CAPITAL MARKETS-

BONDS
Debt markets
BOND (FIXED INCOME SECURITIES)

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 used by companies, municipalities, states and sovereign governments to raise money
to finance a variety of projects and activities.

Owners of bonds are debt holders, or creditors, of the issuer.

 DEBT (LOAN INSTRUMENTS)

Corporate debt / Debentures/ Bonds

• Debentures are instrument issued by companies to raise debt capital.

• The investor is paid interest at a fixed rate (usually payable half yearly on specific dates)

• Repayment of loan amount on a specified maturity date say after 5/7/10 years (redemption).

• Specific asset(s) of the company may be held (secured) in favour of debenture holders. This can be liquidated, if
the company is unable to pay the interest or principal amount.

• Unlike loans, you can buy or sell these instruments in the market.
INSTRUMENTS TRADED IN THE DEBT MARKET

The list is only illustrative

 FEATURES
Face Value:
• Par value
• The amount declared by the issuer at the time of issuance, in the offer document.
• In case of private placements of bonds, the face value is Rs.1 lac per bond. In case of public issue, the issuer is free
to choose the face value; the industry practice is to fix it at Rs. 1,000/- per bond.

Price of bond:
The price at which a bond is issued (issue price) or trades at (trading price).
Coupon rate:
The issuer of the bond compensates the bondholders by paying them interest; the rate of interest is called the
‘coupon’ rate. The rate of interest or coupon payment varies depending upon the economic circumstances, the
creditworthiness of the issuer, type of bond, maturity, etc.

Maturity:
Bondholders get repaid at a specific date when the bonds get matured. The bonds are categorized as short-term (say
3-5 years) or long-term bonds (say 10 years and more) based on maturity period.
 FEATURES

Credit rating:
A higher rating suggests a lower amount of risk and lower yields and a lower rating may be indicative that the risk
involved in the bond is higher along with higher returns.

Yield:
Yield means the return an investor gets from the bond for a specific time. If the bond is held till maturity, the return is
termed as yield to maturity. The yield can be calculated considering the face value, interest payment frequency,
maturity, and the market price of the bond.

Callable Bonds: Callable bonds that give the issuer the right to call back the bonds at a pre-agreed price and date.

Puttable bonds give the bondholder the right to return the bond and ask for repayment of principal at a pre-agreed
date before maturity.
 TYPES OF DEBENTURES

o Non convertible debentures (NCD) – Total amount is redeemed by the issuer. NCDs have fixed
maturity date and the coupon/ interest can be paid along monthly, quarterly, half-yearly or annually, with
or without the principal amount, depending on the frequency and tenure specified at the time of issuance.

o Partially convertible debentures (PCD) – Part of it is redeemed and the remaining is converted to
equity shares as per the specified terms

o Fully convertible debentures (FCD) – Whole value is converted into equity after a specified period at a
predetermined rate or price.
 Difference
between
Fully-convertible
and
Partially-
convertible
debentures
 Difference
between
Convertible
and
Non- convertible
debentures
 Risks of choosing convertible debentures
1. Equity dilution: Dilutes ownership in the company and also affects the shareholder value
and the earnings from the per share.

2. Risks with returns: For instance, if the stock market is not showing the desired growth
or if the stock price goes down, then the potential return will be low or the value of
convertible debenture will go down, resulting to a loss for the debenture-holders.

3. Risk arising due to fixed-income element: The convertible debenture provides a

downside protection through a fixed-income element, in case there is a decline in stock
price, however, at the same time if there is an increase in the stock price, the fixed-income
element will work as a limitation on the returns of the debenture-holders.

4. Risk with the credits: This risk is associated with the debenture issuer, if the issuers fail
in fulfilling their obligation For instance, if they fail to pay the interest or fail to pay the
principal amount back, then the investor will suffer the loss.
NCD ISSUANCE IN PRIMARY MARKET- EXAMPLE

NCD notification_primary market

Business Standard, July 04,2024 https://www.nseindia.com/market-data/bonds-traded-in-capital-market
 SOME MORE BASICS

Relation between yield and price of a bond: Inversely

related to each other

Difference between coupon and yield?

• Coupon is the interest received by the bond holder till

maturity.Yield is the return received by the bond holder from
his date of investment at the then prevailing market price of
the bond.
• On the date of allotment when the price of the bond is at par
the coupon and yield of a bond is the same. The yield may be
different once the bond price changes based on demand and
supply.
Premium and discount in Bond pricing?

Premium: Coupon rate > the prevalent market interest rates; demand goes up; bonds are sold at a higher price
than the face value.

Discount:

Coupon rate < the prevalent market interest rates; demand goes down; bonds are sold at a lower than the face
value.

