Confidential

PRIMER ON INDIAN DEBT MARKETS

Glossary of Important Terms and Commonly Used Market Terminology6Some Useful Information12What are Fixed Income Securities?12What is Money Market?12What is a Certificate of Deposit (CD)?13What is a Commercial Paper (CPs)?13What is a Fixed Deposit?14What is Over the Counter (OTC)?14What is a Credit Default Swap?14What is an Interest Rate Swap?15What is a Call money market?15What are a Repo and a Reverse Repo Rate?15What is a Repo market?16What is a Cash Reserve Ratio (CRR)?17What is a Statutory Liquid Ratio (SLR)?17What are Open Market Operations (OMOs)?18What is meant by buyback of Government securities?18What is Liquidity Adjustment Facility (LAF)?19What is the role of the Clearing Corporation of India Limited (CCIL)?19What is Collateralized Borrowing and Lending Obligation (CBLO)20What are the role and functions of FIMMDA?21What is the role of National Securities Clearing Corporation Ltd. (NSCCL)?23What is a debenture?23What is Convexity?24Analytics25What is time value of money?25What is present value?25What is Yield?26How is Yield to Maturity computed?26How is the Price of a bond calculated? What is the total consideration amount of a trade and what is accrued interest?27What is the relationship between yield and price of a bond?27How is the yield of a bond calculated?28What is the day count conventions used in calculating bond yields?29How is the yield of a Treasury bill calculated?30What is Duration?30What are Clean Price and the Dirty Price in reference to trading in G-Secs?30How are the Face Value, Trade Value and the settlement value different from each other?31What are credit spreads?32What is a Debt Market?33Who are the market participants in the Government Securities (G-Secs) Market?34Participants and products in the Indian G-Secs markets37What are the advantages for investing in Fixed Income securities?38What are the risks associated with Indian Debt Markets?38What factors determine the interest rate in the Debt market?40What is a Government Security (G-Secs)?41What are Treasury Bills?41What are Cash Management Bills (CMBs)?41What are Dated Government Securities?42What are Fixed Rate Bonds?42What are Floating Rate Bonds?43What are Zero Coupon Bonds?43What are Capital Indexed bonds?43What are Bonds with Call / Put options?44What are special securities?44Who regulates Indian G-Secs market?45Why should one invest in G-Secs?45What are the Dos and Donts prescribed by the RBI for dealing in government securities?46What are auctions and how are the G-Secs issued through these auctions?46What are the different types of auctions used for issue of G-Secs?48What is competitive and non competitive bidding?49How and in what form can G-Secs be held?50How does the trading in Government securities take place?51How are the dealing transactions recorded by the dealing desk?53How do the Government securities transactions settle in the primary market?54How do the Government securities transactions settle in the secondary market?54What are the important considerations while undertaking security transactions?55What are the important guidelines for valuation of G-Secs?57Example showing valuation of G-Secs58What affects the price of G-Sec?60How are the G-secs transactions reported?60What are the various websites that give information on Government securities?62What is shut period?66What is Delivery versus Payment (DvP) settlement?66Bond credit ratings67What are corporate bonds?68Why should one invest in corporate bonds?68Who regulates the Corporate Bond Markets?68What are the different types of corporate bonds?69What are the key components of the corporate bonds?70What are the factors and risks investors should keep in mind while trading / investing in the Corporate Bonds?72How are corporate bonds issued in India?73Where are the corporate bonds listed?73How trading takes place in the Capital market segment for the corporate bonds?74What are the important guidelines for valuation of Corporate Bonds?74What are the corporate bonds available for trading in the capital market segment?75Where will one get details of todays corporate bond trade data in the capital market segment?76Important Excel functions for bond related functions77Present Value77Future Value78Coupon days79Yearfrac80PRICE81YIELD82DURATION83Modified Duration84

Glossary of Important Terms and Commonly Used Market TerminologySOURCE: RBIAccrued Interest

The accrued interest on a bond is the amount of interest accumulated on a bond since the last coupon payment. The interest has been earned, but because coupons are paid only on coupon dates, the investor has not gained the money yet. In India day count convention for Government Securities (G-Secs) is 30/360.

Bid Price/ Yield

The price/yield being offered by a potential buyer for a security

Big Figure

When the price is quoted as Rs.102.35, the portion other than decimals (102) is called the big figure.

Competitive Bid

Competitive bid refers to the bid for the stock at the price stated by a bidder in an auction.

Coupon

The rate of interest paid on a debt security as calculated on the basis of the securitys face value.

Coupon Frequency

Coupon payments are made at regular intervals throughout the life of a debt security and may be quarterly (4 times during a year), semi-annual (twice a year) or annual payments.

DiscountWhen the price of a security is trading below the par value or the face value (FV), it is said to be trading at discount. The value of the discount is the difference between the FV and the Price. For example, if a security with a FV of 100 is trading at Rs.99, the discount is Rs.1.

Duration (Macaulay Duration)Duration of a bond is the number of years taken to recover the initial investment of a bond.

Related Reference:What is Duration?

Face ValueFace value is the amount that is to be paid to an investor at the maturity date of the security. Debt securities can be issued at varying face values; however in India they typically have a face value of Rs.100. The face value is also known as the repayment amount. This amount is also referred as redemption value, principal value (or simply principal), maturity value or par value.

Floating-Rate BondBonds whose coupon rate is re-set at predefined intervals and is based on a pre-specified market based interest rate.

Gilt/ Government Securities (G-Secs)Government securities are also known as gilts or gilt edged securities. Government security means a security created and issued by the Government for the purpose of raising a public loan or for any other purpose as may be notified by the Government in the Official Gazette and having one of the forms mentioned in The Government Securities Act, 2006.

Market Lot

Market lot refers to the standard value of the trades that happen in the market. The standard market lot size in the Government securities market is Rs. 5 crore in face value terms.

Maturity Date

Maturity date is the date when the principal (face value) is paid back. The final coupon and the face value of a debt security are repaid to the investor on the maturity date. The time to maturity can vary from short term (1 year) to long term (30 years).

Non-Competitive Bid

Non-competitive bidding means the bidder would be able to participate in the auctions of dated government securities without having to quote the yield or price in the bid. The allotment to the non-competitive segment will be at the weighted average rate that will emerge in the auction on the basis of competitive bidding. It is an allocating facility wherein a part of total securities are allocated to bidders at a weighted average price of successful competitive bid.

Odd Lot

Transactions of any value other than the standard market lot size of Rs. 5 crore are referred to as odd lot. Generally the value is less than the Rs. 5 crore with a minimum of Rs.10, 000/-. Odd lot transactions are generally done by the retail and small participants in the market.

Par

Par value is nothing but the face value of the security which is Rs. 100 for Government securities in India. When the price of a security is equal to face value, the security is said to be trading at par.

Premium

When the price of a security is above the par value or the face value (FV), the security is said to be trading at premium. The value of the premium is the difference between the price and the face value. For example, if a security with a FV of Rs. 100 is trading at Rs.102, the premium is Rs.2.

Price

The price quoted is for per Rs. 100 of face value. Like any other financial instrument, the price of the G-Sec is equal to the present value of all the future cash flows. This price is based on a number of factors. In the secondary market, where already-issued debt securities are bought and sold between investors, the price one pays for a bond is based on a host of variables, including market interest rates, accrued interest, supply and demand, credit quality, maturity date, and state of issuance, market events and the size of the transaction.

Primary Dealers

Primary dealers are entities that are appointed to play role of intermediary between the issuer of the G-Secs and the market. They are also known as market makers. Their obligations include making continuous bids and offer price in the marketable government securities or submitting reasonable bids in the auctions.

Real Time Gross Settlement (RTGS) system

RTGS system is a funds transfer mechanism for transfer of money from one bank to another on a real time and on gross basis. This is the fastest possible money transfer system through the banking channel. Settlement in real time means payment transaction is not subjected to any waiting period. The transactions are settled as soon as they are processed. Gross settlement means the transaction is settled on one to one basis without bunching with any other transaction. Considering that money transfer takes place in the books of the Reserve Bank of India, this payment is taken as final and irrevocable.

Repo Rate

Repo rate is the return earned on a repo transaction expressed as an annual interest rate.

Residual Maturity

The remaining period until maturity date of a security is its residual maturity. For example, a security issued for an original term to maturity of 10 years, after 2 years, will have a residual maturity of 8 years.

Secondary Market

Secondary market refers to the buying and selling that goes on after the initial public sale of the security. This market is different from the primary or initial market when securities are sold for the first time.

