Effective Duration & Convexity Computation requires an interest rate model There are several models (suggested by different

researchers) We do not analyze these models in this course The job is left to the practitioner (p.214-222, Ch. 9) Price Value of a Basis Point PVBP, also called money (rupee) value of a 01 (V01), is the value (ignoring sign) of the change in the price of a bond for a 1 bp change in yield Since increase and decrease in price will be same for a small change in yield, PVBP will be the same for increase as well as decrease PVBP & Duration is a special case of duration One can compute the %change in price due to any bp change in the yield

If we consider %change in price for 1 bp change in yield, it is the PVBP See Excel 14 G-Sec Market in India 1 Major segments are T-bills Dated securities of the Central Government Securities of the State Governments Govt. guaranteed bonds Repo (RBI & Interbank) Fixed-Income derivatives (FRAs and IRS), IRFs Treasury Bills Issued at a discount to the face value of Rs. 100 Return is calculated as r = {(100 P)/100}x(n/365) [should be expressed on BEY basis to facilitate comparison] 14-d and 182-d TBs were discontinued since May 2001 G-Sec Market in India 2

364-d TBs on auction basis introduced in April 1992, and 91-day TBs on auction basis were introduced in January 1993 Earlier, 91-d TBs were issued on On Tap basis as and when required led to automatic monetization of fiscal deficit phased out after 1996-97 Even individuals can hold TBs TBs not only help cash surplus agents to invest for a short period, they also help to price non-treasury short-term securities Plays an important role in monetary policy

G-Sec Market in India 3 Dated Government Securities Central Governemnt issues dated g-secs to fund its borrowing programme Apart from that, dated g-secs provide basis for pricing issues from non-Govt. sector Extremely important for conduct of monetary policy (both liquidity

management through OMO, and controlling interest arte through auctions) Instruments include Regular Coupon Bonds ZCBs (first issued in 1994) FRBs (first issued in 1995) CIBs (only issue is 6% 5-year CIB issued in Dec-1997) G-Sec Market in India 4 State Government Bonds A small part of borrowing requirement of States is met through market borrowing Issues are conducted by RBI Usually by bunching, as individual issues are small in size But has the effect that both good & bad states pay the same price Normally has fixed tenure of 10 years Earlier yield was fixed at 25 bp above 10year GoI security, but now market determined G-Sec Market in India 5

Government Guaranteed Bonds Both Central and State Governments provide guarantee to PSUs, DFIs, other statutory bodies for issuing bonds The tendency provide guarantees by both State and Central Governments have declined Market belief is that State Government guarantees have high chance of not being honoured in case of default Fixed Income Derivatives Allowed by RBI in 1999 IRS & FRAs They have become quite popular G-Sec Market in India 6 Repo RBI and Inter-bank RBI fixed repo rate is 5.75% & reverse repo rate is 4.50% RBI injects liquidity (banks borrow money from RBI) through Repo RBI absorbs liquidity (banks park their surplus with RBI) through reverse repo

Since 2004, in line with international practice, meaning of repo/reverse repo changed ADB technical report follows older definition Interbank repo discontinued in 1992 (except for TBs) Re-introduced gradually after DVP in 1995 G-Sec Market in India 7 G-secs & TBs are eligible for repo/ reverse repo From 1997-98, PSU bonds and private debt instruments have also been made eligible for repo, but only if held in demat form Not very popular (PSU bonds and private debt instruments)

Issues in G-Sec Market in India 1 Automatic monetization of fiscal deficit WMA, 1996-97

Govt. borrowing based on market determined rates See the data Auctions of TBs & G-Secs Competitive & Non-Competitive Price-based (coupon fixed) & yield-based (issued at par) Price based auctions are more efficient as it allows finer bids Uniform Price (Yield) or Multiple Price/Yield (Discriminatory) auction Notified amount (regular calendar) & MSS See RBIs notifications on auctions of TBs

RBI

Press Release on Auction of 364D TB

`PRESS RELEASE RESERVE BANK OF INDIAwww.rbi.org.in\; e-mail: helpprd@rbi.org.in PRESS RELATIONS DIVISION, Central Office, Post Box 406, Mumbai 400001Phone: 2266 0502 Fax: 2266 0358, 2270 3279 364-day Treasury Bills auction : Rs.1000 crore under regular auction, Rs.1000 crore under MSS

The Reserve Bank of India has announced the auction of 364-day Government of India Treasury Bills for notified amount of Rs. 2000 crore (Rs.1000 crore under the regular auction calendar and Rs.1000 crore under the Market Stabilisation Scheme (MSS)). The auction will be conducted on November 8, 2006 using "Multiple Price Auction" method. The allocation to the non-competitive bidders will be outside the notified amount, at the discretion of the Bank. The sale will be subject to the terms and conditions specified in the General Notification No. F.2 (12)-W & M/97 dated 31st March 1998 issued by Government of India and as amended from time to time. Tenders should be submitted in the prescribed form on Wednesday, November 8, 2006 by 12.30 P.M. Results will be announced on the same evening. Payments by successful bidders will be on Friday, November 10, 2006. Ajit Prasad Manager Press Release : 2006-2007/612, Dated November 3, 2006

RBI

Press Release on Auction of 91-D

TB

RESERVE BANK OF INDIA www.rbi.org.inwww.rbi.org.in\hindie-mail: helpprd@rbi.org.in PRESS RELATIONS DIVISION, Central Office, Post Box 406, Mumbai 400001Phone: 2266 0502 Fax: 2266 0358, 2270 3279 91-day Treasury Bills auction :

