INVESTING IN FIXED INCOME SECURITIES

Investing in Fixed Income Securities (Part 1)

Debt Market: The debt market enables borrowers to issue debt securities, which investors can buy in the primary or secondary market, playing a crucial role in economic growth by channeling funds from savers to investors.
Debt Financing: Debt financing involves borrowing with fixed obligations, whereas equity financing grants ownership rights, with governments and corporates raising debt for funding needs.
Bond Market Ecosystem: Bonds create fixed financial obligations on the issuers, with the issuer agreeing to pay a fixed amount of interest (coupon) periodically and repay the fixed amount of principal (face value) at the date of maturity.
Key Features of Bonds:
- Coupon: The interest income/coupon income that the bond holder will receive over the life of the bond.
- Maturity Period: The time period before a bond matures, also known as tenor or tenure.
- Principal Value: The original value of the obligation, different from the bond's market price unless the coupon rate and market interest rate are the same.
Risks Associated with Fixed Income Securities:
- Market Risk: The risk of changes in interest rate levels in the economy.
- Credit Risk: The risk of change in the creditworthiness of the borrower, including Downgrade Risk, Spread Risk, and Default Risk.
Types of Risks:
- Interest Rate Risk: The price of the bond is inversely related to the interest rate movement.
- Call Risk: The risk of a bond being prematurely called or repaid by the issuer.
- Reinvestment Risk: The risk that interest rates may decrease during the life of the bond, affecting the reinvestment of periodic income.
- Credit Risk: The risk that the issuer may default on the debt obligation, including Downgrade Risk, Spread Risk, and Default Risk.

Investing in Fixed Income Securities (Part 2)

Default Risk: The possibility of non-payment of coupon or principal when due, which arises when a company fails to meet its financial obligations towards interest and principal repayments.
Liquidity Risk: The risk involved with an instrument that the investor would not be able to sell the investment at the time of need, which can result in significant losses if the investor is forced to sell at a lower price.
Exchange Rate Risk: The risk associated with bonds issued in foreign currency, where the issuer must acquire foreign currency to fulfill its obligations, and the cost of acquiring such foreign exchange may increase if the domestic currency has depreciated.
Inflation Risk: The risk faced by an investor of inadequacy of funds received from the bond investment to fulfill the deferred needs, which can result in a decrease in the real return on investment.
Volatility Risk: The risk that affects bonds with embedded options, where the pricing of the bond takes into account the volatility level.
Political or Legal Risk: The risk associated with bonds that have tax benefits, which can be affected by changes in government rules or regulations.
Event Risk: The risk of an unexpected or unplanned event that forces the value of an investment to drop substantially, which can be specific to a particular sector or industry.

Bond Pricing

Par Value: The face value of a debt instrument, which is promised to be paid as principal at the maturity of the debt instrument.
Determining Cash Flow, Yield, and Price of Bonds: A bond is valued using future known cash flows, which are calculated using the promised coupon on the principal.
Discount Factors: The present value of future cash flows, which are calculated using the yield to maturity (YTM) of the bond.
Bond Pricing Formula: The price of a bond is the sum of the present value of all future cash flows of the bond, which can be calculated using the formula: Value = Annual Coupon cash flow * PVIF + Par Value or Face value or Redemption Value * PV of last maturity.

Bond Yield Measures

Coupon Yield: The ratio of the annual coupon payment to the bond's face value.
Yield to Maturity (YTM): The total return an investor can expect to earn from a bond if they hold it until maturity, which takes into account the coupon payments, capital gain or loss, and the reinvestment of interest payments.
XIRR Formula: A formula used to calculate the yield to maturity of a bond, which assumes reinvestment of interest payments at the same rate as the outcome of the XIRR formula.

