DEBT MARKET AND MUTUAL

FUNDS
CIA 3- Component 1

SUBMITTED BY:
SUBMITTED PRARTHANA.
BY: M (1720552)
SAYONI.V (1620380)
Debt Instruments

A debt instrument is a paper or electronic obligation that enables the issuing party to raise funds
by promising to repay a lender in accordance with terms of a contract. Types of debt
instruments include notes, bonds, debentures, certificates, mortgages, leases or other
agreements between a lender and a borrower. These instruments provide a way for market
participants to easily transfer the ownership of debt obligations from one party to another.

Short-Term Debt Instruments

From a personal finance perspective, short-term debt instruments come in the form of credit
card bills, payday loans, car title loans and other consumer loans that have repayment terms of
less than 12 months. If a person incurs a credit card bill of $1,000, the debt instrument is the
agreement that outlines the obligated payment terms between the borrower and the lender.

In corporate finance, short-term debt usually comes in the form of revolving lines of credit,
loans that cover networking capital needs and Treasury bills. If for example, a corporation
looks to cover six months of rent with a loan while it tries to raise venture funding, the loan is
considered a short-term debt instrument.

Long-Term Debt Instruments

Long-term debt instruments in personal finance are usually mortgage payments or car loans.
For example, if an individual consumer takes out a 30-year mortgage for $500,000, the
mortgage agreement between the borrower and the mortgage bank is the long-term debt
instrument.

Different type of debt instruments are:

1. Bonds
A Bond is simply an 'IOU' in which an investor agrees to lend money to a company
or government in exchange for a predetermined interest rate. If a business wants to
expand, one of its options is to borrow money from individual investors. The
company issues bonds at different interest rates and sells them to the public.
Investors purchase them with the understanding that the company will pay back
 their original principal with some interest that is due by a set date (this is known as
the "maturity"). The interest a bondholder earns depends on the strength of the
corporation.

Following are allowed to issue bonds:

• Government Bonds
• Municipal Bonds
• Institutions Bonds
• Corporate Bonds

Risk and Return in Bonds

In certain cases, the issuer has a call option mentioned in the prospectus. This
means that after a certain period, the issuer has the choice of redeeming the
bonds before their maturity. If interest rates go up, bond prices go down and
vice-versa.

Returns is depends on the nature of the bonds that have been purchased by the
investor. Bonds may be secured or unsecured. Interest payments depend on the
health and credit rating of the issuer. Therefore, it is essential to check the credit
rating and financial health of the issuer before loosening up the bond.

Bond market Liquidity

Some issues also offer Put and Call option.

• In Put option, the investor has the option to approach the issuing entity
after a specified period (say, three years), and sell back the bond to the
issuer.
• In Call option, the company has the right to recall its debt obligation
after a particular time frame.

Project bonds

Project bonds are debt securities issued to fund part or all of the costs of a project. Loan
financing is usually used for projects but obtaining bond market financing is an increasingly
popular option for issuers—to get extra liquidity, broaden their funding base, obtain cheaper
funding and to avoid the restrictive covenant package of loan financing.

Retail bonds

Retail bonds are small denomination debt securities marketed to retail investors. Interest rates,
and therefore the income paid on traditional savings accounts, have been at historically low
levels since the financial crisis of 2008. This has encouraged retail investors to look at a wider
range of investment products, including debt securities. This in turn has encouraged initiatives
to make the established debt securities markets more accessible to retail investors, such as the
Order book for Retail Bonds (ORB) launched by the London Stock Exchange (LSE) in 2010—
see Retail offers by SMEs on the ORB.

Green bonds

Green bonds are debt securities issued to finance projects that will promote progress on
environmentally sustainable activities. Green bonds have historically been issued by
multilateral lenders such as the World Bank, the African Development Bank and the European
Investment Bank. However, corporates are increasingly issuing green bonds where the
proceeds will be used for environmentally friendly projects such as development of renewable
energy

Mini-bonds

Mini-bonds are debt securities offered by small and medium-sized enterprises (SMEs) to the
public in principal amounts less than the threshold below which the prospectus requirements
of the Prospectus Directive 2003/71/EC (PD) do not apply (€5m in any 12-month period).
Mini-bonds are usually issued through crowdfunding platforms but are sometimes issued
directly to the public by the issuing companies

2. Debentures

A debenture is similar to a bond except the securitization conditions are different. A debenture
is generally unsecured in the sense that there are no liens or pledges on specific assets. It is
defined as a certificate of agreement of loans which is given under the company's stamp and
 carries an undertaking that the debenture holder will get a fixed return (fixed on the basis of
interest rates) and the principal amount whenever the debenture matures.

In finance, a debenture is a long-term debt instrument used by governments and large

companies to obtain funds. The advantage of debentures to the issuer is they leave specific
assets burden free, and thereby leave them open for subsequent financing. Debentures are
generally freely transferrable by the debenture holder. Debenture holders have no voting rights
and the interest given to them is a charge against profit.

