PROJECT REPORT ON

BOND MARKET

IN PARTIAL FULFILLMENT OF
THE DEGREE AWARDED AT
M.COM PART II (BANKING & FINANCE)
SEMESTER III

SUBMITTED TO
UNIVERSITY OF MUMBAI
FOR ACADEMIC YEAR 2017 – 2018
SUBMITTED BY

NAME: BHAVANA SINGH

ROLL NO: 38

VIVA COLLEGE OF ARTS, COMMERCE AND SCIENCE

VIRAR (WEST)
401303
 DECLARATION

I hereby declare that the project titled “ BOND MARKET” is an original

work prepared by me and is being submitted to University of Mumbai in
partial fulfillment of “M.COM – PART II SEM IV (BANKING &
FINANCE)” degree for the academic year 2017-2018.
To the best of my knowledge this report has not been submitted earlier
to the University of Mumbai or any other affiliated college for the
fulfillment of “M.COM” degree.

Name : BHAVANA SINGH Signature:

Date: Place:
 ACKNOWLEDGEMENT

I BHAVANA SINGH the student of VIVA College pursuing my

“M.COM –II (BANKING & FINANCE)”, would like to pay the
credits, for all those who helped in the making of this project.
The first in accomplishment of this project is our Principal Dr. A. P.
Pandey, Vice-Principal Prof. Prajakta Paranjape, Course Co-
ordinator Prof. Nilima Bhagwat and Guide Prof. Vasanthi R.
Shenoy. & teaching & non-teaching staff of VIVA college.
I would also like to thank all my college friends those who influenced
my project in order to achieve the desired result correctly.
 TABLE OF CONTENTS:
PARTICULARS DESCRIPTION PG NO

CHAPTER 1 INTRODUCTION
1.1 HISTORY
CHAPTER 2 LITERATURE REVIEW
CHAPTER 3 OBJECTIVE OF STUDY
3.1 RESEARCH METHODOLOGY
CHAPTER 4 OVERVIEW OF BOND MARKET
4.1 DEBT MARKET INDTRUMENT
4.2 STRUCTURE OF BOND MARKET
4.3 REFORMING GOVERNMENT BOND
MARKET IN INDIA
4.3 FACTOR AFFECTING BOND MARKET
CHAPTER 5 CORPORATE BOND MARKET IN INDIA
5.1 RECENT TRENDS IN CORPORATE BOND
MARKET IN INDIA

5.2 ISSUE AND CHALLENGES CORPORATE

BOND MARKET IN INDIA

5.3 MUNCIPAL BOND MARKET

CHAPTER 6 INTERNATIONAL BOND MARKET

6.1 EURO BOND MARKET

CHAPTER 7 India’s Bond Market— Developments and
Challenges
CHAPTER 8 CONCLUSION
CHAPTER 9 BIBLIOGRAPHY
 INTRODUCTION

Finance in its modern form really dates only from the 1950s. In the forty years since then,
the field has come to surpass many, perhaps even most, of the more traditional fields of
economics in terms of the numbers of students enrolled in finance courses, the numbers
of faculty teaching finance courses, and above all in the quantity and quality of their
combined scholarly output.

The huge body of scholarly research in finance over the last forty years falls naturally
into two main streams. And no, I don’t mean “asset pricing” and “corporate finance,” but
instead a deeper division that cuts across both. The division I have in mind is the more
fundamental one between what I will call the business school approach to finance and the
economics department approach. Let me say immediately, however, that my distinction is
purely “notional,” not physical a distinction over what the field is really all about, not
where the offices of the faculty happen to be located.

In the United States, the vast majority of academics in finance teach in business schools,
not economics departments, and always have. At the same time, in the elite schools at
least, a substantial fraction of the finance faculties have been trained in that is, have
received their Ph.D.s from economics departments. Habits of thought acquired in
graduate school have a tendency to stay with you.

In this account of the evolution of finance theory, the “father of modern finance” uses the
series of Nobel Prizes awarded finance scholars in the 1990s as the organizing principle
for a discussion of the major developments of the past 50 years. Starting with Harry
Markowitz's 1952 Journal of Finance paper on “Portfolio Selection,” which provided the
mean variance framework that underlies modern portfolio theory (and for which
Markowitz received the Nobel Prize in 1990), the paper moves on to consider the Capital
Asset Pricing Model, efficient market theory, and the M & M irrelevance propositions. In
describing these advances, Miller's major emphasis falls on the “tension” between the
two main streams in finance scholarship:

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  The Business School (or “micro normative”) approach, which focuses on
investors ‘attempts to maximize returns and corporate managers’ efforts to
maximize shareholder value, while taking the prices of securities in the market as
given; and
 The Economics Department (or “macro normative”) approach, which assumes a
“world of micro optimizers” and deduces from that assumption how the market
prices actually evolve.
The tension between the two approaches is resolved, and the two streams converge, in the
final episode of Miller's history–the breakthrough in option pricing accomplished by
Fischer Black, Myron Scholes, and Robert Merton in the early 1970s (for which Merton
and Scholes were awarded the Nobel Prize in 1998, “with the late Fischer Black
everywhere acknowledged as the third pivotal figure”). As Miller says, the BlackScholes
option pricing model and its many successors “mean that, for the first time in its close to
50 year history, the field of finance can be built, or rebuilt, on the basis of ‘observable’
magnitudes.” That option values can be calculated (almost entirely) with observable
variables has made possible the spectacular growth in financial engineering, a highly
lucrative activity where the practice of finance has come closest to attaining the precision
of a hard science. Option pricing has also helped give rise to a relatively new field called
“real options” that promises to revolutionize corporate strategy and capital budgeting.
But if the practical applications of option pricing are impressive, the opportunities for
further extensions of the theory by the “macro normative” wing of the profession are
“vast,” including the prospect of viewing all securities as options.

The financial system is essentially concerned with borrowing and lending. Lending
occurs either directly to borrowers (e.g. equities held by an individual) or indirectly via
financial intermediaries (e.g. an individual holds units and the unit trusts holds as assets
the liabilities of the ultimate borrowers). Although this is the main function, there are
many related others as reflected in the following definition of the financial system:
The financial system is a set of arrangements/conventions embracing the lending and
borrowing of funds by non-financial economic units and the intermediation of this
function by financial intermediaries in order to facilitate the transfer of funds, to create

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additional money when required, and to create markets in debt and equity instruments
(and their derivatives) so that the price and allocation of funds are determined efficiently.

The purpose of this text is to provide an overview of the bond market and its role in the
financial system. We start with a brief introduction to the financial system, and then
contrast the money market with the bond market, although together they make up the
debt market. We then describe the characteristics of the most common bond, the so-called
plain vanilla bond. We then just mention the bond derivatives.
The following sections are presented:
 The financial system in brief.
 The money market in a nutshell.
 The bond market in a nutshell.
 Essence of the plain vanilla bond.
 Bond derivatives.

Dissecting this definition reveals six essential elements:

 First: lenders (surplus economic units or surplus budget units) and borrowers
(deficit economic units or deficit budget units), i.e. the non-financial economic
units that undertake the lending and borrowing process. There are four groups of
lenders and borrowers: household sector, corporate sector, government sector and
foreign sector, and many members of these groups are lenders and borrowers at
the same time.

 Second: financial intermediaries which intermediate the lending and borrowing

process. They interpose themselves between the lenders and borrowers.

 Third: financial instruments, which are created to satisfy the financial

requirements of the various participants; these instruments may be marketable
(e.g. treasury bills) or non-marketable (e.g. participation interest in a retirement
annuity).

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  Fourth: the creation of money when demanded. Banks have the unique ability to
create money by simply lending because the general public accepts bank deposits
as a medium of exchange.

 Fifth: financial markets, i.e. the institutional arrangements and conventions that
exist for the issue and trading (dealing) of the financial instruments;

 Sixth: price discovery, i.e. the price of shares/equity and the price of money/debt
(the rate of interest) are “discovered” (made and determined) in the financial
markets. Prices have an allocation of funds function.

1.1 HISTORY

The term "financial services" became more prevalent in the United States partly as a
result of the Gramm-Leach-Bliley Act of the late 1990s, which enabled different types of
companies operating in the U.S. financial services industry at that time to merge.

Companies usually have two distinct approaches to this new type of business. One
approach would be a bank which simply buys an insurance company or an investment
bank, keeps the original brands of the acquired firm, and adds the acquisition to its
holding company simply to diversify its earnings. Outside the U.S. (e.g. Japan), non-
financial services companies are permitted within the holding company. In this scenario,
each company still looks independent, and has its own customers, etc. In the other style, a
bank would simply create its own brokerage division or insurance division and attempt to
sell those products to its own existing customers, with incentives for combining all things
with one company.

1.2 Commercial banking services

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A commercial bank is what is commonly referred to as simply a bank. The term
"commercial" is used to distinguish it from an investment bank, a type of financial
services entity which instead of lending money directly to a business, helps businesses
raise money from other firms in the form of bonds (debt) or stock (equity).

The primary operations of commercial banks include:

 Keeping money safe while also allowing withdrawals when needed

 Issuance of cheque books so that bills can be paid and other kinds of payments
can be delivered by the post
 Provide personal loans, commercial loans, and mortgage loans (typically loans to
purchase a home, property or business)
 Issuance of credit cards and processing of credit card transactions and billing
 Issuance of debit cards for use as a substitute for cheques
 Allow financial transactions at branches or by using Automatic Teller Machines
(ATMs)
 Provide wire transfers of funds and Electronic fund transfers between banks
 Facilitation of standing orders and direct debits, so payments for bills can be made
automatically
 Provide overdraft agreements for the temporary advancement of the bank's own
money to meet monthly spending commitments of a customer in their current
account.
 Provide internet banking system to facilitate the customers to view and operate
their respective accounts through internet.
 Provide charge card advances of the bank's own money for customers wishing to
settle credit advances monthly.
 Provide a check guaranteed by the bank itself and prepaid by the customer, such
as a cashier's check or certified check.
 Notary service for financial and other documents
 Accepting the deposits from customer and provide the credit facilities to them.
 Sell investment products like mutual funds Etc.
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  The United States is the largest location for commercial banking services.

Investment banking services

Capital markets services - underwriting debt and equity, assist company deals (advisory
services, underwriting, mergers and acquisitions and advisory fees), and restructure debt
into structured finance products.
Brokerage services - facilitating the buying and selling of financial securities between a
buyer and a seller. stock brokers, brokerages services are offered online to self trading
investors throughout the world who have the option of trading with 'tied' online trading
platforms offered by a banking institution or with online trading platforms sometimes
offered in a group by so-called online trading portals.

Private banking - Private banks provide banking services exclusively to high-net-worth

individuals. Many financial services firms require a person or family to have a certain
minimum net worth to qualify for private banking service. Private banks often provide
more personal services, such as wealth management and tax planning, than normal retail
banks.
New York City is the largest location for investment banking services, which is
dominated by domestic U.S. business, while London is the largest location for
international business and commerce.

Foreign exchange services

Foreign exchange services are provided by many banks and specialist foreign exchange
brokers around the world. Foreign exchange services include:

Currency exchange - where clients can purchase and sell foreign currency banknotes.
Wire transfer - where clients can send funds to international banks abroad.
Remittance - where clients that are migrant workers send money back to their home
country.

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London handled 36.7% of global currency transactions in 2009 – an average daily
turnover of US$1.85 trillion – with more US dollars traded in London than New York,
and more Euros traded than in every other city in Europe combined.

