The Debt Market is the market Where fixed income securities of various types and features are issued and traded
Securities Issued by: Central and State Governments, Municipal Corporations, Govt. bodies Financial Institutions Banks Public Sector Units Public Ltd. companies Structured Finance Instruments
Money market instruments are fixed income instruments, generally having maturity less than 1 year and are discounted instruments.
The Money Market is basically concerned with the issue and trading of securities with short term maturities or quasi-money instruments
Maturity Principal
Segments in the Debt Market Government Securities Corporate Bonds Money Market
G-SECS
BONDS
CENTRAL Govt.
STATE Govt.
FI BONDS
PSU BONDS
Corporate Securities
CALL / NOTICE
T-BILLS
TERMS MONEY
CD
ICD
CP
REPO
COMMERCIAL BILL
Issuer
Central Government
Instruments
Zero Coupon Bonds, Coupon Bearing Bonds, Treasure Bills, STRIPS Coupon Bearing Bonds. Govt. Guaranteed Bonds, Debentures PSU Bonds, Debentures, Commercial Paper Debentures , Bonds, Commercial Paper, Floating Rate Bonds. Zero Coupon Bonds, Inter-Corporate Deposits
Corporates
Banks
Financial Institutions
Long Term (> 1 year) Debt Products Used by Long Term Debt/Income Funds
Credit Ratings
Credit rating is primarily intended to systematically measure credit risk arising from transactions between lender and borrower. Credit risk is the risk of a financial loss arising from the inability (known in credit parlance as default) of the borrower to meet the financial obligations towards its creditor
Credit Ratings
Independent Opinion on credit worthiness of an issuer, awarded by a registered credit rating agency. Both Quantitative and qualitative research Only credit opinions, no guarantees Can be different grades by different agencies Credit Rating agency appointed by the issuer Advantages of Credit rating
Issuer: Widen investor base Lower cost of funds Higher financial flexibility
Investor
Independent assessment of credit worthiness Improved liquidity of the paper help in valuing a security
Credit Rating
In India, it is mandatory for credit rating agencies to register themselves with SEBI and abide by the SEBI (Credit Rating) Regulations, 1999.
Repo and reverse-repo together become corridor for call money market
Worldwide Central Bankers use Repost manage Money Supply in the economy
Repo Transaction
Difference between cash given by RBI & received back is Repo Rate
CBLOContinued
Mutual Funds are major lenders Primary Dealers are major borrowers Transaction Denomination INR 5 M Auction basis Discount rate & Maturity Unlike REPO, lenders here can call their funds and borrowers can repay before maturity by unwinding their position Participants Banks, MFs, Co-operative Banks, FIs, Insurance Companies, NBFCs, Corporate, Provident/Pension Funds
BOND VALUATION
Fundamentals of Valuation
Spread
Duration
Modified duration
Yield
Yield refers to the percentage rate of return paid on a stock in the form of dividends, or the effective rate of interest paid on a bond or note
There are many different kinds of yields depending on the investment scenario and the characteristics of the investment
Current Yield is the coupon divided by the Market Price and gives a fair approximation of the present yield Current Yield = Coupon of the Security(in%) x Face Value of the Security (viz. 100 in case of G- Secs.)/Market Price of the Security Eg: Suppose the market price for a 10.18% G-Sec 2012 is Rs.120. The current yield on the security will be (0.1018 x 100)/120 = 8.48% The yield on the government securities is influenced by various factors such as level of money supply in the economy, inflation, future interest rate expectations, borrowing program of the government & the monetary policy followed by the government
Yield To Maturity
Yield To Maturity (YTM) is the most popular measure of yield in the Debt Markets and is the percentage rate of return paid on a bond, note or other fixed income security if you buy and hold the security till its maturity date Yield to maturity on a bond is also called the Internal Rate of Return (IRR) The calculation for YTM is based on the coupon rate, length of time to maturity and market price. It is the Internal Rate of Return on the bond and can be determined by equating the sum of the cash-flows throughout the life of the bond to zero. A critical assumption underlying the YTM is that the coupon interest paid over the life of the bond is assumed to be reinvested at the same rate The YTM is basically obtained through a trial and error method by determining the value of the entire range of cash-flows for the possible range of YTMsso as to find the one rate at which the cash-flows sum up to zero.
Yield Curve
The graphical depiction of the relationship between the interest rates (or yields) on bonds of the same credit quality and different maturities is known as the yield curve
In other words, the yield curve is a depiction of debt market interest rates across maturities, with time being plotted on the X-axis and yields on the Y-axis. The curve graphically demonstrates the rate at which market participants are willing to transact debt capital for shortterm, medium-term and long-term periods
The yield curve is generally upward sloping indicating that investors demand a premium for holding securities for a longer period of time.
Yield Curve
Credit Spread
The difference between the yield on a corporate bond and government bond is called the credit spread( Also called the yield spread)
Duration
Duration is the weighted average term to maturity Duration of a bond is less than its maturity except for zero coupon bond Duration is longer the longer the maturity except for deep discount bonds
Modified Duration
The modified duration of a bond measures the percentage change in its price for a given change in interest rates or yields Modified Duration = Duration/ (1+ytm) Modified duration measures the risk of the bond with respect to changes in the yield, in other words it is the price risk of the bond with a unit change in yield, in general longer duration bonds carry more price risk for a given change in yield and vice versa
Price-Yield relationship in Bonds Graphical Representation Price / Yield Graph (10Y Govt Security)
Volatility due to change in Interest rate Change in Bond Price vs Duration for 1% Yield Change-
Background
When certain financial asset classes (retail or corporate) are pooled together and undivided interest in the pool is sold, pass-through securities are created The term 'undivided interest' means that each holder of the security has a proportionate interest in each cash flow generated by the pool The pass-through securities assure that cash flow from the underlying asset classes would be passed through to the holders of the securities in the form of regular payments of interest and principal The entity selling the receivables (also usually the originating entity) to the Trust is called the Originator' and the entity which has borrowed the funds and is responsible for repayment is the obligor
Nature of a Typical PTC transaction: First, a special purpose vehicle (SPV) is created, to de-link the pool assets (cash flows) from the company that wants to securitise(the `originator'). The SPV is usually a trust and has no borrowings of its own The SPV then issues tradable debt instruments called `pass through certificates' and sells them to potential investors. Proceeds from the sale of PTCsare then utilized by the SPV to purchase/ buy-out the asset pools from the Originator
In a typical securitization deal, assets in the pool include auto loans, Commercial vehicle (CV) and construction equipment (CE) loans, personal loans OR single corporate loans Since the SPV is a set up as a bankruptcy remote entity, it is not impacted by bankruptcy of the originator
All PTCs are rated by one of the four accredited rating agencies in the country The rating is based on the financial strength of the obligor, as the end-investors have no recourse to the originator of the loans Effectively the rating on the PTCs represents the stand-alone credit risk of the obligor The rating takes into account the relative repayment ability of the obligor
There is no difference in the credit risk on the exposure taken through a single loan PTC vis--vis a plain vanilla debenture
Credit risk assessment in a PTC investment is based on the analysis of the obligor and not originator of the loan
The methodology adopted to evaluate the credit risk in the case of a single loan PTC is identical to that followed in the case of investment in debentures / CPsor other financial instruments issued by the obligor
Credit Risk
Probability of default by the borrower
Change in credit rating downgrade increases the yield & decreases the price upgrade decreases the yield & increases the price
SpreadThe payoff for assuming credit risk
THANK YOU
www.prudentcorporate.com