Bond market ecosystem, risks, pricing, yield measures, yield curve, duration, money market, government & corporate debt, small savings instruments
The debt market enables governments and corporates to borrow by issuing debt securities that investors buy in primary/secondary markets. Unlike equity, debt is relatively safer (often secured by assets), but recovery on default is a lengthy legal process. India's debt market has three segments: (a) Government securities (G-Secs, T-Bills, SDLs), (b) PSU & bank bonds, (c) Private sector instruments (bonds, debentures, commercial papers).
A bond creates a fixed obligation on the issuer — to pay periodic interest (coupon) and repay principal/face value at maturity. Most bonds pay semi-annual coupons (zero-coupon bonds pay none). Bonds maturing in ≤ 1 year are money market securities; > 1 year are capital market securities. Maximum 12 ISINs can mature for an issuer in one financial year.
| Market price vs Coupon | Result |
|---|---|
| Coupon rate = Market interest rate | Bond trades at Par |
| Market interest rate > Coupon rate | Bond sells at Discount |
| Market interest rate < Coupon rate | Bond sells at Premium |
| Type | Feature |
|---|---|
| Callable bond | Issuer can redeem before maturity — creates reinvestment risk for investor when rates fall |
| Puttable bond | Bondholder can sell back to issuer at pre-set price/dates — benefits investor |
| Convertible bond | Plain bond + option to convert into issuer's equity shares |
Govt bonds = risk free (low return); PSU/bank bonds = moderate risk/return; corporate bonds = higher risk/return. Two broad risk groups: Market Risk (interest rate movements) and Credit/Default Risk (issuer creditworthiness).
Bond price & interest rates move inversely. HTM (hold to maturity) avoids this risk.
Issuer redeems bond early (e.g., to refinance at lower cost), forcing reinvestment at lower rates.
Coupons must be reinvested at prevailing rates — risk that future rates are lower.
Sub-types: Downgrade Risk (e.g., IL&FS 2018), Spread Risk (spread over G-Sec widens with risk), Default Risk (non-payment of coupon/principal — "junk bonds" pay high rates for high default risk).
Inability to sell without loss of value; common in long-term bonds; better credit quality → lower impact cost.
Foreign-currency bonds (e.g., Masala Bonds) expose investors to currency depreciation risk.
Rising inflation erodes real returns; floating-rate / inflation-indexed bonds mitigate this.
Affects bonds with embedded options — pricing factors in volatility.
Tax-rule changes (tax-free bonds), repatriation rules, or sudden shocks (e.g., COVID-19 impact on travel sector debt).
Par Value: Face value to be repaid at maturity — typically ₹100 for G-Secs, ₹10,000 for corporate bonds.
10% annual coupon, 5-year maturity, Face Value ₹100, market yield 8%.
| Year | Discount Factor @ 8% | Cash Flow (₹) | PV (₹) |
|---|---|---|---|
| 1 | 0.9259 | 10 | 9.2593 |
| 2 | 0.8573 | 10 | 8.5734 |
| 3 | 0.7938 | 10 | 7.9383 |
| 4 | 0.7350 | 10 | 7.3503 |
| 5 | 0.6806 | 110 | 74.8642 |
| Sum of DFs (PVIF) = 3.9927 | 107.9854 | ||
Value = 10 × 3.9927 + 100 × 0.6806 = 39.9271 + 68.0583 = ₹107.9854
Each coupon = ₹5 every 6 months, discounted at 4% per period (10 periods). Sum of DFs = 8.1109.
Value = 5 × 8.1109 + 100 × 0.675564 = 40.5545 + 67.5564 = ₹108.1109
Note it is valued higher than the annual-pay bond (107.9854) due to greater compounding frequency.
Coupon ₹8.24, Face Value ₹100, Market Value ₹103.