Investment services

Investment management - the term usually given to describe companies which run
collective investment funds. Also refers to services provided by others, generally
registered with the Securities and Exchange Commission as Registered Investment
Advisors. Investment banking financial services focus on creating capital through client
investments.
Hedge fund management - Hedge funds often employ the services of "prime brokerage"
divisions at major investment banks to execute their trades.
Custody services - the safe-keeping and processing of the world's securities trades and
servicing the associated portfolios. Assets under custody in the world are approximately
US$100 trillion.
New York City is the largest center of investment services, followed by London.

Insurance

Insurance brokerage - Insurance brokers shop for insurance (generally corporate property
and casualty insurance) on behalf of customers. Recently a number of websites have been
created to give consumers basic price comparisons for services such as insurance, causing
controversy within the industry.
Insurance underwriting - Personal lines insurance underwriters actually underwrite
insurance for individuals, a service still offered primarily through agents, insurance
brokers, and stock brokers. Underwriters may also offer similar commercial lines of
coverage for businesses. Activities include insurance and annuities, life insurance,
retirement insurance, health insurance, and property insurance and casualty insurance.
Finance & Insurance - a service still offered primarily at asset dealerships. The F&I
manager encompasses the financing and insuring of the asset which is sold by the dealer.

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F&I is often called "the second gross" in dealerships who have adopted the model

Reinsurance - Reinsurance is insurance sold to insurers themselves, to protect them from

catastrophic losses.
The United States, followed by Japan and the United Kingdom are the largest insurance
markets in the world.

Other financial services

Bank cards - include both credit cards and debit cards. According to the Nilson Report,
JP Morgan Chase is the largest issuer of bank cards.
Credit card machine services and networks - Companies which provide credit card
machine and payment networks call themselves "merchant card providers".
Intermediation or advisory services - These services involve stock brokers (private client
services) and discount brokers. Stock brokers assist investors in buying or selling shares.
Primarily internet-based companies are often referred to as discount brokerages, although
many now have branch offices to assist clients. These brokerages primarily target
individual investors. Full service and private client firms primarily assist and execute
trades for clients with large amounts of capital to invest, such as large companies,
wealthy individuals, and investment management funds.
Private equity - Private equity funds are typically closed-end funds, which usually take
controlling equity stakes in businesses that are either private, or taken private once
acquired. Private equity funds often use leveraged buyouts (LBOs) to acquire the firms in
which they invest. The most successful private equity funds can generate returns
significantly higher than provided by the equity markets
Venture capital is a type of private equity capital typically provided by professional,
outside investors to new, high-growth-potential companies in the interest of taking the
company to an IPO or trade sale of the business.

Angel investment - An angel investor or angel (known as a business angel or informal

investor in Europe), is an affluent individual who provides capital for a business start-up,

8
usually in exchange for convertible debt or ownership equity. A small but increasing
number of angel investors organize themselves into angel groups or angel networks to
share resources and pool their investment capital.

Conglomerates - A financial services company, such as a universal bank, that is active in

more than one sector of the financial services market e.g. life insurance, general
insurance, health insurance, asset management, retail banking, wholesale banking,
investment banking, etc. A key rationale for the existence of such businesses is the
existence of diversification benefits that are present when different types of businesses
are aggregated i.e. bad things don't always happen at the same time. As a consequence,
economic capital for a conglomerate is usually substantially less than economic capital is
for the sum of its parts.

Financial market utilities - Organisations that are part of the infrastructure of financial
services, such as stock exchanges, clearing houses, derivative and commodity exchanges
and payment systems such as real-time gross settlement systems or interbank networks.
Debt resolution is a consumer service that assists individuals that have too much debt to
pay off as requested, but do not want to file bankruptcy and wish to pay off their debts
owed. This debt can be accrued in various ways including but not limited to personal
loans, credit cards or in some cases merchant accounts.

1.3 REGULATORIES

The Reserve Bank of India (RBI) is India's central banking institution, which controls
the monetary policy of the Indian rupee. It commenced its operations on 1 April 1935 in
accordance with the Reserve Bank of India Act, 1934.[6] The original share capital was
divided into shares of 100 each fully paid, which were initially owned entirely by private
shareholders.

Following India's independence on 15 August 1947, the RBI was nationalised on 1

January 1949. The RBI plays an important part in the Development Strategy of
the Government of India. It is a member bank of the Asian Clearing Union. The general
9
superintendence and direction of the RBI is entrusted with the 21-member Central Board
of Directors: the Governor, 4 Deputy Governors, 2 Finance Ministry representatives, 10
government-nominated directors to represent important elements of India's economy, and
4 directors to represent local boards headquartered at Mumbai, Kolkata, Chennai and
New Delhi. Each of these local boards consists of 5 members who represent regional
interests, the interests of co-operative and indigenous banks.

Securities and Exchange Board of India

The Securities and Exchange Board of India (SEBI) is the regulator for the securities
market in India. It was established in the year 1988 and given statutory powers on 30
January 1992 through the SEBI Act, 1992.

Forward Markets Commission

The Forward Markets Commission (FMC) is the chief regulator of commodity futures
markets in India. As of July 2014, it regulated Rs 17 trillion of commodity trades in
India. It is headquartered in Mumbai and this financial regulatory agency is overseen by
the Ministry of Finance. The Commission allows commodity trading in 22 exchanges in
India, of which 6 are national.

On 28 September 2015 the FMC was merged with the Securities and Exchange Board of
India (SEBI)

Insurance Regulatory and Development Authority

The Insurance Regulatory and Development Authority of India (IRDAI) is an

autonomous, statutory body tasked with regulating and promoting the insurance and re-
insurance industries in India.[2] It was constituted by the Insurance Regulatory and
Development Authority Act, 1999,[3] an Act of Parliament passed by the Government of
India.[4] The agency's headquarters are in Hyderabad, Telangana, where it moved from
Delhi in 2001

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Pension Fund Regulatory and Development Authority

The Pension Fund Regulatory and Development Authority (PFRDA) is the pension
regulator of India which was established by Government of India on August 23, 2003 and
was authorized by Ministry of Finance, Department of Financial Services. Upon
introduction of the PFRDA Bill by the Government of India in the Parliament of
India and the subsequent passage of the PFRDA Act[2]in 2013, the Authority became a
Central Autonomous Body. Like other financial sector regulators namely Reserve Bank
of India (RBI), Securities and Exchange Board of India (SEBI), Insurance Regulatory and
Development Authority (IRDAI) and Insolvency and Bankruptcy Board of India (IBBI),
PFRDA is a quasi government organization having executive, legislative and judicial
powers. PFRDA promotes old age income security by establishing, developing and
regulating pension funds and protects the interests of subscribers to schemes of pension
funds and related matters. Currently, PFRDA is regulating and administering the National
Pension System (NPS) along with administering the Atal Pension Yojana (APY) which is
a defined benefits pension scheme for the unorganized sector, guaranteed by
the Government of India.[3] PFRDA is responsible for appointment of various
intermediate agencies such as Central Record Keeping Agency (CRA), Pension Fund
Managers, Custodian, NPS Trustee Bank, etc.

Ministry of Corporate Affairs

The Ministry of Corporate Affairs (MCA) is an Indian government ministry.This

Ministry is primarily concerned with administration of the Companies Act 2013, the
Companies Act 1956, the Limited Liability Partnership Act, 2008 & other allied Acts and
rules & regulations framed there-under mainly for regulating the functioning of the
corporate sector in accordance with law.[1] It is responsible mainly for regulation of
Indian enterprises in Industrial and Services sector. The current minister of corporate
affairs is Arun Jaitley. The current Minister of State for Corporate Affairs is Mr. PP
Choudhary.

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12
 Bond market

The long-term debt market is an extension of the money market. The bond market is a
part of the long- term debt market: it is the market for marketable long-term debt; i.e.
debt that is issued in the form of tradable securities. Few borrowers are able to access this
market, mainly because of the demands of the lenders in terms of credit risk,
marketability, etc. (this will become clearer as we progress this discussion). Formally, we
define the bond market as:

The bond market is the mechanism / conventions that exist for the issue of, investing in,
and the trading of instruments that represent the long-term undertakings (usually of a
fixed capital nature) of the issuers.

If this definition is dissected, we arrive at the following key words:

 Bonds.
 Market mechanism.
 Issue (primary market).
 Investing.
 Trading (secondary market).
 Long-term undertakings of a fixed capital nature.

Each of these key words will be explained briefly.

Bonds

Bonds may be defined as marketable long-term debt obligations of the issuers. Each
issuer undertakes to repay the face value at the end of the stated redemption (maturity)2
period of the bond, plus interest at specified intervals or at the end of the period, and the
interest rate may be fixed or floating.

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The holder of a bond has a claim on the assets and revenue of the issuer in the event of
bankruptcy. This means that the corporate bondholder has a prior claim on assets in
relation to equity. In many cases the bond certificate states that the holder has such a
claim.

Market mechanism

The market mechanism is the structure, systems and conventions that exist to facilitate
the issue and trading of bonds. As we have seen, there are two types of market, i.e. the
OTC market and the exchange- regulated market. Most bond markets around the world
are OTC markets.

Issue (primary market)

There are five broad classes of issuers in the bond market:

 Government sector (usually three levels).

 Corporate sector entities (private sector-owned).
 Corporate sector entities (public sector-owned; called public enterprises or
parastatals).
 Special purpose vehicles (SPVs).

 Foreign sector entities (inward listings).

Investing

The investors in (or holders of) bonds are also depicted in Figure 4. Of the ultimate
lenders, the foreign sector is the largest investor. The other three ultimate lender sectors
are insignificant holders and may be largely ignored in the big picture scenario we are
creating. All the mainstream financial intermediaries are investors in bonds, but the

14
largest holders are the retirement funds (a CI), the long-term insurers (a CI) and the bond
unit trusts (a CIS).

Trading (secondary market)

Trading in bonds (i.e. secondary market broking and dealing) is a sizeable business in
most financial markets. As noted earlier the secondary market is either OTC or exchange-
driven.

Long-term undertakings of a fixed capital nature

The long-term undertakings of a fixed capital nature of issuers are what give rise to the
issue of bonds. Many companies and governments and public enterprises (also called
parastatals) have a requirement for long-term funds to finance projects such as
infrastructure (roads, telecommunications systems, deep mining, etc). The financial
planning side of a long-term project would be problematical if the company was only
able to issue short-term instruments (like commercial paper – CP). There would be two
main financial considerations (and inconveniences) in this regard:

 The uncertainty of obtaining the funds at each rollover at maturity.

 The uncertainty of the rate of interest to be paid at each rollover date.

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2.1 Meaning

The bond market – also called the debt market or credit market – is a financial market in
which the participants are provided with the issuance and trading of debt securities. The
bond market primarily includes government-issued securities and corporate debt
securities, facilitating the transfer of capital from savers to the issuers or organizations
requiring capital for government projects, business expansions and ongoing operations.

The bond market – also called the debt market or credit market – is a financial market in
which the participants are provided with the issuance and trading of debt securities. The
bond market primarily includes government-issued securities and corporate debt
securities, facilitating the transfer of capital from savers to the issuers or organizations
requiring capital for government projects, business expansions and ongoing operations.

2.2 Types

The general bond market can be classified into corporate bonds, government and agency
bonds, municipal bonds, mortgage-backed bonds, asset-backed bonds, and collateralized
debt obligations.

Corporate Bond

Corporations provide corporate bonds to raise money for different reasons, such as
financing ongoing operations or expanding businesses. The term "corporate bond" is
usually used for longer-term debt instruments that provide a maturity of at least one year.

