Escolar Documentos
Profissional Documentos
Cultura Documentos
A PROJECT REPORT
ON
DEBT INVESTMENT OPTION FROM INVESTORS PERSPECTIVE
A PROJECT SUBMITTED TO
BY
RUPALI N. SHEVATE
ACADEMIC YEAR: 2015-2017
EXECUTIVE SUMMARY
In investing money, the amount of interest you want should depend on whether you
want to eat well or sleep well.
Saving is an important part of any economy of any nation with saving invested various option
available to people. An investment refers to the commitment of fund at present, in
anticipation of some positive rate of return in future today the spectrum of investment is
indeed wide.
The debt instruments that constitute the entire financial markets (including capital markets
and money markets) represents contracts whereby one party lends money to another party on
pre-determined terms with regard to rate of interest to be paid by the borrower to the lender,
the periodicity of such interest payment, and the repayment of the principal amount
borrowed. In the Indian securities markets, we use the term bonds for debt instruments
issued by central or state governments and public sector organizations and the term
debentures for the securities issued by the private corporate organizations.
This project finds out the various instruments being issued by the government viz., Bonds,
Treasury Bills, Call Money Markets, Repo Markets etc., in order to finance its fiscal deficit.
It tries to analyze the basic issuance process of these instruments and the participants those
are involved in various transactions in the Wholesale Debt Market.
The project takes help of various tables and graphs in order to easily analyze the various
parameters viz., Market-wise distribution of various instruments traded, participant- wise
distribution, concentration of participants in the wholesale debt market, etc.
The project also seeks to analyze how an investor can judge whether his/her money invested
is safe by analyzing the credit rating of various securities and also to find out at what rate will
the money grow within the tenure of investment
INDEX
Sr. No.
1
Contents
Page No.
8-9
10-14
15-28
29-31
34-35
35-38
2.3 Participants
39-41
42-43
44-46
47-48
49
50
51-52
53-66
4
3.6 Bibliography
amount
of
money borrowed
by one
party from
another
party
Many
corporations/individuals use debt as a method for making large purchases that they could not
afford under normal circumstances. A debt arrangement gives the borrowing party permission
to borrow money under the condition that it is to be paid back at a later date, usually with
interest.
An amount owed to a person or organization for funds borrowed. Debt can be represented by
a loan note, bond, mortgage or other form stating repayment terms and, if applicable, interest
requirements. These different forms all imply intent to pay back an amount owed by a
specific date, which is set forth in the repayment terms.
A debt is an obligation owed by one party (the debtor) to a second party, the creditor; usually
this refers to assets granted by the creditor to the debtor, but the term can also be used
metaphorically to cover moral obligations and other interactions not based on economic
value.
A debt is created when a creditor agrees to lend a sum of assets to a debtor. Debt is usually
granted with expected repayment; in modern society, in most cases, this includes repayment
of the original sum, plus interest.
In finance, debt is a means of using anticipated future purchasing power in the present before
it has actually been earned. Some companies and corporations use debt as a part of their
overall corporate finance strategy.
Debt is as old as economy. Before a debt can be made, both the debtor and the creditor must
agree on the manner in which the debt will be repaid, known as the standard of deferred
5
payment. This payment is usually denominated as a sum of money in units of currency, but
can sometimes be denominated in terms of goods or services. Payment can be made in
increments over a period of time, or all at once at the end of the loan agreement
Debt funds are preferred by individuals who are not willing to invest in a highly volatile
equity market. A debt fund provides a steady but low income relative to equity. It is
comparatively less volatile. A debt fund is an investment pool, such as a mutual fund or
exchange-traded fund, in which core holdings are fixed income investments. A debt fund may
invest in short-term or long-term bonds, securitized products, money market instruments or
floating rate debt. The fee ratios on debt funds are lower, on average, than equity funds
because the overall management costs are lower.
Debt funds also tend to perform better in periods of economic slowdown. Analysts believe
that debt should be looked upon as an effective hedge against equity market volatility, which
lends stability in terms of value and income to a portfolio. Some hybrid debt schemes take
exposure in equities allowing investors participate in the stock markets as well.
Debt funds have a fairly wide range of schemes offering something for all types of
investors. Liquid fund, Liquid plus funds, Short term income funds, GILT funds, income
funds and hybrid funds are some of the more popular categories.
Basic principle of sound investing postulates a diversified portfolio. Though debt funds
often may just be the difference between being able to retain the profits and loosing it all in
the next round of volatility. The main advantage of debt funds is relatively lower risk and
steady income additional to liquidity of investments, professional fund management
expertise at low costs besides diversification of portfolio to have a balanced risk return
profile.
