Debt Markets

Prof. Ameet Kumar Banerjee

Capital Markets Bifurcation

Capital Market

Debt Market Equity Market

Debt Markets Bifurcation

Debt Market

Secured Debt Market Unsecured Debt Market

Debt Market - Bonds

Focus of the Session

• Focus on longer-term securities: bonds.
• Bonds are like money market instruments, but maturities exceed one year.
e.g. These include Treasury bonds and corporate bonds, etc.
Definition

• A bond is a debt instrument in which an investor loans money to an entity (typically corporate or
government) which borrows the funds for a defined period of time at a variable or fixed interest
rate.

• Bonds are typically issued by companies, municipalities, states and sovereign governments to raise
money to finance a variety of projects and activities.
Key Terminology of Bonds

• Face Value or Notional Value

• Coupon Rate or Interest
• Term to Maturity
• Yield or Internal Rate of Return of the Bond
Different Types of Bonds

• Plain Vanilla Bond or Fixed Income Bond : This bonds pay fixed coupon payments for the entire
life (i.e. till maturity) of the bond.

e.g. Government Bonds 8.24% GS 2018 was issued on April 22, 2008 for a tenor of 10 years
maturing on April 22, 2018. Coupon on this security will be paid half-yearly at 4.12% (half yearly
payment being half of the annual coupon of 8.24%) of the face value on October 22 and April 22 of
each year
Cont..

• Floating Rate Bonds or Floaters : Variable interest paying bonds with rate pegged to a benchmark
Rate.

• Zero Coupon Bonds: Zero coupon bonds are bonds with no coupon payments. Like T Bill they
are sold at discount and redeemed at par.

• Deep Discount Bonds or Junk Bonds: Bonds issued at highly discounted pricing or earning very
high yields.
E.g After relaxation RBI Junk Bonds made a comeback 2019 Indian 2019 June raised $3.7 Billion
in Junk Bonds in Off shore Markets the growth witnessed was 180% from 2018.
Vedanta Resources, JSW Steel have raised capital through Junk bonds
Cont..
Inflation Indexed Bonds (IIBs) - IIBs are bonds wherein both coupon flows and Principal amounts
are protected against inflation.
• The inflation index used in IIBs may be Whole Sale Price Index (WPI) or Consumer Price Index (CPI).
• Government of India through RBI issued IIBs (linked to WPI) in June 2013.

Bonds with Call/ Put Options – Bonds can also be issued with features of optionality wherein
the issuer can have the option to buy-back (call option) or the investor can have the option to sell the
bond (put option) to the issuer during the currency of the bond.
• The first G-Sec with both call and put option viz. 6.72%GS2012 was issued on July 18, 2002 for a
maturity of 10 years maturing on July 18, 2012.
Cont..

Municipal Bonds or Munis : Bonds issued by local governments or their agencies

AMRUT Scheme (formerly Jawaharlal Nehru National Urban Renewable Mission).

Some of the issuers are

Pune.
Andhra Pradesh Capital Region Development Authority (APCRDA), Amravati (Raised 2000 crores).
Karnataka Water and Sanitation Pooled Fund.
Cont..
Convertible Bonds: Gives the option to convert a bond to specific number of Shares of the issuers
common stock.

Perpetual Bonds (Consols in U K)

UK issued some of these securities 1888 still trading
West Shore Railroad issued a bond which matures in 2361 (24 Century).

Asset Backed Securities : bonds whose interest and principal payments are backed by underlying
cash flows from other assets.
Examples: Mortgage backed Securities, Collateralized Debt Obligations
Special kinds of Bonds

• War Bonds:  Bond issued by a government to fund military operations during wartime.
• Climate Bonds: bond issued by a government or corporate entity in order to raise finance for
climate change mitigation- or adaptation-related projects or programmes.
• Electoral Bonds: Bonds issued for election funding
E.g. Central government has introduced electoral bonds worth Rs. 1,000, Rs. 10,000, Rs. 1 lac,
Rs. 10 lacs and  Rs. 1 crore to bring transparency in election funding.
bonds can be used by the individuals, institutions and organizations to donate money to the
political parties.
In India these are sold from selected branches of SBI.
Investors earn no interest in this bonds.
Foreign Currencies
• Euro dollar Bond : dollar-denominated bond issued by a non-U.S. entity outside the U.S

• Yankee bond: US dollar-denominated bond issued by a non-US entity in the US market.

