Bonds

DEBT MARKET

Debt market is a market meant for buying or selling of debt securities also called as bonds or fixed income securities.

BONDS

A bond is simply a loan with a definitive instrument features taken (issued) by an entity from the lender. Here, the entities taking a loan could be governments (central, state or municipal bodies) or companies (PSUs, private corporates, financial institutions etc) and are called as Issuers. The lender could be individuals, corporates, mutual funds, banks or anybody who invests in order to receive periodic income and are called as Investors.

DIFFERENCE BETWEEN EQUITY AND BONDS

When an investor invests money via equity, he becomes an owner in the corporation issuing the equity shares. With ownership he also gets voting right in the company and a share in future profits. In case of debt, the investor becomes a lender to the issuing corporation. As a lender, he has higher claim to the assets of the issuer as compared to a shareholder in the event of the company filing for bankruptcy. However, a debt investor does not get voting rights or a share in future profits. He is only repaid in the form of a predetermined interest rate.

Bonds offer a predictable stream of payments by way of interest and repayment of principal at the maturity of the instrument.

Debt securities enable wide-based and efficient portfolio diversification and thus assist in portfolio risk-mitigation.

The investors benefit by investing in fixed income securities as they preserve and increase their invested capital and also ensure the receipt of regular interest income.

Most bonds carry a fixed charge on the assets of the entity and generally enjoy a reasonable degree of safety by way of the security of the fixed and/or movable assets of the company.

The investors can even neutralize the default risk on their investments by investing in Govt. securities, which are normally referred to as risk-free investments due to the sovereign guarantee on these instruments.

A. COUPON RATE refers to the periodic interest payments that are made by the issuer to the investor and are expressed as a percentage of the face value. Example: - 9.20%

B. MATURITY DATE refers to the date on which the bond matures, or the date on which the borrower has agreed to repay (redeem) the principal amount to the lender. Example:-25 January 2025

C. TERM TO MATURITY refers to the number of years remaining for the bond to mature from the date of purchasing the instrument. Term to maturity of a bond changes every day from the date of issue of the bond until its maturity. Example:-2.27 years

D. PAR OR FACE VALUE: The amount of money that is paid to the bondholders at maturity. Example:- Rs. 100 or Rs. 1000 or Rs. 10 Lakhs etc.

E. PRINCIPAL is the amount that has been invested. Example: - Rs. 50 Lakhs

F. MARKET PRICE: The current price the bond is selling for in the market. Example:-Rs. 101.17 or 99.56

G. CALL OPTION AND CALL DATE: The call option provides the issuer a right to redeem a bond before its maturity date. If interest rates decline, the issuer will prefer to redeem and re-issue the bonds at a lower rate and hence in all likelihood likely to exercise the call option. For bonds which are callable, i.e., bonds which can be redeemed by the issuer prior to maturity, the call date represents the date at which the bonds can be called. Example: 25 January 2023 is a call option date implies issuer can redeem the bond on 25 January 2023, if he wants to or else it will get redeemed automatically on the maturity date.

H. PUT OPTION AND PUT DATE: A put option provides the investor the right to sell a low coupon-paying bond to the issuer, and invest in higher coupon paying bonds, if interest rates move up. For bonds which are puttable, i.e, bonds which can be redeemed by the investor of such bonds prior to maturity, the put date represents the date at which the bonds can be put. Example: 25 January 2022 is a put option date implies the investor can redeem the bond on 25 January 2022, if he wants to.

A. REGULAR BONDS (PLAIN VANILLA BONDS)

Fixed Coupon
Maturity Date is fixed
Does not have a call / put option
Issued at Par

B. CALLABLE BONDS

Bonds that allow the issuer to exercise a call option and redeem the bonds prior to its original maturity date.
Since these options are not separated from the original bond issue, they are also called embedded options.
The call option provides the issuer the option to redeem a bond, if interest rates decline, and re-issue the bonds at a lower rate.

C. PUTTABLE BONDS

Provide the investor with the right to seek redemption from the issuer, prior to the maturity date.
A put option provides the investor the right to sell a low coupon-paying bond to the issuer, and invest in higher coupon paying bonds, if interest rates move up.

D. CONVERTIBLE BONDS

A convertible bond provides the investor the option to convert the value of the outstanding bond into equity of the borrowing firm, on pre-specified terms
Exercising this option leads to redemption of the bond prior to maturity, and its replacement with equity
Bonds can be fully converted or partly converted depending up on the predetermined terms

E. PERPETUAL BONDS

Fixed Coupon
No Maturity Date
Generally has a call option at the end of 5th or 10th year.
Generally have a step up in coupon if call option is not exercised, i.e., the initial coupon rate will rise by pre-specified basis points mentioned at the time of issuance.