Coupon Yield = 8.24/100 = 8.24% | Current Yield = 8.24/103 = 8%
Coupon 8% on Face Value 100, required yield 6% → PV = (100 × 8%) / 6% = ₹133.33
| Measure | Meaning / Formula |
|---|---|
| Current Yield | Coupon / Market Price × 100 |
| Yield to Maturity (YTM) | Discount rate equating PV of future cash flows to current price; the bond's IRR. Calculated by trial & error / Excel YIELD() function. |
| Effective Yield | Equivalent annualized rate reflecting compounding (e.g., 4.20% annual coupon paid monthly ≈ 4.28% effective) |
| Yield to Call | Estimated return if a callable bond is held to its first call date |
| Yield to Put | Estimated return assuming bond is put back to issuer at the first put date |
Settlement 15-01-2025, Maturity 15-01-2027, Rate 8%, Price 102, Redemption 100, Frequency 2, Basis 2 → Yield = 6.9121%
| Bond Selling at | Relationship |
|---|---|
| Par | Coupon Rate = Current Yield = YTM |
| Discount | Coupon Rate < Current Yield < YTM |
| Premium | Coupon Rate > Current Yield > YTM |
A yield curve plots the relationship between time-to-maturity and interest rate. A positively sloped curve (preferred for the economy) shows higher rates demanded for longer maturities.
| Shape | Description |
|---|---|
| Normal | Upward sloping — long-term rates higher (higher risk premia for longer maturity) |
| Inverted | Short-term rates higher than long-term — may signal recession ahead |
| Flat | Yield constant regardless of maturity |
| Humped | Short & long term yields lower than medium-term yields |
In the sovereign bond market, the curve typically flattens after 5–7 years (default risk near zero); for corporate bonds, the spread/risk-premia rises with maturity.
Macaulay Duration = the weighted-average time (in years) to recover a bond's price in present-value terms — i.e., its "payback period". Steps to compute:
Modified Duration measures % change in bond price for a change in yield, and is generally lower than Macaulay Duration. Convexity measures the curvature in the price-yield relationship.
Provides avenue for ultra-short to short-term lending/borrowing (overnight to 1 year). Critical to financial stability and the primary transmission channel for monetary policy (a trigger of the 2008 GFC was the freeze in overnight money markets).
| Instrument | Tenor | Key Notes |
|---|---|---|
| Call Money | Overnight | Unsecured interbank (SCBs & PDs only); NDS-CALL/CCIL |
| Notice Money | 2–14 days | Extension of call market |
| Term Money | 15 days–1 yr | Uncollateralized interbank lending |
| Market Repo (G-Sec) | Overnight–1 yr | Sale with repurchase agreement; CROMS/CCIL |
| TREP (Triparty Repo) | Overnight–1 yr | TREPS platform; CCIL is CCP; exempt from CRR/SLR for borrower |
| CMBs | Up to 90 days | Unstructured T-Bills for temporary cash mismatches |
| T-Bills | 91/182/364 days | Zero-coupon, issued at discount, redeemed at par |
| Commercial Paper (CP) | 7 days–1 yr | Unsecured corporate borrowing; min ₹5 lakh |
| Certificate of Deposit (CD) | Banks 7d–1yr; FIs 1–3 yrs | Issued against bank deposits; min ₹1 lakh |
The most active segment of India's fixed income market; provides benchmark interest rates. Key participants: banks (SLR-driven), Primary Dealers (market makers), insurance companies, MFs, FPIs, and RBI itself.
