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SEBT
SEC
NIFTY 100 has provided more consistent returns over NIFTY50 over a period of
10 years. This is from Jan 2012 - Oct 2022. It has, however, been slightly riskier
with higher returns and lower negative returns in case of a recession or an
economic downturn. The same goes for NIFTY200 returns over NIFTY50. It is a
little riskier than NIFTY100.

NIFTY NEXT50 means the 51st to 100th Company based on Free Float Market
Cap. The returns generated by NIFTY NEXT50 have although been a little more
volatile than NIFTY50, they have been steadily higher than NIFTY50. Also known
as NIFTY JUNIOR Index. NIFTY NEXT50 too comprises Large Cap companies.

Auto index is a cyclical index. Although FMCG index has not been hampered
much by downturns as it is essential for the economy.

IT Sector has seen a tremendous growth in India lately. This is especially since
India has become a services exporter hub, in the form of Infrastructure Technology
services. Pharma sector has been a defensive sector.

India consumption has been steadily rising albeit at a faster rate than the returns
generated by NIFTY50.

ESG too (Environment Social Governance) has been gaining traction lately.

Alpha50 index has been by far the best performing index. It generates returns well
over and above the ones given by the Market (NIFTY50). Although they are
extremely risky too (inherent in nature).

High Beta stocks are very volatile with Betas greater than 1. Some stocks which
are defensive in nature have a negative beta too.
Institutions:

RBI (Reserve Bank of India)

It is the Central Bank of India. It maintains the reserves of all schedules banks and
is hence known as the “Reserve Bank.”

It maintains Forex (Foreign Exchange Reserves) in the form of foreign currency i.e
USD. As of today, RBI has forex more than $540 Billion. It has the responsibility
to control the banking system in the country. Controls the supply of money through
its monetary policies.

Commercial Banks
A commercial bank is a financial institution that provides services like loans,
certificates of deposits, savings bank accounts, bank overdrafts, etc. to its
customers. These institutions make money by lending loans to individuals and
earning interest on loans. They borrow money from the RBI. Examples are: SBI,
ICICI Bank, HDFC Bank etc.

Investment / Merchant Banks

They are financial intermediaries that acquire the savings of people, corporations,
government and direct these funds into the business enterprises seeking capital.
They provide services such as long term financing, Underwriting, purchase and
selling of securities, advisory services etc. They act as intermediaries between
security issuers and investors and help new firms to go public.

Mutual Funds
It is a company that pools money from many investors and invests the money in
securities such as stocks (long term), bonds (long-term) and even short-term debt.
The combined holdings of the mutual fund are known as its portfolio. Investors
buy shares in mutual funds. NAV is the Net Asset Value of a Mutual fund which is
the unit price of the mutual fund. NAV is the total assets minus its total liabilities.
For example, if an investment company has securities and other assets worth $100
million and has liabilities of $10 million, the investment company's NAV will be
$90 million.
Net Asset Value = (Fund Assets - Fund Liabilities) / Total number of Outstanding
Shares.

Insurance/ Pension funds

Insurance companies offer insurance policies and annuities, which can be financial
instruments. Pension funds use a variety of different financial instruments to invest
across different asset allocations. Both pension funds and insurance companies are
the leading institutional investors in bond and stock markets, as they make a major
contribution to the development of stock markets as investors, but also as financial
intermediaries.

Stock Exchanges
It is a platform where buyers and sellers come together to trade financial tools
during specific hours of any business day while adhering to SEBI's well-defined
guidelines. However, only those companies who are listed in a stock exchange are
allowed to trade in it.

There are 23 stock exchanges in India. Among them, two are national-level stock
exchanges namely Bombay Stock exchange (BSE) and National Stock Exchange
(NSE). The rest 21 are Regional Stock Exchanges (RSEs).
Depositories and Custodians

There are two types of depositories in India namely CDSL (Central Depository
Services Limited) and NSDL (National Securities Depository Limited). A
depository allows traders and investors to hold securities in dematerialized form
(Demat Account). It eliminates the risk related to holding physical financial
securities (earlier held as share certificates).

Custodians are clearing members but not trading members. They settle trades on
behalf of their clients that are executed through other trading members. A trading
member may assign a particular trade to a custodian for settlement. The custodian
is required to confirm whether he is going to settle that trade or not. Custodians are
generally large financial institutions that hold their customers' securities.

Clearing Houses

A clearing house or clearing division is an intermediary that validates and finalizes

transactions between buyers and sellers in a financial market. It ensures that both
the buyer and the seller honor their contractual obligations. The responsibilities of
a clearinghouse include "clearing" or finalizing trades, settling trading accounts,
collecting margin payments, regulating delivery of the assets to their new owners,
and reporting trading data.

Brokers / Dealers

A broker executes orders on behalf of clients and can be either a full-service broker
or a discount broker that only executes trades.

Meanwhile, a dealer facilitates trade on behalf of itself. Some dealers, also called
primary dealers, also facilitate trades on behalf of the U.S. Federal Reserve to help
implement monetary policy.
Broker-dealers are those that perform both responsibilities, such as traditional Wall
Street organizations, as well as large commercial banks among others.

FIMMDA (Fixed Income Money Market and Derivatives Association)

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, its associate banks, Bank
of India, Bank of Baroda; Private sector Banks such as ICICI Bank, HDFC Bank,
IDBI Bank; Foreign Banks such as Bank of America, ABN Amro, Citibank.
FIMMDA addresses issues that affect the entire industry.

It functions 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.

Primary Dealers / PDAI (Primary Dealers' Association of India)

A primary dealer (PD) is an RBI registered entity that is authorized in buying and
selling government securities. Examples are:
a) Goldman Sachs (India) Capital Markets Private Limited.
b) Morgan Stanley India Primary Dealership Ltd.
c) ICICI Securities Primary Dealership Ltd.
d) Nomura Fixed Income Securities Private Limited.
e) PNB Gilts Limited.
They have the license to purchase and sell government securities. They are entities
who buy government securities directly from the RBI (the RBI issues government
securities on behalf of the government), aiming to resell them to other buyers.

PDAI is simply a group of them.

CCIL (Clearing Corporation of India Ltd.)

