CHAPTER 9: INVESTING IN FIXED INCOME SECURITIES

LEARNING OBJECTIVES:

After studying this chapter, you should know about:

 Debt market and its need in financing structure of Corporates and Government
 Know the Bond market ecosystem
 Various kinds of risks associated with fixed income securities
 Pricing of bond
 Traditional Yield Measures
 Concepts of Yield Curve
 Concept of Duration
 Introduction to Money Market
 Introduction to Government Debt Market
 Introduction to Corporate Debt Market
 Small-savings instruments

9.1 Debt market and its need in financing structure of Corporates and Government
The debt market enables borrowers, including governments and private firms, to issue debt
securities, which investors can buy in the primary or secondary market. It plays a crucial role
in economic growth by channeling funds from savers to investors willing to take risks. Unlike
the equity market, debt investments are relatively safer as they are often secured by physical
assets. However, in case of default, recovering funds can be a lengthy legal process, making a
company’s goodwill a key factor in honoring debt obligations.

Debt financing involves borrowing with fixed obligations, whereas equity financing grants
ownership rights. Governments and corporates raise debt for funding needs, with primary
markets facilitating direct issuance and secondary markets enabling liquidity and risk
assessment.

India’s debt market has three key segments: (a) Government securities (G-secs, T-bills, SDLs),
(b) PSU and bank bonds, and (c) private sector instruments like bonds, debentures, and
commercial papers. A well-developed debt market requires strong legal frameworks and
credit risk assessments to attract investors.

9.2 Bond market ecosystem

Since bonds create fixed financial obligations on the issuers, they are referred as fixed income
securities. The issuer of a bond agrees to 1) pay a fixed amount of interest (known as coupon)
periodically and 2) repay the fixed amount of principal (known as face value) at the date of
maturity. The fixed obligations of the security are the most defining characteristic of bonds.
Most bonds make semi-annual interest payments, though some may make annual, quarterly
or monthly interest payments (except zero coupon bonds which make no interest payment).

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Typically, par value of the bond is paid on the maturity date. Bonds have fixed maturity dates
beyond which they cease to exist as a legal financial instrument. (except perpetual bonds,
which have no maturity date). On the basis of term to maturity, bonds with a year or less than
a year maturity are terms as money market securities. Long-term obligations with maturities
in excess of 1 year, are referred to as capital market securities. Thus, long term bonds as they
move towards maturity become money market securities.

The coupon, maturity period and principal value are important intrinsic features of a bond.
The coupon of a bond indicates the interest income/coupon income that the bond holder will
receive over the life (or holding period) of the bond.

The term to maturity is the time period before a bond matures (or expires). All G-Secs are
normally coupon (interest rate) bearing and have semi-annual coupon or interest payments
with a tenor of between 5 to 30 years. Maturity period is also known as tenor or tenure.

The principal or par value of the bond is the original value of the obligation. Principal value of
the bond is different from the bond’s market price, except when the coupon rate of the bond
and the prevailing market rate of interest is exactly the same. When coupons and the
prevailing market rate of interest are not the same, market price of the bond can be lower or
higher than principal value. If the market interest rate is above the coupon rate, the bond will
sell at a discount to the par value. If the market rate is below the bond’s coupon, the bond
will sell at a premium to the par value. The interest rate here is assumed to be for the
remaining maturity of the bond.

Another interesting thing about bonds is that unlike equity, companies can issue many
different bond issues outstanding at the same time. As per regulation, maximum 12 ISINs can
mature in one financial year. Companies re-issue existing ISINs. For completely new issuances
(ISINs), the limit of 12 is applicable. These bonds can have different maturity periods and
coupon rates. These features of the bonds will be part of the indenture. 9

Bonds with options

Bonds can also be issued with embedded options. Some common types of bonds with
embedded options are: bonds with call option, bonds with put option and convertible bonds.

A callable bond gives the issuer the right to redeem all or part of the outstanding bonds before
the specified maturity date. Callable bonds are advantageous to the issuer of the security but
they present investors with a higher level of reinvestment risk than non-callable bonds. The
issuer will call the bond before its maturity only when the interest rates for similar bonds fall
in market. The investor will receive the face value of the bond before its maturity, and will be

9 Indenture is the legal agreement between two parties, in case of bond indenture the two parties are the bond issuer
(borrower) and the investors (lender).

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forced to reinvest that money for the remaining period lower interest rates. This is called
reinvestment risk.

A put provision gives the bondholders the right to sell the bond back to the issuer at a pre-
determined price on specified dates. Puttable bonds are beneficial to the bondholder by
guaranteeing a pre-specified selling price at the redemption dates.

A convertible bond is a combination of a plain vanilla bond plus an embedded equity

conversion option. It gives the bondholder the right to exchange the bond for a specified
number of common shares of the issuing company.

9.3 Risks associated with fixed income securities

Investors need to understand the risks involved in a fixed income asset before investing in it.
Government bonds are considered as risk free and hence provide low return on investment
while corporate bonds in general being riskier provide higher returns to the investor
(assuming both were held from issue date till the maturity date). Entities like public sector
undertakings or banks are relatively less risky vis-à-vis the pure corporate firms and thus
provide returns higher than the government bonds but lower than the corporate papers.
Understanding the relative risk involved in fixed income assets helps investors to decide the
type of risk they are willing to take while investing. Major risk comes from changes in interest
rate levels in the economy and change in the creditworthiness of the borrower. The first group
of risk is known as Market Risk while the second group of risk is known as Credit Risk or Default
Risk.

9.3.1 Interest Rate Risk

The bonds are subject to risk emanating from interest rate movements. The price of the bond
is inversely related to the interest rate movement. If the interest rate rises, the price of the
bond will fall.

Any investment in bonds has two risks – market risk and credit risk. Market risk can be
explained by the change in the price of the bond resulting from change in market interest
rates. Further, the coupons that would be received at different points in time in future need
to be re-invested at the rate prevailing at the time of receipt of such coupons. An investor
holding bonds would face an erosion in value if the interest rates rise and this can lead to a
capital loss if the bonds are sold below their purchase price. On the other hand, a fall in
interest rates would push up the bond prices and this can raise the overall returns for the
investor. Hold till maturity (HTM) can obviate interest rate risk because on maturity, you
receive what was initially contracted.

9.3.2. Call risk

The Call risk is the risk of a bond being prematurely called or repaid by the issuer exercising
the right provided in the indenture of the issuance. The Call risk gives the right to the issuer

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to call back the bond and repay all the required amount under the indenture specifications.
This typically happens when a company decides either to go as a zero-debt company or wants
to refinance its liabilities with low cost of borrowing. This low cost of borrowing may be
possible if the company’s credit rating has improved or if the market condition has changed
in a manner that would help the company to source funds at a low interest rate. The call risk
makes the bond unattractive to the investor vis-à-vis a non-embedded option bond. The call
risk increases uncertainties for the investor.

9.3.3. Reinvestment Risk

Reinvestment risk arises when the periodic income received from bonds or other fixed income
securities are reinvested after their receipt at the rate prevailing in the market at the time of
such receipts. If the interest rate is higher at the time of receipt of periodic coupon, the
reinvestment would happen at a higher rate that would be beneficial to the investor but if
the market interest rate is low at the time of receipt of the coupons, the investor would be
reinvesting the coupons at a lower rate. However, it may be remembered that higher interest
rate vis-à-vis the coupon would mean capital loss in the market value of the bond if the
investor wants to sell in the market. Therefore, reinvestment risk is the risk that interest rates
may decrease during the life of the bond. If an investor wants to hold the security till maturity,
then reinvestment risk is very high. Reinvestment risk is an important part of bond
investment.

