FIMMDA stands for The Fixed Income Money Market and Derivatives Association of India (FIMMDA). It is an Association of Commercial Banks, Financial Institutions and Primary Dealers. FIMMDA is a voluntary market body for the bond, Money And Derivatives Markets.

FIMMDA has members representing all major institutional segments of the market. The membership includes Nationalized Banks such as State Bank of India, Bank of India, Bank of Baroda, Canara Bank ,  Private sector Banks such as ICICI Bank, HDFC Bank, IDBI Bank,  Foreign Banks such as Bank of America, Citibank, Standard Chartered Bank , Financial institutions such as EXIM Bank, IFCI, SIDBI; and Primary Dealers.

• To function as the principal interface with the regulators on various issues that impact the functioning of these markets.
• To undertake developmental activities, such as, introduction of benchmark rates and new derivatives instruments, etc.
• To provide training and development support to dealers and support personnel at member institutions.
• To adopt/develop international standard practices and a code of conduct in the above fields of activity.
• To devise standardized best market practices.
• To function as an arbitrator for disputes, if any, between member institutions.
• To develop standardized sets of documentation.
• To assume any other relevant role facilitating smooth and orderly functioning of the said markets.

FIMMDA addresses issues that affect the entire industry. Some of the work done in past pertains to issues like legal and accounting norms, documentation requirements and valuation methodologies. Planned initiatives include providing training and certification to members, setting up a dispute resolution mechanism as well as creating new products and addressing the attendant details. As a member, you have the opportunity to participate in all of FIMMDA's activities and contribute to the development of the Indian debt markets.

Securities are financial instruments that represent a creditor relationship with a corporation or government. Generally they represent agreements to receive a certain amount depending on the terms contained within the agreement.

Fixed-income securities are investments where the cash flows are according to a predetermined amount of interest, paid on a fixed schedule.

The different types of fixed income securities include government securities, corporate bonds, commercial paper, treasury bills, strips etc.

Holders of fixed-income securities are creditors of the issuer, not owners. Equity represents a share in the ownership of the issuer.

Fixed interest rate securities are those in which the interest payable is fixed beforehand. Floating interest rate securities are those in which the interest payable is reset from at pre-determined intervals according to a pre-determined benchmark.

Credit quality, yield, and maturity are key components of fixed-income securities.

Credit quality is an indicator of the ability of the issuer of the fixed income security to pay back his obligation. The credit quality of fixed-income securities is usually assessed by independent rating agencies such as Standard & Poor's, Moody's in the U.S. and CRISIL in India. Most large financial institutions also have their own internal rating systems.

Yield on a security is the implied interest offered by a security over its life, given its current market price.

Maturity indicates the life of the security i.e. the time over which interest flows will occur.

Coupon payments are the cash flows that are offered by a particular security at fixed intervals. The coupon expressed as a percentage of the face value of the security gives the coupon rate.

The difference between coupon rate and yield arises because the market price of a security might be different from the face value of the security. Since coupon payments are calculated on the face value, the coupon rate is different from the implied yield.

Long-term securities typically offer more return than short-term securities because investors usually prefer to lend money for shorter terms. Hence money lent out for longer terms will have a higher yield.

Callable securities are those which can be called by the issuer at a predetermined time/times, by repaying the holder of the security a certain amount which is fixed under the terms of the security.

Prices and interest rates are inversely related.

Derivative securities are those whose value depends on the value of another asset (called the underlying asset)

The different types of derivatives include forwards, futures, options, swaps etc.

A forward contract is a contract to trade in a particular asset (which may be another security) at a particular price on a pre-specified date.

A forward rate agreement is an agreement to lend money on a particular date in the future at a rate that is determined today. It is like a forward contract where the underlying asset is a bond.

Futures are standardized forward contract that are traded on an exchange and where the counter-party (the party with which the contract has been signed) is the exchange itself.

Options are one-way contract where one party has the right but not the obligation to trade in a particular asset at a particular price on a pre-determined date/dates or in a particular time interval.

Interest rate swaps are agreements where one side pays the other a particular interest rate (fixed or floating) and the other side pays the other a different interest rate (fixed or floating).

