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Organization and conduct of debt market (session 5)


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Organization and conduct of debt market (session 5)

  1. 1. Organization and Conduct of Debt Market M S Narasimhan Indian Institute of Management, Bangalore
  2. 2. Market Organization <ul><li>Organized Exchanges vs. OTC </li></ul><ul><ul><li>G-Sec. And money market securities are generally traded in OTC – Why? </li></ul></ul><ul><ul><li>Corporate Bonds and Derivatives are also traded in organized exchanges </li></ul></ul><ul><li>Trading Mechanism </li></ul><ul><ul><li>Direct Search, Brokered market & Dealer market </li></ul></ul><ul><ul><li>Dealers act as market makers; liquidity benefit </li></ul></ul><ul><ul><li>Bid-ask spread of dealers is additional cost – inventory carrying cost and adverse selection cost </li></ul></ul>
  3. 3. Participants of Markets <ul><li>Treasury (Government – Central, local) </li></ul><ul><li>Central Bank </li></ul><ul><ul><li>Federal Reserve System in the US, RBI in India </li></ul></ul><ul><li>Government Agencies </li></ul><ul><li>Primary and other dealers </li></ul><ul><li>Brokers </li></ul><ul><li>Investors – Banks, Funds, Corporate </li></ul>
  4. 4. Treasury and Central Bank <ul><li>Treasury to meet long-term and short-term needs sells securities through Central Bank </li></ul><ul><li>Central banks in addition to selling securities of treasury is also responsible for monetary economy of the country </li></ul><ul><li>Central banks use monetary polices to control inflation and induce growth and such monetary policies create ‘active’ market for FIS </li></ul><ul><ul><li>Discount Rate or Bank Rate, Reserve Requirements, Open market operations </li></ul></ul>
  5. 5. Government Agencies <ul><li>Government Agencies include municipal corporations and large government organizations mainly on infrastructure developments </li></ul><ul><li>Government agencies directly sells securities in the market – either through dealers or public offer </li></ul><ul><li>Securities are either backed by general stream of revenue or specific revenue stream </li></ul><ul><li>Generally long-term securities </li></ul><ul><li>Regulations often require credit rating </li></ul>
  6. 6. Dealers <ul><li>High net worth corporations approved by central bank as primary dealers </li></ul><ul><li>Primary dealers participate in treasury auctions </li></ul><ul><li>Primary dealers generally have network of other dealers to absorb the stocks </li></ul><ul><li>Primary dealers also act as market maker </li></ul>
  7. 7. Brokers <ul><li>What is the need and role of brokers when there is a market maker? </li></ul><ul><ul><li>Primary dealers act as market makers only for G-sec. </li></ul></ul><ul><ul><li>Buyers and sellers would normally prefer to conceal their identity to each others/primary dealers </li></ul></ul><ul><ul><li>Liquidity problem on ‘off-the-run issues’; liquidity is fairly high in recent issues ‘on-the-run issues </li></ul></ul><ul><ul><li>Primary dealers would also prefer brokers to disseminate information and also avoid dealing with large number of investors and counter party risk </li></ul></ul>
  8. 8. Investors <ul><li>Broadly three categories </li></ul><ul><ul><li>Investors, who park their surplus funds temporarily (banks) </li></ul></ul><ul><ul><li>Investors, who put their savings for long-term (pension funds, mutual funds, etc.) </li></ul></ul><ul><ul><li>Investors, who take active positions based on certain expectations or price corrections or arbitrage between markets </li></ul></ul>
  9. 9. Trading Mechanism <ul><li>Treasury securities are initially auctioned and traded subsequently traded in OTC market </li></ul><ul><li>Trades are negotiated and concluded through telephones but reported through trading system </li></ul><ul><ul><li>Brokers also act as a mini-exchange </li></ul></ul><ul><li>Participants maintain account with Central Bank and concluded trades are entered in their respective accounts </li></ul><ul><li>Trading takes place on the basis of yield or price </li></ul><ul><ul><li>Price – Clean price and dirty price </li></ul></ul>
  10. 10. Summary <ul><li>Debt markets are organized differently based on products </li></ul><ul><li>G-sec. markets are organized as OTC market supported by dealers </li></ul><ul><ul><li>Few issuers, few trades but high-value, primarily institutional investors </li></ul></ul><ul><li>Corporate Bonds are generally traded in organized exchanges </li></ul>