Government Bonds

National governments issue government bonds and entice buyers by providing the face
value on the agreed maturity date with periodic interest payments. This characteristic
makes government bonds attractive for conservative investors.

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Municipal Bonds

Local governments and their agencies, states, cities, special-purpose districts, public
utility districts, school districts, publicly owned airports and seaports, and other
government-owned entities issue municipal bonds to fund their projects.

Mortgage Bonds

Pooled mortgages on real estate properties provide mortgage bonds. Mortgage bonds are
locked in by the pledge of particular assets. They pay monthly, quarterly or semi-annual
interest.

Bond Indices

Just like the S&P 500 Index or Russell Indexes for equities, bond indices manage and
measure bond portfolio performance. Big names include Barclays Capital Aggregate
Bond Index, the Merrill Lynch Domestic Master and the Citigroup U.S. Broad
Investment-Grade Bond Index. Many bond indices are members of broader indices that
may be used to provide and measure the performances of global bond portfolios.

2.3 Regulatories

Reserve Bank of India (RBI)

The Reserve Bank of India Act, 1934 governs policies framed by the Reserve Bank of
India. The functions of RBI in this regard are as follows:

 Implementation of monetary and credit policies

 Issuance of currency notes
 Government’s Banker
 Banking system regulator
 Foreign Exchange through Foreign Exchange Management Act, 1999

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  Managing payment & settlement system
 Apart from the above functions, RBI is also actively involved in developing the
financial market.
 Securities & Exchange Board of India (SEBI)

The Securities & Exchange Board of India (SEBI) Act, 1992 regulates the functioning of
SEBI. SEBI is the apex body governing the Indian stock exchanges.

The primary functions of SEBI are as follows:

 Safeguarding investor’s interest

 Promotion and development of Indian stock market

The participation in the Indian stock market of both the domestic or foreign financial
intermediaries, governed by their respective market regulators, are governed by the
regulations framed by SEBI. Additionally, foreign portfolio investors (FPIs) can
participate in Indian stock market after registering them with an authorized depository
participant.

2.4 Trading

Trading in bonds (i.e. secondary market broking and dealing) is a sizeable business in
most financial markets. As noted earlier the secondary market is either OTC or exchange-
driven. The market is “made” / facilitated by a number of players:

 Members of bond exchanges where such exchanges exist.4 The members are the
banks, smaller broker-dealers and interdealer brokers. In some countries the banks
act as primary dealers (a subset of market makers), which is dealt with later. The
broker-dealers are smaller firms that trade for own account or for clients.
Interdealer brokers exist in some markets; they offer a brokerage service
exclusively between the members of the exchanges.

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  Discount houses. In some countries where exchanges do not exist and the banks
are reluctant to make a market in bonds, the discount houses (which are
specialised banks) act in this capacity.
 Banks. In some countries where exchanges do not exist the banks act as market
makers / primary dealers.
 Issuers. Certain issuers make a market in their own paper, with the objective of
enhancing the liquidity of their paper, thus reducing the rate of interest (cost) for
them.
 Speculators / arbitrageurs. These may be members of exchanges (the members
that only deal for themselves) or non-members. Most of them trade intra-day in
order to avoid settlement outlays. Their usefulness lies in increasing the turnover
in the bond market, leading to efficient price discovery.
 Investors. The investors play a significant role in the bond market. The major
investors as noted are the retirement funds and insurers), the foreign sector
(mainly foreign retirement funds) and bond unit trusts.

National Stock Exchange of India (NSE)

NSE is responsible for formulating and implementing the rules pertaining to:

 Registration of members
 Listing of securities
 Monitoring of transactions
 Compliance

Other additional functions related to the above functions

NSE itself is regulated by SEBI and is under regular vigilance for all regulatory
compliances.

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Stock Exchange

In simple terms, a stock market is a platform where people buy and sell stocks, prices of
which are set according to the prevalent demand and supply situation. It is very similar to
a marketplace where traders buy and sell goods, quoting prices on the basis of the
demand for the good and the availability or supply of it. The term trade, in the context of
the bourses, means the transfer of money from the seller to the buyer in exchange for a
security/ shares. The price at which the seller sells or the buyer buys is listed on the stock
exchange. You can easily trade through a trading member registered on a stock exchange.

As per National Securities Clearing Corporation Limited “A trading member means any
person admitted as a member in any exchange in accordance with the Rules, Bye-laws
and Regulations of that Exchange.”

The stock market doesn’t differentiate between any citizen of the country. Outside
investments were only permitted in the 1990s and can take place through either Foreign
Direct Investments (FDIs) or Foreign Portfolio Investments (FPIs). Thus, the stock
market participants range from small individual investors to insurance companies, banks,
mutual fund companies, manufacturing companies etc.

However, the rules and regulations formulated by SEBI remain the same for all types of
market participants and everybody is obligated to abide by such rules and mandates.

2.5 Companies

Axis Trustee Services Limited

Axis Trustee Services Limited, a wholly owned subsidiary of Axis Bank Limited was
incorporated on May 16, 2008 The Company is a SEBI registered Debenture Trustee and
has successfully handled various Trusteeship activities namely Debenture Trustee,
Security Trustee, Security Agent , Lenders' Agent, Facility Agent, Trustee for
Securitisation Issuances, Escrow Agent etc.

20
Essar Power

Essar Global Fund is a global investor, controlling a number of world-class assets

diversified across the core sectors of Metals & Mining, Energy, Infrastructure and
Services.

JSPL

SPL is an industrial powerhouse with a dominant presence in steel, power, mining and
infrastructure sectors. Part of the US $ 18 billion OP Jindal Group this young, agile and
responsive company is constantly expanding its capabilities to fuel its fairy tale journey
that has seen it grow to a US $ 3.3 billion business conglomerate.

JSPL has been rated as the second highest value creator in the world by the Boston
Consulting Group, the 11th fastest growing company in India by Business World and has
figured in the Forbes Asia list of Fab 50 companies. It has also been named among the
Best Blue Chip companies and rated as the Highest Wealth Creator by the Dalal Street
Journal. Dun & Bradstreet has ranked it 4th in its list of companies that generated the
highest total income in the iron and steel sector.

MOIL ltd

MOIL is a Schedule “A” Miniratna Category-I Company. It was originally incorporated

as Manganese Ore (India) Limited in the year 1962. Subsequently, name of the Company
was changed from Manganese Ore (India) Limited to MOIL Limited during the financial
year 2010-11.

MOIL was originally set up in the year 1896 as Central Province Prospecting Syndicate
which was later renamed as Central Provinces Manganese Ore Company Limited
(CPMO), a British Company incorporated in the UK. In 1962, as a result of an agreement
between the Government of India and CPMO, the assets of the latter were taken over by
the Government and MOIL was formed with 51% capital held between the Govt. of India
and the State Governments of Maharashtra and Madhya Pradesh and the balance 49% by

21
CPMO. It was in 1977, the balance 49% shareholding was acquired from CPMO and
MOIL became a 100% Government Company under the administrative control of the
Ministry of Steel.

AMTEK GROUP

The Amtek Group, headquartered in India, is one of the largest integrated component
manufacturers in India with a strong global presence. It has also become one of the
world’s largest global forging and integrated machining companies. The Group has
operations across Forging, Iron and Aluminium Casting, Machining and Sub-Assemblies.
It has world-class facilities across India, Japan, Thailand, Germany, Hungary, Italy,
Romania, UK, Brazil, Mexico and US. The Amtek Group is comprised of corporate
entities Amtek Auto, JMT Auto, Amtek Global Technologies and other subsidiaries and
associates. With the infrastructure and technology platform developed over 25 years, the
Group is well positioned in the Indian Auto and Non-Auto component markets.

2.6 Bombay Stock Exchange

The Bombay Stock Exchange (BSE) is the first and largest securities market in India and
was established in 1875 as the Native Share and Stock Brokers' Association. Based in
Mumbai, India, the BSE lists close to 6,000 companies and is one of the largest
exchanges in the world, along with the New York Stock Exchange (NYSE), NASDAQ,
London Stock Exchange Group, Japan Exchange Group, and Shanghai Stock Exchange.

In 1995 the BSE switched from an open-floor to an electronic trading system. There are
more than a dozen electronic exchanges in the U.S. alone with the New York Stock
Exchange (NYSE) and Nasdaq being the most widely known. Today electronic systems
dominates the financial industry overall, offering fewer errors, faster execution and better
efficiency than traditional open-outcry trading systems.

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Securities that the BSE lists includes stocks, stock futures, stock options, index futures,
index options and weekly options. The BSE's overall performance is measured by the
Sensex, an index of 30 of the BSE's largest stocks covering 12 sectors.

In addition to the BSE major international stock exchanges include:

The New York Stock Exchange (NYSE). NYSE is considered the largest equities-based
exchange in the world, based on the total market capitalization of its listed securities.
NYSE was formerly a private organization but became public in 2005 after it acquired
the electronic trading exchange Archipelago.

Nasdaq--a global electronic marketplace and the benchmark index for U.S. technology
stocks. National Association of Securities Dealers (NASD) created Nasdaq in 1971 to
enable investors to trade securities on a rapid, computerized, and transparent system.
Today “Nasdaq” also refers to the Nasdaq Composite, an index of more than 3,000 listed
technology that include Apple, Google, Microsoft, Oracle, Amazon, Intel and Amgen.

London Stock Exchange (LSE). The primary U.K. stock exchange and largest in
Europe, LSE developed after several regional exchanges merged in 1973. LSE was first
called the Stock Exchange of Great Britain and Ireland. 100 of the top blue chips on the
LSE form the Financial Times Stock Exchange (FTSE) 100 Share Index, or "Footsie",

Other major international stock exchanges in Asia include the Tokyo Stock Exchange and
Shanghai Stock Exchange.

2.7 DEBT MARKET INSTRUMENTS

A like equity market, there is a market of debt instruments, which implies instruments
floated or issued by companies, institutions, or banks which are debt to the issuer and are
payable to the contributor of debt along with considerations in the form of interest or
premium on repayment/redemption security and consistency in returns. Such debt
instruments may be- Government bonds fixed rate or floating rate bonds, PSU Bond,

23
certificate of deposits, debentures, pension bonds, tax free bonds, certificates(rural
bonds), company deposits, bond options, structured obligations, securitized instruments,
gilts.

New Instruments

With the on-going liberalization and deregulation of capital markets, a number of new
instruments have been used by companies and financial institutions in record past as a
tool of raising funds from capital market-Commercial paper, zero interest bonds and
debentures, option bonds, deep discount bonds, cumulative convertible preference shares,
debentures with equity and tradable warrants, secured premium notes(SPN) euro
convertible bonds(ECB), multiple option convertible debentures(MOCD), optionally
fully convertible debentures(OFCD), regular returns/retirement bonds. There are other
couple of risk investments available to investors which are not securities as defined in the
law. Such investments instruments may be time share of holiday resorts, time sharp car
ownership scheme, oil-palm scheme, milk, mineral water scheme or plantation schemes,
such schemes are innovative and structured in a mannered to attract common man who is
looking for non-conventional investment avenues. Such schemes are not subject to any
regulation in India. Such schemes are highly risky and thus offer a much higher returns
than ordinary investment.