Acts as the central counterparty in settlement of all trades in securities and forex
segment
• Manages risks to avoid system failures
• Provides guarantee to non-SLR trades
• Operates a settlement guarantee fund
• Manages the NDS-OM and NDS-CALL electronic trading platforms for trading
in government securities and call money
• Introduces innovative products/tools such as ZCYC, Bond and T-bill indices,
and benchmarks reference rates
• Introduced CBLO and FX-CIEAR

FBIL (Financial Benchmarks India Ltd.)

Financial Benchmarks India Pvt. Ltd (FBIL) was incorporated in 2014 as per the
recommendations of the Committee on Financial Benchmarks. FBIL has so far
taken over existing benchmarks such as Mumbai Inter-Bank Outright Rate
(MIBOR) and option volatility and introduced new benchmarks such as Market
Repo Overnight Rate (MROR), Certificate of Deposits (CDs) and T-Bills yield
curves.
The development of FBIL as an independent organization for administration of all
financial market benchmarks including valuation benchmarks is important for the
credibility of these benchmarks and integrity of financial markets. Accordingly, it
is proposed that (i) FBIL would assume the responsibility for standardizing the
valuation of Government securities (issued by both the Centre and States) currently
being done by FIMMDA; and (ii) FBIL would also assume the responsibility for
computation and dissemination of the daily “Reference Rate” for Spot USD/INR
and other major currencies against the Rupee, which is currently being done by the
Reserve Bank. The effective dates for implementation of these two functions will
be indicated by FBIL and the Reserve Bank.

FEDAI (Foreign Exchange Dealers Association)

The FEDAI is a self-regulating organization (SRO) that formulates rules around

Indian interbank forex dealings.
Some core functions of the FEDAI include advising and supporting member banks,
representing member banks on the Reserve Bank of India (RBI), and announcing
rates to member banks.
FEDAI also help stabilize markets through its cooperation with the RBI and the
Fixed Income Money Market and Derivatives Association of India (FIMMDA).

Underwriting determines the risk and price of a particular security. It is a process

seen most during initial public offerings, wherein investment banks first buy or
underwrite the securities of the issuing entity and then sell them in the market. The
most common type of underwriting agreement is a firm commitment in which the
underwriter agrees to assume the risk of buying a certain inventory of stock issued
in the IPO and selling it to the public at the IPO price.

Rights Issue ratio of 1:3 (pronounced 1 for 3) means 1 Equity Share for every 3
Equity Shares held by the Eligible Equity Shareholders in the Company are
eligible to subscribe to this rights issue. Only given to existing shareholders.

Private placements

A private placement is a sale of stock shares or bonds to pre-selected investors and

institutions rather than publicly on the open market. It is an alternative to an initial
public offering (IPO) for a company seeking to raise capital for expansion. It is
where a business sells corporate bonds or shares to investors without offering them
for sale on the open market. These investors could be insurance companies, VCs
(Venture Capitalists), High-Net-Worth Individuals (HNIs) etc.

Euro Issues
Euro issue is a name given to sources of finance/capital available to raise money
outside the home country in foreign currency.

Types of euro issue:

The most frequently used bases of funds that fall under Types of Euro Issues are:

ADR: It stands for American Depository Receipts, which are a kind of negotiable
security instrument that is issued by a US Bank representing a specific number of
shares in a foreign company that trades in US financial markets. ADRs make it
easy for US investors to purchase stock in foreign companies.

GDR: It stands for Global Depositary receipts. It is a type of bank certificate that
acts as shares in foreign companies. It is a mechanism by which a company can
raise equity from the international market. GDR is issued by a depository bank
located overseas or in other words, GDR is issued by a depository bank which is
located outside the domestic boundaries of the company to the residents of that
country. GDR is mostly traded in the European Market. Issuing GDR is one of the
best ways to raise equity from overseas. Eg: A company located in India, looking
to get stock listed on the French Stock Exchange, will get into an agreement with a
depository bank of France, which in turn will issue shares to the residents of
France after getting permission from the company’s domestic custodian.

DRHP (Draft Red Herring Prospectus): A draft red herring prospectus (DRHP),
also known as the offer document, is prepared by the merchant bankers as a
preliminary registration document for companies looking to float an IPO for book
building issues. It is basically a comprehensive document that's filed to provide key
information about the company to prospective investors.
Seasoned offering or Follow-on Public Offering (FPOs): If a company is
already listed on stock exchanges and simply decides to release additional stock or
debt instruments, it is considered a seasoned issue. When an existing publicly
traded company decides to raise additional capital by selling additional shares of
its stock or debt instruments to the public, the share offering is considered a
seasoned issue. New shares are issued here.

Syndicated public offering - Basically a group of investment banks that work

together to sell an initial public offering (IPO) of stock or other securities to the
market. This usually happens when the issue size is too large as seen in the case of
LIC IPO.

Best Efforts Underwriting - In a best effort underwriting, the underwriters do not

agree to purchase all the securities from the issuer. Underwriters agree to use their
best efforts to sell the securities and act only as an agent of the issuer in marketing
the securities to investors.

Private Placement Agents - registered agent who connects investors with

companies offering securities. Some placement agents provide other services, such
as negotiating, preparing marketing material, and developing targeting strategies.

Shelf Registration / Offering

A shelf offering allows a company to register a new issue with the SEC but allows
for a three-year period (up to one year in India) to sell the offering instead of all-at-
once.
This lets a company adjust the timing of the sales of a new issue to take advantage
of more favorable market conditions should they arise in the future.
The company maintains any unissued shares as treasury stock, where they remain
"on the shelf" until offered for public sale.
QIB (Qualified Institutional Buyers)

Qualified Institutional Buyers are those institutional investors who are generally
perceived to possess expertise and the financial muscle to evaluate and invest in
the capital markets. QIBs are mostly representatives of small investors who invest
through mutual funds, ULIP schemes of insurance companies and pension
schemes. QIB's are prohibited by SEBI guidelines to withdraw their bids after the
close of the IPOs. QIB's are not eligible to bid at cut-off price.

SPACs (Special Purpose Acquisition Companies)

It is a company without commercial operations and is formed strictly to raise

capital through an initial public offering (IPO) or the purpose of acquiring or
merging with an existing company.

