DRAFT

“FINANCIAL MARKETS( DEBT MARKET)”

PRESENTED BY

Roll No. Name

MR
FK-2080 . ADITYA PATIL
MR
FK-2061 . ANNA NICHOLAS
MR
FN-115 . BIBIN CHACKO E
MR
FO-79 . GYANENDRA KUMAR SAMAL
MR
FK-2183 . MADHURIMA PRAKASH
MR
FK-2097 . MEGHA T N
MS
FK-2044 . NUBIA G CHAKKALAKAL
MR
FK-2109 . RAJ JANA ROY
MR
FN-127 . REVATHY JEEVAN
MR
FK-2192 . ROHIT RAMACHANDRAN

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The bond market (also known as the debt, credit, or fixed income
market) is a financial market where participants buy and
sell debt securities, usually in the form of bonds. As of 2009, the size of
the worldwide bond market (total debt outstanding) is an estimated $82.2
trillion, of which the size of the outstanding U.S. bond market debt was
$31.2 trillion according to BIS (or alternatively $34.3 trillion according
to SIFMA).

References to the "bond market" usually refer to the government

bond market, because of its size, liquidity, lack of credit risk and,
therefore, sensitivity to interest rates. Because of the inverse relationship
between bond valuation and interest rates, the bond market is often used
to indicate changes in interest rates or the shape of the yield curve.

TYPES OF BOND(DEBT) MARKET

Bond market can be broadly classified into five specific bond markets.

 Corporate
 Government & agency
 Muncipal
 Mortgage backed, asset backed.
 Funding

BOND MARKET PARTICIPANTS

Bond market participants are similar to participants in most financial
markets and are essentially either buyers (debt issuer) of funds or sellers
(institution) of funds and often both.

Participants include:

 Institutional investors
 Governments
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  Traders
 Individuals

BOND(DEBT) MARKET SIZE

Amounts outstanding on the global bond market increased 10% in 2009 to

a record $91 trillion. Domestic bonds accounted for 70% of the total and
international bonds for the remainder. The US was the largest market with
39% of the total followed by Japan (18%). Mortgage-backed bonds
accounted for around a quarter of outstanding bonds in the US in 2009 or
some $9.2 trillion.

The sub-prime portion of this market is variously estimated at between

$500bn and $1.4 trillion. Treasury bonds and corporate bonds each
accounted for a fifth of US domestic bonds. In Europe, public sector debt
is substantial in Italy (93% of GDP), Belgium (63%) and France (63%).

Concerns about the ability of some countries to continue to finance their

debt came to the forefront in late 2009. This was partly a result of large
debt taken on by some governments to reverse the economic downturn
and finance bank bailouts. The outstanding value of international bonds
increased by 13% in 2009 to $27 trillion. The $2.3 trillion issued during
the year was down 4% on the 2008 total, with activity declining in the
second half of the year.

REGULATION
Any meaningful discussion of financial market regulation first requires a
description of the basic regulatory framework. Not so long ago, financial
market regulation in Asia consisted primarily of a set of rules and
restrictions that were mostly aimed at ensuring market (and
broader macroeconomic) stability and protecting onshore financial
institutions from offshore competition. In the late 1980s and early 1990s,
some of these rules and restrictions, especially capital controls, were
eased. This led to a surge in offshore borrowing and what
followed is well known history.

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The usage of the term regulation term still creates some confusion and
often has a negative connotation. On the one hand, people talk about
regulatory restrictions that hamper market development and the need for
deregulation and market liberalisation. On the other hand, there is
growing demand for more sound regulation and supervision of market
practices,

ECONOMIC REGULATION

The motivation behind economic rules and restrictions often varies, but
the end effect is that they undermine the free operation of market forces
by prohibiting certain business activities
or making them difficult. Good examples are market entry restrictions,
capital controls, price controls and certain taxes. Often, economic
regulations are used to support macroeconomic policy objectives, like
financial market or foreign exchange stability. But while such
regulations may help governments achieve their policy objectives, they
are typically inefficient and lead to a misallocation of resources. Moreover,
market participants often seek loopholes to circumvent these restrictions,
which leads to a whole new set of problems.
Another motive behind economic regulations, especially entry barriers, is
to protect domestic financial institutions from foreign competition.
However, such protection typically leads to inefficiencies and preserves
poor market practices.

