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Basic concepts Types of bonds Introduction to Corporate Bonds Reasons of stunted growth of Corporate Bond market in India Current scenario of Indian Corporate Bond market

Yield - Rate of return on the investment in bonds

Current Yield Annual return on the amount paid for the bond irrespective of the maturity. eg. Face value of the Bond is Rs. 1000 and Coupon 6% If, Purchased at par, then Yield = Coupon = 6% If, Purchased at low value, suppose Rs.900 then Yield= (6% of 1000)/900 = 6.67 % > Coupon If, Purchased at high value, suppose Rs.1200 then Yield= (6% of 1000)/1200 = 5 % < Coupon Yield to maturity Return on the bond investment at maturity Includes all interest plus any capital gain (if you purchase the bond below par) or minus any capital loss (if you purchase the bond above par).

Yield curve - A graph that shows the yields at different maturities .you have bonds of various maturities 1 year, 2 year, 10 year etc .if we plot the yields of each bond with the respective yield, we get a yield curve

Source: CRISIL Debt market Update - 2009

bond markets. Corporate Bond Spread is the difference between the yield of a corporate bond and a government bond. For an investor who is investing INR, GoI (Government of India) bonds are considered risk-free bonds. All corporate bonds carry a risk and thus have yields higher than GoI bonds. When the financial markets are confident and risk-appetite is high, the difference in yields (spread) narrows. When there is uncertainty and riskappetite is low, the spread widens. In October 2008, there was so much panic in the market, yields of corporate bonds were rising (bond prices were falling) and yields of GoI bonds were falling (bond prices were rising), hence spread was more. In 2005, this spread was as low as 30-40 bps due to positive sentiments of market. The credit spread between 10-year AAA-rated credit and 10-year GoI bond went up from 200 basis points to almost 400 in October 2008 and has come back to 200 at the end of April 2009. (Source: Bloomberg)

Spread - The spread indicates the risk appetite of investors in the

Stays same until maturity; i.e: buy a RS.1000 bond with 8% fixed interest rate and you will receive RS.80 every year until maturity and at maturity you will receive the $1000 back.

FLOATING: adjustable to prevailing market rates. PAYABLE AT MATURITY: receive no payments until
maturity and at that time you receive principal plus the total interest earned compounded semi-annually at the initial interest rate.

1.Short-term notes: maturities of up to 4 years; 2.Medium-term notes/bonds: maturities of five to 12 years; 3.Long-term bonds: maturities of 12 or more years.

Bond with a redemption provision usually have higher return to compensate for the risk that the bonds might be called early. Call Option: provisions that allow or require the issuer to repay the investors principal at a specified date before maturity. Put Option: option of requiring the issuer to repurchase the bonds, at a specified time, prior to maturity.

Introduction to Corporate Bonds

A Corporate bond is a debt security issued by a public or private corporation. It is issued to raise the capital required to fund business activities like building new plant, purchasing new equipments etc.. It represents a promise to pay bondholders a fixed sum of money (called the bond s principal, or par or face value) at a future maturity date, along with periodic payments of interest (called coupons). Coupons are generally paid Semi-annually. Does not give ownership rights of the company to bondholders like in equity shares.

1. 2. 3. 4. 5. 6. 7. 8. 9. Assets Backed Securities Extendible Bonds Foreign Currency Bonds High Yield or Junk Bonds Mortgage-backed Securities Zero Coupon Eurobonds Government Bonds Corporate Bonds

Assets Backed Securities :- ABS are bonds or notes backed by financial assets like receivables. Extendible Bonds :- An extendible bonds gives its holder the right to extend the initial maturity to a longer maturity date. Foreign Currency Bonds :- A foreign currency bond is bonds that is issued by an issuer in currency other than its national currency. High Yield or junk Bonds :- These are usually purchased for speculative purposes. Junk bonds typically offer interest rates three to four percentage points higher than safer government issues.