IPO Process
There are two types of IPOs.
A fixed price issue where the price of shares is fixed and a book building issue
where the shares are set after the closing date of the bid. A company can make use
of both types of shares separately or combined for an IPO.

Book building is the process by which an underwriter attempts to determine the

price at which an initial public offering (IPO) will be offered. The process of price
discovery involves generating and recording investor demand for shares before
arriving at an issue price. Book building is the de facto mechanism by which
companies price their IPOs and is highly recommended by all the major stock
exchanges as the most efficient way to price securities.

Green Shoe Option - It is simply an intervention mechanism used by the

underwriter to buy back a certain percentage of the company's shares to support
dropping prices and stabilize share prices during the 30-day stabilization period
immediately after listing.
It is an option exercised by the underwriter to buy back a specified number of the
company's shares at a predetermined price to support the share price without
putting any of its own money at risk. The underwriter is allowed to do so because,
at the time of the IPO, the firm provides an extra 15 percent share to the
underwriter purely for risk management purposes if the share price falls below the
offer price after listing.
The underwriter sells these shares short only to buy them back at the same price at
which they were sold. If the scrip's price rises, the underwriter may purchase them
back at the same price, exiting the position at no-profit, no-loss. The green shoe
option refers to the exceptional privilege that allows the underwriter to purchase
back the shares at the offer price alone. If the price falls below the offer price, the
underwriter buys the shares back at the market price. The underwriter's significant
purchasing move leads the stock price to climb. The underwriter also receives a
per-share profit equivalent to the drop in share price after listing. The following
example clarifies the green shoe choice process:

The corporation sells its shares to an underwriter for Rs 10 per share. At the offer
prices, the underwriter sells 115 per cent of the shares. This effectively suggests
that the underwriter is 15% short.

The price dropped to Rs 8 after the listing. Instead of exercising the green shoe
shares option, the underwriter acquires the stock for Rs 8. This buying activity
boosts the stock's price. The underwriter earns Rs 2 per share.

If the price rises to Rs 12, the underwriter exercises the green shoe shares option,
which allows him to buy back the shares at Rs 10 only if the market price is Rs 12.
Bond markets: The bond market broadly describes a marketplace where investors buy debt
securities that are brought to the market by either governmental entities or corporations

Govt securities are sold using Dutch auction method.

Dutch Auction method: refers to a type of auction in which an auctioneer starts with a very high
price, incrementally lowering the price until someone places a bid.

Market Liquidity: Market liquidity is a market's ability to facilitate the purchase or sale of an asset
without causing drastic change in the asset's price. So, an asset's market liquidity describes an
asset's ability to sell quickly without having to reduce its price to a significant degree. Bond market
liquidity therefore refers to the market liquidity of bonds.

Round Trip: Round trip transaction costs refer to all the costs incurred in a financial transaction, such
as commissions and exchange fees.

Market Architecture:

Open outcry was a popular method for communicating trade orders in trading pits before 2010. The
verbal and hand signal communication used by traders at stock, option, and futures exchanges are
now rarely employed, replaced by faster and more accurate electronic order system.

A dealer market is a transparent financial market mechanism in which multiple dealers post the
prices they are willing to buy or sell a specific security.Bonds and foreign exchanges trade primarily
in dealer markets.

Alternative trading systems (ATS) are venues for matching large buy and sell transactions.They are
not as highly regulated as exchanges. Ex. An electronic communication network (ECN) is a digital
system that matches buyers and sellers looking to trade securities in the financial markets

Market Design:

1. Standardization ensures that certain goods or performances are produced in the same way via set
guidelines. Standardized lots are used in trading stocks, commodities, and futures to allow for
greater liquidity, efficiency, and reduced costs.

2. Intermediaries: Intermediaries are the middlemen between any two parties that are partaking in
a transaction. These middlemen act as the bridge between them and help in exchanging necessary
information towards fulfilling the objective of a common goal. Types: Agents & Brokers, Distributors,
Retailers, Resellers and Wholesellers.

3. Anonymous trading may be important to large traders who don't want to provide clues to other
traders that they are buying or selling.

4. Enforcement and Prosecution: is to promote efficient, open, stable and sound financial systems,
based on high levels of transparency, confidence, and integrity, so as to contribute to sustainable
and inclusive growth.

Settlement And Clearing

1. Short Selling: Going 'short' indicates that an investor believes that prices will drop and
therefore will profit if they can buy back their position at a lower price.
2. Margin Trading: Margin trading refers to the process of trading where an individual
increases his/her possible returns on investment by investing more than they can afford to.
Here, investors can benefit from the facility of purchasing stocks at a marginal price of their
actual value. Such trading transactions are funded by brokers who lend investors the cash to
purchase stocks. The margin can later be settled when investors square off their position in
the stock market.

Types of Orders:

1. Time Conditions: - A day order is an order to buy or sell a security at a specific price that
automatically expires if it is not executed on the day the order was placed.
- A Good-Til-Cancelled (GTC) order is an order to buy or sell a stock that lasts until the
order is completed or canceled.
- this means that this order is valid till a specified date or time unless it has been already
fulfilled or cancelled.
- An Immediate-Or-Cancel (IOC) order is an order to buy or sell a stock that must be
executed immediately. Any portion of an IOC order that cannot be filled immediately will
be cancelled.
2. Price Conditions:
- A limit order in the financial markets is a direction to purchase or sell a stock or other
security at a specified price or better
- A market order is an order to buy or sell a stock at the market's current best available
price. A market order typically ensures an execution, but it does not guarantee a
specified price. Market orders are optimal when the primary goal is to execute the trade
immediately
- A stop order is an order to buy or sell a stock at the market price once the stock has
traded at or through a specified price (the "stop price"). If the stock reaches the stop
price, the order becomes a market order and is filled at the next available market price.
3. Quantity Conditions:
- A Disclosed Quantity condition allows you to disclose only a part of the order quantity to
the market. This quantity, however cannot be more than the total quantity of the stocks
you are purchasing. The Stock Exchange may set minimum disclosed quantity criteria
from time to time.
- A special term order with a minimum fill condition will only begin to trade if its first fill
has the required minimum number of shares. For example, an order to buy 5,000 shares
with a minimum volume of 2,000 shares can only trade if 2,000 or more shares become
available.
- An All-Or-None (AON) order is an order to buy or sell a stock that must be executed in its
entirety, or not executed at all. AON orders that cannot be executed immediately
remain active until they are executed or cancelled.