Tap Sale

Under Tap sale, a certain amount of securities is created and made available for sale, generally with a minimum price, and is sold to the market as bids are made. These securities may be sold over a period of day or even weeks; and authorities may retain the flexibility to increase the (minimum) price if demand proves to be strong or to cut it if demand weakens. Tap and continuous sale are very similar, except that with Tap sale the debt manager tends to take a more pro-active role in determining the availability and indicative price for tap sales. Continuous sale are essentially at the initiative of the market.

Treasury Bills

Debt obligations of the government that have maturities of one year or less are normally called Treasury Bills or T-Bills. They are instruments issued at a discount to the face value and form an integral part of the money market.

Underwriting

The arrangement by which investment bankers undertake to acquire any unsubscribed portion of a primary issuance of a security

Weighted Average Price/ Yield

It is the weighted average mean of the price/ yield where weight being the amount used at that price/ yield. The allotment to the non-competitive segment will be at the weighted average price/yield that will emerge in the auction on the basis of competitive bidding.

Yield or Current Yield

Yield is the annual percentage rate of return earned on a security. Yield is a function of a securitys purchase price and coupon interest rate. Yield fluctuates according to numerous factors including global markets and the economy.

Please note that, the current yield does not include any of the capital gains or the losses that an investor would make if the bond were bought at a discount or a premium. Due to this we can also use the Adjusted Current Yield

Yield to Maturity (YTM)

Yield to maturity is the total return one would except to receive if the security is being held until maturity. Yield to maturity is essentially the discount rate at which the present value of future payments (investment income and return of principal) equals the price of the security.

Yield Curve

The graphical relationship between yield and maturity among bonds of different maturities and the same credit quality. This line shows the term structure of interest rates. It also enables investors to compare debt securities with different maturities and coupons.

Some Useful Information

What are Fixed Income Securities?A fixed-income security is a debt instrument issued by a government or any other entity to finance and expand their operations.Fixed-income securities provide investors a return in the form of fixed periodic payments and eventual return of principal at maturity.

What is Money Market? While the Government Securities (G-Secs) market generally caters to the investors with a long term investment horizon, the money market provides investment avenues of short term tenor.

Money market transactions are generally used for meeting short term liquidity mismatches.

By definition, money market is for a maximum tenor of up to one year. Within the one year, depending upon the tenors, money market is classified into:

Overnight market - The tenor of transactions is one working day. Notice money market The tenor of the transactions is from 2 days to 14 days. Term money market The tenor of the transactions is from 15 days to one year.

The money market is regulated by the RBI. All the above mentioned money market transactions should be reported on the Negotiated Dealing System (NDS)

What is a Certificate of Deposit (CD)?

CDs are short-term borrowings in the form of Usance Promissory Notes having a maturity of not less than 15 days up to a maximum of one year. CDs are subject to payment of Stamp Duty under Indian Stamp Act, 1899 (Central Act) They are like bank term deposits accounts. Unlike traditional time deposits these are freely negotiable instruments and are often referred to as Negotiable Certificate of Deposits

Features of CD

All scheduled banks (except regional rural banks (RRBs) and Co-operative banks) are eligible to issue CDs Issued to individuals, corporations, trusts, funds and associations They are issued at a discount rate freely determined by the issuer and the market/investors Freely transferable by endorsement and delivery. At present CDs are issued in physical form

These are issued in denominations of Rs.5 Lakh initially and Rs. 1 Lakh thereafter. Bank CDs have maturity up to one year. Minimum period for a bank CD is fifteen days. Financial Institutions are allowed to issue CDs for a period between 1 year and up to 3 years. CDs issued by All India Financial Institutions (AIFI) are issued in physical form and at a discount to the face value. SOURCE: FIMMDA

What is a Commercial Paper (CPs)?

CPs are short term borrowings by Corporates, Financial Institutions, Money Market. CPs when issued in Physical Form are negotiable by endorsement and delivery and hence highly flexible instruments Issued subject to minimum of Rs 5 lakh and in the multiples of Rs. 5 lakh thereafter Maturity is 15 days to 1 year Unsecured and backed by credit of the issuing company Can be issued with or without Backstop facility (facility to advance funds only when a borrower cannot obtain funds under short term instruments like CPs etc) of Bank or a financial institution

What is a Fixed Deposit?

A fixed deposit account allows an investor to deposit his money for a set period of time in the bank, thereby earning a higher rate of interest in return.

What is Over the Counter (OTC)?

Over-the-counter (OTC) or off-exchange trading is to trade financial instruments such as stocks, bonds, commodities or derivatives directly between two parties. It is contrasted with exchange trading, which occurs via facilities constructed for the purpose of trading (i.e. exchanges), such as futures exchanges or stock exchanges.

What is a Credit Default Swap?

A credit default swap (CDS) is an agreement that the seller of the CDS will compensate the buyer in the event of a loan default. The buyer of the CDS makes a series of payments (the CDS "fee" or "spread") to the seller and, in exchange, receives a payoff if the loan defaults. In the event of default the buyer of the CDS receives compensation (usually the face value of the loan), and the seller of the CDS takes possession of the defaulted loan. However, anyone can purchase a CDS, even buyers who do not hold the loan instrument and who have no direct insurable interest in the loan (these are called "naked" CDSs). If there are more CDSs contracts outstanding than bonds in existence, a protocol exists to hold a credit event auction; the payment received is usually substantially less than the face value of the loanSOURCE: Wikipedia

What is an Interest Rate Swap?

Interest rate swaps are simply the exchange of one set of cash flows (based on interest rate specifications) for another. Because they trade OTC, they are really just contracts set up between two or more parties, and thus can be customized in any number of ways.Generally speaking, swaps are sought by firms that desire a type of interest rate structure that another firm can provide less expensively. SOURCE: Investopedia

What is a Call money market?

Call money market is a market for uncollateralized lending and borrowing of funds. This market is predominantly overnight and is open for participation only to scheduled commercial banks and the primary dealers.

What are a Repo and a Reverse Repo Rate? Repo (Repurchase) rate is the rate at which the RBI lends shot-term money to the banks against securities. When the repo rate increases borrowing from RBI becomes more expensive. Therefore, we can say that in case, RBI wants to make it more expensive for the banks to borrow money, it increases the repo rate; similarly, if it wants to make it cheaper for banks to borrow money, it reduces the repo rate

Reverse Repo rate is the rate at which banks park their short-term excess liquidity with the RBI. The banks use this tool when they feel that they are stuck with excess funds and are not able to invest anywhere for reasonable returns. An increase in the reverse repo rate means that the RBI is ready to borrow money from the banks at a higher rate of interest. As a result, banks would prefer to keep more and more surplus funds with RBI.Thus, we can conclude that Repo Rate signifies the rate at which liquidity is injected in the banking system by RBI, whereas Reverse repo rate signifies the rate at which the central bank absorbs liquidity from the banks

What is a Repo market?

Repo or ready forward contract is an instrument for borrowing funds by selling securities with an agreement to repurchase the said securities on a mutually agreed future date at an agreed price which includes interest for the funds borrowed. The reverse of the repo transaction is called reverse repo which is lending of funds against buying of securities with an agreement to resell the said securities on a mutually agreed future date at an agreed price which includes interest for the funds lent. It can be seen from the definition above that there are two legs to the same transaction in a repo/ reverse repo. The duration between the two legs is called the repo period. Predominantly, repos are undertaken on overnight basis, i.e., for one day period. Settlement of repo transactions happens along with the outright trades in government securities. The consideration amount in the first leg of the repo transactions is the amount borrowed by the seller of the security. On this, interest at the agreed repo rate is calculated and paid along with the consideration amount of the second leg of the transaction when the borrower buys back the security. The overall effect of the repo transaction would be borrowing of funds backed by the collateral of Government securities. As part of the measures to develop the corporate debt market, RBI has permitted select entities (scheduled commercial banks, all-India Financial Institutions, Non Banking Financial Companies, mutual funds, housing finance companies, insurance companies) to undertake repo in corporate debt securities This is similar to repo in G-Secs except that corporate debt securities are used as collateral for borrowing funds Only listed corporate debt securities that are rated AA or above by the rating agencies are eligible to be used for repo Commercial paper, certificate of deposit, non-convertible debentures of original maturity less than one year are not eligible for the purpose These transactions take place in the OTC market and are required to be reported on FIMMDA platform within 15 minutes of the trade for dissemination of information They are also to be reported on the clearing house of any of the exchanges for the purpose of clearing and settlement

What is a Cash Reserve Ratio (CRR)?