9.3.4. Credit Risk

Bonds are essentially certificates of debt or in other words loans from the investors to the
issuers who promise to repay the principal amount with periodic interest/coupon payments.
Particularly for bonds issued by non-government corporates, the repayment of the principal
back to the investor relies heavily on the issuer’s ability to repay that debt. The price of these
bonds depends on the credibility of the company issuing it and often offer a yield higher than
the risk-free government bonds as the investors are at a risk of losing their capital if the
financials of the issuer deteriorate. For example, in India, Corporate Deposits and NCDs offer
higher rates on investment.

Types of credit risk include: Downgrade Risk, Spread Risk and Default Risk

[Link]. Downgrade Risk

A company's ability to operate and repay its debt (and individual debt) issues is frequently
evaluated by major ratings agencies. Downgrade risk arises for investors when the rating of
an issuer is lowered after they have purchased its bonds. If a company's credit rating is
downgraded by the rating agency on account of deterioration in its financials, the issuing

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company faces higher cost for raising new resources. The existing bond holders would be
facing this drop in price of their bonds issued by this company as the cost of funds for the
company increases in the market. An example of this is the cascading effect of the rating
downgrades in the IL&FS case in August-September 2018.

[Link]. Spread Risk

Corporate bonds or non-Government bonds pay a spread (depending on its Credit rating) over
comparable Government securities as the risk increases. The spread keeps on changing
dynamically as the situation changes in the market. In good times when the business is doing
very well and there is no shortage of liquidity in the system, the risk of corporate failures due
to market conditions is very rare. A corporate can fail to perform the debt service or equity
service to investors only when the performance of the company drops significantly due to bad
management or bad market conditions or both. In such situations, the riskiness of the
company’s instruments in the market increases. Bad performance means the company would
face cash flow problems and may not be able to meet its obligations of interest payment and
redemption payments. This would make the company’s debt very costly. The spread over
comparable Government securities would change keeping in mind the possible default of the
company. The spread charged for higher rated papers would be far lower compared to the
lower rated papers in the market. In tight liquidity situations or when the general market
condition is bad, the risk appetite drops in the market and the spread increases.

[Link]. Default Risk

Default risk is the possibility of non-payment of coupon or principal when due. Default arises
when the company fails to meet its financial obligations towards interest and principal
repayments. While credit ratings help to measure an issuer’s risk of default, there is still
always a risk that some unforeseen event can force the issuer to default. The spread measures
the default risk of a bond. If the market considers the possibility of default for a bond, the
interest rate for the bond would increase in the market. Junk bonds with very high credit risk
or default risk pay very high interest rates to investors.

9.3.5. Liquidity Risk

Liquidity risk is the risk involved with an instrument that the investor would not be able to sell
the investment at the time of need. Every investment is an action to defer the present
consumption by an investor for a future date. Hence, when the consumption time arises, the
investor must be able to monetize the investment and convert the same to cash without loss
of much of its intrinsic value. If the market is liquid to absorb the selling, then the investor
would not lose substantially as there would be other investors willing to take the risk on the
asset by buying the same from one investor selling the asset. When liquidity is tight in the

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market, investors find it difficult to sell the asset and at times, the investors have to fire sell
the asset at a much lower price. Hence, liquidity risk is very common on long-term bonds.
Short-term instruments are more liquid as they are like cash instruments whose cash flows
would come to the investors shortly but long-term investments pose risk of selling. Better the
credit quality of the bond e.g. G-Sec or AAA rated corporate bond, lower is the impact cost.

9.3.6. Exchange Rate Risk

Bonds issued in foreign currency are exposed to currency risk or exchange rate risk. When the
issuer of a foreign currency bond has to pay back the bond principal or pay a promised
periodic coupon, the company has to acquire foreign currency from the market to fulfil its
obligations. The cost of acquiring such foreign exchange may increase if the domestic
currency has depreciated against the currency in which bonds have been issued. Currency risk
is an inherent risk for bonds issued in non-domestic currency by domestic borrowers in the
international market. Masala Bonds issued by Indian entities expose the investors to the
Exchange rate risk as the Rupee amount if fixed and the investors who are foreign entities
would receive Indian Rupee and have to buy the foreign currency for repatriation. Exchange
rate risk is very important for foreign currency denominated bonds.

9.3.7. Inflation Risk

Inflation risk is the risk faced by an investor of inadequacy of funds received from the bond
investment to fulfil the deferred needs. While investing in the bond, the investor expected a
return level keeping in mind the stable interest rate as the assumption of stable inflation
would have helped him in such assumptions. However, if suddenly the inflation rate increases,
the cost of goods would increase and the real return comes down. The nominal return may
remain the same but the real income after adjustment of inflation would be far lower. A fixed
rate bond does not take into account changing future scenarios while a floating rate bond can
take care of such changes as the new interest rate would be keeping in sync with the market
rate. When expected inflation levels are higher, investors prefer floating rate bonds or
inflation-indexed bonds to save themselves from the risk of higher inflation. However, the
issuance quantum / market segment for floating rate bonds and inflation-indexed bonds is
limited.

9.3.8. Volatility Risk

Volatility risk affects the bonds with embedded options. The pricing of an embedded option
bond takes into account the volatility level to price the same.

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9.3.9. Political or Legal Risk

The bonds with tax benefits would be exposed to such risks. Tax free bonds may become
taxable because, changes in Government rules would impact the price of such tax free bonds,
but this is unlikely. Further, if an issuer decides not to pay a coupon due to its tight cash
position or plan to roll over its debt or pay a coupon in the form of new bonds, this can lead
to substantial value change for the bonds as investors face higher risk of non-receipt of
required cash on planned dates. Government changing repatriation rules may affect the
foreign bond investors in a domestic economy.

9.3.10. Event Risk

An event risk refers to an unexpected or unplanned event that forces the value of an
investment to drop substantially. Certain events may force companies to seek moratorium on
repayment as their business gets affected by such unplanned events. For example, during the
recent Covid-19 pandemic, the travel industry was severely impacted and many companies
could not service their debt. This type of risk is different for each sector and the amount of
exposure depends on the sector.

9.4 Pricing of Bond

The value of bonds can be determined in terms of rupee values or the rates of return they
promise under some set of assumptions. Since bonds are fixed income securities,
generating a series of pre-specified cashflows, we determine the value of the bond using
the present value model. The present value model computes the value for the bond using
a single discount rate. Alternatively, the yield model can be applied, which computes the
promised rate of return based on the bond’s current price and a set of assumptions.

9.4.1 Par Value

“Par” is the Face value of a debt instrument which is promised to be paid as Principal at the
maturity of the debt instrument. Typically, it is ₹100 for a Government bond but ₹10000 for
a corporate bond. This is the amount that an issuer is bound to pay back to the bond investor
as per the indenture of the debt issuance. The periodic interest/coupon paid on a debt
instrument is on the basis of the Face value. The Face Value is also known as the redemption
value for a plain vanilla bond.

The market trades bonds as a percentage of price. If a trader quotes a Bid price of 106.35, the
trader is willing to buy the security at 106.35% of the Face Value of the security. Bonds are
considered as premium ones when they trade above their Face value or Par value and are
known as discount bonds when they trade below the Face Value. During the life of the bond
(from the date of issuance to date of maturity), the bond price may move from Par value to
Premium or Discount but at the end, the bond will be pulled to the Par value of 100.

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Many debt instruments are issued at a discount to the Par value – Treasury Bills, Commercial
papers, etc. are always issued at a discount to the Par value and the investor pays less than
Par value at the time of buying the instrument but at the maturity receives Par value. The
difference between the Par Value and the purchase price is the return that the investor gets
for the investment.

9.4.2 Determining Cash Flow, Yield and Price of bonds

A bond is valued using future known cash flows. The future cash flows are calculated using
the promised coupon on the principal. We will use the below equation to price a bond. Let us
assume an annual coupon paying Bond with a 10% promised rate at the time of issuance and
the residual maturity is 5 years from today. Currently, the similar type of securities are
available in the market at the yield or interest rate of 8% in the market. Now we have to find
the cash flows, discount factors and ultimately the price of the bond assuming a Face Value
or Par Value of 100.

