Debt market financial services


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Debt Market

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Debt market financial services

  1. 1. CHAPTER 1. 1.1INTRODUCTION TO DEBT MARKET MEANING AND DEFINITON: Debt market refers to the financial market where investors buy and sell debt securities, mostly in the form of bonds. Entire debt segment is generally consists of 2/3 of primary market and 4/5 of secondary market. The Indian debt market is today one of the largest in Asia and includes securities issued by the Government (Central & State Governments), public sector undertakings, other government bodies, financial institutions, banks and corporate. The debt market is any market situation where trading debt instruments take place. Examples of debt instruments include mortgages, promissory notes, bonds, and Certificates of Deposit. A debt market establishes a structured environment where these types of debt can be traded with ease between interested parties. The debt market often goes by other names, based on the types of debt instruments that are traded. In the event that the market deals mainly with the trading of corporate bond issues, the debt market may be known as a bond market. If mortgages and notes are the main focus of the trading, the debt market may be known as a credit market. When fixed rates are connected with the debt instruments, the market may be known as a fixed income market. A debt is an obligation owed by one party (the debtor) to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value. A debt is created when a creditor agrees to lend a sum of assets to a debtor. Debt is usually granted with expected repayment; in modern society, in most cases,
  2. 2. this includes repayment of the original sum, plus interest. In finance, debt is a means of using anticipated income and future purchasing power in the present before it has actually been earned. Some companies and corporations use debt as a part of their overall corporate finance strategy. DEFINITION:  According BUSINESS DICTIONARY, “A market that is involved in the trading of debt instruments such as government and corporate bonds, as well as has an involvement with the trading of packaged loan products that are sold to investors.”  According NASDAQ, “The market for trading debt instruments.”  According QFINANCE, “A market in which corporate or municipal, government, or public debts are bought and sold”
  3. 3. 1.2 CLASSIFICATION OF DEBT MARKET. 1.GOVERNMENT SECURITIES MARKET: Government Securities Market (G-Sec Market): It consists of central and state government securities. It means that, loans are being taken by the central and state government. It is also the most dominant category in the India debt market.The government debt market is the market for bonds and securities issued by the central government, state government and the semi government authorities which includes local government authorities like city corporations, metropolitan authorities public sector corporations and other government agencies such as IDBI ,IFCI ,SFCs . 2. CORPORATE BONDS MARKET: Bond Market: It consists of Financial Institutions bonds, Corporate bonds and debentures and Public Sector Units bonds. These bonds are issued to meet financial requirements at a fixed cost and hence remove uncertainty in financial costs. In broader terms Corporate bonds are fixed income securities issued by corporate i.e. entities other than Government.
  4. 4. 2.A TYPES OF CORPORATE BONDS: 1. Based on Maturity Period 2. Based on Coupon 3. Based on Option 4. Based on redemption 1.BASED ON MATURITY PERIOD: SHORT TERM MATURITY: - Security with maturity period less than one year. MEDIUM TERM MATURITY: - 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 2.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.
  5. 5. 3. 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. 4. BASED ON REDEMPTION: Bonds with single redemption: - In this case principal amount of bond is paid at thetime of maturity only. Amortising Bonds: - A bond, in which payment made by the borrower over the life of the bond, includes both interest and principal, is called an amortizing bond.
