Bond Valuation by Prof. Bap

8/8/2019 Bond Valuation by Prof. Bap

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BOND MARKETS

Presented By

PROF. BHAVIN A. PATEL(BAP)


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Indian Debt Market - Pillars of the

Indian Economy

The Debt Market plays a very critical role forany growing economy which need to employa large amount of capital and resources for

ach

ieving th

e desired industrial and financialgrowth. The Indian debt market is today one of the

largest in Asia and includes securities issuedby the Government (Central & State

Governments), public sector undertakings,other government bodies, financialinstitutions, banks and corporates.


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DEBT MARKET SIZE

The Indian debt markets is the largestsegment of the Indian financial markets.(Source RBI & CCIL)

Outstanding issue size of Governmentsecurities (Central and state) close toRs.13,474 billion (or Rs.1,34,7435 crore)

Secondary market turnover of around Rs56,033 billion (in the previous year 2007)


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DEBT MARKET SIZE

INCREASED FROM $ 13 BILLION IN2006TO $ 20 BILLION IN 2007

Non-government sector expected to growto $ 575 BILLION $ BY2016,ACCORDING TO A GOLDMANSACHS REPORT


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INTRODUCTION

The Bond Market is the financialmarket where debt securities or bondsare traded.

Those buying these bonds become thecreditors of the company.

The most distinguishing feature of these

instruments is that the return is fixed i.e.they are as close to being risk free aspossible, if not totally risk free


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Contd.

The debt market in India can be dividedinto two categories

1. The government securities market or the G-Sec markets consisting of central

government and state governmentsecurities (therefore loans being taken bythe central and state governments)

2. Bond market consisting of FI (financial

institutions) bonds, PSU (public sector units)bonds and corporate bonds/debentures.


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Pros n cons

Pros

The returns are riskfree.

High liquidity.

Loans can be easilyprocured from

banks against govt.securities

Cons

The returns are notas high as securities

markets.

The retail debtmarket is not very

well developed


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Types of bonds

Dated Securities

Zero Coupon Bonds

Capital Indexed Bonds Fixed Income Instruments issued by

corporates

T-Bills


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T-Bills

Treasury bills (T-bills) offer short-terminvestment opportunities, generally up toone year.

At present, the Government of India issuesthree types of treasury bills through auctions,namely, 91-day, 182-day and 364-day.

Treasury bills are available for a minimum

amount of Rs.25,000 and in multiples of Rs.25,000. Treasury bills are issued at a discountand are redeemed at par. Treasury bills arealso issued under the Market StabilizationScheme (MSS).


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Dated Securities

These instruments are of the face value of Rs100, which the buyer has to pay upfront.

The return is pre-decided. This is known as

the coupon rate or the interest rate. Theinterest rate indicates the amount that willbe paid out by the government every yeartill maturity. Time to maturity is fixed.

When the security matures the face valuewill be returned to the holder


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Zero Coupon Bonds

ZCBs are available at a discount to theirface value.

There is no interest paid on these instruments

but on maturity the face value is redeemedfrom the RBI

The difference between the issue price

(discounted price) and face value is thereturn on this security


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Capital Indexed Bonds

Capital indexed bonds have interest ratesas fixed percentage over the wholesaleprice index

The purpose is to provide investors with aneffective hedge against inflation

They are issued at face value. The coupon is

fixed as a percentage over the WPI


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Fixed Income instruments

issued by Corporates

The companies issue debentures, which have aface value and fixed coupon rate

Debentures can be converted into sharesdepending on the type of the instruments

Those that cannot be converted are known as NCD(non-convertible debentures). Some of the debentures can be partly converted to

stocks. These are known as PCDs (partly convertibledebentures).

Those debentures that can be fully converted intostocks are known as FCDs (fully convertibledebentures).


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Calculation of Yields

Current Yield-The current yield calculates the

percentage return that the annual couponpayment provides the investor. In other

words, this yield calculates whatpercentage the actual coupon payment isof the price the investor pays for the bond.