The cash flows are: Yearly 10 and in the last year at the time of maturity, we get back 100
along with the last coupon.

This means 1 Rupee to be received after 1 year from now would be valued at 0.9259 today
with 8% current interest rate. The same way we compute Discount Factors as follows:

Year Discount factors using 8% Yield

1 0.9259
2 0.8573
3 0.7938
4 0.7350
5 0.6806

The Cash flows to be received in future years would be as follows along with their respective
Present value using the present yield of 8% for such investment:
Year Discount factors using 8% Yield Cash flows Value=DF*Cash flow
(DF)
1 0.9259 10 9.2593
2 0.8573 10 8.5734
3 0.7938 10 7.9383
4 0.7350 10 7.3503
5 0.6806 110 74.8642

Now the value of the bond in our example would be sum of all discounted value of future
cash flows as given in the above table. The same would work out as follows:

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 Year Discount factors using 8% Yield Cash flows Value=DF*Cash flow
(DF)
1 0.9259 10 9.2593
2 0.8573 10 8.5734
3 0.7938 10 7.9383
4 0.7350 10 7.3503
5 0.6806 110 74.8642
3.9927 107.9854

The sum of all Discount Factors (3.9927) in this case would be known as PVIF or Present value
interest factor. This 3.9927 is arrived at using (8%, 5) with annual cash flows. We can use the
above PFIV to calculate the bond as follows:

Value = Annual Coupon cash flow * PVIF + Par Value or Face value or Redemption Value * PV
of last maturity

Or

Value of the Bond with 10% Coupon with 5 years maturity and present yield of 8% = 10*3.9927
+ 100*0.6806 = 39.9271 +68.0583 = 107.9854.

Bond Pricing

The price of a bond is sum of the present value of all future cash flows of the bond. The
interest rate used for discounting the cash flows is the Yield to Maturity (YTM) of the bond.
Price of a bond can be calculated using the excel function ‘price’ (Illustration 9.1).

Illustration 9.1: Calculating Price of a Bond in excel

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Bond Yield Measures

Bond holders receive return from one or more of the following sources, when they buy
bonds:

1. The coupon interest payments made by the issuer;

2. Any capital gain (or capital loss) when the bond is sold/matured; and
3. Income from reinvestment of the interest payments. In excel XIRR formula, reinvestment
is assumed in the formula, though we are not consciously aware of it. The assumed rate
is same as the outcome of the XIRR formula.
There are yield measures commonly used to measure the potential return from investing
in a bond are briefly described below:

Coupon Yield

The coupon yield is the coupon payment as a percentage of the face value. It is the nominal
interest payable on a fixed income security like G-Sec.

Coupon yield = Coupon Payment / Face Value

Illustration:

Coupon: Rs. 8.24

Face Value: Rs. 100
Market Value: Rs. 103.00
Coupon yield = 8.24/100 *100= 8.24%
Current Yield: Coupon / Market Price i.e. 8.24 / 103 = 8%

9.4.3 Valuation and pricing of bonds

Consider a bond paying coupons with frequency n maturing in year T. The cash flows
associated with the bond are: coupon C paid with frequency n up to year T, plus the principal
M, paid at T.

We can use the same bond price equation to describe the value of a Semi-annual coupon
paying Bond. If the bond is paying a coupon twice in a year, then the investor will receive only

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5 (half of 10) every 6 months and the same can be reinvested at the current market interest
rate of 8%.

Valuation of bonds with semi-annual compounding is given in the table below:

Discount Factors
Value = Cash Flow *
Year using 8% Yield Cash flows (₹)
DF (₹)
(DF)
0.5 (period 1) 0.961538462 5 4.8077
1 (period 2) 0.924556213 5 4.6228
1.5 (period 3) 0.888996359 5 4.445
2 (period 4) 0.854804191 5 4.274
2.5 (period 5) 0.821927107 5 4.1096
3 (period 6) 0.790314526 5 3.9516
3.5 (period 7) 0.759917813 5 3.7996
4 (period 8) 0.730690205 5 3.6535
4.5 (period 9) 0.702586736 5 3.5129
5 (period 10) 0.675564169 105 70.9342
SUM of DF 8.110895779 Total Value 108.1109

The Discount Factor for the first period is calculated as 1 / 1.04 = 0.9615

The bond can be valued as 5 * PVIF + face value * DF for the maturity year.

The same would be = 5*8.1109 + 100*0.675564 = 40.5545 + 67.5564 = ₹108.1109. The semi-
annual coupon paying bond is valued more at 108.1109 than the annual coupon paying bond
at 107.9854 with similar maturity, yield and coupon rate due to the greater frequency of
compounding.

The valuation rule for valuing semi-annual bonds can be extended to valuing bonds paying
interest more frequently – like once in a quarter. Hence, if “n” is the frequency of payments
per year, “t” the maturity in years, and, as before, R the present interest quoted on an annual
basis, then the formula for valuing the bond would be:

When n becomes very large, this approaches continuous compounding.

Valuation of zero coupon bonds

A zero-coupon bond has a single cash flow resulting from an investment. The zero-coupon
pricing formula can be modified to calculate YTM.

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 100
P
 Days to Maturity 
1  r * 
 365 

100  P 365
YTM  * *100
P Days to maturity

The coupon rate (CR), current yield (CY) and yield-to-maturity (YTM) are related such that:

Bond Selling at Relationship

Par CR = CY = YTM

Discount CR < CY < YTM

Premium CR > CY > YTM

Valuing Bonds at Non-Coupon Dates

Bonds are generally valued in between coupon dates when they are traded. Hence the
concept of Clean price and Dirty price has to be established. The Dirty price is the sum of clean
price and accrued interest. In this formula, the accrued interest is not discounted to arrive at
the Clean Price as there is no intervening cash flow in the first coupon to be received after an
investor buys the bond. The market convention is the amount the buyer would pay to the
seller the clean price plus the accrual interest. This amount is often called the full-price or
invoice price. The price of a bond excluding accrued interest would be the clean price. The
market typically trades a bond on the basis of clean price. All yield, and price formulas are on
the basis of clean price.

In order to price a bond in between coupon days, the following principles are followed. Firstly,
take the settlement date (buying date) to the previous coupon date and value the bond using
the coupon, yield and the residual maturity from the last coupon date. Secondly, bring the
said price or value to the future date (settlement date or buying date) with a Future Value
Factor. Thirdly, deduct the accrued interest from the total value to arrive at the clean price or
trade price or invoice price.

9.4.4 Price-Yield relationship

The price yield relationship is inverse. When we calculate the relationship, we use the Clean
price only and all price and yield formulas use only Clean price. If we want to plot the price –
yield relationship of two bonds, we can compare their relative effective riskiness.

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The price-yield relationship can be summarized as follows:

- The inverse relation between a bond's price and rate of return is given by the negative slope
of the price-yield curve. The movement across the curve is non-linear.

- The bond having larger maturity time would have higher sensitivity to interest rate changes.

- The lower a bond's coupon rate, the greater is its price sensitivity.

Relation between Coupon Rate, Required Rate, Value, and Par Value

Bonds can trade at Par when the coupon and yield are same. But, if the Coupon is lower than
the current market yield, then the bond would be trading at Discount. If the coupon is higher
than the current market yield, it would be trading at premium.

9.4.5 Perpetual bonds and pricing of perpetual bonds

A perpetual bond is an instrument that continuously pays the agreed coupons but it never
pays the Face value and has no maturity date affixed to the bond. For a simple perpetuity
paying regular coupons, the payment is the same as the interest payment of the one-year
bond. Hence, a perpetual bond is an instrument issued without any finite maturity date.
Perpetual bonds promise to pay a coupon indefinitely as the issuer is not bound to pay back
the principal. This Value of a perpetuity would be calculated as:

Coupon
PV 
Yield

If Coupon of a Perpetuity is 8% on a face Value of 100 and if the investor would like to have
an annual yield of 6%, then the perpetuity would be valued as (100*8%)/6% = 133.33.

