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Understanding and measuring the liquidity of government bond markets

is important to various market participants. Primarily, these markets serve to
governments for financing purposes. Market participants use government
bonds as collateral, as benchmarks for pricing other financial instruments
and as hedging or investment instruments. Central banks extract from these
markets information on future interest rates and use government bonds as
monetary policy instrument. Liquidity directly affects the usability of
government bonds for these purposes.

Until recently, most research articles focused on stock or foreign

exchange markets and only few were dedicated to government
bond markets. Researchers and regulators started to focus on the
liquidity of government bond markets after the financial market
turmoil in 1998, which had an impact even on such liquid markets
like the U.S. Treasury market.

Through the efforts of this project, we understood in depth the various

instruments used by individuals as well as by organizations for raising and
using debt. Earlier we were under the impression that we have limited scope to
the debt markets but after this study, we are aware of the various opportunities
in the debt instrument market.

The debt market is a bigger source of borrowed funds than the banking
system. The market for debt is larger than the market for equities (i.e., is
larger than the stock market). The debt market is commonly divided into
the so-called money market (short-term debt, maturity of one year or less)
and the so-called capital market (long-term debt). Both of these terms are
misnomers. All productive assets are capital (including equities). The
terminology may be rationalized by the convention that capitalized
expenses are amortized over periods in excess of one year. "Money
market" instruments are debt and although they can be used as a store of
value they can only be regarded as a medium of exchange in the sense that
they are readily sold at a price which is usually predictable within a short
time frame. Moreover, it is hard to base a conceptual distinction between
money & non-money based on a one-year maturity dividing line.

Most debt instruments are not traded through exchanges, but are traded over-
the-counter (OTC) in a telephone/electronic network market where dealers or
brokers frequently act as direct intermediaries. Money-market instruments
usually have such large denominations that they are not accessible to small
investors except through mutual funds.

The market for debt can be viewed as a market for money in the sense
that sellers of debt (lenders) have a supply of money which is demanded
by would-be buyers (borrowers). In this model, interest rates are the
"price" of money. An increase in demand to borrow money due to
increased economic opportunity increases interest rates (everything else
being equal). The market for debt is influenced by term-to-maturity,
credit-worthiness of borrowers, security for loan and many other factors.
By their control of money supply, government central banks try to
manipulate interest rates to stimulate their economies without causing

Financial System of any country consists of financial markets, financial

intermediation and financial instruments or financial products. This paper
discusses the meaning of finance and Indian Financial System and focus on
the financial markets, financial intermediaries and financial instruments. The
brief review on various money market instruments are also covered in this

The term "finance" in our simple understanding it is perceived as equivalent to

'Money'. We read about Money and banking in Economics, about Monetary
Theory and Practice and about "Public Finance". But finance exactly is not
money, it is the source of providing funds for a particular activity. Thus public
finance does not mean the money with the Government, but it refers to sources
of raising revenue for the activities and functions of a Government.


The economic development of a nation is reflected by the progress of the
various economic units, broadly classified into corporate sector, government
and household sector. While performing their activities these units will be
placed in a surplus/deficit/balanced budgetary situations.

There are areas or people with surplus funds and there are those with a deficit.
A financial system or financial sector functions as an intermediary and
facilitates the flow of funds from the areas of surplus to the areas of deficit. A
Financial System is a composition of various institutions, markets, regulations
and laws, practices, money manager, analysts, transactions and claims and

The word "system", in the term "financial system", implies a set of complex
and closely connected or interlined institutions, agents, practices, markets,
transactions, claims, and liabilities in the economy. The financial system is
concerned about money, credit and finance-the three terms are intimately
related yet are somewhat different from each other. Indian financial system
consists of financial market, financial instruments and financial
intermediation. These are briefly discussed below;


“A real or virtual document representing a legal agreement involving some sort
of monetary value” In today's financial marketplace, financial instruments can
be classified generally as equity based, representing ownership of the asset, or
debt based, representing a loan made by an investor to the owner of the asset.
Foreign exchange instruments comprise a third, unique type of
instrument. Different subcategories of each instrument type exist, such as
preferred share equity and common share equity, for example

Money Market Instruments

The money market can be defined as a market for short-term money and financial
assets that are near substitutes for money. The term short-term means generally a
period upto one year and near substitutes to money is used to denote any financial
asset which can be quickly converted into money with minimum transaction
cost.Some of the important money market instruments are briefly discussed below;

2.Treasury Bills
3.Term Money
4.Certificate of

1. Call /Notice-Money Market

Call/Notice money is the money borrowed or lent on demand for a very short
period. When money is borrowed or lent for a day, it is known as Call (Overnight)
Money. Intervening holidays and/or Sunday are excluded for this purpose. Thus
money, borrowed on a day and repaid on the next working day, (irrespective of the
number of intervening holidays) is "Call Money". When money is borrowed or lent
for more than a day and up to 14 days, it is "Notice Money". No collateral security
is required to cover these
2. Inter Bank Term Money

Inter-bank market for deposits of maturity beyond 14 days is referred to as the

term money market. The entry restrictions are the same as those for
Call/Notice Money except that, as per existing regulations, the specified
entities are not allowed to lend beyond 14 days.

3. Treasury Bills

Treasury Bills are short term (up to one year) borrowing instruments of the
union government. It is an IOU of the Government. It is a promise by the
Government to pay a stated sum after expiry of the stated period from the
date of issue (14/91/182/364 days i.e. less than one year). They are issued
at a discount to the face value, and on maturity the face value is paid to the
holder. The rate of discount and the corresponding issue price are
determined at each auction.

4. Certificate of Deposits

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. Guidelines for issue of CDs are presently governed
by various directives issued by the Reserve Bank of India, as amended
from time to time. 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.
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.
5. Commercial Paper

CP is a note in evidence of the debt obligation of the issuer. On issuing

commercial paper the debt obligation is transformed into an instrument. CP is
thus an unsecured promissory note privately placed with investors at a
discount rate to face value determined by market forces. CP is freely
negotiable by endorsement and delivery. A company shall be eligible to issue
CP provided - (a) the tangible net worth of the company, as per the latest
audited balance sheet, is not less than Rs. 4 crore; (b) the working capital
(fund-based) limit of the company from the banking system is not less than
Rs.4 crore and (c) the borrowal account of the company is classified as a
Standard Asset by the financing bank/s. The minimum maturity period of CP
is 7 days. The minimum credit rating shall be P-2 of CRISIL or such
equivalent rating by other agencies.

Capital Market

The capital market generally consists of the following long term period i.e.,
more than one year period, financial instruments; In the equity segment Equity
shares, preference shares, convertible preference shares, non-convertible
preference shares etc and in the debt segment debentures, zero coupon bonds,
deep discount bonds etc.

Hybrid Instruments

Hybrid instruments have both the features of equity and debenture. This kind
of instruments is called as hybrid instruments. Examples are convertible
debentures, warrants etc

A financial market is a mechanism that allows people to buy and sell (trade) financial
securities (such as stocks and bonds), commodities (such as precious metals or
agricultural goods), and other fungible items of value at low transaction costs and at
prices that reflect the efficient-market hypothesis. Both general markets (where many
commodities are traded) and specialized markets (where only one commodity is
traded) exist. Markets work by placing many interested buyers and sellers in one
"place", thus making it easier for them to find each other. An economy which relies
primarily on interactions between buyers and sellers to allocate resources is known as
a market economy in contrast either to a command economy or to a non-market
economy such as a gift economy.

In finance, financial market facilitate:

• The raising of capital (in the capital markets)

• The transfer of risk (in the derivatives markets)

• International trade (in the currency markets)

– and are used to match those who want capital to those who have it.

Typically a borrower issues a receipt to the lender promising to pay back the capital.
These receipts are securities which may be freely bought or sold. In return for lending
money to the borrower, the lender will expect some compensation in the form of
interest or dividends.

In mathematical finance, the concept of a financial market is defined in terms of a

continuous-time Brownian motion stochastic process.