| Instrument | Description |
|---|---|
| T-Bills | 91D/182D/364D, zero-coupon, issued at discount, weekly RBI auctions |
| Cash Management Bills (CMBs) | < 91 days, for temporary cash mismatches (used post-demonetization 2016, forex volatility 2013) |
| Fixed Rate Bonds | Largest component of dated securities; e.g., "5.77% GS 2030" pays 2.885% semi-annually |
| Floating Rate Bonds (FRB) | Coupon reset periodically, linked to 182-Day T-Bill rate; introduced Sept 1995 |
| Zero Coupon Bonds (ZCBs) | Issued at discount, redeemed at par; last issued in 1996 |
| Capital Indexed Bonds (CIBs) | Principal linked to inflation index; experimented 1997 |
| Inflation Indexed Bonds (IIBs) | Principal & coupon both inflation-protected; WPI-linked (2013), CPI-linked for retail (Dec 2013) — discontinued |
| Bonds with Call/Put | e.g., 6.72% GS 2012 (issued July 2002) — first option-embedded G-Sec; not issued currently |
| Special Securities | Issued in lieu of cash subsidies (oil/food/fertilizer bonds, bank recap bonds); not SLR-eligible, pay higher coupon |
| STRIPS | Separate Trading of Registered Interest & Principal — converts a coupon bond into multiple ZCB-like instruments; zero reinvestment risk |
| Sovereign Gold Bonds (SGB) | Gold-linked, denominated in grams, fixed coupon, redeemed at average gold price; no fresh issuances now |
| Savings (Taxable) Bonds | Min ₹1,000, floating rate (reset every 6 months from FY21), interest taxable |
| SGSs / Uday Bonds | State Government Securities; Uday bonds (DISCOM turnaround) not SLR-eligible |
| Instrument | Feature |
|---|---|
| Company Deposits | Fixed-rate time deposits (1–3 yrs); not transferable, not "securities" under SCRA |
| Bonds & Debentures | Often secured; longer tenor; credit risk to be assessed |
| Infrastructure Bonds | Long term (10–20 yrs), finance infra projects |
| Inflation Indexed Bonds | Coupon varies with inflation, protecting real returns |
| Instrument | Key Features |
|---|---|
| Bank FD | DICGC insurance up to ₹5 lakh/depositor; tenor 7 days–10 yrs; senior citizens get 0.25–0.75% extra; 5-yr tax-saver FDs eligible u/s 80C (₹1.5 lakh) |
| Floating Rate GOI Bond | Launched 1 July 2020 @ 7.15%; reset twice yearly; linked to NSC rate + 0.35%; resident Indians only, demat/bond ledger only; interest taxable |
| Public Provident Fund (PPF) | 15-year account; one account per person (+ minor); not for HUF/NRI; no joint holding; instituted 1968 |
| National Savings Certificate (NSC) | 5-year tenor; interest compounded annually, paid at maturity; min ₹100; 80C benefit; joint holding (up to 2) allowed |
| Senior Citizens' Savings Scheme (SCSS) | Age 60+ (55+ for VRS/retirees); held singly or jointly with spouse; not for NRI/HUF |
| POMIS | 5-year term; min ₹1,500, max ₹4.5 lakh (single)/₹9 lakh (joint); monthly income; penalty 2% (1–3 yrs) / 1% (after 3 yrs) on premature closure |
| POTD | 1/2/3/5-year terms; min ₹100; quarterly compounding; 5-yr term gets 80C benefit |
| Post Office RD | Min ₹10/month; quarterly compounding; withdrawal allowed after 1 year & 12 deposits; extendable by 5 years |
| Kisan Vikas Patra (KVP) | Min ₹1,000; no max; nomination & transfer allowed; interest taxed on accrual; no tax incentive |
| Sukanya Samriddhi Account | For girl child < 10 yrs; min ₹250/max ₹1,50,000 p.a.; matures in 21 yrs; partial withdrawal (50%) after age 18; 80C eligible |
1. If the market interest rate rises above a bond's coupon rate, the bond will trade at:
2. The current yield for an 8.24% coupon bond (Face Value ₹100) selling at ₹103 is approximately:
3. Which type of bond will always have its Macaulay Duration exactly equal to its remaining maturity?
4. T-Bills in India are issued by RBI for which tenors?
5. Under the high watermark / yield-curve based risk premium discussion, a flat yield curve indicates: