Fixed Income Markets:

Conventions and
Trading

1
 Fixed Income Instruments
Call Money
Term Money
GOI Securities
T Bills
Dated Securities
State Govt. Bonds
PSU and Corporate Bonds
CP’s
CD’s
Interest Rate Swaps / Options, Futures etc.
Hybrids / Structured Notes etc.
2
Money Markets

3
 Definition and Purpose of Money
Markets
The Money Markets are associated with the issuance and
trading of short-term (less than 1 year) debt obligations
of large corporations, FIs and governments
Only High-Quality Entities can borrow in the Money
Markets and individual issues are large
Investors in Money Market Instruments include
corporations and FIs who have idle cash but are
restricted to a short-term investment horizon
The Money Markets essentially serve to allocate the
nation’s supply of liquid funds among major short-term
lenders and borrowers

4
 Money Market Instruments
Treasury Bills - short-term obligations issued by the U.S.and
other central governments
Call Money (Federal Funds) - short-term funds transferred
between financial institutions usually for no more than one
day
Repurchase Agreements - agreement involving the sale of
securities between parties with a promise to repurchase the
security at a specific date and price
Commercial Paper - short-term unsecured promissory notes
issued by a company to raise short-term cash
Negotiable Certificates of Deposit - negotiable bank-issued time
deposit with specified interest rate and maturity
Bankers Acceptances - time draft payable to seller of goods,
with payment guaranteed by a bank
5
 Treasury Bill Basics
Issued by RBI on behalf of GOI to meet short-term
liquidity shortfalls
Repaid at par, issued at discount
No default risk – highest rated!
yields at various maturities serve as short-term
benchmarks
Features
Highly liquid
Now, 91, 182 and 364-day T-bills issued/traded in the
market
Issued under an auctioning system; hence, yields are
market-determined

6
 Call Money (Federal Funds)
Short-term funds transferred between Banks and FIs,
usually for a period of one day
Call (Federal Funds) rate
a focus or target rate in the conduct of monetary
policy
Call money rates are market determined as deals are
between Banks and FIs

7
 Trading in the Call Money Market
Commercial banks conduct the majority of
transactions in the market
Banks with excess reserves lend, while banks
with deficient reserves borrow
Transactions can be initiated by either the
lending or borrowing institution or handled
through a broker

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 0.00
10.00
20.00
30.00
40.00
50.00
60.00
70.00
80.00
15-Jun-98
06-Apr-99
15-Jan-00
06-Nov-00
28-Aug-01
14-Jun-02
25-Mar-03
09-Jan-04
25-Oct-04
8-Aug-05
22-May-06
27-Feb-07
8-Dec-07
19-Sep-08
14-Jul-09
08-May-10
MIBOR

17-Mar-11
01-Mar-12
14-Feb-13
27-Jan-14
15-Jan-15
4/1/2016
15/12/2016
22/11/2017
1/11/2018
15/10/2019
21/9/2020
1/9/2021
India Call Money Rates – Jun 98 – Sep 22

9
 1.00
2.00
3.00
4.00
5.00
8.00
9.00
10.00

0.00
6.00
7.00
1/9/2017
7/11/2017
10/1/2018
19/3/2018
25/5/2018
26/7/2018
4/10/2018
12/12/2018
13/2/2019
24/4/2019
28/6/2019
3/9/2019
11/11/2019
14/1/2020
19/3/2020
2/6/2020
MIBOR

3/8/2020
5/10/2020
9/12/2020
11/2/2021
26/4/2021
29/6/2021
2/9/2021
10/11/2021
12/1/2022
21/3/2022
27/5/2022
28/7/2022
India Call Money Rates – Sep 17 – Sep 22

10
 Repurchase Agreements (RPs or
Repos)
An agreement involving the sale of securities by one
party to another with a promise to repurchase the
securities at a specified price on a specified date
Essentially a collateralized short term loan with
collateral in the form of securities (e.g. T-bills and
Govt. securities)
Reverse repurchase agreement
involves the purchase of securities between parties with the
promise to sell them back at a given date in the future

11
 Trading Process for Repurchase
Agreements

Arranged either directly between two parties or

with the help of brokers and dealers
The repo buyer arranges to purchase T-bills
from the repo seller with an agreement that
the seller will repurchase the T-bills within a
stated period of time

12
 1.00
2.00
3.00
4.00
5.00
8.00
9.00
10.00

0.00
6.00
7.00
1/9/2017
7/11/2017
10/1/2018
19/3/2018
25/5/2018
26/7/2018
4/10/2018
12/12/2018
13/2/2019
24/4/2019
28/6/2019
3/9/2019
11/11/2019
14/1/2020
19/3/2020
2/6/2020
MIBOR

3/8/2020
5/10/2020
9/12/2020
and Repo Rates?