Instruments Issued Outside India

Companies can issue financial instruments and securities in foreign markets and in
foreign currency. Such securities are subscribed by non-residents and foreign citizens in
foreign currency and are convertible into equity shares of the issuer company, the
instruments issued are Foreign currency convertible bonds, depository receipts, euro
convertible bonds, foreign currency options, American depository receipts. Due to
different requirement of the companies and the investor aforesaid instruments have been
tried out in Indian capital market. These instruments are certainly going to create a sound
footing in capital market.

24
2.8 Factors Affecting Debt Market

1. Interest rates

2. Inflation

3. Credit rating.

Role of Debt Market in Transforming Economy

1. The state of the Indian capital market and its emerging scenario has attracted
considerable attention in recent years with economic reforms; capital market restructuring
could provide an important impetus to the real sector growth. While the markets for both
debt and equity could be developed to meet the emerging needs of the economy, the debt
market in particular, assumes great importance for the following reason: 1. Debt markets
provide an assured rate of return to the investors, particularly when real and financial
sector are all geared for change;

2. Debt markets can signal about the long run prospects of the economy, through a
constellation of growth-inflation interest rate expectation;

3. A shift of focus from an automatic accommodation of fiscal deficits would mean

that both state and central governments would have to rely on debt market;

4. The restructuring of public sector enterprises would involve greater access to

capital markets and with less equity dilution at the moment implies that they will have to
depend on the bond market, the equity market in India can be said to have become
sophisticated and vibrant during the last decade, although a number of regulatory
pressures still cripple its growth. However, the bond segment is still narrow and lacking
dynamism. This is the sharp contrast with the bond markets in the world over where these
are a prominent segment and serve as the base to all other markets. Traditionally,
government has shown preference for liberalizing the bond market segment to the
international investors than diluting the ownership of domestic companies through equity.
This situation has given enormous impetus to the growth of foreign and Eurobond market
with the opening up of the Indian debt and equity markets, overseas investors seem to
have been only attracted to the later.
25
2.9 STRUCTURE OF INDIAN BONDMARKET

26
2.10 Reforming Government Bond Market in India

Auctions, Benchmarks, and Vintages: Government must make a credible commitment

to conduct regular and predictable auction cycles with defined benchmarks, across the
maturity spectrum. The goal should be to develop (and sustain over time) at strategic

27
point along the yield curve, deep and liquid benchmarks. Right now, Indian Government
Securities Markets is too fragmented, with many illiquid issues, and very few actively
traded issues in isolated points on the yield curve. This issue is not difficult to solve, but
does require an enlightened thinking on the part of Ministry of Finance, RBI and
institutions in the private sector. For example, it is important to consolidate old vintages
through repackaging and buy-backs. Private sector can repackage if the markets are
transparent and legal roadblocks to securitization are removed. Second, Government
must make a commitment to be an active and predictable issuer in some strategic
benchmark maturity sectors: two-years, five-years, ten-years, twenty-years, and thirty-
years. This is central to the price discovery function.

Broadening Institutional Ownership: It is a stunning fact that 85% of the Government

securities in India is in the hands of three classes of institutions – commercial banks, Life
Insurance Company (LIC), and the Reserve Bank of India(RBI). This type of an
arrangement is insidious and promotes opacity, and sets wrong incentives. In contrast,
the Treasury debt issued by the United States is invested by many private sector
institutions such as pension funds, mutual funds, insurance companies, banks, foreign
institutions, etc. The ability of the Government to raise large amounts of debt capital
(which is sorely needed in India for many infra-structure projects) critically depends on
how liquid and transparent the underlying Government Securities Markets is. In addition
to this very narrow ownership of Government Securities, which resemble a “private
placement” market, the captive holders (such as banks in India) of Government
Securities are given dispensations such as Hold to Maturity (HTM) accounting
provisions, whereby the securities are held at par value, irrespective of their market
prices (which in itself is difficult to get at as there is no liquid secondary market at all
maturities). HTM provisions that banks enjoy serve to understate the true risk that banks
present to the Indian economy. It makes the bond markets more opaque, and adversely
affects the ability of the Indian Government make large scale bond issues. Banks which
tend to hold Government Securities may also have less of an incentive to lend to private
sector and this hinders the efficiency of the most critical credit channel in the economy.
It is also in the self-interest of the Government to eventually have all Government

28
Securities trade in secondary markets to establish a “market determined” cost of
borrowing at different terms. A useful counterfactual is the following: if a significant
fraction of Government Securities that is held by banks is to be eventually sold to private
parties at market prices over time, what would be the yields at which they would trade?
What would be the effect on capitalization of banks? Basel III and other guidelines will
eventually force all countries to get their book in order, and it behooves India to think
ahead and act to avoid a potentially major crisis.

Establishing a Retail Investor Base: It is ironic that in India where National ID can be
used to deliver cash to poor households directly by the Government, we do not have the
ability for saving households to electronically invest in Government securities in a “user
friendly” manner. While such facilities may exist in principle, I gather that they are not a
very important segment of the investor base. It is worthy of note that many households
invest in bank debt instruments with a (possibly incorrect) view that such securities are
default-free. The introduction of a significant retail investor base such as saving
households for the Government Securities through web-based investing in small

denominations will enable the Government to directly access the savings in the economy,
and simultaneously put banks on notice to look for alternative sources of funding and/or
be more competitive in attracting retail term deposits. Stock Exchanges can play a role in
promoting Government Securities to the retail investor base. They already have a
significant amount of expertise in delivering stocks to retail investors through electronic
networks. They are therefore ideally situated to deliver Government Securities to retail
investors as well. Significant issues, such as taxation of income from Government
Securities, custody, clearing and other issues have to be addressed to make this happen.

Ability to finance long and short positions: institutions should be able to express their
bullish or bearish views on interest rates at different points across the yield curve, in
order to promote price discovery. In developed markets such as the United States and
Europe, this is accomplished through markets for repurchase (repo) and reverse
repurchase (reverse repo) agreements, backed by clearing arrangements, schedule of
haircuts or margins for different eligible collateral. While much progress has been made

29
recently in this area, it is nevertheless the case that liquidity is lacking for reasons cited
earlier. The development of an active market for repo and reverse repo transactions with
appropriate safeguards is an essential step to invigorate the cash market for Government
Securities in India.

Spill-Over Effects of an Active Government Securities Market: Indian Corporate

Bond markets will be a significant beneficiary, if an active and transparent Government
Securities Markets were to develop in India. For Indian firms, this will provide an
opportunity to tap debt capital directly from investors at a much bigger scale. Additional
reforms in the following areas would be important to secure a thriving corporate bond
market:

Post-trade transparency, whereby investors are in a position to see recently completed

trades in the market, the size, the initiator of the trade, and the trade time. In the United
States, TRACE has provided such a transparency enabling a more active participation of
retail investors in corporate bond markets.

Bankruptcy reforms, to ensure that the process of financial distress resolution in efficient.
Hart (1999) has suggested three metrics for an “efficient bankruptcy code”: first, the code
must be expost efficient, ensuring that the residual value available to all claimants is
maximized. Second, the are protected ex-ante. This calls for severe punishments to
borrowers who do not comply with their contractual obligations to the creditors. Third,
some residual value must be set aside for the borrowers so that they do not take excessive
risks when the firm approaches the bankruptcy state. The extent of delays and dead-
weight losses associated with the distress resolution process will clearly be a key
determinant, ex ante, of the attractiveness of corporate bond to the investor.

2.11 Advantages
It is considered a wise move to invest in bonds as part of a considered diversified
investment portfolio that also consists of stocks and cash. They are considered to be a
relatively safe investment for increasing capital and receiving a reliable interest income.
The principal and interest are set at the time the bond is purchased. If the owner collects

30
the coupon and holds it to maturity, the market is irrelevant to final payout. As a long-
term investment, bonds may be considered a wise choice bearing in mind the
disadvantages.
 Bonds can be a reliable source of current income depending on the structure of the
bond you buy
 Bonds provide a certain element of liquidity, as the bond market is large and
active
 If you sell a bond before it matures, you may receive more or less than your
principal investment because bond values fluctuate
 Generally, interest income from federal government bonds is exempt from
taxation at the state and local level, and the interest income from municipal bonds
is usually not subject to federal tax
 In the spectrum of the investment options, investment grade bonds are a relatively
low-risk investment

Disadvantages
 Bonds are not advisable for short-term savings for the individual participant in the
market.

 Long-term commitment is essential as the participant who cashes in before

maturity is open to the risk of fluctuations in interest rates. Whenever there is an
increase in interest rates, there is a corresponding decrease in the value of existing
bonds. Conversely, a decrease in interest rates will correspond to a rise in the
value of existing bonds. This is due to the fact that new issues pay out a lower
yield. The basic concept of bond market volatility is that the value of bonds and
changes in interest rates run inversely to each other.

 When interest rates drop, investors have to reinvest their interest income and
return of principal at lower rates.

 The final purchasing power of an investment in bonds is reduced by a

31
 corresponding increase in inflation, which also results in higher interest rates and
correspondingly lower bond prices.

 If there is a decline in the bond market as a whole, individual securities also fall in
value.

 Timing is crucial: a security may in the future unexpectedly underperform relative

to the market.

 A bond may perform poorly after purchase, or it may improve after you sell it.

 Corporate bonds have relatively low liquidity compared with government bonds,
which usually have a short lock-in period (i.e. they can be cashed in quickly).

2.12 Features

Set Maturity Dates

Bonds have set maturity dates that can range from one to 30 years — short-term bonds
(mature in three years or less), intermediate bonds (mature in three to ten years) and long-
term bonds (mature in ten years or more).

Interest Payments
Bonds typically offer some form of interest payment; however, this depends on their
structure: "Fixed Rate Bonds" provide fixed interest payments on a regular schedule for
the life of the bond; "Floating Rate Bonds" have variable interest rates that are
periodically adjusted; and, "Zero Coupon Bonds" do not pay periodic interest at all, but
offer an advantage in that they are can be bought at a discounted price of the face value
and can be redeemed at the face value at maturity

Principal Investment Repayment

Bond issuers are obligated to repay the full principal amount of a bond in a lump sum

32
when the bond reaches maturity

Credit Ratings
Evaluate the "default risk" (the risk that the issuers won't be able to make interest or
principal payments) of a bond by checking the rating it has been given by a bond rating
agency such as Moody's Investors Service or Standard and Poor's

Callable Bonds
If the bond has a "call feature", the issuer is allowed to redeem the bond before its
maturity date, repay the loan and thus, stop paying interest on it

Investing In Bonds
Bonds are bought and traded mostly by institutions like central banks, sovereign wealth
funds, pension funds, insurance companies, hedge funds, and banks. Insurance companies
and pension funds have liabilities which essentially include fixed amounts payable on
predetermined dates. They buy the bonds to match their liabilities, and may be compelled
by law to do this. Most individuals who want to own bonds do so through bond funds.
Still, in the U.S., nearly 10% of all bonds outstanding are held directly by households.