Credit spread in bonds? (Quality spread)

Additional yield an investor receives while investing in a corporate bond over and above the Government
securities having similar maturity.Varies across tenures
Example: 10-year G-Sec is at 7.50% yield while 10 year HDFC is at 8.40% yield. Hence, spread is 8.40% - 7.50%
= 0.90% i.e. spread of 90 bps.
 RISKS OF INVESTING IN BONDS

• Inflation risk: High inflation erodes the value of your investment as the purchasing power of the bonds' coupons/ yield
and principal falls.
• Interest rate risk: Bond prices are inversely affected by interest rate movements. A rise in interest rates could see a fall
in bond prices. If interest rates fall, buyers pay a higher price to receive a coupon that is higher than the prevailing
market rates.
• Call risk: Some bonds have a callable feature which gives the issuer an option to buy back (redeem) the bond before its
maturity date at a predefined date. If a bond is called when prevailing interest rates are lower than at the time you
bought it, you will be exposed to reinvestment risks.
• Credit risk: Bond prices will be affected by the perceived credit quality or probability of default of the bond issuer.
• Liquidity risk: Bonds are usually less liquid than equity. This may happen if the investors of a particular bond issue are
largely buying to hold, so there are fewer buyers and sellers. Even in cases where the bonds are listed or traded on an
exchange, there is no certainty that a liquid secondary market will develop.
• Market risk: A bond's price/ value will fluctuate with changing market conditions, including the forces of supply and
demand and interest rate changes.
• Reinvestment risk: In an environment of declining interest rates, investors may have to reinvest the income received and
any return of principal at lower prevailing rates.
JPMORGAN CHASE & CO’S EMERGING-MARKET
BOND INDEX
Jun 28 2024 |

https://www.livemint.com/market/stock-market-news/jp-morgan-bond-index
-india-inclusion-this-week-explained-key-changes-flows-impact-on-yields-wh
at-should-investors-do-11719388118238.html

https://www.business-standard.com/markets/news/indian-govt-bonds-now-part-
of-jp-morgan-s-bond-index-here-s-what-it-means-124062800086_1.html

https://www.youtube.com/watch?v=I8VhoqOWVHo
 G-SEC (GOVERNMENT SECURITY)

❑ Long- term (Dated bonds) or short- term

❑ Issued by Central and State governments. State Governments issue dated bonds called State Development
Loans.
❑ Risk-free gilt-edged instruments.
 DATED G-SECS

Dated G-Secs are securities which carry a fixed or floating coupon (interest rate) which is paid on the
face value, on half-yearly basis.

Generally, the tenor of dated securities ranges from 5 years to 40 years.

 INSTRUMENT FEATURES

i) Fixed Rate Bonds – The coupon rate is fixed for the entire life (i.e. till maturity) of the bond. Most
Government bonds in India are issued as fixed rate bonds.
For example – 8.24%GS2018 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%

ii) Floating Rate Bonds (FRB) – Variable coupon rate which is re-set at pre-announced intervals (say, every
six months or one year). FRBs were first issued in September 1995 in India. For example, a FRB was
issued on November 07, 2016 for a tenor of 8 years, thus maturing on November 07, 2024.

FRBs can also carry the coupon, which will have a base rate plus a fixed spread, to be decided by way of
auction mechanism. The spread will be fixed throughout the tenure of the bond.

For example, FRB 2031 (auctioned on May 4, 2018) carry the coupon with base rate plus a fixed spread
decided by way of auction.
Capital Indexed Bonds – The principal amount is linked to
an accepted index of inflation with a view to protecting the
Principal amount of the investors from inflation.

The CIBs issued in 1997 provided only principal protection

and not interest protection. Hence IIPs were introduced
 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 Wholesale Price
Index (WPI) or Consumer Price Index
(CPI).

https://www.rbi.org.in/commonperson/english/scripts/FAQs.aspx?Id=1165
 RISKS INVOLVED IN HOLDING G-SECS

Market risk – Market risk arises out of adverse movement of prices of the securities due to changes in interest rates. This will result in valuation losses on marking to
market or realizing a loss if the securities are sold at adverse prices. Small investors, to some extent, can mitigate market risk by holding the bonds till maturity so that they
can realize the yield at which the securities were actually bought.

Reinvestment risk – Cash flows on a G-Sec includes a coupon every half year and repayment of principal at maturity. These cash flows need to be reinvested whenever
they are paid. Hence there is a risk that the investor may not be able to reinvest these proceeds at yield prevalent at the time of making investment due to decrease in
interest rates prevailing at the time of receipt of cash flows by investors.

Liquidity risk – Liquidity in G-Secs is referred to as the ease with which security can be bought and sold i.e. availability of buy-sell quotes with narrow spreads. Usually,
when a liquid bond of fixed maturity is bought, its tenor gets reduced due to time decay. For example, a 10-year security will become 8 year security after 2 years due to
which it may become illiquid. The bonds also become illiquid when there are no frequent reissuances by the issuer (RBI) in those bonds. Bonds are generally reissued till a
sizeable amount becomes outstanding under that bond. However, issuer and sovereign have to ensure that there is no excess burden on Government at the time of
maturity of the bond as very large amount maturing on a single day may affect the fiscal position of Government. Hence, reissuances for securities are generally stopped
after outstanding under that bond touches a particular limit. Due to illiquidity, the investor may need to sell at adverse prices in case of urgent funds requirement.
https://old.ccilindia.com/OMHome.aspx

https://rbiretaildirect.org.in/#/
https://www.moneycontrol.com/news/business/personal-finance/ulips-cant-be-promoted-as-pure-investment-tool-
without-mention-of-life-cover-element-irdai-12753199.html

https://www.moneycontrol.com/news/business/personal-finance/invest-wise-equity-markets-may-not-be-as-expens
ive-as-they-look-12749794.html

https://www.rbi.org.in/commonperson/English/Scripts/FAQs.aspx?Id=711#3

https://blog.ipleaders.in/convertible-debentures/
https://www.sebi.gov.in/sebi_data/faqfiles/jan-2023/1674793029919.pdf

https://www.youtube.com/watch?v=bwSGf9e-dfg