F. BASEL III - TIER-I BONDS

Perpetual structure but should conform to the basel III norms set by the committee of global apex banks
Standards set to improve robustness in banks and to increase capitalisation levels
Have certain covenants such as clause on conversion to equity, loss of principal or interest or both etc in the event of reaching a pre-described trigger levels.

G. BASEL III - TIER-II BONDS

Fixed Coupon
Maturity Date is fixed
Has a call option at the end of 5-10 years

A. YIELD TO MATURITY (YTM)

The rate of return that an investor would earn if an investor buys the bond at its current market price & held it until maturity, Represents the discount rate which equates the discounted value of a bond’s future cash flows to its current market price. This is the most scientific tool used while valuing the bond securities

B. YIELD TO CALL (YTC)

The rate of return an investor would earn if an investor buys a callable bond at its current market price & hold it until the call date

C. YIELD TO PUT (YTP)

The rate of return an investor would earn if an investor buy a pu􀁊able bond at its current market price & hold it until the put date

D. CURRENT YIELD

It is calculated as annual Coupon divided by the market Price of the Bond.

Nowadays current yield is no longer used as a standard yield measure, because it fails to capture the future cash flows, re-investment income and capital gains/losses on investment return.

E. ACCRUED INTEREST

If a coupon bearing security is traded between two coupon dates, the buyer has to compensate the seller by paying him that part of the interest which is due to him for the period for which he has held the security after the immediately preceding coupon date.

F. DIRTY PRICE

If the bond is traded between two coupon dates, the buyer of the bond will have to compensate the seller for that part of the period between coupons for which the seller owned the bond. The price arrived at after adjusting this factor (Accrued Interest) is called the Dirty Price.

G. CLEAN PRICE

The price arrived at without adjusting the accrued interest component is called Clean Price.

WHAT IS CREDIT RATING?

A Rating is the assessment of a borrower’s credit quality.
Rating performs the function of credit risk evaluation reflecting the borrower’s ability to repay the debt as per the terms of the issue.
Rating is not a recommendation to buy, hold or sell.
It is a well-informed opinion made to the public and might influence their investments decisions.
Credit rating saves the investors time and enables him to take quick decisions and provides them better choice among available investment opportunities.
The agency that performs the rating of the debt is known as the credit rating agency.

CREDIT RATING AGENCIES IN INDIA

CREDIT RATING AGENCIES IN INDIA
CRISIL: Credit Rating Information Services of India Limited
ICRA: Investment Information and credit rating agency of India Ltd
CARE: Credit analysis and research Ltd
India Ratings and Research a FITCH Group Company
Brickwork Ratings India Private Ltd
SMERA: SME Rating Agency of India

ANALYTICAL FRAMEWORK FOR RATING COMPRISES OF

Business Analysis
Financial Analysis
Management Evaluation
Fundamental Analysis

Long-Term Rating Scale
Long-Term rating Scale All Bonds, NCDs, and other debt instruments (excluding Public Deposits) with original maturity exceeding one year.
AAA	Instruments with this rating are considered to have the highest degree of safety regarding timely servicing of financial obligations. Such instruments carry lowest credit risk.
AA	Instruments with this rating are considered to have high degree of safety regarding timely servicing of financial obligations. Such instruments carry very low credit risk.
A	Instruments with this rating are considered to have adequate degree of safety regarding timely servicing of financial obligations. Such instruments carry low credit risk.
BBB	Instruments with this rating are considered to have moderate degree of safety regarding timely servicing of financial obligations. Such instruments carry moderate credit risk.
BB	Instruments with this rating are considered to have moderate risk of default regarding timely servicing of financial obligations.
B	Instruments with this rating are considered to have high risk of default regarding timely servicing of financial obligations.
C	Instruments with this rating are considered to have very high risk of default regarding timely servicing of financial obligations.
D	Instruments with this rating are in default or are expected to be in default soon.
Note: For the rating categories [ICRA]AA through to [ICRA]C, the modifiers + (plus) or – (minus) may be appended to the rating symbols to indicate their relative position within the rating categories concerned. Thus, the rating of [ICRA]AA+ is one notch higher than [ICRA]AA, while [ICRA]AA- is one notch lower than [ICRA]AA.