Accordingly, swaps are:

Fixed vs Floating swaps: Where one side pays the other a fixed interest rate and the other pays a floating rate determined by some benchmark and reset at fixed time intervals.

Basis swaps: Where the two sides pay each other rates determined by different benchmarks.

Overnight interest rate swaps are currently prevalent to the largest extent. They are swaps where the floating rate is an overnight rate (such as NSE MIBOR) and the fixed rate is paid in exchange of the compounded floating rate over a certain period.

The call money market is an integral part of the Indian Money Market, where the day-to-day surplus funds (mostly of banks) are traded. The loans are of short-term duration varying from 1 to 14 days. The money that is lent for one day in this market is known as "Call Money", and if it exceeds one day (but less than 15 days) it is referred to as "Notice Money". Term Money refers to Money lent for 15 days or more in the InterBank Market.

Banks borrow in this money market for the following purpose:

• To fill the gaps or temporary mismatches in funds
• To meet the CRR & SLR mandatory requirements as stipulated by the Central bank
• To meet sudden demand for funds arising out of large outflows.

Thus call money usually serves the role of equilibrating the short-term liquidity position of banks

Call Money Market Participants :

1.Those who can both borrow as well as lend in the market - RBI (through LAF) Banks, PDs

2.Those who can only lend Financial institutions-LIC, UTI, GIC, IDBI, NABARD, ICICI and mutual funds etc.

Reserve Bank of India has framed a time schedule to phase out the second category out of Call Money Market and make Call Money market as exclusive market for Bank/s & PD/s.

By convention, the term "Money Market" refers to the market for short-term requirement and deployment of funds. Money market instruments are those instruments, which have a maturity period of less than one year.The most active part of the money market is the market for overnight call and term money between banks and institutions and repo transactions. Call Money / Repo are very short-term Money Market products. The below mentioned instruments are normally termed as money market instruments:

• Certificate of Deposit (CD)
• Commercial Paper (C.P)
• Inter Bank Participation Certificates
• Inter Bank term Money
• Treasury Bills
• Bill Rediscounting
• Call/ Notice/ Term Money

Commercial Papers are short term borrowings by Corporates, FIs, PDs, from Money Market.

Features

• Commercial Papers when issued in Physical Form are negotiable by endorsement and delivery and hence highly flexible instruments
• Issued subject to minimum of Rs 5 lakhs and in the multiples of Rs. 5 Lac thereafter,
• Maturity is 15 days to 1 year
• Unsecured and backed by credit of the issuing company
• Can be issued with or without Backstop facility of Bank / FI

Eligibility Criteria

Any private/public sector co. wishing to raise money through the CP market has to meet the following requirements:

• Tangible net-worth not less than Rs 4 crore - as per last audited statement
• Should have Working Capital limit sanctioned by a bank / FI
• Credit Rating not lower than P2 or its equivalent - by Credit Rating Agency approved by Reserve Bank of India.
• Board resolution authorizing company to issue CPs
• PD and AIFIs can also issue Commercial Papers

Commercial Papers can be issued in both physical and demat form. When issued in the physical form Commercial Papers are issued in the form of Usance Promissory Note. Commercial Papers are issued in the form of discount to the face value.

Commercial Papers are short-term unsecured borrowings by reputed companies that are financially strong and carry a high credit rating. These are sold directly by the issuers to the investors or else placed by borrowers through agents / brokers etc.

FIMMDA has issued operational and documentation guidelines, in consultation with Reserve Bank of India, on Commercial Paper for market.

CDs are short-term borrowings in the form of Usance Promissory Notes having a maturity of not less than 15 days up to a maximum of one year.