More conservative funds generally hold out the prospect of reasonable returns and low
risk exposure, while aggressive funds seek to offer higher returns in return for accepting
higher risk exposure. As the relative risk profile of such securities is higher, investors in
such bonds expect higher income streams compared to higher-rated bonds.
categorized on the basis of the type of debt securities they invest in. The distinction can be
primarily on the basis of the tenor of the securities: short term or long term, and the issuer:
government, corporate, PSUs and others. The risk and return of the securities will vary based
on the tenor and issuer. The strategy adopted by the fund manager to create and manage the
portfolio can also be a factor for categorizing debt funds.
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liquidity is considerably higher in case of government securities. However, prices of longterm government securities are very sensitive to interest rate changes.
B. Corporate bond funds
Corporate bond funds invest in debt securities issued by companies, including PSUs. There
is a credit risk associated with the issuer that is denoted by the credit rating assigned to the
security. Such bonds pay a higher coupon income to compensate for the credit risk associated
with them.
2. On the basis of Tenor
A. Liquid schemes
Liquid schemes or money market schemes are a variant of debt schemes that invest only in
short term debt securities. They can invest in debt securities of upto 91 days maturity.
However, securities in the portfolio having maturity more than 60-days need to be valued at
market prices [marked to market (MTM)]. Since MTM contributes to volatility of NAV,
fund managers of liquid schemes prefer to keep most of their portfolio in debt securities of
less than 60-day maturity. As will be seen later in this Work Book, this helps in positioning
liquid schemes as the lowest in price risk among all kinds of mutual fund schemes. Therefore,
these schemes are ideal for investors seeking high liquidity with safety of capital.
B. Short term debt schemes
Short term debt schemes invest in securities with short tenors that have low interest rate risk
of significant changes in the value of the securities. Ultra-short term debt funds, short-term
debt funds, short-term gilt funds are some of the funds in this category. The contribution of
interest income and the gain/loss in the value of the securities and the volatility in the returns
from the fund will vary depending upon the tenor of the securities included in the portfolio
C. Ultra short-term plans
Ultra short-term plans are also known as treasury management funds, or cash management
funds. They invest in money market and other short term securities of maturity up to 365
days. The objective is to generate a steady return, mostly coming from accrual of interest
income, with minimal NAV volatility.
D. Short Term Plans
Short Term Plans combines short term debt securities with a small allocation to longer term
debt securities. Short term plans earn interest from short term securities and interest and
capital gains from long term securities. Fund managers take a call on the exposure to long
term securities based on their view for interest rate movements. If interest rates are expected
to go down, these funds increase their exposure to long term securities to benefit from the
resultant increase in prices. The volatility in returns will depend upon the extent of long-term
debt securities in the portfolio.
3. On the basis of Investment Strategy
Duration of these portfolios are not fixed, but are dynamically managed. If the manager
believes that interest rates could move up, the duration of the portfolio is reduced and vice
versa.
D. Fixed maturity plans
Fixed maturity plans are a kind of debt fund where the investment portfolio is closely aligned
to the maturity of the scheme. AMCs tend to structure the scheme around pre-identified
investments. Further, being close-ended schemes, they do not accept moneys post-NFO.
Thanks to these characteristics, the fund manager has little ongoing role in deciding on the
investment options.
As will be seen in Chapter8, such a portfolio construction gives more clarity to investors on
the likely returns if they stay invested in the scheme until its maturity (though there can be no
guarantee or assurance of such returns). This helps them compare the returns with alternative
investments like bank deposits.
E. Floating rate funds
Floating rate funds invest largely in floating rate debt securities i.e. debt securities where the
interest rate payable by the issuer changes in line with the market. For example, a debt
security where interest payable is described as5-year Government Security yield plus 1%,
will pay interest rate of 7%, when the 5-year Government Security yield is 6%; if 5-year
Government Security yield goes down to 3%, then only 4% interest will be payable on that
debt security. The NAVs of such schemes fluctuate lesser than other debt funds that invest
more in debt securities offering a fixed rate of interest.
10
A. Money Market :
11
It is a market to issue and trade securities with short term maturity or quasi-money
instruments. Instruments like treasury bills, certificates of deposits, commercial papers, bills
of exchange etc are traded in the money market. The money market offers an alternative to
these higher-risk investments.
The money market is better known as a place for large institutions and government to manage
their short-term cash needs. However, individual investors have access to the market through
a variety of different securities.
The money market is a subsection of the fixed income market. In reality, a bond is just one
type of fixed income security. The difference between the money market and the bond market
is that the money market specializes in very short-term debt securities (debt that matures in
less than one year). Money market investments are also called cash investments because of
their short maturities.
There are several different instruments in the money market, offering different returns and
different risks. In the following sections.
The major money market instruments
1). Treasury Bills
Treasury Bills are the most marketable money market security. Their popularity is mainly due
to their simplicity.
