Instruments and Players in Debt Market: Government Securities, PSU Bonds, Corporate Bonds

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.

Fixed Income securities offer a predictable stream of payments by way of interest and repayment of principal at the maturity of the instrument. The debt securities are issued by the eligible entities against the moneys borrowed by them from the investors in these instruments. Therefore, most debt securities carry a fixed charge on the assets of the entity and generally enjoy a reasonable degree of safety by way of the security of the fixed and/or movable assets of the company.

The Debt Market is the market where fixed income securities of various types and features are issued and traded. Debt Markets are therefore, markets for fixed income securities issued by Central and State Governments, Municipal Corporations, Govt. bodies and commercial entities like Financial Institutions, Banks, Public Sector Units, Public Ltd. companies and also structured finance instruments.

Debt Markets in India and all around the world are dominated by Government securities, which account for between 50 – 75% of the trading volumes and the market capitalization in all markets. Government securities (G-Secs) account for 70 – 75% of the outstanding value of issued securities and 90-95% of the trading volumes in the Indian Debt Markets.

Government Securities

G-Secs in India currently have a face value of ` 100/- and are issued by the RBI on behalf of the Government of India. All G-Secs are normally coupon (Interest rate) bearing and have semi-annual coupon or interest payments with tenure of between5to30years.This may change according to the structure of the Instrument.

The Zero Default Risk is the greatest attraction for investments in G-secs so that it enjoys the

greatest amount of security possible. The other advantages of investing in G- Secs are:

• Greater safety and lower volatility as compared to other financial instruments.
• Variations possible in the structure of instruments like Index linked Bonds, STRIPS
• Higher leverage available in case of borrowings against G-Secs.
• No TDS on interest payments.
• Tax exemption for interest earned on G-Secs. up to Rs.3000/- over and above the limit of Rs.9000/- under Section 80L.
• Greater diversification opportunities.

PSU Bonds

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.

Corporate Bonds

Corporate bonds are issued by corporations and usually mature within 1 to 30 years. These bonds usually offer a higher yield than government bonds but carry more risk. Corporate bonds can be categorized into groups, depending on the market sector the company operates in. They can also be differentiated based on the security backing the bond or the lack of security.

A corporate bond is a type of debt security that is issued by a firm and sold to investors. The company gets the capital it needs and in return the investor is paid a pre-established number of interest payments at either a fixed or variable interest rate. When the bond expires, or “reaches maturity,” the payments cease and the original investment is returned.

The backing for the bond is generally the ability of the company to repay, which depends on its prospects for future revenues and profitability. In some cases, the company’s physical assets may be used as collateral.

Corporate bonds sometimes have call provisions to allow for early prepayment if prevailing interest rates change so dramatically that the company deems it can do better by issuing a new bond.

Investors may also opt to sell bonds before they mature. If a bond is sold, the owner gets less than face value. The amount it is worth is determined primarily by the number of payments that still are due before the bond matures.

Investors may also gain access to corporate bonds by investing in any number of bond-focused mutual funds or ETFs.

Benefits of corporate bond funds

• Components of corporate bonds

Corporate bond funds invest predominantly in debt papers. Companies issue debt papers, which include bonds, debentures, commercial papers, and structured obligations. All of these components carry a unique risk profile, and the maturity date also varies.

• Price of the bond

Every bond has a price, and it is dynamic. You can buy the same bond at different prices, based on the time you choose to buy. Investors should check how it varies from the par value it will give information about the market movement.

• Par Value of the bond

This is the amount the company (bond issuer) pays you when the bond matures. It is the loan principal. In India, a corporate bond’s par value is usually Rs 1,000.

• Coupon (interest)

When you buy a bond, the company will payout interest regularly until you exit the corporate bond or the bond matures. This interest is called the coupon, which is a certain percentage of the par value.

• Current Yield

The annual returns you make from the bond is called the current yield. For example, if the coupon rate of a bond with Rs 1,000 par value is 20%, then the issuer pays Rs 200 as the interest per year.

• Yield to Maturity (YTM)

This is the in-house rate of returns of all the cash-flows in the bond, the current bond price, the coupon payments until maturity and the principal. Greater the YTM, higher will be your returns and vice versa.

• Tax-efficiency

If you are holding your corporate bond fund for less than three years, then you must pay short-term capital gains tax (STCG) based on your tax slab. On the other hand, Section 112 of the Indian Income Tax mandates 20% tax on long-term capital gains. This applies to those who hold the bond for more than three years.

• Exposure & allocation

Corporate bond funds, sometimes, do take small exposures to government securities as well. But they do so only when no suitable opportunities in the credit space are available. On average, corporate bond funds will have approximately 5.22% allocation to sovereign fixed income.

Types of corporate bonds

Convertible bonds: You can convert these bonds into predefined stocks at your disposal. So, if at any point in time, you feel that stocks are likely to give you better returns than bonds, you can convert them into shares.

Non-convertible: As the name suggests, these bonds cannot be converted into stocks. These will be plain bonds purchased from a corporation for some time.

Types of corporate bond funds.

Type One: Type one corporate bonds invest in high-rated companies; public sector unit (PSU) companies and banks.

Type Two: Type two corporate bonds invest in slightly lower rated companies such as ‘AA- ‘and below.