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What are Fixed Income Securities

Fixed Income Securities Markets: An Overview

Dr HK Pradhan XLRI Jamshedpur

Debt securities are often called fixed income securities, wherein borrowings being made in return for a predetermined stream of cash flows, paid on a fixed schedule. Fixed income securities broadly are classified under the general definition of debt securities or interest rate sensitive securities The concept of fixed income is often nebulous when instruments such as floating rate instruments or other instruments that have future cash flows uncertainties

Defining Features
The defining feature is that there are well-defined rules governing when there will be a payout to the holder of the security Holders of debt securities are creditors, and the issuer is the borrower (Government, or corporate) Cash flows promised to the holders of securities represent contractual obligations of the respective issuers

Role of Debt Markets in the Economy

Facilitates government financing and its roll over Low-cost financing opportunities for the government Governments use special purpose securities for raising resources for specific purposes (Relief bonds, Oil bonds..) Meets long-term investments needs for infrastructure long term Banks and financial institutions invest in debt instruments to meet their statutory requirements Eases over-concentration of credit risk and funding mismatch in the banking system Provident funds, pension funds, insurance companies require long term instruments, invest in debt markets

Role of Debt Markets

Debt markets provide an assured rate of return for buy-hold investors Household prefer bank deposits, savings schemes, and to an extent debt instruments Sub sovereign entities (state local and state sponsored SPVs) Sub-sovereign (state, extensively use debt markets for financing & investments Corporate raise money thro debt markets (CPs, debentures, bonds) Mutual funds, ULIPs invest in debt related instruments FIIs too allowed to invest in debt markets, though to a limited extent

Government Securities serve important purposes

Yields on government securities serve important purposes G Sec yields represent indicators of risk free rates Government securities yields serve as benchmark yields for rest of the sector Used for derivative pricing Government securities can be used to meet liquidity needs of an institution Government securities can be used as collateral to borrow funds in the repo/CBLO market

Government Securities issued keeping in view the yield curve development, liquidity positions, minimizing roll over risk, benchmark & YC implications i li ti Benchmarks is a product of market as well as RBI operations

10-year GOI bond yield

Key Components of Debt Markets

Issuers Investors Instruments Intermediaries Infrastructure Market regulations Benchmark reference rates Primary & secondary markets Coordination & monetary policy issues

Classification of Debt Securities

By Issuers Central Government, State Governments, Municipal Corporations, PSUs, PFIs, Corporate By Instruments T Bills, Government Securities, SDLs, Municipal Bonds, Corporate bonds, FRBs, Inflation Indexed, Convertibles, ABSs By Interest rates Fixed rate issues, Floating rate issues, Zero coupons, inflation indexed bonds g p By Maturity money market instruments (T Bills, CPs), Bonds with 2 or more years tenor, By Optionality, Structured Obligations Calls, Puts & Convertibles, ABS, CDS By Tax features Taxable, non-taxable bonds Sectoral/Special bonds PUSs, Bank bonds, Infra, oil, special purpose bonds By Derivatives FRAs, IRFs, OIS, IRFs, Options, Caps and Floors

Market Participants

Treasury Bills
Instruments of short-term borrowings of Govt. Maturity 91, 182 and 364 days Issued at a discount through auction by RBI and redeemed at par Serves as a bench mark for short-term securities All issuance of T-Bills (including under MSS & LAF) run online on PDO-NDS system Multiple Price based Auction Demand for T-Bills inversely related to call rates Repo transactions permitted in all T-Bills

State Government Securities

Until 1998-99 the states issued securities at pre-announced coupon rates and prices and were issued by the Reserve Bank through common tranches. Since 1999, an option has been given to the states to raise their borrowings by way of competitive auctions RBI manages state borrowing programmes Sub-sovereign issuances, carries implicit guarantees The outstanding SDLs increased from 5.9 per cent of GDP (at CMP) in 2006-07 to 6.6 per cent of GDP in 2008-09. Number of Securities outstanding as on March 3, 2009 at 1233 (vis a vis 97 securities of the GoI) Security-wise outstanding amount ranges from Rs1.5 Crore (7.02% Tripura SDL 2015) to Rs.4000 crore (7.83% Maharashtra SDL 2019)

State Sponsored Institutions

State sponsored institutions include state level financial institutions, state sponsored special p p purpose vehicles ( (SPVs), and statutory boards ), y such as Water Supply and Sewerage Boards. The instruments are usually known in India as structured obligations(SO)

Municipal bonds(ULBs)
Trends towards decentralization and urbanization have necessitated borrowings by municipal corporations Municipal bonds have a number of interesting features. features There are two basic types: General Obligation Bonds: The governments taxation authority backs the bond. Revenue bonds revenue from a specific project is used to pay the bonds down Tax-free bonds

