Bond Market


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Bond Market

  1. 1. Bonds Introduction Bonds refer to debt instruments bearing interest on maturity. In simple terms, organizations may borrow funds by issuing debt securities named bonds, having a fixed maturity period (more than one year) and pay a specified rate of interest (coupon rate) on the principal amount to the holders. Bonds have a maturity period of more than one year which differentiates it from other debt securities like commercial papers, treasury bills and other money market instruments. Terminology Used in Bond Market Bonds: Loans (in the form of a security) Issuer of Bonds : Borrower Bond Holder : Lender Principal Amount: Amount at which issuer pays interest and which is repaid on the maturity date. Issue Price : Price at which bonds are offered to investors Maturity Date : Length of time (More than one year) Coupon : Rate of interest paid by the issuer on the par/face value of the bond Coupon Date: The date on which interest is paid to investor
  2. 2. <ul><li>Some of the benefits to the investors in debt instruments are: </li></ul><ul><li>The investors benefit by investing in fixed income securities as they preserve and increase their invested capital and also ensure the receipt of regular interest income. </li></ul><ul><li>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. </li></ul><ul><li>The prices of Debt securities display a lower average volatility as compared to the prices of other financial securities and ensure the greater safety of accompanying investments. </li></ul><ul><li>Debt securities enable wide-based and efficient portfolio diversification and thus assist in portfolio risk-mitigation. </li></ul><ul><li>Almost all debt instruments have a rating assigned to them by a Rating Agency which enables the investor to choose his degree of risk and corresponding returns. </li></ul>
  3. 3. <ul><li>How do the debt markets impact the economy? </li></ul><ul><li>Opportunity for investors to diversify their investment portfolio. </li></ul><ul><li>Higher liquidity and control over credit. </li></ul><ul><li>Better corporate governance. </li></ul><ul><li>Improved transparency because of stringent disclosure norms and auditing requirements. </li></ul><ul><li>Less risk compared to the equity markets, encouraging low-risk investments. This leads to inflow of funds in the economy. </li></ul><ul><li>Increased funds for implementation of government development plans. The government can raise funds at lower costs by issuing government securities. </li></ul><ul><li>Implementation of a monetary policy. </li></ul><ul><li>Reduced role of banks and political intervention in use of funds, as banks have to follow norms laid down by the central bank. </li></ul>
  4. 4. Types of Bonds <ul><ul><li>Zero Coupon Bonds </li></ul></ul><ul><li>Zero Coupon Bonds are issued at a discount to their face value and at the time of maturity, the principal/face value is repaid to the holders. </li></ul><ul><li>No interest (coupon) is paid to the holders and hence, there are no cash inflows in zero coupon bonds. </li></ul><ul><li>The difference between issue price (discounted price) and redeemable price (face value) itself acts as interest to holders. </li></ul><ul><li>The issue price of Zero Coupon Bonds is inversely related to their maturity period, i.e. longer the maturity period lesser would be the issue price and vice-versa. These types of bonds are also known as Deep Discount Bonds. </li></ul><ul><li>  </li></ul><ul><ul><li>Floating Rate Bonds </li></ul></ul><ul><li>In some bonds, fixed coupon rate to be provided to the holders is not specified. Instead, the coupon rate keeps fluctuating from time to time, with reference to a benchmark rate. Such types of bonds are referred to as Floating Rate Bonds. </li></ul>
  5. 5. <ul><li>Convertible Bonds </li></ul><ul><li>The holder of a convertible bond has the option to convert the bond into equity (in the same value as of the bond) of the issuing firm (borrowing firm) on pre-specified terms. This results in an automatic redemption of the bond before the maturity date. </li></ul><ul><li>The conversion ratio (number of equity of shares in lieu of a convertible bond) and the conversion price (determined at the time of conversion) are pre-specified at the time of bonds issue. </li></ul><ul><li>Convertible bonds may be fully or partly convertible. For the part of the convertible bond which is redeemed, the investor receives equity shares and the non-converted part remains as a bond. </li></ul><ul><li>Amortizing Bonds </li></ul><ul><li>Amortizing Bonds are those types of bonds in which the borrower (issuer) repays the principal along with the coupon over the life of the bond. </li></ul><ul><li>The amortizing schedule (repayment of principal) is prepared in such a manner that whole of the principle is repaid by the maturity date of the bond and the last payment is done on the maturity date. For example - auto loans, home loans, consumer loans, etc. </li></ul>