T-bills are short-term securities that mature in one year or less from their issue date. They are
issued with three-month, six-month and one-year maturities. T-bills are purchased for a price
that is less than their par (face) value; when they mature, the government pays the holder the
full par value. Effectively, your interest is the difference between the purchase price of the
security and what you get at maturity. For example, if you bought a 90-day T-bill at $9,800
and held it until maturity, you would earn $200 on your investment. This differs from coupon
bonds, which pay interest semi-annually. Treasury bills (as well as notes and bonds) are
issued through a competitive bidding process at auctions.
2). Certificate of Deposit
(CD) is a time deposit with a bank. CDs are generally issued by commercial banks but they
can be bought through brokerages. They bear a specific maturity date (from three months to
five years), a specified interest rate, and can be issued in any denomination, much like bonds.
Like all time deposits, the funds may not be withdrawn on demand like those in a checking
account.
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CDs offer a slightly higher yield than T-Bills because of the slightly higher default risk for a
bank but, overall, the likelihood that a large bank will go broke is pretty slim. Of course, the
amount of interest you earn depends on a number of other factors such as the current interest
rate environment, how much money you invest, the length of time and the particular bank
you choose. While nearly every bank offers CDs, the rates are rarely competitive, so it's
important to shop around.
3).Commercial Paper
For many corporations, borrowing short-term money from banks is often a laborious and
annoying task. The desire to avoid banks as much as possible has led to the widespread
popularity of commercial paper.
Commercial paper is an unsecured, short-term loan issued by a corporation, typically for
financing accounts receivable and inventories. It is usually issued at a discount, reflecting
current market interest rates. Maturities on commercial paper are usually no longer than nine
months, with maturities of between one and two months being the average.
For the most part, commercial paper is a very safe investment because the financial situation
of a company can easily be predicted over a few months. Furthermore, typically only
companies with high credit ratings and credit worthiness issue commercial paper. Over the
past 40 years, there have only been a handful of cases where corporations have defaulted on
their commercial paper repayment.
Commercial paper is usually issued in denominations of $100,000 or more. Therefore,
smaller investors can only invest in commercial paper indirectly through money market
funds.
4).Bankers acceptance
A bankers' acceptance (BA) is a short-term credit investment created by a non-financial firm
and guaranteed by a bank to make payment. Acceptances are traded at discounts from face
value in the secondary market.
For corporations, a BA acts as a negotiable time draft for financing imports, exports or other
transactions in goods. This is especially useful when the creditworthiness of a foreign trade
partner is unknown.
Acceptances sell at a discount from the face value:
13
$1,000,000
-$20,000
$980,000
B. Government Securities :
A government security is a bond or other type of debt obligation that is issued by a
government with a promise of repayment upon the security's maturity date. Government
securities are usually considered low-risk investments because they are backed by the taxing
power of a government.
A Government security is a tradable instrument issued by the Central Government or the
State Governments. It acknowledges the Governments debt obligation. Such securities are
short term (usually called treasury bills, with original maturities of less than one year) or long
term (usually called Government bonds or dated securities with original maturity of one year
or more).
In India, the Central Government issues both, treasury bills and bonds or dated securities
while the State Governments issue only bonds or dated securities, which are called the State
Development Loans (SDLs).
Government securities carry practically no risk of default and, hence, are called risk-free giltedged instruments. Government of India also issues savings instruments (Savings Bonds,
National Saving Certificates (NSCs), etc.) or special securities (oil bonds, Food Corporation
of India bonds, fertilizer bonds, power bonds, etc.). They are, usually not fully tradable and
are, therefore, not eligible to be SLR securities.
C. Bond
Bond is a debt security, in which the authorized issuer owes the holders a debt and, depending
on the terms of the bond, is obliged to pay interest (the coupon) to use and/or to repay the
principal at a later date, termed maturity. A bond is a formal contract to repay borrowed
money with interest at fixed intervals (ex semiannual, annual, and sometimes monthly).
Bonds provide the borrower with external funds to finance long-term investments, or, in the
case of government bonds, to finance current expenditure. Bonds and stocks are both
securities, but the major difference between the two is that (capital) stockholders have an
equity stake in the company (i.e., they are owners), whereas bondholders have a creditor
stake in the company (i.e., they are lenders). Another difference is that bonds usually have a
defined term, or maturity, after which the bond is redeemed, whereas stocks may be
outstanding indefinitely.
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.
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Participants include:
Institutional investors
Governments
Traders
Individuals
TYPES OF BONDS
1) Government Bonds
In general, fixed-income securities are classified according to the length of time before
maturity. These are the three main categories:
Bills - debt securities maturing in less than one year.
Notes - debt securities maturing in one to 10 years
Bonds - debt securities maturing in more than 10 years
Marketable securities from the U.S. government - known collectively as Treasuries - follow
this guideline and are issued as Treasury bonds, Treasury notes and Treasury bills (T-bills).
