Debt Markets

Shagun Thukral, CFA

Debt Markets
Market where fixed income securities of

various types and features are issued and

traded
Critical component of the financial system
OTC market
US Bond Market is more than $35 trillion in
size with daily turnover exceeding $800 Billion
Total world bond market in excess of $80
trillion
Indian debt market is approx $200 Bn

Types of Instruments
Central Government
Zero Coupon Bonds
Coupon Bearing bonds/Dated securities
Treasury Bills
FRBs
STRIPS
State Government
Coupon Bearing Bonds
FRBs

Public Sector
Debentures Fixed and Floating
Taxable/Tax-free bonds and debentures
CPs
ZCBs/DDBs
Guaranteed Bonds Central or State Government Guaranteed
Private Sector Corporate, Banks. FIs

Regulators
Government Securities and Money Markets

Reserve Bank of India

Corporate Debt - SEBI

Government Securities
Market
Important source of borrowing for the government
Benchmark for pricing corporate papers of

varying maturities
Pre-requisite for development of corporate bond
market
Used as a tool for managing fiscal and monetary
policies
OMOs
SLR
Fiscal Deficit

Participants in Govt Sec

Market
Governments As issuers (suppliers)
Primary Dealer Market

makers/intermediaries
Banks captive investors through SLRs
Mutual Funds launched gilt funds
Insurance Cos Regulatory requirement to
invest in Gsec
PFs and Pension Funds
FIIs within permissible limits
Brokers

Primary Market
Annual borrowing amount announced in the budget
Borrowing calendar released semi-annually
Underwriting PDs /Underwriting commission
Auction Process on Fridays
Multiple Price Method
Uniform Price Method

Yield based auction for new securities

Competitive and Non-competitive bids
Devolvement -PDs
When-Issued Market
Sale Route at predetermined rates (discontinued)
Private Placement -

Govt Borrowing Plan

Annual Borrowing for 2012-13 as announced

in the Union Budget INR 5.69 lakh crores

Gross and Net INR 4.7 lakh crores
First Half borrowing to be INR 3.7 lakh crores
(gross) and INR 2.85 lakh crores net
Actual borrowing v/s budgeted borrowing

Secondary Market
Wholesale segment
Active market through SGL or CSGL with PDO-RBI
Lot size of 5 Crs
NDS-OM
Broker/PD
Settlement on NDS by RBI/CCIL
T+1
DVP III
Reporting on NSE/CCIL
Retail segment
SGL/physical form/demat
Less than 1 Cr
Settled directly
Broker market
No reporting

State Government Bonds

Also known as State Development Loans

(SDLs)
Issued through Auction process
Only 10 yr issuances in primary market
Qualify for SLR but not for repo
Trade at slightly higher levels than central
government bonds but lower than corporate
bonds
Similar Secondary Market operations

Corporate Debt Market

Dominated by the PSU bonds segment
PFC
REC
PGC
IRFC
Primary Market issuances through public issue or private placement
Mainly comprises of bonds and debentures
Mutual funds, Insurance companies, Banks
Mostly issuances are up to 10 year maturity- max 15 years
Most securities held in demat form
Secondary Market Securities traded on the WDM segment of NSE/BSE or OTC
Settlement through custodians on T+0 or T+1 or T+2 basis through DVP I
Reporting of Trades on FIMMDA F-Trac
Settlement on NSE/BSE platforms NSCCL not guaranteed
Letter of Allotment (LoA) issued initially and then securities recd

Factors inhibiting the growth of

Private Corporate Debt Market
Narrow issuer and investor base
Primary issuance through private placement
Lack of transparency
Absence of a benchmark rate
Absence of Market Making
Dull secondary market
Accessible only to high rated borrowers
FII investment is limited
Differential stamp duties levied by different

states inhibiting the growth of primary market

Innovative Debt
Instruments
Floating rate bonds
Zero coupon bonds
Deep discount bonds
Fully Convertible Debentures with Interest (optional)
Perpetual Bonds
Securitised paper
ABS
MBS
PTC
CDO
SRs issued by Asset Reconstruction companies

Inverse Float Bonds

Structured Securities
Securities backed by a pool of loans or receivables
Asset Backed Security (ABS) is a security created from a

portfolio of other underlying assets like:

Loans
Bonds
Credit card receivables
Mortgages
Auto Loans

Assets are classified and clubbed according to the credit

quality of a borrower and sold to investors

Done through creation of a SPV or trust
Bank receives a servicing/origination fee
Credit risk passed on to the investor

Structure of ABS/MBS
Cash flows of similar assets are pooled together
Allocated into tranches based on credit risk
Tranches receive returns in order of their seniority

and payment waterfall

Senior most tranches would have the lowest returns
and bear the lowest losses. Normally rated AAA
Mezzanine tranches rank lower than senior tranches
with the equity tranche ranked lowest and receiving
the highest returns
In case of defaults, equity tranche is affected first
and if defaults are high,

Structure of ABS
Senior Tranche
Principal-75%
Return 6%

Asset 1
Asset 2
Asset 3
Asset N
Total = $
100 Mn

SP
V

Mezzanine Tranche
Principal -20%
Return 10%

Equity Tranche
Principal - 5%
Return 30%

Waterfall Mechanism
Asset
Cash
Flows

Senior
Tranche
Mezzanine Tranche
Equity Tranche

Options, Futures, and Other Derivatives 8th Edition, Copyright

John C. Hull 2012

21

Collateralized Debt Obligation

(CDO)
A kind of ABS in which the underlying are

bonds with a larger number of tranches

Similar to ABS in terms of risk-return and
rating of tranches
The originator acquires a portfolio of bonds
and splits into tranches passes it on to a SPV
for a profit
ABS CDOs are created by clubbing tranches of
existing ABS

ABS- CDOs
Assets

The mezzanine tranche is

repackaged with other
mezzanine tranches

Senior Tranche (80%)

AAA

Mezzanine Tranche (15%)

BBB

Senior Tranche (65%)

AAA

Mezzanine Tranche
(25%) BBB
Equity Tranche (5%)
Not Rated
Equity Tranche (10%)

Losses to AAA rated ABS

CDOs
Losses on
Subprime
portfolios

Losses on
Mezzanine
Tranche of
ABS

Losses on
Equity
Tranche of
ABS CDO

Losses on
Mezzanine
Tranche of
ABS CDO

Losses on
Senior
Tranche of
ABS CDO

10%

33.3%

100%

93.3%

0%

13%

53.3%

100%

100%

28.2%

17%

80.0%

100%

100%

69.2%

20%

100%

100%

100%

100%