Professional Documents
Culture Documents
SERVICES
DEBT MARKET
By
ULTIMATE INVESTMENTS
Nurturing Wealth
Who are the key players in the debt
and money markets in India?
The above diagram provides a consolidated picture of the various players in the bond/money markets and the securities.
ZCB: Zero Coupon Bond I/L bonds : Inflation linked bonds FRN : Floating rate notes
What are Money Markets and
money market instruments?
It is a weighted average of
the maturities of all the
instruments in a portfolio
What is duration and
modified duration?
Duration is a measure of a bonds' price risk. It is weighted
average of all the cash flows associated with a bond in
terms of their present value. For example, a bond with a
duration 1.50 years means that a rise in its yield by 1%
would result in a decline of its value by approximately
1.50% There are two types of duration, Macaulay
duration and modified duration. Macaulay duration is
useful in immunization, where a portfolio of bonds is
constructed to fund a known liability. Modified duration
indicates the percentage change in the price of a bond
for a given change in yield. The percentage change
applies to the price of the bond including accrued
interest.
What is convexity?
Convexity is a measure of the way duration and
price change when interest rates change. A bond
is said to have positive convexity if the
instrument's value increases at least as much as
duration predicts when rates drop and decreases
less than duration predicts when rates rise.
Typically, fund managers and investors prefer
bonds with higher convexity. This is because
such bonds rise higher than other bonds when
interest rate falls. And what is more, they fall
lower than other bonds, when interest rate rises.
Convexity is an important factor when interest
rates are volatile
What is marking to market?
It means adjusting value of any security to
reflect its current market value. While fixed
income instruments carry a fixed rate of return
if held till maturity, interest rate movements
can increase/decrease the returns, if one has
to sell the security during the holding period.
Hence, open end income and liquid funds are
required to value securities with a residual
maturity of over six months based on their
market value. The mark to market component
of a portfolio on a given day includes securities
with residual maturity of more than six months
and does not include CPs and CDs.
What are floating rate
instruments?
Unlike fixed income instruments, floating rate instruments have
variable interest rates, which change at present frequencies. Since
they don’t have any mark to market component, the possibility of
negative returns doesn’t exist for these instruments. Among the
floating rate instruments, MIBOR (Mumbai Inter-bank Offer Rate)
linked ones have become very popular in the money market segment
as they benefit both the issuer and investor. Coupon rates on short-
term Non-convertible debentures (NCDs) are pegged at a mark-up
over MIBOR. The mark-up on the NCD is typically 25 to 50 basis points
over MIBOR. Borrowing or lending through NCDs with the call/put
option is akin to borrowing or lending in the inter-bank call money
market. So companies use NCDs more like a cash management tool.
Whenever they generate surpluses, companies exercise the call option
and pay off investors. In a falling interest rate scenario, companies
tend to convert the NCD into a fixed-term borrowing in order to lock
into a lower interest rate. Many of these floaters offer ready liquidity
by means of daily put/call option. This allows mutual funds to tackle
illiquidity risk, in case of huge redemption pressures.
What are Interest Rate Swaps
Interest Rate Swap (IRS) is a transaction in
which a flow of coupon of one variety is
exchanged for another of a different
variety, but in the same currency. These
derivatives are used by the fund manager
for hedging the portfolio risk on a non-
leverage basis (i.e., not used for
speculative activities). In India, IRS are
generally OIS (Overnight Indexed Swaps)
products benchmarked on the MIBOR
Example :
Fixed rate payment
Fixed rate
payment
Terms:
1. CRISIL
2. ICRA
3. CARE
4. Fitch (Duff and Phelps is now part of Fitch)
What is the “SO” in a rating ? [AAA(SO)]
Pass Through Certificate/PTC
Structured Obligation (SO) or Structured Finance is a
term that is applied to a wide variety of debt
instruments wherein the repayment of principal
and interest is backed by: Cash flows from a pool
of financial assets and/or Credit enhancement
from a third party The process of converting
financial assets (loans, receivables, etc.) into
tradable securities is generally referred as
‘securitization’ and the securities thus created are
referred as ‘asset backed securities’ (ABS). The
Pass Through Certificates (PTCs) in our portfolios
also fall under this category
VALUATION OF
THINLY/NON-TRADED
SECURITIES
Forex Markets How is a
currency valued?
The floating exchange rate system is a confluence of various demand and
supply factors prevalent in an economy like – Current account balance :
The trade balance is the difference between the value of exports and
imports. If India is exporting more than it importing, it would have a
positive trade balance with USA, leading to a higher demand for the
home currency. As a result the demand will translate into appreciation
of the currency and vice versa.
H D FC
Cash Flows
21-Jul-01
2-Apr-02 11.45 10.93
2-Apr-03 11.45 10.22
2-Apr-04 11.45 9.56
2-Apr-05 11.45 8.95
3-Jan-06 108.66 80.74
N PV 120.40
Gilt Funds
Long Term Plan
.
Income Funds
Returns
FRIF
Liquid Funds
Risk
A Comparison with Liquid Funds
Liquid Fund Floating Rate Fund
Avg. Maturity 90 days 182-365 days
Typical tenor of
Investments 3-6 mos. 12 - 18 mos.