Technically speaking, T-bills aren't bonds because of their short maturity. (You can read more
about T-bills in our Money Market tutorial.) All debt issued by Uncle Sam is regarded as
extremely safe, as is the debt of any stable country. The debt of many developing countries,
however, does carry substantial risk. Like companies, countries can default on payments.
2) Municipal Bonds
Municipal bonds, known as "munis", are the next progression in terms of risk. Cities don't go
bankrupt that often, but it can happen. The major advantage to Municipal Bond is that the
returns are free from federal tax. Furthermore, local governments will sometimes make their
debt non-taxable for residents, thus making some municipal bonds completely tax free.
Because of these tax savings, the yield on Municipal Bond is usually lower than that of a
taxable bond. Depending on your personal situation Municipal Bond can be a great
investment on an after-tax basis.
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3) Corporate Bonds
A company can issue bonds just as it can issue stock. Large corporations have a lot of
flexibility as to how much debt they can issue: the limit is whatever the market will bear.
Generally, a short-term corporate bond is less than five years; intermediate is five to 12 years,
and long term is over 12 years.
Corporate bonds are characterized by higher yields because there is a higher risk of a
company defaulting than a government. The upside is that they can also be the most
rewarding fixed-income investments because of the risk the investor must take on. The
company's credit quality is very important: the higher the quality, the lower the interest rate
the investor receives. Other variations on corporate bonds include convertible bonds, which
the holder can convert into stock, and callable bonds, which allow the company to redeem an
issue prior to maturity.
4) Zero-Coupon Bonds
This is a type of bond that makes no coupon payments but instead is issued at a considerable
discount to par value. For example, let's say a zero-coupon bond with a $1,000 par value and
10 years to maturity is trading at $600; you'd be paying $600 today for a bond that will be
worth $1,000 in 10 years.
Zero Coupon Bonds are issued at a discount to their face value and at the time of maturity,
the principal/face value is repaid to the holders. No interest (coupon) is paid to the holders
and hence, there are no cash inflows in zero coupon bonds. The difference between issue
price (discounted price) and redeemable price (face value) itself acts as interest to holders.
The issue price of Zero Coupon Bonds is inversely related to their maturity period, i.e. longer
the maturity period lesser would be the issue price and vice-versa. These types of bonds are
also known as Deep Discount Bonds.
5) Floating Rate Bonds
In some bonds, fixed coupon rate to be provided to the holders is not specified. Instead, the
coupon rate keeps fluctuating from time to time, with reference to a benchmark rate. Such
types of bonds are referred to as Floating Rate Bonds.
6) Convertible Bonds
The holder of a convertible bond has the option to convert the bond into equity (in the same
value as of the bond) of the issuing firm (borrowing firm) on pre-specified terms. This results
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in an automatic redemption of the bond before the maturity date. The conversion ratio
(number of equity of shares in lieu of a convertible bond) and the conversion price
(determined at the time of conversion) are pre-specified at the time of bonds issue.
Convertible bonds may be fully or partly convertible. For the part of the convertible bond
which is redeemed, the investor receives equity shares and the non-converted part remains as
a bond.
RISK OF INVESTING IN BONDS
Interest rate risk: The bond trading prices are inversely related to the interest rates. When
interest rates rise, bond prices decline. If you need to sell you bond in a high interest rate
environment, you may get less than you paid for it. The risk from fluctuations in interest rate
declines the closer the instrument is to maturity.
Credit risk: If the issuer faces a financial crunch or bankruptcy, it may default on payments
towards the instrument.
Liquidity risk: If the coupon rate is lower than prevailing interest rates in the market, then an
investor may find it difficult to sell the instrument before maturity. Debt instruments are
generally more liquid during the initial period after they are issued.
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Call risk or reinvestment risk: For a bond with a call option, the issuer may redeem the
instrument prior to maturity as per the predetermined dates and prices for such a trade. Issuers
normally redeem such bonds when the interest rates are falling, and as a result investors have
to reinvest their funds at a lower rate
BOND PRICING
2. Maturity
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D. Debenture
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
20
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 can be of following types:
Redeemable and Irredeemable Debentures
Redeemable debentures are those which can be redeemed or paid back at the end of a
specified period mentioned on the debentures or within a specified period at the
option of the company by giving notice to the debenture holders or by instalments as
per terms of issue.
Irredeemable debentures are those which are repayable at any time by the company
during its existence. No date of redemption is specified. The debenture holders cannot
claim their redemption. However, they are due for redemption if the company fails to
pay interest on such debentures or on winding up of the company. They are also called
perpetual debentures.
Secured and Unsecured Debentures
Secured or mortgaged debentures carry either a fixed charge on the particular asset of
the company or floating charge on all the assets of the company.
Unsecured debentures, on the other hand, have no such charge on the assets of the
company. They are also known as simple or naked debentures.
