FIXED INCOME SECURITIES

S.Y.B.A.F.

July 2011

BONDS
Meaning A debt instrument issued for a period of more than one year with the purpose of raising capital by borrowing.

A debt security is generally issued by a company,municipality or government.A bond investor lends money to the issuer and in exchange,the issuer promises to repay the loan amount on a specified maturity date.The issuer usually pays the bond holder periodic interest payments over the life of the bond. A written and signed promise to pay a certain sum of money on a certain date, or on fulfillment of a specified condition. All documented contracts and loan agreements are bonds. Bonds are actual contract notes issued by the borrower to pay interest at regular intervals and return the principal on the maturity of the bond. These bonds are issued by the companies for their expenses and future expansions. The bonds are also issued by the government for its expenses. A bond is seen as loan taken by a borrower from the investor so unlike equity share it does not give stake in the company but he is seen as a lender. These bonds are redeemed at a definite time. These are secured loans and can yield low to medium interest rate.

Debentures
Meaning A debenture is defined as a certificate of agreement of loans which is given under the company's stamp and carries an undertaking that the debenture holder will get a fixed return (fixed on the basis of interest rates) and the principal amount whenever the debenture matures.

Bonds v/s Debentures

Debentures are issued by companies where as Bonds are issued by public sector companies which are backed and supported by government. Risk in bonds is less as compared to Debentures. Bonds are more secure than debentures. As a debenture holder, you provide unsecured loan to the company. It carries a higher rate of interest as the company does not give any collateral to you for your money. For this reason bond holders receive a lower rate of interest but are more secure.

Risk in Debt Instruments

Like all other investments, certain risks are associated with investments made in bonds and debentures. Some of such risks are :(i) Default Risk / Credit Risk : This risk refers to the risk of default in payment of interest and / or principal on due dates. There can be various reasons for such default e.g. poor performance of the company. To manage such risks, the investor has to be careful while taking

Yield Curve
Meaning & Example What is the Yield Curve? The yield curve is a line graph that plots the relationship between yields to maturity and time to maturity for bonds Yield relation to bond price Inverse: As the yield increases the bond price reduces

Part 1: The What

What is the Yield Curve? The yield curve is a line graph that plots the relationship between yields to maturity and time to maturity for bonds of the same asset class and credit quality. The plotted line begins with the spot interest rate, which is the rate for the shortest maturity, and extends out in time, typically to 30 years.

The Why- Why are yield curves important?

Investors use the yield curve as a reference point for forecasting interest rates, pricing bonds and creating strategies for boosting total returns. The yield curve is a important policy instrument for the monetary authorities to stimulate or check economic growth The yield curve has also become a reliable leading indicator of economic activity especially in the light of international capital flows as we have seen in the earlier slides
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Bond Valuation
1.

Face Value: is the principal amount on which interest is paid by issurer. It remains the same throughout the life of Bond. Redemption:: Bonds are normally redeemed at premium to face value. Coupon Rate : is annual rate at which interest is paid. Maturity Rate: is the date on which bond is repaid. Call Option: Many bond contains call option which entitles the issuer to call the bonds and redeem them before maturity. 9

2.

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Bond Valuation
6. Put Option: Many bond contain put option which entitles the bond holder to put the bond back to the issuer for redemption before maturity. 7. Bond Price: This is market price of the bond and its expressed as a percentage of Face Value.

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Bond Valuation
The Value of Bond is Present value of all future cash flows which is determined as follows: Value of Bonds = interest(PVAF) + Future value (DF) PVAF= Present value of annuity factor.

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Bond YTM
Yield to Maturity is same as Internal rate of Return of bond.

YTM= Interest amount + Future value present value Year to maturity . Future value + present value 2

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Preference shares valuation

(a)

Value of Preference shares = Net assets available to preference shareholders No of preference shares

(b) When preference shares are NON- PARTICIPATING Value of Preference shares =Paid up Preference share capital + Arrears of dividend No of preference shares (c) When preference shares are PARTICIPATING Value of Preference shares =Paid up Preference share capital + Arrears of dividend +Surplus
No of preference shares

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Part 1: The What

What is the Yield Curve? The yield curve is a line graph that plots the relationship between yields to maturity and time to maturity for bonds of the same asset class and credit quality. The plotted line begins with the spot interest rate, which is the rate for the shortest maturity, and extends out in time, typically to 30 years.

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The What contd..

The yield curve is a measure of the markets expectations of future interest rates given the current market conditions. A graphic representation that shows the relationship at a given point in time between yields and maturity for bonds that are identical in every way except maturity. This relationship between yields and maturities is known as the term structure of interest rates. When investors purchase bonds they are taking a view that the interest rates will either remain steady or will fall in the future
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The Why- Why are yield curves important?

Investors use the yield curve as a reference point for forecasting interest rates, pricing bonds and creating strategies for boosting total returns. The yield curve is a important policy instrument for the monetary authorities to stimulate or check economic growth The yield curve has also become a reliable leading indicator of economic activity especially in the light of international capital flows as we have seen in the earlier slides
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Glossary
Yield: Annual return earned on an investment Current yield: Annual return earned on the price paid for a bond. It is calculated by dividing the bond's annual coupon interest payments by its purchase price. Yield to maturity: reflects the total return an investor receives by holding the bond until it matures. A bonds yield to maturity reflects all of the interest payments from the time of purchase until maturity, including interest on interest. When we talk about yield we are talking about yield to maturity

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