Debt Market

By- Paridhi Agarwal

What is Debt Capital Market ?
The Debt Market often called the bond market or credit market is a financial marketplace where
investors can trade in government-issued and corporate-issued debt securities.

Governments typically issue bonds in order to raise capital to pay down debts or fund infrastructural
improvements.

Publicly-traded companies issue bonds when they need to finance business expansion projects or
maintain ongoing operations.

The debt or bond market is broadly segmented into two different types:

- Primary Market is frequently referred to as the "new issues" market in which transactions strictly
occur directly between the bond issuers and the bond buyers.
- Secondary Market are securities that have already been sold in the primary market are then
bought and sold at later dates.
Importance of Debt Market in the Economy
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 objectives.

The debt markets also provide greater funding avenues to public-sector and private sector projects
and reduce the pressure on institutional financing.

It also enhances mobilization of resources by unlocking illiquid retail investments like gold.
Participants of the Debt Market
Issuers: The entities which issue debt securities are called issuers. Issuers in the debt market have
traditionally been major companies, financial institutions, governments and multi-lateral agencies.

Investors: The entities which invest in debt securities are called investors. Debt securities have traditionally
been marketed mainly to investment funds, pension funds, insurance companies etc.

Managers: The entities which arrange, structure, underwrite market and distribute issues of debt securities
are called managers and dealers.

Agent & Trustee: The entities which provide trustee & agency services called trustees & agents. Trustee &
agency services are usually provided by the agency & trust departments of major banks.

Trading infrastructure: The entities which provide trading infrastructure systems and services include: stock
exchanges, non-exchange financial trading venues, and investment firms who engage in market making,
proprietary trading, and brokerage.
Instruments of the Debt Market
Loans: Loans are possibly the most easily understood debt instrument. Loans can be acquired from
financial institutions or individuals and can be used for a variety of purposes, such as the purchase of
a home or vehicle or to finance a business venture.

Debentures: They are issued by the company to raise medium and long term funds.

Bonds: Bonds are issued generally by the government. Bonds also ensure payment of fixed interest
rates to the lenders of the money. On maturity of bond, the principal amount is paid back.

Mortgage: Mortgage is a loan against residential property. It is secured by an associated property. In a

case of failure of payment, the property can be seized & sold to recover the loaned amount.

Treasury Bills: Treasury bills are short-term debt instruments that mature within a year. They can be
redeemed only at maturity. They are sold at a discount if sold before maturity.
Types of Government Bonds
Fixed Coupon Bonds - Government bonds of this nature come with a fixed rate of interest which remains
constant throughout the tenure of investment irrespective of fluctuating market rates.

The coupon on a Government Bond is mentioned in nomenclature. For instance, 7% GOI 2021

Floating Coupon Bonds - As the name suggests, FRBs are subject to periodic changes in rate of returns.
The change in rates is undertaken at intervals which are declared beforehand during the issuance of such
bonds. For instance, an FRB could have a pre-announced interval of 6 months; which means interest rates
on it would be re-set every six months throughout the tenure.

There is another variant to FRBs, wherein the rate of interest rate is bifurcated into two components: a
base rate and a fixed spread. This spread is decided through auction and remains constant throughout the
maturity tenure.
Zero Coupon Bonds - As the name suggests, Zero-Coupon Bonds do not earn any interest. Earnings from
Zero-Coupon Bonds arise from the difference in issuance price (at a discount) and redemption value (at
par).

Sovereign Gold Bonds (SGBs) - The Central Government issues sovereign Gold Bonds, wherein entities
can invest in gold for an extended period through such bonds, without the burden of investing in physical
gold. The interest earned on such bonds is exempted from tax.Prices of such bonds are linked with gold’s
prices. The nominal value of SGBs is reached by calculating the simple average of closing prices of
99.99% purity gold, three days preceding such bonds’ issuance. SGBs are also denominated in terms of
one gram of gold.Individuals and Hindu Undivided Families can only hold up to 4 kg of Sovereign Gold
Bonds in a financial year. Trusts and other relevant entities can hold up to 20 kg if SGBs during a similar
time frame.
Inflation-Indexed Bond: It is a unique financial instrument, wherein the principal, as well as the interest
earned on such bond, is accorded with inflation. Mainly issued for retail investors, these bonds are
indexed as per the Consumer Price Index (CPI) or Wholesale Price Index (WPI). Such IIBs ensure real
returns accrued with such investments remain constant, thereby allowing investors to safeguard their
portfolio against inflation rates.Another variant of such inflation-adjusted securities is Capital Indexed
Bond. However, unlike IIBs, only the capital or principal proportion of balance is accorded with an inflation
index.

7.75% GOI Savings Bond :This G-Sec was introduced as a replacement to the 8% Savings Bond in 2018.
As noted from its nomenclature, the interest rate of such bonds is set at 7.75%. As per RBI regulations,
these bonds can only be held by –
-An individual or individuals who are/are not NRI(s) in any capacity
-A minor with a legal guardian representative
-A Hindu Undivided Family
Interest earnings from such bonds are taxable under the Income Tax Act 1961 as per the investors’
applicable income tax slab. The minimum amount at which these bonds are issued is Rs. 1000 and in
multiples of Rs.1000 thereof
Types of Debentures
On the Basis of Security:

a. Secured or Mortgage Debentures:

They are debentures which are secured by a charge on the assets of the company. The charge on the
assets of the company may be fixed charge or a floating charge. If the charge is on some specified assets
of the company it is called a fixed charge. On the other hand, if the charge is not on any particular asset of
the company but on the assets in general, it is called floating charge.