21
22
Safety:
The Zero Default Risk is the greatest attraction for investments in Government
Securities. It enjoys the greatest amount of security possible, as the Government of
India issues it. Hence they are also known as Gilt-Edged Securities or 'Gilts'.
Fixed Income:
During the term of the security there is likely to be fluctuations in the Government
Security prices and thus there exists a price risk associated with investment in
Government Security. However, the return on the holding of investment is fixed if the
security is held till maturity and the effective yield at the time of purchase is known
and certain. In other words the investment becomes a fixed income investment if the
buyer holds the security till maturity.
Convenience:
Government Securities do not attract deduction of tax at source (TDS) and hence the
investor having a non-taxable gross income need not file a return only to obtain a
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TDS refund.
Simplicity:
To buy and sell Government Securities all an individual has to do is call his / her
Broker and place an order. If an individual does not trade in the Equity markets, he /
she has to open a demat account and then can commence trading through any broker.
Liquidity:
Government Security when actively traded on exchanges will be highly liquid, since a
national trading platform is available to the investors.
Diversification:
Government Securities are available with a tenor of a few months up to 30 years. An
investor then has a wide time horizon, thus providing greater diversification
opportunities.
Another tax-friendly feature of debt funds is that there is no tax deduction at source (TDS) on
the gains. In fixed deposits, if your interest income exceeds Rs 10,000 a year, the bank will
deduct 10.3% from this income. If you are not liable to pay tax, you will have to submit
either Form 15H or 15G to escape TDS. The other problem is that the income from fixed
deposits is taxed on an annual basis.
You will get the money once the deposit matures, but the income is taxed every year. In debt
funds, the tax is deferred indefinitely till the investor redeems his units. What's more, the
gains from a debt fund can be set off against short-term and long-term capital losses you may
have suffered in other investments.
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There is no single location or exchange where debt market participants interact for common
business. Participants talk to each other, conclude deals, send confirmations etc. on the
telephone, with clerical staff doing the running around for settling trades. In that sense, the
wholesale debt market is a virtual market.
In order to understand the entirety of the debt market we have looked at it through a
framework based on its main elements. The market is best understood by understanding these
elements and their mutual interaction. These elements are as follows:
Instruments - the instruments that are being traded in the debt market.
Issuers - entity which issue these instruments
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29
CRISIL BB
(Moderate Risk)
CRISIL B
(High Risk)
CRISIL C
(Very High Risk)
Instruments with this rating are considered to have the highest degree
of safety regarding timely servicing of financial obligations. Such
instruments carry lowest credit risk.
Instruments with this rating are considered to have high degree of
safety regarding timely servicing of financial obligations. Such
instruments carry very low credit risk.
Instruments with this rating are considered to have adequate degree
of safety regarding timely servicing of financial obligations. Such
instruments carry low credit risk.
Instruments with this rating are considered to have moderate degree
of safety regarding timely servicing of financial obligations. Such
instruments carry moderate credit risk.
Instruments with this rating are considered to have moderate risk of
default regarding timely servicing of financial obligations.
Instruments with this rating are considered to have high risk of
default regarding timely servicing of financial obligations.
Instruments with this rating are considered to have very high risk of
default regarding timely servicing of financial obligations.
CRISIL D
Default
CRISIL AA
(High Safety)
CRISIL A
(Adequate Safety)
CRISIL BBB
(Moderate Safety)
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FC
High Risk
FD
Default
NM
Not Meaningful
2.3 PARTICIPANTS
Debt markets are pre-dominantly wholesale markets, with dominant institutional investor
participation. The investors in the debt markets concentrate in banks, financial institutions,
mutual funds, provident funds, insurance companies and corporate. Many of these
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participants are also issuers of debt instruments. The smaller number of large players has
resulted in the debt markets being fairly concentrated, and evolving into a wholesale
negotiated dealings market. Most debt issues are privately placed or auctioned to the
participants. Secondary market dealings are mostly done on telephone, through negotiations.
In some segments such as the government securities market, market makers in the form of
primary dealers have emerged, who enable a broader holding of treasury securities. Debt
funds of the mutual fund industry, comprising of liquid funds, bond funds and gilt funds,
represent a recent mode of intermediation of retail investments into the debt markets, apart
from banks, insurance, provident funds and financial institutions, who have traditionally been
major intermediaries of retail funds into debt market products.
The market participants in the debt market are:
1. Central Governments, raising money through bond issuances, to fund budgetary deficits
and other short and long term funding requirements.
2. Reserve Bank of India, as investment banker to the government, raises funds for the
government through bond and t-bill issues, and also participates in the market through openmarket operations, in the course of conduct of monetary policy. The RBI regulates the bank
rates and repo rates and uses these rates as tools of its monetary policy. Changes in These
benchmark rates directly impact debt markets and all participants in the market.
3. Primary dealers, who are market intermediaries appointed by the Reserve Bank of India
who underwrite and make market in government securities, and have access to the call
markets and repo markets for funds.