Current Yield= Coupon Rate 100

Purchase Price


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Contd.

Yield to Maturity-YTM is discount rate that

equates present value of the all the cashinflows to the cost price of the governmentsecurity (market price), which is actually theInternal Rate of Return of the government

security. The concept of Yield to Maturityassumes that the future cash flows arereinvested at the same rate at which theoriginal investment was made.


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Contd.

YTM = I+(F-M)/N

(F+M)/2

whereI = Annual interest RateF = Face value of bond

M = Market price of the bondN = Number of years to maturity


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.

.


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Types of Risk Bondholders

Face

Interest Rate RiskThe risk of a bond changing in value when interest rates

change. This affects all bonds regardless of credit

quality, but is more severe for longer maturity bonds.

Reinvestment RiskThe risk that investors will be unable to reinvest thecoupon payments at the coupon rate. This is more

important for high coupon bonds.

Default (Credit) RiskThe risk that the firm will go bankrupt and not make all payments

tobondholders.

Other Risks: Inflation, Liquidity


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Factors that affect valuations of

debt instruments

Monetary policy

Economic growth

Fiscal policy Inflation

Attractiveness of debt market


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Wholesale Debt Market

The Wholesale Debt Market (WDM) segmentof the Exchange commenced operationson June 30, 1994. This provided the first

formal screen-based trading facility for thedebt market in the country.

Provides trading facility G-secs, T-Bills, Bondsissued by PSUs, commercial papers,

corporate debentures etc


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WHOLESALE DEBT MARKET-MAJOR PLAYERS

BANKS

FIs

RBI

Primary Dealers Insurance Companies

Provident Funds

MFs

Corporates

FIIs


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TYPES OF TRADE IN THEWDM

1. OUTRIGHT SALE OR PURCHASE2. REPOTRADE-Also known as Ready Forward Trade,

trade which is intended to be reversed at a later pointin time at a rate which will include interest component

for the remaining period, one participant sells t

hesecurities to the other with an agreement to purchase

them back at a later date Advantages:-

Facilitates creation of liquidity by permitting the sellerto avail a specific sum of money in lieu of interestpayment

Broken Period Concept


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G-SEC

The Government Securities market is theoldest and the largest component of theIndian debt market in terms of marketcapitalization, outstanding securities andtrading volumes.

The G-Secs market plays a vital role in theIndian economy as it provides the benchmarkfor determining the level of interest rates in

the country through the yields on thegovernment securities which are referred toas the risk-free rate of return in any economy


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Growth inWDM

The Debt Segment has shown a gradual butconsistent growth in turnover in the past fewyears with increased participation from themainstream banking and institutional players.This Segment expects a sustained rise inturnover and participation in the coming yearswith the initiation of activity by new Membersand the continued support and participation

of major banks, Primary Dealers andinstitutions.


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Transformations in the Market

Structure The first half of the twentieth century had witnessed a significant amount of

retail interest and participation in the G-Sec market with more than half theholdings of G-Secs issued being held by retail investors, a trend whichcontinued until the early sixties.

The Indian Debt Market structure was hitherto that of a wholesale market

with participation largely restricted to the Banks, Institutions and the PrimaryDealers.

The volumes in theWholesale Debt Market over the past few years arerapidly expanding showing attractive financial market with a strong potentialfor retail participation.

The Retail Debt Market in India is being created, thanks to the pioneeringefforts of the Exchanges and the market participants and the strongleadership and guidance by SEBI, RBI and the Govt. of India.


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Govt. Initiative

The Hon'ble Union Finance Minister, while presenting theUnion Budget for 2006-2007, accepted the recommendationsof the High Level Committee on Corporate Bonds andSecuritization and made a significant policy announcementabout creation of a single, unified exchange-traded market for

corporate bonds in India.