Typically, the term market means the aggregate of possible buyers and sellers of a
certain good or service and the transactions between them. The term "market" is
sometimes used for what are more strictly exchanges organizations that facilitate the
trade in financial securities, e.g., a stock exchange or commodity exchange. This may
be a physical location (like the NYSE) or an electronic system (like NASDAQ). Much
trading of stocks takes place on an exchange; still, corporate actions (merger, spinoff)
are outside an exchange, while any two companies or people, for whatever reason,
may agree to sell stock from the one to the other without using an exchange.

Trading of currencies and bonds is largely on a bilateral basis, although some

bonds trade on a stock exchange, and people are building electronic systems for
these as well, similar to stock exchanges.

Financial markets can be domestic or they can be international.

Types of Financial Markets

The financial markets can be divided into different subtypes:

• Capital markets which consist of:

o Stock markets, which provide financing through the issuance of shares or

common stock, and enable the subsequent trading thereof.

o Bond markets, which provide financing through the issuance of bonds, and
enable the subsequent trading thereof.

• Commodity markets, which facilitate the trading of commodities.

• Money markets, which provide short term debt financing and investment.

• Derivatives markets, which provide instruments for the management of financial


• Futures markets, which provide standardized forward contracts for trading products
at some future date; see also forward market.

• Insurance markets, which facilitate the redistribution of various risks.

• Foreign exchange markets, which facilitate the trading of foreign exchange.

The capital markets consist of primary markets and secondary markets. Newly formed
(issued) securities are bought or sold in primary markets. Secondary markets allow
investors to sell securities that they hold or buy existing securities.

Raising the capital

To understand financial markets, let us look at what they are used for, i.e. what
Without financial markets, borrowers would have difficulty finding lenders
themselves. Intermediaries such as banks help in this process. Banks take deposits
from those who have money to save. They can then lend money from this pool of
deposited money to those who seek to borrow. Banks popularly lend money in the
form of loans and mortgages.

More complex transactions than a simple bank deposit require markets where
lenders and their agents can meet borrowers and their agents, and where existing
borrowing or lending commitments can be sold on to other parties. A good example
of a financial market is a stock exchange. A company can raise money by selling
1shares to investors and its existing shares can be bought or sold. The following
table illustrates where financial markets fit in the relationship between lenders and
between lenders and borrowers


Many individuals are not aware that they are lenders, but almost everybody
does lend money in many ways. A person lends money when he or she:
• puts money in a savings account at a bank;
• contributes to a pension plan;
• pays premiums to an insurance company;
• invests in government bonds; or
• invests in company shares.


Companies tend to be borrowers of capital. When companies have surplus cash that is
not needed for a short period of time, they may seek to make money from their cash
surplus by lending it via short term markets called money markets.

There are a few companies that have very strong cash flows. These companies tend to
be lenders rather than borrowers. Such companies may decide to return cash to
lenders (e.g. via a share buyback.) Alternatively, they may seek to make more money
on their cash by lending it (e.g. investing in bonds and stocks.)


Individuals borrow money via bankers' loans for short term needs or longer term
mortgages to help finance a house purchase.

Companies borrow money to aid short term or long term cash flows. They also
borrow to fund modernization or future business expansion.

Governments often find their spending requirements exceed their tax revenues. To
make up this difference, they need to borrow. Governments also borrow on behalf of
nationalised industries, municipalities, local authorities and other public sector bodies.
In the UK, the total borrowing requirement is often referred to as the Public sector net
cash requirement (PSNCR).
Governments borrow by issuing bonds. In the UK, the government also borrows from
individuals by offering bank accounts and Premium Bonds. Government debt seems
to be permanent. Indeed the debt seemingly expands rather than being paid off. One
strategy used by governments to reduce the value of the debt is to influence inflation.
Municipalities and local authorities may borrow in their own name as well as
receiving funding from national governments. In the UK, this would cover an
authority like Hampshire County Council.

Public Corporations typically include nationalised industries. These may

include the postal services, railway companies and utility companies. Many
borrowers have difficulty raising money locally. They need to borrow
internationally with the aid of Foreign exchange markets.

Derivative products

During the 1980s and 1990s, a major growth sector in financial markets is the trade in
so called derivative products, or derivatives for short. In the financial markets, stock
prices, bond prices, currency rates, interest rates and dividends go up and down,
creating risk. Derivative products are financial products which are used to control risk
or paradoxically exploit risk. It is also called financial economics.

Currency markets

Seemingly, the most obvious buyers and sellers of currency are importers and
exporters of goods. While this may have been true in the distant past, when
international trade created the demand for currency markets, importers and exporters
now represent only 1/32 of foreign exchange dealing, according to the Bank for
International Settlements.

Analysis of financial markets

Much effort has gone into the study of financial markets and how prices vary with
time. Charles Dow, one of the founders of Dow Jones & Company and The Wall
Street Journal, enunciated a set of ideas on the subject which are now called Dow
Theory. This is the basis of the so-called technical analysis method of attempting to
predict future changes. One of the tenets of "technical analysis" is that market trends

give an indication of the future, at least in the short term. The claims of the technical
analysts are disputed by many academics, who claim that the evidence points rather to
the random walk hypothesis, which states that the next change is not correlated to the.

Having designed the instrument, the issuer should then ensure that these financial
assets reach the ultimate investor in order to garner the requisite amount. When the
borrower of funds approaches the financial market to raise funds, mere issue of
securities will not suffice. Adequate information of the issue, issuer and the security
should be passed on to take place. There should be a proper channel within the
financial system to ensure such transfer. To serve this purpose, Financial
intermediaries came into existence. Financial intermediation in the organized sector
is conducted by a wide range of institutions functioning under the overall surveillance
of the Reserve Bank of India. In the initial stages, the role of the intermediary was
mostly related to ensure transfer of funds from the lender to the borrower. This
service was offered by banks, FIs, brokers, and dealers. However, as the financial
system widened along with the developments taking place in the financial markets,
the scope of its operations also widened. Some of the important intermediaries
operating in the financial markets include; investment bankers, underwriters, stock
exchanges, registrars, depositories, custodians, portfolio managers, mutual funds,
financial advertisers financial consultants, primary dealers, satellite dealers, self
regulatory organizations, etc. Though the markets are different, there may be a few
intermediaries offering their services in more than one market e.g. underwriter.
However, the services offered by them vary from one market to
What is the Debt Market?
The debt market is any market situation where the trading debt instruments take
place. Examples of debt instruments include mortgages, promissory notes, bonds, and
Certificates of Deposit. A debt market establishes a structured environment where
these types of debt can be traded with ease between interested parties.

Individual investors as well as groups or corporate partners may

participate in a debt market. Depending on the regulations imposed by
governments, there may be very little distinction between how an
individual investor versus a corporation would participate in a debt
market. However, there are usually some regulations in place that require
that any type of investor in debt market offerings have a minimum amount
of assets to back the activity. This is true even with situations such as
bonds, where there is very little chance of the investor losing his or her
investment. One of the advantages to participating in a debt market is that
the degree of risk associated with the investment opportunities is very
low. For investors who are focused on avoiding riskier ventures in favor
of making a smaller but for less guaranteed return, going with bonds and
similar investments simply makes sense. While the returns will never be
considered spectacular, it is possible to earn a significant amount of
money over time, if the right debt market offerings are chosen.

Issuers of various bonds, notes, and mortgages also benefit from the structured
environment of a debt market. By offering the instruments on a market that is
regulated and has a solid working process, it is possible to interact with a larger
base of investors who could be attracted to the type of debt instrument offered.
Because most markets have at least some basic requirements for participation on
the market, the issuers can spend less time qualifying potential buyers and more
time spreading the word about the debt instruments they have to offer.