Banks in India are required to hold a certain proportion of their deposits in the form of cash. However please note that, Banks dont hold these as cash with themselves, but deposit such cash with RBI / currency chests, which is considered as equivalent to holding cash with RBI. This minimum ratio (that is the part of the total deposits to be held as cash) is stipulated by the RBI and is known as the CRR. Thus, when a banks deposits increase by Rs100, and if the cash reserve ratio is 5.50%, the banks will have to hold additional Rs 5.50 with RBI and Bank will be able to use only Rs 95.5 for investments and lending / credit purpose. Therefore, higher the ratio (i.e. CRR), the lower is the amount that banks will be able to use for lending and investment. This power of RBI to reduce the lendable amount by increasing the CRR makes it an instrument in the hands of a central bank through which it can control the amount that banks lend. Thus, it is a tool used by RBI to control liquidity in the banking system.

What is a Statutory Liquid Ratio (SLR)? This term is used by bankers and indicates the minimum percentage of deposits that the bank has to maintain in form of gold, cash or other approved securities. Thus, we can say that it is ratio of cash and some other approved securities to liabilities (deposits) It regulates the credit growth in India.

What are Open Market Operations (OMOs)?

OMOs are the market operations conducted by the RBI by way of sale/ purchase of G-Secs to/ from the market with an objective to adjust the rupee liquidity conditions in the market on a durable basis. When the RBI feels there is excess liquidity in the market, it resorts to sale of G-Secs thereby sucking out the rupee liquidity. Similarly, when the liquidity conditions are tight, the RBI will buy securities from the market, thereby releasing liquidity into the market.

What is meant by buyback of Government securities?

Buyback of Government securities is a process whereby the Government of India and State Governments buy back their existing securities from the holders. The objectives of buyback are as follows: Reduction of cost (by buying back high coupon securities) Reduction in the number of outstanding securities and improving liquidity in the Government securities market (by buying back illiquid securities) Infusion of liquidity in the systemGovernment makes provisions in their budget for buying back of existing securities. Buyback can be done through an auction process or through the secondary market route, i.e., NDS/NDS-OM.

What is Liquidity Adjustment Facility (LAF)?

LAF is a facility extended by the RBI to the scheduled commercial banks and primary dealers to avail of liquidity in case of requirement or park excess funds with the RBI in case of excess liquidity on an overnight basis against the collateral of Government securities including State Government securities. Basically LAF enables liquidity management on a day to day basis. LAF is an important tool of monetary policy and enables RBI to transmit interest rate signals to the market. The operations of LAF are conducted by way of repurchase agreements with RBI being the counter-party to all the transactions. The interest rate in LAF is fixed by the RBI from time to time. Currently the rate of interest on repo under LAF (borrowing by the participants) is 6.25% and that of reverse repo (placing funds with RBI) is 5.25%.

What is the role of the Clearing Corporation of India Limited (CCIL)?

The CCIL is the clearing agency for Government securities.

It acts as a Central Counter Party (CCP) for all transactions in Government securities itself between two counterparties thus neutralizing the counterparty risk

On this platform, anonymous trading takes place

In effect, during settlement, the CCP becomes the seller to the buyer and buyer to the seller of the actual transaction.

All outright trades undertaken in the OTC market and on the Negotiated Dealing System Open Market (NDS-OM) platform are cleared through the CCIL.

Once CCIL receives the trade information, it works out participant-wise net obligations on both the securities and the funds leg.

The payable / receivable position of the constituents is reflected against their respective custodians.

CCIL forwards the settlement file containing net position of participants to the RBI where settlement takes place by simultaneous transfer of funds and securities under the Delivery versus Payment system.

CCIL also guarantees settlement of all trades in Government securities. That means, during the settlement process, if any participant fails to provide funds/ securities, CCIL will make the same available from its own means. For this purpose, CCIL collects margins from all participants and maintains Settlement Guarantee Fund.Related Reference:Delivery vs. Payment system

What is Collateralized Borrowing and Lending Obligation (CBLO)

CBLO is a money market instrument operated by the Clearing Corporation of India Ltd. (CCIL), for the benefit of the entities who have either no access to the interbank call money market or have restricted access in terms of ceiling on call borrowing and lending transactions. CBLO is a discounted instrument available in electronic book entry form for the maturity period ranging from one day to ninety days (up to one year as per RBI guidelines). In order to enable the market participants to borrow and lend funds, CCIL provides the Dealing System through Indian Financial Network (INFINET), a closed user group to the Members of the Negotiated Dealing System (NDS) who maintain Current account with RBI and through Internet for other entities who do not maintain Current account with RBI.By participating in the CBLO market, CCIL members can borrow or lend funds against the collateral of eligible securities. Eligible securities are Central Government securities including Treasury Bills, and such other securities as specified by CCIL from time to time. Borrowers in CBLO have to deposit the required amount of eligible securities with the CCIL based on which CCIL fixes the borrowing limits. CCIL matches the borrowing and lending orders submitted by the members and notifies them. While the securities held as collateral are in custody of the CCIL, the beneficial interest of the lender on the securities is recognized through proper documentation.

What are the role and functions of FIMMDA?

The Fixed Income Money Market and Derivatives Association of India (FIMMDA), is an association of Scheduled Commercial Banks, Public Financial Institutions, Primary Dealers and Insurance Companies

FIMMDA is a voluntary market body for the bond, money and derivatives markets.

FIMMDA has members representing all major institutional segments of the market.

The membership includes Nationalized Banks such as State Bank of India, its associate banks and other nationalized banks;

Private sector banks such as ICICI Bank HDFC Bank IDBI Bank

Foreign Banks such as Bank of America ABN Amro Citibank,

Financial institutions such as IDFC EXIM Bank NABARD

Insurance Companies like Life Insurance Corporation of India (LIC) ICICI Prudential Life Insurance Company Birla Sun Life Insurance Company and all Primary Dealers

FIMMDA represents market participants and aids the development of the bond, money and derivatives markets.

It acts as an interface with the regulators on various issues that impact the functioning of these markets.

It also undertakes developmental activities, such as, introduction of benchmark rates and new derivatives instruments, etc.

It releases rates of various Government securities that are used by market participants for valuation purposes.

It also plays a constructive role in the evolution of best market practices by its members so that the market as a whole operates transparently as well as efficiently.

What is the role of National Securities Clearing Corporation Ltd. (NSCCL)?

The National Securities Clearing Corporation Ltd. (NSCCL) is a wholly owned subsidiary of NSE.

NSCCL carries out the clearing and settlement of the trades executed in the Equities and Derivatives segments and operates Subsidiary General Ledger (SGL) for settlement of trades in government securities.

It assumes the counter-party risk of each member and guarantees financial settlement.

It also undertakes settlement of transactions on other stock exchanges like, the Over the Counter Exchange of India.

NSCCL has successfully brought about an up-gradation of the clearing and settlement procedures and has brought Indian financial markets in line with international markets.

What is a debenture?

A Debenture is a debt security issued by a company (called the Issuer), which offers to pay interest in lieu of the money borrowed for a certain period. In essence it represents a loan taken by the issuer who pays an agreed rate of interest during the lifetime of the instrument and repays the principal normally, unless otherwise agreed, on maturity. These are long-term debt instruments issued by private sector companies. These are issued in denominations as low as Rs 1000 and have maturities ranging between one and ten years. Long maturity debentures are rarely issued, as investors are not comfortable with such maturities Debentures enable investors to reap the dual benefits of adequate security and good returns. Unlike other fixed income instruments such as Fixed Deposits, Bank Deposits they can be transferred from one party to another by using transfer from. Debentures are normally issued in physical form. However, Corporates/PSUs have started issuing debentures in Demat form. Generally, debentures are less liquid as compared to Public Sector Unit bonds and their liquidity is inversely proportional to the residual maturity. Debentures can be secured or unsecured.

What is Convexity?

Calculation of change in price due to change in yields based on duration works only for small changes in prices. This is because the relationship between bond price and yield is not strictly linear i.e., the unit change in price of the bond is not proportionate to unit change in yield. However, over large variations in prices, the relationship is curvilinear i.e., the change in bond price is either less than or more than proportionate to the change in yields. This is measured by a concept called convexity, which is the change in duration of a bond per unit change in the yield of the bond.