9.5 Traditional Yield Measures

9.5.1 Current Yield

The current yield is the coupon payment as a percentage of the bond’s current market price.

Current yield = (Annual coupon rate / current market price of the bond) *100%

Illustration:

The current yield for a 10 year 8.24% coupon bond selling for Rs. 103.00 per Rs. 100 par value
is calculated below:

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Annual coupon interest = 8.24% x Rs. 100 = ₹8.24

Current yield = 8.24 / 103 = 8%

9.5.2 Yield to Maturity

Yield to Maturity (YTM) is the discount rate which equates the present value of the future
cash flows from a bond to its current market price. It is the expected rate of return on a bond
if it is held until its maturity. The price of a bond is simply the sum of the present values of all
its remaining cash flows. Present value is calculated by discounting each cash flow at a rate;
this rate is the YTM. It is also known as the internal rate of return of the bond.

The calculation of YTM involves a trial-and-error procedure. A calculator or software can be

used to obtain a bond’s YTM easily.

Illustration

Take a two-year bond bearing a coupon of 8% and a market price of Rs. 102 per face value of
Rs. 100; the YTM could be calculated by solving for ‘r’ below. Typically, it involves trial and
error by taking a value for ‘r’ and solving the equation and if the right-hand side is more than
102, take a higher value of ‘r’ and solve again. Linear interpolation technique may also be
used to find out exact ‘r’ once we have two ‘r’ values so that the price value is more than 102
for one and less than 102 for the other value. Since the coupon is paid semi-annually, there
will be 4 payments of half of yearly coupon amount.

In the MS Excel programme, the following function could be used for calculating the yield of
periodically coupon paying securities, given the price.

YIELD (settlement, maturity, rate, price, redemption, frequency, basis)

Wherein;
Settlement is the security's settlement date. The security settlement date is the date on which
the security and funds are exchanged. Maturity is the security's maturity date. The maturity
date is the date when the security expires.
Rate is the security's annual coupon rate.
Price is the security's price per Rs. 100 face value.
Redemption is the security's redemption value per Rs. 100 face value.
Frequency is the number of coupon payments per year. (2 for Government bonds in India)
Basis is the type of day count basis to use. (4 for Government bonds in India which uses 30/360
basis)
[The day count convention is explained in Box 9.1)

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 Settlement 15-01-2025
Maturity 15-01-2027
Rate 8%
Price 102
Redemption 100
Frequency 2
Basis 2
Yield 6.9121%

Box 9.1: Day Count convention

Day count convention refers to the method used for arriving at the holding period (number
of days) of a bond to calculate the accrued interest. As the use of different day count
conventions can result in different accrued interest amounts, it is appropriate that all the
participants in the market follow a uniform day count convention.

For example, the conventions followed in Indian market for bonds is 30/360, which means
that irrespective of the actual number of days in a month, the number of days in a month
is taken as 30 and the number of days in a year is taken as 360.

Whereas in the money market the day count convention followed is actual/365, which
means that the actual number of days in a month is taken for number of days (numerator)
whereas the number of days in a year is taken as 365 days. Hence, in the case of T-Bills,
which are essentially money market instruments, money market convention is followed.

In some countries, participants use actual/actual, some countries use actual/360 while
some use 30/actual. Hence the convention changes in different countries and in different
markets within the same country (e.g. Money market convention is different than the
bond market convention in India).

9.5.3 Effective Yield

Deposit taking institutions often quote two quantities when they advertise interest rates on
various products they are selling. The first would be the actual annualized interest rate which
is nothing but the nominal rate or the stated rate. The second rate would be an equivalent
rate that would produce the same final amount at the end of 1 year if simple interest is
applied. This is called the “effective yield”. A bond paying 4.20% annual coupon would be
worth 4.28% if the is coupon is paid every month.

9.5.4 Yield to call

A bond with an embedded call option increases the risk for the investors. Yield to call
measures the estimated rate of return for bonds held to the first call date.

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9.5.5 Yield to Put

Yield to Put is the exact opposite of Yield to call but the principle is the same. It gives the
investor the right to redeem the bond if the after a certain date and such papers trade in the
market by adjusting their maturity till the first Put option date.

9.6 Concept of Yield Curve

Yield curve is typically an upward sloping curve in a two-dimensional surface plotting the
relationship between time and interest rate. The slope of the curve gives us the relative risk
premia for additional time we are out of money. In the yield curve presented below, taking a
higher risk of investing for 2 years as against 1 year results in a risk premia of 22bps. But, if
we invest for 3 years as against 2 year, we get a risk premia of only 13bps and the same risk
premia is maintained for our investment for 4 years as against 3 years. The risk premia depicts
the perception of risk of investment that is depicted in the slope of the yield curve. Typically,
in sovereign bond market, we see the yield curve flattens after 5-7 years as the risk of default
is zero and investor only want a small premia to cover the liquidity risk of the investment.
However, for corporate bonds, the risk premia significantly increases as the time to maturity
increases. The slope instead of flattening shows a good upward movement.

The yield curves are never smooth and people have different expectations about the future
and may demand different rates for the same maturity investment even if the rating remains
the same. If investors are expecting higher inflation in future, they would require higher
nominal yield to compensate them for the expected higher expenditure as they are pushing
their present consumption to a future date through investing. A positively sloped yield curve
is the most preferred yield curve for the economy as the shorter term would demand a lower
interest rate while long term would demand a higher interest rate.

Typically, the yield curves take 4 shapes:

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 1. Normal Yield curve: This is an upward sloping yield curve indicating higher interest
rate for higher maturity. Long term rates are higher compared to short term yields as
the risk premia is higher for higher maturities.
2. Inverted Yield curve: In this kind of curve, we find the short-term rates are higher than
the long-term rates. At times, the policy rates are kept high to bring down excess
demand and reduce bubbles. At times, severe Asset Liability mismatch may also
produce an inverted yield curve. It indicates the economy may go into recession; in
that case the coupon on bonds to be issued in future would be low.
3. Flat Yield Curve: When the yield remains constant irrespective of time to maturity,
such a curve would be flat. There is no difference between short term yield and long
term yield.
4. Humped yield curve: At times, yield curves can be humped and the short term and
long term yields would be lower than medium term yield.

9.7 Concept of Duration

Bond prices are sensitive to changes in interest rates. As market rates of interest increase
(decrease) the market values of the bond portfolios decrease (increase).

Duration (also known as Macaulay Duration) of a bond is a measure of the time taken to
recover the initial investment in present value terms. In simplest form, duration refers to the
payback period of a bond to break even, i.e., the time taken for a bond to repay its own
purchase price. Duration is expressed in number of years.

The price sensitivity of a bond to changes in interest rates is approximated by the bond's
duration. The significance of the duration is that greater the duration, more volatile is the
portfolio’s return in respect to changes in the level of interest rates.

A step-by-step approach for working out duration is given below.

1. Calculate the present value of each of the future cash flow.

2. The present values of future cash flows are to be multiplied with their respective
time periods in years (these are the weights).
3. Add the weighted Present Values of all cash flows and divide it by the current price
of the bond.
The resultant value is bond duration in no. of years.

Duration does not increase exponentially with increase in maturity of a bond and stagnates
after a maturity level is reached.

Duration is the weighted average term (time from now to payment) of a bond's cash flows or
of any series of linked cash flows. It is always less than or equal to the overall life (to maturity)

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of the bond in years. Only a zero-coupon bond (a bond with no coupons) will have duration
equal to its remaining maturity. Modified duration shows the change in the value of a security
in response to a change in interest rates. It is thus measured in percentage change in price.
Modified duration can be calculated by dividing the Macaulay duration of the bond by 1 plus
the periodic interest rate prevailing in the market i.e. the discounting rate, which means a
bond’s Modified duration is generally lower than its Macaulay duration. Convexity measures
the degree of the curve in the relationship between bond prices and bond yields.