Rs.500 crore under regular auction, Rs.1500 crore under MSS The Reserve Bank of India has announced the auction of 91day Government of India Treasury Bills for notified amount of Rs.2000 crore (Rs. 500 crore under the regular auction calendar and Rs.1500 crore under the Market Stabilisation Scheme (MSS)). The auction will be conducted on November 8, 2006 using "Multiple Price Auction" method. The allocation to the non-competitive bidders will be outside the notified amount, at the discretion of the Bank. The sale will be subject to the terms and conditions specified in the General Notification No. F.2 (12)-W & M/97 dated 31st March 1998 issued by Government of India and as amended from time to time. Tenders should be submitted in the prescribed form on Wednesday, November 8, 2006 by 12.30 P.M. Results will be announced on the same evening. Payments by successful bidders will be on Friday, November 10, 2006. Ajit Prasad Manager Press Release : 2006-2007/611, Dated November 3, 2006

RBI

Press Release on Auction of 182D TB

RESERVE BANK OF INDIA www.rbi.org.inwww.rbi.org.in\hindie-mail: helpprd@rbi.org.in PRESS RELATIONS DIVISION, Central Office, Post Box 406, Mumbai 400001Phone: 2266 0502 Fax: 2266 0358, 2270 3279

182-day Treasury Bills auction : Rs.500 crore under regular auction, Rs.1000 crore under MSS The Reserve Bank of India has announced the auction of 182-day Government of India Treasury Bills for notified amount of Rs.1500 crore (Rs.500 crore under the regular auction calendar and Rs. 1000 crore under the Market Stabilisation Scheme (MSS)). The auction will be conducted on November 1, 2006 using "Multiple Price Auction" method. The allocation to the non-competitive bidders will be outside the notified amount, at the discretion of the Bank. The sale will be subject to the terms and conditions specified in the General Notification No. F.2 (12)-W & M/97 dated 31st March 1998 issued by Government of India and as amended from time to time. Tenders should be submitted in the prescribed form on Wednesday, November 1, 2006 by 12.30 P.M. Results will be announced on the same evening. Payments by successful bidders will be on Friday, November 3, 2006. P.V.Sadanandan Manager Press Release : 2006-2007/577, Dated October 27, 2006

Issues in G-Sec Market in India 2 Uniform Price Auction Bid-cover ratio

Higher

is this, stronger the auction

Dispersion of the winning bids

Higher

is this, more uncertainty in market about the yield

Stop-out yield (Cut-off yield in India) decided by RBI depending on liquidity conditions Bidders who bid above this will not win Pro-rata allocation if required, or mandatory purchase by PDs, failing which devolvement on RBI Even if one bids aggressively, will get at the stop-out yield only (if successful)

Issues in G-Sec Market in India 3 Multiple Price (Discriminatory) Auction Successful bidders get the rate bid by them Stop-out yield determined by RBI depending on liquidity conditions Bidders who bid above this will not win Pro-rata allocation at stop-out bid if required, or mandatory purchase by PDs, failing which devolvement on RBI Only the more aggressive bidders will win

Winers Curse: possibility that aggressive bidder will pay too much relative to market consensus To counter this possibility, bidders tend to shade down their bids, invest considerably to find market consensus

Issues in G-Sec Market in India 4 The incentive to do research is much less in uniform price auction Because winners curse is absent Uniform price auction tends to experience higher bid-cover ratio and a higher dispersion of winning bids Bidders bid more aggressively in UPA, because they know they will be paying the market-clearing price (stop-out yield) As more aggressive bids are received, stopout yield will go down, given the quantity notified This will benefit the exchequer Issues in G-Sec Market in India 5 When-Issued Market

When, as, and if issued Trading during the time between when the auction is announced and when the securities are issued Helps the bidders to form an idea of the markets expectation about the yield Position has to be necessarily closed on receipt of securities Forward contract with issue date as the settlement date Recently (May 2006) been allowed in India Initially with re-issuance (Central Govt. securities) Later on with new issues Issues in G-Sec Market in India 6 Negotiated Dealing System (NDS) Electronic platform for dealing in g-secs & money market instruments Both primary (submission of bids/ application) & secondary market transactions Only holder of SGL/Current account with RBI can become member of NDS

Only TBs & dated securities for both repo and outright transaction will be through NDS Deals done on NSE/BSE by brokers of these exchanges will have to be reported to NDS by corresponding NDS member (& not by the brokers) Issues in G-Sec Market in India 7 Deals done over phone or directly between two parties have to be reported to NDS Settlement is ultimately through Securities Settlement System at PDO, RBI Trades over NDS can also be settled through CCIL CCIL follows novation, which eliminates counterparty risk It also has improved risk management system (mark-to-market and maintenance margins, guarantee fund) CCIL settles securities on gross basis and funds on net basis

Members have the option to settle either thorough CCIL or directly through SSS of PDO G-Sec Market in India Readings
Government Securities Market in India ADB Report on Development of a Secondary Market, Chapter 1 (pp. 1 22 of document; p. 18 39 of PDF file). Broadening & Deepening Bond Market in India Patil Developing Bond Markets Usha Thorat Chapters 4 & 5, RBI Report on Central Government Securities Market (July 2005). FAQ_NDS Corporate Bond Market in India ADB Report on Development of a Secondary Market, Chapter 1 (pp. 23 41 of document; p. 40 58 of PDF file). Broadeing & Deepening Bond Market in India Patil Developing Bond Markets Usha Thorat