📘 9.1 Debt Market and Its Role in Financing
The debt market enables both corporates and governments to raise funds through the issue of debt securities. It plays a crucial role in transferring capital from savers to borrowers, helping fund infrastructure, welfare schemes, and corporate expansion:contentReference[oaicite:1]{index=1}.
🏛️ Government Borrowing
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.
🏢 Corporate Financing
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 vs Secondary Markets
Primary Market: Direct issuance by borrowers.
Secondary Market: Enables trading, liquidity, and pricing for debt instruments. Vital for investor confidence and market efficiency.
⚖️ Debt vs Equity
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.
A well-developed debt market depends on robust legal enforcement, reliable credit ratings, and transparency. These encourage investor participation and reduce funding costs:contentReference[oaicite:2]{index=2}.
📘 9.2 Bond Market Ecosystem
Bonds are fixed income securities where the issuer agrees to pay periodic interest (coupon) and repay a fixed principal (face value) at maturity. The fixed nature of cash flows is what defines bonds and distinguishes them from equity【302:0†NISM Series X-A-Investment Adviser Level 1 2025-2.pdf】.
💰 Coupon
The interest the investor receives, usually semi-annually. Can be fixed, floating, or zero (in case of zero-coupon bonds).
⏳ Maturity
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.
📉 Price vs Par
If coupon < market rate → bond trades at discount
If coupon > market rate → bond trades at premium
If coupon = market rate → bond trades at par
🔀 Multiple Issuances
Companies can have multiple bonds (ISINs) outstanding simultaneously with varying terms. Regulation limits new ISINs to 12 per fiscal year.
🔁 Bonds with Embedded Options
📞 Callable Bonds
Issuer can redeem bonds before maturity if rates fall. Saves cost for issuer but exposes investor to reinvestment risk.
📥 Puttable Bonds
Investor can sell bond back to issuer at set date and price. Offers downside protection to bondholders.
🔄 Convertible Bonds
Bonds that allow conversion into equity shares. Offers upside potential to bondholders and helps issuer reduce interest burden.
A legal contract between the issuer and bondholders that contains all terms — coupon, maturity, covenants, call/put provisions, and obligations. It defines the bond’s enforceability and investor rights.
📘 9.3 Risks Associated with Fixed Income Securities
Fixed income investments carry several types of risk depending on the issuer, interest rate environment, credit quality, and market conditions. Understanding these helps investors assess suitability and return expectations from debt instruments【302:0†NISM Series X-A-Investment Adviser Level 1 2025-2.pdf】.
📉 Interest Rate Risk
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).
📞 Call Risk
Issuer can redeem bonds early when interest rates drop, forcing investors to reinvest at lower yields. Applies to callable bonds, increasing uncertainty for investors.
🔁 Reinvestment Risk
Coupon income may have to be reinvested at lower prevailing rates, especially during falling rate cycles. This reduces future returns.
⚠️ Credit Risk
Issuer may default on coupon or principal payments. Higher credit risk = higher return expectation. Credit ratings measure this risk but are not fail-proof.
🔻 Downgrade Risk
If issuer’s credit rating drops, bond value falls and future borrowing becomes expensive. Example: IL&FS downgrade triggered broad market impact.
📊 Spread Risk
The difference in yield between corporate and government bonds changes based on liquidity, economic sentiment, and issuer fundamentals. Wider spreads signal risk aversion.
🚫 Default Risk
Issuer fails to meet financial obligations. Common in low-rated or junk bonds. Default risk is priced into higher yields.
💧 Liquidity Risk
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.
💱 Exchange Rate Risk
Bonds issued or repaid in foreign currency expose issuer/investor to currency fluctuations. Masala Bonds and other FX-denominated issues carry this risk.
🔥 Inflation Risk
Inflation reduces real returns. Fixed coupons may not keep up with rising prices, decreasing purchasing power of returns.
🌪️ Volatility Risk
Price swings are more pronounced for bonds with embedded options (calls/puts). Volatility affects pricing accuracy and portfolio returns.
⚖️ Political/Legal Risk
Changes in tax laws, repatriation rules, or issuer policy may affect bond cash flows. Especially relevant for tax-free or government-supported bonds.
📉 Event Risk
Unexpected events (pandemics, disasters) may affect issuer’s ability to repay. Sectoral risks vary based on event sensitivity (e.g. aviation during COVID-19).
📘 9.4 Pricing of Bonds
Bond prices are based on the present value of future cash flows — including periodic interest (coupon) and the final principal repayment. Prices fluctuate based on interest rates, time to maturity, and bond structure【302:0†NISM Series X-A-Investment Adviser Level 1 2025-2.pdf】.
💵 9.4.1 Par Value
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.