9.8 Introduction to Money Market

The money market provides an avenue for ultra-short term to short-term lending and
borrowing of funds with maturity ranging from overnight to one year. Participation in the
money market can be broadly divided into two parts: fund raising and asset acquisition. The
first refers to short term fund borrowings either by posting collateral or unsecured borrowing
using one’s credit standing in the market. The second part addresses the market for short
maturity assets i.e. investors deploying over a short horizon of upto one year

Money market transactions are generally used for including the government securities market
and for meeting short term liquidity mismatches. Funding purchase transactions in other
markets to tide over these mismatches is the most common reasons for participating in the
money market. Being a primary source of funding, a liquid money market is critical to financial
stability. In fact, a trigger for the Global Financial Crisis of 2008 was the seizing up of the
lending in the international overnight money markets. The money market is integral to a
country’s financial infrastructure and is the primary transmission channel of the central banks’
monetary policy.

9.8.1 Key players in the money market

Participants in the Indian money market include: Public Sector Banks, Private Sector Banks,
Foreign Banks, Co-operative Banks, Financial Institutions, Insurance Companies, Mutual
Funds, Primary Dealers, Bank cum Primary Dealers, Non-Banking Financial Companies
(NBFCs), Corporates, Provident/ Pension Funds, Payment Banks, Small Finance Banks, etc.

9.8.2Types of Instruments
The various products considered to be the part of the Indian money market are:
Instrument Duration Trading & Settlement Face Value
Reporting
Call Money Overnight NDS-CALL RBI Minimum market
order ₹1 lakh
Notice Money 2-14 days NDS-CALL RBI Minimum market
order ₹1 lakh
Term Money 15 days - 1 year NDS-CALL RBI Minimum market
order ₹1 lakh

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 Market Repo (G- Overnight - 1 CROMS CCIL Minimum market
Sec) year order ₹1 crore

TREP Overnight - 1 TREPS CCIL ₹5 lakh and

year multiples thereof
Corporate Bond Overnight - 1 OTC/Stock Authorized clearing Market lot size ₹1
Repo year Exchanges, houses of Stock crore
Reported on F- Exchanges
TRAC
CMBs Upto 90 days NDS-OM CCIL ₹10,000 and
multiples thereof
T-Bills 91 day - 364 NDS-OM CCIL ₹10,000 and
days multiples thereof
CPs 7 days - 1 year OTC, Reported Authorized clearing ₹5 lakh and
on F-TRAC houses of Stock multiples thereof
Exchanges
CDs Banks: 7 days - OTC, Reported Authorized clearing ₹1 lakh and
1 year, FIs: 1 on F-TRAC houses of Stock multiples thereof
year - 3 years Exchanges

These are explained briefly below:

Call Money

The call money market is an avenue for unsecured lending and borrowing of funds. This
market is a purely interbank market in India restricted only to Scheduled Commercial Banks
(SCBs) and the Primary Dealers (PDs). Call money transactions are dealt/ reported on the
Reserve Bank of India’s (RBI) NDS-CALL platform which is managed by CCIL and are
predominantly overnight (tenor of borrowing may be extended to account for weekends and
holidays).

Notice Money

This is an extension of the interbank call market with uncollateralized lending and borrowing
of funds for a period beyond overnight and upto 14 days. Notice money transactions are
dealt/ reported on the RBI’s NDS-CALL platform which is managed by CCIL.

Term Money

This is an extension of the interbank call market for uncollateralized lending and borrowing
of funds for a period between 15 days and 1 year. Term money transactions are dealt/
reported on the RBI’s NDS-CALL platform which is managed by CCIL.

Market Repo

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Repo also known as a ready forward contract refers to borrowing funds via sale of securities
with an agreement to repurchase the same at a future date with the interest for the
borrowings incorporated in the repurchase price. Reverse repo is the exact opposite
transaction which is essentially a collateralized lending of funds. Each repo/ reverse repo deal
thus has 2 parts / legs. The repo period is the time between the 2 legs. The interest is
computed on the actual amount borrowed by the repo seller which is the consideration
amount in the repo’s first leg. The lender receives the interest in the second leg when the
security is bought back by the borrower at a higher consideration that includes the interest.
RBI regulates the repo market in India and major participants are SCBs, PDs, Mutual Funds,
NBFCs, Financial Institutions (FIs), Insurance Companies, Corporates, Provident/ Pension
Funds, Payment Banks, Small Finance Banks, etc.

Repo transactions against G-secs are traded/ reported on the Clearcorp Repo Order Matching
System (CROMS) electronic platform of the Clearcorp Dealing Systems. These are settled by
CCIL along with G-secs.

Triparty Repo

"Triparty repo" is a type of repo contract with a third-party intermediary between the
borrower and lender known as the Triparty Agent (TPA). The TPA does the collateral selection,
payment and settlement, custody and management during repo period. Following RBI’s
authorization to CCIL to act as a TPA, the ‘Collateralized Borrowing and Lending Obligation’
(CBLO) launched by CCIL on January 20, 2003 was converted into TREP on November 5, 2018.
The Tri Party Repo Dealing System (TREPS) anonymous order matching trading platform is
provided by Clearcorp Dealing Systems (India) Ltd with CCIL as the Central Counterparty (CCP)
for borrowing and lending of funds against government securities in India with a triparty
arrangement. All the repo eligible entities can trade on TREPS and the funds borrowed on
TREPS are exempted from RBI’s CRR/SLR computation and the security acquired under the
deal is eligible for SLR. Stock Exchanges have also introduced Triparty Repo on Corporate
Bonds for the benefit of investors.

Treasury Bills (T-bills)

In India Treasury bills or T-bills are used for short-term borrowing by the Government of India
and are considered to be a part of the money market as they mature within a year from issue.
These are basically zero-coupon securities which are issued at a discount and are redeemed
at par. Normally RBI conducts weekly auctions for three tenors of T-bills: 91, 182 and 364
days. The 14 Day T-bills are not available for public consumption. RBI may use the same for
parking short term surplus funds of State Governments.

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Cash Management Bills (CMBs)

Essentially very short-term T-bills, Cash Management Bills (CMBs) are issued by the
Government of India to fund the temporary mismatches in its cash flow. CMBs have
maturities less than 91 days.

Commercial Paper (CP)

A Commercial Paper (CP) is used by Indian corporates to raise short-term unsecured funds.
CPs are also discounted instruments like T-bills and are issued for ₹5 lakh and multiples
thereof for maturities between 7 days and one year. CP issuances are governed by RBI
regulations. The corporate entities with a good credit rating (typically the minimum is the
Second highest credit rating) and required minimum net-worth can issue CPs. It is used as a
part of working capital resources for corporates.

Certificate of Deposit (CD)

A Certificate of Deposit (CD) is issued against funds deposited at a bank or eligible FIs. CDs are
issued for ₹1 lakh and in multiples of ₹1 lakh thereafter for maturities of 7 days to 364 days
by banks and for 1 year to 3 years by FIs. Banks and Financial institutions issue CDs. Banks
issue CDs upto one year while Financial Institutions can issue upto 3 years.

Corporate Bond Repo (CBR)

Repo in corporate bonds was introduced by RBI in 2010 and the eligible securities for CBR
include: (i) Listed corporate bonds and debentures, (however, participants cannot borrow
against the collateral of their own securities or those of related entities); (ii) CPs and CDs; and
(iii) Units of Debt ETFs. Triparty repo in corporate bonds was launched in India in 2017 by
stock exchanges and currently includes only select AAA category bonds, A1+ rated CPs and
CDs. CBR trading can be done OTC or on stock exchanges.

9.9 Introduction to Government Debt Market

The government securities (G-Sec) market is the most active segment of the Indian fixed
income securities market. Regular structural and infrastructural measures by the Government
and Reserve Bank of India (RBI) have contributed to its substantial growth and expansion over
the last two decades. Along with meeting the governments’ funding needs, it provides the
benchmark interest rates in the market for pricing of various products and schemes and is
also an indirect channel for monetary policy.