4. State Governments, municipalities and local bodies, which issue securities in the debt
markets to fund their developmental projects, as well as to finance their budgetary deficits.
5. Public sector units are large issuers of debt securities, for raising funds to meet the long
term and working capital needs. These corporations are also investors in bonds issued in the
debt markets.
6. Corporate treasuries issue short and long term paper to meet the financial requirements of
the corporate sector. They are also investors in debt securities issued in the market.
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7. Public sector financial institutions regularly access debt markets with bonds for funding
their financing requirements and working capital needs. They also invest in bonds issued by
other entities in the debt markets.
8. Banks are the largest investors in the debt markets, particularly the Treasury bond and bill
markets. They have a statutory requirement to hold a certain percentage of their deposits
(currently the mandatory requirement is 25% of deposits) in approved securities (all
government bonds qualify) to satisfy the statutory liquidity requirements. Banks are very
large participants in the call money and overnight markets. They are arrangers of commercial
paper issues of corporate. They are also active in the inter-bank term markets and repo
markets for their short term funding requirements. Banks also issue CDs and bonds in the
debt markets.
9. Mutual funds have emerged as another important player in the debt markets, owing
primarily to the growing number of bond funds that have mobilized significant amounts from
the investors. Most mutual funds also have specialized bond funds such as gilt funds and
liquid funds. Mutual funds are not permitted to borrow funds, except for very short-term
liquidity requirements. Therefore, they participate in the debt markets pre-dominantly as
investors, and trade on their portfolios quite regularly.
10. Foreign Institutional Investors are permitted to invest in Dated Government Securities
and Treasury Bills within certain specified limits.
11. Provident funds are large investors in the bond markets, as the prudential regulations
governing the deployment of the funds they mobilize, mandate investments pre-dominantly in
treasury and PSU bonds. They are, however, not very active traders in their portfolio, as they
are not permitted to sell their holdings, unless they have a funding requirement that cannot be
met through regular accruals and contributions.
12. Charitable Institutions, Trusts and Societies are also large investors in the debt markets.
They are, however, governed by their rules and byelaws with respect to the kind of bonds
they can buy and the manner in which they can trade on their debt portfolios.
The matrix of issuers, investors, instruments in the debt market and their maturities are
presented in Following Table.
33
34
With debt funds, bonds and debentures getting popular among the investors , and investors
starting to shift from fixed deposits to debt funds , tax on debt funds/ bonds and debentures is
something that needs to be understood before making investments in a debt fund.
COMPUTATION OF TAX ON DEBT FUNDS
TAX on bonds/ debentures/ debt funds is computed in a different manner for short term and
long term investment. The investment in debt fund is classified as short term / long term on
the following basis:
Debt fund held for less than 3 years: short term investment
Debt fund held for more than 3 years: long term investment
In case of short term investments, tax on debt funds would be levied at the time of sale as per
the income tax slab rates in force.
In case of long term investments, as per section 112 the tax would be levied @20% of profit
earned at the time of sale.
The duration for which these funds were required to be held to be classified as long term was
earlier 1 year but this has been increased to 3 years in budget 2014. Earlier the rate of tax on
long term gains was also 10% which has now been increased to 20%.
It is important to note here that no STT(securities transaction tax) is paid on the sale of debt
funds/ bonds/ debentures where as STT is paid on the sale of mutual funds. And therefore, no
tax is levied on the sale of mutual funds in case of period of holding is long term whereas tax
on sale of debt funds is liable to be paid.
Tax on interest on debt funds: interest received on debt funds is tax free in the hands of the
investors.
35
36
Let us assume that you had invested Rs. 100 in a 5-year bank Fixed Deposit at the interest
rate of 10 per cent (annual interest payout) a year ago. You have received Rs. 10 as the first
years interest payment. If the interest rate in the country fell by 1 per cent now, you will earn
1 per cent more than the market for the next four years. Now, your friend too wishes to get a
10 per cent interest, or Rs. 10 interest income on an FD; however, she cannot do that as the
current rates are 9 per cent. But if she is willing to pay a price to generate a regular 10 per
cent income for herself, she might want to buy it from you to secure her annual income.
Bank FDs cannot be transferred by you. But just for the sake of this example, let us assume
that it is transferable. If your friend is keen to generate Rs. 10 as income today, she will have
to invest at least Rs. 103 to generate Rs. 10 every year. Now that is the value of your Rs. 100
deposit today.
But if the deposit market is not very liquid, and not easily available in the market for sale,
then Rs. 103 could be trading at an even slightly higher price as a result of demand. That
means, if you sell it today, you get a capital gain (Rs. 3), over and above the Rs. 10 interest.