11/2/2021
26/4/2021
29/6/2021
2/9/2021
10/11/2021
12/1/2022
21/3/2022
27/5/2022
28/7/2022
Any Linkage between Call Money Rates

13
 Commercial Paper
An unsecured short-term promissory note issued by a
corporation to raise short-term cash, often to finance
working capital requirements
Needs to be rated
Generally held until maturity so there is not an active
secondary market

14
 Negotiable Certificates of Deposits
A bank-issued time deposit that specifies an interest rate
and maturity date and is negotiable in the secondary
market
Bearer Instrument
whoever holds the CD when it matures receives the
principal and interest
Often purchased by money market mutual funds with
pools of funds from individual investors

15
 Banker’s Acceptances
A time draft payable to a seller of goods with
payment guaranteed by a bank
Arise from international trade transactions and are
used to finance trade in goods that have yet to
be shipped from a foreign exporter (seller) to a
domestic importer (buyer)
Foreign exporters prefer that banks act as
guarantors for payment before sending goods to
importer

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 Money Market Participants

Instrument Principal Issuer Principal Investor

Treasury bills RBI / U.S. Treasury RBI/FRS; Comm banks

Brokers and dealers;
Other FIs; Corp’s
Call Money RBI; Commercial banks Commercial banks
Repurchase agreement RBI /FRS; Comm banks;RBI/FRS, Comm banks
Brokers and dealers; Brokers and dealers
Other FIs Other FIs, Corp’s
Commercial Paper Corporates Brokers and dealers
Other FIs MFS; Corporations
Negotiable CDs Commercial banks Brokers and dealers;
Corps; Other FIs
Banker’s acceptances Commercial banks Comm banks; Corp’s;
Brokers and dealers

17
Bond Markets

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 Overview of the Bond Markets
A bond is a promise to make periodic coupon
payments and to repay principal at maturity;
breech of this promise is an event of default
Bonds carry original maturities greater than one
year so bonds are instruments of the capital
markets
Issuers are corporations and government units

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 Main Features of Bonds

•Time to Maturity
•Fixed or Floating Rate
•No Coupon – ZERO’s •Bullet Payment
•Stepped Up Coupons
Principal •Coupons with Caps &
or Issue Floors
Amount

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 Main Features of Bonds
(Continued)
Secured or Unsecured
Security of the obligation – junior, senior
Repayment options – calls and puts – sinking
fund
Events of Default – cross default clauses
Hybrids – convertible Bonds
Strips - Separate Trading of Registered Interest
and Principal Securities
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 Treasury Notes and Bonds
T-notes and T-bonds issued by the U.S. Treasury to
finance the national debt and other federal government
expenditures
Backed by the full faith and credit of the U.S. government
and are default risk free
Pay relatively low rates of interest (yields to maturity)
Given their longer maturity, not entirely risk free due to
interest rate fluctuations
Pay coupon interest (semiannually): notes have maturities
from 1-10 years; bonds 10-30 years

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 The Principal Bond Markets
The Government Securities Market – G-Secs or
“GoISecs”
State government Bonds – state guaranteed
F. I. Bonds
PSU Bonds
Corporate Bonds (Private Sector)

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 Gsecs – Primary Market Issuance
Auction
Price-based auction
Yield-based auction
Non-competitive bidding

Private placement with RBI

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 The Main Investors
Banks – required to maintain 18% of Net Demand and Time
Liabilities in Government and State Government Bonds
Excess investments of 10%
LIC and Other Insurance and Pension Funds
Provident Funds need to maintain at least 25% in
Government Bonds and 15% in State Government Bonds
Mutual Funds have emerged as large investors – specially
for structured obligations
Trusts are also large investors, unless specifically
constituted to invest in other instruments

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 Calculation Basis
Dated GOI Securities
30 / 360 days European Convention – 30th
and 31st to be construed as the same day.
If deal settles on the 30th or 31st of the
month then Accrued Interest to be
calculated for 29 days
Interest semi-annual
Issued at INR 100 : With Bullet
Repayments
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 How Dealt
Still a “dirty” phone market
NDS – the Negotiated Dealing System launched in Feb
2002
Phone deals confirmed on the NDS and CCIL
NDS Order Matching (NDS-OM) launched in Aug
2005
Deals usually T+1
Lot Size : Rs 5 crores

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 Clean and Dirty Price
If a bond is purchased between coupon
periods, buyer will receive interest on the
coupon date, a part of which belongs to the
seller. Interest that belongs to the seller is
called accrued interest
Price that includes the accrued interest is
called full price or dirty price.
Clean price or flat price is calculated as Dirty
price less accrued interest

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 Clean and Dirty Price

Most markets quote the clean price, though

the buyer always pays the seller the dirty
price
Accrued interest is calculated as
(days from last coupon to settlement/days in
the coupon period) X coupon.

