What is the Debt Market?
The Debt Market is the market where fixed income securities of various types and
features are issued and traded. Debt Markets are therefore, markets for fixed income
securities issued by Central and State Governments, Municipal Corporations, Govt.
bodies and commercial entities like Financial Institutions, Banks, Public Sector
Units, Public Ltd. companies and also structured finance instruments.
What are the different types of instruments, which are normally traded in this market?
The instruments traded can be classified into the following segments based on the
characteristics of the identity of the issuer of these securities:
What is the importance of the Debt Market to the economy?
The key role of the debt markets in the Indian Economy stems from the following
• Efficient mobilization and allocation of resources in the economy
• Financing the development activities of the Government
• Transmitting signals for implementation of the monetary policy
Facilitating liquidity management in tune with overall short term and long term
objectives. Since the Government Securities are issued to meet the short term and
long term financial needs of the government, they are not only used as instruments
for raising debt, but have emerged as key instruments for internal debt management,
monetary management and short term liquidity management. The returns earned on the
government securities are normally taken as the benchmark rates of returns and are
referred to as the risk free return in financial theory. The Risk Free rate obtained
from the G-sec rates is often used to price the other non-govt. securities in the
What are the benefits of an efficient Debt Market to the financial system and the
• Reduction in the borrowing cost of the Government and enable mobilization of resources
at a reasonable cost.
• Provide greater funding avenues to public-sector and private sector projects and
reduce the pressure on institutional financing.
• Enhanced mobilization of resources by unlocking illiquid retail investments like
• Development of heterogeneity of market participants.
• Assist in development of a reliable yield curve and the term structure of interest
What are the different types of risks with regard to debt securities?
The following are the risks associated with debt securities:
This 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.
Interest Rate 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. A
good case would be an upswing in the prevailing interest rate scenario leading to
a situation where the investors' money is locked at lower rates whereas if he had
waited and invested in the changed interest rate scenario, he would have earned
Reinvestment Rate 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.
The following are the risks associated with trading in debt securities:
Counter Party 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.
Refers to the possibility of not being able to receive the expected price on any
order due to a adverse movement in the prices.
Who regulates the fixed income markets?
The issue and trading of fixed income securities by each of these entities are regulated
by different bodies in India. For eg: Government securities and issues by Banks,
Institutions are regulated by the RBI. The issue of non-government securities comprising
basically issues of Corporate Debt is regulated by SEBI.
What are the segments in the secondary debt market?
The segments in the secondary debt market based on the characteristics of the investors
and the structure of the market are:
Wholesale Debt Market - where the investors are mostly Banks, Financial Institutions,
the RBI, Primary Dealers, Insurance companies, MFs, Corporate and FIIs.
Retail Debt Market - involving participation by individual investors, provident
funds, pension funds, private trusts, NBFCs and other legal entities in addition
to the wholesale investor classes.
What is the structure of the Wholesale Debt Market?
The Debt Market is today in the nature of a negotiated deal market where most of
the deals take place through telephones and are reported to the Exchange for confirmation.
It is therefore in the nature of a wholesale market.
Who are the most prominent investors in the Wholesale Debt Market in India?
The Commercial Banks and the Financial Institutions are the most prominent participants
in the Wholesale Debt Market in India. During the past few years, the investor base
has been widened to include Co-operative Banks, Investment Institutions, cash rich
corporate, Non-Banking Finance companies, Mutual Funds and high net-worth individuals.
FIIs have also been permitted to invest 100% of their funds in the debt market,
which is a significant increase from the earlier limit of 30%. The government also
allowed in 1998-99 the FIIs to invest in T-bills with a view towards broad basing
the investor base of the same.
What are the types of trades in the Wholesale Debt Market?
There are normally two types of transactions, which are executed in the Wholesale
• An outright sale or purchase and
• A Repo trade
What is a Repo trade and how is it different from a normal buy or sell transaction?
An outright Buy or sell transaction is a one where there is no intended reversal
of the trade at the point of execution of the trade. The Buy or sell transaction
is an independent trade and is in no way connected with any other trade at the same
or a later point of time.