NOTE: The information provided in the above section has been sourced from various websites like RBI, NSE, and FIMMDA

AnalyticsWhat is time value of money? The concept of time value of money is based on the premise that an investor prefers to receive a payment of a fixed amount of money today, rather than an equal amount in the future, all else being equal. In particular, if one receives the payment today, one can then earn interest on the money until that specified future date, hence increasing the purchasing power of the investor.What is present value? Present value is the current worth of a future sum of money or stream of cash flows given a specified rate of return. Future cash flows are discounted at the discount rate, and the higher the discount rate, the lower the present value of the future cash flows. Determining the appropriate discount rate is the key to properly valuing future cash flows, whether they are earnings or obligations. This is also referred to as "discounted value". SOURCE: Investopedia

What is Yield? Yield refers to the percentage rate of return paid on a stock in the form of dividends, or the effective rate of interest paid on a bond or note. There are many different kinds of yields depending on the investment scenario and the characteristics of the investment. Yield to Maturity (YTM) is the most popular measure of yield in the Debt Markets and is the percentage rate of return paid on a bond, note or other fixed income security if you buy and hold the security till its maturity date. Current Yield is the coupon divided by the Market Price and gives a fair approximation of the present yield.Current Yield = Coupon of the Security (in %) x Face Value of the Security /Market Price of the SecurityMarket Price = 120, Coupon = 10.18% then Current Yield = (0.1018 x 100)/120 = 8.48%

How is Yield to Maturity computed? The calculation for YTM is based on the coupon rate, length of time to maturity and market price. It is the Internal Rate of Return on the bond and can be determined by equating the sum of the cash-flows throughout the life of the bond to zero. A critical assumption underlying the YTM is that the coupon interest paid over the life of the bond is assumed to be reinvested at the same rate. The YTM is basically obtained through a trial and error method by determining the value of the entire range of cash-flows for the possible range of YTMs so as to find the one rate at which the cash-flows sum up to zero.

How is the Price of a bond calculated? What is the total consideration amount of a trade and what is accrued interest? The price of a bond is nothing but the sum of present values all future cash flows of the bond. The interest rate used for discounting the cash flows is the Yield to Maturity (YTM) of the bond. Accrued interest is the interest calculated for the broken period from the last coupon day till a day prior to the settlement date of the trade. Since the seller of the security is holding the security for the period up to the day prior to the settlement date of the trade, he is entitled to receive the coupon for the period held. During settlement of the trade, the buyer of security will pay the accrued interest in addition to the agreed price and pays the consideration amount The price of the bond is usually in 2 decimal places

What is the relationship between yield and price of a bond? When the market price of the bond is less than the face value, i.e., the bond sells at a discount, Yield To Maturity (YTM) > current yield > coupon yield. When the market price of the bond is more than its face value, i.e., the bond sells at a premium, coupon yield > current yield > YTM. When the market price of the bond is equal to its face value, i.e., the bond sells at par, YTM = current yield = coupon yield.

How is the yield of a bond calculated?An investor who purchases a bond can expect to receive a return from one or more of the following sources: The coupon interest payments made by the issuer; Any capital gain (or capital loss) when the bond is sold; and Income from reinvestment of the interest payments that is interest-on-interest.The most commonly used yield measures by investors to measure the potential return from investing in a bond are briefly described below:

Coupon Yield The coupon yield is simply the coupon payment as a percentage of the face value. It refers to nominal interest payable on a fixed income security like G-Secs. This is the fixed return the Government (i.e., the issuer) commits to pay to the investor. Coupon yield thus does not reflect the impact of interest rate movement and inflation on the nominal interest that the Government pays.Coupon yield = Coupon Payment / Face ValueCoupon: 8.24, Face Value: Rs.100, Market Value: Rs.103.00, Coupon yield = 8.24/100 = 8.24%

Current Yield The current yield is simply the coupon payment as a percentage of the bonds purchase price.

It does not take into account the reinvestment of the interest income received periodically. It only considers the coupon interest and ignores other sources of return that will affect an investors return.Current yield = (Annual coupon rate / Purchase price) X100 The current yield for a 10 year 8.24% coupon bond selling for Rs.103.00 per Rs.100 par value is calculated below:Annual coupon interest = 8.24% x Rs.100 = Rs.8.24Current yield = (8.24/Rs.103)X100 = 8.00%

What is the day count conventions used in calculating bond yields?The conventions followed in Indian market are given below. Bond market: The day count convention followed is 30/360, which means that irrespective of the actual number of days in a month, the number of days in a month is taken as 30 and the number of days in a year is taken as 360. Money market: The day count convention followed is Actual/365, which means that the actual number of days in a month is taken for number of days (numerator) whereas the number of days in a year is taken as 365 days. Please note that: In case of Treasury bills, which are essentially money market instruments, money market convention is followed. SOURCE: BSE

How is the yield of a Treasury bill calculated?The yield on the Treasury bill is calculated in the following manner

Wherein;P Purchase priceD Days to maturityDay Count: For Treasury Bills, D = [actual number of days to maturity/365]

What is Duration?Duration refers to the payback period of a bond to break even, i.e., the time taken for a bond to repay its own purchase price. In other words, it is a measurement of how long, in years, it takes for the price of a bond to be repaid by its internal cash flows. It is an important measure for investors to consider, as bonds with higher durations carry more risk and have higher price volatility than bonds with lower durations. Calculation for Duration First, each of the future cash flows is discounted to its respective present value for each period. Since the coupons are paid out every six months, a single period is equal to six months and a bond with two years maturity will have four time periods. Second, the present values of future cash flows are multiplied with their respective time periods (these are the weights). That is the Present Value (PV) of the first coupon is multiplied by 1, PV of second coupon by 2 and so on. Third, the above weighted PVs of all cash flows are added and the sum is divided by the current price (total of the PVs in step 1) of the bond. The resultant value is the duration in no. of periods. Since one period equals to six months, to get the duration in no. of year, divide it by two. This is the time period within which the bond is expected to pay back its own value if held till maturity. The rate at which the above cash flows are discounted is the yield on the bond.

What are Clean Price and the Dirty Price in reference to trading in G-Secs?G-Secs are traded on a clean price (Trade price) but settled on the dirty price (Trade price + Accrued Interest). This happens, as the coupon payments are not discounted in the price, as is the case in the other non-govt. debt instruments.

How are the Face Value, Trade Value and the settlement value different from each other? The Cumulative face Value of the securities in a transaction is the face Value of the Transaction and is normally the identifiable feature of each transaction. The Trade value is the cumulative price of the traded G-Secs (i.e. no. of securities multiplied by the price) The Settlement value will be the trade value plus the Accrued Interest. The Accrued Interest per unit of the Bond is calculated as = Coupon of Bond x Face Value of the G-Sec. (100) x (No. of Days from Interest Payment Date to Settlement Date)/360. In computing the no. of days between the Interest Payment Date and the Settlement Date of the trade, only one of the two days is to be included. SOURCE: BSE

What are credit spreads?

The difference between the yield on a corporate bond and a government bond is called the credit spread (sometimes just called the yield spread).

As the illustrated yield curves demonstrate, the credit spread is the difference in yield between a corporate bond and a government bond at each point of maturity. As such, the credit spread reflects the extra compensation investors receive for bearing credit risk. So, the total yield on a corporate bond is a function of both the Treasury yield and the credit spread, which is greater for lower-rated bonds. If the bond is callable by the issuing corporation, the credit spread increases more, reflecting the added risk that the bond may be called.SOURCE: InvestopediaNOTE: The information provided in the above section has been sourced from various websites like RBI, NSE, and FIMMDATop

Government Securities MarketWhat is a Debt Market?Debt market is a platform for trading (buying and selling) of the fixed income securities. These fixed income securities are issued by: Central and State Governments Municipal Corporations Govt. bodies Commercial entities Financial Institutions Banks Public Sector Units Public Ltd. CompaniesA debt market is also known as a fixed income market as debt instruments mostly pay fixed returns or coupons. SOURCE: RBIPlease find below a table showing growth in the Indian Wholesale Debt Market Business.**NSETopRelated Reference:Fixed Income Securities

Who are the market participants in the Government Securities (G-Secs) Market?

Demand Side Participants

Supply Side Participants

Reserve Bank of IndiaRBI acts as an investment banker to the government, raises funds for the government through bond and t-bill issues, and also participates in the market through open- market operations, in the course of conduct of monetary policy.

Central GovernmentThey raise money through bond issuances, to fund budgetary deficits and other short and long term funding requirements

BanksThese are the largest investors in the debt markets; particularly the Treasury bond and bill markets on statutory basis

They are also very large participants in the call money and overnight markets. They are arrangers of commercial paper issues of Corporates.

They are also active in the inter-bank term markets and repo markets for their short term funding requirements.

Reserve Bank of IndiaThe RBI regulates the bank rates and repo rates and uses these rates as tools of its monetary policy. Changes in these benchmark rates directly impact debt markets and all participants in the market.

Through open- market operations, in the course of conduct of monetary policy, it creates supply of Government Bonds and Bills.

Mutual fundsThey have emerged as another important player in the debt markets, owing primarily to the growing number of bond funds that have mobilised significant amounts from the investors.

Most mutual funds also have specialised bond funds such as gilt funds and liquid funds.

Mutual funds are not permitted to borrow funds, except for very short-term liquidity requirements. Therefore, they participate in the debt markets pre-dominantly as investors, and trade on their portfolios quite regularly.

