CHARACTERISTICS OF DEBT SECURITIES

CHARACTERISTICS OF DEBT SECURITIES (Part 1)

Definition: A debt security is a contract between the issuer (company) and the lender (investor) that allows the issuer to borrow a sum of money at pre-determined terms.
Details: The features of a debt security include:
- Principal: The amount being borrowed by the issuer.
- Coupon: The rate of interest to be paid by the borrower to the lender.
- Maturity Date: The date on which the contract requires the borrower to repay the principal amount.
- Key differences between debt securities and equities:
  - Debt holders are lenders, while equity-holders are owners.
  - Debt securities have a fixed maturity period, while equities are perpetual.
  - Returns to debt holders are fixed, while equity-holders are entitled to residual profit.

Definition: The market value of a debt instrument is the value at which it is traded in the market before its maturity.
Details: Market value may be higher or lower than the face value of the debt instrument and fluctuates due to market dynamics.

Definition: The returns to an investor in bonds, made up of coupon payments and potential capital gains or losses.
Details: The term yield is used to denote the returns to the investor, which can be calculated using:
- Current Yield: Compares the coupon of a bond with its market price.
- Yield to Maturity (YTM): A method for computing the return on a bond investment, taking into account the discounted value of future cash flows.

Definition: Various types of debt securities, including:
- Convertible Debt Securities: Hybrid instruments with features of both debt and equity.
- Zero Coupon Bond: A bond with no coupons paid or specified, issued at a discount to its face value.
- Fixed Rate Bonds: Bonds that pay a pre-defined interest at specified intervals.
- Floating Rate Bonds: Bonds whose coupon rate is reset periodically based on a benchmark rate.
- Inflation Indexed Bonds: A type of floating rate bond where the benchmark is the inflation rate.
- Amortising Bonds: Bonds where the principal is repaid over the life of the bond, rather than at maturity.
- Asset-backed Securities: Bonds created by pooling together assets and representing participation in the cash flows from the asset pool.

Definition: The debt market can be segmented based on the type of borrower and the tenor of the instrument.
Details: The debt market can be classified into:
- Government Securities: Bonds issued by governments, with no credit or default risk.
- Corporate Bond Markets: Bonds issued by non-government agencies, with credit risk defined by the credit rating of the bond.

Definition: The evaluation of a borrower's ability to meet its obligations, based on internal and external factors.
Details: Credit rating is used to determine the risk associated with a borrower and the cost of lending, with higher credit ratings indicating lower risk of default.

Credit Risk: The risk of a borrower defaulting on their obligations, which is evaluated by credit rating agencies.
Credit Rating Agencies: Registered with SEBI, these agencies assess the creditworthiness of borrowers and assign a credit rating based on their ability to meet financial obligations.

Evaluation: Credit rating agencies consider qualitative and quantitative factors that impact a borrower's business and ability to service debt.
Rating Assignment: A rating committee assigns a rating to the borrowing based on the evaluation, which is a dynamic process that can change over time.
Provisional Ratings: SEBI has guidelines for provisional ratings, which are assigned when certain compliances or documentations are pending.

Long Term Debt Instruments:
- AAA: Highest degree of safety, lowest credit risk
- AA: High degree of safety, very low credit risk
- A: Adequate degree of safety, low credit risk
- BBB: Moderate degree of safety, moderate credit risk
- BB: Moderate risk of default
- B: High risk of default
- C: Very high risk of default
- D: In default or expected to be in default soon
Short Term Debt Instruments:
- A1: Very strong degree of safety, lowest credit risk
- A2: Strong degree of safety, low credit risk
- A3: Moderate degree of safety, higher credit risk
- A4: Minimal degree of safety, very high credit risk
- D: In default or expected to be in default on maturity
Long Term Debt Mutual Fund Schemes:
- AAAmfs: Highest degree of safety
- AAmfs: High degree of safety
- Amfs: Adequate degree of safety
- BBBmfs: Moderate degree of safety
- BBmfs: Moderate risk of default
- Bmfs: High risk of default
- Cmfs: Very high risk of default
Short Term Debt Mutual Fund Schemes:
- A1mfs: Very strong degree of safety
- A2mfs: Strong degree of safety
- A3mfs: Moderate degree of safety
- A4mfs: Minimal degree of safety

Definition: Bonds without a current or valid rating from an external rating agency.
Characteristics: Unrated bonds are more illiquid and have higher yields than rated bonds.

Definition: Instruments with a maturity of less than one year, used for short-term financing.
Examples: Commercial papers, certificates of deposit, treasury bills.

Definition: An unsecured money market instrument issued in the form of a promissory note.
Eligible Issuers: Highly rated corporate borrowers, primary dealers, and all-India financial institutions.
Investors: Individuals, banks, corporate bodies, non-resident Indians, and foreign portfolio investors.

Definition: A negotiable money market instrument issued in dematerialized form or as a usance promissory note.
Eligible Issuers: Scheduled commercial banks and select all-India financial institutions.
Minimum Amount: Rs. 1 lakh, with subsequent investments in multiples of Rs. 1 lakh.

Issuance: CDs can be issued to Non-Resident Indians (NRIs) only on a non-repatriable basis.
Transferability: These CDs cannot be endorsed to another NRI in the secondary market.
Maturity Period: The maturity period for CDs issued by banks should be between 7 days and 1 year, while for Financial Institutions (FIs), it should be between 1 year and 3 years.

Definition: Treasury Bills (T-bills) are short-term debt instruments issued by the Government of India.
Tenors: T-bills are issued in three tenors: 91 days, 182 days, and 364 days.
Interest Payment: T-bills are zero-coupon securities, meaning they pay no interest. Instead, they are issued at a discount and redeemed at face value at maturity.
Return on Investment: The return to investors is the difference between the face value and the issue price.

The coupon of a bond refers to the interest payable on a bond.
A bond with a higher credit rating will pay lower interest rates.
The prices of bonds are inversely related to interest rate movements.
A zero-coupon bond is always issued at a discount, not a premium. Therefore, the statement is FALSE.
The Yield to Maturity (YTM) of a bond is indeed the yield that investors will earn on holding a bond to maturity. Therefore, the statement is TRUE.