Bond Market - Known as the Debt, Credit, or Fixed Income Market

Bond Market

INTRODUCTION

Presently, as there is a robust growth of industrial activity in our economy, the need for investment has grown significantly and has resulted in a strong credit growth Some disintermediation is expected to take place as the most creditworthy borrower seeks the lowest borrowing costs. This development has re-emphasized the fact that bond financing has to supplement the traditional bank financing to take care of the growing credit needs of the economy. The Indian debt market, particularly the government securities market, has undergone a significant transformation since the introduction of reforms in the financial markets in 1991-92. The primary objective behind the reforms has been to moderate liquidity growth, contain inflationary pressure, and conduct public debt management in a cost-effective manner. Various reforms have also been undertaken in the corporate debt market. The corporate bond market is an important segment of the financial market in terms of funds raised well as potential for future growth. The Securities and Exchange Board of India (SEBI) was established in 1992, to regulate the primary issue in equity and de markets and to ensure sound trading practices in the secondary market throu stock exchanges. The bond market is an important source of funding for both t government and corporate sector.

The bond market, also known as the debt, credit, or fixed income market, is

a market where participants buy and sell debt securities usually in the form of bonds. The majority of trading volume in the bond market takes place between broker-dealers and large institutions in a decentralized, over the counter (OTC) market. However, a small number of bonds, mainly corporate, are listed on the exchange. "Bond market" usually refers to the government bond market because on the 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 t yield curve.

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Bond Market 25

BONDS vs. EQUITY

Bonds are debt whereas stocks are equity. This is the important distinction between the two securities. By purchasing equity (stock) an investor becomes an owner in a corporation. Ownership comes with voting rights and the right to share in any future profits. By purchasing debt (bonds) an investor becomes a creditor to the corporation (or government). The primary advantage of being a creditor is that you have a higher claim on assets than shareholders do: that is, in the case of bankruptcy a bondholder will get paid before a shareholder. However, the bondholder does not share in the profits if a company does well--he or she is entitled only to the principle plus interest. There is generally less risk in owning bonds than in owning stocks.

WHAT ARE BONDS?

The bond is a security issued by a borrower that obligates the issuer to make specified payments to a holder over a specific period. Bonds are debt because when an investor buys a bond, they are effectively loaning the bond's issuer a sum of money and that issuer is incurring a debt. So the issuer--or the seller of the bond-- is a borrower and the investor--or the buyer of the bond--is a lender.

The price paid for the bond is the money the investor is loaning the issuer. And, like most other loans, when you buy a bond the borrower pays you interest for as long as the loan is outstanding and then--at the end of the agreed period of the loan--pays you the loan back.

With bonds, the price you pay for the bond--the loan itself--is known as the principal amount, or the face value of the bond. The length of the loan is referred to as its maturity. And the interest paid on the loan by the borrower is called the coupon. Bonds are rated depending upon the financial status of the issuer of the bond. Most things called bonds are not really bonds at all. Bonds encompass the wide sweep of fixed income securities.

26 * Financial Services

Bonds are also known as fixed income securities, because most bonds pay a regular income to the lender--a rate of interest on the loan. The amount of interest paid and how regularly that interest is paid is specified in the terms under which the bond is issued. Another reason bonds are known as fixed income securities is that-- unlike stocks, which make no guarantee in terms of their returns--a company that issues a bond guarantees to pay you back your principal plus interest.

Traditionally, the biggest issuers of bonds have been government bodies: national governments, local or municipal government and governmental agencies. These bodies borrow money to fund their activities. Governments and municipal bodies need money to spend on public goods--roads, defense, health, social security and so on. And for governments and municipal bodies--apart from taxation and selling public assets--borrowing money is one of their few options. And businesses need cash for all sort of reasons--to meet working capital shortfalls, to invest in new products, to expand into new markets, and so on.

Most bonds have no specific security attached to them and really should be called unsecured debentures. This means that in a default situation, the bondholders rank equally with the other unsecured creditors of the company. Since governments do not pledge specific security, most government bonds are actually debentures. An unsecured debenture usually has a "negative pledge" which prevents the issuer from having assets secured ahead of that issue.

BASIC BOND CONCEPTS

There are three basic concepts that will help you understand bonds:

1. Par value: Par value, also known as face or principal value, is how much

the bondholder will receive at maturity. A Rs. 1,000 par value bond will be worth Rs. 1,000 when it matures.

2. Coupon: Coupon is the interest rate the bond pays. It is called the coupon rate because bonds once came with a book of coupons, which the holder had to clip and send in to receive an interest payment. Bond investors are still sometimes referred to as "coupon clippers." This interest rate does not vary over the life of the bond, although there are some bonds, which have variable interest rate tied