9.9.1 Key players in the Government debt market

Primary participants in the Indian G-Sec market are large institutional players like banks,
Primary Dealers (PDs) and insurance companies. Historically, commercial banks invest in
Government securities because of Statutory Liquidity Ratio (SLR) requirements as well as

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diversification towards safe assets. However, RBI has made many calibrated changes to SLR
requirements giving more operational room to Banks for managing the liabilities and SLR has
been reduced keeping in mind the phased implementation of Basel norms. Primary Dealers
(PDs) play a very important role in the form of market making and they provide firm two way
(buy and sell) quotes for the Government securities. Other participants include Co-operative
Banks (after the change of application of SLR norms for them), Mutual Funds, Corporates,
Provident and Pension Funds and Foreign Portfolio Investors (FPIs). Reserve Bank of India is
also a very large holder of Government securities as it has to operate market liquidity window.

9.9.2 Types of Instruments

A Government Security (G-Sec) in Indian markets implies a debt instrument issued either by
the Central Government of India or the State Governments which is tradeable in nature. The
Central Government issues both bills (original maturities of less than one year) and bonds
while the State Governments issue only bonds also known as the State Development Loans
(SDLs). G-Secs are considered risk-free with nearly no risk of default. Each security is known
by a unique number - ISIN (International Security Identification Number) – which is tagged to
an instrument at the time of issuance. Over the years a variety of instruments have been
introduced to match the diverse risk appetites and investment horizons of the market
participants. These instruments have been discussed in detail below.

Treasury Bills (T-bills)

Treasury bills or T-bills are 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. The RBI issues three T-Bills for the investors – 91D, 182D and 364D.
RBI conducts weekly auctions for these T-bills. RBI announces issuance calendar every quarter
and issues the said T-bills as per the notified amount mentioned in the said issuance calendar.

Cash Management Bills (CMBs)

Cash Management Bills (CMBs) are basically unstructured T-bills maturing within 91 days. It
was launched in 2010 in order to meet the temporary shortage in the cash flow for the
Government of India. CMBs have been extensively used by RBI for smoothening systemic
issues such as liquidity management post demonetization in 2016, forex market volatility in
2013, etc.

Dated G-Secs

Government securities are issued on the basis of issuance calendar notified by RBI in the
month of March (for sale of securities between April and September) and in the month for
September (for the sake of securities between October and March). The notified amounts are
informed to the market well in advance. Long term bonds are usually referred to as dated

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securities and these are the largest component of the Indian G-Sec market. With maturities
ranging from one to fifty years, these securities pay a fixed or floating coupon on a semi-
annual basis. Public Debt Office (PDO) of RBI handles the issue, makes coupon payment and
principal repayment. RBI is the depository of Government securities as per the legal
provisions. RBI plays the role of the Merchant banker as well the role of Registrar and Transfer
Agent (RTA) for the issue of Government securities. When coupon payment dates fall on
holidays, the coupon amount is paid on the next working day. However, redemption proceeds
are paid on the previous working day if a maturity date falls on a holiday. The following types
of dated G-Secs have been issued in India.

Fixed Rate Bonds

The largest component within dated securities are fixed coupon securities or fixed rate bonds.
These securities pay a fixed coupon over their entire life but all coupons are paid semi-
annually. For example: Consider the case of “5.77% GS 2030” issued on August 3, 2020 and
maturing on August 3, 2030. This 10-year security pays a coupon every six months i.e. on
February 3rd and August 3rd each year till its maturity at 2.8850% (half yearly payment being
half of the annual coupon of 5.77%) of the ₹100 face value. Coupons for these bonds are fixed
on the date of the issue and typically, the cut-off rate for the bond in the primary auction
becomes the Coupon for the security.

Floating Rate Bonds (FRB)

First introduced by the Government of India in September 1995, FRBs pay interest at a
variable coupon rate that is reset at pre-announced intervals. While majorly linked to the 6-
month rate i.e. the 182 Day T-Bill rate, FRBs coupons at each semi-annual date are currently
determined in various ways: (a) As the average of the implicit cut-off yields of the last three
182 Day T-Bill auctions; (b) Base rate equivalent to weighted average yield of last three 182
Day T-Bills auctions of plus a fixed spread; (c) Reset every five years at the prevailing 5 year
G-Sec yield as on the last working day prior to commencement of each period of five years.
FRBs are not preferred for investment in the market. Since retail participation in the market
is very low, the success of FRB is also not satisfactory.

Zero Coupon Bonds (ZCBs)

ZCBs do not pay any fixed coupon and are issued at a discount and redeemed at par like T-
Bills. These had last been issued by Government of India in 1996. Currently, these securities
are not the favour of the market.

Capital Indexed Bonds (CIBs)

The principal amount of a CIB is linked to an inflation index to protect it from inflation. RBI
had experimented with a 5 year CIB issued in December 1997.

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Inflation Indexed Bonds (IIBs)

In IIBs both the principal amount and coupon flows are protected against inflation. Globally,
while the United Kingdom first introduced IIBs in 1981, in India, the first IIBs (linked to
Wholesale Price Index (WPI)) were issued in June 2013. In December 2013, IIBs linked to the
Consumer Price Index (CPI) were issued exclusively for retail customers. However, like the
Zero Coupon Bonds and Capital Indexed Bonds these bonds did not find wider acceptance
and were discontinued after the initial issues and the Government repurchased most of the
bonds that had already been issued.

Bonds with Call/Put Options

The Government of India has also experimented with bonds with embedded options. The first
such embedded option bond with both call and put option - 6.72% GS 2012 was issued on July
18, 2002 in which the Government had the right to buy-back the bond (call option) at par
while the investors had the right to sell back the bond (put option) to the Government at par
on any of the semi-annual coupon dates beginning July 18, 2007. Currently, Government does
not issue any embedded option bonds.

Special Securities

Occasionally, the Government of India may issue bonds as compensation in lieu of cash
subsidies to entities like the Food Corporation of India, Oil Marketing Companies, Fertilizer
Companies, etc. (also known as food, oil bonds and fertilizer bonds respectively). Government
of India also issues Bank recapitalization bonds under the special securities. These are not
eligible as SLR securities and thus pay a marginally higher coupon over the yield of the similar
maturity G-Secs.

Separate Trading of Registered Interest and Principal of Securities (STRIPS)

STRIPS are essentially separate ZCBs created by breaking down the cash flows of a regular G-
Sec. For example, when ₹100 of the 5.77% GS 2030 mentioned earlier is stripped, the ₹100
principal payment at maturity becomes a principal STRIP while each coupon cash flow
(₹2.885) becomes a coupon STRIP, which can all then be traded separately as independent
securities in the secondary market. STRIPS can be created out of all existing fixed coupon SLR
eligible G-Secs. STRIPS can be attractive to retail/non-institutional investors as being ZCBs,
they have zero reinvestment risk.

Sovereign Gold Bond (SGB)

SGBs are unique instruments with commodity (gold) linked prices. Part of budgeted
borrowing, these are issued in tranches and are denominated in units of one gram of gold and
multiples thereof. They pay a fixed coupon per annum on the nominal value paid on semi-

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annual basis and are redeemed at simple average of closing price published by the India
Bullion and Jewellers Association Limited of gold (999 purity) of the previous 3 business days
from the date of repayment. There may not be fresh issuances of SGBs from now on. Earlier
issuances are available in the secondary market.

Savings (Taxable) Bonds

Specially issued for retail investors at par for a minimum amount of ₹1,000 (face value) and
in multiples thereof, while these bonds have no maximum limit for investment, the interest
paid is taxable under the Income Tax Act, 1961. From FY21, these bonds bear a floating rate
of interest which is reset every 6 months.