The volatility of bonds (especially short and medium dated bonds) is lower than that of
equities (stocks). Thus, bonds are generally viewed as safer investments than stocks, but
this perception is only partially correct. Bonds do suffer from less day-to-day volatility
than stocks, and bonds' interest payments are sometimes higher than the general level of
dividend payments. Bonds are often liquid – it is often fairly easy for an institution to sell
a large quantity of bonds without affecting the price much, which may be more difficult
for equities – and the comparative certainty of a fixed interest payment twice a year and a
fixed lump sum at maturity is attractive. Bondholders also enjoy a measure of legal
protection: under the law of most countries, if a company goes bankrupt, its bondholders
will often receive some money back (the recovery amount), whereas the company's
equity stock often ends up valueless. However, bonds can also be risky but less risky than
stocks:

33
Fixed rate bonds are subject to interest rate risk, meaning that their market prices will
decrease in value when the generally prevailing interest rates rise. Since the payments are
fixed, a decrease in the market price of the bond means an increase in its yield. When the
market interest rate rises, the market price of bonds will fall, reflecting investors' ability
to get a higher interest rate on their money elsewhere — perhaps by purchasing a newly
issued bond that already features the newly higher interest rate. This does not affect the
interest payments to the bondholder, so long-term investors who want a specific amount
at the maturity date do not need to worry about price swings in their bonds and do not
suffer from interest rate risk.
Bonds are also subject to various other risks such as call and prepayment risk, credit risk,
reinvestment risk, liquidity risk, event risk, exchange rate risk, volatility risk, inflation
risk, sovereign risk and yield curve risk. Again, some of these will only affect certain
classes of investors.

Price changes in a bond will immediately affect mutual funds that hold these bonds. If the
value of the bonds in their trading portfolio falls, the value of the portfolio also falls. This
can be damaging for professional investors such as banks, insurance companies, pension
funds and asset managers (irrespective of whether the value is immediately "marked to
market" or not). If there is any chance a holder of individual bonds may need to sell their
bonds and "cash out", interest rate risk could become a real problem (conversely, bonds'
market prices would increase if the prevailing interest rate were to drop, as it did from
2001 through 2003. One way to quantify the interest rate risk on a bond is in terms of its
duration. Efforts to control this risk are called immunization or hedging.

Bond prices can become volatile depending on the credit rating of the issuer – for
instance if the credit rating agencies like Standard & Poor's and Moody's upgrade or
downgrade the credit rating of the issuer. An unanticipated downgrade will cause the
market price of the bond to fall. As with interest rate risk, this risk does not affect the
bond's interest payments (provided the issuer does not actually default), but puts at risk
the market price, which affects mutual funds holding these bonds, and holders of

34
individual bonds who may have to sell them.
A company's bondholders may lose much or all their money if the company goes
bankrupt. Under the laws of many countries (including the United States and Canada),
bondholders are in line to receive the proceeds of the sale of the assets of a liquidated
company ahead of some other creditors. Bank lenders, deposit holders (in the case of a
deposit taking institution such as a bank) and trade creditors may take precedence.
There is no guarantee of how much money will remain to repay bondholders. As an
example, after an accounting scandal and a Chapter 11 bankruptcy at the giant
telecommunications company Worldcom, in 2004 its bondholders ended up being paid
35.7 cents on the dollar. In a bankruptcy involving reorganization or recapitalization, as
opposed to liquidation, bondholders may end up having the value of their bonds reduced,
often through an exchange for a smaller number of newly issued bonds.

Some bonds are callable, meaning that even though the company has agreed to make
payments plus interest towards the debt for a certain period of time, the company can
choose to pay off the bond early. This creates reinvestment risk, meaning the investor is
forced to find a new place for their money, and the investor might not be able to find as
good a deal, especially because this usually happens when interest rates are falling.

Corporate Bond Markets in India

35
Corporates, governments and individuals rely on various sources of funding to meet their
capital requirements. Specifically, corporates use either internal accruals or external
sources of capital to finance their business. Funds are raised from external sources either
in the form of equity or debt or hybrid instruments that combine the features of both debt
and equity. The capital raised by companies through debt instruments is broadly referred
to as corporate debt. Corporate debt consists of broadly two types – bank borrowings and
bond. Corporates borrow from banks and other financial institutions for various business
purposes and for varying durations through non-standardized and negotiated bank loans.
Bank finance takes the form of project loans, syndicated loans, working capital, trade
finance, etc. Corporate bonds are transferable debt instruments issued by a company to a
broad base of investors (including but not restricted to banks and other financial
institutions). We distinguish between a) public debt (debt issued by central and state
governments, municipal authorities) and b) private debt (bonds issued by private issuers:
financial and non-financial corporates). We focus our study on private debt. Certain
typical features of corporate bonds, including but not limited to the following, are a)
corporate bonds are issued to the public (similar to equity instruments) b) listed on stock
exchanges and traded in secondary markets c) are transferable d) possess a broad base of
issuers (ranging from small companies to conglomerates and multinationals) and
investors (including retail participants), and e) are under the additional purview of the
regulators of the securities market other than the central bank or other banking
supervisor. Corporate bond markets are further defined as the segment of capital markets
in the economy that deals with corporate bonds. There are three main pillars that make up
the corporate bond market ecosystem – the institutions, participants and the instruments.
The study of corporate bond market is essentially the study of these three pillars, their
roles, responsibilities and actions in the corporate bond market. The institutions comprise
of the securities market regulator, the banking regulator, the credit rating agencies,
clearing houses, stock exchanges and the regulations and governance norms prescribed
by these institutions. The participants comprise of the market players – investors on the
demand side and issuers on the supply side. The term ‘instruments’ is used to indicate the
form and features of securities issued in the corporate bond market.2 Further, certain
securities and derivatives, such as interest rate and currency derivatives and government

36
securities, even though, not a part of the corporate bond market, play a significant role in
ensuring its vibrancy and smooth functioning. As stated above, the study of corporate
bond market involves institutions, participants and instruments of the corporate bond
market. Hence we propose to study the history and evolution of institutions and
institutional framework to understand the issues pertaining to the macrostructure of bond
markets. Similarly, an investigation into the diversity, volumes and characteristics of
investors and issuers would help to uncover the core issues underlying the problems of
illiquidity, lack of transparency and low-level equilibrium in the corporate bond market.
A comparative study of cross-country experiences of corporate bond markets, focusing
but not limited to development of the three pillars of the bond markets, will lend depth
and perspective to our understanding of the shortcomings of the Indian market. To further
enhance our theoretical understanding, we propose to study the interplay of the three
pillars and reveal practical issues through our analysis of trends in the corporate bond
market in India. The analysis of trends will focus on a) regulatory initiatives and reforms
to develop the bond markets, b) trends in investor participation (including their market
volumes and shares and the volume of activity in primary and secondary markets) and
issuer participation (in terms of volumes, types, credit ratings, etc.), and c) types of
instruments dominating the corporate bond markets in India. Through the methodology
outlined above, we aim to arrive at comprehensive list of core issues that are restricting
the development of corporate bond market in India and propose recommendations to
address the same.

RECENT TRENDS IN CORPORATE DEBT MARKETS IN INDIA

Reserve Bank of India (2011) observes that listed corporate debt forms only 2 per cent of
GDP. This is significantly low compared to other emerging economies, such as Malaysia,
Korea and China. Further, Government of India (2009) makes an important observation;
even today most of the large issuers in the corporate debt market segment are “quasi-
government” i.e. banks, public sector oil companies or government sponsored financial
institutions. Of the rest, only a few notable names dominate the market. Therefore,

37
increasingly, there has been a lot of focus on the development of debt markets in India
and it has garnered a lot of policy and regulatory attention. As such, we see an evolving
institutional setup in the debt markets space

The Corporate debt market is primarily regulated by three institutions namely the Reserve
Bank of India, the Securities and Exchange Board of India and the IRDA. It is important
to understand the context associated with each of the regulatory institutions. The RBI is
the monetary authority in India and is therefore primarily interested in ensuring an
adequate flow of credit in the economy, maintaining foreign currency market, and
managing the twin objectives of economic development and price stability.

On the other hand the SEBI’s outlook is more narrow- promotion, development and
regulation of securities’ markets in India keeping the investors’ interests protected. The
backbone of SEBI’s action plan has been the SEBI (Issue and Listing of Debt Securities)
Regulations, 2008 in an attempt to reduce costs and improve transparency in the
corporate debt market. Since insurance companies are one of the largest components in
the demand side of the corporate debt market, it is essential to note that the governing
body, IRDA has kept pace with the supply side reforms initiated by the RBI and SEBI.
IRDA ensures the participation of insurance companies in the corporate debt setup.
Shifting our attention to the various instruments available in the economy to provide
credit to the corporates, Table 1 lays out the composition of sources of financing for
corporates in India. It is evident from the trend for last decade that share of bonds in
sources of finance for corporate has changed marginally, by 0.4 per cent, indicating
stagnation of growth in corporate bond markets. On the other hand, reliance on bank
credit, which is generally a costlier source of finance, has increased from 14.4 per cent to
17.8 per cent. Internal financing also continues to form a substantial source of funds for
corporates, indicating inability of corporates to access bond market or bank lending for
credit or unwillingness to do so.

Foreign borrowings have also shown a healthy growth, indicating preference for cheaper
foreign funds over costlier Indian debt markets. However, the recent depreciation in
rupee exchange rate against major currencies has tremendously increased the foreign
obligations of corporate and stressed corporate balance sheets. Thus, lack of vibrant

38
corporate debt market has indirectly led corporates to take on excessive foreign
borrowings, leading to severe foreign exchange losses now.

Municipal Bond Market

Another noteworthy feature of the bond markets in developed economies is the municipal
or local government bond market. The USA and Japan have the world’s largest municipal
bond markets today. Among the emerging economies, the Chinese bond market is
perhaps the largest in terms of outstanding debt. Fahim (2011) states that there were
approximately $3.7 trillion outstanding in municipal bonds in 2011 in the USA. Mainly
state and local governments raised debt for the development of America’s infrastructure.
Tracing the evolution of American local government bond markets, Fahim observes that
the major impetus for growth came from the pressing need for state and municipal
governments to increase spending in the wake of a 15 year drought in the 1960-70s.
Municipal and state government debt grew 611 per cent in a 21 year period to support
migrating populations, housing demands and infrastructure needs. Two types of bonds
are issued by most local government authorities across the world. These include the
general obligation bonds which are secured against the government’s taxing power 21
and the revenue bonds that are secured by exclusive pledge of project revenues. Hybrid
bonds combine features of both revenue and general obligation bonds.

ISSUES AND CHALLENGES IN DEVELOPMENT OF CORPORATE DEBT

MARKET IN INDIA

1. Multiple and overlapping financial supervisory bodies The Indian financial regulatory
structure is quite complex with a lot of overlapping and ambiguous regulatory
jurisdictions. With multiple agencies entrusted with the task of regulation and
supervision, the lines of jurisdiction become blurred often leading to inefficiencies in the
regulatory process. This sometimes has regulatory bodies working at cross purposes to

39
 each other often causing friction. 2. Legal impediments Several missing and inadequate
legal structures are observed in the context of corporate bond markets, the most
prominent being those relating to enforcement contracts and corporate insolvency. A
corporate bond is essentially a debt and the expeditious enforcement of debt contracts is a
natural concern for lenders. In India enforcement contract litigation is often embroiled in
delays and deficiencies of India’s overburdened legal system, not the least of which are
prohibitive costs. This lack of remedial opportunities increases the risk of corporate bond
lending.4 Similar inefficiencies have been observed in cases of corporate insolvency.
Analogous to enforcement contracts, the process of liquidation and winding up of
companies is important because it determines the distribution of assets to the lenders. In
India, the RDBF Act and the SARFAESI Act form the pillars of insolvency laws.
However, these are not sufficient since they address only debts due to banks and financial
institutions and not ordinary creditors. As far as ordinary creditors are concerned, the
only recourse available is ordinary civil court litigation.