Primary dealers These are market intermediaries appointed by the RBI, who underwrite and make market (i.e. buy& sell) in government securities and bills.

Foreign Institutional Investors (FIIs)FIIs are permitted to invest in Dated Government Securities and Treasury Bills within certain specified limits.

State Governments, municipalities and local bodiesThese participants issue securities in the debt markets to fund their developmental / infrastructure projects, as well as to finance their budgetary deficits. Please note that there has not been enough participation from the municipal and local bodies

Provident funds PFs are large investors in the bond markets as their prudential regulations governing the deployment of the funds they mobilise, mandate investments pre-dominantly in treasury and Public Sector Units bonds. They are, however, not very active traders in their portfolio, as they are not permitted to sell their holdings, unless they have a funding requirement that cannot be met through regular accruals and contributions.

Public sector units (PSUs)These entities are large issuers of debt securities. They use the funds for raising funds to meet their short term and long term requirements.

Charitable Institutions, Trusts and Societies. These are also large investors in the debt markets. They are, however, governed by their rules and byelaws with respect to the kind of bonds they can buy and the manner in which they can trade on their debt portfolios.

Corporate treasuriesThese entities issue short and long term paper to meet their financial requirements.

Retail Investors / High Net Worth Individuals (HNWI)These investors have also started taking keen interest in this market due to the stability and risk free returns it offers

Public sector financial institutionsThese entities regularly access debt markets with bonds for funding their long term financing requirements and working capital needs.

Corporates These investors also buy the government securities to manage their overall portfolio risk.

SOURCE: FIMMDA

Please note that there is very less direct participation from the retail, HNWI and corporate investors in the Government Securities market as compared to the other participants. The markets are mostly dominated by wholesale players. Retail and smaller investors mostly participate though debt mutual funds or listed debentures and bonds in NSE and BSE. Most of the demand side players in due course become supply side players too.

Related references:Government SecuritiesOpen market operationsStatutory Liquid RatioDated Government SecuritiesTreasury Bills

Did you know?Traditionally, the Banks have been the largest investors in G-Secs accounting for more than 60% of the transactions in the Wholesale Debt Market.The Banks are a prime and captive investor base for G-secs as they are normally required to maintain an SLR of 24% but it has been observed that the banks normally invest 5% to 10% more than the normal requirement in G-Secs because of the risk free nature of the G-Secs and also the greater returns in G-Secs as compared to other investments of comparable nature

SOURCE: RBI

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Participants and products in the Indian G-Secs markets

SOURCE: FIMMDA and NSE

What are the advantages for investing in Fixed Income securities? The investors can achieve diversification from uncertainties in other risk asset classes like equities, real estate etc There are no credit risks especially in Government securities If timed properly then there is an advantage of capital gains These instruments offer a predictable stream of payments by way of interest and repayment of principal at the maturity of the instrument. These are issued by the eligible entities against the moneys borrowed by them from the investors in these instruments The investors can preserve and increase their invested capital and also ensure the receipt of dependable interest income. The investors can even neutralize the default risk on their investments by investing in Govt. securities, which are normally referred to as risk-free investments due to the sovereign guarantee on these instruments.SOURCE: RBITopWhat are the risks associated with Indian Debt Markets?

Risks associated with the Indian Debt marketsIf Investments are held till maturityIf Investments are not held till maturity

If an investment is held till maturity then there will be no default risk ( for G-Secs) and the interest risk, however there will be a re-investment risk from the coupons received

For non government debt investments, apart from above there will also be a counter party risk where the central clearing mechanism is not at work; however they will not face any return volatilityIf an investment is not held till maturity then an investor will face a interest rate risk (also known as market risk)re-investment risk

However there will be volatility in the returns achieved

Default RiskThis risk can be defined as the risk that an issuer of a bond may be unable to make timely payment of interest or principal on a debt security or to otherwise comply with the provisions of a bond indenture and is also referred to as credit risk.

Default risk can be mitigated by Credit Default Swaps, subject to RBI regulations.

Interest Rate RiskThis risk can be defined as the risk emerging from an adverse change in the interest rate prevalent in the market so as to affect the yield on the existing instruments.

Interest rate risk can be mitigated by holding securities till maturity.

Reinvestment Rate RiskThis risk can be defined as the probability of a fall in the interest rate resulting in a lack of options to invest the interest received at regular intervals at higher rates at comparable rates in the market.

Reinvestment Rate risk can also be mitigated by Credit Default Swaps, subject to RBI regulations.

Counter Party RiskThis risk is the normal risk associated with any transaction and refers to the failure or inability of the opposite party to the contract to deliver either the promised security or the sale-value at the time of settlement. This risk occurs when the transactions are not settled by the Clearing Corporation of India Ltd (CCIL).

Please note that Some of the above tools are not available to the retail investors due to high market lots. Advanced market risk management techniques involve use of derivatives like Interest Rate Swaps (IRS) through which the nature of cash flows could be altered. However, these are complex instruments requiring advanced level of expertise for proper understanding. Adequate caution, therefore, need to be observed for undertaking the derivatives transactions and such transactions should be undertaken only after having complete understanding of the associated risks and complexities.

Related References:Role of CCILSettlement Procedure by CCILCredit Default SwapsInterest rate SwapsSOURCE: RBITopWhat factors determine the interest rate in the Debt market?Some of the factors which determine the interest rate in the debt market are: Monetary policy driven by the RBI Liquidity available within the banks GDP growth rates Global economic scenarios Demand for money Supply of money Government borrowings Inflation rateSOURCE: FIMMDARelated Reference:What factors affect the price of a G Sec?Top

What is a Government Security (G-Secs)? A Government security is a tradable instrument issued by the Central or the State Governments. It acknowledges the Indian Governments debt obligation. Such securities are short term (usually called treasury bills, with original maturities of less than one year) or long term (usually called Government bonds or dated securities with original maturity of one year or more). In India, the Central Government issues both, treasury bills and bonds or dated securities while the State Governments issue only bonds or dated securities, which are called the State Development Loans (SDLs). Government securities carry practically no risk of default and, hence, are called risk-free instruments. SOURCE: RBITopWhat are Treasury Bills?Treasury bills or T-bills, are money market instruments, which Are short term debt instruments issued by the Government of India Are presently issued in three tenors, namely, 91 day, 182 day and 364 day Are zero coupon securities and pay no interest Please note that the RBI releases an annual calendar of T-bill issuances for a financial year in the last week of March of the previous financial year. They announce the issue details of T-bills through a press release every week. SOURCE: RBITopWhat are Cash Management Bills (CMBs)? These are issued by Government of India to meet the temporary mismatches in their cash flow They have the generic character of T-bills but are issued for maturities less than 91 days Like T-bills, they are also issued at a discount and redeemed at face value at maturity. The tenure, notified amount and date of issue of the CMBs depend upon the temporary cash requirement of the Government. The announcement of their auction is made by RBI through a Press Release which is issued one day prior to the date of auction. The settlement of the auction is on T+1 basis. Investment in CMBs is also reckoned as an eligible investment in Government securities by banks for Statutory Liquid Rate (SLR) purpose under Section 24 of the Banking Regulation Act, 1949. SOURCE: RBITop

What are Dated Government Securities? Dated Government securities are long term securities and carry a fixed or floating coupon (interest rate) which is paid on the face value, payable at fixed time periods (usually half-yearly). The tenor of dated securities can be up to 30 years The Public Debt Office (PDO) of the RBI acts as the registry / depository of Government securities and deals with the issue, interest payment and repayment of principal at maturity. Most of the dated securities are fixed coupon securities. SOURCE: RBITopWhat are Fixed Rate Bonds? These are bonds on which the coupon rate is fixed for the entire life of the bond. Most Government bonds are issued as fixed rate bonds. SOURCE: RBI

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Did you know?

Majority of the government and corporate bonds issued are fixed rate bonds. Indian markets have less of floating rate bonds, zero coupon bonds and capital indexed bonds due to its liquidity, demand and pricing issue

What are Floating Rate Bonds? These are securities which do not have a fixed coupon rate. The coupon is re-set at pre-announced intervals (say, every six months or one year) by adding a spread over a base rate. SOURCE: RBI

TopWhat are Zero Coupon Bonds? These are bonds with no coupon payments. Like Treasury Bills, they are issued at a discount to the face value. The Government of India issued such securities in the nineties; it has not issued zero coupon bonds after that.SOURCE: RBITopWhat are Capital Indexed bonds? These are bonds in which the principal is linked to an accepted index of inflation with a view to protecting the holder from inflation. SOURCE: RBITop

Did you know? The government is currently working on a fresh issuance of Inflation Indexed Bonds wherein payment of both, the coupon and the principal on the bonds, will be linked to an Inflation Index (Wholesale Price Index). In the proposed structure, the principal will be indexed and the coupon will be calculated on the indexed principal. In order to provide the holders protection against actual inflation, the final WPI will be used for indexation.