CD is subject to payment of Stamp Duty under Indian Stamp Act, 1899 (Central Act)

They are like bank term deposits accounts. Unlike traditional time deposits these are freely negotiable instruments and are often referred to as Negotiable Certificate of Deposits

Features of CD

• All scheduled banks (except RRBs and Co-operative banks) are eligible to issue CDs
• Issued to individuals, corporations, trusts, funds and associations
• They are issued at a discount rate freely determined by the issuer and the market/investors.
• Freely transferable by endorsement and delivery. At present CDs are issued in physical form (UPN)

These are issued in denominations of Rs.5 Lacs and Rs. 1 Lac thereafter. Bank CDs have maturity up to one year. Minimum period for a bank CD is fifteen days. Financial Institutions are allowed to issue CDs for a period between 1 year and up to 3 years. CDs issued by AIFI are also issued in physical form (in the form of Usance promissory note) and is issued at a discount to the face value.

There is no single location or exchange where debt market participants interact for common business. Participants talk to each other, over telephone, conclude deals, and send confirmations by Fax, Mail etc. with back office doing the settlement of trades. In the sense, the wholesale debt market is a virtual market. The daily transaction volume of all the debt instruments traded would be about Rs.4000 - 5000 crores per day. In India, NSE has its separate segment, which allows online trades in the listed debt securities through its member brokers. Recently BSE as well as OTCI have introduced Debt Market Segment. Reserve Bank of India has proposed Negotiated Dealing System (NDS) for trades in the G-Secs and Repos. NDS is likely to be operational by October 2001.

A tradable form of loan is normally termed as a Debt Instrument. They are usually obligations of issuer of such instrument as regards certain future cash flow representing Interest & Principal, which the issuer would pay to the legal owner of the Instrument. Debt Instruments are of various types. The distinguishing factors of the Debt Instruments are as follows: -

• Issuer class
• Coupon bearing / Discounted
• Interest Terms
• Repayment Terms (Including Call / put etc. )
• Security / Collateral / Guarantee

Institutional investors operating in the Indian Debt Market are :

• Banks
• Insurance companies
• Provident funds
• Mutual funds
• Trusts
• Corporate treasuries
• Foreign investors (FIIs)

RBI

The Reserve Bank of India is the main regulator for the Money Market. Reserve Bank of India also controls and regulates the G-Secs Market. Apart from its role as a regulator, it has to simultaneously fulfill several other important objectives viz. managing the borrowing program of the Government of India, controlling inflation, ensuring adequate credit at reasonable costs to various sectors of the economy, managing the foreign exchange reserves of the country and ensuring a stable currency environment.

RBI controls the issuance of new banking licenses to banks. It controls the manner in which various scheduled banks raise money from depositors. Further, it controls the deployment of money through its policies on CRR, SLR, priority sector lending, export refinancing, guidelines on investment assets etc.

Another major area under the control of the RBI is the interest rate policy. Earlier, it used to strictly control interest rates through a directed system of interest rates. Each type of lending activity was supposed to be carried out at a pre-specified interest rate. Over the years RBI has moved slowly towards a regime of market determined controls.

SEBI

Regulator for the Indian Corporate Debt Market is the Securities and Exchange Board of India (SEBI). SEBI controls bond market and corporate debt market in cases where entities raise money from public through public issues.

It regulates the manner in which such moneys are raised and tries to ensure a fair play for the retail investor. It forces the issuer to make the retail investor aware, of the risks inherent in the investment, by way and its disclosure norms. SEBI is also a regulator for the Mutual Funds, SEBI regulates the entry of new mutual funds in the industry. It also regulates the instruments in which these mutual funds can invest. SEBI also regulates the investments of debt FIIs.

Apart from the two main regulators, the RBI and SEBI, there are several other regulators specific for different classes of investors, eg the Central Provision Fund Commissioner and the Ministry of Labour regulate the Provident Funds.

Religious and Charitable trusts are regulated by some of the State governments of the states, in which these trusts are located.

When we talk of interest rates, there are different types of interest rates - rates that banks offer to their depositors, rates that they lend to their borrowers, the rate at which the Government borrows in the bond/G-Sec,market, rates offered to small investors in small savings schemes like NSC rates at which companies issue fixed deposits etc.

The factors which govern the interest rates are mostly economy related and are commonly referred to as macroeconomic. Some of these factors are:

• Demand for money
• Government borrowings
• Supply of money
• Inflation rate
• The Reserve Bank of India and the Government policies which determine some of the variables mentioned above.

