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Debt Market
Debt Market
DEBT MARKET
By
ULTIMATE INVESTMENTS
Nurturing Wealth
Who are the key players in the debt and money markets in India?
The above diagram provides a consolidated picture of the various players in the bond/money markets and the securities. ZCB: Zero Coupon Bond I/L bonds : Inflation linked bonds FRN : Floating rate notes
Commercial Paper
A Commercial Paper is a short term unsecured promissory note issued by the raiser of debt to the investor. In India corporates, primary dealers (PD), satellite dealers (SD) and financial institutions (FIs) can issue these notes. It is generally companies with very good rating which are active in the CP market, though RBI permits a minimum credit rating of Crisil-P2. The tenure of CPs can be anything between 15 days to one year, though the most popular duration is 90 days. Companies use CPs to save interest costs
Certificates of Deposit
These are issued by banks/financial institutions in denominations of Rs 5 lakhs and have maturity ranging from 30 days to 3 years. Banks are allowed to issue CDs with a maturity of less than one year while financial institutions are allowed to issue CDs with a maturity of at least one year.
Treasury Bills
Treasury Bills are instruments issued by RBI at a discount to the face value and form an integral part of the money market. In India treasury bills are issued in three different maturities 14 days, 182 days and 364 days. Apart from the above money market instruments, certain other short-term instruments are also in vogue with investors. These include short-term corporate debentures, bills of exchange and promissory notes.
What is a Repo?
Repo or Repurchase Agreements or Ready Forward transactions are short-term money market instruments. Repo is nothing but collateralized borrowing and lending. In a repo, securities (like Government securities and treasury bills) are sold in a temporary sale with an agreement to buy back the securities at a future date at specified price. In reverse repo`s, securities are purchased in a temporary purchase with an agreement to sell it back after a specified number of days at a pre-specified price. When one is doing a repo, it is reverse repo for the other party. For example, RBI could engage in a three-day repo transaction with SBI, i.e., it would sell a security at, say, Rs. 100 to the SBI agreeing to buy it back at Rs. 100.07, in three days. The difference in price, is the interest RBI would have to pay for the money lent by SBI.
Repo rate is nothing but the annualized interest rate for the funds transferred by the lender to the borrower in a repo transaction.
Inflation Rate
Inflation Rate : Typically a higher inflation rate means higher interest rates. The interest rates prevailing in an economy at any point of time are nominal interest rates, i.e., real interest rates plus a premium for expected inflation. Due to inflation, there is a decrease in purchasing power of every rupee earned on account of interest in the future; therefore the interest rates must include a premium for expected inflation. In the long run, other things being equal, interest rates rise one for one with rise in inflation.
Simply put, the annualised return an investor would get by holding a fixed income instrument until maturity. It is the composite rate of return of all payouts and coupon.
What is convexity?
Convexity is a measure of the way duration and price change when interest rates change. A bond is said to have positive convexity if the instrument's value increases at least as much as duration predicts when rates drop and decreases less than duration predicts when rates rise. Typically, fund managers and investors prefer bonds with higher convexity. This is because such bonds rise higher than other bonds when interest rate falls. And what is more, they fall lower than other bonds, when interest rate rises. Convexity is an important factor when interest rates are volatile
Example :
Fixed rate payment
Fixed rate player
Terms:
Fixed Interest Rate : 7% p.a. Variable Interest Rate : NSE Over-Night MIBOR reset daily and compounded daily. Notional Principal Amount : Rs. 50 crore Period of Agreement : 1 year Payment Frequency : Semi - Annual Now, suppose the six-month period from the effective date of the swap to the first payment date comprises 182 days and the daily compounded NSE Over - Night MIBOR is 6 % p.a. on the first payment date, then the fixed and variable rate payment on the first payment date would be as follows:
1.
Fixed Rate Payment : Rs. 1,74,52,055 = (Rs. 50,00,00,000) X (7%) X (182 Days / 365 Days) 2. Variable Payment : Rs. 1,49,58,904 = (Rs. 50,00,00,000) X (6%) X (182 Days/ 365 Days) Often, a swap agreement will call for only the exchange of net amount between the counter parties. In the above examples, the fixed - rate payer will pay the variable - rate payer a net amount of Rs. 24,93,151 = Rs. 1,74,52,055 - Rs. 1,49,58,904. The second and final payment will depend on the daily NSE MIBOR compounded daily for the remaining 183 days. The fixed rate payment will also change to reflect the change in holding period from 182 days to 183 days.
2.
1. 2. 3. 4.