In most of the countries, the debt market is more popular than the equity market. This
is due to the sophisticated bond instruments that have return- reaping assets as their
underlying. In the US, for instance, the corporate bonds (like mortgage bonds)
became popular in the 1980s. However, in India, equity markets are more popular
than the debt markets due to the dominance of the government securities in the debt
markets. Moreover, the government is borrowing at a pre-announced coupon rate
targeting a captive group of investors, such as banks. This, coupled with the automatic
monetization of fiscal deficit, prevented the emergence of a deep and vibrant
government securities market. The bond markets exhibit a much lower volatility than
equities, and all bonds are priced based on the same macroeconomic information. The
bond market liquidity is normally much higher than the stock market liquidity in most
of the countries. The performance of the market for debt is directly related to the
interest rate movement as it is reflected in the yields of government bonds, corporate
debentures, MIBOR-related commercial papers,and non-convertible debenture


Debt market refers to the financial market where investors buy and sell debt
securities, mostly in the form of bonds. These markets are important source of funds,
especially in a developing economy like India. India debt market is one of the largest
in Asia. Like all other countries, debt market in India is also considered a useful
substitute to banking channels for finance.

Wholesale Debt Market

The Wholesale Debt Market segment deals in fixed income securities and is fast
gaining ground in an environment that has largely focussed on equities. The
Wholesale Debt Market (WDM) segment of the Exchange commenced operations on
June 30, 1994. This provided the first formal screen-based trading facility for the debt
market in the country. This segment provides trading facilities for a variety of debt
instruments including Government Securities, Treasury Bills and Bonds issued by
Public Sector Undertakings/ Corporates/ Banks like Floating Rate Bonds, Zero
Coupon Bonds, Commercial Papers, Certificate of Deposits, Corporate Debentures,
State Government loans, SLR and Non-SLR Bonds issued by Financial Institutions,
Units of Mutual Funds and Securitized debt by banks, financial institutions, corporate
bodies, trusts and others. Large investors and a high average trade value characterize
this segment. Till recently, the market was purely an informal market with most of
the trades directly negotiated and struck between various participants. The
commencement of this segment by NSE has brought about transparency and
efficiency to the debt market.

Retail Debt Market

With a view to encouraging wider participation of all classes of investors across the
country (including retail investors) in government securities, the Government, RBI
and SEBI have introduced trading in government securities for retail investors.
Trading in this retail debt market segment (RDM) on NSE has been introduced w.e.f.
January 16, 2003. Trading shall take place in the existing Capital Market segment of
the Exchange. In the first phase, all outstanding and newly issued central
government securities would be traded in the retail segment. Other securities like
state government securities, T-Bills etc. would be added in subsequent phases .

The debt market is a market where fixed income securities issued by the Central and
state governments, municipal corporations, government bodies, and commercial
entities like financial institutions, banks, public sector units, and public limited
companies. Therefore, it is also called fixed income market. The key role of the debt
markets in the Indian Economy stems from the following reasons:

• Efficient mobilization and allocation of resources in the economy

• Financing the development activities of the Government

• Transmitting signals for implementation of the monetary policy

• Facilitating liquidity management in tune with overall short term and long term

Since the Government Securities are issued to meet the short term and long term
financial needs of the government, they are not only used as instruments for raising
debt, but have emerged as key instruments for internal debt management, monetary
management and short term liquidity management.

The returns earned on the government securities are normally taken as the benchmark
rates of returns and are referred to as the risk free return in financial theory. The Risk
Free rate obtained from the G-sec rates are often used to price the other non-govt.
securities in the financial markets.

Advantages of debt instruments:

(a) Reduction in the borrowing cost of the Government and enable

mobilization of resources at a reasonable cost. (b) Provide greater
funding avenues to public-sector and private sector projects and reduce
the pressure on institutional financing. (c) Enhanced mobilization of
resources by unlocking illiquid retail investments like gold. (d)
Development of heterogeneity of market participants (e) Assist in
development of a reliable yield curve and the term structure of interest
Risks associated with debt securities

The debt market instrument is not entirely risk free. Specifically, two
main types of risks are involved, i.e., default risk and the interest rate
risk. The following are the risks associated with debt securities:

• Default Risk: This can be defined as the risk that an issuer of a bond may be unable
to make timely payment of interest or principal on a debt security or to otherwise
comply with the provisions of a bond indenture and is also referred to as credit risk.

• Interest Rate Risk: can be defined as the risk emerging from an adverse change in
the interest rate prevalent in the market so as to affect the yield on the existing
instruments. A good case would be an upswing in the prevailing interest rate
scenario leading to a situation where the investors' money is locked at lower rates
whereas if he had waited and invested in the changed interest rate scenario, he would
have earned more.

• Reinvestment Rate Risk: can be defined as the probability of a fall in the

interest rate resulting in a lack of options to invest the interest received at regular
intervals at higher rates at comparable rates in the market.

The following are the risks associated with trading in debt securities:

• CounterParty Risk: is the normal risk associated with any transaction and refers to
the failure or inability of the opposite party to the contract to deliver either the
promised security or the sale-value at the time of settlement.

• Price Risk: refers to the possibility of not being able to receive the expected
price on any order due to a adverse movement in the prices.


The Indian debt market is composed of government bonds and corporate

bonds. However, the Central government bonds are predominant and they
form most liquid component of the bond market. In 2003, the National Stock
Exchange (NSE) introduced Interest Rate Derivatives. The trading platforms
for government securities are the ̳Negotiated Dealing System‘ and the
Wholesale Debt Market (WDM) segment of NSE and BSE. In the negotiated
market, the trades are normally decided by the seller and the buyer, and
reported to the exchange through the broker, whereas the WDM

trading system, known as NEAT (National Exchange for Automated Trading), is a

fully automated screen-based trading system, which enables members across the
country to trade simultaneously with enormous ease and efficiency.

Price determination of debt instruments

The price of a bond in the markets is determined by the forces of demand and supply,
as is the case in any market. The price of a bond also depends on the changes in:

• Economic conditions

• General money market conditions, including the state of money supply in the

• Interest rates prevalent in the market and the rates of new issues

• Future Interest Rate


• Credit quality of the


Debt Instruments are

categorized as:

• Government of India dated Securities: (G Secs) are 100-rupee face-value units/

debt paper issued by the Government of India in lieu of their borrowing from the
market. They are referred to as SLR securities in the Indian markets as they are
eligible securities for the maintenance of the SLR ratio by the banks.

• Corporate debt market: The corporate debt market basically contains PSU bonds
and private sector bonds. The Indian primary Corporate Debt market is basically a
private placement market with most of the corporate bonds being privately placed
among the wholesale investors, which include banks, financial Institutions.
The following debt instruments are available in the corporate debt

• Non-Convertible Debentures

• Partly-Convertible Debentures/Fully-Convertible Debentures (convertible into

Equity Shares)

• Secured Premium Notes

• Debentures with

• Deep Discount

• PSU Bonds/Tax-Free

Interest Rate Derivatives

An interest rate futures contract is "an agreement to buy or sell a package of debt
instruments at a specified future date at a price that is fixed today." The price of debt
securities and, therefore, interest rate futures, is inversely proportional to the
prevailing interest rate. When the interest rate goes up, the price of debt securities and
interest rate futures goes down, and vice versa. Some of the assets underlying interest
rate futures include US Treasuries, Euro- Dollars, LIBOR Swap, and Euro-Yen


long-term (more than one year) interest bearing instruments as the underlying asset. In
the US, short-term interest rate futures like 90-day T-Bill and 3-month Euro Dollar
time deposits are more popular. Long-term interest rate futures include the 10-year
Treasury Note futures contract, and the Treasury Bond futures contract.

Hedging with Interest rate futures

Interest rate futures can be used to protect against an increase in interest rates as well
as a decline in interest rates. By selling interest rate futures, also known as short
hedging, an investor can protect himself against an increase in interest rates; and by
buying interest rate futures, also known as long hedging, an investor can protect
himself against a decline in interest rates. Thus, short, medium, and long-term interest
rate risks can be managed with products based on Euro-Dollars, US Treasuries, and
Swaps in Europe and the US. In India, interest rate derivatives would be used for
hedging in the near future.

Money market opportunities for SMEs

To begin with a brief rejoinder, the Indian money market is a market for short term
securities like T-bills, certificates of deposits, commercial papers, repos and others.
These debts are issued by the government, banks, companies and financial
institutions, respectively. The papers traded are almost like a promissory note which
usually has a fixed interest rate and a maturity of less than one year.