SEBI has subsequently taken several steps towards creationof a vibrant Corporate Bond market.On July 2,2007 SEBIpermitted BSE to launch a trade matching platform withessential features of an OTC Market. Several other initiatives

like simplification of the Debt listing agreement, rationalizationof stamp duty and introduction of Repos on Corporate Bondshave been taken by SEBI.


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Retail Debt Market Segment (RDM)

The Retail Debt Market, in the new millennium,presents a vast kaleidoscope of opportunities forthe Indian investor whose knowledge andparticipation hitherto has been restricted to the

equity market.

The development of the Retail Debt Market hasengaged the attention of policy makers, regulatorsand the Government in the past few years.

The potential of the Retail Debt Market can begauged from the investor strength of more than 40million in the Indian equity market


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Emergence of the Retail Debt Market

It would surprise many to know that a retail debt market was at one point of time very muchpresent in India.

The growing investments in the Bond Funds and the Money Market Mutual Funds are asign of the increasing recognition of this fact by the retail investors.

Retail investors would have a natural preference for fixed income returns and especially soin the current situation of increasing volatility in the financial markets.The CentralGovernment Securities (G-Secs) are the one of the best investment options for anindividual investor today in the financial markets due to the following factors:

Zero default risk - due to their sovereign guarantee, ensures the total safety of allinvestments in G-Secs

Lower average volatility in bond prices Greater returns as compared to the conventional safe investment avenues like Bank

Deposits and Fixed Deposits, which also contain credit risk Higher leverage -Greater borrowing capacity against G-Secs due to their zero risk status

Wider range of innovations in the nature of securities like TBills, Index linked Bonds, PartlyPaid Bonds and others like STRIPS and securities with call and put options to follow soon

Better and greater features to suit a large range of investment profiles and investorrequirements

Growing liquidity and the increased turnover in recent times in the Indian Debt Markets


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Retail Trading in G-Secs

The Government of India and RBI, in early 2000 announced ascheme for enabling retail participation through a non-competitive bidding facility in the G-Sec auctions with areservation of5% of the issue amount for non-competitivebids by retail investors.

The Retail Trading in G-Secs. commenced on January 16,2003.The Indian Fixed Income Markets, which until sometime ago was the mainstay of the wholesale investors, weremade accessible to the retail investors to enable retail tradingin G-Secs through stock exchanges.

The Indian Investor is today able to buy or sell G-Secsthrough the nationwide BSE BOLT Network of more than7,000 terminals spread across 410 cities around the country.


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The Retail Debt Market Module of BSE

The key features of the system are:

Trading: by electronic order matching based on price-time prioritythrough the BOLT. Retail Trading in G-secs is on a RollingSettlements basis with a T+2 Delivery Cycle

Clearing and Settlement: The Clearing and Settlement mechanismfor the Retail trading in G-Secs is based on the existing institutionalmechanism available at BSE.The trades executed throughout thecontinuous trading sessions are netted out at the end of the tradinghours through a process of multilateral netting.The transactions arenetted out member-wise and then scrip-wise so as to determine thenet settlement and payment obligations of the Members.


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..cont

The Delivery obligations and the payment orders in respect of theseMembers are generated by the Clearing and Settlement system ofBSE.These statements indicate the pay-in and pay-out positions ofthe Members for securities and funds who then give the necessaryinstructions to their Clearing Banks and depositories.

The entire risk management and the clearing and settlementactivities for the trades executed in the Retail Debt Market System isundertaken by BSE Exchange Clearing House

Holding and Transfer of G-Secs: The G-secs for retail tradingthrough BSE can be held by investors in the same Demat account


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FUTURE

The BSE Debt Market solution would soon providelive Internet trading on its state-of-the-artBSEWebx Trading System.

The BSE Debt segment would seek to pave the

way for the development of a healthy, efficient andactive debt market mechanism and marketstructure in line with world class standards andgreater integration with the global economy.Thiswill truly help the Indian capital markets to attain a

place of pride among the leading capital marketsof the world


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Topic Ends

Bond Valuation by Prof. Bap

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