MF and AON are no longer available

Order Matching: Matching orders is the process of identifying and effecting a trade between
equal and opposite requests for a security (i.e., a buy and a sale at the same price).Order
matching is how many exchanges pair buyers and sellers at compatible prices for efficient
and orderly trading.

What Drives Prices?

The CAPE ratio is used to analyze a publicly held company's long-term financial performance
while considering the impact of different economic cycles on the company's earnings.The
CAPE ratio is similar to the price-to-earnings ratio and is used to determine whether a stock
is over-or under-valued.

India VIX is a volatility index based on the NIFTY Index Option prices. From the best bid-ask
prices of NIFTY Options contracts, a volatility figure (%) is calculated which indicates the
expected market volatility over the next 30 calendar days

Fixed Income Securities:

Call money is any type of short-term, interest-earning financial loan that the borrower has
to pay back immediately whenever the lender demands it.Call money allows banks to earn
interest, known as the call loan rate, on their surplus funds.

Where money is borrowed or lend for period between 2 days and 14 days it is known as
'Notice Money'. And 'Term Money' refers to borrowing/lending of funds for period
exceeding 14 days.

Treasury bills are money market instruments issued by the Government of India as a
promissory note with guaranteed repayment at a later date. Funds collected through such
tools are typically used to meet short term requirements of the government, hence, to
reduce the overall fiscal deficit of a country.

What are dated securities? Dated G-Secs. 1.5 Dated G-Secs are securities which carry a fixed
or floating coupon (interest rate) which is paid on the face value, on half-yearly basis.
Generally, the tenor of dated securities ranges from 5 years to 40 years.

Corporate bonds are debt securities issued by private and public corporations. Companies
issue corporate bonds to raise money for a variety of purposes, such as building a new plant,
purchasing equipment, or growing the business
Commercial paper is an unsecured form of promissory note that pays a fixed rate of
interest. It is typically issued by large banks or corporations to cover short-term receivables
and meet short-term financial obligations, such as funding for a new project

Commercial Deposits: Commercial banks accept various types of deposits from the public
especially from its clients, including saving account deposits, recurring account deposits, and
fixed deposits. These deposits are returned whenever the customer demands it or after a
certain time period.

Companies, banks and insurers issue hybrid securities and notes. They are complex financial
products that combine the features of bonds and shares. They can provide income, like a
bond, but their value can fall dramatically, like shares. Hybrids can also have features that
impact the future value of your investment.

An interest rate swap is a contractual agreement between two parties to exchange interest
payments. The most common type of interest rate swap arrangement is one in which Party A
agrees to make payments to Party B based on the fixed interest rate, and Party B agrees to
pay party A based on the floating interest rate
 bUs md datea eewuie

CDCowAhak depou -isved ky wk h dpeuh

ce mmnjal pape - shnt tLun momy n t h a a
mpray nmin 2H Aayt
mmiud þape >No ullatral luukr
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lyrnd NAs
Comblhe Cauc bmds ad choe.

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pr
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s

ha tnbin rnulHple payok

prm mulhpla
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 bullek paymunt: a Jump sum payment made frr
The ntih on oudstandinn loan amounf
hich tre
1oum v mahvih. ngm q hme duwuun
w|l oere invt "pymentr he Invutmert:
gore
e w n

ManCaNIU bmds Cmhnued

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Cross dlault clauses

to cortaln loans r bmd
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in me (ngtance will COuy ovor to another

Somene dhaulkk om their Cos loan.

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du auulh om hou movtq

o
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intvet pamen bur (wn be Cmvekevd in id

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mbrid Note

STRIPS Sepmate hadim o vegickend inttut

na Poncipal slwnhe.

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(oupm bcainy bmd intwitindiudua
CouPor Amal inci pa cmpmenk
make no peiodic intevect paymenh and
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T Pincipa Bmd Market

-Secs GOL Secs

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to meet
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mahura d meyun awu catteA 1-bil.
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stale developmen loans
Alko Calud SDL
ReL m bchal-o sfate
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Sunday, 20 November 2022

FIS 138 onwards

Page 133-138 on physical notebook

Auction -
A government bond auction is the process of selling short
and long-term government bonds to investors in an attempt
to minimise the cost of financing national debt.

The process starts with the central bank announcing how

much money it intends to borrow. Details like the term
length of the bonds and the date of the auction are included
in the announcement.

Price-based auction -

Price Based Auction: A price based auction is conducted

when Government of India re-issues securities issued
earlier. Bidders quote in terms of price per Rs.100 of face
value of the security (e.g., Rs.102.00, Rs.101.00, Rs.100.00,
Rs.99.00, etc., per Rs.100/-). Bids are arranged in
descending order and the successful bidders are those who
have bid at or above the cut-off price. Bids which are below
the cut-off price are rejected.

1
Yield-based auction-
Yield Based Auction: A yield based auction is generally
conducted when a new Government security is issued.
Investors bid in yield terms up to two decimal places (for
example, 8.19 per cent, 8.20 per cent, etc.). Bids are
arranged in ascending order and the cut-off yield is arrived
at the yield corresponding to the notified amount of the
auction. The cut-off yield is taken as the coupon rate for the
security. Successful bidders are those who have bid at or
below the cut-off yield. Bids which are higher than the cut-
off yield are rejected.

Non-competitive bidding -
Non-competitive bidding means the bidder would be able
to participate in the auctions of dated government
securities without having to quote the yield or price in
the bid.

Private placement with RBI -

A ‘private placement’ of securities is an offering of
securities that is not a ‘public offering’. In general, private
placement is defined as issuance of securities to less than 50
persons.1 Unlike a public offering, private placement is
exempt from filing an offer document with the Securities
and Exchange Board of India (SEBI) for its comments.
Further it may not involve any form of general
announcement, general solicitation, advertising, any
seminar or meeting whose attendees have been invited by a
general solicitation or advertisement.