Since the securities in this market are less than one year, and the source of these
securities is the government/banks/highly-rated companies, the credit risk involved is
considered to be low (though slightly higher than an FD). Moreover, the tax incidence
on the income from these schemes (depending on the plan) is usually lower than the
one that the interest on savings accounts or FDs invite.

Therefore, from the SMEs point of view, the leveraging of the debt market can
actually come in two forms. First, as a supplier of debt, and second, as the buyer. The
capacity of the SME to tap the debt market is correlated directly to the growth
trajectory of the corporate debt segment. However, the real and immediate gain
potential for SMEs rests on their ability as the buyer of debt, especially of short term

A convenient alternative and yet a potentially enhanced ̳revenue- generative‘ method

of parking the surplus is in the liquid, ultra-short term and the bond/gilt schemes of
mutual funds. These schemes usually also invest your money in the money market
and debt market securities, depending on the investment mandate of the fund. .Debt
market refers to the financial market where investors buy and sell debt securities,
mostly in the form of bonds. These markets are important source of funds, especially
in a developing economy like India. India debt market is one of the largest in Asia.
Like all other countries, debt market in India is also considered a useful substitute to
banking channels for finance. The most distinguishing feature of the debt instruments
of Indian debt market is that the return is fixed. This means, returns are almost risk-
free. This fixed return on the bond is often termed as the 'coupon rate' or the 'interest
rate'. Therefore, the buyer (of bond) is giving the seller a loan at a fixed interest rate,
which equals to the coupon rate.
Classification of Indian Debt Market

Indian debt market can be classified into two categories:

Government Securities Market (G-Sec Market): It consists

of central and state government securities. It means that, loans
are being taken by the central and state government. It is also
the most dominant category in the India debt market.

Bond Market: It consists of Financial Institutions bonds, Corporate bonds and

debentures and Public Sector Units bonds. These bonds are issued to meet financial
requirements at a fixed cost and hence remove uncertainty in financial costs.


The biggest advantage of investing in Indian debt market is its assured returns.
The returns that the market offer is almost risk-free (though there is always
certain amount of risks, however the trend says that return is almost assured).
Safer are the government securities. On the other hand, there are certain amounts
of risks in the corporate, FI and PSU debt instruments. However, investors can
take help from the credit rating agencies which rate those debt instruments. The
interest in the instruments may vary depending upon the ratings.

Another advantage of investing in India debt market is its high liquidity. Banks offer
easy loans to the investors against government securities.


As there are several advantages of investing in India debt market, there are certain
disadvantages as well. As the returns here are risk free, those are not as high as the
equities market at the same time. So, at one hand you are getting assured returns,
but on the other hand, you are getting less return at the same time. Retail
participation is also very less here, though increased recently. There are also some
issues of liquidity and price discovery as the retail debt market is not yet quite.

Government Securities are securities issued by the Government for raising a

public loan or as notified in the official Gazette. They consist of Government
Promissory Notes, Bearer Bonds, Stocks or Bonds held in Bond Ledger
Account. They may be in the form of Treasury Bills or Dated Government

Government Securities are mostly interest bearing dated securities issued by RBI on
behalf of the Government of India. GOI uses these funds to meet its expenditure
commitments. These securities are generally fixed maturity and fixed coupon
securities carrying semi-annual coupon. Since the date of maturity is specified in the
securities, these are known as dated Government Securities, e.g. 8.24% GOI 2018 is
a Central Government Security maturing in 2018, which carries a coupon of 8.24%
payable half yearly.

Features of Government Securities

1. Issued at face

2. No default risk as the securities carry sovereign guarantee.

3. Ample liquidity as the investor can sell the security in the secondary
4. Interest payment on a half yearly basis on face value

5. No tax deducted at

6. Can be held in Demat


7. Rate of interest and tenor of the security is fixed at the time of issuance and
is not subject to change (unless intrinsic to the security like FRBs - Floating
Rate Bonds).

8. Redeemed at face value on


9. Maturity ranges from of 2-30


10. Securities qualify as SLR (Statutory Liquidity Ratio) investments (unless

otherwise stated).

The dated Government securities market in India has two segments:

1. Primary Market: The Primary Market consists of the issuers of the

securities, viz., Central and Sates Government and buyers include Commercial
Banks, Primary Dealers, Financial Institutions, Insurance Companies & Co-
operative Banks. RBI also has a scheme of non- competitive bidding for small
investors (see SBI DFHI Invest on our website for further details).

2. Secondary Market: The Secondary Market includes Commercial banks,

Financial Institutions, Insurance Companies, Provident Funds, Trusts, Mutual Funds,
Primary Dealers and Reserve Bank of India. Even Corporates and Individuals can
invest in Government Securities. The eligibility criteria is specified in the relative
Government notification.

Auctions:Auctions for government securities are either multiple- price auctions or

uniform price auction - either yield based or price based.

Yield Based: In this type of auction, RBI announces the issue size or notified
amount and the tenor of the paper to be auctioned. The bidders submit bids in term of
the yield at which they are ready to buy the security. If the Bid is more than the cut-
off yield then its rejected otherwise it is accepted

Price Based:In this type of auction, RBI announces the issue size or notified
amount and the tenor of the paper to be auctioned, as well as the coupon rate. The
bidders submit bids in terms of the price. This method of auction is normally used
in case of reissue of existing Government Securities. Bids at price lower then the
cut off price are rejected and bids higher the cut off price are accepted. Price
Based auction leads to a better price discovery then the Yield based auction.

Underwriting in Auction: One day prior to the auction, bids are received from the
Primary Dealers (PD) indicating the amount they are willing to underwrite and the
fee expected. The auction committee of RBI then examines the bid on the basis of
the market condition and takes a decision on the amount to be underwritten and the
fee to be paid. In case of devolvement, the bids put in by the PD‘s are set off against
the amount underwritten while deciding the amount of devolvement and in case the
auction is fully subscribed, the PD need not subscribe to the issue unless they have
bid for it. G-Secs, State Development Loans & T-Bills are regularly sold by RBI
through periodic public auctions. SBI DFHI Ltd. is a leading Primary Dealer in
Government Securities. SBI DFHI Ltd gives investors an opportunity to buy G- Sec
/ SDLs / T-Bills at primary market auctions of RBI through its SBI DFHI Invest
scheme (details available on website ). Investors may also invest in high yielding
Government Securities through ―SBI DFHI Trade‖ where ―buy and sell price‖ and
a buy and sell facility for select liquid scrips in the secondary markets is offered.


The Bond Market in India with the liberalization has been transformed
completely. The opening up of the financial market at present has influenced
several foreign investors holding upto 30% of the financial in form of fixed
income to invest in the bond market in India.

The bond market in India has diversified to a large extent and that is a huge
contributor to the stable growth of the economy. The bond market has
immense potential in raising funds to support the infrastructural
development undertaken by the government and expansion plans of the

Sometimes the unavailability of funds become one of the major problems for the
large organization. The bond market in India plays an important role in fund
raising for developmental ventures. Bonds are issued and sold to the public for

Bonds are interest bearing debt certificates. Bonds under the bond market in
India may be issued by the large private organizations and government company.
The bond market in India has huge opportunities for the market is still quite
shallow. The equity market is more popular than the bond market in India. At
present the bond market has emerged into an important financial sector.

The different types of bond market in India

• Corporate Bond Market

• Municipal Bond

• Government and Agency Bond Market

• Funding Bond

• Mortgage Backed and Collateral Debt Obligation Bond Market

The major reforms in the bond market in India

• The system of auction introduced to sell the government securities.

• The introduction of delivery versus payment (DvP) system by the Reserve

Bank of India to nullify the risk of settlement in securities and assure the
smooth functioning of the securities delivery and payment.

• The computerization of the SGL.

• The launch of innovative products such as capital indexed bonds and zero coupon
bonds to attract more and more investors from the wider spectrum of the populace.

• Sophistication of the markets for bonds such as inflation indexed bonds.