G-Secs or Government of India dated Securities are Rupees One hundred face-value units / debt paper issued by Government of India in lieu of their borrowing from the market. These can be referred to as certificates issued by Government of India through the Reserve Bank acknowledging receipt of money in the form of debt, bearing a fixed interest rate (or otherwise) with interests payable semi-annually or otherwise and principal as per schedule, normally on due date on redemption

The term government securities encompass all Bonds & T-bills issued by the Central Government, state government. These securities are normally referred to, as "gilt-edged" as repayments of principal as well as interest are totally secured by sovereign guarantee.

’Gilt Securities’ are issued by the RBI, the central bank, on behalf of the Government of India. Being sovereign paper, gilt securities carry absolutely no risk of default.

Like Treasury Bills, G-Secs are issued by the Reserve Bank of India on behalf of the Government of India. These form a part of the borrowing program approved by the parliament in the ‘union budget’. G- Secs are normally issued in dematerialized form (SGL). When issued in the physical form they are issued in the multiples of Rs. 10,000/-. Normally the dated Government Securities, have a period of 1 year to 20 years. Government Securities when issued in physical form are normally issued in the form of Stock Certificates. Such Government Securities when are required to be traded in the physical form are delivered by the transferor to transferee along with a special transfer form designed under Public Debt Act 1944.

The transfer does not require stamp duty. The G-Secs cannot be subjected to lien. Hence, is not an acceptable security for lending against it. Some Securities issued by Reserve Bank of India like 8.5% Relief Bonds are securites specially notified & can be accepted as Security for a loan.

Earlier, the RBI used to issue straight coupon bonds ie bonds with a stated coupon payable periodically. In the last few years, new types of instruments have been issued. These are :-

Inflation linked bonds: These are bonds for which the coupon payment in a particular period is linked to the inflation rate at that time - the base coupon rate is fixed with the inflation rate (consumer price index-CPI) being added to it to arrive at the total coupon rate.

The idea behind these bonds is to make them attractive to investors by removing the uncertainty of future inflation rates, thereby maintaining the real value of their invested capital.

FRBs or Floating Rate Bonds comes with a coupon floater, which is usually a margin over and above a benchmark rate. E.g, the Floating Bond may be nomenclature/denominated as +1.25% FRB YYYY ( the maturity year ). +1.25% coupon will be over and above a benchmark rate, where the benchmark rate may be a six month average of the implicit cut-off yields of 364-day Treasury bill auctions. If this average works out 9.50% p.a then the coupon will be established at 9.50% + 1.25% i.e., 10.75%p.a. Normally FRBs (floaters) also bear a floor and cap on interest rates. Interest so determined is intimated in advance before such coupon payment which is normally,Semi-Annual.
Zero coupon bonds: These are bonds for which there is no coupon payment. They are issued at a discount to face value with the discount providing the implicit interest payment. In effect, zero coupon bonds are like long duration T - Bills.

State government securities (State Loans) : SDLs These are issued by the respective state governments but the RBI coordinates the actual process of selling these securities. Each state is allowed to issue securities up to a certain limit each year. The planning commission in consultation with the respective state governments determines this limit. Generally, the coupon rates on state loans are marginally higher than those of GOI-Secs issued at the same time.

The procedure for selling of state loans, the auction process and allotment procedure is similar to that for GOI-Sec. State Loans also qualify for SLR status Interest payment and other modalities are similar to GOI-Secs. They are also issued in dematerialized form.

SGL Form State Government Securities are also issued in the physical form (in the form of Stock Certificate) and are transferable. No stamp duty is payable on transfer for State Loans as in the case of GOI-Secs. In general, State loans are much less liquid than GOI-Secs.

Treasury bills are actually a class of Central Government Securities. Treasury bills, commonly referred to as T-Bills are issued by Government of India against their short term borrowing requirements with maturities ranging between 14 to 364 days. The T-Bill of below mentioned periods are currently issued by Government/Reserve Bank of India in Primary Market 91-day and 364-day T-Bills. All these are issued at a discount-to-face value. For example a Treasury bill of Rs. 100.00 face value issued for Rs. 91.50 gets redeemed at the end of it's tenure at Rs. 100.00. 91 days T-Bills are auctioned under uniform price auction method where as 364 days T-Bills are auctioned on the basis of multiple price auction method.

