Governments issue Treasury Bills (T-Bills), State Development Loans (SDLs), and dated securities to finance fiscal deficits and public expenditure. These are low-risk instruments and form the backbone of the sovereign debt structure.
Corporates issue bonds, debentures, and commercial papers (CPs) to raise capital without diluting ownership. These instruments attract investors seeking higher returns for higher risk.
Primary Market: Direct issuance by borrowers.
Secondary Market: Enables trading, liquidity, and pricing for debt instruments. Vital for investor confidence and market efficiency.
Debt provides capital without ownership dilution. Interest on debt is a fixed obligation, offering predictable cash flow to investors. In contrast, equity involves risk-sharing and dividend-based returns.
The interest the investor receives, usually semi-annually. Can be fixed, floating, or zero (in case of zero-coupon bonds).
Time until the bond expires and principal is repaid. Bonds with ≤1 year are money market instruments, >1 year are capital market securities. Maturity is also referred to as tenor.
If coupon < market rate → bond trades at discount
If coupon > market rate → bond trades at premium
If coupon = market rate → bond trades at par
Companies can have multiple bonds (ISINs) outstanding simultaneously with varying terms. Regulation limits new ISINs to 12 per fiscal year.
Issuer can redeem bonds before maturity if rates fall. Saves cost for issuer but exposes investor to reinvestment risk.
Investor can sell bond back to issuer at set date and price. Offers downside protection to bondholders.
Bonds that allow conversion into equity shares. Offers upside potential to bondholders and helps issuer reduce interest burden.
Bond prices move inversely to market interest rates. Rising rates decrease bond prices. Reinvestment of coupons at new rates also impacts returns. This risk is nullified if held till maturity (HTM).
Issuer can redeem bonds early when interest rates drop, forcing investors to reinvest at lower yields. Applies to callable bonds, increasing uncertainty for investors.
Coupon income may have to be reinvested at lower prevailing rates, especially during falling rate cycles. This reduces future returns.
Issuer may default on coupon or principal payments. Higher credit risk = higher return expectation. Credit ratings measure this risk but are not fail-proof.
If issuer’s credit rating drops, bond value falls and future borrowing becomes expensive. Example: IL&FS downgrade triggered broad market impact.
The difference in yield between corporate and government bonds changes based on liquidity, economic sentiment, and issuer fundamentals. Wider spreads signal risk aversion.
Issuer fails to meet financial obligations. Common in low-rated or junk bonds. Default risk is priced into higher yields.
Difficulty in selling bonds at fair value when needed. Long-term or low-rated bonds are more exposed. G-Secs and AAA bonds are typically more liquid.
Bonds issued or repaid in foreign currency expose issuer/investor to currency fluctuations. Masala Bonds and other FX-denominated issues carry this risk.
Inflation reduces real returns. Fixed coupons may not keep up with rising prices, decreasing purchasing power of returns.
Price swings are more pronounced for bonds with embedded options (calls/puts). Volatility affects pricing accuracy and portfolio returns.
Changes in tax laws, repatriation rules, or issuer policy may affect bond cash flows. Especially relevant for tax-free or government-supported bonds.
Unexpected events (pandemics, disasters) may affect issuer’s ability to repay. Sectoral risks vary based on event sensitivity (e.g. aviation during COVID-19).
Also called face value or principal, this is the amount repaid at maturity. Bonds trade at a premium if priced above par and at a discount if priced below. Government bonds usually have a par value of ₹100, corporates ₹1,000 or more.
The bond price equals the sum of discounted coupon payments and final principal. The discount rate is the bond’s Yield to Maturity (YTM).
Formula: Price = Σ(Coupon ÷ (1+r)t) + (Principal ÷ (1+r)n)
Example: 5-year bond with 10% coupon and market yield of 8% → Price ≈ ₹107.99
Bond prices and yields move inversely. Longer maturity and lower coupon bonds are more sensitive to interest rate changes. Relationship is convex (non-linear).
No maturity date. Pay coupons forever without principal repayment. Valuation formula: Price = Coupon / Yield
Example: 8% perpetual bond, required return 6% → Value = 8 / 0.06 = ₹133.33
Current yield is calculated as:
Formula: Current Yield = (Annual Coupon ÷ Market Price) × 100
Example: 8.24% bond at ₹103 → 8.24 ÷ 103 = 8%
Reflects income return, does not consider capital gains or losses.
YTM is the internal rate of return of a bond held till maturity. It equates the present value of all future cash flows to the bond’s current market price.
In Excel: =YIELD(settlement, maturity, rate, price, redemption, frequency, basis)
Example: 8% bond at ₹102 maturing in 2 years → YTM ≈ 6.91%
Accounts for the effect of compounding. Converts nominal coupon to annualized compounded yield.
Example: A 4.20% monthly coupon = 4.28% effective annual yield.
Applicable for callable bonds. Measures return if the bond is redeemed at first call date rather than maturity. Assumes call option is exercised.
Applicable for puttable bonds. Measures return assuming investor exercises the put option. Used when pricing bonds with early exit options.
Upward sloping curve – longer maturity earns higher yield. Reflects stable economic growth and higher future uncertainty.
Short-term yields are higher than long-term. Often signals an expected economic slowdown or recession.
Yields are almost the same across tenors. Indicates market uncertainty or transition between growth and slowdown.
Medium-term yields are higher than both short and long-term. Suggests short-term tightness but long-term easing expectations.
The result is the bond’s duration in years. Duration reflects how long it will take for an investor to recover the bond’s price in present value terms.
Duration is always less than or equal to the bond’s maturity. A zero-coupon bond has a duration equal to its maturity, while bonds with coupons have shorter durations.
Important: Duration does not increase exponentially with maturity. It tends to plateau after a certain point.
Modified duration measures the bond price’s sensitivity to changes in interest rates. It’s calculated by dividing Macaulay duration by (1 + periodic market interest rate).
Formula: Modified Duration = Macaulay Duration / (1 + periodic interest rate)
Modified duration is typically lower than Macaulay duration because it accounts for changes in interest rates.
Convexity measures the curvature in the relationship between bond prices and bond yields. Higher convexity indicates a greater price increase for a drop in interest rates and a lesser price decrease when rates rise.
Participants in the Indian money market include:
The Indian money market consists of various short-term instruments like:
Call Money: Unsecured overnight lending between commercial banks and primary dealers.
Market Repo: Borrowing using government securities as collateral, highly liquid with daily settlement.
A 15-year retirement savings scheme that offers tax benefits under Section 80C of the Income Tax Act. The scheme guarantees returns, and the amount is compounded annually.
Exclusively for senior citizens aged 60 or above. Offers higher interest rates and tax benefits. The investment is capped at ₹15 lakhs.
A government-backed savings bond with a 5-year term. It offers tax benefits and is a popular option for risk-averse investors.
Designed to encourage rural savings, KVP offers a fixed return and guarantees the maturity amount after a specified number of years.
Opened in the name of a girl child to encourage savings for her education and marriage. Offers tax benefits and attractive interest rates.