Types of bond markets
Different types of bond market
Major reforms in bond market
What Are Bonds?
A bond is a debt security, similar to an I.O.U. When you purchase a bond, you are lending money to a government, municipality, corporation, federal agency or other entity known asan issuer.* In return for that money, the issuer provides you with a bond in which it promises to pay a specified rate of interest during the life of the bond and to repay the face value of the bond (the principal) when it matures, or comes due.
Bonds can be also called bills, notes, debt securities, or debt obligations. To simplify matters, we will refer to all of these as "bonds."
The Bond Market in India with the liberalization has been transformed completely. The opening up of the financial market at present has influenced several foreign investors holding upto 30% of the financial in form of fixed income to invest in the bond market in India. The bond market in India has diversified to a large extent and that is a huge contributor to the stable growth of the economy. The bond market has immense potential in raising funds to support the infrastructural development undertaken by the government and expansion plans of the companies.
Sometimes the unavailability of funds become one of the major problems for the large organization. The bond market in India plays an important role in fund raising for developmental ventures. Bonds are issued and sold to the public for funds.
Bonds are interest bearing debt certificates. Bonds under the bond market in India may be issued by the large private organizations and government company. The bond market in India has huge opportunities for the market is still quite shallow. The equity market is more popular than the bond market in India. At present the bond market has emerged into an important financial sector.
The different types of bond market in India
- Corporate Bond Market
- Municipal Bond Market
- Government and Agency Bond Market
- Funding Bond Market
- Mortgage Backed and Collateral Debt Obligation Bond Market
The major reforms in the bond market in India
- The system of auction introduced to sell the government securities
- The introduction of delivery versus payment (DvP) system by the Reserve Bank of India to nullify the risk of settlement in securities and assure the smooth functioning of the securities delivery and payment
- The computerization of the SGL
- The launch of innovative products such as capital indexed bonds and zero coupon bonds to attract more and more investors from the wider spectrum of the populace
- Sophistication of the markets for bonds such as inflation indexed bonds
- The development of the more and more primary dealers as creators of the Government of India bonds market
- The establishment of the a powerful regulatory system called the trade for trade system by the Reserve Bank of India which stated that all deals are to be settled with bonds and funds
- A new segment called the Wholesale Debt Market (WDM) was established at the NSE to report the trading volume of the Government of India bonds market
- Issue of ad hoc treasury bills by the Government of India as a funding instrument was abolished with the introduction of the Ways And Means agreement
Lehman effect: Loan, bond market crumbled
November 20, 2008 19:02 IST
The fall of Lehman Brothers, which triggered the global financial crisis has wrecked havoc for global syndicated loan volume and the bond market across the world, according to a latest report.
In the nine weeks since Lehman Brothers filed for bankruptcy, global syndicated loan volume declined 37 per cent as against the nine weeks prior period to Lehman's collapse, deal tracking firm Dealogic said.
Similar trend was witnessed on the bond market as well. In the nine weeks after the fall of Lehman the global syndicated loan volume dipped 41 per cent as compared to the nine weeks prior to the US investment bank's collapse, Dealogic added.
Global meltdown: Complete coverage
In the said period under consideration a decline in the volume terms was also witnessed. As in the nine month prior period to the collapse there were 1,036 syndicated loan deals while in the prior period there were as many as 1,189 such transactions.
Dealogic said 'in the nine month prior period to the collapse, global syndicated loan volume has reached just $321 billion through 1,036 deals, a decline of 37 per cent from the total raised in the nine weeks prior to Lehman's collapse, when loan volume reached $508.6 billion via 1,189 deals."
Syndicated loan refers to a large sum of funds provided by a group of banks collectively to a borrower. There is usually one lead bank that takes a percentage of the loan and syndicates the rest to other banks.
Syndicated loans to financial institutions has been particularly affected, with volume in the nine weeks since the collapse reaching just $27.8 billion, 53 per cent below the level nine weeks prior.
Dealogic further said, Russian bank VTB Group's $1.4 billion loan for general corporate purposes, signed on June 23, had a margin of 65 bps and participation fee of 85 bps (for $50 million commitment).
In a similar deal, Russian Sberbank's $1.2 billion loan signed October 3, had a higher margin of 85 bps and a higher participation fee of 110 bps (also for $50 million).