Treasury Bills are short term GOI Securities. They are issued for different maturities viz. 14-day, 28 days (announced in Credit policy but yet to be introduced), 91 days, 182 days and 364 days. 14 days T-Bills had been discontinued recently. 182 days T-Bills were not re-introduced.

Auction is a process of calling of bids with an objective of arriving at the market price. It is basically a price discovery mechanism. There are several variants of auction. Auction can be price based or yield based. In securities market we come across below mentioned auction methods.

French Auction System : After receiving bids at various levels of yield expectations, a particular yield level is decided as the coupon rate. Auction participants who bid at yield levels lower than the yield determined as cut-off get full allotment at a premium. The premium amount is equivalent to price equated differential of the bid yield and the cut-off yield. Applications of bidders who bid at levels higher than the cut-off levels are out-right rejected. This is primarily a Yield based auction.
(b) Dutch Auction Price : This is identical to the French auction system as defined above. The only difference being that the concept of premium does not exist. This means that all successful bidders get a cut-off price of Rs. 100.00 and do not need to pay any premium irrespective of the yield level bid for.

(c) Private Placement : After having discovered the coupon through the auction mechanism, if on account of some circumstances the Government / Reserve Bank of India decides to further issue the same security to expand the outstanding quantum, the government usually privately places the security with Reserve Bank of India. The Reserve Bank of India in turn may sell these securities at a later date through their open market windiow albeit at a different yield.

(d) On-tap issue : Under this scheme of arrangements after the initial primary placement of a security, the issue remains open to yet further subscriptions. The period for which the issue remains open may be sometimes time specific or volume specific

A Debenture is a debt security issued by a company (called the Issuer), which offers to pay interest in lieu of the money borrowed for a certain period. In essence it represents a loan taken by the issuer who pays an agreed rate of interest during the lifetime of the instrument and repays the principal normally, unless otherwise agreed, on maturity.
These are long-term debt instruments issued by private sector companies. These are issued in denominations as low as Rs 1000 and have maturities ranging between one and ten years. Long maturity debentures are rarely issued, as investors are not comfortable with such maturities
Debentures enable investors to reap the dual benefits of adequate security and good returns. Unlike other fixed income instruments such as Fixed Deposits, Bank Deposits they can be transferred from one party to another by using transfer from. Debentures are normally issued in physical form. However, corporates/PSUs have started issuing debentures in Demat form. Generally, debentures are less liquid as compared to PSU bonds and their liquidity is inversely proportional to the residual maturity. Debentures can be secured or unsecured.

Debentures are divided into different categories on the basis of: (1)convertibility of the instrument (2) Security
Debentures can be classified on the basis of convertibility into:

• Non Convertible Debentures (NCD): These instruments retain the debt character and can not be converted in to equity shares
• Partly Convertible Debentures (PCD): A part of these instruments are converted into Equity shares in the future at notice of the issuer. The issuer decides the ratio for conversion. This is normally decided at the time of subscription.
• Fully convertible Debentures (FCD): These are fully convertible into Equity shares at the issuer's notice. The ratio of conversion is decided by the issuer. Upon conversion the investors enjoy the same status as ordinary shareholders of the company.
• Optionally Convertible Debentures (OCD): The investor has the option to either convert these debentures into shares at price decided by the issuer/agreed upon at the time of issue.

On basis of Security, debentures are classified into:

• Secured Debentures: These instruments are secured by a charge on the fixed assets of the issuer company. So if the issuer fails on payment of either the principal or interest amount, his assets can be sold to repay the liability to the investors
• Unsecured Debentures: These instrument are unsecured in the sense that if the issuer defaults on payment of the interest or principal amount, the investor has to be along with other unsecured creditors of the company.

Secured refers to the security given by the issuer for the loan transaction represented by the debenture. This is usually in the form of a first mortgage or charge on the fixed assets of the company on a pari passu basis with other first charge holders like financial institutions etc. Sometimes, the charge can also be a second charge instead of a first charge. Most of the times the charge is created on behalf of the entire pool of debenture holders by a trustee specifically appointed for the purpose.