37
Bank FDs are not tradable in real life situations; hence, you cant gain from it by selling it
before the maturity. However, government bonds, Public Sector Unit (PSU) bonds, corporate
bonds, and bank certificates of deposits are tradable instruments. As a retail investor, you
cant buy them in small quantities. You need to open an account with a primary dealer to buy
and sell these bonds in large quantities. Besides, would you know when is the right time to
buy or sell them? Also for every such sale after buying, you would have a tax impact,
especially if you actively churn your portfolio.
As highlighted in the below chart, risk increases with the tenure of investment instruments.
When there is a fall in the markets interest rates, fixed income instruments with the longest
tenure will gain more compared to the shortest tenure instruments. Hence, funds such as
dynamic bond funds, long term income funds, and gilt funds are best placed to gain from the
falling interest rate scenario as when rates fall, the price of their underlying instruments rise.
In terms of taxation, debt funds score better than Bank FDs. If you hold your investments for
more than three years, you just need to pay only 20 per cent capital gains tax (with indexation
benefits). Since you take indexation benefits (that means adjusting the cost of your
investment for inflation), your real tax outgo will be far lower than the 20 per cent. Be it in
terms of liquidity, superior returns or tax benefits, debt mutual funds score over passive bank
deposits. Diversify your traditional debt holding with these schemes, based on your time
frame of investment to take advantage of them.
38
39
Different plans
Debt Liquid funds come with different plans like growth plans, daily dividend plan, weekly
dividend plans and monthly dividend plans. Growth plans don't declare any dividend, and
appreciation of fund is reflected in higher unit value.
Investors can choose their plan as per their convenience and liquidity needs. Retail investors
can also invest in direct plans as they have a lower expense ratio which helps in getting a
higher return.
Taxation
Dividends received under liquid plans are not taxed at the hands of resident individual
investors but fund houses pay dividend distribution tax @28.325 per cent (including
surcharge and cess).
Individual investors who books gains before a year on their investment in liquid funds are
taxed at the same rate as per their income slabs. Interest earned from savings accounts are
also taxed at this same rate.
If investors redeem liquid fund units after a year, they have to pay a long-term capital gains
tax of 11.33 per cent (including cess and surcharge) or 22.66 per cent with indexation benefit,
whichever is lower. This helps in reducing tax outgo for those in higher income tax slabs.
Earnings from savings accounts or banks fixed deposits are clubbed to one's income and are
taxed at respective slabs.
40
3.2 LIMITATION
Some of the persons were not so responsive.
Possibility of error in data collection because many of investors may have not given
actual answers of my questionnaire
Sample size is limited to visitors
41
Some respondents were reluctant to divulge personal information which can affect the
validity of all responses.
The total number of debt financial instruments in the market is so large that it needs a
lot of time and resources to analyze them all.
3.3
LITERATURE REVIEW
42
more likely to sell these assets, and consequently reduce the value of assets within the firm,
which is disadvantageous for debt holders.
Therefore, Venkiteshwaren (2010), Alderson and Betker (1995) and Sibilkov (2007) have
incorporated a difference between secured and unsecured debt in their research. Second,
assets with high liquidity have relatively low cost when being sold; as result, when mangers
have the power to liquidate the assets, investors will order management to liquidate the firm,
since this has a higher value. Consequently, this brings conflict between managers and
outside investors. By limiting a managers authority to liquidate assets this transformation
risk is eliminated.
Accordingly, Myers and Rajan (1998) conclude that there will be a curvilinear relation
between leverage and asset liquidity when managers have the power to transform assets.
Third, in some cases managers prefer to hold a lower level of debt, due to the agency
problems, risk aversion, and high performance level pressures that are associated with
holding a high amount of debt within a firm ( Berger, Ofek, and Yermack, 1997). This results
in a weak or insignificant relation between asset liquidity and leverage. Finally, when
adjusting the firms capital structure is associated with high costs and these costs are bigger
than the benefits of changing the capital structure, firms become reluctant to adjust their debt.
Age Group
No. of Investors
Less then 30
5
31- 35
3
36 40
2
43
4
Series 1
0
Less then 30
31- 35
36- 40
Interpretation :
According to this chart out of 10 Debt fund investors , 5 investors are in the age group of less
than 30, the second most investors are in the age group of 31-35 Yrs and least investors are in
the group of 36- 40.
No. of Investors
2
7
1
10
44
Education
Graduate; 70%
Interpretation
Out of 10 debt fund Investors 70% Investors are Graduate, 20% Investors are Post Graduate
and 10% Investors are Under Graduate
No. of Investors
1
9
-
45
Occupation
Student
10%
90%
Interpretation:
In occupation group 90% Investors are in Private Sector Employee and 10% are student.
No. of Investors
2
1
5
1
-
46
2
1
0
Interpretation:
In the above graphs it has to be seen that 10 out of 2 investors annual income is below 50000,
2 investor annual income is between 50000-100000 and 300000- 500000 , 5 Investors annual
income is between 100000-300000.