Municipal Bonds With AMC as an Intermediary

Municipal Bonds
Municipal issues are in the nature of revenue bonds, with fixed interest rate, with government guarantee, maturity 7-15 years, are in the form of Structured Obligations(SO)
M unic i pa l C o r po ra t io ns (A mo u nt i n C ro re s o f R upe e s )
M u n ic ip al C o rp o ratio n B an g alo re A h me d abad N as h ik L u d hain a N ag pu r M ad u rai I n d o re H yde rab ad Is s ue D ate 1 997 1 998 1 999 1 999 2 001 2 001 2 001 2 002 M atu rity (Y e ars ) 7 7 7 10 7 15 7 8 .5 C o upo n (% ) 13 14 1 4.75 1 3.5 -14 1 3.43 1 2.25 1 1.50 7 R atin g A -(S O ) A A -(S O ) A A -(S O ) L A A (SO ) L A A -(SO ) L A + (SO ) A A +(S O ) A ge nc y C R ISIL C R ISIL C R ISIL IC R A IC R A IC R A C R ISIL A m o unt 1 00 1 00 1 00 10 50 30 10 8 2.5 G u ar an te e Yes No No No No No Ye s No

Investors Principal Interest Municipal Bonds


Guarantee by DFIs/MDBs

Bonds Principal + Interest ULBs Loan/Bonds Project Cash Flows Escrow Debt Reserve Fund

Corporate Securities
Commercial papers, Bonds/NCDs/ABS Secured or unsecured debt Embedded Options: calls, puts Spread as per ratings Ratings and rating migration Securities other than AAA are classified as non-SLR securities Corporate trustee represents bondholders May have guarantees(third partys guarantees) May have debt service reserve fund/Sinking Fund Can be asset backed, structured securities

Debt Market: Selected Indicators

Trading Size

Major Players
Issuers (typically Governments, Corporations, Municipalities, Banks and FIs) Investors or the buy side institutions (banks, financial institutions, Pension Funds, Mutual Funds, Debt Funds, Reserve Bank of India, Insurance Companies, etc. etc ) Foreign Institutional Investors Primary Dealers Inter-dealer Brokers Rating Agencies Reserve Bank of India

G Sec Operations
G-SECs issued by the Order of the President of India thro the Ministry of Finance(Department of Economic Affairs: Budget Division) RBI manages the entire government debt operations at its IDM Both the initial sale of securities and subsequent transfers are handled by the RBI Settlement thro a computerized book-entry system called the SGL and constituents SGL Accounts Settlement System is Delivery versus payment (DvP)/RTGS with T+0, T+1 as the conditions of deals

Institutional Arrangements
Regulator Government of India (through the Public Debt Act of 1944, replaced with GS Act, 2006) empowers RBI to regulate primary issuance of debt securities, issuance and redemption; Lien/Pledge /Hypothecation, STRIPS SEBI regulates primary issuance of debt securities other than government securities Trading Direct, Broker driven (OTC markets generally predominate) Anonymous Order Driven

Negotiated Dealing System (NDS) NDS of RBI provides an electronic platform for negotiating trades in government securities. NDS Order Matching (NDS-OM) NDS-OM is an electronic, screen based, anonymous, order driven trading system, introduced by RBI as part of the existing NDS system to system facilitate electronic dealing in government securities WDM Segment of NSE Trading System
BSE and NSE to have in place for bond trading

NSEs Wholesale Debt Market (WDM) segment offers a fully automated screen based trading platform through the NEAT (National Exchange for Automated Trading) system

Clearing & Settlement CCIL

Trading, Clearing & Settlement System of CCIL

Pre-Trade Orders Management Execution Deal Management Risk Management/ Novation Netting/ Exercise/Assignment DVP III Account Management

Debt market serves as important conduits for monetary policy

Key route for monetary policy applications Management of liquidity in the financial markets Statutory liquidity requirements for banks and financial institutions are met using government securities markets gg Debt markets signal long run prospects of the economy Signals inflationary expectations, in term structure of interest rates Links money markets and foreign exchange markets










RBI operates both as the monetary authority and the debt manager to the GOI
Debt manager (debt management functions are undertaken at the IDM cell of the RBI) Issuer & custodian of government bills and securities Manages servicing and redemptions Raises funds on behalf of the state governments Monetary Authority (monetary policies for price stability and liquidity management) Open-market operations (OMO) Bank rate policy Repo/Liquidity Adjustment facility (LAF) Market Stabilization Schemes (MSS de-sequestering recently)

Demand and Supply of G Secs

Long Term Securities Budget financing Redemption Short Term Securities Treasury Bills, Cash Management bills Moderating variables OMOs, Repos, MSS, LAFs Cash management (pattern of taxes/Government expenditures expenditures are front loaded, whereas tax collections gather towards year-end

Net Supply of Issuances 2009-10

GOI Borrowings : 1st Half of the FY 2009-10 (Dated securities) (Rs.crore) Item Gross Market Borrowings Less : Repayments Net Market Borrowings Less : OMO Purchases Less : MSS Unwinding * Add : MSS Issuances (net)* Net Supply of Fresh Securities * Includes dated securities and Treasury Bills 69,077 135,523 2007-08 97,000 30,554 66,446 0 0 5,263 67,235 143,911 2008-09 106,000 44,028 61,972 0 0 2009-10 299,000 33 089 265,911 80,000 42,000 0

SEBI regulates corporate debt instruments listed on the stock exchanges.

