FINANCIAL ECONOMICS

CIA 3

CAPITAL MARKET INSTRUMENT: BOND MARKET

Rahul Baid

1533348

6 Eco (H) – A

1. INTRODUCTION:

Capital market is a market that helps in raising long-term funds for government, banking
institutions and corporates while providing a platform for the trading of financial securities
[CITATION Cap13 \l 2057 ]. Capital markets facilitates the sale of long term securities by deficit
units to the surplus units in order to raise sufficient amount of funds to organize the activities
of the financial institution. The capital raised through the capital market securities are
commonly used in purchasing capital assets such as the machinery, building, stocks or
equipment [ CITATION Jef13 \l 2057 ]. Basically, the capital markets are the markets where the
equity and debt instruments are traded. The capital markets provide a platform for the
borrowers to raise funds by issuing the stocks or bonds and an opportunity to the investors to
invest in these stocks or bonds. Therefore, a capital market bridges the gap between the
investors and the borrowers by pooling the savings and utilizing it for productive activities.
Thus, the capital markets helps in diversifying the resources from a less productive and a
wasteful area to a productive and efficient sector making the country prosperous and
productive.

The capital market instruments usually have a time period of over a year with greater risks
than the money market instruments. It includes the stock market and the bond market which
can be further classified on the basis of primary and secondary markets. Every capital market
is regulated by a regulatory board to ensure a greater protection to the investors and to curb
the illicit and unethical activities.

2. BONDS:

Bonds are long term debt securities that helps the government, financial institutions and the
corporates to raise capital by borrowing from public and fund their activities. It is a form of
debt that provides the investors a fixed income at regular intervals in the form of interest in a
medium or long term until the maturity period is reached. The investor who purchases bonds
receives the principal amount that he invested at the time of maturity. The maturity period of
the bonds ranges from 10 years to 20 years.

Issuing bonds can diversify the risks of the corporate bodies as they do not have to
completely rely on the banking institutions. During the time of any financial difficulty,
corporates and the government have the chances of better funding sources thus reducing the
overall risks and reducing the capital costs. Bonds also help the investors with the large
plethora of investment opportunities and providing the investors a chance of investing in
high-quality bonds with a reasonable risk-yield trade-off.

Bonds are issued in the primary markets through a telecommunication structure and are
identified on the basis of ownership structure as either bearer bonds or registered bonds.
Bearer bonds requires the owner to send the coupons to the issuer on regular intervals to
receive the interest payments whereas in the case of registered bonds, the issuer of the bond is
responsible for maintaining the record for the payment of the coupons on the due dates.

Bonds are classified further into various categories on the basis of the issuers:

 Government bonds: Government bonds is the debt capital raised by the government
institutions. It is an investment wherein there is low risk and low return as compared
to the corporate debt raised by the private institutions. Therefore, the government
bonds are considered as a benchmark value which helps in determining the
investment on the corporate bonds. The government bonds offers good liquidity and
can be issued by the national, state, regional and local authorities and the maturity
period can range from 15-20 years.
 Corporate Bonds: Companies and corporates also borrow in long and medium term
from the public at a fixed interest. The company rating helps it issue bonds as it
determines the principal amount, the interest charged and the maturity period of the
bonds issued by private institutions. Most of the corporate bonds usually pay the
coupon interests twice a year and the par value at the time of the maturity of the
bonds.
The difference between the corporate bond and the government bonds is on the basis
of the interest paid and the risks associated with the bonds. The government bonds
usually pays less interest as the risks associated are low whereas in the case of
 corporate bonds, the risks associated are high and hence they have to pay greater
interest.

Bonds can also be classified on the basis of maturity as maturity is the main determinant that
attracts investors: [ CITATION Cap06 \l 2057 ]

 Short term bonds with maturity of less than five years.

 Medium term bonds that have a maturity period of five to twelve years.
 Long term bonds whose maturity ranges from time period of above 12 years.

