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The debt segment of
secondary market which mainly comprises of bonds.
Bond: - A bond is simply a form of loan borrowed by the government, the
municipality or a company. A bond purchaser who plays the role of a
lender to such borrower institutions holds in return a negotiable
certificate that acknowledges indebtedness of the bond issuer. Such
certificates are also termed as bonds. Bonds normally are unsecured. The
issuer pays the bond holder periodic interest ranging over the life of
the loan.
The secondary market for bonds in India is an over the counter market
whereas the market for equities is a system-automated market. The buy
orders and sell orders are electronically matched. We shall delve deeper
into this in the following chapters.
What Are
The Various Types Of Bonds?
Zero Coupon
Bond: These are issued at a discount to the face value and at the
time of redemption the bond holder is reimbursed with the face value of
the bond.
The difference between the issue price and redemption price represents
the return to the holder. The holder of such bonds does not enjoy
periodic interest payments.
Convertible Bond: These bonds offer the investor the option to
convert the bond into equity at a fixed conversion price
Treasury Bills: T-bills are short-term securities issued by the
Government. They mature in one year or less time from their issue date.
What are
Government Bonds?
COMPANIES need
funds to run their business. One way they raise money is by issuing
corporate bonds.
Similarly, the government also issues bonds to run its 'business', that
is, to fund development projects, to fund the fiscal deficit and so on.
More on government bonds
a) These bonds form the largest segment of the debt market.
b) Government bonds are of varying interest rates and tenures.
c) They are issued through an auction system.
Can I invest in these bonds?
Traditionally, the debt market has been an institutional market all over
the world.
In India, banks, financial institutions, mutual funds, provident funds,
insurance companies and corporates can invest in these bonds.
So, you can (indirectly) invest in a government bond by investing in,
lets say, a mutual fund scheme that invests in it. For instance, gilt
funds invest in government securities.
You can
invest directly as well
Since January
2002, retail investors have been permitted to submit non-competitive
bids at a primary auction through any bank or primary dealer.
You can submit bids of Rs 10,000 and multiples thereof. A single bid
cannot exceed Rs 1 crore.
These bids, up to a maximum of 5 per cent of the notified amount, are
accepted at weighted average price/ yield.
The ABCs of
State Government Securities:
OVER the years, the gross fiscal deficit of state governments has been
on the rise. Nearly 60 per cent of the deficit is on account of revenue
deficits arising mainly due to expenditure overruns.
State government bonds represent the market borrowings used in financing
this deficit. The state government bond issuance is currently managed by
the Reserve Bank of India along with the central borrowings. The states
have the option to manage their own market borrowings to the extent of
35 per cent of total market borrowings.
Can I invest in these securities?
No. You cannot invest directly.
Mainly banks, provident funds, mutual funds and insurance companies like
the Life Insurance Corporation invest in state government securities.
So, by investing in instruments issued by these companies, you will have
an indirect exposure to state government securities.
Returns given by state government securities?
Today, the coupon rate for state government securities is fixed at 25
basis points above central government securities
What is the risk on these securities?
Maturity Risk: Default risk in government securities is always zero.
However, these securities suffer from a small variant of default risk,
that is, maturity risk. Maturity risk is the risk associated with the
likelihood of the government issuing a new security in place of
redeeming the existing security.
A state guarantee does not mean assured return of capital. State
governments can default as well. The ratio of the total outstanding
guarantees to total revenue receipts indicates the degree of
vulnerability of the state government. The high coupon incorporates
these risks.
Redemption Risk: There could be two scenarios:
1) Straight default -- This, however, may not happen, given the
political considerations (if a large number of retail investors are
involved). Further, according to a state legislature act, the total
outstanding government guarantees as on April 1 in any year shall not
exceed 80 per cent of the state's revenue receipts of the second
preceding year. Logically, therefore, a state government can honour
commitments of an existing issue by borrowing from the market.
2) Compulsory renewal -- This is, in fact, more likely to take place.
The government might force investors to renew the bonds at a rate that
could upset their YTM (yield-to-maturity) calculations, even though it
would assure repayment of principal.
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