• The development of the more and more primary dealers as creators of the
Government of India bonds market.

• The establishment of the a powerful regulatory system called the trade for trade
system by the Reserve Bank of India which stated that all deals are to be settled with
bonds and funds.
• A new segment called the Wholesale Debt Market (WDM) was established at the
NSE to report the trading volume of the Government of India bonds market.
• Issue of ad hoc treasury bills by the Government of India as a funding instrument
was abolished with the introduction of the Ways And Means agreement.

Types of Debt Instruments

The various instruments of debt can be classified into long term and short term debt
depending on the tenure for which the amount has been raised or the period of
repayment. The various instruments under each category are mentioned .

Long Term Debt

1. Bond: A bond, also sometimes called a fixed-income security, is a type of debt

instrument that memorializes a loan made by an investor to a corporate or
government entity. The loan is to be paid back over a period of time with a fixed
interest rate and is often secured to fund projects. Bonds refer to debt instruments
bearing interest on maturity. In simple terms, organizations may borrow funds by
issuing debt securities named bonds, having a fixed maturity period (more than
one year) and pay a specified rate of interest (coupon rate) on the principal
amount to the holders. Bonds have a maturity period of more than one year which
differentiates it from other debt securities like commercial papers, treasury bills
and other money market instruments.


Used in Bond Market Meaning in General Terms

Bonds Loans (in the form of a security)

Issuer of Bonds Borrower

Bond Holder Lender

Principal Amount:- Amount at which issuer pays interest and which is

repaid on the maturity date

Issue Price :- Price at which bonds are offered to investors

Maturity Date :- Length of time (More than one year)

Coupon :- Rate of interest paid by the issuer on the par/face value of the bond

Coupon Date :- The date on which interest is paid to investors

Types of Bonds

1. Classification on the basis of Variability of Coupon

Zero Coupon Bonds

Zero Coupon Bonds are issued at a discount to their face

value and at the time of maturity, the principal/face value is
repaid to the holders. No interest (coupon) is paid to the
holders and hence, there are no cash inflows in zero
coupon bonds. The difference between issue price
(discounted price) and redeemable price (face value) itself
acts as interest to holders. The issue price of Zero Coupon
Bonds is inversely related to their maturity period, i.e.
longer the maturity period lesser would be the issue price
and vice-versa. These types of bonds are also known as
Deep Discount Bonds.

Treasury Strips

Treasury strips are more popular in the United States and not yet available in India.
Also known as Separate Trading of Registered Interest and Principal Securities,
government dealer firms in the United States buy coupon paying treasury bonds
and use these cash flows to further create zero coupon bonds. Dealer firms then sell
these zero coupon bonds, each one having a different maturity period, in the
secondary market

Floating Rate Bonds

In some bonds, fixed coupon rate to be provided to the holders is not

specified. Instead, the coupon rate keeps fluctuating from time to
time,with reference to a benchmark rate. Such types of bonds are referred
to as Floating Rate Bonds.

1. Classification on the Basis of Variability of Maturity

Callable Bonds

The issuer of a callable bond has the right (but not the obligation) to change the
tenor of a bond (call option). The issuer may redeem a bond fully or partly before
the actual maturity date. These options are present in the bond from the time of
original bond issue and are known as embedded options. A call option is either a
European option or an American option. Under an European option, the issuer can
exercise the call option on a bond only on the specified date, whereas under an
American option, option can be exercised anytime before the specified date. This
embedded option helps issuer to reduce the costs when interest rates are falling,
and when the interest rates are rising it is helpful for the holders.

Puttable Bonds

The holder of a puttable bond has the right (but not an obligation) to seek
redemption (sell) from the issuer at any time before the maturity date. The
holder may exercise put option in part or in full. In riding interest rate scenario,
the bond holder may sell a bond with low coupon rate and switch over to a
bond that offers higher coupon rate. Consequently, the issuer will have to resell
these bonds at lower prices to investors. Therefore, an increase in the interest
rates poses additional risk to the issuer of bonds with put option (which are
redeemed at par) as he will have to lower the re-issue price of the bond to
attract investors.

Convertible Bonds

The holder of a convertible bond has the option to convert the bond into
equity (in the same value as of the bond) of the issuing firm (borrowing firm)
on pre-specified terms. This results in an automatic redemption of the bond
before the maturity date. The conversion ratio (number of equity of shares in
lieu of a convertible bond) and the conversion price (determined at the time of
conversion) are pre-specified at the time of bonds issue. Convertible bonds
may be fully or partly convertible. For the part of the convertible bond which
is redeemed, the investor receives equity shares and the non-converted part
remains as a bond.

2. Classification on the basis of Principal Repayment

(i) Amortising Bonds

Amortising Bonds are those types of bonds in which the borrower (issuer)
repays the principal along with the coupon over the life of the bond. The
amortising schedule (repayment of principal) is prepared in such a manner that
whole of the principle is repaid by the maturity date of the bond and the last
payment is done on the maturity date. For example - auto loans, home loans. con.

(ii) Bonds with Sinking Fund Provisions

Bonds with Sinking Fund Provisions have a provision as per which the issuer
is required to retire some amount of outstanding bonds every year. The issuer has
following options for doing so

1. By buying from the market

2. By creating a separate fund which calls the bonds on behalf of the issuer


A Debenture is a unit of loan amount. When a company intend stories the loan
amount from the public it issues debentures. A person holding debenture or
debentures is called a debenture holder. A debenture is a document issue under the
seal of the company. It is an acknowledgment of the loan received by the company
equal to the nominal value of the debenture .It bears the date of redemption and rate
and mode of payment of interest. A debenture holder is the creditor of the company.

As per section(12) of Companies Act 1956,―Debenture includes debenture

stock, bond and any other securities of the company whether constituting a
charge on the company‘s assets or not‖.

Debenture can be classified as


1.From security point of


(i)Secured or Mortgage

These are the debentures that are secured by a charge on the assets of the
company.These are also called mortgage debentures. The holders of secured
debentures have the right to recover their principal amount with the unpaid
amount of interest on such debentures out of the assets mortgaged by the
company. In India, debentures must be secured. Secured debentures can be
of two types:

(a)First mortgage debentures: The holders of such debentures have a first

claim on the assets charged.

(b) Second mortgage debentures: The holders of such debentures have a

second claim on the assets charged.

(ii) Unsecured debentures: Debentures which do not carry any security

with regard to the principal amount to run paid interest are called unsecured
debentures. These are called simple debentures.

2. On the basis of redemption

(i) Redeemable debentures: These are the debentures which are issued for
a fixed period. The principal amount of such debentures is paid off to the
debenture holders on the expiry of such period. These can be redeemed by
annual drawings or by purchasing from the open market.

(ii) Non-redeemable debentures : These are the debentures which are not redeemed
in the life time of the company. Such debentures are paid back only when the
company goes into liquidation.
3. On the basis of Records

(i) Registered debentures

These are The amount of

such debentures is payable
only to those debenture
holders whose name appears
in the register of the

(ii) Bearer debentures: These are

the debentures which are not
recorded in a register of the
company. Such debentures are
transferable merely by delivery.
Holder of these debentures is entitled
to get the interest.

On the basis of convertibility

(i) Convertible debentures: These are the debentures that can be converted in to
shares of the company on the expiry of pre decided period. The term and conditions of
conversion are generally announced at the time of issue of debentures.

(ii) Non-convertible debentures: The debenture holders of such debentures cannot

convert their debentures into shares of the company.

4. On the basis of priority

(i) First debentures : These debentures are redeemed before other debentures.
Second debentures : These debentures are redeemed after the redemption of first


Definition: A loan for equipment, real estate and working capital that's paid off like a
mortgage for between one year and ten years
Term loans are your basic vanilla commercial loan. They typically carry fixed interest
rates, and monthly or quarterly repayment schedules and include a set maturity date.
The range of funds typically available is $25,000 and greater.

Bankers tend to classify term loans into two categories:

Intermediate-term loans: Usually running less than three years, these loans are
generally repaid in monthly instalments (sometimes with balloon payments) from a
business's cash flow. According to the American Bankers Association, repayment is
often tied directly to the useful life of the asset being financed.