The aim of any developing economy should be to gradually reduce

economic regulations and open up its markets. The only caveat is that
such liberalisation should not run ahead of other economic, policy and
market reforms, including the establishment of strong prudential
Regulation.

PRUDENTIAL REGULATION
Prudential regulation and supervision are meant to protect investors,
ensure that financial markets are fair, transparent and efficient and reduce
systemic risks. A strong prudential regulatory environment is the key to a
successful financial centre. Contrary to popular

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wisdom, most financial institutions do not want lax regulation. The
customers of financial firms need the assurance that the institutions with
which they do business have high ethical
standards, are prudently run, have high-quality staff, and adhere to the
highest business standards. Unless they have confidence in these factors,
they will simply take their business elsewhere.

Most financial institutions recognise that good regulation is a valuable

asset which raises the
value of their services in the eyes of their customers. It is no accident that
the most
successful financial centres, New York, London, Hong Kong and Singapore,
all have rigorous supervision. Even so, detailed mechanical rules and
ratios enforced by frequent checking are undoubtedly burdensome. When
these rules constrain otherwise desirable transactions, they can contribute
to driving business away.

Good prudential regulation works with the grain of market forces and
should provide
incentives to reinforce prudent instincts. This is why the trend of
regulation and supervision is towards encouraging high-quality risk
management processes, and away from detailed
monitoring of balance sheet ratios. It stresses transparency, market
discipline and self regulation, and not just compliance with formal rules. In
this spirit, the relationship between the regulatory agency and the
regulated entity should not be adversarial.

REGULATORS OF BOND MARKET IN INDIA

1] RESERVE BANK OF INDIA

2] SECURITIES & EXCHANGE BOARD OF INDIA

RBI

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The Reserve Bank of India is the central banking institution
of India and controls the monetary policy of the rupee as well as US$
300.21 billion (2010) of currency reserves.

Guidelines Issued by Reserve Bank of India for

the Regulation of Financial Markets

1) Management oversight, policy/operational guidelines – The

management of a Primary Dealer should bear primary responsibility for
ensuring maintenance of appropriate standards of conduct and adherence
to proper procedures by the entity. Primary Dealers (PD) should frame
and implement suitable policy guidelines on securities transactions.
Operational procedures and controls in relation to the day-to-day business
operations should also be worked out and put in place to ensure that
operations in securities are conducted in accordance with sound and
acceptable business practices. With the approval of respective Boards, the
PDs should clearly lay down the broad objectives to be followed while
undertaking transactions in securities on their own account and on behalf
of clients, clearly define the authority to put through deals, procedure to
be followed while putting through deals, and adhere to prudential
exposure limits, policy regarding dealings with brokers, systems for
management of various risks, guidelines for valuation of the portfolio and
the reporting systems etc. While laying down such policy guidelines, the
Primary Dealers should strictly observe Reserve Bank’s instructions on the
following:
1) Ready Forward deals

2) Transactions through SGL Account

3) Internal Controls/Risk Management System

4) Dealings through Brokers

5) Accounting Standards

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6) Audit, Review and Reporting

Any other instructions issued from time to time The internal policy
guidelines on securities transactions framed by the PD, duly certified by its
management to the effect that they are in accordance with the RBI
guidelines and that they have been put in place, may be perused by the
Statutory Auditors and commented upon as to the conformity of the
guidelines with the instructions/guidelines issued by RBI. The
effectiveness of the policy and operational guidelines should be
periodically evaluated.

2) Prohibition of short selling of securities – The Primary Dealers should

not put through any sale transaction without actually holding the security
in its portfolio i.e. under no circumstances, a PD should hold a oversold
position in any security.

3) Concurrent audit of securities transactions – Securities transactions

should be separately subjected to a concurrent audit by internal/external
auditors to the extent of 100% and the results of the audit should be
placed before the CEO(Chief Operating Officer)/ CMD(Chief Managing
Director) of the PD once every month. The compliance wing should
monitor the compliance on ongoing basis, with the laid down policies and
prescribed procedures, the applicable legal and regulatory requirements,
the deficiencies pointed out in the audits and report directly to the
management.

4) All problem exposures where security of doubtful value, diminution of

value to be provided for – All problem exposures, if any, which are not
backed by any security or backed by security of doubtful value should be
fully provided for.

5) Provision also for suits under litigation – Even in cases where a PD has
filed suit against another party for recovery, such exposures should be
evaluated and provisions should be made to the satisfaction of auditors.