  7. 7. 1.4REGULATORS ASPECT IN DEBT MARKET. 1.RESERVE BANK OF INDIA(RBI)  Issuer Of Debt Instruments  Started the Banking Ombudsman Scheme.  Determines the investment of commercial banks in debt. 2. SECURITIES AND EXCHANGE BOARD OF INDIA (SEBI)
  8. 8.  To require the Stock Exchange to amend by their laws.  Secondary Role In Regulatory Aspect  Determines the guidelines for raising money through public issues  SEBI is also the main regulator for Mutual Funds
  9. 9. CHAPTER 2. 2.1 MARKET SEGMENTS OF DEBT MARKET. Market Segment Primary market A.PRIMARY MARKET B. SECONDARY MARKET Secondary market
  10. 10. A. PRIMARY MARKET: It is that market in which shares, debentures and other securities are sold for the first time for collecting long term capital. This market is concerned with new issues. Therefore the primary market is also called “new issue market”. In this market, the flow of funds is from savers to borrowers. Hence, it helps directing in the capital formation of the country. B. SECONDARY MARKET: SECONDARY MARKET NSE BSE BSE deal with debt market NSE deal with debt market Wholesale debt market Retail debt market
  11. 11. It is a market where the corporate debt securities of both private sector & public sector undertakings are traded. These securities are traded on Wholesale Debt Segment (WDM) segment of NSE , OTCEI & BSE. 2.2 MARKET PARTICIPANTS IN INDIAN DEBT MARKET 1. Central Government raises money through issuance of bonds and T-bill to fund budgetary deficits and other short and long-term funding requirements through Reserve Bank of India (RBI). 2. RBI participates in the market through open-market operations as well as through Liquidity Adjustment facility (LAF) in the course of conduct of monetary policy. RBI also regulates the bank rates and repo rates, and uses these rates as indirect tools of its monetary policy. Changes in these benchmark rates directly impact debt markets and all participants in the market as other interest rates realign themselves with these changes. 3. Primary Dealers (PDs), who are market intermediaries appointed by RBI, underwrite and make market in government securities by providing two-way quotes, and have access to the call and repo markets for funds. Their performance is assessed by RBI on the basis of their bidding commitments and the success ratio achieved at primary auctions. They normally hold most liquid securities in their portfolio. 4. State governments, municipal and local bodies issue securities in the debt markets to fund their developmental projects as well as to finance their budgetary deficits.
  12. 12. 5. Public Sector Undertakings (PSU) and their finance corporations are large issuers of debt securities. They raise funds to meet the long term and working capital needs. These corporations are also investors in bonds issued in the debt markets. 6. Corporates issue short and long-term paper to meet their financial requirements. They are also investors in debt securities issued in the market. 7. DFIs regularly issue bonds for funding their financing requirements and working capital needs. They also invest in bonds issued by other entities in the debt markets. Most FIs hold government securities in their investment and trading portfolios. 8. Banks are the largest investors in the debt markets, particularly in the government securities market due to SLR requirements. They are also the main participants in the call money market. Banks arrange CP issues of corporates and are active in the inter-bank term markets and repo markets for their short term funding requirements. Banks also issue CDs and bonds in the debt markets. They also issue bonds to raise funds for their Tier-II capital requirement. 9.The investment norms for insurance companies make them large participants in government securities market. 10. MFs have emerged as important players in the debt market, owing to the growing number of debt funds that have mobilised significant amounts from the investors. Most mutual funds also have specialized debt funds such as gilt funds and liquid funds. They participate in the debt markets pre-dominantly as investors, and trade on their portfolios quite regularly. 11. Foreign Institutional Investors (FIIs) are permitted to invest in Dated Government Securities and Treasury Bills within certain limits.
  13. 13. 12. Provident and pension funds are large investors in the debt markets. The prudential regulations governing the deployment of the funds mobilised by them mandate investments pre-dominantly in treasury and PSU 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. 13. Charitable institutions, trusts and societies are also large investors in the debt markets. They are, however, governed by their rules and bye-laws with respect to the kind of bonds they can buy and the manner in which they can trade on their debt portfolios. 14. Since January 2002, retail investors have been permitted to submit noncompetitive bids at primary auction through any bank or PD. They submit bids for amounts of Rs. 10,000 and multiples thereof, subject to the condition that a single bid does not exceed Rs. 1 crore. The noncompetitive bids upto a maximum of 5% of the notified amount are accepted at the weighted average cut off price/yield. 15. NDS, CCIL and WDM segment of NSEIL are other important platforms for the debt market which are discussed in greater detail in subsequent sections.