All government securities are deemed listed as and when they are issued. SEBI issues guidelines for corporate debt issuance and also for their listing on stock exchanges exchanges. Secondary market trading of corporate bonds are conducted as per the rules set by SEBI Privately placed debt paper of banks, institutions and corporates requires an investment grade credit rating to be eligible for listing
Self regulatory organization Market follows FIMMDA practices Valuation methods prescribed for the markets FIMMDA/PDA/Bloomberg yield curve used by markets FIMMDA-CRISIL Spread matrix for corporate bond pricing FIMMDA corporate bond valuer

Government Debt Issuance

Half-yearly issuance calendars Rationalization of Issuance (auction formats, frequency, size of issuances, allocation among specific instruments, acceptance criteria, etc) Development of yield curve, efforts to issue longer maturities up to 30 years Passive Consolidation ( reissuances/ reopening) Restructuring Buyback of illiquid securities & reissue of liquid securities (reverse auction, switch/swap, secondary market purchase) Primary Issuance (underwriting commitments from PDs, liquidity support..)

Primary Dealers
Primary Dealers are those banks & securities firms that are approved to transact directly with the Reserve Bank in auctions. Advantage of primary dealer system is that the Reserve Bank will be in a position to conduct its auctions efficiently with a small number of well capitalized institutions. Primary dealers are expected to Participate in auctions Underwrite Auction Act as "Market Makers RBI provides liquidity support (LAF) PDs have access to the RBIs open market operations PDs are permitted to borrow and lend in the money market

Primary Dealers
A Bank PDs 1 Citibank N.A., 2 Standard Chartered Bank 3 Bank of America N.A. 4 J P Morgan Chase Bank, N.A. 5 HSBC Bank 6 Bank of Baroda 7 Canara Bank 8 Kotak Mahindra Bank Ltd. 9 Corporation Bank 10 HDFC Bank B Stand alone PDs 1 IDBI Gilts 2 ICICI Sec P D Ltd. 3 PNB Gilts Ltd. 4 SBI DFHI Ltd 5 STCI PD Ltd 6 ABN AMRO Securities (India) Pvt 7 Deutsche Securities (India) Pvt Ltd 8 DSP Merrill Lynch Securities Trading Ltd 9 Lehman Brothers Securities Pvt.Ltd.

New Issues & Re-issuances

Government maintains large benchmarks in bonds across maturities, in order to promote market liquidity Reopen/Reissue an issue in an auction to create

Adequate availability of benchmark securities Benchmark issuance focus more on supply of bonds across maturities Re-issuance/re-opening be tailored to market liquidity Lengthening of the maturity helps develop the secondary debt securities market


Issuing benchmarks across the yield curve

In the absence of benchmark bonds, market prices may not, therefore, truly reflect ideal prices Issue benchmark bonds at the right data points of the yield curve

Secondary Markets
Banks typically hold a substantial portion for bonds, effectively to maturity, to a smaller extent for short term trading purpose Large portion of HTM portfolio as against the trading portfolio Contractual saving institutions mainly focus on long term bonds, buy-hold investors in general Captive nature of holdings create market distortions in yield and illiquidity (Pension funds, mutual funds, insurance companies) Price discovery processes must be as efficient as possible such that true market prices that accurately reflect conditions in the economy


Reference Rates

Market Benchmarks
FIMMDA, PDAI & Bloomberg Prices of GOI Securities FIMMDA Corporate Bond Spread Matrix FIMMDA Corporate Bond Traded Data & Spreads FIMMDA Moneyline Telerate India Commercial Paper FIMMDA y p Moneyline Telerate India Treasury Bill FIMMDA State Loan Calculator FIMMDA NSE MIBID/MIBOR FIMMDA Reuters MIFOR, MIOCS, MIOIS and MITOR


Corporate Bonds Spreads

Yield Curve
NSE ZCYC based on NS CCIL ZCYV based on NSS FIMMDA/Bloomberg Bootstrapping g pp g


Indian and global markets

Yield Curve Stability 2007-09

Dollar Index and Indian rupee

Dollar Index: EUR 57.6%, JPY 13.6%, GBP 11.9%, CAD 9.1%, SEK 4.2%, CHF 3.6%

10-year US treasury and 10-year Indian G-sec

Retail Investors in Debt Markets

Good avenue for investment Highest safety Regular stream of income every six months Assured yield to maturity if held till redemption) Diversification of risk Liquidity through trading Specific debt instruments are available for retail investors

Foreign Issuers in Local Market

Recent efforts by ADB/WB to issue local currency bond issuance in India Such issuances have shown great interest by local investors FIIs are allowed to hold government securities


Repos, CLBO, Short sales permitted When Issued introduced STRIPs introduced IRF i introduced d d FRAs, Swaps, OIS exist

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Indian debt market is becoming vibrant