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Guidelines Issued by Securities and Exchange
Board of India for the Regulation of Securities
Markets

1)Prohibition of certain dealings in securities

a) No person shall buy, sell or otherwise deal in securities in a fraudulent
manner.

2)Prohibition against Market Manipulation

No person shall -
(a) effect, take part in, or enter into, either directly or indirectly,
transactions in securities, with the intention of artificially raising or
depressing the prices of securities and thereby inducing the sale or
purchase of securities by any person;
(b) indulge in any act, which is calculated to create a false or misleading
appearance of trading on the securities market;
(c) indulge in any act which results in reflection of prices of securities
based on transactions that are not genuine trade transactions;
(d) enter into a purchase or sale of any securities, not intended to effect
transfer of beneficial ownership but intended to operate only as a device
to inflate, depress, or cause fluctuations in the market price of securities;
(e) pay, offer or agree to pay or offer, directly or indirectly, to any person
any money or money’s worth for inducing another person to purchase or
sell any security with the sole object of inflating, depressing, or causing
fluctuations in the market price of securities19.

3) Prohibition of misleading statements to induce sale or purchase

of securities

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No person shall make any statement, or disseminate any information
which -
(a) is misleading in a material particular; and
(b) is likely to induce the sale or purchase of securities by any other
person or is likely to have the effect of increasing or depressing the
market price of securities, if when he makes the statement or
disseminates the information-
(i) he does not care whether the statement or information is true or false;
or
(ii) he knows, or ought reasonably to have known that the statement or
information is misleading in any material particular.
Nothing in this sub-regulation shall apply to any general comments made
in good faith in regard to -
(a) the economic policy of the Government,
(b) the economic situation in the country,
(c) trends in the securities markets, or
(d)any other matter of a similar nature, whether such comments be made
in public or in private.

4) Prohibition on unfair trade practice relating to securities

No person shall -
(a) in the course of his business, knowingly engage in any act, or practice
which would operate as a fraud upon any person in connection with the
purchase or sale of, or any other dealing in, any securities;
(b) on his own behalf or on behalf of any person, knowingly buy, sell or
otherwise deal in securities, pending the execution of any order of his
client relating to the same security for purchase, sale or other dealings in
respect of securities. Nothing contained in this clause shall apply where
according to the clients instruction, the transaction for the client is to be
effected only under specified conditions or in specified circumstances;
(c) intentionally and in contravention of any law for the time being in force
delays the transfer of securities in the name of the transferee or the
dispatch of securities or connected documents to any transferee;
(d) Indulge in falsification of the books, accounts and records (whether
maintained manually or in computer or in any other form);
(e) When acting as an agent, execute a transaction with a client at a price
other than the price at which the transaction was executed by him,
whether on a stock exchange or otherwise, or at a price other than the
price at which it was offset against the transaction of another client

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DEBT MARKET

The most distinguishing feature of the debt instruments of Indian debt

market is that the return is fixed. This means, returns are almost risk-
free. This fixed return on the bond is often termed as the 'coupon rate' or
the 'interest rate'. Therefore, the buyer (of bond) is giving the seller a
loan at a fixed interest rate, which equals to the coupon rate.

CLASSIFICATION OF DEBT MARKET IN INDIA

Indian debt market can be classified into two categories:

Government Securities Market (G-Sec Market): It consists of central

and state government securities. It means that, loans are being taken by
the central and state government. It is also the most dominant category
in the India debt market.

Bond Market: It consists of Financial Institutions bonds, Corporate bonds

and debentures and Public Sector Units bonds. These bonds are issued to
meet financial requirements at a fixed cost and hence remove uncertainty
in financial costs.

ADVANTAGES

The biggest advantage of investing in Indian debt market is its assured

returns. The returns that the market offer is almost risk-free (though
there is always certain amount of risks, however the trend says that
return is almost assured). Safer are the government securities. On the
other hand, there are certain amounts of risks in the corporate, FI and
PSU debt instruments. However, investors can take help from the credit
rating agencies which rate those debt instruments. The interest in the
instruments may vary depending upon the ratings.

Another advantage of investing in India debt market is its high liquidity.

Banks offer easy loans to the investors against government securities.

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DISADVANTAGES

As there are several advantages of investing in India debt market, there

are certain disadvantages as well. As the returns here are risk free, those
are not as high as the equities market at the same time. So, at one hand
you are getting assured returns, but on the other hand, you are getting
less return at the same time.