📉 9.4.2 Bond Pricing Using Present Value
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
📊 9.4.3 Yield Measures
- Coupon Yield: Coupon ÷ Face Value
- Current Yield: Coupon ÷ Market Price
- YTM: Total return if held till maturity (includes price appreciation/loss)
🔁 9.4.4 Price-Yield Relationship
Bond prices and yields move inversely. Longer maturity and lower coupon bonds are more sensitive to interest rate changes. Relationship is convex (non-linear).
♾️ 9.4.5 Perpetual Bonds
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
Bonds trade with accrued interest between coupon dates. Dirty Price = Clean Price + Accrued Interest. Market quotes are usually on clean price. All yield calculations are based on clean prices.
📘 9.5 Traditional Yield Measures
💸 9.5.1 Current Yield
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.
📉 9.5.2 Yield to Maturity (YTM)
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%
📈 9.5.3 Effective Yield
Accounts for the effect of compounding. Converts nominal coupon to annualized compounded yield.
Example: A 4.20% monthly coupon = 4.28% effective annual yield.
📞 9.5.4 Yield to Call
Applicable for callable bonds. Measures return if the bond is redeemed at first call date rather than maturity. Assumes call option is exercised.
📬 9.5.5 Yield to Put
Applicable for puttable bonds. Measures return assuming investor exercises the put option. Used when pricing bonds with early exit options.
For Government bonds, India uses 30/360 convention.
For T-Bills and money market instruments, Actual/365 is used.
These conventions affect accrued interest and bond yield calculations.
📘 9.6 Concept of Yield Curve
A yield curve plots the relationship between interest rates (Y-axis) and different maturities (X-axis) of bonds with similar credit quality. It helps visualize time-based risk premia and investor expectations around growth, inflation, and liquidity.
📈 Normal Yield Curve
Upward sloping curve – longer maturity earns higher yield. Reflects stable economic growth and higher future uncertainty.
🔻 Inverted Yield Curve
Short-term yields are higher than long-term. Often signals an expected economic slowdown or recession.
📊 Flat Yield Curve
Yields are almost the same across tenors. Indicates market uncertainty or transition between growth and slowdown.
📉 Humped Yield Curve
Medium-term yields are higher than both short and long-term. Suggests short-term tightness but long-term easing expectations.
Yield curves help in pricing bonds, managing interest rate risk, and understanding market expectations. For sovereign bonds, curves often flatten beyond 7 years due to low default risk. For corporate bonds, the curve is typically steeper due to higher risk premiums with longer tenors.
📘 9.7 Concept of Duration
Duration (or Macaulay Duration) measures a bond’s sensitivity to interest rate changes by calculating the weighted average time to recover the initial investment in present value terms. It serves as a measure of price volatility in response to interest rate movements:contentReference[oaicite:0]{index=0}.
🧮 Calculating Duration
- Step 1: Calculate the present value of each future cash flow.
- Step 2: Multiply each present value by its respective time period (weights).
- Step 3: Sum the weighted present values and divide by the current bond price.
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 vs Maturity
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
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
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.
Bonds with higher duration are more sensitive to interest rate changes. Understanding duration and convexity is key to managing bond portfolio risk, especially in fluctuating interest rate environments.
📘 9.8 Introduction to Money Market
The money market provides short-term borrowing and lending opportunities with maturities ranging from overnight to one year. It is crucial for liquidity management and financial stability in the economy, ensuring smooth transactions and stability within financial markets .
🏦 9.8.1 Key Players in the Money Market
Participants in the Indian money market include:
- Public and Private Sector Banks
- Co-operative Banks
- Foreign Banks
- Financial Institutions (FIs)
- Mutual Funds, Insurance Companies
- NBFCs, Corporates, Provident/Pension Funds
- Small Finance Banks, Payment Banks
📊 9.8.2 Types of Instruments
The Indian money market consists of various short-term instruments like:
- Call Money – Overnight lending between banks (₹1 lakh minimum)
- Notice Money – Borrowing with 2–14 days maturity
- Term Money – 15 days to 1 year maturity
- Market Repo – Government securities-backed borrowing
- TREP – Triparty Repo (CCIL-managed, ₹5 lakh minimum)
- T-Bills – Short-term Government bonds (91–364 days)
- CPs & CDs – Commercial Papers and Certificates of Deposit issued by corporates and banks
💡 Call Money and Repo
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 liquid money market ensures stability in the financial system and helps central banks execute monetary policy efficiently. It is integral for managing short-term liquidity mismatches and market operations.
📘 9.9 Introduction to Government Debt Market
The Government Securities (G-Sec) market is a crucial part of India’s fixed income securities market. It not only helps fund the government’s fiscal requirements but also serves as a benchmark for pricing other financial products and facilitates the implementation of monetary policy .