Long-term loans:. These loans are commonly set for more than three years. Most are
between three and 10 years, and some run for as long as 20 years. Long-term loans are
collateralized by a business's assets and typically require quarterly or monthly
payments derived from profits or cash flow. These loans usually carry wording that
limits the amount of additional financial commitments the business may take on
(including other debts but also dividends or principals' salaries), and they sometimes
require that a certain amount of profit be set-aside to repay the loan.

Term loans are most appropriate for established small businesses that can leverage
sound financial statements and substantial down payments to minimize monthly
payments and total loan costs. Repayment is typically linked in some way to the item
financed. Term loans require collateral and a relatively rigorous approval process but
can help reduce risk by minimizing costs. Before deciding to finance equipment,
borrowers should be sure they can they make full use of ownership-related benefits,
such as depreciation, and should compare the cost with that leasing.

The best use of a term loan is for construction; major capital improvements; large
capital investments, such as machinery; working capital; purchases of existing
businesses. Fortunately, the cost of such a loan is relatively inexpensive if the
borrower can pass the financial litmus tests. Rates vary, making it worthwhile to shop,
but generally run around 2.5 points over prime for loans of less than seven years .
What do banks look for when making decisions about term loans? Well, the "five
C's" continue to be of utmost importance.

• Character. How have you managed other loans (business and personal)? What is
your business experience?

• Credit capacity. The bank will conduct a full credit analysis, including a detailed
review of financial statements and personal finances to assess your ability to repay.
• Collateral. This is the primary source of repayment. Expect the bank to want this
source to be larger than the amount you're borrowing.

• Capital. What assets do you own that can be quickly turned into cash if
necessary? The bank wants to know what you own outside of the business-bonds,
stocks, apartment buildings-that might be an alternate repayment source. If there is
a loss, your assets are tapped first, not the bank's. Or, as one astute businessman
puts it, "Banks like to lend to people who already have money." You will most
likely have to add a personal guarantee to all of that, too.

• Comfort/confidence with the business plan. How accurate are the revenue
and expense projections? Expect the bank to make a detailed judgment. What
is the condition of the economy and the industry--hot, warm or cold?


A mortgage is a secured lien or loan on residential property. The loan is secured by

the associated property. More specifically, if the borrower fails to pay, the lender
can take the property to fulfill the outstanding debt.

Lease( A lease is an agreement between an owner of property and a tenant )

A lease is a type of loan instrument because it secures a regular rent payment

from the tenant to the owner, thereby creating a secured long-term debt.

Debt Instruments in India

Traditionally when a borrower takes a loan from a lender, he enters into an

agreement with the lender specifying when he would repay the loan and what
return (interest) he would provide the lender for providing the loan. This entire
structure can be converted into a form wherein the loan can be made tradable by
converting it into smaller units with pro rata allocation of interest and principal.
This tradable form of the loan is termed as a debt instrument. Therefore, debt
instruments are basically obligations undertaken by the issuer of the instrument as
regards certain future cash flows representing interest and principal, which the
issuer would pay to the legal owner of the instrument. Debt instruments are of
various types. The key terms that distinguish one debt instrument from another are
as follows:

• Issuer of the instrument

• Face value of the instrument

• Interest rate

• Repayment terms (and therefore maturity period/tenor)

Government Securities

There are various types of debt instruments available that one It

is the Reserve Bank of India that issues Government Securities
or G- Secs on behalf of the Government of India. These
securities have a maturity period of 1 to 30 years. G-Secs offer
fixed interest rate, where interests are payable semi-annually.
For shorter term, there are Treasury Bills or T-Bills, which are
issued by the RBI for 91 days, 182 days and 364 days.

Advantages of Government

• Greater safety and lower volatility as compared to other financial


• Variations possible in the structure of instruments like Index linked Bonds,


• Higher leverage available in case of borrowings against G-Secs.

• No TDS on interest payments

• Tax exemption for interest earned on G-Secs. up to Rs.3000/- over and above the
limit of Rs.12000/- under Section 80L (as amended in the latest Budget).

• Greater diversification opportunities

• Adequate trading opportunities with continuing volatility expected in interest

rates the world over
Corporate Bonds

These bonds come from PSUs and private corporations and are offered for an
extensive range of tenures up to 15 years. There are also some perpetual bonds.
Comparing to G-Secs, corporate bonds carry higher risks, which depend upon the
corporation, the industry where the corporation is currently operating, the current
market conditions, and the rating of the corporation. However, these bonds also give
higher returns than the G- Secs.

Advantages of Corporate Bonds:

• They are provide a fixed stream of income so they are safer than stocks.

• Bondholders get paid by companies before stockholders. For example,companies

are required to make interest payments to bondholders, but are not required to
make dividend payments to stockholders. Another example of this is that if the
company went bankrupt, the bond holders would be the ones to get the proceeds
from auctioning off the company's assets and the stockholders would get nothing.

• Another advantage of corporate bonds over government bonds is that they provide
higher interest. The reason for this is because interest rates are made up of a few
ingredients. First is the real interest rate (the actual money you are receiving simply
for loaning money), then the inflation premium (bonds have to pay extra interest so
that bond holders don't have the value of their payments decline due to inflation), then
is the liquidity premium (this is extra interest bond issuers have to pay if their bond is
not easily bought and sold.

Disadvantages of Corporate Bonds:

• As we said earlier, bonds are considered safer than stocks because they offer a
steady flow of income while there is no guaranteed income from stocks. However,
stocks offer greater potential returns if its price increases. So in this way, bonds and
stocks obey a fundamental rule of economics: with greater risk there is greater
reward. So in periods of slow economic growth, bonds may look more attractive
because it is unlikely stocks will provide good returns. In a period of expansion,
however, stocks look much more attractive than bonds because you could make a lot
more in much less time if your stocks go up.

• Another disadvantage of corporate bonds over government bonds is that corporate

bonds have more risk. While this does offer a higher yield in return, if you are risk
averse, you would view this as a disadvantage of corporate bonds. This is where the
biggest difference between corporate and government bonds lies. Government bonds
are considered to be the safest investments having basically no risk that the
government will default on its loans. On the other hand, corporations can and do go
bankrupt. Because of this, corporate bonds are considered riskier than government

• Because bonds are a fixed investment, they may not offer protection against
inflation changes within an economy. If the interest rates on a bond investment are
low and inflation increases more than average or expected, the investor has the
potential to lose purchasing power within their portfolio.

• The prices of bonds are affected by fluctuations in interest rates within the
economy. Bond prices move inversely to interest rates; when interest rates rise,
bond rates fall and vice versa.

• Some bonds are callable, meaning that the Issuer can redeem the bonds issued.
This is common when interest rates decline, making it more favourable for the
Issuer to refinance their debts. If this occurs, the investor would be forced to
redeem their bond and replace it with a new one that potentially would have lower
coupon rates. For an investor who is relying on this income for their lifestyle, this
can be a substantial disadvantage.

Certificate of Deposit

These are negotiable money market instruments. Certificate of Deposits (CDs), which
usually offer higher returns than Bank term deposits, are issued in demat form and
also as a Usance Promissory Notes. There are several institutions that can issue CDs.
Banks can offer CDs which have maturity between 7 days and 1 year. CDs from
financial institutions have maturity between 1 and 3 years. There are some agencies
like ICRA, FITCH, CARE, CRISIL etc. that offer ratings of CDs. CDs are available
in the denominations of Rs. 1 Lac and in multiple of that.

Advantages of Certificate of

• CDs typically offer a higher rate of interest than Treasury bills and savings
account due to the higher risk associated with them.

• As the rate of interest is fixed, your return on investment is ensured despite

the rate fluctuations in the market.

• CDs are insured by Federal Deposit Insurance Corporation and hence are a good
investment option for single income households and retired folks. CDs are a risk-free

• The return on CDs is assured and helps in financial planning.