What are Bonds with Call / Put options? These are bonds with features of optionality wherein the issuer can have the option to buy-back (call option) or the investor can have the option to sell the bond (put option) to the issuer during the currency of the bond. SOURCE: RBITop

What are special securities? Government issues special securities to entities like Oil Marketing Companies, Fertilizer Companies, the Food Corporation of India, etc. as compensation to these companies in lieu of cash subsidies. These securities are usually long dated securities carrying coupon with a spread of about 20-25 basis points over the yield of the dated securities of comparable maturity. These securities are, however, not eligible SLR securities but are eligible as collateral for market repo transactions. The beneficiary oil marketing companies may divest these securities in the secondary market to banks, insurance companies / Primary Dealers, etc., for raising cash. SOURCE: RBITop

Did you know?Steps are being taken to introduce new types of instruments like STRIPS (Separate Trading of Registered Interest and Principal of Securities).STRIPS are instruments wherein each cash flow of the fixed coupon security is converted into a separate tradable Zero Coupon Bond and traded. For example, when Rs.100 of the 8.24%GS2018 is stripped, each cash flow of coupon (Rs.4.12 each half year) will become coupon STRIP and the principal payment (Rs.100 at maturity) will become a principal STRIP.STRIPS will also provide institutional investors with an additional instrument for their asset- liability management. Further, as STRIPS have zero reinvestment risk, being zero coupon bonds, they can be attractive to retail/non-institutional investors.

Who regulates Indian G-Secs market?The Reserve Bank of India controls and regulates the G-Secs Market.Top

Why should one invest in G-Secs?Investing in G-Secs has the following advantages: Besides providing a return in the form of coupons (interest), they offer the maximum safety as they carry the Sovereigns commitment for payment of interest and repayment of principal. They can be held in book entry, i.e., dematerialized/ scrip less form, thus, obviating the need for safekeeping. They are available in a wide range of maturities from 91 days to as long as 30 years to suit the duration of a bank's liabilities. They can be sold in market lots in the secondary market to meet cash requirements. For retail investors, retail lots can be sold on NSE or the BSE They can also be used as collateral to borrow funds in the repo market. The settlement system for trading in G-Secs, which is based on Delivery versus Payment (DvP), is a very simple, safe and efficient system of settlement. The details about this system have been explained later below. Their prices are readily available due to a liquid and active secondary market and a transparent price dissemination mechanism. SOURCE: RBIRelated References:Delivery vs. Payment

TopWhat are the Dos and Donts prescribed by the RBI for dealing in government securities?

SOURCE: RBITopWhat are auctions and how are the G-Secs issued through these auctions? An auction is a price building process driven by a competitive bidding process, wherein the seller receives a collective assessment of prospective value of the asset to be sold. G-Secs are issued through auctions conducted by the RBI. (detailed information about type of auctions is given below) These auctions are conducted on the electronic platform called the NDS (negotiated dealing system) which is also called an Auction platform. Commercial banks, scheduled urban co-operative banks, Primary Dealers, insurance companies and provident funds, who maintain funds account (current account) and securities accounts (SGL Subsidiary General Ledger account) with RBI, are members of this electronic platform. All members of PDO-NDS (public debt office negotiated dealing system) can place their bids in the auction through this electronic platform. All non-NDS members including non-scheduled urban co-operative banks can participate in the primary auction through scheduled commercial banks or Primary Dealers. For this purpose, the urban co-operative banks need to open a securities account with a bank / Primary Dealer such an account is called a Gilt Account. (A Gilt Account is a dematerialized account maintained by a scheduled commercial bank or Primary Dealer for its constituent (e.g., a non-scheduled urban co-operative bank)). The RBI, in consultation with the Government of India, issues an indicative half-yearly auction calendar which contains information about the amount of borrowing, the tenor of security and the likely period during which auctions will be held. A Notification and a Press Communication giving exact particulars of the securities, viz., name, amount, and type of issue and procedure of auction are issued by the Government of India about a week prior to the actual date of auction. RBI places the notification and a Press Release on its website (www.rbi.org.in) and also issues an advertisement in leading English and Hindi newspapers. SOURCE: RBI

Related References:How securities are settled in the primary market?How securities are settled in the secondary market?

Please refer the following document for an example of RBIs press release for auction

Please refer the following document for an example of RBIs declaration of the auction result

Please refer the following document for an example of RBIs issuance calendar

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What are the different types of auctions used for issue of G-Secs?Before the introduction of auctions, the interest rates (coupon rates) on G-Secs were administratively fixed by the Government of India. With the introduction of auctions, these get fixed through a market based price discovery process.

Yield Based AuctionA yield based auction is generally conducted when a new G-Sec is issued. Investors bid in yield terms up to two decimal places (for example, 8.19%)Bids are then arranged in ascending order and the cut-off yield is arrived at the yield corresponding to the notified amount of the auction. The cut-off yield is taken as the coupon rate for the security. Successful bidders are those who have bid at or below the cut-off yield. Bids which are higher than the cut-off yield are rejected.

Price Based AuctionA price based auction is conducted when Government of India re-issues G-Secs issued earlier. Bidders quote in terms of price per Rs.100 of face value of the security (e.g., Rs.102.00)Bids are arranged in descending order and the successful bidders are those who have bid at or above the cut-off price. Bids which are below the cut-off price are rejected.

Uniform price auctionIn a Uniform Price auction, all the successful bidders are required to pay for the allotted quantity of G-secs at the same rate, i.e., at the auction cut-off rate, irrespective of the rate quoted by them. Multiple price auctionsIn a Multiple Price auction, the successful bidders are required to pay for the allotted quantity of G-secs at the respective price / yield at which they have bid.Top

What is competitive and non competitive bidding?Competitive Bidding

Non Competitive Bidding

In a competitive bidding, an investor bids at a specific price / yield and is allotted securities if the price / yield quoted is within the cut-off price / yield

Under the scheme, eligible investors apply for a certain amount of securities in an auction without mentioning a specific price / yield.

Competitive bids are made by well informed investors such as banks, financial institutions, primary dealers, mutual funds, and insurance companies.Non-competitive bidding is open to individuals, Hindu Undivided Families, Regional Rural Banks (RRBs), co-operative banks, firms, companies, corporate bodies, institutions, provident funds, and trusts.

This kind of bidding is useful for retail / small investors who can participate in the primary auction by opening a Constituents' Subsidiary General Ledger Account (CSGL) with any bank or a primary dealer

Multiple bidding is also allowed, i.e., an investor may put in several bids at various price/ yield levels.The participants in non-competitive bidding are, however, required to hold a gilt account with a bank. RRBs and co-operative banks which hold SGL and Current Account with the RBI can also participate under the scheme of non-competitive bidding without holding a gilt account

SOURCE: RBITop

How and in what form can G-Secs be held?The Public Debt Office (PDO) of the RBI, Mumbai acts as the registry and central depository for the G-Secs. These may be held by investors either as physical stock or in dematerialized form. However, please note that from May 20, 2002, it is mandatory for all the RBI regulated entities to hold and transact in G-Secs only in dematerialized (SGL) form.

Physical Form These are held as stock certificates which cannot be transferred by way of endorsement and delivery. These are transferred by executing a transfer form as the ownership and transfer details are recorded in the books of PDO. The transfer of a stock certificate is final and valid only when the same is registered in the books of PDO.Please refer below for a copy of a government security stock certificate

Demat FormThe holders can maintain their securities in dematerialsed form in either of the two ways: SGL Account: Reserve Bank of India offers Subsidiary General Ledger Account (SGL) facility to select restricted entities who can maintain their securities in SGL accounts maintained with the Public Debt Offices of the Reserve Bank of India. Gilt Account: As the eligibility to open and maintain an SGL account with the RBI is restricted, an investor including a retail investor has the option of opening a Gilt Account with a bank or a Primary Dealer which is eligible to open a Constituents' Subsidiary General Ledger Account (CSGL) with the RBI. Under this arrangement, the bank or the Primary Dealer, as a custodian of the Gilt Account holders, would maintain the holdings of its constituents in a CSGL account (which is also known as SGL II account) with the RBI. The servicing of securities held in the Gilt Accounts is done electronically, facilitating hassle free trading and maintenance of the securities. Please note that the investors also have the option of holding G-Secs in a dematerialized account with a depository (NSDL / CDSL, etc.). This facilitates their trading on the stock exchanges. SOURCE: RBI

TopHow does the trading in Government securities take place?The trading for government securities can be done in the following ways: Over the counter (OTC) / Telephone

Please click on the below attachment for an example of a Deal Slip

Negotiated Dealing Systems (NDS) NDS facilitates the members to submit electronically, bids or applications for primary issuance of G-Secs when auctions are conducted. NDS also provides an interface to the Securities Settlement System (SSS) of the PDO, RBI, Mumbai thereby facilitating settlement of transactions in G-Secs (both outright and repos) conducted in the secondary market. Membership to the NDS is restricted to members holding SGL and/or Current Account with the RBI, Mumbai.