🏛️ 9.9.1 Key Players in the Government Debt Market
- Banks: Public, private, and foreign banks are major participants, investing in G-Secs for liquidity management.
- Primary Dealers (PDs): Facilitate trading and market-making activities.
- Mutual Funds: Large institutional investors that hold a significant share of government securities.
- Insurance Companies: Secure long-term funding with low-risk assets.
- Foreign Portfolio Investors (FPIs): Actively participate in the G-Sec market, especially in medium to long-term securities.
📊 9.9.2 Types of Instruments
- Treasury Bills (T-Bills): Short-term government securities issued at a discount. Maturities: 91, 182, and 364 days.
- Cash Management Bills (CMBs): Short-term instruments for managing government’s cash flow mismatches.
- Dated G-Secs: Long-term securities with fixed or floating interest rates, typically maturing between 1 to 50 years.
- Fixed Rate Bonds: Bonds that pay a fixed coupon over the life of the bond.
- Floating Rate Bonds (FRBs): Bonds with variable interest rates based on an underlying benchmark.
- Zero-Coupon Bonds (ZCBs): Issued at a discount and redeemed at face value, offering no periodic interest payments.
- Inflation-Indexed Bonds (IIBs): Bonds where both the principal and coupon are indexed to inflation (e.g., CPI/WPI linked).
- Convertible Bonds: Bonds with embedded options that allow conversion into equity shares at a later date.
The government debt market provides a stable, risk-free investment option for institutional investors. It also facilitates the execution of monetary policy, offers market liquidity, and sets a benchmark for other financial products in India.
📘 9.10 Introduction to Corporate Debt Market
The corporate debt market in India continues to grow despite challenges. It provides an avenue for companies to raise funds through debt instruments. This market is mainly accessed by institutional investors, and it provides an alternative to bank financing and foreign borrowings .
🏛️ 9.10.1 Key Players in the Corporate Debt Market
- Issuer: The entity issuing the debt instrument. Bonds can be issued via private placement or public offerings under SEBI regulations.
- Debenture Trustees (DT): Legal entities responsible for protecting the interests of bondholders. They ensure compliance with the terms of issuance and act in the event of defaults.
- Qualified Institutional Buyers (QIB): Institutional investors like banks, insurance companies, mutual funds, pension funds, and FIIs who are major players in the corporate bond market.
- Retail Individual Investors: Individuals investing up to ₹2 lakh in corporate bonds. They are encouraged through public issues and bond listings.
📊 9.10.2 Types of Corporate Debt Instruments
- Company Deposits: Fixed interest-bearing deposits, usually offered by corporates for 1-3 years. Not transferable and not categorized as securities under SCRA.
- Bonds and Debentures: Debt instruments issued by companies, often secured with collateral. Investors should assess credit risk before investing.
- Infrastructure Bonds: Long-term bonds (10-20 years) issued to fund infrastructure projects. These bonds can be traded in the secondary market.
- Inflation-Indexed Bonds: Bonds where the coupon rate is linked to inflation. These bonds protect the investor from inflation risk and ensure real return protection.
The corporate debt market plays a vital role in diversifying the funding sources for companies and provides investors with various risk-return options. Understanding key players, instruments, and risks involved is crucial for both investors and issuers.
📘 9.11 Small Saving Instruments
Small saving schemes in India are government-backed instruments designed to encourage regular savings. These schemes offer an implicit guarantee by the government, making them a low-risk investment option. They are offered through post offices and select banks.
💰 Public Provident Fund (PPF)
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.
👵 Senior Citizens’ Saving Scheme (SCSS)
Exclusively for senior citizens aged 60 or above. Offers higher interest rates and tax benefits. The investment is capped at ₹15 lakhs.
📈 National Savings Certificate (NSC)
A government-backed savings bond with a 5-year term. It offers tax benefits and is a popular option for risk-averse investors.
🌾 Kisan Vikas Patra (KVP)
Designed to encourage rural savings, KVP offers a fixed return and guarantees the maturity amount after a specified number of years.
🎒 Sukanya Samriddhi Account
Opened in the name of a girl child to encourage savings for her education and marriage. Offers tax benefits and attractive interest rates.
📊 Types of Small Saving Instruments
- PPF: Long-term retirement savings, tax-free returns
- SCSS: Higher returns for senior citizens, tax benefits
- NSC: 5-year savings bond, tax savings under 80C
- KVP: Rural-focused, guarantees returns after fixed tenure
- Sukanya Samriddhi: Special scheme for girl children, tax-free returns
These instruments provide a safe, government-backed investment option for conservative investors. They are useful for long-term goals like retirement, children’s education, and tax-saving.