  14. 14. CHAPTER 3. 3.1 WHY DO WE NEED A DEBT MARKET?  Ensuring financial system stability  A liquid corporate bond market can play a critical role because it supplements the banking system to meet the requirements of the corporate sector for long-term capital investment and asset creation.  Enabling meaningful coverage of real sector needs  The financial sector in India is much too small to cater to the needs of the real economy.  The debt markets need to grow manifold to ensure that the financial sector becomes adequate for an economy as large and as ambitious as India’s.  Creating new classes of investors  Financial institutions like insurance companies and provident funds have longterm liabilities and do not have access to adequate high quality long-term assets to match them.  Creation of a deep corporate bond market can enable them to invest in long-term corporate debt, thus serving the twin goals of diversifying corporate risk across the financial sector and enabling these institutions to access high quality longterm assets.  Reduced Currency Mismatches  These markets help reduce potential currency mismatches in the financial system by allowing for the issue of local currency bonds.
  15. 15.  Therefore, well-developed and liquid bond markets can help firms reduce their overall cost of capital by allowing them to tailor their asset and liability profiles to reduce the risk of both maturity and currency mismatches.  Term Structure and Effective transition of Monetary Policy  The creation of long-term debt markets will also enable the generation of market interest rates at the long end of the yield curve.  A deeper, more responsive interest rate market would in turn provide the central bank with a mechanism for effective transmission of monetary policy.
  16. 16. CHAPTER 4. 4.1 NEED FOR DEVELOPMENT. In retrospect every Indian knows we cannot systematically ignore the role of slavery, the absolutely central role of war and our fight for independence in creating and shaping the basic institutions of what we now call “The Indian economy”. What’s more, origins matter. It’s imperative that we look back at an important aspect in our history, slavery, whose role was instrumental in shaping our outlook towards the market and in particular the Debt Market. Slavery is seen as a consequence of war and if you surrender in war, what you surrender is your life; your conqueror has the right to kill you, and often he will. And if he chooses not to, you literally owe your life to him; a debt conceived as absolute, infinite, and irredeemable. And all your responsibilities or obligations towards your loved ones are negated and now you are solely indebted to him alone. This logic has an interesting consequence. Debt was hence looked upon as being slave and equity as more participative or voluntary in India. Secondly Indians have always looked at debt as Dakshina (fees paid to our gurus). Daskhina is a karmic debt-instrument, which means you are obliged to pay. Charity or Daan on the other hand is an equity instrument where you do it voluntarily; but doing so helps you earn good karma (shareholders support and brand building). However, these logics are more relevant from the borrower’s perspective. Indian investors on the other hand have been traditionally risk averse. It has perhaps something to do with the monsoons of this land. Fear of droughts and floods is so ingrained in us that we prefer being moneylenders to farmers. Interests are more secure than harvests. Read through reports and you will know where the small Indian investor’s money is? Debt markets in India have
  17. 17. definitely suffered from chronic neglect on the part of policymakers, despite the fact that there is clear evidence of fairly strong debt preference among households in their investment portfolios. Capital markets in India are more synonymous with the equity markets – both on account of the investors’ preferences and the capital gains it offers. But to add to its world class equity and banking sector, the country needs to build its bond market. While they have grown in size, they continue to remain illiquid. The corporate market, in addition, restricts participants and is largely arbitrage-driven. In a developing economy such as India, the role of the public sector and its financial requirements need no emphasis. Government securities markets have traditionally dominated the Indian Bond market. The reason being the high government deficit and the need to service it at an optimal cost, the predominance of bank lending in corporate financing and regulated interest rate environment that protected the banks’ balance sheets on account of their exposure to the government securities. While these factors ensured the existence of a big Government securities market, the market was passive with the captive investors buying and holding on to the government securities till they mature. The trading activity was conspicuous by its absence. The scenario’s completely changed since the nineties. The notable changes being gradual deregulation of interest rates and the Government’s decision to borrow through auction mechanism and at market related rates. This move towards a market-based economy meant now resources are allocated based on the risk return profiles of alternative investments instead of being guided by direct or indirect intervention of the Government. Also, the fact that the monetary as well as government debt management functions are centralized in the RBI, it calls for greater coordination between monetary and debt management policies. While the objective of