What does one mean by a currency being over-valued? What is Real Effective Exchange Rate (REER)?
1. When RBI says that the rupee is overvalued, they mean that it has been appreciating against other major currencies due to their weakening against dollar which might impact the competitiveness of India's exports. REER is the change in the external value of the currency in relation to its main trading partners. It is Rupee's value on a trade-weighted basis. It takes into account the Rupee's value not only in terms of dollar but also Euro, Yen and Pound Sterling. The exchange rates versus other major currencies are average weighted by the value of India's trade with the respective countries and are then converted into a single index using a base period which is called the nominal effective exchange rate. But the relative competitiveness of Indian goods increases even when the nominal effective exchange rate remains unchanged when the rate of price increases of the trading partner surpasses that of India's. Taking this into account, prices are adjusted for the nominal effective exchange rate and this rate is called the "real effective exchange rate."
2.
3.
1. What are thinly traded debt securities ? A debt security that has a trading volume of less than Rs. 5 crores in the previous calendar month is considered a thinly traded security. 2.What are non traded securities ? When a security is not traded on any stock exchange for a period of 30 days prior to the valuation, it is treated a non traded security.
Average Gilt AAA AA+ AA AAA+ A ABBB+ BBB BBBBB+ BB BBB+ B BC D 6.32% 6.95% 7.29% 7.66% 8.18% 8.86% 9.45% 10.38% 11.30% 12.38% 13.87% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
0.5-1.0 yrs 5.70% 0.63% 0.99% 1.33% 1.85% 2.50% 2.90% 3.60% 4.37% 5.46% 6.96% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
1.0-2.0 yrs 5.90% 0.72% 1.01% 1.28% 1.74% 2.47% 3.03% 4.01% 4.88% 6.02% 7.52% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
2.0-3.0 yrs 6.02% 0.71% 0.96% 1.28% 1.74% 2.50% 3.10% 4.19% 5.10% 6.19% 7.69% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
3.0-4.0 yrs 6.18% 0.71% 0.92% 1.24% 1.73% 2.49% 3.14% 4.12% 5.09% 6.17% 7.67% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
4.0-5.0 yrs 6.43% 0.59% 0.92% 1.39% 1.91% 2.60% 3.28% 4.17% 5.14% 6.16% 7.66% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
5.0-6.0 yrs 6.87% 0.52% 0.98% 1.41% 1.97% 2.60% 3.26% 4.18% 5.15% 6.18% 7.68% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
> 6.0 yrs 7.17% 0.51% 1.01% 1.44% 2.08% 2.60% 3.15% 4.10% 5.10% 6.19% 7.61% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%
Mark-up/Mark-down yield
All debt securities are prone to certain risk and hence the marking up or down of yield is essential to get a true picture about that particular security. The yields calculated above are marked up/marked down to account for the liquidity risk, promoter background, finance company risk and the issuer class risk. The marking differs for rated and non-rated securities and is as follows : Rated securities: Securities of less than 2 year duration could be marked up or down upto 0.5% and for securities of more than 2 year duration marking is allowed upto +/- 0.25% to be provide for the above mentioned types of risks Non-rated securities : Since non-rated securities tend to be more illiquid than rated securities, the yields are marked up by adding 0.5% for securities having a duration of upto two years and 0.25% for securities having duration of higher than two years to account for the illiquidity risk
Illustration
Lets take the example of a AAA rated thinly traded debenture of HDFC which has a duration of 3.25 years and a coupon rate of 11.45%. Say, we purchased the debenture on July 21, 2002. By looking at the matrix above, we arrive at a yield of 6.89%. The enclosed excel sheet provides the calculation of NPV. (click on the cells to view the formulas -Lets take the example of a AAA rated thinly traded debenture of HDFC which has a duration of 3.25 years and a coupon rate of 11.45%. Say, we purchased the debenture on July 21, 2002. By looking at the matrix above, we arrive at a yield of 6.89%. The enclosed excel sheet provides the calculation of NPV. (click on the cells to view the formulas -
Par value = Rs.100 Discount rate = 9.65% (ie, yield from the matrix) Purchase date = July 21, 2001 HDFC Cash Flows 21-Jul-01 2-Apr-02 2-Apr-03 2-Apr-04 2-Apr-05 3-Jan-06 11.45 11.45 11.45 11.45 108.66 NPV 10.93 10.22 9.56 8.95 80.74 120.40
FRIF
Liquid Funds
Risk
Investments
Typical Yields
3-6 mos.
M + 40 bps
12 - 18 mos.
M + 75 bps