Investing in Fixed Income Securities (Part 3)

Coupon Yield: The coupon payment as a percentage of the face value, calculated as Coupon Payment / Face Value.
Current Yield: The coupon payment as a percentage of the bond's current market price, calculated as Annual coupon rate / current market price of the bond.
Valuation of Bonds: The process of determining the present value of a bond's future cash flows, using the bond price equation.
Semi-Annual Compounding: A method of calculating interest where the interest is compounded twice a year, resulting in a higher effective yield.
Zero-Coupon Bonds: Bonds that do not pay periodic interest, but instead pay the face value at maturity.
Perpetual Bonds: Bonds with no maturity date, paying a constant stream of coupons indefinitely.

Key Concepts in Bond Valuation

Clean Price: The price of a bond excluding accrued interest.
Dirty Price: The sum of the clean price and accrued interest.
Accrued Interest: The interest that has accrued since the last coupon payment.
Yield to Maturity (YTM): The discount rate that equates the present value of a bond's future cash flows to its current market price.
Effective Yield: The equivalent rate that would produce the same final amount at the end of 1 year if simple interest is applied.

Yield Measures

Current Yield: The coupon payment as a percentage of the bond's current market price.
Yield to Maturity (YTM): The discount rate that equates the present value of a bond's future cash flows to its current market price.
Effective Yield: The equivalent rate that would produce the same final amount at the end of 1 year if simple interest is applied.
Yield to Call: The estimated rate of return for bonds held to the first call date.
Yield to Put: The estimated rate of return for bonds held to the first put date.

Yield Curve

Definition: A graph that plots the yields of bonds with different maturities against their respective maturities.
Importance: Helps investors understand the relationship between bond yields and maturities, and makes informed investment decisions.

Investing in Fixed Income Securities (Part 4)

Yield Curve: A graphical representation of the relationship between time and interest rates, typically upward sloping, indicating higher interest rates for longer maturities.
Risk Premia: The excess return demanded by investors for holding a riskier security, reflected in the slope of the yield curve.
Yield Curve Shapes: Four main shapes, including:
- Normal Yield Curve: Upward sloping, with higher interest rates for longer maturities.
- Inverted Yield Curve: Downward sloping, with higher interest rates for shorter maturities.
- Flat Yield Curve: Constant interest rates across all maturities.
- Humped Yield Curve: Short-term and long-term yields are lower than medium-term yields.

Key Concepts in Fixed Income Securities

Duration: A measure of the time taken to recover the initial investment in present value terms, also known as Macaulay Duration.
Modified Duration: A measure of the change in the value of a security in response to a change in interest rates.
Convexity: A measure of the degree of the curve in the relationship between bond prices and bond yields.

Introduction to Money Market

Money Market: A market for ultra-short term to short-term lending and borrowing of funds, with maturities ranging from overnight to one year.
Participants: Include public sector banks, private sector banks, foreign banks, co-operative banks, financial institutions, insurance companies, mutual funds, primary dealers, and corporates.
Instruments: Include call money, notice money, term money, market repo, triparty repo, commercial paper, certificates of deposit, and treasury bills.

Types of Money Market Instruments

Call Money: Unsecured lending and borrowing of funds, predominantly overnight, dealt on the RBI's NDS-CALL platform.
Notice Money: Uncollateralized lending and borrowing of funds for a period beyond overnight and up to 14 days, dealt on the RBI's NDS-CALL platform.
Term Money: Uncollateralized lending and borrowing of funds for a period between 15 days and 1 year, dealt on the RBI's NDS-CALL platform.
Market Repo: A ready forward contract, where funds are borrowed via the sale of securities with an agreement to repurchase at a future date, traded on the CROMS electronic platform.
Triparty Repo: A type of repo contract with a third-party intermediary, known as the Triparty Agent, traded on the TREPS anonymous order matching trading platform.

