debt market
DESCRIPTION
debt market pptTRANSCRIPT
Debt Markets
Introduction
Debt instruments are contracts in which one party lends money to another on pre-determined terms with regard to rate of interest to be paid by the borrower to the lender, the periodicity of such interest payment, and the repayment of the principal amount borrowed (either in installments or in bullet).
Evolution of Debt Market in India
Indian Economic Crisis 1991
Pre-liberalization 1947-1991: Socialism Industrialization under state monitoring Foreign trade restrictions (import tariffs, export taxes and
quantitative restrictions, foreign direct investment (FDI) upper limit, restrictions on technology transfer, export obligations and government approvals)
Economic intervention Elaborate licenses, regulations (commonly referred to
as License Raj)
Debt Market in India before Liberalization: Control on pricing of assets, administered interest rates (Rates
not market related) Segmentation of markets and barriers to entry Limited number of players High transactions cost High Statutory Liquidity Ratio (SLR) requirements The absence of a liquid and transparent secondary market
Economic Crisis 1990’s Large and growing fiscal imbalances over the 1980s Financial Repression Investors withdrew on low sentiments Import bill swelled, exports slumped Balance of payments problems Rupee Depreciation Defending the currency by expending foreign reserves
The economic liberalization in India Opening for international trade and foreign investment (Globalization) Deregulation Initiation of Privatization Inflation-controlling measures Private sector enterprise and competition Setting up of a comprehensive system of primary dealers Adoption of DVP system for settlement of government securities
transactions Abolition of tax deduction at source on government securities (Tax
reforms) Permission for FII’s to Hedge their foreign currency risk in the forward
market Introduction of Treasury bills of varying maturities Placing investments of banks in preference shares/debentures/bonds of
corporate outside the five per cent limit Recommendation that the Government borrowings at market related rates
The main objective of the government was to transform the economic system from socialism to capitalism so as to achieve high economic growth and industrialize the nation.
Financial Markets
A financial market is a market in which people and entities can trade financial securities, commodities, and other fungible items of value at low transaction costs and at prices that reflect supply and demand.
Financial markets facilitate: The raising of capital (in the capital markets) The transfer of risk (in the derivatives markets) Price discovery (Demand and supply equilibrium) The transfer of liquidity (in the money markets) International trade (in the currency markets)
Types of Financial Markets
Money MarketThe money market can be defined as a market for short term money and financial assets that are near substitutes for money.
Money Market Instruments
Call Money or Notice Money Amount borrowed for very short period, more than one day up to 14
days.
Enables banks and institutions to even out their day to day deficits and surpluses of money
Needed to adjust CRR requirement for Banks
Completely inter-bank market, only specified financial institutions & MF’s allowed to access call money market
Interest rates are market determined
Participants of call money market need to maintain current account with RBI
Bill Market
Bills of exchange can be rediscounted by the banks in bills market
RBI introduced the Bills Market Scheme (BMS) in 1952 & New Bill Market Scheme (NBMS) in 1970 to promote the bill market in India
Precaution on bills regarding Accommodation bills, Credibility of the parties, Completeness of the bill, Dishonor of the bill, Stamped bill
Certificate of Deposits
Marketable receipt of funds deposited in a bank for a fixed period issued in form of promissory notes
They are negotiable and marketable bearing specific face value and maturity
CD can be registered or bearer
They are liquid and risk free
Commercial Papers
Short term negotiable unsecured promissory note
Issued by Private sector, public sector and non banking company
Maturity period of a minimum 30 days to max 364 days
Direct commercial papers (without intermediary, issued directly to the investors) or Dealer papers (dealer or merchant banker issues on behalf of the company & advisory service)
Ready Forward Contracts
Agreement to sell and repurchase the same security and vice versa
Sellers perspective of transaction is Repo and buyers perspective is Reverse Repo
Only RBI approved parties and the securities are allowed to repo and reverse repo trade
Highly useful for banks to maintain SLR & CRR
Treasury Bills Market
Short term and lowest risk instrument
Issued at a pre-fixed day (14 & 91-day T Bill every Friday, 182 & 364-day T bill every alternate Wednesday) and a fixed amount
Governments borrowing instrument
Yield is based on bids received at the auction
Money Market Mutual Funds
The fund portfolio consists of various short term market instruments
Small-scale investor actively take part in the money markets
Minimum lock-in period is 15 days
Credit Cards
Monetary instrument that enables the card holder to obtain goods and service without actual payment at the time of purchase
Credit can be availed for a period of 30 to 45 days
The card carried a pre-determined limit up to which the holder can spend
Debt MarketDebt market is where debt instruments or bonds are traded. The most distinguishing feature of these instruments is that the return is fixed i.e. they are as close to being risk free as possible, if not totally risk free. The fixed return on the bond is known as the interest rate or the coupon rate.