A Ready Forward Trade (which is normally referred to as a Repo trade or a Repurchase
Agreement) is a transaction where the said trade is intended to be reversed at a
later point of time at a rate which will include the interest component for the
period between the two opposite legs of the transactions.
So in such a transaction, one participant sells securities to other with an agreement
to purchase them back at a later date. The trade is called a Repo transaction from
the point of view of the seller and it is called a Reverse Repo transaction from
point of view of the buyer.
Repos therefore facilitate creation of liquidity by permitting the seller to avail
of a specific sum of money (the value of the repo trade) for a certain period in
lieu of payment of interest by way of the difference between the two prices of the
Repos and reverse repos are commonly used in the money markets as instruments of
short-term liquidity management and can also be termed as a collateralized lending
and borrowing mechanism. Banks and Financial Institutions usually enter into reverse
repo transactions to manage their reserve requirements or to manage liquidity.
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
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.
Therefore, Current Yield = Coupon of the Security (in %) x Face Value of the Security
(viz. 100 in case of G-Secs.)/Market Price of the Security
E.g.: Suppose the market price for a 10.18% G-Sec 2012 is Rs.120. The current yield
on the security will be (0.1018 x 100)/120 = 8.48%
The yield on the government securities is influenced by various factors such as
level of money supply in the economy, inflation, future interest rate expectations,
borrowing program of the government & the monetary policy followed by the government.
Who are the participants in the Retail Debt Market?
The following are the main investor segments who could participate in the Retail
• Mutual Funds
• Provident Funds
• Pension Funds
• Private Trusts
• Religious Trusts and charitable organizations having large investible corpus
• State Level and District Level Co-operative Banks
• Housing Finance Companies
• NBFCs and RNBCs
• Corporate Treasuries
• Hindu-Undivided Families (HUFs)
• Individual Investors
What are the main points to be kept in mind by the investor while investing in the
The main features which you need to check for any debt security is:
• Coupon (or the discount implied by the price as in the case of zero coupon bonds)
and the frequency of interest payments. The securities can also be chosen in such
a manner so that the interest payments coincide with any requirements of funds at
that point of time.
• Timing of Cash Flows - In case the interest and redemption proceeds, at one single
point or at different points of time, are planned to be used for meeting certain
planned expenses in the future.
• Information about the Issuer and the Credit Rating - It is essential to obtain
enough information about the background, the business operations, the financial
position, the use of the funds being collected and the future projections to satisfy
oneself of the suitability of the investment. As per the regulations in force in
the capital markets, it is essential for any corporate debt security to obtain a
credit rating from any of the major credit rating agencies. A proper analysis of
the background and the financials of the issuer of any non-govt. debt instrument
and especially the credit rating would lend greater safety to your investments.
• Other Terms of particular Issue - It is also advisable to check on certain terms
of the issue like the use of the issue proceeds, the monitoring agency, the formation
of trustees, the secured or unsecured nature of the bonds, the assets underlying
the security and the credit-worthiness of the organization.
Most of the said information can be available from the prospectus of the said issue
(In case of and any required and relevant details can also be obtained on demand
from the lead manager of the issue:
• Obtain all the relevant knowledge on the debt security like the coupon, maturity,
interest payments, put and call options (if any), Yield To Maturity (at the particular
price at which the trade is intended to be carried out) and the Duration of the
• Check the Yield To Maturity (YTM) of the debt security with the YTMs
of other comparable debt securities of the same class and features.
• Remember that
the Yield and the Price are inversely related. So, you will be able to obtain a
higher yield at a lower price.
• It is desirable to check on the liquidity of any
corporate debt instrument before investing in it so as to ensure the availability
of satisfactory exit options.
The investor should be well aware of the set of risks associated
with the Debt Markets like the default risk (non-receipt or delay in receipt of
interest or principal), price risk, interest rate risk (risk of rates moving adversely
after investment), settlement risk (or risk of non-delivery of securities and funds
in the secondary market) and the re-investment risk (interest payments fetching
a lower return when re-invested). Investors in the Debt Markets should follow a
process of judicious investing after a careful study of the economic and money market
condition, various instruments available for investment, the desired returns and
its compatibility with existing investment opportunities, alternative modes available
for investments and the relevant transaction costs.