Investing in Fixed Income Securities (Part 5)

Introduction: Fixed income securities are debt instruments that provide a fixed return in the form of interest or dividends. They are considered a low-risk investment option and are often used by investors to generate regular income.
Types of Fixed Income Securities:
- Treasury Bills (T-bills): Short-term money market instruments issued by the Government of India at a discount to its face value and are zero coupon securities issued to be redeemed at par (100) at maturity.
- Cash Management Bills (CMBs): Essentially very short-term T-bills, issued by the Government of India to fund the temporary mismatches in its cash flow, with maturities less than 91 days.
- Commercial Paper (CP): Used by Indian corporates to raise short-term unsecured funds, with maturities between 7 days and one year.
- Certificate of Deposit (CD): Issued against funds deposited at a bank or eligible FIs, with maturities of 7 days to 364 days by banks and for 1 year to 3 years by FIs.
- Corporate Bond Repo (CBR): Repo in corporate bonds was introduced by RBI in 2010, allowing participants to borrow against the collateral of their securities.

Government Debt Market

Introduction: The government securities (G-Sec) market is the most active segment of the Indian fixed income securities market, providing benchmark interest rates in the market for pricing of various products and schemes.
Key Players: Primary participants in the Indian G-Sec market include large institutional players like banks, Primary Dealers (PDs), and insurance companies.
Types of Instruments:
- Treasury Bills (T-bills): Short-term money market instruments issued by the Government of India at a discount to its face value and are zero coupon securities issued to be redeemed at par (100) at maturity.
- Cash Management Bills (CMBs): Essentially unstructured T-bills maturing within 91 days, used by RBI for smoothening systemic issues such as liquidity management.
- Dated G-Secs: Long-term bonds with maturities ranging from one to fifty years, paying a fixed or floating coupon on a semi-annual basis.
- Fixed Rate Bonds: Pay a fixed coupon over their entire life, with all coupons paid semi-annually.
- Floating Rate Bonds (FRB): Pay interest at a variable coupon rate that is reset at pre-announced intervals.
- Zero Coupon Bonds (ZCBs): Do not pay any fixed coupon and are issued at a discount and redeemed at par like T-Bills.
- Capital Indexed Bonds (CIBs): The principal amount is linked to an inflation index to protect it from inflation.
- Inflation Indexed Bonds (IIBs): Both the principal amount and coupon flows are protected against inflation.
- Bonds with Call/Put Options: The Government of India has also experimented with bonds with embedded options.
- Special Securities: Occasionally, the Government of India may issue bonds as compensation in lieu of cash subsidies to entities.
- Separate Trading of Registered Interest and Principal of Securities (STRIPS): Essentially separate ZCBs created by breaking down the cash flows of a regular G-Sec.
- Sovereign Gold Bond (SGB): Unique instruments with commodity (gold) linked prices, paying a fixed coupon per annum on the nominal value paid on semi-annual basis.
- Savings (Taxable) Bonds: Specially issued for retail investors at par for a minimum amount of ₹1,000 (face value) and in multiples thereof.
- State Development Loans (SDLs): Issued by State Governments, with maturities ranging from 5 to 25 years.

INVESTING IN FIXED INCOME SECURITIES (Part 6)

State Development Loans (SDLs): Market borrowings of State Governments / Union Territories through semi-annual coupon paying dated securities, eligible for SLR and borrowing under the LAF window.
Uday bonds: Special securities issued by State Governments for financial turnaround of power distribution companies (DISCOMs), not eligible for SLR status.
SDLs/SGS (State Government Securities): Nowadays, SDLs are also referred to as SGS.

Introduction to Corporate Debt Market

Corporate debt: Continues to have a low share of the total debt issuance in India, with investment demand largely restricted to institutional investors.
Institutional investors: Investments are limited by prudential norms for investment issued by their respective regulators.
Corporate debt market growth: Despite constraints, the Indian corporate debt market has witnessed significant growth in recent years due to enhanced transparency, expanded issuer and investor base, and better market infrastructure.

Key Players in the Corporate Bond Ecosystem in India

Issuer: Entity that issues a debt instrument to borrow money from investors, with the option to use private placement or public issue protocol of SEBI.
Debenture Trustee (DT): Registered with SEBI, holds secured property on behalf of the debt issuer and for the benefit of debenture holders, responsible for protecting the interest of debenture holders.
Qualified Institutional Buyer (QIB): Includes scheduled commercial banks, insurance companies, mutual funds, state industrial development corporations, and more.
Retail Individual Investor: Investors who bid/apply for securities for ₹2 lakh or less.