Negotiated Dealing Systems Order matching (NDS OM) NDS-OM is operated by the Clearing Corporation of India Ltd. (CCIL) on behalf of the RBI This is an order driven electronic system, where the participants can trade anonymously by placing their orders on the system or accepting the orders already placed by other participants. Direct access to the NDS-OM system is currently available only to select financial institutions like Commercial Banks, Primary Dealers, Insurance Companies, Mutual Funds, etc. Other participants can access this system through their custodians, i.e., with whom they maintain Gilt Accounts. The main advantages of this system are price transparency and better price discovery

Stock Exchanges Retail investors can trade in the debt market securities on stock exchanges like BSE and NSE. SOURCE: RBITop

How are the dealing transactions recorded by the dealing desk?

For every transaction entered into by the trading desk, a deal slip should be generated which should contain data relating to the following: nature of the deal name of the counter-party whether it is a direct deal or through a broker (if it is through a broker, name of the broker) details of security amount Price contract date time and settlement date These deal slips should be serially numbered and verified separately to ensure that each deal slip has been properly accounted for. Once the deal is concluded, the deal slip should be immediately passed on to the back office (it should be separate and distinct from the front office) for recording and processing. For each deal, there must be a system of issue of confirmation to the counter-party. The timely receipt of requisite written confirmation from the counter-party, which must include all essential details of the contract, should be monitored by the back office. With the need for counterparty confirmation of deals matched on NDS-OM will not arise, as NDS-OM is an anonymous automated order matching system. However, in case of trades finalized in the OTC market and reported on NDS, confirmations have to be submitted by the counterparties in the system i.e., NDS. Once a deal has been concluded through a broker, there should not be any substitution of the counter-party by the broker. Similarly, the security sold / purchased in a deal should not be substituted by another security under any circumstances. A maker-checker framework should be implemented to prevent any individual misdemeanor. It should be ensured that the same person is not carrying out the functions of maker (one who inputs the data) and checker (one who verifies and authorizes the data) on the system. On the basis of vouchers passed by the back office (which should be done after verification of actual contract notes received from the broker / counter party and confirmation of the deal by the counter party), the books of account should be independently prepared. SOURCE: RBITop

How do the Government securities transactions settle in the primary market? Once the allotment process in the primary auction is finalized (as explained earlier), the successful participants are advised of the consideration amounts that they need to pay to the Government on settlement day. The settlement cycle for dated security auction is T+1, whereas for that of Treasury bill auction is T+2. On the settlement date, the fund accounts of the participants are debited by their respective consideration amounts and their securities accounts (SGL accounts) are credited with the amount of securities that they were allotted. SOURCE: RBITopHow do the Government securities transactions settle in the secondary market? The transactions relating to G-Secs are settled through the members securities / current accounts maintained with the RBI, with delivery of securities and payment of funds being done on a net basis. CCIL guarantees settlement of trades on the settlement date by becoming a central counter-party to every trade through the process of novation, i.e., it becomes seller to the buyer and buyer to the seller. Please note that, all outright secondary market transactions in G-Secs are settled on T+1 basis. However, in case of repo transactions, the market participants will have the choice of settling the first leg on eitherT+0 basis or T+1 basis as per their requirement. SOURCE: RBITop

What are the important considerations while undertaking security transactions?

Which security to invest in

Typically this involves deciding on the maturity and coupon. Maturity is important because this determines the extent of risk an investor is exposed to higher the maturity, higher the interest rate risk or market risk. If the investment is largely to meet statutory requirements, it may be advisable to avoid taking undue market risk and buy securities with shorter maturity. Within the shorter maturity range (say 5-10 years) it would be safer to buy securities which are liquid, that is, securities which trade in relatively larger volumes in the market. The information about such securities can be obtained from the website of the CCIL (http://www.ccilindia.com/OMMWCG.aspx), which gives real-time secondary market trade data on NDS-OM. Since pricing is more transparent in liquid securities, prices are easily obtainable thereby reducing the chances of being misinformed on the price in these cases. The coupon rate of the security is equally important for the investor as it affects the total return from the security. In order to determine which security to buy, the investor must look at the Yield to Maturity (YTM) of a security. Thus, once the maturity and yield (YTM) is decided, the investor may select a security by looking at the price/yield information of securities traded on NDS-OM or by negotiating with bank or PD or broker.

Related Reference:Yield to maturity

Where and whom to buy from

This structure is for the wholesale debt markets which is dominated by large players having market lots of over 5 crore. Retail investors, who find this process difficult, can participate in this through the non competitive bidding (this has been explained above). Retail investors can participate in this market through retail lots in stock exchanges like BSE and the NSE and also through the debt mutual funds. The wholesale markets are used as benchmark for the retail lots. However, these retail lots come at a premium as compared to the market lots. In terms of transparent pricing, the NDS-OM is the safest because it is a live and anonymous platform where the trades are disseminated as they are struck and where counterparties to the trades are not revealed. In case the trades are conducted on the telephone market, it would be safe to trade directly with a bank or a PD. In case one uses a broker, care must be exercised to ensure that the broker is registered on NSE or BSE or OTC Exchange of India. So it is better to deal directly with bank / PD or on NDS-OM, which also has a screen for odd-lots. Wherever a broker is used, the settlement should not happen through the broker. Trades should not be directly executed with any counterparties other than a bank, PD or a financial institution, to minimize the risk of getting adverse prices. In the odd lot market which is very illiquid, prices can vary a lot and liquidity can be low as a result.

How to ensure correct pricing

To be sure of prices, only liquid securities may be chosen for purchase. A safer alternative for investors with small requirements is to buy under the primary auctions conducted by RBI through the non-competitive route. To check the large traded prices of the whole sale lot for the correct pricingSOURCE: RBI and FIMMDABelow is the NDS platform screen for market based pricing

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What are the important guidelines for valuation of G-Secs?

For the Cooperative banks, investments classified under 'Held to Maturity' (HTM) category need not be marked to market and will be carried at acquisition cost unless it is more than the face value.

If it is more than the face value, the premium should be amortized over the period remaining to maturity. The individual scrip in the Available for Sale (AFS) category in the books of the cooperative banks will be marked to market at the year-end or at more frequent intervals.

The individual scrip in the Held for Trading (HFT) category will be marked to market at monthly or at more frequent intervals. The book value of individual securities in AFS and HFT categories would not undergo any change after marking to market.

Central Government securities should be valued by taking the prices/ yields put out by the Fixed Income Money Market and Derivatives Association of India (FIMMDA) and the Primary Dealers Association of India (PDAI) jointly on the website of the FIMMDA.

Prices of all Central Government securities are given out every day while prices and yield curve for valuation are given at the end of every month. For example, the FIMMDA valuation of a Central Government security, 7.46%2017 as on March 31, 2009 was Rs.101.69. If a cooperative bank was holding the same security in AFS or HFT categories at a book value of Rs.102, the bank would be required to book a depreciation of Rs.0.31 per Rs.100 face value of holding. If the total holding was Rs. 1 crore, the total depreciation to be booked would be Rs.31,000/-.

State Government and other securities are to be valued by adding a spread on the Central Government security yield of the corresponding residual maturity. Currently, a spread of 25 basis points (0.25%) is added while valuing State Government securities, special securities (oil bonds, fertilizer bonds, SBI bonds, etc.) whereas for corporate bonds the spreads given by the FIMMDA need to be added.Top

Example showing valuation of G-Secs

Security 7.32% A.P.SDL 2014Issue date December 10, 2004Maturity date December 10, 2014Coupon 7.32%Date of valuation March 31, 2008ProcedureValuation of the above bond involves the following steps Find the residual maturity of the bond to be valued. Find the Central Government security yield for the above residual maturity. Add appropriate spread to the above yield to get the yield for the security Calculate the price of the security using the derived yield above.

Step 1Since valuation is being done on March 31, 2008, we need to find out the number of years from this date to the maturity date of the security, December 10, 2014 to get the residual maturity of the security. This could be done manually by counting the number of years and months and days. However, an easier method is to use MS. Excel function Yearfrac wherein we specify the two dates and basis This gives us the residual maturity of 6.69 years for the security.