• It‘s very easy to set up a CD. One needs to just walk to their local bank and
request for purchase of CD. Money from the existing savings account will be
marke against the CD that has been purchased. The only thing to be made sure that
the bank is FDIC ensure.

• CDs can be purchased and sold through a brokerage firm. This way you can
encash the CD before the maturity term without paying the penalty.

Disadvantages of Certificate of Deposit

• Money is tied down for long durations

of time. Though the investor can
withdraw money, he has to generally
incur penalty in terms of some amount of
loss of interest on the deposit amount.
You can get a waiver on the penalty in
case of special circumstances like
disability, death or retirement.

• As the rate of interest is fixed, it is difficult to change or to take

advantage of the market situation when the market rates are favorable.
You will not be able to get an interest rate that favors inflation.

• Though the return rate is higher on CDs than savings account, it is much lower
than other money market instruments where you can make possible investments.
Commercial Papers

market security issued (sold) by large banks and corporations to get money to
meet short term debt obligations (for example, payroll), and is only backed by an
issuing bank or corporation's promise to pay the face amount on the maturity date
specified on the note. Since it is not backed by collateral, only firms with excellent
credit ratings from a recognized rating agency will be able to sell their
commercial paper at a reasonable price. Commercial paper is usually sold at a
discount from face value, and carries higher interest repayment dates than bonds.
Typically, the longer the maturity on a note, the higher the interest rate the issuing
institution must pay. Interest rates fluctuate with market conditions, but are
typically lower than banks' rate There are short term securities with maturity of 7
to 365 days. CPs are issued by corporate entities at a discount to face value.

Advantage of commercial paper:

• High credit ratings fetch a lower cost of capital.

• Wide range of maturity provide more flexibility.

• It does not create any lien on asset of the company.

• Tradability of Commercial Paper provides investors with exit options.

Disadvantages of commercial paper:

• Its usage is limited to only blue chip companies.

• Issuances of Commercial Paper bring down the bank credit limits.

• A high degree of control is exercised on issue of Commercial Paper.

• Stand-by credit may become necessary

Non-Convertible Debentures

Non-convertible debentures, which are simply regular debentures, cannot be

converted into equity shares of the liable company. They are debentures without
the convertibility feature attached to them. As a result, they usually carry higher
interest rates than their convertible counterparts.
Advantages of Non-Convertible Debentures:

• The advantage of issuing corporate bonds can be seen in achieving a higher

degree of company capital structure flexibility, and a company is thus more
able to react promptly to constantly changing conditions, which consequently
leads to generating larger financial sources.

• Another advantage means that corporate bonds emissions can make up a

considerable amount of money provided by a large number of creditors.

• As a consequence of a risk distribution among a large number of creditors the bond

emission is a lower costs alternative in comparison to bank loans under a certain debt
level condition.

• Companies first accept bank loans, and that is to the degree to which the loan is
cheaper and otherwise more advantageous than bonds emissions. Then they issue
bonds and use a part of the gained finance to paying loans and other liabilities off,
which increases the ability to accept other bank loans. After reaching the top limit
of bank loans a company issues bonds again and the cycle repeats itself.

• In the third cycle a company issues shares and a part of sources is used for
paying off the bank loans, paying off the bonds and the rest is used to finance a
further development. Then a company increases bank loans and the cycle repeats
itself again.

• A significant advantage rests in the fact that returns of corporate bonds

represent a tax base and in case of a company profitability an interest tax shield
can be used.

• Furthermore shareholders do not lose a company activity control when issuing

corporate bonds, while issuing them often does not even need a collateral in a
form of a property pledge.

• It is due to say that as a consequence of an obligation to pay back the principal

and returns of bonds managers get a clearer view of rate of returns and that
successful issuing of corporate bonds (especially their placement) is considered
a prestigious thing helping the company to gain respect by the public and
business partners.

Disadvantages of Non-Convertible Debentures:

• On the other hand, the disadvantage of corporate bonds rests in the fact that
investors require a lot from credit issuer credibility, while returns and principal
must be always paid in time regardless the company profit.

• A substantial disadvantage of bonds emissions lies in considerable emission

costs created by costs of issue (costs directly connected with issuing
corporate bonds) and costs of bonds life cycle (costs connected with the
particular emission, arising in course of the life cycle and in connection to
paying back the emission).

• On the top of it creditors may restrict the issuing company in various ways and have
a right to express their opinions on problem issues the solution of which may affect
setting up claims to the bonds themselves.

• The bond holder meeting decides common concerns of bond holders and expresses
opinions on problem issues that may affect setting up claims to a bond, especially on
suggestions of changes in terms of bond emission conditions, on suggestions
regarding: issuer exchanges, issuer takeover bids by another subject, conclusions of a
contract to control a company or contracts on the profit transfer, a sale of a company,
a hire of a company or its part - all this in the meaning of a Commercial Code; further
on suggestions regarding a bond programme, however also on problem issues of a
common process providing a bond issuer delays in discharging the bond

• If a bond holder meeting does not agree on any of the suggestions, they can
decide an issuer obligation to pay back bond holders a nominal bond value or an
emission rate (in case of zero coupon bonds) including a proportionate return. An
issuer must do so before one-month time from the date of this decision at the very

Partly-Convertible Debentures/Fully-Convertible Debentures (convertible

in to Equity

Convertible debenture is basically is a type of commercial loan or a debenture.

A convertible debenture, as the name suggests gives a lender the option of
converting a loan into stock. So the company who has issued the debentures
can convert these into equity shares after, during or on certain dates, making
the debenture holder, a shareholder. This conversion factor also depends upon
the type of convertible debenture the company has issued and the exact
agreement between company and debenture holders. The 'convertible' factor is
often added to the commercial loan so as to attract the buyers as they can be
the shareholders later.
Advantages of Convertible Debenture:

• Convertible bonds are usually issued offering a higher yield than

obtainable on the shares into which the bonds convert.

• Convertible bonds are safer than preferred or common shares for the investor.
They provide asset protection, because the value of the convertible bond will
only fall to the value of the bond floor. At the same time, convertible bonds can
provide the possibility of high equity-like returns.

• Also, convertible bonds are usually less volatile than regular shares. Indeed, a
convertible bond behaves like a call option.

• The simultaneous purchase of convertible bonds and the short sale of the
same issuer's common stock is a hedge fund strategy known as convertible
arbitrage. The motivation for such a strategy is that the equity option
embedded in a convertible bond is a source of cheap volatility, which can be
exploited by convertible arbitrageurs.

• limited circumstances, certain convertible bonds can be sold short, thus

depressing the market value for a stock, and allowing the debt-holder to claim
more stock with which to sell short. This is known as death spiral financing

Disadvantages of Convertible Debenture:

• To convert the debentures into shares, if these are new:

• They don‘t pass immediately through the quotations.

• The securities have a less quotation price due that temporarily they have lesser

• They are less liquid, due that there is a lesser amount of them.

• You can‘t dispose of money soon due to the former explanation. Usually the type
of interests that they offer is inferior to that of the ordinary debentures due that they
offer the additional advantage of placing them as shares on the markets.


Both debt and money instruments are popular

financial instruments on

which large amounts of money are traded between different businesses and
investors; however, they each deal with a different type of funding. The
instruments give businesses different types of obligations and investors different
perks when they deal in one or the other. Both, however, are used by public
businesses to raise money.

1. Debt Instrument

Debt instruments are used to trade debt instruments. In other words, the business
issues a debt instrument, and an investor buys it. In a specific period of time, the
investor is paid back for the debt, along with interest. Interest rates and time frames
can vary according to the instrument. Bonds are one of the most widely tred debt
instruments on the debt instrument. Both large corporations and governments use the
debt instrument to raise money or to change economic conditions.

2. Money Instrument

On the money instrument, equity is traded instead of debt. this instrument is more
commonly known as the stock instrument. In the stock instrument, stocks are sold as
securities that give investors the right to a certain amount of the company's earnings
and assets. There are many different types of stock shares sold to different types of
investors, but they do not exist as a debt to be paid off.

