This document provides an overview of fixed income securities such as bonds. It defines what a bond is, noting that a bond represents a loan where the issuer pays interest to the investor. It describes the key characteristics of bonds like the issuer, coupon rate, maturity date, and ratings. It also distinguishes bonds from equities, explaining that bonds are lower risk but provide fixed income while equities provide ownership and potential share of profits. The document outlines the major issuers of bonds and provides background on how bond markets evolved. It discusses risks associated with bonds and how bonds are valued and traded on exchanges.

1. Fixed income securities

2. UNIT 1
1. Valuation of Fixed Income Securities
2. Introduction to Bond Markets
3. Yield and Conventions
4. Spot and Forward Rates
5. Terminology and characteristics of Bonds/Types of fixed income
securities:
Central Government securities
State Government securities
Government-guaranteed bonds
PSU bonds
Corporate debentures
Money market instruments and preferred stock
Valuation/Pricing of bonds, Bond Yields
6. Term structure of interest rates

3. INTRODUCTION
 Companies and governments need money for developmental
activities
 They can borrow from banks or raise money from the public by
issuing bonds
 A bond is nothing but a loan for which the public is the lender
 A bond can be considered as an IOU given by the borrower
(issuer) to the lender (investor)
 The issuer of the bonds pays interest to the lender at a predetermined rate and schedule
 Bonds are called as fixed-income securities as the investor is
aware of the exact amount he will get back if he holds the
security till maturity

4. DEFINITION AND FEATURES
 A bond represents a contract under which a borrower promises to pay
interest and principal on specific dates to the holder of the bond.
 The most important things to note in a fixed income instrument are
 Issuer – Example BOB,ICICI, L&T, SBI, Hindalco, NHB, NABARD,
Railway finance corpn.
 Coupon or interest – Ex. 8%, 9%, 10%, Zero Coupon
 Tenure – Say 5 yrs., 10 yrs, 15 years
 Maturity date – the date on which the borrower repays the amount
 Interest payment schedule – Monthly, Quarterly, Semi Annually,
Annually, Compounded, Simple, Floating
 Ratings – AA, AA+
 Pre closure options – Call after 5 years, Put after 5 years, 1 % interest
penalty.
 Issue price or value – At par, At discount

5. DIFFERENCES BETWEEN BOND AND EQUITY
 Bond
 Bonds are debt instruments
 An investor becomes a creditor to the organisation
 A bond holder has a higher claim on the assets
 He does not have a share in the profits – he gets only principal and
interest
 Stocks and shares
 Shares are equity
 An investor becomes an owner in an organisation – he has voting
rights
 A shareholder is paid only after all the debt payments are made
 He has a right to share in the profits of the company – he is paid
dividend depending on the amount of profits

6. WHY INVEST IN BONDS?
 Bonds are not as volatile as the stock markets
 They provide a fixed income and thus are safe retirement plans
 They are good investments for short term horizons when money
is required for a definite purpose
 If a person is in his 20s and 30s, a majority of investment can be
in equities, whereas if a person is in his middle age, a majority of
investments must be in fixed income securities

7. WHO ISSUES BONDS?
 Central Government
 State Government
 Public sector Undertakings
 Private Sector Companies

8. BOND MARKET - HOW IT EVOLVED INTO A MARKET
 Investors had a general perception that bonds with longer maturity give
higher returns.
 Some investors who had bought these bonds wanted to exit, but the issuer
was not ready to buy it back
 There were some who sensed that they can sell their bonds and make capital
gains
 There were some regulatory requirements due to which people wanted to
sell
 There were some changes in the risk profile of the issuer and holders wanted
to offload
 As the category of “Available for sale” increased and more investors flocking
to buy bonds round the year, it created what is called the bond market

9. BOND MARKET
 The National Stock exchange has a Wholesale debt Market segment. It is a
market for high value transactions
 The retail trade in corporate debt securities is done primarily on the capital
market segment of the NSE and the debt segment of the Bombay Stock
exchange

10. TRADE TIMINGS
 Trading in the WDM segment is open on all days except Saturdays, Sundays
and other holidays, as specified by the Exchange.
Settlement
Monday to Friday
Same Day Settlement (Government
10.00 hrs to 15.00 hrs
Securities)
Other Day Settlement (Government
10.00 hrs to 17.15 hrs
Securities)
Same Day and Other Day
Settlement (Non-Government
10.00 hrs to 18.15 hrs
Securities)

11. PHASES OF TRADE
Trading on WDM segment is divided into three phases as under:
 Pre-Open Market Phase
The pre-open period commences from 9.00 hrs This period allows the trading
member/Participant to:
set up counter party exposure limits
set up Market Watch (the security descriptor)
make inquiries
 Market Open Phase
The system allows for inquiries of the following activities when the market is
open for trading:
Order Entry
Order Modification
Order Cancellation
Trade Cancellation

12. PHASES OF TRADE
 Post Market Phase (also called SURCON)
During the period of SURCON (SURveillance and CONtrol) a trading member gets
only inquiry access with a facility to request for trade cancellation. On
completion of SURCON the trading system processes data and gets the system
ready for the next day.