2
The Main Investors
Banks – required to maintain 18% of Net Demand and Time
Liabilities in Government and State Government Bonds

Excess investments of 10%

LIC and Other Insurance and Pension Funds

Provident Funds need to maintain at least 25% in
Government Bonds and 15% in State Government Bonds

Mutual Funds have emerged as large investors – specially

for structured obligations
"Structured Finance Obligation means any obligation issued
by a special purpose vehicle and secured directly by,
referenced to, or representing ownership of, a pool of
receivables or other financial assets of any obligor,
including collateralized debt obligations and mortgaged-
backed securities."

Trusts are also large investors, unless specifically

constituted to invest in other instruments
Still a “dirty” phone market
In short, a dirty bond price includes accrued interest while
a clean price does not.

Accrued interest is calculated as

(days from last coupon to settlement/days in the coupon
period) X coupon.

3
NDS – the Negotiated Dealing System launched in Feb
2002

Phone deals confirmed on the NDS and CCIL

NDS Order Matching (NDS-OM) launched in Aug 2005

The System facilitates placement of bids and offers which it
matches on price/time priority or yield/time priority that is,
within the orders of the same price or yield (as applicable),
it matches the order first received by the System.

While order matching is facilitated in "clean" price and or

yield terms, based on the type of instrument, settlements
take place only in "dirty" price terms based on settlement
considerations computed on the basis of relative clean
traded price and taking into account broken period interest
from the last coupon payment date for the traded security.

Deals usually T+1 Lot Size : Rs 5 crores

Dated Government securities are long term securities or
bonds of the government that carries a fixed or
floating coupon (interest rate). Securities are issued by the
government (centre or state) for mobilizing funds.

The securities are named as dated securities because of the

date of maturity expressed. For example, a January
1st, 2018 security will mature on January 1st, 2018. Its
interest may be expressed as say, 7.97% as the coupon rate.

4
Main Risks in a Bond
Credit Risk -
Credit risk is the possibility of a loss resulting from a
borrower's failure to repay a loan or meet contractual
obligations. Traditionally, it refers to the risk that a lender
may not receive the owed principal and interest, which
results in an interruption of cash flows

Risk of default-
Default risk is the possibility that a bond's issuer will go
bankrupt and will be unable to pay its obligations in a
timely manner if at all. If the bond issuer defaults, the
investor can lose part or all of the original investment and
any interest that was owed.

Risk of rating change -

Above all, credit ratings affect the cost of borrowing—that
is, the interest rate that will have to be paid by the issuer to
attract buyers. The interest cost to the issuer is the coupon
you will earn.
If bonds are downgraded (that is, if the credit rating is
lowered), the bond price declines. If the rating is upgraded,
the price goes up. In fact, bond prices sometimes change if
there is even a strong possibility of an upgrade or a
downgrade. This is because anxious investors sell bonds
whose credit quality is declining and buy bonds whose
credit quality is improving.

5
Inflation Risk
Just as inflation erodes the buying power of money, it can
erode the value of a bond's returns. Inflation risk has the
greatest effect on fixed bonds, which have a set interest rate
from inception.
For example, if an investor purchases a 5% fixed bond and
inflation rises to 10% per year, the bondholder is effectively
losing money on the investment because the purchasing
power of the proceeds has been greatly diminished.

Market Risk
Market risk is the probability of losses due to market
reasons like slowdown and rate changes. Market
risk affects the entire market together. In a bond market, no
matter how good an investment is, it is bound to lose value
when the market declines. Interest rate risk is another form
of market risk.

Changes in interest rate Manage by BPV

Basis Point Value
BPV is a method that is used to measure interest rate risk. It
is sometimes referred to as a delta or DV01. It is often used
to measure the interest rate risk associated with swap
trading books, bond trading portfolios and money market
books. Traders can use BPV in order to adjust their
exposure to interest rate risk. If a dealer expects interest
rates to rise he will reduce the BPV of the portfolio. If he
expects rates to fall the BPV will be increased.

6
Duration
Duration, expressed in years, is a key measure of a bond
fund's sensitivity to interest rate changes. The longer the
duration, the more a bond's value will rise or fall with
changes in market interest rates. Investing in shorter-
duration bonds or funds when interest rates rise may help
limit price declines.

Reinvestment Risk Yield Curve Risk

Reinvestment risk refers to the possibility that an investor
will be unable to reinvest cash flows received from an
investment, such as coupon payments or interest, at a rate
comparable to their current rate of return. This new rate is
called the reinvestment rate.

The yield curve risk is the risk of experiencing an adverse

shift in market interest rates associated with investing in
a fixed income instrument. When market yields change, this
will impact the price of a fixed-income instrument. When
market interest rates, or yields, increase, the price of a bond
will decrease, and vice versa.

Shape of the curve

When interest rates converge, the yield curve flattens.
A flattening yield curve is defined as the narrowing of
the yield spread between long- and short-term interest rates.

If the yield curve steepens, this means that the spread

between long- and short-term interest rates widens. In other
7
words, the yields on long-term bonds are rising faster than
yields on short-term bonds, or short-term bond yields are
falling as long-term bond yields are rising. Therefore, long-
term bond prices will decrease relative to short-term bonds.

On rare occasions, the yield on short-term bonds is higher

than the yield on long-term bonds. When this happens, the
curve becomes inverted. An inverted yield curve indicates
that investors will tolerate low rates now if they believe
rates are going to fall even lower later on

Liquidity Risk
Liquidity risk Liquidity refers to the investor’s ability to sell
a bond quickly and at an efficient price, as reflected in the
bid-ask spread. A difference may exist between the prices
buyers are bidding and the prices sellers are asking on large,
actively traded bond issues. The gap is often small,
producing greater liquidity. As the spread rises on less
actively traded bonds, so does liquidity risk

8
Bonds affect the stock market because when bonds go
down, stock prices tend to go up. The opposite also
happens: when bond prices go up, stock prices tend to go
down. Bonds compete with stocks for investors' dollars
because bonds are often considered safer than stocks.

9
The price return typically captures the capital gain or loss
without coupons or dividends. By comparison, the total
return captures both the capital gains and the income
generated from coupons and dividends. The latter provides
a much more complete picture of performance — especially
for stocks or funds that have high coupons and dividends.