Different types of Bond Structures:

 Floating Rate note is a bond that offers a different interest rate based on the floating
interest rate. Typically the interest payment is a fixed spread over a three-month or
six-month reference rate. At the commencement of the coupon period, the spread is
added to the reference rate of that specific day to determine the coupon. While the
spread or margin remains constant the reference rate is variable. 
 Index-linked bonds that offers variable coupons based on different indexes like the
CPI or stock index.
 Zero-coupon bonds do not have any coupon attached with it. The source of income
for these types of bonds are when the bonds are discounted in the market. The
difference between the nominal value of the bonds and the discounted value is the
interest earned on the bonds.
 STRIPS or Separate Trading of Registered interest and Principal Securities is a type
of bond wherein the interest coupons and the principal amount of the bonds can be
stripped from the cash flow and then traded in the market just like the zero-coupon
bonds.
 Perpetual Bonds are the bonds which do not have a maturity date. These bonds are
redeemed only when the issuer goes into liquidation.
 Convertible Bonds are those that can be converted into a specific percentage of shares
at any point before the maturity date.
 Then there are other type of bonds in the market namely:
- Collateralization
- Asset-backed securities
- Calls and Puts
 - Medium-Term notes.

INDIAN BOND MARKET:

Primary debt market in India includes issuers such as large corporates and companies, the
government institutions, the financial institutions, banks and medium/small industries. The
instruments of debt include partly convertible debentures, fully convertible debentures, deep
discount bonds, zero coupon bonds, bonds with warrants, FRN’s and secured premium notes [
CITATION Gar15 \l 2057 ] . When we talk about bond market specifically, we see that the
different types of bonds that are negotiated in India are:

 Corporate Bond Market

 Municipal Bond Market
 Government and Agency Bond Market
 Funding Bond Market
 Mortgage backed and Collateral Debt Obligation Bond Market.

The Indian bond market is not efficient in meeting the requirements of the country. The
ASIFMA report of 2012 tells that the Indian bond market is only 27% of the Chinese bond
market and 69% of the Korean bond market making it weak in front of the other economies.
The Indian bond market is concentrated with the government backed bonds with about 79%
of the total outstanding bonds – comparatively a larger percentage than that of the Chinese
government bonds (73%) and the Korean government bonds (39%). India’s bond markets
stand at around 1 trillion which is comparatively very low in comparison to China, US and
Australia.

The bond market of any country determines that level of financial stability of an economy
and also tells about the financial system of the country. The Indian bond market lacks in
productivity with low levels of participation by the general public. The turnover of the bond
market is on low levels and the concentration of wealth is limited to very few bonds and
securities. The top 10 securities share rose to 44.4% in 2012-13 from 44.2% in 2011-12. The
low issuance of bonds is the result of legal issues with respect to corporate bond market and
lack of regulations, creditor protection and restrictions on institutional investors. Moreover a
lack of efficiency in the secondary market for bonds (where the bonds can be negotiated from
one investor to another) poses another roadblock in the development of the Indian bond
market [ CITATION Sni16 \l 2057 ].

There are certain committees set up to suggest measures in order to improve the bond market
in the country. The major reforms taken in order to improve the bond market in India are:

 Auction process to sell the government securities leading to the efficiency and
transparency.
 Delivery versus Payment system is introduced to eliminate the risks of payment.
 Digitalization of SGL.
 Development of more primary markets to attract dealers.
 Indices like the Wholesale Debt Market (WDM) index, Inflation indexed bonds,
capital indexed bonds and zero coupon bonds to attract more investors.
 WDM was established at the NSE to report the trading volume of the government of
Indian bond markets.

Therefore to conclude, the Indian bond market are at weak efficiency levels. Efficient
reforms need to be initiated to ensure a growing bond market and ensuring a healthy financial
system in the country. Efficient bankruptcy laws, strict laws for the opportunist and greater
laws for attracting the foreign investors’ needs to be initiated to improve the bond markets in
the country.

Further steps that have to be taken to develop the bond market are:

 India should take up deregulation programme in order to increase access to the bond
markets. It will also lead to risk free benchmark rate and the improvement of the
futures and options market.
 A change in regulatory framework in order to reduce the poor enforcement of
contracts, and increase transparency in the primary markets.
 Moreover standardization of the primary markets is also another important aspect that
would lead to the improvement of the bond markets in the country.

REFERENCES
 Capital market instruments. (2006 ). Retrieved from treasurytoday:
http://treasurytoday.com/2006/10/capital-market-instruments
 Capital Markets . (2012-13). Pakistan Economic Survey.

 Madura, J. (2013). Financial Markets and Institutions . Florida Atlantic University:

Cengage Learning .

 Raghuwanshi, G. (2015). A Study of Indian Financial Stability and Debt Market.

IJARIIE.

 Snigdha. (2016). Bond Market –An Overall View. International Journal of

Management and Commerce Innovations, 385-393.