Corporate Debt Instruments

Company deposits: Time deposits issued by companies for a specific time period, usually 1, 2, and 3 years, with a fixed rate of interest.
Bonds and debentures: Issued by companies, usually for a slightly longer time frame, with many being secured in nature.
Infrastructure Bonds: Long-term bonds, issued to finance infrastructure projects, often traded in the secondary market.
Inflation indexed bond: Interest rate changes depending on the inflation rate in the economy, ensuring a protected real rate of return for the investor.

Small Saving Instruments

Bank Deposits: Fixed deposits (FDs) offer higher returns than savings accounts, with a fixed interest rate and return of the deposited sum on maturity.
Fixed Deposit (FD) features:
- Insured up to Rs.5 lakh by the Deposit Insurance and Credit Guarantee Corporation (DICGC)
- Interest can be paid into the depositor’s savings bank account or accumulated and paid at the end of the term
- Minimum deposit amount varies across banks
- Duration of deposits can range from 7 days to 10 years
Interest Rates on FDs: Depend on the duration of deposit, amount deposited, and policies of the bank, with longer-term deposits paying a higher rate.
Floating rate Government of India Bond: Launched on July 1, 2020, with an interest rate of 7.15 per cent, reset twice a year based on changes in the benchmark rate.
Small Saving Schemes: Instituted by the Indian government to encourage investors to save regularly, offered through the post office and select banks, including:
- Public Provident Fund (PPF)
- Senior Citizens’ Saving Scheme (SCSS)

Investing in Fixed Income Securities (Part 7)

Public Provident Fund (PPF): A 15-year deposit account that can be opened with a designated bank or post office, providing a long-term retirement planning option.
Key Features of PPF:
- Can be opened by an individual at any age
- HUFs and NRIs are not allowed to open PPF accounts
- Joint accounts are not allowed, but nomination facility is available
National Savings Certificate (NSC): A government-issued certificate with a tenor of 5 years, available for purchase at post offices.
Key Features of NSC:
- Can be bought by individuals on their own account or on behalf of minors
- NRI, HUF, companies, trusts, societies, or other institutions are not allowed to purchase NSCs
- Investments made in NSC VIII issue enjoy tax benefits under section 80C of Income Tax Act, 1961
Senior Citizens’ Saving Scheme (SCSS): A savings product available to senior citizens of age 60 years or above, with some exceptions for retired personnel.
Key Features of SCSS:
- Can be opened at any post office undertaking savings bank work and a branch of a bank authorized to do so
- The scheme can be held in individual capacity or jointly with the spouse
- NRIs, PIOs, and HUF are not eligible to invest in this scheme
Post Office Schemes and Deposits:
- Post Office Monthly Income Scheme (POMIS): Provides a regular monthly income to depositors, with a term of 5 years.
- Post Office Time Deposits (POTD): Similar to fixed deposits of commercial banks, with terms of one year, two years, three years, and five years.
- Post Office Recurring Deposit (RD): Allows deposits to be made at a minimum amount of Rs.10 per month, with no maximum investment limit.
Kisan Vikas Patra (KVP): A savings certificate that can be purchased by an adult for self or by two adults for a minor investor, with a minimum investment of Rs.1,000.
Key Features of KVP:
- Can be purchased from any departmental post office or bank through cash, local cheque
- No maximum limit, and the instrument maturity depends on the applicable rate of interest
- Facility of nomination and joint holding is available
Sukanya Samriddhi Account Scheme:
- A scheme launched for the benefit of girl children, with the account to be opened in the name of the girl child by a natural or legal guardian.
- Key Features:
  - Only one account can be opened in the name of a child, and a guardian can open a maximum of two accounts in the name of two different girl children.
  - The age of the child cannot be more than 10 years at the time of opening the account.
  - The minimum investment in the account is Rs.250 in a financial year, and a maximum of Rs.1,50,000.
  - Any amount deposited in the account is eligible for deduction under section 80C of the Income Tax Act.

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