Retail participation is also very less here, though increased recently. There
are also some issues of liquidity and price discovery as the retail debt
market is not yet quite well developed

DEBT INSTRUMETS

There are various types of debt instruments available that one can find in
Indian debt market.

Government Securities

It is the Reserve Bank of India that issues Government Securities or G-

Secs on behalf of the Government of India. These securities have a
maturity period of 1 to 30 years. G-Secs offer fixed interest rate, where
interests are payable semi-annually. For shorter term, there are Treasury
Bills or T-Bills, which are issued by the RBI for 91 days, 182 days and 364
days.

Corporate Bonds

These bonds come from PSUs and private corporations and are offered for
an extensive range of tenures up to 15 years. There are also some
perpetual bonds. Comparing to G-Secs, corporate bonds carry higher
risks, which depend upon the corporation, the industry where the
corporation is currently operating, the current market conditions, and the
rating of the corporation. However, these bonds also give higher returns
than the G-Secs.

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Certificate of Deposit

These are negotiable money market instruments. Certificate of Deposits

(CDs), which usually offer higher returns than Bank term deposits, are
issued in demat form and also as a Usance Promissory Notes. There are
several institutions that can issue CDs. Banks can offer CDs which have
maturity between 7 days and 1 year. CDs from financial institutions have
maturity between 1 and 3 years.

There are some agencies like ICRA, FITCH, CARE, CRISIL etc. that offer
ratings of CDs. CDs are available in the denominations of Rs. 1 Lac and in
multiple of that.

Commercial Papers

There are short term securities with maturity of 7 to 365 days. CPs are
issued by corporate
entities at a discount to face value.

WORKING OF GOVERMNET BOND

The Reserve Bank of India issues Central and State Government securities
through an auction mechanism.2 The auctions of government securities
are open to individuals, institutions, pension funds, provident funds, NRIs,
Overseas Corporate Bodies (OCBs) and foreign institutional investors.
Individuals and small investors such as provident and pension funds and
corporations can also participate in auctions on a non-competitive basis in
certain specific issues of dated government securities and in Treasury bill
auctions. Non-competitive bidding has been allowed since January 2002
and, in the case of dated securities, a small percentage of up to 5 percent
is allocated
for allotment to non-competitive bidders at weighted average cut-off
rates. Bids are received through banks and primary dealers. .

Calendar: The RBI formulates an issuance calendar in consultation with

the Budget
Divison of MoF, which is announced before the auctions. The calendar
does not
cover issuance of Treasury Bills or dated securities under the MSS
scheme.

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Loan notification: As per the borrowing requirement in the calendar, the
government
issues a Public Notification that specifies the amount it wishes to borrow in
dated securities. In the case of money market or MSS auctions, the RBI
directly issues
the press release.

Auction press release: The RBI issues a press release that gives the
details of the
auction - the amount involved and the maturity and tenor of the notes.

Bidding: As per the schedule in the press release, the bidding process is
carried
out both on the Negotiated Dealing System (NDS) and via sealed bid
tenders dropped
in the auction box at the Mumbai office of the RBI . This takes place for
both competitive and non-competitive bids. Primary dealers underwrite
auctions of
dated securities .

Auction results: The RBI announces the allottees of the auctions at the
date and
time indicated in the press release.

Clearance and Settlement: Transactions are settled at the RBI.

Monitoring: The CAS then monitors the interest payments and maturity
dates for issued securities/Treasury Bills.

CORPORATE BOND MARKET

The Corporate Debt Market in India is in its infancy, both in terms of the
market participation and the structure required for efficient price
discovery. Primary corporate debt market is dominated by non-banking
finance companies and relatively a very small amount of funds are raised
by manufacturing and other service industries through this market.

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Indian firms are still seeking bank finance as the path to fulfill the funding
requirements. While, the secondary market activities in corporate bonds
have not picked up till date. Efforts of Securities Exchange Board of India
(SEBI) and the stock exchanges to bring the trading to electronic stock
exchange platforms have not yielded desired results.

On the flip side, the government securities market has grown

exponentially during last decade. This is mainly down to the many
structural changes introduced by the Government and Reserve Bank of
India to improve transparency in the market dealings, method of primary
auctions, deepening the market with new market participants like Primary
Dealers, borrowings at market determined rates, and creating technology
platforms like NDS to recognize the institutional characteristics of the
market. The same kind of impetus has been lacking in the corporate bond
markets in India and as a result this major source of corporate funding is
all but non-existent.