State Development Loans (SDLs)

Market borrowings of State Governments / Union Territories through semi-annual coupon

paying dated securities are known as State Development Loans (SDLs). These are eligible for
SLR and borrowing under the LAF window. Uday bonds were special securities issued by State
Governments for financial turnaround of power distribution companies (DISCOMs). Uday
bonds are not eligible for SLR status. Nowadays SDLs are also referred to as SGS (State
Government Securities).

9.10 Introduction to Corporate Debt Market

Corporate debt continues to have a low share of the total debt issuance in India. Investment
demand is largely restricted to institutional investors whose investments are in turn limited
by prudential norms for investment issued by their respective regulators. On the other hand,
the multitude of steps to be adhered to, push the potential suppliers i.e. the corporates to
opt for bank financing or overseas borrowing to meet their funding requirements in a time
constrained fund raising environment.

Despite these inherent constraints, the Indian corporate debt market has witnessed
significant growth in recent years due to the regulators’ focus on enhanced transparency,
expanded issuer and investor base as well as availability of better market infrastructure.
Nature of secondary market participants being largely wholesale or institutional and non-
availability of trading platforms with guaranteed central counterparty (CCP) facility are
primary obstacles to an active secondary market for individual investors.

9.10.1 Key Players in the Corporate Bond Ecosystem in India

Issuer
The "Issuer” is the entity that issues a debt instrument to borrow money from the investors
against a promise of paying back the principal on the maturity date along with the periodic
interest. The issuer may issue the bond either using a private placement option or using public

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issue protocol of SEBI. If issued to the public, then it must be listed in a stock exchange for
liquidity purposes. Privately placed debt may or may not be listed in a stock exchange.

Debenture Trustee
In India, the terms ‘debenture’ and ‘corporate bond’ are used interchangeably and both are
identified as the same in the Companies Act. Like a bond, a debenture is also a debt
instrument issued by a company to repay the borrowed sum at a specified date along with
payment of interest. A Debenture Trustee (DT) is registered with SEBI. A DT holds the secured
property on behalf of the debt issuer and for the benefit of debenture holders who though
the beneficiaries, have no access to the mortgaged property. Scheduled banks carrying on
commercial activity, insurance companies, public financial institutions or corporate bodies
can act as DTs.

DTs have the responsibility to protect the interest of the debenture holders as they have to
ensure that the property charged is available and sufficient in value terms to discharge the
interest and principal amounts during the life of the debenture. They call for periodic reports
from the issuers and also ensure that the issuers comply with the provisions of the trust deed,
the Companies Act and the listing agreements of the stock exchanges. DTs on noticing any
breach of the trust deed or law have to act immediately to protect the interest of the
debenture holders. In the event of default, DTs can appoint nominee directors on the issuer’s
board and also have the power and authority to sell the secured property to redeem the
debentures.

The SEBI (Debenture Trustees) Regulations, 1993 govern DTs in India. As per the provisions of
Companies Act, appointment of a DT is compulsory if any debentures/bonds are issued with
a maturity of more than18 months. Unsecured debentures/bonds are treated as fixed
deposits, if received from individual investors. In India, the issuer pays fees to the DT for its
services.

Qualified Institutional Buyer (QIB)

QIBs in the Indian market include:
* Scheduled Commercial Banks
*Insurance Companies registered with the Insurance Regulatory and Development Authority
of India (IRDAI)
*Mutual Funds
*State Industrial Development Corporations
*Multilateral and bilateral Development Financial Institutions
*Provident Funds with minimum corpus of ₹25 crore
*Pension Funds with minimum corpus of ₹25 crore
*Public Financial Institution as defined in the Companies Act

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*Foreign Institutional Investor registered with SEBI
*Venture Capital Funds registered with SEBI
*Foreign Venture Capital Investors registered with SEBI
Retail Individual Investors
“Retail Individual Investor” refers to investors who bid/apply for securities for ₹2 lakh or less.

Designated stock exchange

“Designated stock exchange” means a stock exchange with nationwide trading terminals on
which debt securities are listed.

9.10.2 Corporate debt Instruments

Company deposits
These are time deposits issued by companies for a specific time period which is usually 1, 2
and 3 years. Since they are issued by companies they are known as company deposits. There
is a fixed rate of interest that is paid on these deposits, which is usually higher than the bank
fixed deposit rate depending on the financial position of the company. Investors need to look
at the company and its financial situation before making a decision about investing in these
deposits. Deposits are not securities as per the definition of SCRA as these are not
transferable.

Bonds and debentures

These are bonds and debentures that are issued by companies and they are usually for a
slightly longer time frame. Another factor that is present for bonds and debentures is that
many of them are secured in nature. This means that there is the security of an asset behind
these issues so there is an additional level of comfort for the investor. The risk of a credit
default needs to be considered by investors when they look at such issues.

Infrastructure Bonds
The infrastructure bonds are very long-term bonds that are issued and they can be for 10 to
even 20 years, these are meant to finance infrastructure projects and hence they are long
term in nature. Specific companies that operate in this space are the ones who issue these
bonds and they are often traded in the secondary market. Investors need to analyse these in
a different light in the consideration of the projects for which the money would be used.

Inflation indexed bond

The inflation indexed bonds set themselves apart as they do not have a fixed rate of interest
on them. At a specified time interval the interest rate on these bonds will change depending
on the inflation rate in the economy. This ensures that the real rate of return for the investor
is protected.

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9.11 Small Saving Instruments

Bank Deposits

A bank fixed deposit (FD) is also called a term or time deposit, as it is a deposit account with
a bank for a fixed period of time. It entitles the investor to pre-determined interest payments
and return of the deposited sum on maturity. Fixed bank deposits offer higher returns than
savings accounts as the money is available for use by the bank for a longer period of time.
Fixed deposits are preferred by investors who like the safety that a bank provides, want to
know how much they will earn and do not have an immediate need for the funds.

Bank FDs are considered to be a safe investment option. This is because each depositor is
insured up to Rs.5 lakh by the Deposit Insurance and Credit Guarantee Corporation (DICGC).
It includes all deposits and interest on them, held across branches of a given bank. The limit
of Rs 5 lakh per bank is a significant sum that provides an element of comfort for the investor
as they know that their money is not going to be lost if the bank goes down.

A fixed deposit is created by opening an FD account with the bank which in turn issues an FD
receipt. Interest on an FD can be paid into the depositor’s savings bank account at a
predefined frequency, or accumulated and paid at the end of the term. On maturity, the lump
sum deposit amount is returned to the investor.

Investors can also choose to renew the deposit on the maturity date. The minimum deposit
amount varies across banks. The duration of deposits can range from 7 days to 10 years
though FDs longer than 5 years are not very common.

Interest Rates on FDs

Interest rates depend on the duration of deposit, amount deposited and policies of the bank.
In general, longer-term deposits pay a higher rate than shorter term deposits. There could be
a specific time bracket that could have a higher interest rate because the bank wants to
attract money for that specific duration. However, banks might also introduce deposits with
specific terms like 333 days or 777 days which can have a special rate of interest. Banks also
offer special rates to senior citizens, defined as those who are over 60 years of age. The special
rate is usually an amount ranging from 0.25% to 0.75% extra interest above the normal
applicable one. Interest rates also vary from bank to bank. The interest rate paid by a bank
depends on its need for funds for a particular tenor.

Interest rates do not remain unchanged. Deposit rates offered by banks for various tenors
change over time, depending on the economic cycle, their need for funds and demand for
credit (loans) from banks. However, a rate committed to be payable for a tenor, until maturity,
does not change even if market interest rates change. New rates usually apply only for fresh
deposits.

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Banks may also prescribe a minimum lock-in period during which funds cannot be withdrawn
from the FD account. They may levy a penalty on depositors for pre-mature withdrawals. FD
holders may enjoy additional benefits such as loan facility against the security of their FD
receipts, or cash overdraft facility.

Investment in specified (under Section 80C of the Income Tax Act) 5-year bank FDs are eligible
for tax deductions up to a maximum amount of Rs.1.5 lakh, along with other investment
options listed under the same section. These deposits are subject to a lock-in period of 5
years.