2. Lack of a benchmark yield curve The availability of a liquid government securities

market is often observed to be a prerequisite for the development of corporate debt
markets in India. The presence of a well-defined yield curve provides a price discovery
mechanism for private institutions. The government securities market yield curve
provides a natural floor for the borrowing costs of the private sector and facilitates the
pricing of cash flows off the curve. With a dependable yield curve, the private issuer
only needs to concentrate on the credit spread for its issue. The Government’s and
investing banks’ preference for 10 year securities has resulted in a lack of a reliable
yield curve across maturities, which has in turn hampered the pricing of corporate
bonds. Indian government bonds are generally 10 year bonds with a few issues of longer
issues stretching to 25 or 30 years. The corporate bond market mirrors this behavior and
maturities typically range in the 5 to 10 year range 6 . The lack of yield curve has also
been stressed in the Financial Stability Report (RBI, 2013).

40
 INTERNATIONAL BOND MARKETS

Despite the complexity associated with the bond market, a bond is simple and it might
be consider a bit boring when compared with a stock. After all, a stock represents a

41
piece of a company's wealth. An evaluation of a stock requires an evaluation of the
entire company's worth. An ordinary bond is an agreement that merely entitles one party
to make and another to receive a series of cash flows. While differences among forms of
equity are small, there is a wide range of bonds; innovative financial engineers are
creating new fixed-income securities almost continuously.

wide variety of bond types used in international bond markets. Then, we will describe
how bond markets are organized around the world. Finally, we will show how tools and
concepts used in international bond markets.

I. Introduction to International

Bond Markets Debt certificates have been traded internationally for several
centuries. Kings and emperors borrowed heavily to finance their wars. In the
14th century, for example, Edward I financed his wars through bond issues
launched in Italy by the then big banking families. Centuries later, the great
coalition against Louis XIV led by William of Orange was financed by a group
of Dutch families operating from The Hague. Later, the Rothschilds became
famous for supporting the British war effort against Napoleon I through their
European family network.

Although debt financing has always been international in nature, there is still no
unified international bond market. The international bond market is divided into
three bond market groups:

i. Domestic bonds.

They are issued locally by a domestic borrower and are usually denominated in
the local currency.

ii. Foreign bonds.

42
 They are issued on a local market by a foreign borrower and are usually
denominated in the local currency. Foreign bond issues and trading are under the
supervision of local market authorities.

iii. Eurobonds.

They are underwritten by a multinational syndicate of banks and placed mainly

in countries other than the one in whose currency the bond is denominated.
These bonds are not traded on a specific national bond market.

Example XII.1: Distinction between bond markets.

Domestic bonds- In February 2015, Apple, the U.S. tech giant, issued bonds for
USD 6.5 billion in the U.S. for placement in the U.S. domestic market. The issue was
underwritten by a syndicate of investment banks: Bank of America Merrill Lynch,
Deutsche Bank, Goldman Sachs, and JP Morgan. The issue is denominated in the
currency of the intended investors, i.e., USD.

Foreign bonds- In August 2015, Apple issued bonds for AUD 2.25 billion for
placement in the Aussie market alone. The issue was underwritten by a syndicate of
securities houses, with Goldman Sachs, Commonwealth Bank and Deutsche Bank as the
lead managers.

Eurobonds- In September 2015, Apple issued bonds for EUR 2.8 billion, in
London. The issue was underwritten by an international syndicate of securities houses,
led by Goldman Sachs and Deutsche Bank. The issue is denominated in EUR to be traded
mainly in London, but also in other markets.

Foreign bonds issued on national markets have a long history. They often have colorful
names: Yankee Bonds (in the U.S.), samurai bonds (in Japan), Rembrandt bonds (in the
Netherlands) and bulldog bonds (U.K.). Government regulations have forced many

43
international borrowers to leave foreign bond markets and borrow instead in the
Eurobond market.

The Eurobond market has had a fantastic growth during the past 30 years. At its
inception, in the early 1960s, the Eurobond market was mainly a Eurodollar bond market,
that is, a market for USD bonds issued outside the U.S. Today, the Eurobond market
comprises bonds denominated in all the major currencies and several minor currencies.

Euromarkets

44
The Eurobond market is an offshore market where borrowers and lenders meet because
of its lower costs and lack of regulation. The Eurobond market is just one segment of the
so-called Euromarket, which also includes Eurocurrency, Euronotes, Eurocommercial
paper, and Euroequity markets. Euromarkets are offshore capital markets, in the sense
that the currency of denomination is not the official currency of the country where the
transaction takes place. For example, a Malayan firm deposits USD not in the U.S. but
with a bank outside the U.S., for example in Singapore or in Switzerland. This USD
deposit outside the U.S. is called an Eurodeposit. Today, Euromarkets are well-
developed, sophisticated markets where the traded instruments are denominated in many
currencies, not just in the major currencies. For example, in 1996, the Eurobond market
included issues denominated in the Egyptian pound, Polish zloty and Croatian kuna. At
its inception, however, Euromarkets were just Eurodollar markets. For example, the first
Euromarket was the market for short-term USD deposits and USD loans, where European
banks acted as intermediaries between investors and borrowers.

Origins of Euromarkets

Long before World War II it was not rare for banks outside the U.S. to accept deposits
denominated in U.S. dollars. The volume of such deposits, however, was small and the
market for them had little economic significance. During the 1950s things began to
change. Since Russia and other communist countries had to deal in hard currency for
their international trade transactions, the central banks of these countries ended up
holding USD balances. Initially these balances were held in New York. But as the cold
war tensions increased, the communist government transferred these balances to banks in
London and other European centers.

While the cold war may have initiated the Eurocurrency market, there were other factors
that stimulated its development. Historically, the pound sterling played a key role in
world trade. A great deal of trade was denominated in GBP. Two events helped to boost
the USD as the currency for international trade:

45
The sterling crisis in the U.K. in the mid-1950s. In 1957, the U.K. imposed controls on
nonresident GBP borrowing and lending by U.K. banks. These institutions then turned to
the USD to finance their international trade.

In 1958, West European countries in preparation for the creation of the EEC (now, EU)
allowed banks to trade freely in USD to finance trade.

On the hand, the U.S. government, unknowingly, gave a very important stimulus to the
growth of the Euromarket with several regulations. During the 1960s the U.S.
government imposed several measures to control international capital flows. These
measures were aimed to improve the U.S. balance of payments, which was in a big
deficit:

In 1963, the U.S. government imposed an Interest Equalization Tax (IET) on foreign
securities held by U.S. investor. The government's idea was to equalize the after-tax
interest rate paid by U.S. and foreign borrowers, and, thus, discourage U.S. residents to
buy foreign securities (reducing capital outflows). The IET forced non-U.S. corporations
to pay a higher interest rate in order to attract U.S. investors. Therefore, non-U.S.
corporati XII.4 Regulation Q. Regulation Q, widened the interest differential between a
USD deposit in the U.S. and a USD deposit abroad. All these restrictions brought the
major financial institutions to European money centers like London, Zurich, and
Luxembourg. This development had some spillover effects on financial centers in other
parts of the world such as Tokyo, Hong Kong, Singapore, Beirut, Bahamas, and Bahrain.
Several European governments also imposed capital controls during this period, which
triggered the creation of the non-USD segments of the Eurocurrency market. For
example, during the 1970s, the Bundesbank required foreigners with DEM accounts to
place a fraction of their funds in noninterestbearing accounts. This regulation gave an
incentive to foreigners to make DEM deposits outside Germany, and, then, the Euro-
DEM was born. The regulations and restrictions that gave birth to Euromarkets have all
disappeared. Euromarkets, however, have continued to grow. Today, Euromarkets are
free from regulations, exempt from national taxes and reserve requirements. These
conditions allow international banks to take advantage of the lower cost of funds. Then,

46
they can lend the funds to international borrowers at lower rates than those that can be
obtained in domestic markets.

Eurocurrency Markets

The first Euromarket to emerge was the market for short-term deposits and loans, where
banks acted as intermediaries between investors and borrowers. The Eurocurrency market
for short-term deposits -Eurodeposits- rapidly became a reference market for domestic
market-makers. For example, several domestic instruments started to be priced taking the
interest rate on Eurodeposits as the relevant discount rate.

When Eurocurrency markets started to emerge, a typical Eurodeposit involved a time

deposit, that is, a non-negotiable, registered instrument with a fixed maturity. When
investing in a Eurocurrency time deposit, the investor commits funds for a certain period
of time, at a specified rate. At maturity the investor receives the principal plus the
interest. Later, Eurodeposits included more flexible instruments. The most popular
instrument is the certificate of deposit (CD), which is negotiable -can be sold to another
investor at any time- and is often a bearer instrument. There are several kinds of CDs: tap
CDs, tranche CDs, and rollover CDs. The tap CD is a standard fixed-time deposit, which
is denominated in amounts of USD 1 million or more. The trance CD is a tap CD that has
been divided into several portions to make it attractive to small investors. The rollover
CD is an instrument by which an investor buys a CD on a continuous basis with floating
interest rates adjusted by market conditions when the CD matures and rollovers occur.
According to the Bank of England more than 90 percent of the Eurodeposits are time
deposits.

The majority of the Eurodeposits have a very short-term duration, for example, one or
seven days, or one, three, or six months. For long-term CDs (up to ten years), there is a
fixed coupon or floatingrate coupon. For CDs with floating-rate coupons, like rollovers,
the life of the CD is divided into subperiods of usually six months. The interest earned
over such period is fixed at the beginning of the period, the reset date. This interest rate is
based on the prevailing market interest rate at the time. This market rate is usually the

47
LIBOR, the London Interbank Offer Rate or the Interbank Offer Rate in the currency's
domestic financial center.

Although the majority of Eurodeposits are in the form of time deposits, CDs play a
significant role in the Eurocurrency market because of a liquid secondary market. Banks,
regularly, buy and sell their own CDs in the secondary market to insure investor of the
liquidity of the secondary market, and therefore, making the CDs more attractive. The
CD rates shown in newspapers are usually the secondary market rates. Most CDs issued
in London are denominated in USD.

In general, the deposits will be effective two business days after the contract is in effect,
and mature, for example, 30 days later. On maturity, payment is usually made by a
transfer in the currency's home country (i.e., Japan for Euroyen). The minimum period
for delivery of funds is usually two working days, which is the usual settlement period in
the wholesale foreign exchange market.

A Eurodollar Transaction Suppose IBM has USD 1 million in excess cash available for a
week. IBM decides to invest this USD 1 million in a 7-day deposit. Bank of New York
pays 5.25% for a 7-day domestic deposit. Banco Santander Central Hispano (BSCH) has
a bid rate of 5.50% for a 7-day Eurodollar time deposit. IBM deposits the USD 1 million
with Banco de Santander for 7 days. The transaction involves the following steps:

i. BSCH must have a USD bank account with a U.S. bank, say, with Citibank.
ii. IBM deposits USD 1 million with Citibank for credit to the account of BSCH.
iii. BSCH withdraws the funds from its account at Citibank.
iv. In 7 days, BSCH transfers USD 1 million plus accrued interest through its
account
at Citibank to the account designated by IBM. Note that if Bank of New York had
received the deposit, they should have set aside a part of the deposit as reserve, as
specified by the U.S. Federal Reserve. BSCH is free to loan the Eurodeposit to
anyone, without any reserve requirement. The absence of reserve requirements lowers
BSCH costs.

48
 Eurobanks: More competitive rates As we mentioned above, the unregulated
framework allows Eurobanks to be more competitive than domestic regulated banks. In
general, due to competition and the unregulated nature of Eurobanking, we observed that
the domestic deposit rate is lower than the London Interbank Bid Rate (LIBID) and the
domestic lending rate is higher than the LIBOR.