The catch is that the total return assumes that dividends are
reinvested into the stock or fund in question.

10
Fixed income markets: risk and return conventions

Bonds are rated taking into consideration the issues default risk. Bond investors
typically evaluate the default risk by analysing the issuers financial ratios and
security prices. Two major bond rating agencies are Moody's and Standard and
Poor.
In this figure we can see that the 5 year Government Securities bond and 5Y
AAA Bond Yield move along the same lines, the gap represents the spread/ risk
of the company.

For Example
5 YR G-SEC Yield: 7%
Spread is 100 basis points
5 YR AAA Bond Yield= 7% + 1%(100 bp) = 8%

Valuation of Bonds

Any instrument in finance can be broken down into two components:

1. Amount and Timing of Cash Flow
2. Time Value of Money: Present Value, Future Value

Valuing bonds also includes finding the values of cashflows and finding the
present value of cash flows.
The Cashflows from a bond can be widely divided into two parts
1. Periodic interest payments called coupons: Eg: A bond promising a
coupon at the rate of 10% payable semi-annually will pay Rs 5 per 100
rupees of face value every 6 months till the date of maturity.

2. A bond with a face value of Rs 100 will pay the holder Rs 100 on the date
of maturity, in addition to last coupon payments.

Calculating Bond Price

This is exactly similar to NPV.

Here we have to discount the cash flows using Y. We divide it by K

because k = frequency of coupon payment in a year so if coupon is paid 6
times k=6.
t= period

And FV is the face value which is discounted using n which is the year
maturity

Relationship Between Coupon Yield and Price

Keeping the coupon rate constant, an increase in yield will lead to a
decrease in price of the bond and vice-versa.

Keeping the yield constant an increase in coupon rate will lead to an

increase in price of the bond and vice-versa.

Bond will trade at par when the coupon and the yield are same.

Example

Face Value = 100

Coupon Rate= 7%
Maturity: 2 years
YTM= 114 (When Trading at Par)

Suppose market interest rates fall to 5%, hence the bond is now more
lucrative in the market, so the bond will trade at a premium, say Rs 105.
Now since the coupon payment is fixed percentage on face value, and the
payment on maturity is the face value, the YTM in this case decreases.

In short keeping coupon payment constant, when price of bond increases,

YTM decreases, similarly when price of bond decreases, YTM increases.

Intuitively, keeping yield constant, if coupon payment increases, the price

of bond increases, and when coupon payment decreases price of bond
decreases.
Price of bond is directly proportional to coupon payment, keeping all
things constant.
Price of bond is indirectly proportional to YTM, keeping all things
constant.

For reference: https://www.youtube.com/watch?v=4dm_BmAvMZI

How do I value a bond on a non-coupon date?

Concept of Accrued Interest: Compensation paid by buyer to seller for
the period for which the seller has held the security
after the immediately preceding coupon date.

I am holding a bond. The bond gives out annual coupon payment of 8%

on the Face value, i.e. Rs 8. I receive the payment on 1st January. Now,
Saumya is buying this bond from me on 1st July. Since I held onto this
bond for extra 7 months without any return, I will demand an accrued
interest from Saumya because I am forgoing an income.

The concept of Day count convention: Method of counting days between

coupon periods for estimating accrued interest.

In the above case I am forgoing an Income of 7 months so I should get a

compensation of Rs 8 * 7/12= Rs 4.66.

Clean Price vs Dirty Price

The Price arrived at by discounting on a date other than the coupon
payment date contains the accrued interest component. This is the Dirty
Price.
The Clean Price is arrived at by reducing the accrued interest from the
Dirty Price.
The advantage is that Clean Prices do not show jumps or discontinuities
on the coupon date or at any time during its time path.

The Time Path of a Bond

As the time to maturity approaches, bonds are “pulled to par”, i.e. the
bonds price and the face value of the bond come closer and closer and
converge.

The price of the bond at maturity has to be equal to its redemption value
(“There is no Free Lunch”) This has significant implications for fixed
income derivatives and as far as the volatility of bond prices is concerned.

Pull to Par Effect: As the bond move towards maturity, the present value
of the face value forms a greater proportion of the bonds price because
there are a very few coupon payments left. Hence the discount or
premium bonds will converge to par at maturity.

Yield Measures

Current Yield: Relates the annual coupon interest to the market price of
the financial instrument.

Current yield = Annual coupon interest / Market price

Eg: Annual coupon interest = Rs 8
Interest rate= 8% p.a
FV= 100
Current Market Price = 98

Hence current yield= 8/98 = 8.163%

Yield-to-Maturity: The yield to maturity is the interest rate (IRR) that will
make the present value of the cash flow equal to the price of the financial
instrument.

Yield-to-Call: The Yield computed assuming the bond is called on its

first call date.

Yield-to-Worst: If the bond has a number of call options, then the worst
yield-to-call.

Yield for a Portfolio: The yield for a portfolio of bonds is computed by

determining the cash flows for the portfolio and the interest that will
make the present value of cash flows equal to the market value of the
portfolio.

Calculation of YTM
Same as calculation of IRR, set NPV to 0
Realized Yield
The actual returns on a bond consist of the following components

1. Coupon Income
2. Price realized when bond is sold
3. Re-Investment returns from coupons

Realized Yield will be different from YTM even if the bond is held to
maturity
Since the bond was held for exactly one year, the coupon received is Rs
12.50. Now the assumption is that the coupon payment is paid bi-annualy,
so the holder of the bond got Rs 12.5 / 2 = Rs 6.5 on 23rd March 2020.
He earned an interest of 7.5% on the coupon payment for the whole year
hence the effective cash inflow is Rs 6.25 * 107.5%= Rs 6.7188

Second coupon payment after 6 months was reinvested @ 7% p.a for 6

months hence effective cash inflow = Rs 6.25 * 103.5% = Rs 6.4687

Capital Gain on sale of bond = Rs 108.5 – Rs 107.42 = Rs 1.08

Hence Total Cash flow from the bond = Rs 6.7188+ Rs 6.4687 + Rs

1.08= Rs 14.2675

I had bought the bond at Rs 107.42

Hence my realized yield = Rs 14.2675/ Rs 107.42 = 13.282 %

Problems with YTM
YTM is the interest rate an investor would earn by reinvesting
every coupon payment from the bond at a constant interest
rate until the bond's maturity date, the present value of all the
future cash flows equals the bond's market price.
a. You can only calculate YTM after you know a bond’s
price.
b. It only applies to a single bond.
You should not use YTM to value COUPON PAYING
BONDS.
Correct way to value Bonds
a. Don’t use YTM
b. Use Zero Coupon Rate (ZCR) for each cash flow

ZCR: ZCR for a maturity is defined as the interest on a zero

coupon bond of that maturity.