• Samurai Bonds: a Japanese yen-denominated bond issued by a non-Japanese entity in the

Japanese market.

• Bulldog bond, a pound sterling-denominated bond issued in London by a foreign institution or

government.
Cont..

Masala Bond: an Indian rupee denominated bond issued outside India

• The term was coined by International Finance Corporation (IFC) to popularise the culture and
cuisine of India on foreign platforms.
• Objective of Masala Bonds is to fund infrastructure projects in India, fuel internal growth via
borrowings and internationalize the Indian currency.
• Masala bonds should have a minimum maturity of five years, and there is a $750 million per
year limit for borrowers which can be exceeded with the RBI approval.
• HDFC, NTPC and Indiabulls Housing have raised funds via this option.
Pricing of Bonds

P= Bond’s Fair value

C: Annual Coupons
r: Discount rate or yield
n= years to Maturity
M= The maturity amount or notional value
In case of Semi annual Payments

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Practice Questions

Compute the price of the bond if the term to maturity of the bond is 10 years carrying a coupon rate
of 10% with a notional value of INR 1000. Knowing the required yield on the bond is 11%?

• Coupon rate < Required Rate then Price less than par (Selling at discount)
• Coupon rate = Required Rate the price equal par
• Coupon rate > Required rate then the price is more than par (selling at Premium)
Practice Question

• Question: Suppose a portfolio manager has invested INR 1 Million at par on an 8-year bond that
has coupon rate of 7% paid annually after 1 year. Calculate what will portfolio manager earn if the
benchmark rate is 8%?

• Calculate the price of the bond if the coupons are paid semi annually?
Current Yield

What is the current yield for a bond with a face value of Rs. 1,000, a current price of Rs. 921.01,
and a coupon rate of 10.95%?
Answer:
ic = C / P = 109.50 / 921.01 = 11.89%
Note: C ( coupon) = 10.95%  1,000
= Rs. 109.50
Yield of the Bond

Using Trial and Error Method

And Interpolation Formula
Practice Questions

Calculate the yield of the bond with notional value of Rs. 1000 selling at 950 in the market carrying
a coupon rate of 10% with a maturity of 5years
Calculate what will be the yield if the bond is selling at Rs 1050?
Duration of the Bond

Key facts about duration

1. All else equal, when the maturity of a bond lengthens, the duration rises
as well
2. All else equal, when interest rates rise, the duration of a coupon bond
fall
Cont..

1. The higher the coupon rate on the bond, the shorter the duration of the bond
2. Duration is additive: the duration of a portfolio of securities is the weighted-average of the
durations of the individual securities, with the weights equaling the proportion of the portfolio
invested in each security
Practice Session

Calculate the duration a bond with face value of Rs. 1000 carrying a coupon rate of 10% knowing
the yield of the bond is 10% issued for 5 years?
Duration and Interest-Rate Risk

i  10% to 11%
Duration and Interest-Rate Risk (cont.)

• The greater the duration of a security, the greater the percentage change in the market value of the
security for a given change in interest rates.

• Therefore, the greater the duration of a security, the greater its interest-rate risk
Yield Curves
The plot of yield of bonds against maturity is called a yield curve.
 

Remark The most typical shape of a yield curve has a upward slope.
Types of Yield Curves

Rising Yield Curve Falling Yield Curve

Flat Yield Curve Humped Shaped Yield Curve

Risk in Bond Investment
1. Interest Rate Risk
2. Reinvestment Risk
3. Liquidity Risk
4. Credit Risk
5. Inflationary Risk
6. Exchange Rate Risk ( Case of Foreign currency bonds)
Thanks