13. RISK ASSOCIATED WITH BONDS

14. RISK ASSOCIATED WITH BONDS

15. BOND VALUATION
Requirements
 An estimate of expected cash flows
 An estimate of the required rate of return
The formula :
P=A*(1+r)ⁿ-1 / r(1+r) ⁿ
P= Present Value in rupees
A= Annual coupon amount
n= Number of years to Maturity
r= Periodic required return
M= Maturity Value
+ M/ (1+r) ⁿ

16. A BOND SPECIMEN COPY

17. TERM STRUCTURE OF INTEREST RATES
Term structure of interest rates is the variation of
yields of bonds with similar risk profiles with the terms
of bonds
Interest rates depend on
o Time
o Level of risk
o Market trends
Identical bonds (same risk profile, liquidity, tax
structures) with different terms to maturity have
different interest rates

18. YIELD CURVES
The term structure of interest rates is shown by the
yield curve
It is a graph that plots the yields of similar-quality
bonds against their maturities, ranging from shortest
to longest.
The yield curve is generally indicative of future
interest rates, which are indicative of an economy's
expansion or contraction
Therefore, yield curves and changes in yield curves
can convey a great deal of information.

19. YIELD CURVES
Year
Interest
rate
0
8%
1
10
2
3
Year
Price
YTM
1
925.93
8%
2
841.75
8.995
11
3
758.33
9.660
11
4
683.18
9.993
1000/1.08= 925.93
1000/(1.08*1.10) = 841.75
1000/(1.08*1.10*1.11) = 758.33
841.75=1000/(1+y2)2

21. YIELD CURVES

22. TYPES OF YIELD CURVES

23. TYPES OF YIELD CURVES
Normal Yield curve – upward sloping – depicts normal
economic conditions – growth at a normal rate
o Steeply +ve sloping yield curve is an indicator of an economic
recovery and found at the end of a recession
Inverted yield curve – downward sloping – rare and
abnormal market conditions – Long term rates are
lower than short term rates
Flat yield curve – Finally, a flat yield curve exists when
there is little or no difference between short and long
term yields – market is sending mixed signals – Short
term rates may rise, Long term may fall

24. SPOT AND FORWARD RATES
 Let us consider 2 zero coupon bonds with a maturity value of Rs.1000
 Bond A is a 1 year bond with a rate of 8%
 Bond B is a 2 year bond with a rate of 10%
I will be able to buy these bonds today at the above rates. So we refer to this as
the spot rate.
0
Bond A
Bond B
1
8%
2
Rs.1000
10%
Present value of both bonds can be easily calculated
Rs.1000

25. FORWARD RATES
Let us say I had invested Rs.826.45, it would grow as below
826.45 X (1.10)²
The above when expressed as below gives us the forward rate
826.45 X (1.10)² = 826.45 X 1.08 X 1.1204
When an individual invests in a two-year zero coupon bond yielding 10
percent, his wealth at the end of two years is the same as if he received
an 8 percent return over the first year and a 12.04 percent return over
the second year. This hypothetical rate over the second year, 12.04
percent, is called the forward rate.
More generally, given the 1 year (r1) and the 2 year (r2) spot rates, we
can calculate the forward rate as below
f = (1+r2)²
1+r1

26. CHARACTERISTICS OF YIELD CURVES
Three characteristics of yield curves
The change in yields of different term bonds tend to
move in the same direction
The yields of short term bonds are more volatile
than the long term bonds
The yields of long term bonds tend to be higher
than the short term bonds

27. THREE THEORIES TO EXPLAIN YIELD CURVES
1. The “expectations theory”
2. The “liquidity preference hypothesis”
3. The “segmented market hypothesis”

28. EXPECTATION HYPOTHESIS
The Expectation hypothesis states that different term
bonds can be viewed as a series of 1-period bonds with
yields of each bond equal to the expected short term
interest rate for that period.
The forward interest rates are unbiased estimates of
future interest rates
The expectation hypothesis is about maximization of
utility of money in the form of higher expected return
over the long term horizon
Accordingly present long term interest rate is just an
average of the current short term rates and one period
forward rates

29. Return
EXPECTATION HYPOTHESIS
1
2
3
Term
4
5

30. LIQUIDITY PREFERENCE THEORY
This theory propounded by J R Hicks, states that
investors have a preference for liquidity
Long term investments are comparatively less liquid
and investors demand a higher compensation while
investing in long term investments
This results in the increased interest rate for longer
maturity in contrast to the shorter maturity.
As a parallel, long term investments are more risky and
hence investors demand more return to compensate
such higher degree of risk

31. LIQUIDITY PREFERENCE THEORY
However, forward rates differ from expected short
rates because of a risk premium known as liquidity
premium
A liquidity premium can cause the yield curve to slope
upward even if no increase in short rates is anticipated

32. TERM STRUCTURE OF INTEREST RATES
 Fact 1: Interest rates for different maturities tend to move
together over time.
 Fact 2: Yields on short-term bond more volatile than yields on
long-term bonds.

33. TERM STRUCTURE OF INTEREST RATES
 Fact 3: Long-term yield tends to be higher than short term yields
(i.e. yield curves usually are upward sloping).

34. SEGMENTATION THEORY
 This theory is based on the rational behavior of investors. Here
rational behavior implies that investors are risk averse or risk
minimizers.
 Different market participants with differing requirements invest
in different parts of the term structure.
o for. Eg. Banks and financial institutions invest in short term bonds
whereas pension funds will invest in long term bonds.
 The best way to minimize risk is by having a proper match
between the investment requirement and the term of the bond
 Investors have a preferred maturity pattern and will choose
other maturities only if compensated with premium.
 Investors prefer short term investments and will be attracted
only if they are offered sufficient premiums.

35. Thank you