 1.B Eurobonds: Some Descriptive Statistics

1.B.1 Borrowers According to the BIS, in 1999, the total amount borrowed in the
international bond market was USD 1,152.7 billion. The major borrowers on the
international bond markets were industrial countries XII.6 (93% of total amount
borrowed in 1999). The U.S. (39%), and the Euro area (40%) were by far the heaviest
borrowers. The heaviest largest borrowers were financial institutions, with a 51% share.
The corporate sector issues and the public sector –governments and state agencies—
issued 30% and 17% of the international bond debt, respectively. Supranational
corporations –the World Bank, European Investment Bank, Asian and African
Development Banks,

the European Community-- had seen their participation substantially decreased in the last
5 years: from 4.22% in 1995 to 2% in 1999.

SIZE AND INSTRUMENTS

Few investors would consider an investment strategy that systematically excludes the
fixed-income market from his or her portfolio. Yet, U.S. investors routinely ignore non-
USD bonds, which account for almost 55 % of the world bond market. Table XII.A
presents the major bond issues, by currency of denomination and sector.

1.C Type of Bond Instruments

The variety of bonds offered to the international or even domestic investor is amazing
due to the recent development of bonds with variable interest rates and complex optional
clauses. (For a review of the basic concepts and techniques behind bonds, Most issues on

49
the international bond market, however, are fixed interest bonds. The most popular
instruments in international bond markets are:

 Straight or fixed income bonds: a fixed income bond is a financial instrument with
specific interest payments on specified dates over a period of years. On the last specified
date, or maturity, the payment includes a repayment of principal. The interest rate or
coupon is expressed as a percentage of the issue amount and is fixed at launch. For the
issuer, the attraction of these bonds is the knowledge of level payments on interest and a
set repayment schedule. For investors, the attraction of straight bonds lies in a known
income.

 Partly-paid bonds: these are standard straight bonds in all respects but for the payment
of principal by investors on the closing date of the issue -which is limited to 0-33 percent
of the principal amount, with the balance falling due up to six months later. These bonds
are popular with issuers who can tailor the second payment to their cash flow
requirements.

 Zero-coupon bonds: a zero-coupon bond is a straight bond with no schedule of

periodic interest payments. The cash flow consists of two payments, the receipt of the
proceeds on issue date and the repayment of principal on maturity. For the issuer, zero
coupon bonds are an ideal financing instrument for a project, which generates no income
for some years. On the other hand, the loading of the debt service of the bond into a
single payment some years later creates a higher credit risk. For this reason the market is
confined to highly rated borrowers. Investors are attracted to zero-coupon bonds to meet
future liabilities.

 Floating rate notes (FRNs): FRNs are a medium-term instrument similar in structure
to straight bonds but for the interest base and interest rate calculations. The coupon rate is
reset at specified regular intervals, normally 3 months, 6 months, or one year. The coupon
comprises a money market rate (e.g., the London Interbank Offered Rate for 6-month
deposits, or LIBOR) plus a margin, which reflects the creditworthiness of the issuer.
FRNs usually carry a prepayment option for the issuer. Issuers like FRNs because they
combine the lower pricing of a bank loan and larger maturities than the straight bond

50
market. Investors are attracted to FRNs because the periodic resetting of the coupon
offers the strongest protection of capital.

 Perpetual FRNs: They are FRNs but have no maturity date. Issuers have a call option
to prepay investors. Perpetual FRNs usually have investors put options or options to
exchange the undated bonds for bonds with finite maturity. Perpetual FRNs have
subordinated status and in some cases junior subordinated status, so they can rank close
to equity. As a quasi-equity instrument, they qualify as capital, and for the purposes of
capital adequacy, are treated as equity.

 Convertible bonds: A convertible bond is a bond that can usually be exchanged or

converted at the option of the holder into other assets at a fixed conversion rate set at time
of launch. Convertible bonds are usually launched in conditions of poor fixed-rate bond
markets, high interest rates and an expectation of falling rates. Issuers benefit from (1) the
lower funding costs relative to short-term money markets and (2) the possibility of no
repaying the principal if the conversion right is exercised. Investors benefit because they
receive the benefit of regular coupon payments plus the option of locking in to a better
yield later.

 Bonds with warrants: Bonds with warrants resemble convertibles except that the
warrant can be traded separately. The proceeds from the warrants are applied to the
reduction of the cost of the host bond. Bonds can have equity warrants, bond warrants, or
commodity warrants attached. Bonds with equity warrants differ from convertible bonds
in one other aspect: when the warrants are exercised new money is normally used to
subscribe for the shares, and the total capitalization of the borrower increases. This is
unlike the conversion of a convertible bond, which merely shifts debt capital into equity
capital. The equity warrant is effectively a call option on the underlying stock. Therefore,
pricing a warrant relies on (1) variations of the Black-Scholes formula, and (2) a market
view based on supply and demand.

 Dual-currency bonds: Dual-currency bonds are bonds that are purchased in terms of
one currency but pay coupons or repay principal at maturity in terms of a second
currency. Japanese firms have frequently issued CHF-denominated bonds convertible

51
into common shares of a Japanese company. A foreign investor can benefit from
purchasing this bond in any one of three situations:

(1) A drop in the market interest rate on CHF bonds (as on any straight CHF bond).

(2) A rise in the price of the company's stock (because the bonds are convertible into
stocks).

(3) A rise in the JPY relative to the CHF (because the bond is convertible into a JPY
asset). Dual currency bonds represent a combination of an ordinary bond combined with
one or more forward contracts.

Valuing a bond with coupons

The theoretical value of a bond with coupons may be considered the present value of a
stream of cash flows (coupons and principal payments). The cash flows occur at different
times and they should be discounted at the interest rate corresponding to their date of
disbursement. In essence, a coupon-paying bond is a combination of bonds with different
maturities.

Sinking Fund

The most common bond is the bullet bond. That is, a bond in which all of the principal is
repaid in a single installment at maturity. For some bonds, however, the principal is
repaid in installments according to a predetermined repayment schedule. Three methods
are used by issuers for early bond redemption:

Lot drawing at par.

After a grace period, the bond issue is repaid according to a fixed schedule. The bonds to
be repaid are drawn at random and reimbursed at par value. ii. Market repurchase. Part of

52
the bond issue is repaid according to a fixed schedule by which it is purchased in the
market at market prices. iii. Issuing of serial bonds. Serial bonds each have a serial
number, and each series has a different maturity and yield. Investors know at issue which
bond will be reimbursed and when. This method is seldom used because each series
represents a different bond, which reduces the liquidity of the issue. Sometimes a
combination of methods is used.

Accrued Interest

Bonds pay interest on coupon payment dates. When an investor sells a security, the buyer
compensates for the interest foregone by including an amount of accrued interest in the
settlement in the settlement price. This amount of accrued interest is calculated as the
fraction of the interest period elapsed multiplied by the interest payment date. Different
markets have different methods to calculate the fraction of the interest period using
different day-count bases. Even different instruments in the same market have different
methods.

Convertible Bonds and the Global Premium

Convertibles are usually issued at par, or 100%, of the nominal value of the bond. This
price includes the value of the investor's option to convert (or the conversion right), as
well as the value of the bond as a straight debt instrument (which must therefore be less
than par). It follows that to produce a YTM in line with current yields, the coupon level
of the issue will be below-market. In practice, the coupon is set above the yield of the
stock to encourage the investor to buy a convertible bond rather than the stock itself. The
rule of thumb is to set the coupon at a level halfway between the yield of the stock and
the coupon on a conventional straight bond.

Call Options

Bonds are sometimes issued with a call or other options. This is very common in the
Eurobond markets, but less so in certain domestic markets, such as the British gilt
market. The most common call option is the right given to the issuer to call back the bond
at a given date at a price set in the bond contract. This is profitable to the issuer if the

53
market interest rate falls because he or she can redeem high-coupon bonds and issue new
bonds with a lower coupon.

Quality Spreads

The interest rate required by a bondholder is a function of the default risk assumed: the
greater the risk, the higher the yield that the borrower must pay. In established markets,
agencies (for example, in the U.S., Standard and Poor's, Moody's) assess the
creditworthiness of borrowers with respect to specific obligations. The rating is based on
both the likelihood of default and the nature and protection afforded by specific
obligations. Moody's and Standard and Poor's provide credit ratings on most international
bonds (foreign and Eurobonds).

Specific International Techniques

The multi-currency dimension is the major complication of international bond

investment. A strategic approach implies decisions about currencies and maturities and
requires the use of analytical tools to merge interest and exchange rate analysis.

International yield comparisons

A term structure of interest rates exists for each currency. Investors focus on the yield
curve for government bonds ("default-free term structure"). Yields generally differ across
currencies. International interest rate differences are caused by a variety.

54
 India’s Bond Market— Developments and Challenges Ahead

The Indian financial system is changing fast, marked by strong economic growth, more
robust markets, and considerably greater efficiency. But to add to its world-class equity
markets, and growing banking sector, the country needs to improve its bond markets.
While the government and corporate bond markets have grown in size, they remain
illiquid. The corporate market, in addition, restricts participants and is largely arbitrage-
driven.

To meet the needs of its firms and investors, the bond market must therefore evolve. This
will mean creating new market sectors such as exchange traded interest rate and foreign
exchange derivatives contracts. It will need a relaxation of exchange restrictions and an
easing of investment mandates on contractual savings institutions to attract a greater
variety of investors (including foreign) and to boost liquidity. Tax reforms, particularly
stamp duties, and a revamping of disclosure requirements for corporate public offers,
could help develop the corporate bond market. And streamlining the regulatory and
supervisory structure of the local currency bond market could substantially increase
efficiency, spurring innovation, economies of scale, liquidity and competition. Such
reforms will help level the playing field for investors.

In deciding the course for reform, however, the innovations and experiences of markets
in the region are also important. Developing markets often mimic more advanced
European and North American markets. But complex structures designed for diverse
developed markets are sometimes ill-suited to less-developed economies. Instead,
looking to neighboring, emerging markets at similar stages of development can be more
useful. For example, India’s unique collateralized borrowing and lending obligations
(CBLO) system and its successful electronic trading platform could usefully be studied
by its neighbors, many of which suffer from limited repo markets or which have (like
India) tried unsuccessfully to move bonds on to electronic platforms. India could benefit,
by contrast, from the lessons of its neighbors in developing its corporate bond market.

55
This paper reviews these issues and discusses policies that can help further develop
India’s debt market. Section II highlights and compares market development and outlook
to emerging East Asian economies. Sections III and IV summarize salient characteristics,
reforms and obstacles. Section V discusses the development and prospects for India’s
securitization market. Section VI looks at the main market participants and the depth of
the pool of available investors, arguably the most significant factor in market
development. Section VII tackles policy issues. And Section VIII concludes with a look
at the importance of the lessons and innovations of other countries.

India’s economy has expanded an average of about 8.5% annually for the past 4 years,
driven by rising productivity and investment. After rising sharply in early 2007, inflation
has ebbed, and the current account deficit has moderated. India’s bright prospects have
attracted record capital inflows, even amid heightened global uncertainty and slowing
growth in the United States (US).

The Indian financial system is now in a process of rapid transformation marked by strong
economic growth, increased market robustness, and a considerable increase in
efficiency.
ADB has disbursed loans and technical assistance to develop India’s capital market in
areas that include regulation and supervision of derivative instruments, development of
secondary debt market, and development and reform of mutual fund industry, among
others.