Redeemable refers to the process whereby the debenture is extinguished on payment of all the obligations due to the holder after the repayment of the last installment of the principal amount of the debenture.

Long-term debt securities issued by the Government of India or any of the State Government’s or undertakings owned by them or by development financial institutions are called as bonds. Instruments issued by other entities are called debentures. The difference between the two is actually a function of where they are registered and pay stamp duty and how they trade.

Debenture stamp duty is a state subject and the duty varies from state to state. There are two kinds of stamp duties levied on debentures viz issuance and transfer. Issuance stamp duty is paid in the state where the principal mortgage deed is registered. Over the years, issuance stamp duties have been coming down. Stamp duty on transfer is paid to the state in which the registered office of the company is located. Transfer stamp duty remains high in many states and is probably the biggest deterrent for trading in debentures in physical segment, resulting in lack of liquidity.

On issuance, stamp duty is linked to mortgage creation, wherever applicable while on transfer, it is levied in accordance with the laws of the state in which the registered office of the company in question is located. A debenture transfer, has to be effected through a transfer form prescribed for under Companies Act.

Issuance of stamp duty on bonds is under Indian Stamp Act 1899 (Central Act). A bond is transferable by endorsement and delivery without payment of any transfer stamp duty.

Public Sector Undertaking Bonds (PSU Bonds) : These are Medium or long term debt instruments issued by Public Sector Undertakings (PSUs). The term usually denotes bonds issued by the central PSUs (ie PSUs funded by and under the administrative control of the Government of India). Most of the PSU Bonds are sold on Private Placement Basis to the targeted investors at Market Determined Interest Rates. Often investment bankers are roped in as arrangers to this issue. Most of the PSU Bonds are transferable and endorsement at delivery and are issued in the form of Usance Promissory Note.

In case of tax free bonds, normally such bonds accompany post dated interest cheque / warrants.

Apart from public sector undertakings, Financial Institutions are also allowed to issue bonds. They issue bonds in 2 ways :-

1) Through public issues targeted at retail investors and trusts

2) Through private placements to large institutional investors.

PFIs offer bonds with different features to meet the different needs of investors eg. Monthly return bonds, Quarterly coupon bearing Bonds, cumulative interest Bonds, step up bonds etc. Some PFIs are allowed to issue bonds (as per their respective Acts) in the form of Book entry hence, PFIs like IDBI, EXIM Bank, NHB, do issue Bonds in physical form (in the form of holding certificate or debenture certificate as the case may be,in book entry form) PFIs who have provision to issue bond in the form of book entry are permitted under the Respective Acts to design a special transfer form to allow transfer of such securities. Nominal stamp duty / transfer fee is payable on transfer transactions.

The Coupon rate is simply the interest rate that every debenture/Bond carries on its face value and is fixed at the time of issuance. For example, a 12% p.a coupon rate on a bond/debenture of Rs 100 implies that the investor will receive Rs 12 p.a. The coupon can be payable monthly, quarterly, half-yearly, or annually or cumulative on redemption

Securities are issued for a fixed period of time at the end of which the principal amount borrowed is repaid to the investors. The date on which the term ends and proceeds are paid out is known as the Maturity date. It is specified on the face of the instrument. In respect of Demat Debt instrument due date is known from ISIN Number of the security.

On reaching the date of maturity, the issuer repays the money borrowed from the investors. This is known as Redemption or Repayment of the bond/debenture.
If the redemption proceeds are more than the face value of the bond/debentures, the debentures are said to be redeemed at a premium. If one gets less than the face value, then they are redeemed at a discount and if one gets the same as their face value, then they are redeemed at par.

This is the yield or return derived by the investor on purchase of the instrument (yield related to purchase price)
It is calculated by dividing the coupon rate by the purchase price of the debenture. For e. g: If an investor buys a 10% Rs 100 debenture of ABC company at Rs 90, his current Yield on the instrument would be computed as:
Current Yield = (10%*100)/90 X 100 , That is 11.11% p.a.