Step 2To find the Central Government yield for 6.69 years, we derive it by interpolating the yields between 6 years and 7 years, which are given out by FIMMDA. As on March 31, 2008, FIMMDA yields for 6 and 7 years are 7.73% and 7.77% respectively. The yield for the 6.69 years is derived by using the following formula.

Here we are finding the yield difference for 0.69 year and adding the same to the yield for 6 years to get the yield for 6.69 years. Also notice that the yield has to be used in decimal form (e.g., 7.73% is equal to 7.73/100 which is 0.0773)

Step 3Having found the Central Government yield for the particular residual maturity, we have to now load the appropriate spread to get the yield of the security to be valued. Since the security is State Government security, the applicable spread is 25 basis points (0.25%). Hence the yield would be 7.76%+0.25% = 8.01%.

Step 4The price of the security will be calculated using the MS Excel function Price Here, we specify the valuation date as March 31, 2008, maturity date as December 10, 2014, rate as 7.32% which is the coupon, yield as 8.01%, redemption as 100 which is the face value, frequency of coupon payment as 2 and basis as 4. The price we get in the formula is Rs.96.47 which is the value of the security.If the bank is holding Rs.10 crore of this security in its portfolio, the total value would be 10*(96.47/100) = 9.647 crore.Related Reference:Excel function YearfracExcel function - PriceTop

What affects the price of G-Sec? Rupee fluctuations as against other foreign currencies The level and changes in interest rates in the economy and other macro-economic factors, such as, expected rate of inflation, liquidity in the market, etc. Developments in other markets like money, foreign exchange, credit and capital markets Further, developments in international bond markets, specifically the US Treasuries affect prices of G-secs in India. Policy actions by RBI (e.g., announcements regarding changes in policy interest rates like Repo Rate, Cash Reserve Ratio, Open Market Operations, etc.) Related Reference:What is the effect of Interest rates on the Indian Debt market?Repo RateCash Reserve RatioSOURCE: RBITop

How are the G-secs transactions reported? Transactions undertaken between market participants in the OTC/telephone market are expected to be reported on the NDS platform within 15 minutes after the deal is put through over telephone. Please note that all OTC trades are required to be mandatorily reported on the secondary market module of the NDS for settlement. Reporting on NDS is a four stage process as explained below:

The seller of the security has to initiate the reporting followed by confirmation by the buyer. This is further followed by issue of confirmation by the sellers back office on the system and reporting is complete with the last stage wherein the buyers back office confirms the deal. The system architecture incorporates maker-checker model to preempt individual mistakes as well as misdemeanor. Reporting on behalf of entities maintaining gilt accounts with the custodians is done by the respective custodians in the same manner as they do in case of their own trades i.e., proprietary trades. The securities leg of these trades settle in the CSGL account of the custodian. Once the reporting is complete, the NDS system accepts the trade. Information on all such successfully reported trades flow to the clearing house i.e., the CCIL.. In the case of NDS-OM,

Participants place orders (price and quantity) on the system which can be modified/cancelled their orders. Order could be a bid for purchase or offer for sale of securities. The system, in turn will match the orders based on price and time priority. That is, it matches bids and offers of the same prices with time priority. The NDS-OM system has separate screen for the Central Government, State Government and Treasury bill trading. In addition, there is a screen for odd lot trading for facilitating trading by small participants in smaller lots of less than Rs. 5 crore (i.e., the standard market lot). The NDS-OM platform is an anonymous platform wherein the participants will not know the counterparty to the trade. Once an order is matched, the deal ticket gets generated automatically and the trade details flow to the CCIL. Due to anonymity offered by the system, the pricing is not influenced by the participants size and standing.SOURCE: RBITop

What are the various websites that give information on Government securities?RBI financial market watchhttp://www.rbi.org.in/Scripts/financialmarketswatch.aspxThis site provides links to information on prices of Government securities on NDS (OTC market), NDS-OM, money market and other information on Government securities like outstanding stock etc.

NDS-OM market watch http://www.ccilindia.com/OMHome.aspxThis site provides real-time information on traded as well as quoted prices of Government securities. In addition prices of When Issued (WI) (whenever trading takes place) segment are also provided.

NDS market watchhttp://www.rbi.org.in/Scripts/NdsUserXsl.aspxThis site provides information on prices of Government securities in OTC market. Facility is provided for searching the prices of particular securities in a date range.

FIMMDAhttp://www.fimmda.org/This site provides host of information on market practices for all the fixed income securities including Government securities. Details of various pricing models adopted by FIMMDA are provided in this site. In addition, the details of daily, monthly and yearly closing prices of Government securities, corporate bond spreads etc. are made available by FIMMDA through this site. Accessing information from this site requires a valid login and password which are provided by FIMMDA to the eligible entities.

Related Reference:FIMMDATop

What is shut period?Shut period means the period for which the securities cannot be delivered. During the period under shut, no settlements/ delivery of the security which is under shut will be allowed. The main purpose of having a shut period is to facilitate servicing of the securities viz., finalizing the payment of coupon and redemption proceeds and to avoid any change in ownership of securities during this process. SOURCE: RBITopWhat is Delivery versus Payment (DvP) settlement?Delivery versus Payment (DvP) is the mode of settlement of securities wherein the transfer of securities and funds happen simultaneously. This ensures that unless the funds are paid, the securities are not delivered and vice versa. DvP settlement eliminates the settlement risk in transactions. There are three types of DvP settlements, viz., DvP I, II and III which are explained below; DvP I The securities and funds legs of the transactions are settled on a gross basis, that is, the settlements occur transaction by transaction without netting the payables and receivables of the participant.

DvP II In this method, the securities are settled on gross basis whereas the funds are settled on a net basis, that is, the funds payable and receivable of all transactions of a party are netted to arrive at the final payable or receivable position which is settled.

DvP III In this method, both the securities and the funds legs are settled on a net basis and only the final net position of all transactions undertaken by a participant is settled.Liquidity requirement in a gross mode is higher than that of a net mode since the payables and receivables are set off against each other in the net mode. SOURCE: RBITop

Bond credit ratingsIn investment, the bond credit rating assesses the credit worthiness of a corporation's or government debt issues. It is analogous to credit ratings for individuals.Please refer to the below attached for the different credit rating tiers as per the credit rating agencies, Moodys, Standard &Poors and Fitch

SOURCE: WikipediaTop

Corporate Bonds MarketWhat are corporate bonds? Corporate bonds are fixed income securities issued by Corporates i.e. entities other than Government The default risk in the corporate bonds is much higher than the G-Secs For the above default risk, the investors are compensated by higher returns as there is a high credit spread. Related Reference:What are credit spreads?TopWhy should one invest in corporate bonds? High return Compared to G-secs due to higher credit spreads Low risk Compared to Equity Fixed and Regular Income subject to default risks Flexibility as various types of bonds available Potential capital appreciation as there is a risk if interest rates fall or the credit spreads over the G-Secs fall if the investment is not held till maturity.TopWho regulates the Corporate Bond Markets? Securities and Exchange Board of India (SEBI) is the regulator for the Indian Corporate Debt Market It controls cases where entities raise money from public through public issues. It regulates the manner in which such moneys are raised and tries 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, by way and its disclosure norms. It also regulates the instruments in which these mutual funds (which are governed by SEBI) can invest. It also regulates the investments of debt FIIs.TopWhat are the different types of corporate bonds?Corporates bonds can broadly classify as follows: Based on IssuerIssuers of Corporate Bonds can be broadly classified in following classes: Bonds issued by Local Bodies Bonds issued by Public Sector Units Bonds issued by Financial Institutions Bonds issued by Banks Bonds issued by Corporates

Based on Maturity Period

Short Term Maturity: - Security with maturity period less than one year. Medium Term: - Security with maturity period between 1year and 5 year. Long Term Maturity: -Such securities have maturity period more than 5 years Perpetual: - Security with no maturity. Currently, in India Banks issue perpetual bond.

Based on Coupon Fixed Rate Bonds:-have a coupon that remains constant throughout the life of the bond. Floating Rate Bonds: - Coupon rates are reset periodically based on benchmark rate. Zero-coupon Bonds no coupons are paid. The bond is issued at a discount to its face value, at which it will be redeemed. There are no intermittent payments of interest

Based on option Bond with call option: - This feature gives a bond issuer the right, but not the obligation, to redeem his issue of bonds before the bond's maturity at predetermined price and date. Bond with put option: - This feature gives bondholders the right but not the obligation to sell their bonds back to the issuer at a predetermined price and date. These bonds generally protect investors from interest rate risk.

Based on redemption Bonds with single redemption: - In this case principal amount o