Floating rate Government of India Bond

The Government of India has launched a bond for investment, which investors can use to earn
a regular sum of interest. This bond was launched on July 1, 2020 with an interest rate of 7.15
per cent. Unlike earlier bond series, where the interest rate was fixed for the entire duration
of the bond the situation is different with this issue. The interest rate on this floating rate
bond will be set twice a year based on the changes in the benchmark rate.

The interest on the bond is payable every six months and after the payment is done the
interest rate would be reset for the next six months. The first payment of interest would take
place on January 1, 2021 and then continue according to the schedule. The interest rate on
the bond has been linked to the rate prevailing on the National Savings Certificate (NSC). The
rate here would be 35 basis points or 0.35% over the NSC rate.

A resident Indian can make an investment in these bonds while Non Resident Indians (NRIs)
are not allowed to invest. The bonds can be bought from designated branches of a few public
and private sector banks and will be held only in demat form. This is also called a bond ledger
account which are opened only with a bank for holding government securities.

The interest earned on these bonds is taxable and it is added to the income under the head
of Income from other sources.

Small Saving Instruments10

The Indian government has instituted a number of small saving schemes to encourage
investors to save regularly. The main attraction of these schemes is the implicit guarantee of
the government, which is the borrower. These schemes are offered through the post office
and select banks.

The saving schemes currently offered by the government are:

 Public Provident Fund (PPF)

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  Senior Citizens’ Saving Scheme (SCSS)
 National Savings Certificate (NSC)
 Post Office Schemes and Deposits
 Kisan Vikas Patra (KVP)
 Sukanya Samriddhi Account

Public Provident Fund

Instituted in 1968, the objective of the PPF is to provide a long-term retirement planning
option to those individuals who may not be covered by the provident funds of their employers
or may be self-employed.

PPF is a 15-year deposit account that can be opened with a designated bank or a post office.
It can also be opened online with a few banks. A person can hold only one PPF account in
their name except an account in the name of a minor child to whom he or she is a guardian.
An individual can open a PPF account at any age. HUFs and NRIs are not allowed to open PPF
accounts. If a resident subsequently becomes an NRI during the prescribed term, he/she may
continue to subscribe to the fund till its maturity on a non-repatriation basis. Joint account
cannot be opened, however nomination facility is available.

National Savings Certificate (NSC)

National Savings Certificates are issued by the government and available for purchase at the
post office. NSCs are issued with a tenor of 5 years (NSC VIII issue amended as of December
1, 2011). Interest is compounded annually and accumulated and paid on maturity.

The certificates 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 the
NSCs. If a resident holder becomes an NRI subsequent to the purchase, the certificate can be
held till maturity. However, the maturity value cannot be repatriated. Joint holding is allowed
and the certificate can be held jointly by up to two joint holders on joint basis or either or
survivor basis.

Certificates are available in denominations of Rs.100, 500, 1,000, 5,000, and 10,000. The
minimum investment is Rs.100 without any maximum limit. The certificates can be bought by
cash or through cheques.

Investments made in the NSC VIII issue enjoy tax benefits under section 80C of Income Tax
Act, 1961. Accrued interest is taxable, but is it deemed to be reinvested and therefore the
interest becomes eligible for Section 80C benefits. There is no tax deducted at source at the
time of redeeming the certificate value.

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Senior Citizens’ Saving Scheme (SCSS)

The Senior Citizens’ Saving Scheme is a savings product available to only senior citizens of age
60 years or above on the date of opening the account. Proof of age and a photograph of
account holder are required. The age limit is reduced to 55 years in case of an individual
retiring on superannuation or otherwise, or under VRS or special VRS, provided the account
is opened within one month of date of receipt of retirement benefits. The retired personnel
of Defence Services, excluding Civilian Defence Employees, shall be eligible irrespective of age
limit. The account 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. The age restrictions apply only to the first holder. NRIs, PIOs and HUF are
not eligible to invest in this scheme.

National Savings Schemes / Post Office Schemes and Deposits

a) National Savings Monthly Income Account / Post Office Monthly Income Scheme (POMIS)

The Post Office Monthly Income Scheme provides a regular monthly income to the
depositors. This scheme has a term of 5 years.

Minimum amount of investment in the scheme is Rs.1,500, and the maximum amount is
Rs.4.5 lakhs for a singly held account and Rs.9 lakhs if the account is held jointly. A depositor
can have multiple accounts, but the aggregate amount held in the scheme across all post
offices cannot exceed the maximum permissible limits. The deposit can be made in cash or
cheque.

The applicable interest rate is announced every quarter and is payable on a monthly basis
with no bonus on maturity. Nomination facility is available and can be made at the time of
opening the account or subsequently at any time before maturity.

Premature withdrawal of the invested amount is allowed after 1 year of opening the account.
If the account is closed between 1 and 3 years of opening, 2% of the deposited amount is
deducted as penalty. If it is closed after 3 years of opening, 1% of the deposited amount is
charged as penalty.

b) National Savings Time Deposit Account/ Post Office Time Deposits (POTD)

National Savings Time Deposit Account / Post Office Time Deposits are similar to fixed
deposits of commercial banks. The post office accepts deposits with terms of one year, two
years, three years and five years. The account can be held singly in individual capacity or
jointly by a maximum of two holders. Single account can be converted into Joint and vice
versa.

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The minimum deposit amount is Rs.100. There is no maximum limit. The interest rates on
these deposits are subject to changes every quarter as announced by the government.

Interest rates are compounded quarterly and are subject to tax. The five year term deposit is
eligible for tax benefits under Section 80C of the Income Tax Act, 1961.

c) National Savings Recurring Deposit Account /Post Office Recurring Deposit

National Savings Recurring Deposit Account /Post Office Recurring Deposit (RD) accounts can
be opened by resident individuals, and a maximum of two people can hold an account jointly
or on either or survivor basis. An individual can hold any number of RD accounts, singly or
jointly. Deposits can be made at a minimum amount of Rs.10 per month and in multiples of
Rs.5 thereafter for every calendar month. There is no maximum investment limit. Interest is
payable on a quarterly compounded basis. The maturity amount with interest is paid at the
end of the term. Interest is taxable. Deposits have to be made regularly on a monthly basis,
and penalties apply for non-payment of instalment. One withdrawal is allowed after the
deposit has been in operation for at least one year and 12 monthly deposits have been made.
Interest as applicable will apply on the withdrawal and the repayment can be in lump sum or
in instalments. An account can be extended for another 5-year term after maturity.

Kisan Vikas Patra (KVP)

The KVP can be purchased by an adult for self or by two adults for a minor investor. NRIs,
HUFs and other entities are not eligible to invest in the KVP. It can be purchased from any
departmental post office or bank through cash, local cheque. The minimum investment is
Rs.1,000 and in multiples of Rs. 1,000/-. There is no maximum limit. The instrument maturity
depends on the applicable rate of interest. The effective interest rate is announced on a
quarterly basis. The facility of nomination and joint holding is available in the KVP and the
certificate can be transferred from one person to another and one post office to another by
endorsement and delivery. There is no tax incentive for the investment made and the interest
earned is taxed on accrual basis.

Sukanya Samriddhi Account Scheme

The Sukanya Samriddhi Account is a scheme launched for the benefit of girl children. The
account has to be opened in the name of the girl child by a natural or legal guardian. The
account is opened with an authorized list of banks. 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. Investments can be made in a lumpsum or in tranches. There is
no limit on the number of deposits that can be made in a financial year in multiples of Rs.100.

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The account can be transferred to any place in India. The account will mature on the
completion of 21 years from the date of opening the account. If the girl child gets married
before the completion of 21 years then the account is closed. Partial withdrawal is allowed
after the holder attains 18 years of age, to the extent of 50% of the amount in balance at the
end of the preceding financial year. Any amount deposited in the account is eligible for
deduction under section 80C of the Income Tax Act.

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