, PPF, RBI bonds, Mutual funds

Life insurance Govt. Securities LOW
Graphical representation of risk and return of different investment

options:
Source: wealth creation guide
87/90
RISK AND RETURNS (suggestions):
 Low risk, Low returns (Short investment horizon)

With this investment objective the investor has the option of short-term Bank
deposits for 1-6 months where he could expect returns of 6%-8% p.a.
depending on the tenure.
 Low risk, Moderate returns (Investment horizon of at least 1 year)

An investor with this objective can invest in Company/NBFC deposits, which
are `AAA' rated. This will fetch him returns of around 9% p.a. with moderate
liquidity e.g. HDFC Ltd. Kotak Mahindra Ltd. and ICICI Home Finance.
However, after factoring in tax implications, the actual return on these
deposits comes down to less than 8% p.a.
The other option is government securities i.e. guilts returns of over 8-9% p.a.
along with high safety and liquidity. However these have limited tax benefits,
as the interest is taxable subject to Rs 3,000 tax benefit u/s 80L.
The other option is Relief Bonds which gives 8.5% p.a. tax-free returns with
maximum safety (it is backed by the Government of India). However the
liquidity is very low as the investment is locked for 5 years.
 Moderate risk, Moderate Returns (Investment horizon of 1 year)

An investor with this objective can opt for Company deposits with moderate
safety i.e. `AA' rated that will fetch him over 10% p.a. returns e.g. Dewan
Housing and Berger Paints. However these investments are not liquid.
The other option is the Income and gilt funds, which can give returns of over
10% p.a. and also offer tax benefits, as the dividends from mutual funds are tax
free in the hands of the investor. Both income and gilt funds have very high
liquidity. However these funds can be very volatile in short term.
 High risk, High returns (Long term investment)

Growth (equity)
Before you actually make a call on where to put your money, it is imperative
that you define your objectives in terms of risk appetite, tenure and expected
returns. A good investment plan would tend to be diversified in all these
aspects.
88/90
LIMITAIONS OF STUDY
 ‘Fixed income instruments’ is a very wide topic in itself and time period
was not sufficient to understand terms and conditions of such a wide verity
of instruments available in India. This report is based on the limited
information gathered on fixed income instruments.
 Risk factor is crucial part of any investment decision of the investor but this
report doesn’t speak in terms of value of risk in different instruments that
are available.
 Charts of risk, returns and liquidity are made on the basis of the outcomes
of the information gathered.
 Lack of availability of resources (Books, journals, etc.) about present
Indian market scenario in library.
89/90
References: -
The data was collected from the following sources:
1. College library (IMM)
2. Ankit Jain finance manager (G-Cube solutions)
3. Economic Times
4. Business Standards
5. Business World
6. Financial Economics (journal)
7. Wealth creation guide
8. Websites & Links
a) www.nse-india.com
b) www.bseindia.com
c) www.moneycotrol.com
d) www.valueresearchonline.com
e) www.rbi.org.in
f) www.helplinelaw.com
g) www.amfiindia.com
h) www.webindia123.com/finance
i) www.personalfn.com
j) www.thehindubusinessline.com
k) www.economictimes.com
l) www.crisil.com
90/90

Fixed Income Instruments in India

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Fixed Income Instruments in India

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INSTITUTE OF MARKETING AND MANAGEMENT

“Fixed Income Instrument in India” is my attempt to gather maximum possible

Fixed income instruments are basically obligations undertaken by the issuer

Fixed income instruments can be arranged into 4 sections namely –

The bond market in India is dominated by government bonds. Nearly 90% of

LOW MODERATE HIGH

Co. Fixed deposits Equity, RBI

Co. debentures, Real estate MODERATE

Bank deposits, PPF, RBI bonds, Mutual funds

The desirability of any investment depends not only on its promising or

Objective of study is divided into two parts these are –

a) To collect information about various fixed income instruments

b) Study of liquidity, Risk and Return in each instrument.

4.) 'Fixed Income' Instruments’

Introduction to Fixed Income Instruments

Fixed Income instruments are essentially of two types.

 Tradable. E.g. A debenture

4.2) Why Invest in Fixed Income?

Fixed-income instruments in India typically include company bonds, fixed

 Need for returns in the short-term

 Predictable versus Uncertain Returns

a) Interest Rate Risk

a) Calculate effective yield

b) Consider interest rate (and inflation) expectations

c) Don’t forget taxes

Tenure & Liquidity

- Company bonds/ debentures

- Company fixed deposits

- Fixed income mutual funds

5.) DEBT MARKET:

6.) MARKET MICRO STRUCTURE:

It is necessary to understand microstructure of any market to identify processes,

Figure - The Structure of the Indian Debt Market

SEBI, RBI, DCA

MARKET SEGMENT ISSUERS INSTRUMENTS INVESTORS

GOI dated RBI

Govt. Agencies Govt. Guaranteed PENSION

Comm. Banks/ CD, Debentures, CORPORATES

The instruments traded can be classified into the following segments

Segment Issuer Instruments

Public Sector PSU Bonds, Debenture, Commercial

Debentures, Bonds, Commercial Paper,

Banks Certificate of Deposits, Bonds

Definition of Government securities

9.) Essential terms one should be aware of before investing in

 Accrued Interest: Accrued interest is the interest charged at the coupon

 Day count convention

 A/365 (Actual by 365)

 A/A (Actual by Actual)

 30/360-Day Count: A 30/360-day count says that all months consist of 30

 Yield: Yield is the effective rate of interest received on a security. It takes

 Yield to Maturity (YTM): YTM implies the effective rate of interest

 "Cum-Interest" and "Ex-Interest"

 Trade Value: The Trade Value is the number of Government Security

 Primary Dealers & Satellite Dealers

A Government Security has the following features:

 Demat account for trading in Government Securities –

 The settlement cycle on the exchanges -

 Effect of shut period on trading in stock exchanges

 Intra-day short selling permitted