Debt Market Instruments
Government Securities / Gilt-edged Securities
Issued by Central Government, State government and Quasi-Government agencies
Government securities have maturities ranging from 3 – 20 years
Typically held by banks, financial institutions, insurance companies, provident funds mainly because of certain statutory compulsions
Savings Bonds
Public Sector Undertaking Bonds
Private Sector Debentures
Instruments raised by the company for raising long term debt
Typically secured by a charge on immovable properties
They carry maturity period and coupon rate
Debentures may have convertible clause (option to convert the debentures into equity shares)
Debentures may have call & put option
Preference Shares
Represent hybrid security (combination of equity shares and debentures)
Carry fixed rate of dividend
Dividend payable only out of distributable profits
Dividend is generally cumulative and tax-exempt
May be redeemable
There are three main segments in the debt markets in India Government Securities
Public Sector Units (PSU) bonds and
Corporate securities
Indian Debt Market Structure
Risks Associated with Fixed Income Securities
Interest Rate Risk - The market value of the securities is inversely affected by movements in interest rates. Price Risk - The price received on secondary market (premature exit) depends on the level of interest rates, time to term, credit quality of the issuer and liquidity. Liquidity Risk - the risk that an investor will be unable to sell securities due to lack of demand and thus must sell them at a substantial loss and/or incur substantial transaction costs in the sale process. Reinvestment Risk – the risk that the income and/or principal repayments must be invested at lower rates, especially with callable securities. Prepayment Risk - Prepayment risk is the risk that the issuer may repay bonds prior to maturity; investor faces the risk of reinvesting at lower rates.
Purchasing Power Risk - Investors often focus on the real rate of return, or the actual return minus the rate of inflation. Rising inflation has a negative impact on real rates of return because inflation reduces the purchasing power of both investment income and principal. Credit Risk - The safety of the fixed income investor's principal depends on the issuer's credit quality and ability to meet its financial obligations, such as payment of coupon and repayment of principal at maturity. A change in either the issuer's credit rating or the market's perception of the issuer's business prospects will affect the value of its outstanding securities. Default Risk - The risk of default is the risk that the issuer will not be able to make interest payments and/or return the principal at maturity.
REGULATORS
The Securities Contracts Regulation Act (SCRA) defines the regulatory role of various regulators in the securities market. The RBI regulates the money market segment of the debt products (CPs, CDs) and the Government securities market. The non Government bond market is regulated by the SEBI. The SEBI also regulates the stock exchanges and hence the regulatory overlap in regulating transactions in Government securities on stock exchanges have to be dealt with by both the regulators (RBI and SEBI) through mutual cooperation.
The RBI’s Regulatory Role Licensing Prescribing capital requirements Monitoring governance Setting prudential regulations to ensure solvency and liquidity of the banks Prescribing lending to certain priority sectors of the economy Regulating interest rates in specific areas Setting appropriate regulatory norms related to income recognition, asset
classification, provisioning, investment valuation, exposure limits and the like
Initiating new regulation
SEBI The regulator for the Indian corporate debt market is the Securities and Exchange Board of India (SEBI). SEBI controls the bond market in cases where entities, especially corporates, raise money from public through public issues.
It regulates the manner in which money is raised and to ensure a fair play for the retail investor. It forces the issuer to make the retail investor aware of the risks inherent in the investment and its disclosure norms. SEBI is also a regulator for the mutual funds and regulates the entry of new mutual funds in the industry. It also regulates the instruments in which these mutual funds can invest. SEBI also regulates the investments of FIIs.