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 Benchmark Bond

A newly issued (on-the-run) 10 year G-sec will

be identified as a benchmark G-sec when:
1. The amount outstanding of the newly
issued (on-the-run) 10 year G-sec equals or
exceeds Rs.15,000 crores,
OR
2. The rolling 3 working-days simple average
traded volume of the newly issued (on-
the-run) 10 year G-sec exceeds that of the
current 10 year benchmark G-sec.

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 Municipal Bonds (Munis)
Securities issued by state and local governments to fund
either temporary imbalances between operating
expenditures and receipts or to finance long-term
capital outlays for activities such as school
construction, public utility construction or
transportation systems
Tax receipts or revenues generated are the source of
repayment
Attractive to household investors because interest (but
not capital gains) are tax exempt

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 Corporate Bonds
All long-term bonds issued by corporations
Minimum denominations publicly traded
corporate bonds is $1,000 (Rs. 100 India)
Generally pay interest semiannually
Bond indenture
legal contract that specifies the rights and
obligations of the bond issuer and the bond holder

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 Types of Corporate Bonds
Bearer bonds
coupons attached that are presented by the holder to
the issuer for interest payments when due
Registered bonds
the owner of the bond is recorded by the issuer and
coupon payments are mailed to the registered owner
Term bonds
entire issue matures on a single date
Serial bonds
mature on a series of dates (continued)

33
 Types of Corporate Bonds
Mortgage bonds
issued to finance specific projects which are pledged as
collateral
Equipment Trust Certificates
bonds collateralized with tangible non-real estate property
Debentures
backed solely by the general credit of the issuing firm and
unsecured / secured by specific assets or collateral
Subordinated debentures
unsecured debentures that are junior in their rights to
mortgage bonds and regular debentures (continued)

34
 Types of Corporate Bonds
Convertible bonds
may be exchanged for another security of the issuing firm at
the discretion of the bond holder
Stock Warrant
give the bond holder an opportunity to purchase common
stock at a specified price up to a specified date
Callable bonds
allow the issuer to force the bond holder to sell the bond back
to the issuer at a price above the par value (call price)
Sinking Fund bonds
bonds that include a requirement that the issuer retire a
certain amount of the bond issue each year

35
 Primary and Secondary Markets
for Corp Bonds
Primary sales of corporate bonds occur through
either a public sale (issue) or a private
placement similar to municipal bonds
Two secondary markets
the exchange market (e.g., the NYSE, NSE, BSE)
the over-the-counter (OTC) market
OTC electronic market dominates trading in
corporate bonds
In India, NDS-OM system
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 Bond Ratings
Bonds are rated by the issuer’s default risk
Large bond investors, traders and managers
evaluate default risk by analyzing the issuer’s
financial ratios and security prices
Two major bond rating agencies are Moody’s and
Standard & Poor’s (S&P)
Bonds assigned a letter grade based on perceived
probability of issuer default

37
 Bond Credit Ratings

Explanation Moody’s S&P

Investment grade categories:
Best quality; smallest degree of risk Aaa AAA
High quality; slightly more long-term Aa1 AA+
risk than top rating Aa2 AA
Aa3 AA
Upper medium grade; possible A1 AA-
impairment in the future A2 A+
A3 A-
Medium grade; lack outstanding Baa1 BBB+
investment characteristics Baa2 BBB
Baa3 BBB-

(continued)
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 Bond Credit Ratings

Explanation Moody’s S&P

Speculative investment grades:

Speculative issues; protection may Ba1 BB+
be very moderate Ba2 BB
Ba3 BB-
Very speculative; may have small B1 B+
assurance of interest and principle B2 B
payment B3 B-
Issues in poor standing; may be in default Caa CCC
Speculative in a high degree Ca CC
Lowest quality; poor prospects of attaining C C
real investment standing D

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 Bond Market Participants
The major issuers of debt market securities are
federal, state and local governments and
corporations
The major purchasers of capital market securities are
households, businesses, government units and
foreign investors
Businesses and financial firms (e.g., banks,
insurance companies, mutual funds) are the major
suppliers of funds for all three types of bonds

40
Institutions Connected with Bond
Markets
Stock Exchanges
Depositories and Custodians
Clearing Houses
Brokers / Dealers
FIMMDA (Fixed Income Money Market and
Derivatives Association)
Primary Dealers / PDAI
CCIL (Clearing Corporation of India Ltd.)
FBIL (Financial Benchmarks India Ltd.)
Credit Rating Agencies
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