It gives a correct picture of the value of each cash flow by

eliminating intermediate cash flows hence eliminating the
interest rate and reinvestment risks.

Zero Coupon Bond: It is a debt security that does not pay

interest but instead trades at a deep discount, rendering a
profit at maturity, when the bond is redeemed for its full-face
value(par).
These types of bonds are simple, low-maintenance investment
options, enabling investors to plan for long-term savings goals
by investing relatively small sums that grow over a longer
period of time.
Using Spot Rates for Bond Pricing

A spot rate calculation is made by determining the interest

rate (discount rate) that makes the present value of a zero-
coupon bond equal to its price. A series of spot rates must be
calculated to price a coupon paying bond – each cash
flow must be discounted using the appropriate spot rate, such
that the sum of the present values of each cash flow equals the
price.

Any bond as a package of zero-coupon bonds: To price any

bond which consists of a number of zero-coupon bonds, we
calculate the PV of each zero-coupon bond by discounting at
ZCR corresponding to the maturities of cash flow.

Definitions

Zero Rate- A n-year zero rate is the rate of interest earned on

an investment that starts today and lasts for n years.
Notice that there are no intermediate payments or equivalently
there is no coupon payments
Notice that a zero rate applies to a point of time
Zero rates are scarcely observable beyond a year as most of
the bonds beyond a year have coupon payments attached to
them.

Par rate: Par rate for a certain maturity is the coupon rate that
causes the bond price to equal its face value
Bond price is the present discounted value of future cash
stream generated by a bond.
A bond’s face value refers to how much a bond will be worth
on its maturity date.
Forward Rate: A forward rate is an interest rate applicable to
a financial transaction that will take place in the future.
In simple terms, it is the calculated expectation of the yield on
a bond that, theoretically, will occur in the immediate future,
usually a few months (or even a few years) from the time of
calculation.
It can also be interpreted as the interest rate implied by current
zero rates for a specified future time period
Suppose for a time T1 and T2 the respective spot
rates are R1 and R2 then the implied forward
rate between T1 and T2 is
(R2 T2 - R1 T1) / (T2 - T1)
YTM- is the total rate of return that will have been earned by a bond when it makes all
interest payments and repays the original principal.
The main problem in using the YTM as the measure of interest rates is that it is not
consistent across instruments. Ex- One five-year bond may have a different YTM from
another five-year bond if they have different coupon structure. So using YTM, we cannot
associate a single interest rate for a single maturity.
A zero rate, on the other hand, depends only on the maturity (point of time). A
forward rate depends on a specified future period of time. YTM talks about “up-to-the
maturity” unlike Zero rate/ Forward rate. To sum up, zero rates/forward rates are the pure
prices of time rather than the combinations of instruments and time to maturity (YTM).
Zero curve is a plot of zero rates against time with interest rates on Y axis and time
(maturities) on X axis. Its applications are:

 Identifying the difference between a security’s theoretical value relative to its

market value
 For pricing derivatives testing theories of term structure
 Estimating inflation expectations
 Understanding market expectations to aid in the implementation of monetary
policies
The slope of the yield curve provides an important clue to the direction of future short-term
interest rates; an upward sloping curve generally indicates that the financial markets expect
higher future interest rates; a downward sloping curve indicates expectations of lower rates
in the future.

Observations:

 Short rates and long rates are highly correlated, they move together
 Yield curves tend to have steep slope when short rates are low and downward slope when
short rates are high
 Yield curves are usually upward sloping

Yield curve estimation is nothing but “curve fitting”

Curve fitting is the process of constructing a curve, or mathematical function, that has the
best fit to a series of data points, possibly subject to constraints.
Bootstrapping is a method to construct a zero-coupon yield curve. The slope of the yield
curve provides an estimate of expected interest rate fluctuations in the future and the level of
economic activity.

Bond pricing Equation

 Liquidity premia: A liquidity premium is any form of additional compensation that
is required to encourage investment in assets that cannot be easily and efficiently
converted into cash at fair market value. For example, a long-term bond will carry a
higher interest rate than a short-term bond because it is relatively illiquid.
 Pull to par: Pull to par is the movement of a bond's price toward its face value as it
approaches its maturity date. Premium bonds, which trade at a higher price than
their face (par) value, will decrease in price as they approach maturity.
 Coupon Effect: If a coupon is higher than the prevailing interest rate, the bond's
price rises; if the coupon is lower, the bond's price falls.

 Benchmark effect: A benchmark bond is a bond that provides a standard against

which the performance of other bonds can be measured. Similar to benchmarking
stock performance against an equity index, a benchmark bond is used to measure
the performance of fixed income investments or portfolio managers.
 Taxation discrepancy- Different types of bonds are taxed differently. Example:
Regular taxable bonds, Tax-free bonds, Tax-saving bonds, Zero coupon bonds

Benchmark Rates

Swap Rate:

 Rate quoted by market participants for the specific tenor of swap

  Remains fixed for the tenor of the swap
 Corresponds to floating benchmark

In India there are 2 swap rate curves corresponding to following benchmark rates

 MIBOR OIS Rate

 MIFOR Rate

Some of the other benchmark introduced, but discontinued are: MITOR, Gsec Benchmark (INBMK
MIBOR OIS
The Mumbai Interbank Offer Rate (MIBOR) is one iteration of India's interbank
rate, which is the rate of interest charged by a bank on a short-term loan to
another bank. This is the interest rate at which banks can borrow funds from
other banks in the Indian interbank market.