Meanwhile, global syndicated loan volume totalled just $340.4 billion by way of 1,510 deals iIn the nine weeks since Lehman Brothers filed for bankruptcy, 41 per cent less than the USF 582.1 billion raised through 2,551 deals in the prior period, the report added.
Looking specifically at loans to commercial or savings and investment banks, volume in the last nine weeks has fallen by 50 per cent compared to the nine weeks leading up to the collapse of Lehman.
Corporate bond issuance by financial institutions were most affected, with volume in the nine weeks following Lehman's demise totaling just $68.5 billion, down 61 per cent compared to $176.1 billion prior.
In the same time period, corporate bond volume from investment banks has declined 41 per cent with just $5.8 billion, compared to $9.8 billion during the nine weeks prior.
Average pricing on fixed rate corporate investment grade bonds from FIG issuers have fallen 22 bps to 144 bps since September 15, Dealogic said.
Article: Govt for steps to energise corporate bond market.
Bond Markets in India
Bond markets in India have witnessed a sea change since the early 1990s. The government securities market has practically emerged since the mid-1990s. Trading platforms and settlement mechanisms have improved and new instruments have been experimented with, with varying degrees of success. In comparison, with practically no new primary market issuance of corporate bonds (except in the private placement segment), the current state of the corporate bond market in India is till nascent although in the last 2-3 years it has witnessed significant reform activities. The package of regulatory and infrastructural changes recommended by the Patil committee in 2005, partly implemented already, is likely to increase the primary and secondary market activity.The market for asset securitization in India is relatively small but has demonstrated significant growth in recent years. Asset-backed securities have led the market with mortgage-backed securities lagging. Corporate loan securitization is also considerable but mostly in the form of single loan sell-offs rather than pools of loans as in Collateralized Debt Obligations (CDOs) as securities. Securitization of trade credit or receivables is yet to develop.
Bond market in India — Shaken, but not stirred
THE WINDS of liberalisation sweeping the bond market and attracting foreign institutional investors (who can hold 30 per cent of their portfolios in fixed income instruments) are also making it choppy with changes in interest rates caused by external factors beyond the direct control of the Government and the Reserve Bank of India (RBI).
The shallow market (there are only 17 Primary Dealers eligible to participate in auctions of government bonds) and the RBI's reluctance to give these players access to derivatives in government bonds makes this market even more vulnerable.
Based on current macro-economic indicators, one can draw a trend on where bond prices will go in the next half of 2005; beyond that it may merely be a hazardous guess. Since the government remains the largest borrower in India, the prices of its bonds also tend to drive that of corporate bonds in their respective segments.
In October 2004, when the Cash Reserve Ratio was raised by 25 basis points (from 4.75 per cent to 5 per cent) and the RBI increased the reverse repo rate by 25 basis points (to 4.75 per cent), bond yields jumped, sucking out about Rs 9,000 crore from the financial system.
Immediately, yields on the 91-day Treasury Bills rose by 140 basis points and on the 364-day T-Bill by 155 basis points compared to April 2004. The yield on the 5-year (7.55 per cent) government bond (maturing in 2010) shot up to 7.20 per cent, an unprecedented rise of 241 basis points from 4.79 per cent in April 2004.
In the same period, the yield on the 10-year benchmark shot up from 5.12 per cent to 7.32 per cent, a jump of 220 basis points. Inflation figures then published were around 7 per cent, adding to the panic in the market.
However, the credit overhang in the economy (estimated at Rs 60,000 crore at the end of 2004) brought bond yields down again in the first week of January 2005. Yields softened again as the market discovered that there were enough people wanting to put their funds out to lend.
The yields on the 5-year (7.55 per cent) 2010 bond and the (7.38 per cent) 10-year benchmark fell to 6.40 per cent and 6.65 per cent respectively in January 2005. As yields fell, bond prices rose.
Though this gave some respite to beleaguered bankers who had invested money in government bonds, uncertainty still loomed over the market, and the trends did not point to a bull run like the one in April 2004.
Portends for a bull run are normally shrinking spreads at the short end of the yield curve — in April 2004, when bond prices had peaked, the spreads between the 91-day and 364-day T-Bills were thin, barely three basis points but in January 2005, it became 42 basis points, showing that investors perceived an uncertain future. Even now, the difference is substantial — over 50 basis points — and the yield curve is quite steep.
The RBI's Monetary and Credit Policy announced at end-April raised the reverse repo rate further from 4.75 per cent to 5 per cent. It can be surmised that this was to counter expected inflationary pressures resulting out of rising international oil prices (a part of which the government has now decided to pass on to the consumer).