Bank and financial intermediation, however, remain undeveloped with respect to lending
and deposits, and most banks remain largely controlled by public sector institutions,
limiting the development of a true credit culture, the skills to assess credit risks, and a
willingness to accommodate any but the lowest risk borrowers.

Overseas investors bought a net USD19.5 billion of stocks and bonds during 2007,
compared with the previous record of USD8.9 billion in 2006. The current year has seen
net outflows in the first 9 months totaling USD6.9 billion. The bank rate is currently 6%
(July 2008) and longer-term deposit rates have risen around 50 basis points (bp) to 9.55%
56
in recent months. Real estate markets have been buoyant, although they have cooled
recently, and the banking system remains sound and well capitalized. In March 2008, the
capital adequacy ratio stood at 13.1%, well above the 8% minimum prescribed under the
Basel I accord. Amid strong credit growth, the ratio of scheduled commercial banks’
gross nonperforming loans (NPLs) to advances has fallen to 2.4% in March 2008 from
10.4% in March 2002.2

India has developed a world-class equities market from relatively unpromising

beginnings. Since 1996, the ratio of equity market capitalization to gross domestic
product (GDP) has more than trebled to 108% (down from 130% in September 2007),
from 32.1% in 1996 (Figure 1). During the same period the banking sector expanded to
74% of GDP from 46.5%. In contrast, the development of government and corporate
bond markets has not been so fast: the bond market grew to a more modest 40.0% of
GDP, from 21.3%. In March 2008, the government bond market represented 36.1% of
GDP, compared with the corporate bond market, which amounted to just 3.9% of GDP.

India and EEA Bond Markets (% of GDP), March 2008

Government Corporate Total

China, People’s Rep. of 46.1 4.7 50.8

Hong Kong, China 8.7 35.3 44.0
Indonesia 17.1 2.0 19.1
Korea, Rep. of 48.8 61.8 110.6
Malaysia 48.1 37.5 85.6
Philippines 33.3 3.5 36.8
Singapore 41.2 30.7 72.0
Thailand 40.7 15.9 56.6
Viet Nam 14.6 2.1 16.7

India 36.1 3.9 40.0

Sources: AsianBondsOnline, Bank for International Settlements, and Reserve Bank of
India.

57
Trading in derivatives started in 2000 and the Indian market is now the tenth largest in
the world for futures contracts on single stocks and indexes and the largest for futures on
single stocks. Commodity markets have also developed. Three new markets were created
in 2000, based on National Stock Exchange (NSE) architecture. However, of the 94
commodities traded, gold and silver account for half of turnover: by 2006 India had
become home to the world’s third largest derivative market for gold.

With the strong growth in equity markets, at a time when India’s GDP has itself been
increasing more rapidly, it is similar in terms of % of GDP to Korea and relatively larger
than other emerging East Asia equity markets, with the exception of Hong Kong, China;
Singapore; and Malaysia. Equity trading languished in the early 2000s, when world
equity markets were falling and Indian government debt was rising strongly, but has risen
since.

As is common in the region, India is a bank-dominated market, and the relative

importance of bank assets as a percentage of GDP has continued to grow—partly as
banking penetration has deepened with financial liberalization, and partly as a result of
the ongoing need for deficit financing. However, the ratio of bank assets to GDP is still
low by comparison with other emerging East Asian economies, indicating that India still
has some way to go before its banking sector is fully developed. The same pattern is also
seen in the People’s Republic of China (PRC), which like India has a largely state-
owned/controlled financial sector. Other emerging East Asia markets have seen a decline
in banking assets as a percentage of GDP since 1996, reflecting greater diversification
into other forms of finance, especially for corporate borrowers.

58
 CONCLUSION

Government must relax restrictive investment mandates that tend to limit participation of
financial institutions in primary and secondary debt markets.Further such norms may
result in long term holding of government debt in skewed proportions, illiquidity as well
as lack of pricing information. When financial institutions donot have a large pool of
qualifying assets to choose from, it may result in excess demand for government debt, in
turn resulting in mispriced government debt market. Relevance of such investment may
need to be addressed from time to time. High fiscal deficit, high interest rates may keep
corporate borrowers away from debt market,there should be effective & efficient
management of public debt and monetary operations. The government securities act of
2006 serves as the essential framework for the management of public debt and cash
management. It provides RBI the power to issue and manage the government debt
securities. 6. Reforming Government Securities

BIBLIOGRAPHY

 Acharya, A. (2011). Corporate Bond Market in India : Issues and Challenges. Reserve
Bank of India Occasional Papers, 32(3), 68–106.

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 Bali, G., & Skinner, F. S. (2006). The Original Maturity of Corporate Bonds: The
Influence of Credit Rating, Asset Maturity, Security, and Macroeconomic Conditions.
Financial Review, 41(2), 187–203.

 Bali, G., & Skinner, F. S. (2006). The Original Maturity of Corporate Bonds: The
Influence of Credit Rating, Asset Maturity, Security, and Macroeconomic Conditions.
Financial Review, 41(2), 187–203.

 Bandyopadhyay, A. (2006). Predicting probability of default of Indian corporate bonds:

logistic and Z-score model approaches. The Journal of Risk Finance, 7(3), 255–272.

India’s Bond Market— Developments and Challenges Ahead

The Indian financial system is changing fast, marked by strong economic growth, more
robust markets, and considerably greater efficiency. But to add to its world-class equity
markets, and growing banking sector, the country needs to improve its bond markets.

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While the government and corporate bond markets have grown in size, they remain
illiquid. The corporate market, in addition, restricts participants and is largely arbitrage-
driven.

To meet the needs of its firms and investors, the bond market must therefore evolve. This
will mean creating new market sectors such as exchange traded interest rate and foreign
exchange derivatives contracts. It will need a relaxation of exchange restrictions and an
easing of investment mandates on contractual savings institutions to attract a greater
variety of investors (including foreign) and to boost liquidity. Tax reforms, particularly
stamp duties, and a revamping of disclosure requirements for corporate public offers,
could help develop the corporate bond market. And streamlining the regulatory and
supervisory structure of the local currency bond market could substantially increase
efficiency, spurring innovation, economies of scale, liquidity and competition. Such
reforms will help level the playing field for investors.

In deciding the course for reform, however, the innovations and experiences of markets
in the region are also important. Developing markets often mimic more advanced
European and North American markets. But complex structures designed for diverse
developed markets are sometimes ill-suited to less-developed economies. Instead,
looking to neighboring, emerging markets at similar stages of development can be more
useful. For example, India’s unique collateralized borrowing and lending obligations
(CBLO) system and its successful electronic trading platform could usefully be studied
by its neighbors, many of which suffer from limited repo markets or which have (like
India) tried unsuccessfully to move bonds on to electronic platforms. India could benefit,
by contrast, from the lessons of its neighbors in developing its corporate bond market.

This paper reviews these issues and discusses policies that can help further develop
India’s debt market. Section II highlights and compares market development and outlook
to emerging East Asian economies. Sections III and IV summarize salient characteristics,
reforms and obstacles. Section V discusses the development and prospects for India’s
securitization market. Section VI looks at the main market participants and the depth of

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the pool of available investors, arguably the most significant factor in market
development. Section VII tackles policy issues. And Section VIII concludes with a look
at the importance of the lessons and innovations of other countries.

India’s economy has expanded an average of about 8.5% annually for the past 4 years,
driven by rising productivity and investment. After rising sharply in early 2007, inflation
has ebbed, and the current account deficit has moderated. India’s bright prospects have
attracted record capital inflows, even amid heightened global uncertainty and slowing
growth in the United States (US).

The Indian financial system is now in a process of rapid transformation marked by strong
economic growth, increased market robustness, and a considerable increase in
efficiency.
ADB has disbursed loans and technical assistance to develop India’s capital market in
areas that include regulation and supervision of derivative instruments, development of
secondary debt market, and development and reform of mutual fund industry, among
others.

Bank and financial intermediation, however, remain undeveloped with respect to lending
and deposits, and most banks remain largely controlled by public sector institutions,
limiting the development of a true credit culture, the skills to assess credit risks, and a
willingness to accommodate any but the lowest risk borrowers.

Overseas investors bought a net USD19.5 billion of stocks and bonds during 2007,
compared with the previous record of USD8.9 billion in 2006. The current year has seen
net outflows in the first 9 months totaling USD6.9 billion. The bank rate is currently 6%
(July 2008) and longer-term deposit rates have risen around 50 basis points (bp) to 9.55%
in recent months. Real estate markets have been buoyant, although they have cooled
recently, and the banking system remains sound and well capitalized. In March 2008, the
capital adequacy ratio stood at 13.1%, well above the 8% minimum prescribed under the
Basel I accord. Amid strong credit growth, the ratio of scheduled commercial banks’
gross nonperforming loans (NPLs) to advances has fallen to 2.4% in March 2008 from
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10.4% in March 2002.2

India has developed a world-class equities market from relatively unpromising

beginnings. Since 1996, the ratio of equity market capitalization to gross domestic
product (GDP) has more than trebled to 108% (down from 130% in September 2007),
from 32.1% in 1996 (Figure 1). During the same period the banking sector expanded to
74% of GDP from 46.5%. In contrast, the development of government and corporate
bond markets has not been so fast: the bond market grew to a more modest 40.0% of
GDP, from 21.3%. In March 2008, the government bond market represented 36.1% of
GDP, compared with the corporate bond market, which amounted to just 3.9% of GDP.

India and EEA Bond Markets (% of GDP), March 2008

Government Corporate Total

China, People’s Rep. of 46.1 4.7 50.8

Hong Kong, China 8.7 35.3 44.0
Indonesia 17.1 2.0 19.1
Korea, Rep. of 48.8 61.8 110.6
Malaysia 48.1 37.5 85.6
Philippines 33.3 3.5 36.8
Singapore 41.2 30.7 72.0
Thailand 40.7 15.9 56.6
Viet Nam 14.6 2.1 16.7

India 36.1 3.9 40.0

Sources: AsianBondsOnline, Bank for International Settlements, and Reserve Bank of
India.

Trading in derivatives started in 2000 and the Indian market is now the tenth largest in
the world for futures contracts on single stocks and indexes and the largest for futures on
single stocks. Commodity markets have also developed. Three new markets were created

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in 2000, based on National Stock Exchange (NSE) architecture. However, of the 94
commodities traded, gold and silver account for half of turnover: by 2006 India had
become home to the world’s third largest derivative market for gold.

With the strong growth in equity markets, at a time when India’s GDP has itself been
increasing more rapidly, it is similar in terms of % of GDP to Korea and relatively larger
than other emerging East Asia equity markets, with the exception of Hong Kong, China;
Singapore; and Malaysia. Equity trading languished in the early 2000s, when world
equity markets were falling and Indian government debt was rising strongly, but has risen
since.

As is common in the region, India is a bank-dominated market, and the relative

importance of bank assets as a percentage of GDP has continued to grow—partly as
banking penetration has deepened with financial liberalization, and partly as a result of
the ongoing need for deficit financing. However, the ratio of bank assets to GDP is still
low by comparison with other emerging East Asian economies, indicating that India still
has some way to go before its banking sector is fully developed. The same pattern is also
seen in the People’s Republic of China (PRC), which like India has a largely state-
owned/controlled financial sector. Other emerging East Asia markets have seen a decline
in banking assets as a percentage of GDP since 1996, reflecting greater diversification
into other forms of finance, especially for corporate borrowers.

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