  18. 18. the debt management policy is to reduce the cost of debt servicing in the long term, the efficacy of the monetary policy depends upon how efficiently the transmission mechanism works, the basis of which is an efficiently determined interest rates structure. Also because the sovereign paper will always acts as an benchmark for pricing corporate bonds, unless the prices of the former reflects its intrinsic worth, markets will not be able to price the latter. All these once again emphasize the importance of efficient price discovery mechanism. Bond markets also had major disadvantages as opposed to bank financing. In the absence of hedging avenues, it turned out be more risky and less flexible than bank financing. Risk management was another issue, since the derivatives markets were not developed to enable both issuers and investors to efficiently transfer the risks arising out of interest rate movements. There were no exchange traded interest rate futures or options. The Mark to market regulations also deterred banks from investing in corporate bonds and prefer traditional lending route to finance corporates. Most issues were not Corporate Bonds but Private Placements.TDS was also viewed as a major impediment to the development of the Government securities market. Stamp duties also acted as a deterrent to the development of the bond markets. The stamp duty applicable for a security differed on the basis of the class of investor and this discouraged corporates from issuing bonds to certain class of investors like retail investors and to long-term investors like insurance companies, provident and pension funds. Fragmentation did not further help the development of a liquid bond market. Information and low investor base were among the other problems faced. Today, having addressed most of the problems mentioned above( investor base is being broadened, issuer base is now widened, derivative markets are being developed, price distortion
  19. 19. issues are being addressed , listing norms are being eased, reforming stamp duty) the idea is to look ahead at the bigger picture of bond market. The bond market should witness exponential growth with the growing infrastructure development, budding mutual fund industry, new pension system, developing market for securitized products, rising concerns about the asset liability management on the part of banks along with the development of derivatives market. India has aggressive targets for GDP growth rate at 8-10 % p.a. Investment in infrastructure by both the government and the private sector has been relatively low in the past. Given the quantum of funds required and long gestation periods, achieving financial closure for large infrastructure projects has often been difficult. Banks continue to be exposed to problems of asset / liability mismatches when they lend long tenor as such long term assets are inevitably funded through significantly shorter tenor liabilities. The Indian debt market and the government securities market in particular, is definitely at a turning point in India with significant changes taking place in the domestic economic environment .And hence this is an opportune time to reflect on future debt market development. The economy is estimated to be growing at about 8 % this year with modest inflation and if similar conditions prevail, we can expect growth and inflation next year to also be on a similar path and if it’s to be maintained and accelerated in the long run, financial intermediation will have to further improve the debt market. Needless to say the sustenance of such growth will heavily rely on investments in both infrastructure and industry. Bond financing also has to supplement traditional bank financing to take care of the growing credit needs of the economy. In a very stylized sense, the requirement of investment funds for productive investment can be divided into three broad categories – equity, long-term debt, and medium to short-term debt.
  20. 20. If the financial sector is unable to provide funds as required by the demand, there would simultaneously exist excess demand and excess supply in different segments of the financial market. In such a situation, one of two outcomes is possible. The investing entities could meet their funds need in whatever form available; and thereby expose themselves to needless risk. As a consequence, the over-all risk profile of the economy would tend to go up. Alternatively, if they adhered to norms of prudence, the segment of the financial sector facing the highest level of excess demand would prove to be the binding constraint to investment activity and effectively determine the actual level of investment in the economy. Think about it! It’s possible that ex-post investment may fall short of ex-ante savings, not because of a lack of investment demand, but because of a mismatch between the structures of the demand for and supply of investment funds. In addition, the excess supply of funds in one segment of the financial sector carries the danger that such funds may be used for speculative purposes in foreign exchange, real estate or commodities, which create their own problems in economic management. The net result can be an economy which is performing well below its potential and with high levels of systemic risk. Clearly, progress has to be made in creating the infrastructure and implementing the policy regime that is needed to facilitate the evolution of the Indian debt capital market into a global participant. Further progress in this regards, would only facilitate greater access to credit by enabling risks to be shared by banks and other investors.