Mortgage backed Securities :- Mortgage securities represent an ownership interest in mortgage loans made by financial institution to finance the borrower s purchase of a home or other real estate. Zero coupon Bonds :- Zero coupon bonds are fixed income securities that are created from the cash flows that makes up a normal bond. (Treasury bills) Eurobonds :- Eurobonds are distinct from domestic bonds and foreign bonds.

Governments Bonds :- Govt. securities are classified according to the length of time before maturity 1. Bills- Less than one years 2. Notes- Between one to ten years 3. Bonds- More than 10 years Corporate Bonds :- Corporate bonds are debt obligations, or IOUs issued by private and public corporations.

Stunted growth of corporate bond market in India Reason 1

1951 inception of planning era Birth of DFI (Development Financial Institutions) Motive of DFI is to provide long term funds to industries DFI supported by Budgetary policies and RBI for funds Corporates got easy access to long term loans hence Corporates didn t go for public debt


Recent times withdrawal of budgetary support to DFI DFI started to convert into Commercial banks (to access public deposit mechanism + lending in short and long term) Commercial Banks prefer loans than investing in bonds because later needs Mark-to-market requirements and provisions for valuation loss Less investment in corporate bonds


Strict regulatory requirements

Max debt investors limit 50 for Private placement route through QIB

Workaround adopted by Corporates:

Stage 1- Privately place debt issue to less than 50 investors Stage 2- These investors sell issue to larger number of investors in the guise of secondary market


Strict regulations of SEBI and RBI make it cumbersome for the corporates to issue debt papers due to too many mandatory disclosures Issuing bonds specially to institutions is easy for corporates since only credit rating needs to be disclosed by the approved credit rating agencies Institutional buyers are more informed than retail investors to make investment decision Hence majority retail investors stay away from corporate bonds and so as corporates from retail investors


Cash credit system by Banks Banks granting credit/borrowing limits to corporates and burdening themselves with cash management problems of the borrowers No need of cash management by corporates Corporates became complacent about borrowing through debt and then managing that cash Low activity as far as public debt route is concerned

Reason 6
SEBI directive issued in 2004 All secondary market trading need to be registered on automated screens of stock exchanges This was incorporated to bring in transparency Not applicable to SPOT trades which are between 2 investors and are settled in 2 days Major investors of bond market i.e. institutions don t prefer to go on stock exchange screen, resort to bilateral SPOT trade Brokers depict this as Direct sale instead of issuing Contract notes, thus not liable to even report these trades to stock exchange Expected transparency not observed poor price discovery Low sentiments of public towards trading in secondary bond market


Easy to manage few number of investors like banks, QIB than large number of public holding bonds Option of equity money e.g. IPO, FPO etc. Inefficient development of primary bond market poor development of secondary bond market Few banks/Institutions in secondary market tend to hold debt paper rather than trading poor liquidity in secondary bond market low number of retail investors

Reason 8
No structured Clearing and Settlement system Seller has to first transfer the bond before getting price in hand TDS on interest income of bonds (TDS is abolished from G-sec market) Cap on FII investment in corporate debt is $500 million Corporate bonds are not considered for REPO transactions Stamp duty High for retail investors as compared to RBI, Co-op banks etc. Variable across states

Current scenario
Cap on FII revised from $500 mn to $15 bn Corporate bonds of credit rating AA and above permitted for REPO transactions The market, anticipating a new benchmark bond, has started to offload the current ten-year bond, the 6.35% 2020. The note is no longer the ten-year onthe-run bond and the right levels of the ten-year bond will only be known in April when the first of the new ten-year benchmark bond issuances begin. The market offloading of the 6.35% 2020 bond has taken the yield up by 14 basis points (bps) week on week to 8% levels. Given the lack of alternatives for the 6.35% 2020 bond, the market is shifting to the 7.02% 2016 bond as a substitute. The spread between the 6.35% 2020 bond and the 7.02% 2016 bond has widened from 17 bps to 30 bps over the last one month. From 19-Mar-2009 to 19-Mar-2010, Bonds traded on NSE Avg. no. of trades per day 43, Avg. value traded per day Rs. 635 Cr (Source: NSE)

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