The Corporate Debt Market in India is in its infancy, both in terms of the
market participation and the structure required for efficient price
discovery. Primary corporate debt market is dominated by non-banking
finance companies and relatively a very small amount of funds are raised
by manufacturing and other service industries through this market.

Indian firms are still seeking bank finance as the path to fulfill the funding
requirements. While, the secondary market activities in corporate bonds
have not picked up till date. Efforts of Securities Exchange Board of India
(SEBI) and the stock exchanges to bring the trading to electronic stock
exchange platforms have not yielded desired results.

The Demand Side Scenario

The corporate bond market in India has suffered because of the attitude of
the various market participants:-
Corporates - Since the cash credit system of banks operates in effect like
a loan in perpetuity, many corporates prefer it to bond financing where
the amount has to be returned on a specific date. Also, corporates do not
relish the idea of getting a credit rating done to calculate the premium to
be charged over the zero-risk government bond of comparable maturity.

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FIIs are major players in the equities market. However, due to the ceiling
on their investment in the debt market (currently there is a cumulative
sub-ceiling of $0.5 bn on investment in corporate debt), they are present
only in a limited way in the bond market.

Pension funds and the Insurance Sector could be another constituency,

but the absence of pension funds and low insurance penetration has
meant limited demand for long-term bonds.

Supply Side Scenario

For too long Corporates have got accustomed to raising loans from banks
and term lending institutions as they find this route to be relatively
hassle-free. They feel that it is far more difficult to raise funds through
bond flotation as it involves convincing a larger number of highly
demanding investors, many of whom may be raising far more searching
questions about the viability of the projects for which funds are being
sought.
There is a problem of illiquidity. A large part of the market does not mark-
to-market the corporate bond portfolio. As a result, once any bond goes
into the books, it does not come out. This takes away liquidity from the
market.

Trading is concentrated in AAA - rated bonds, as they carry the highest

safety and are the most liquid. A large part of the market, including
insurance companies, provident funds and banks, have restrictions on
private sector paper. And thus the bonds of public sector units are much
more liquid than private sector bonds.

The Financial System

The corporate bond market could exert a competitive pressure on
commercial banks in the matter of lending to private business and thus
help improve the efficiency of the capital market as a whole.

A well developed corporate bond market would lead to a reduction in the

systemic risk and probability of crisis. This is because the presence of such
an environment is associated with greater accounting transparency, a
large community of professional financial analysts, respected rating
agencies, a wide range of corporate debt securities and derivatives
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demanding sophisticated credit analysis, an opportunity to make private
placements, and efficient procedures for corporates.

RECENT TRENDS

The Indian debt market, and the government securities market in

particular, is at a turning point in India with significant changes taking
place in the domestic economic environment along with various proposed
legislative changes.

The first such significant change is the prohibition of RBI’s subscription to

Government securities in the primary market effective April 1, 2006, as

mandated by the Fiscal Responsibility and Budget Management (FRBM)
Act. This will complete the transition to a fully market based issuance of
Government securities, a process that was initiated in the early 1990s
with the introduction of auctions.

Second, as a consequence of the recommendations of the Twelfth Finance

Commission, the role of the Central Government as a financial

intermediary for State Governments is effectively ending, although there
will be some transitional arrangements. Thus State Governments'
borrowing will be more and more market determined. This is perhaps the
beginning of the emergence of a vibrant subnational debt market –
although it still has a long way to go.

Third, the economy is estimated to be growing at 8.1 per cent this year
with modest inflation and if similar conditions prevail, we can expect
growth and inflation next year to also be on a similar path. If this growth
is to be maintained and accelerated in the medium and long run, financial
intermediation will have to improve and the debt market, in this context
will become even more important.

Fourth, the sustenance of such growth will be possible only if investments

in both infrastructure and industry accelerate. Again, this will require

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debt financing with medium to long term maturity to supplement
traditional bank financing.

Fifth, as Government finances have been improving for both, the Central
and State Governments in consonance with the Central and State FRBM
Acts, the negative savings rate of public sector that had arisen over the
last 5 years has turned positive.

We can, therefore, look forward to Gross Domestic Savings touching 30

per cent or more of GDP on a sustained basis. Moreover, as the combined
fiscal deficit falls, a greater proportion of private financial savings will be
available for channelizing into the private sector. This entails higher risks
but also opens up the possibility of higher returns. There will then be
greater demand for debt securities.

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