  21. 21. 4.2 GROWTH OF INDIAN DEBT MARKET The growth of corporate bond market in India has been aided by existence of a well-developed G-sec market which provides a benchmark yield curve for bond pricing, a well-functioning depository system, credible system of rating agencies and adequate legal framework. Measures, such as, rationalising the listing norms, standardisation of market conventions, reduction in the shut period, setting up of reporting platforms, and implementation of DvP settlement of corporate bond trades have had an encouraging impact on the market resulting in considerable increase in issuance as well as secondary market trading of corporate bonds. Volumes climb to Rs63,782.46 crore in July compared to Rs54,404 crore in June; further upward momentum expected due to increased FII activity. According to data released by the Securities and Exchange Board of India (SEBI), corporate bond trading volumes have climbed 17% at Rs 63,782.46 crore in July 2010 compared to Rs54,404 crore the month before. There were 4,446 combined trades on the National Stock Exchange (NSE), Bombay Stock Exchange (BSE) and The Fixed Income Money Market and Derivatives Association of India (FIMMDA) platforms. Total issuance has increased from `1,747.81 billion in 2008-09 to `2,968.94 billion in 2011-12. Similarly trade volume has increased from `1,481.66 billion in 2008-09 to ` 5,937.83 billion in 2011-12. During the current fiscal year upto September 2012, the trade volumes have been ` 3261.14 billion. The share of bonds issued through public issues has increased from 0.86 per cent in 2008-09 to 7.3 per cent in 2011-12. Out of the four modes of resource mobilisation namely, IPOs, FPOs, bonds and rights issues, the share of bonds have increased from 9.2 per cent in 2008-09 to 73.5 per cent in 2011-12 indicating greater reliance of entities on bonds for resource mobilisation in the recent period.
  22. 22. Recommendations of various committees have been implemented by the respective regulators to promote debt market in India. The growth of corporate bond market in India has been aided by existence of a well-developed G-sec market which provides a benchmark yield curve for bond pricing, a well-functioning depository system, credible system of rating agencies and adequate legal framework. Measures, such as, rationalising the listing norms, standardisation of market conventions, reduction in the shut period, setting up of reporting platforms, and implementation of DvP settlement of corporate bond trades have had an encouraging impact on the market resulting in considerable increase in issuance as well as secondary market trading of corporate bonds. Total issuance has increased from `1,747.81 billion in 2008-09 to `2,968.94 billion in 2011-12. Similarly trade volume has increased from `1,481.66 billion in 2008-09 to ` 5,937.83 billion in 2011-12. During the current fiscal year upto September 2012, the trade volumes have been ` 3261.14 billion. The share of bonds issued through public issues has increased from 0.86 per cent in 2008-09 to 7.3 per cent in 2011-12. Out of the four modes of resource mobilisation namely, IPOs, FPOs, bonds and rights issues, the share of bonds have increased from 9.2 per cent in 2008-09 to 73.5 per cent in 2011-12 indicating greater reliance of entities on bonds for resource mobilisation in the recent period.
  23. 23. CONCLUSION. The debt markets play an important role in 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. The debt market is one of the most critical components of the financial system of any economy and acts as a leverage tool in a financial system. The debt market comprises of two segments: government securities market and corporate debt market. Indian debt market is dominated by government securities as compared to corporate debt securities. Indian corporate bonds market is very underdeveloped and illiquid in comparison with the Government securities market and mostly depends on highly safe AAA rated bonds for both issuance and trading. This paper presents an overview of the corporate debt market in India. It is concluded that Indian corporate debt market has shown growth trend in primary market and secondary market as well. There are a lot of challenges available in the market which are major obstacles in the development of the market like lack of information among the investors, high stamp duty charges, lack of innovative debt instruments etc.
  24. 24. BIBLIOGRAPHY. BOOKS.  Debt Markets and Analysis -by R. Stafford Johnson WEBSITES.      