The yield or the return on the instrument is held till its maturity is known as the Yield-to-maturity (YTM). It basically measures the total income earned by the investor over the entire life of the Security.

This total income consists of the following:

• Coupon income: The fixed rate of return that accrues from the instrument
• Interest-on-interest at the coupon rate: Compound interest earned on the coupon income
• Capital gains/losses: The profit or loss arising on account of the difference between the price paid for the security and the proceeds received on redemption/maturity

G-Sec/Bonds/Debentures keep changing hands in the secondary market. Issuer pays interest to the holders registered in its register on a certain date. Such date is known as record date. Securites are not transferred in the books of issuer during the period in which such records are updated for payment of interst etc. Such period is called as shut period. For G-Secs held in Demat form (SGL) shut period is 3 working days.

Cum-interest means the price of security is inclusive of the interest accrued for the interim period between last interest payment date and purchase date.
Security with ex-interest means the accrued interest has to be paid separately

Securities are generally issued in denominations of 10, 100 or 1000. This is known as the Face Value or Par Value of the security. When a security is sold above its face value, it is said to be issued at a Premium and if it is sold at less than its face value, then it is said to be issued at a Discount

Primary Dealers can be referred to as Merchant Bankers to Government of India, comprising the first tier of the government securities market. Satellite Dealers work in tandem with the Primary Dealers forming the second tier of the market to cater to the retail requirements of the market.

These were formed during the year 1994-96 to strengthen the market infrastructure and put in place an improvised and an efficient secondary government securities market trading system and encourage retailing of Government Securities on large scale.

The role of Primary Dealers is to;
(i) commit participation as Principals in Government of India issues through bidding in auctions
(ii) provide underwriting services
(iii) offer firm buy - sell / bid ask quotes for T-Bills & dated securities
(v) Development of Secondary Debt Market

The market uses quite a few conventions for calculation of the number of days that has elapsed between two dates. It is interesting to note that these conventions were designed prior to the emergence of sophisticated calculating devices and the main objective was to reduce the math in complicated formulae. The conventions are still in place even though calculating functions are readily available even in hand-held devices. The ultimate aim of any convention is to calculate (days in a month)/(days in a year). The conventions used are as below. We take the example of a bond with Face Value 100, coupon 12.50%, last coupon paid on 15th June, 2000 and traded for value 5th October, 2000.

A/360(Actual by 360)

In this method, the actual number of days elapsed between the two dates is divided by 360, i.e. the year is assumed to have 360 days. Using this method, accrued interest is 3.8888.

A/365 (Actual by 365)
In this method, the actual number of days elapsed between the two dates is divided by 365, i.e. the year is assumed to have 365 days. Using this method, accrued interest is 3.8356

A/A (Actual by Actual)
In this method, the actual number of days elapsed between the two dates is divided by the actual days in the year. If the year is a leap year AND the 29th of February is included between the two dates, then 366 is used in the denominator, else 365 is used. Using this method, accrued interest is 3.8356

30/360 ( 30 by 360 - American )
This is how this convention is used in the US. Break up the earlier date as D(1)/M(1)/Y(1) and the later date as D(2)/M(2)/Y(2). If D(1) is 31, change D(1) to 30. If D(2) is 31 AND D(1) is 30, change D(2) to 30. The days elapsed is calculated as Y(2)-Y(1)*360+M(2)-M(1)*30+D(2)-D(1)

30/360 ( 30 by 360 - Europian )

This is the variation of the above convention outside of the United States. Break up the earlier date as D(1)/M(1)/Y(1) and the later date as D(2)/M(2)/Y(2). If D(1) is 31, change D(1) to 30. If D(2) is 31, change D(2) to 30. The days elapsed is calculated as Y(2)-Y(1)*360+M(2)-M(1)*30+D(2)-D(1)

G-Secs are usually referred to as risk free securities. However, these securities are subject to only one type of risk i.e., interest-rate risk. Subject to changes in the over all interest rate scenario, the price of these securities may appreciate or depreciate.