No. of Respondents
6
4
47
Yes
40%
No
60%
Interpretation :
In the above chart it has to be seen that 10 out of 60% investors are invest in debt fund and
other 40% investors not invest in debt fund.
No. of Respondents
6
4
48
Respondents
Yes
No
40%
60%
Interpretation :
In the above diagram it has to be seen that 10 out of 60% investors are invested in debt funds
and other 40% are not invested in debt funds
No. of Investors
2
5
49
Bond
Government Security
Categories
Interpretation :
In the above diagram it has to be seen that 10 out of 29% Investors are invested in fixed
Deposits and 71% investors are invested in Liquid Fund.
No. of Respondents
2
2
50
50%
50%
Interpretation :
Out of 4 people , who have not invested in debt fund , 50% are not aware about debt fund and
50% do not have any specific reason.
No. of Respondents
2
0
5
3
51
No. of Respondents
5
4.5
4
3.5
3
2.5
2
1.5
1
0.5
0
Factors
Interpretation:
Factor to prefer most while investing money 10 out of 2 investors factor is Liquidity, 5
investors factor is High Returns and 3 investors factor is Company Reputation
No. of Respondents
7
3
52
Kind of Investor
High Risk Taker
Kind of Investor
Interpretation :
10 out of 7 investors are Moderate Risk Taker and 4 investors are High Risk Taker.
No. Of Respondents
2
4
3
1
53
Tenure of investment
Above 5 year
3 year- 5 year
1 year- 3 year
0.5
1.5
2.5
3.5
Interpretation :
Tenure of investment 10 out of 2 investors tenure are less than 1 year, 3 investors tenure are
3year-5year , 1 investor tenure are above 5 year and other 4 investors tenure are 1 year 3
year.
No. of Respondents
2
6
2
-
54
15% - 20%
Returns
10% - 15%
Returns
No. of Respondents
Interpretation :
In the graph 10 out of 2 investors expected returns are less than 10% , 6 investors expected
returns are between 10% - 15% and other 2 investors expected returns are between 15% 20%.
No. of Respondents
6
2
2
55
Yes
No
No Response
Interpretation :
10 out of 6 investors are satisfied with Present Investment Structure , 2 investors are not
satisfied with Present Investment Structure and other 2 investors are not response for both.
No. of Response
4
3
2
56
Objective
4.5
4
3.5
3
2.5
No. of Response
2
1.5
1
0.5
0
Capital Appreciation
Liquidity
Monthly Income
Interpretation:
10 out of 4 investors objective are Capital Appreciation, 3 investors objective are Liquidity
and 2 investors objective are monthly income.
57
Questionnaire as follows. Soliciting your opinion on the following aspects. Your help is
highly needed.
1).Name:
2).Age:
3).Qualification
A)Post Graduate
B) Graduate
C) Under Graduate
D) Other
4).Occupation
A)Student
B)Businessmen
E) Other
B)50000-100000
C)100000-300000
D)300000-500000
B) No
D) Bonds
E)Government Security
B) Higher Risk
58
9). While Investing your Money which factor you prefer most?
A)Liquidity
B) Low Risk
C)High Returns
D)Company Reputation
B) Moderate Risk
B) 1year-3year
C) 3year-5year
B) 10% - 15%
C) 15%-20%
D) Above 20%
B) No
B) Tax Saving
C) Liquidity
D) Monthly Income
3.5 CONCLUSION
Debt funds are preferred by individuals who are not willing to invest in a highly volatile
equity market. A debt fund provides a steady but low income relative to equity. It is
comparatively less volatile. A debt fund is an investment pool, such as a mutual fund or
exchange-traded fund, in which core holdings are fixed income investments. A debt fund may
invest in short-term or long-term bonds, securitized products, money market instruments or
59
floating rate debt. The fee ratios on debt funds are lower, on average, than equity funds
because the overall management costs are lower.
Debt funds also tend to perform better in periods of economic slowdown. Analysts believe
that debt should be looked upon as an effective hedge against equity market volatility, which
lends stability in terms of value and income to a portfolio. Some hybrid debt schemes take
exposure in equities allowing investors participate in the stock markets as well.
Debt funds have a fairly wide range of schemes offering something for all types of
investors. Liquid fund, Liquid plus funds, Short term income funds, GILT funds, income
funds and hybrid funds are some of the more popular categories.
This project finds out the various instruments being issued by the government viz., Bonds,
Treasury Bills, Call Money Markets, Repo Markets etc., in order to finance its fiscal deficit.
It tries to analyze the basic issuance process of these instruments and the participants those
are involved in various transactions in the Wholesale Debt Market as per investors
perspective.
3.6 BIBLIOGRAPHY
News Papers
60
www.moneycontrol.com
www.valuerearch.com
www.google.com
www.bseindia.com
www.investopedia.com
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