Though the year-on-year inflation was fairly low (at 5 per cent) when the annual Economic Survey data for 2004-05 were published, inflation figures had seen a fair amount of volatility (Figure 2), because of the shortages created by a late monsoon. This year too could see such volatility, on account of the effect of the oil price rise. Inflation figures definitely affect interest rates, and given the current macroeconomic situation, they would have a tendency to rise.
The RBI has projected an inflation rate of 5-5.5 per cent for 2005, given that the impact of rise in oil prices is yet to be felt, and the dollaris still a little wobbly, and might require the RBI to support it by purchasing dollars and selling rupees.
Immediately after the RBI's rate hike announcement, just as in November 2004, the market jumped before correcting itself on underlying fundamentals. In the government auctions held on May 3, the cut-off yield on the 5-year government bond was fixed at 6.99 per cent, which later eased to 6.94 per cent.
Now, the question is whether this buoyancy in rates will last, or will it be a repetition of the October-December 2004 story. The yields on the 5-year and 10-year bonds softened to 6.82 per cent and 7.20 per cent respectively in the week after, which meant a rise in bond prices (Figure 3).
The enthusiastic response to the RBI's auction of Rs 8,000 crore worth of government paper on May 3 (both the 7.55 per cent 2010 and the 7.5 per cent 2034 bonds were over-subscribed) shows that there is indeed a lot of liquidity in the market. The total liquidity overhang on a daily basis is put at Rs 30,000 crore.
Yields of dated government bonds have fallen further after that, with insurance companies and pension funds buying dated securities, as banks cashed out to enter the loan market in the expectation of another year of growth and increased credit offtake.
The increase in money supply on account of growth in credit offtake and the RBI's continued support to the dollar will push bond prices north as banks park excess funds in government bonds, creating demand for them.
A comparison of the yield curves between May 16 and June 22 shows the flattening effect of this increased liquidity.
On the other hand, considering that the government intends to sell Rs 60,000 crore of government paper in the next six months, and the RBI is using its liquidity adjustment facility (LAF) effectively, this should get mopped up.
The rise in the Fed rate (to 3.25 per cent) will push up short-term interest rates in the US and, expectedly, make investments more attractive there.
There is an equally large camp saying that this may not happen because long-term yields in the US have failed to move up, leading to a flat yield curve there (described aptly as a `conundrum' by the Fed chief, Mr Alan Greenspan).
There is also an argument that the slowdown in the Eurozone economies is reducing investment opportunities there and the FIIs would continue to patronise emerging markets such as India.
True, but this would be more in the equity market, rather than in the bond market. Finally, though inflation reduces the inherent value of money, nominal rates of interest rise to keep pace with inflation.
All factors taken together, interest rate yields should rise moderately in the second half of 2005, in India on the back of moderate inflation and credit growth driven by the appetite of a rapidly growing economy. The slight bump in bond prices that we see now may not be sustainable despite the huge liquidity sloshing around in the economy. However, an increase in liquidity will greatly dampen the effect of a rise in rates.
Considering a 5.5 per cent inflation, and a 12.5 per cent increase in money supply (of which about 20 per cent would get invested in government bonds creating demand for bonds and pushing yields down), yields should move up by about 20 basis points by the year end taking the current ten-year benchmark yield of 6.83 per cent to above 7 per cent. Corporate bond yields would also move up, with a spread to account for credit risk.
The present bond market in India is different from that of the old times, in the sense that there are players who are out there to make money from debt instruments, rather than just invest funds in some interest-bearing government securities to fill up asset-liability `gaps'.
The modern treasury manager will have to take advantage of the small jumps in bond prices on account of policy announcements and changes in demand driven by the FIIs to make money, through the first-mover advantage.
That apart, primary dealers who are connected to banks, would be able to recoup some losses through the spread between their cost of funds (estimated at an average of around 4 per cent) and the reverse repo rate of 5 per cent, not to mention the added income that comes in from increased interest on housing and personal loans.
Pity, the RBI does not allow short-selling in government bonds. This, coupled with a forward market, would have enabled players (who agree with the above hypothesis), to sell now and buy later, whenever bond prices fall, making a profit.
(The author is a Consultant with the Financial Securities Group, Infosys Technologies Ltd. The views are personal.
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