3. Business Differences

To the business, the difference between a money and debt instrument is important.
Every bond that the business issues must be paid back over time--it is a loan, and the
business is borrowing from investors. Eventually the loan comes due. Businesses
should only sell bonds when they are confident they will have enough money in the
future to meet their debt obligations. Stocks, on the other hand, do not incur debt, but
they do divide ownership of the company among investors.
4. Holder Difference

To the investor holding the bond or stock, the difference deals mostly with the return
on his investment. When an investor buys stock, he is buying ownership of the
business and can claim the right to vote on matters the directors of the business
decide. Investors do not have any ownership of the business when they buy bonds;
they receive only an obligation from the business to repay the loan.

5. Risk

Traditionally, the debt instrument is more secure than the money instrument. Stock
dividends can be reduced or suspended when a business suffers, but bond obligations
must be paid as the contract stipulates. This also means that stocks have a greater
chance for growth than bonds because their success depends on the success of


• Issue of FCDs having a conversion period more than 36 months will not be
permissible, unless conversion is made optional with ―put‖ and ―call‖ option.

• Compulsory credit rating will be required if conversion is made for FCDs after 18

• Premium amount on conversion, the conversion period, in stages, if any, shall

be pre-determined and stated in the prospectus.

• The interest rate for above debentures will be freely determinable by the issuer.

• Issue of debenture with maturity of 18 months or less are exempt from the
requirement of appointing Debenture Trustees or creating a Debenture Redemption
Reserve (DRR).

• In other cases, the names of the debenture trustees must be stated in the
prospectus and DRR will be created in accordance with guidelines laid down by

• The trust deed shall be executed within six months of the closure of the issue.

• Any conversion in part or whole of the debenture will be optional at the hands
of the debenture holder, if the conversion takes place at or after 18 months from
the date of allotment, but before 36 months.

• In case of NCDs/ PCDs credit rating is compulsory where maturity exceeds 18


• Premium amount at the time of conversion for the PCD, redemption amount,
period of maturity, yield on redemption for the PCDs/NCDs shall be indicated in the

• The discount on the non-convertible portion of the PCD in case they are traded
and procedure for their purchase on spot trading basis must be disclosed in the

• In case, the non-convertible portions of PCD/NCD are to be rolled over, a

compulsory option should be given to those debenture holders who want to
withdraw and encash from the debenture programme.

• Roll over shall be done only in cases where debenture holders have sent
their positive consent and not on the basis of the non-receipt of their negative reply.

• Before roll over of any NCDs or non-convertible portion of the PCDs, fresh credit
rating shall be obtained within a period of six months prior to the due date of
redemption and communicated to debenture holders before roll over and fresh trust
deed shall be made.

• Letter of information regarding roll over shall be vetted by SEBI with regard
to the credit rating, debenture holder resolution, option for conversion and
such other items, which SEBI may prescribe from time to time.

• The disclosures relating to raising of debentures will contain, amongst other things,
the existing and future equity and long term debt ratio, servicing behavior on existing
debentures, payment of due interest on due dates on terms loans and debentures,
certificate from a financial institution or bankers about their no objection for a
second or pari-passu charge being created in favour of the trustees to the proposed
debenture issues.

• And any other additional disclosure requirement SEBI may prescribe from time to

• Most of the listing requirements are common for both equity and debt
instruments in terms of disclosures with some additional provisions specified for
the debt instruments.

• Until recently only infrastructure and municipal corporations could list debt before
equity, subject to certain requirements. SEBI now permits listing of debt before
equity subject to the condition that the debt instrument is rated not below a minimum
rating of ̳A‘ or equivalent thereof.

1. Short title and commencement of the directions

These directions may be called the Issuance of Non-Convertible Debentures

(Reserve Bank) Directions, 2010 and they shall come into force with effect from
August 02, 2010.

2. Definition

For the purposes of these

Directions, Non-Convertible
Debenture (NCD) means a debt
instrument issued by a

corporate (including NBFCs) with original or initial maturity up to one year and
issued by way of private placement; Corporate‖ means a company as defined in the
Companies Act, 1956

(including NBFCs) and a corporation established by an act of any Legislature

3. Eligibility to issue NCDs

A corporate shall be eligible to issue NCDs if it fulfills the following criteria,


the corporate has a tangible net worth of not less than Rs.4 crore, as per the latest
audited balance sheet;

the corporate has been sanctioned working capital limit or term loan by bank/s or
all-India financial institution/s; and the borrowal account of the corporate is
classified as a Standard Asset by the financing bank/s or institution/s.

4. Rating Requirement
4.1 An eligible corporate intending to issue NCDs shall obtain credit rating for
issuance of the NCDs from one of the rating agencies, viz., the Credit Rating
Information Services of India Ltd. (CRISIL) or the Investment Information and
Credit Rating Agency of India Ltd. (ICRA) or the Credit Analysis and Research
Ltd. (CARE) or the FITCH Ratings India Pvt. Ltd or such other agencies registered
with Securities and Exchange Board of India (SEBI) or such other credit rating
agencies as may be specified by the Reserve Bank of India from time to time, for
the purpose.

4.2 The minimum credit rating shall be P-2 of CRISIL or such equivalent rating by
other agencies.

4.3 The Corporate shall ensure at the time of issuance of NCDs that the rating

so obtained is current and has not fallen due for review.

5. Maturity

5.1 NCDs shall not be issued for maturities of less than 90 days from the date of

5.2 The exercise date of option (put/call), if any, attached to the NCDs shall not fall
within the period of 90 days from the date of issue.

5.3 The tenor of the NCDs shall not exceed the validity period of the credit
rating of the instrument.

6. Denomination

NCDs may be issued in denominations with a minimum of Rs.5 lakh (face

value) and in multiples of Rs.1 lakh.
7. Limits and the Amount of Issue of NCDs

7.1 The aggregate amount of NCDs issued by a corporate shall be within such limit
as may be approved by the Board of Directors of the corporate or the quantum
indicated by the Credit Rating Agency for the rating granted, whichever is lower.

7.2 The total amount of NCDs proposed to be issued shall be completed within a
period of two weeks from the date on which the corporate opens the issue for

8. Procedure for Issuance

8.1 The corporate shall disclose to the prospective investors, its financial position
as per the standard INSTRUMENT practice.

8.2 The auditors of the corporate shall certify to the investors that all the
eligibility conditions set forth in these directions for the issue of NCDs are
met by the corporate.

8.3 The requirements of all the provisions of the Companies Act, 1956 and the
Securities and Exchange Board of India (Issue and Listing of Debt Securities)
Regulations, 2008, or any other law, that may be applicable, shall be complied with
by the corporate.

8.4 The Debenture Certificate shall be issued within the period prescribed in the
Companies Act, 1956 or any other law as in force at the time of issuance.

8.5 NCDs may be issued at face value carrying a coupon rate or at a discount to face
value as zero coupon instruments as determined by the corporate.

9. Debenture Trustee
9.1 Every corporate issuing NCDs shall appoint a Debenture Trustee (DT) for each
issuance of the NCDs.

9.2 Any entity that is registered as a DT with the SEBI under SEBI (Debenture
Trustees) Regulations, 1993, shall be eligible to act as DT for issue of the NCDs
only subject to compliance with the requirement of these Directions.

9.3 The DT shall submit to the Reserve Bank of India such information as
required by it from time to time.

10. Investment in NCD

10.1 NCDs may be issued to and held by individuals, banks, Primary Dealers
(PDs), other corporate bodies including insurance companies and mutual funds
registered or incorporated in India and unincorporated bodies, Non-Resident
Indians (NRIs) and Foreign Institutional Investors (FIIs).

10.2 Investments in NCDs by Banks/PDs shall be subject to the approval of the

respective regulators.

10.3 Investments by the FIIs shall be within such limits as may be set forth in this
regard from time to time by the SEBI

11. Preference for Dematerialisation

While option is available to both issuers and subscribers to issue/hold NCDs in

dematerialised or physical form, they are encouraged to issue/ hold NCDs in
dematerialised form. However, banks, FIs and PDs are required to make fresh
investments in NCDs only in dematerialised form.