The Mumbai Interbank Offer Rate (MIBOR) is modeled closely on London

InterBank Overnight Rate (LIBOR). The rate is used currently for forward
contracts and floating-rate debentures.

Swap curves are commonly known as OIS ( overnight index swap rate)
Floating rate benchmark :
1. Call money rate ( MIBOR)- Call money rate is the rate at which short
term funds are borrowed and lent in the money market. Call money
deals with day to day cash requirement of banks. Banks that are faced
with cash shortage borrow from other commercial banks for a period of
1-14 days
2. Daily resets happen.

TENOR- Tenor. The length of time until a loan is due. For example, a loan is
taken out with a two year tenor. After one year passes, the tenor of the loan is
one year.

Tenor can vary from one month-5 year.

Most liquid segment is 1 year.
MIBOR-OIS Curve will be constructed on the basis of trades executed in the
market. All MIBOR-OIS transactions reported to CCIL upto 5 pm are used for
computation of MIBOR-OIS Curve. The Curve will be constructed for 1, 2, 3, 6,
9, 12, 24, 36, 48 and 60 months Tenors.
Overnight repo rate is the interest rate at which different market participants
swap treasuries for cash to cover short-term cash needs. The repo rate is
helping to ensure banks have the liquidity to meet their daily operational
needs and maintain sufficient reserves.
Treasury bills or T-bills have zero-coupon rates, i.e. no interest is earned on
them. Individuals can purchase T-bills at a discount to the face/value. Later,
they are redeemed at a nominal value, thereby allowing the investors to earn
the difference.
What is a CD rate?
A certificate of deposit (CD) generally earns savers a fixed annual percentage
yield (APY) on money that's deposited for a set period. Typically, the APY on a
CD is higher than a bank's savings account since it requires your funds to be
locked in for the term of the CD.

MIFOR SWAP CURVE

The term Mumbai Interbank Forward Offer Rate (MIFOR) refers to a
benchmark rate used by commercial banks for certain financial contracts in
India. MIFOR is used for setting prices on forward-rate agreements and
derivatives. The MIFOR benchmark is a synthetic benchmark, a composite rate
with the USD LIBOR and USD INR forward premia as its components
Floating benchmark
1. Synthetic Rupee interest rate derived from FX market
2. MIFOR(Implied Rupee Rate) = LIBOR + Fwd premium
3. 6-month MIFOR and 3- month MIFOR commonly serve as the floating leg
benchmark
4. Semi-annual resets
5. Tenor can vary from 2-10 year
As per SEBI regulations, FII can invest up to 24% in India and with shareholders agreement it can go
up to 30% .

Yield curve-
Treasury yield curve

T bills, t notes and t bonds

T bills- up to one-year loans to government

T notes- 1-10 years and

T bonds- 10 -30 years

Interest rates here are annual but that doesn’t mean a T bill would get 6 percent return, 6%*1/12
would be its return.

As the time increases the interest rate increase because the money is locked in for longer duration
and thus it increases the risk associated with it.

Also, the higher the demand relative to supply the lower the interest rate. Lower the demand
higher the interest rate.

For example, government wants to borrow money for a month and a lot of people want to invest in
it then the government would offer lower interest rate and if the demand for the same is lower than
the interest rate offered would be higher.
Inverse relationship between bond price and interest rate-

When interest goes up, the very bond that is paying 10% interest for which 15% could be received in
market. The price of the bond decreases.

Similarly, when the interest rate goes down to 5% in market, but the bond is paying 10% for the
similar risk, then the price of the bond increases.

For example-

Zero Coupon bond-

Now, in this below example, we see the price of the zero-coupon bond is 950 for which the return is
1000. here interest rate is 5.3%

After a treasury price goes up to 980 and the return would be 1000, therefore the interest rate is 2%.

Both the examples show the inverse relationship between bond price and interest rates.
Macaulay Duration

MacD= the weighted average maturity of the cashflows from a bond.

When interest rate rises the price of any bonds that we hold are going to fall so
the question is, is there any metric there is to evaluate a bond and see how
sensitive its going to be the price of that bond and given there is a change in
the interest rate
MacD is measured in years,
It measures how long is it going to take to realise the cashflows.
Higher the number, more time taken, more sensitive to interest rate changes
Lower the number, less time taken, less sensitive to interest rate changes.
Volatility of the price with respect to changes in the interest rate
=4.63 years

(Here 978.05 is less than 1000 because the interest rate of bond is less than
market interest rate)

Macaulay duration equals maturity for a zero-coupon bond

Modified Duration
to measure sensitivity of price to yield.

Mac D and Mod D are equal to each other if you assume continuous compounding of interest.

But in most cases, in actual practise, we have periodic compounding, in those cases-
 30 234
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LYON -
Liquid yield option notes (LYONs), introduced by Merrill Lynch in 1985, are a
form of zero-coupon convertible bonds.

LYONs are callable, which gives the issuer the right to buy them back, and
putable, which gives the holder the right to sell them back.

LYONs have a predetermined conversion feature that allows either the holder or
issuer to convert them to a fixed number of shares of common stock.

LYONs are considered synthetic instruments. Being a synthetic vehicle means

they have a structure that simulates the cash flow of other financial instruments.
The convertible feature allows them to be converted into a predetermined
number of the underlying company's shares at certain times during the bond's
life, usually at the discretion of the bondholder.

Preference equity redemption cumulative stock (PERCS) is an equity derivative

that is classified as a hybrid security and automatically converts to equity at its
pre-determined maturity date.

PERCS are essentially a form of a covered call option structure and are popular
in an environment of declining yields because of the enhanced dividend.
PERCS falls under the umbrella of a non-traditional convertible security known
as "mandatory convertibles."

Preferred Redeemable Increased Dividend Equity Securities (PRIDES) are

synthetic securities consisting of a forward contract to purchase the issuer's
underlying security and an interest-bearing deposit for a specific price.
PRIDES were first introduced by Merrill Lynch & Co.
They are similar to mandatory convertible securities in that the preferred share
must be converted into common stock by a certain date.
PRIDES allow investors to earn stable cash flows while still participating in the
capital gains of an underlying stock.
PRIDES are considered a preferred stock because they have priority over
common stock and carry rights beyond those of common stock.