If the Company is unable to repay the debentures on the due date, the debenture holders can realise their
money from the assets mortgaged with them. First mortgage debentures are those that have a first claim
on the assets charged and second mortgage debentures are those having a second claim on the assets
charged. In India, debentures have necessarily to be secured.
b) Unsecured Debentures:

They are debentures which are not secured by any assets of the company irrespective of the
interest or principal. In the case of these debentures, the company does not offer any security to
the holders either in respect of the payment of interest or repayment of the loan, so the holders of
these debentures are just the ordinary or unsecured creditors of the company. They are also called
as naked debentures.
2. On the Basis of Convertibility:

a. Convertible Debentures:

The convertible debentures require no such security. They can further be either fully convertible debentures
(FCD) or partly convertible debentures (PCD). Fully convertible debentures are redeemed by issuing equity
or preference shares, instead of making any payment. This ratio is predetermined. In case of partly
convertible debentures, the debenture-holders are paid for a fixed part and for the balance part of the
debenture, (the convertible part) they are issued equity or preference shares.

b. Non-Convertible Debentures:

If debentures are non-convertible, they are paid at the time of redemption. Such debentures are not
convertible into shares.
3. On the Basis of Repayment:

a. Redeemable Debentures:
Redeemable debentures are those debentures which will be repaid by the Company either in lump
sum at the end of a specified period or by instalments during the lifetime of the Company. Most of the
debentures are generally of this type.

b. Irredeemable or Perpetual Debentures:

Irredeemable debentures are those debentures which are not repayable by the Company during its life
time. These debentures are repayable only at the time of liquidation of the Company.
Indian Debt Market Structure
Indian Debt Market
Indian debt Market mainly comprises trading of bonds.

In finance, a bond is a debt security, in which the issuer owes the holders a debt and is obliged to pay interest
(the coupon) to use and/or to repay the principal at a later date, termed maturity.

While India has a government (public) bond issuance which is not much out of line with the rest of the world,
its corporate bond issuance is very much lower than the norm.

1. There are almost no public issues in India.That is, where they are offered to a wide range of investors
and conform to the regulatory standards required of public issues of bonds.
2. Almost all corporate bond issues are made as private placements.Offered only to qualified Institutional
Buyers (professional investors)because of limited disclosure requirements and lower regulatory hurdles
1. Maximum no. of bonds are issued for a period of 10 years.Rest of the bonds are predominantly issued
for maturity period of less than or equal to 5 years.The short maturity periods in India debt market can
be attributed to lesser risks in G-sec bonds and high creditor quality. Few extend upto 40 years.

2. Traditionally, the Banks have been the largest category of investors in G-secs.

3. More than 60% of the transaction in the Wholesale Debt Market.

4. The concept was started in 1980s when companies like PFC and MTNL issued bonds to finance their
needs.

5. In 1992, IDBI came up with the concept of Deep Discount bonds. Soon ICICI and IFCI also followed suit.

6. One my invest in bonds directly or indirectly through mutual funds.

Issuance through Secondary Market
Investor Profile
1. Investor profile can be understood by studying major markets for bonds trading:

Wholesale Debt Market (WDM)- Major Investors: Banks, Financial Institutions, the RBI, Insurance
companies, Provident Funds, MFs, Corporates and FIIs.

Retail Debt Market(RDM)- Major Investors:individual investors, Small trusts and investors.

2. Wholesale Debt Market has Large investors and a high average trade value.It is an informal market with
most of the trades directly negotiated and struck between various participants.The commencement of
WDM by NSE(1994) and BSE(2001) has brought greater transparency.
Clearing and Settlement
Clearing : Clearing is all steps of the post-trade processes apart from the final settlement — i.e.
apart from the final payment and change in ownership.

Settlement: Settlement is the last step in the post-trade process. Settlement is a two way process
which involves transfer of funds and securities on the settlement date.
Salient features of Clearing and Settlement Process
1. Clearing and settlement of all trades in the Debt Market shall be subject to the Bye Laws, Rules
and Regulations of the Capital Market Segment and such regulations, circulars and requirements
etc. as may be brought into force from time to time in respect of clearing and settlement of trading
in Debt Market (Government securities).

2. Settlement in Debt Market is on T + 2 Rolling basis viz. on the 2nd working day. For arriving at
the settlement day all intervening holidays, which include bank holidays, NSE holidays, Saturdays
and Sundays are excluded. Typically trades taking place on Monday are settled on Wednesday,
Tuesdays trades settled on Thursday and so on.
Advantages of Debt Financing
Tax advantage: The amount you pay in interest is tax deductible, effectively reducing your net obligation.

Predictability: Principal and interest payments are stated in advance, so it is easier to work these into the
company's cash flow. Loans can be short, medium or long term.

Easier planning: You know well in advance exactly how much principal and interest you will pay back each
month. This makes it easier to budget and make financial plans.

Retain control: When you agree to debt financing from a lending institution, the lender has no say in how
you manage your company.

You make all the decisions.

The business relationship ends once you have repaid the loan in full.
Disadvantages of Debt Financing
Qualification Requirements: You need a good enough credit rating to receive financing.

Collateral: By agreeing to provide collateral to the lender, you could put some business assets at potential risk.
You might also be asked to personally guarantee the loan, potentially putting your own assets at risk.

Cash Flow: Taking on too much debt makes the business more likely to have problems meeting loan
payments if cash flow declines. Investors will also see the company as a higher risk and be reluctant to make
additional equity investments.

Fixed Payments: Principal and interest payments must be made on specified dates without fail. Businesses
that have unpredictable cash flows might have difficulties making loan payments.

Declines in sales can create serious problems in meeting loan payment dates.