(i) Interest Rate risk : Interest rate risk, market risk or price risk are essentially one and the same. Theses are typical of any fixed coupon security with a fixed period-to-maturity. This is on account of an inverse relation between price and interest. As interest rates rise, the price of a security will fall. However, this risk can be completely eliminated incase an investor's investment horizon identically matches the term of the security. (ii) Re-investment risk : This risk is again akin to all those securities, which generate intermittent cash flows in the form of periodic coupons. The most prevalent tool deployed to measure returns over a period of time is the yield-to-maturity (YTM) method. The YTM calculation assumes that the cash flows generated during the life of a security is re-invested at the rate of the YTM. The risk here is that the rate at which the interim cash flows are re-invested may fall thereby affecting the returns.
(iii) Default risk : This kind of risk in the context of a Government security is always zero. However, these securities suffer from a small variant of default risk i.e., 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. In case of Corporate Securities it is referred to as Credit Risk.

A Repo deal is one where eligible parties enter into a contract with another to borrow money against at a pre-determined rate against the collateral of eligible security for a specified period of time. The legal title of the security does change. The motive of the deal is to fund a position. Though the mechanics essentially remain the same and the contract virtually remains the same, in case of a reverse Repo deal the underlying motive of the deal is to meet the security / instrument specific needs or to lend the money. Indian Repo Market is governed by Reserve Bank of India. At present Repo is permitted between permitted 64 players against Central & State Government Securities (including T-Bills) only at Mumbai.

OMO or Open Market Operations is a market regulating mechanism often resorted to by Reserve Bank of India. Under OMO Operations Reserve Bank of India as a market regulator keeps buying or/and selling securities through it's open market window. It's decision to sell or/and buy securities is influenced by factors such as overall liquidity in the system, disciplining a sentiment driven market, signaling of likely movements in interest rate structure, etc.

A Constituent Subsidiary General Ledger Account (CSGL) is a service provided by Reserve Bank of India through Primary Dealers and Banks to those entities who are not allowed to hold direct SGL Accounts with it. This account provides for holding of Central/State Government Securities and Treasury bills in book entry/dematerialized form. Individuals are also allowed to hold a Constituent SGL Account.

Bootstrapping is an iterative process of generating a Zero Coupon Yield Curve from the observed prices/yields of coupon bearing securities. The process starts from observing the yield for the shortest-term money market discount instrument (i.e. one that carries no coupon). This yield is used to discount the coupon payment falling on the same maturity for a coupon-bearing bond of the next higher maturity. The resulting equation is solved to give the zero yield (also called spot yield) for the higher maturity period.

This process is continued for all securities across the time series. If represented algebraically, the process would lead to an nth degree polynomial that is generally solved using numerical methods.

The relationship between time and yield on a homogenous risk class of securities is called the Yield Curve. The relationship represents the time value of money - showing that people would demand a positive rate of return on the money they are willing to part today for a payback into the future. It also shows that a Rupee payable in the future is worth less today because of the relationship between time and money. A yield curve can be positive, neutral or flat. A positive yield curve, which is most natural, is when the slope of the curve is positive, i.e. the yield at the longer end is higher than that at the shorter end of the time axis. This results, as people demand higher compensation for parting their money for a longer time into the future. A neutral yield curve is that which has a zero slope, i.e. is flat across time. T his occurs when people are willing to accept more or less the same returns across maturities. The negative yield curve (also called an inverted yield curve) is one of which the slope is negative, i.e. the long term yield is lower than the short term yield.

The Zero Coupon Yield Curve (also called the Spot Curve) is a relationship between maturity and interest rates. It differs from a normal yield curve by the fact that it is not the YTM of coupon bearing securities, which gets plotted. Represented against time are the yields on zero coupon instruments across maturities. The benefit of having zero coupon yields (or spot yields) is that the deficiencies of the YTM approach (See Yield to Maturity) is removed. However, zero coupon bonds are generally not available across the entire spectrum of time and hence statistical estimation processes are used. The zero coupon yield curve is useful in valuation of even coupon bearing securities and can be extended to other risk classes as well after adjusting for the spreads. It is also an important input for robust measures of Value at Risk (VaR)