3.Commercial Papers

Commercial Paper (CP) is an unsecured money market instrument issued in the form of a
promissory note. It was introduced in India in 1990 with a view to enable highly rated corporate
borrowers/ to diversify their sources of short-term borrowings and to provide an additional
instrument to investors. Subsequently, primary dealers and satellite dealers were also permitted
to issue CP to enable them to meet their short-term funding requirements for their operations.
CP can be issued in denominations of Rs.5 lakh or multiples thereof. Amount invested by a
single investor should not be less than Rs.5 lakh (face value). It will be issued foe a duration
of 30/45/60/90/120/180/270/364 days. Only a scheduled bank can act as an Issuing and Paying
Agent IPA for issuance of CP.

Who can Issue Commercial Papers?

• Corporates and primary dealers (PDs)

• All-India financial institutions (FIs)

4. Certificate of Deposits

A certificate of deposit or CD is a time deposit, a financial product commonly offered to

consumers by banks, thrift institutions, and credit unions. CDs are similar to savings accounts
in that they are insured and thus virtually risk-free; they are "money in the bank". They are
different from savings accounts in that the CD has a specific, fixed term (often 3 months, 6
months, or 1 to 5 years), and, usually, a fixed interest rate. It is intended that the CD be held
until maturity, at which time the money may be withdrawn together with the accrued interest.
5. Fixed Deposits

A fixed deposit account allows you to deposit your money for a set period of time, thereby
earning you a higher rate of interest in return. Fixed deposits also give you a higher rate of
interest than a savings bank account. Any investment portfolio should comprise the right mix
of safe, moderate and risky investments. While mutual funds and stocks are the preferred
contenders for moderate and risky investments, fixed deposits, government bonds etc. are
considered safe investments. Fixed deposits have been particularly popular among a large
section of investors in India as a safe investment option for a long period. With fixed deposits
or FDs as they are popularly known, a person can invest an amount for a fixed duration. The
banks give interest rates depending on this loan amount and the tenure of deposit.

FD Returns

While the money invested in stock markets may give you a return of 20% the fixed deposits
will yield only about 10%. So, the money grows slowly in the case of fixed deposits.

FD Tax Savings

The interest earned on fixed deposits is fully taxable (except Tax saving Schemes) and is added
to the annual income of the individual. Gains from stocks are considered capital gains while
dividends are tax free.

6. G- Securities

Government securities (G-secs) are supreme securities which are issued by the Reserve Bank
of India on behalf of Government of India in lieu of the Central Government's market
borrowing program.

The term Government Securities includes :

• Central Government Securities.

• State Government Securities
• Treasury bills
 The Central Government borrows funds to finance its 'fiscal deficit'. The market borrowing of
the Central Government is increased through the issue of dated securities and 364 days treasury
bills either by auction or by floatation of loans. In addition to the above, treasury bills of 91
days are issued for managing the temporary cash mismatches of the Government. These do not
form part of the borrowing program of the Central Government.

7. National Savings Certificate

National Savings Certificate (NSC) is a fixed interest, long term instrument for investment.
NSCs are issued by the Department of Post, Government of India. Since they are backed by
the Government of India, NSCs are a practically risk free avenue of investment. They can be
bought from authorized post offices. NSCs have a maturity of 6 years. They offer a rate of
return of 8% per annum. This interest is calculated every six months, and is merged with the
principal. That is, the interest is reinvested, and is paid along with the principal at the time of
maturity. For every Rs. 100 invested, you receive Rs. 160.10 at maturity.

NSCs qualify for investment under Section 80C of the Income Tax Act (IT Act). Even the
interest earned every year qualifies under Sec 80C. This means that investments in NSCs and
the interest earned on it every year, upto Rs. 1 Lakh, are deductible from the income of the
investor. There is no tax deducted at source (TDS).

NSC Features

• Minimum investment Rs. 500/- No maximum limit.

• Rate of interest 8% compounded half yearly.
• Rs. 1000/- grow to Rs. 1601/- in six years.

8.Interest-bearing securities

Most debt securities provide for interest payments to be made at regular intervals. Like interest
on a loan, interest on a debt security can be at a fixed, floating or variable rate basis.
 9. Zero coupon securities

Zero coupon securities do not bear interest, but instead are issued at a discount to their face
value. When the security is redeemed by the investor, the issuer repays the full face value of
the security. The return for the investor is the difference between the issue price and the full
face value of the security that it receives from the issuer on redemption.

The Indian Debt Market

The Indian debt market is a market meant for trading (i.e. buying or selling) fixed income
instruments. Fixed income instruments could be securities issued by Central and State
Governments, Municipal Corporations, Govt. Bodies or by private entities like financial
institutions, banks, corporates, etc. Simply put, a bond/debt can be defined as a loan in which
an investor is the lender. The issuer of the bond pays the investor interest (at a predetermined
rate and schedule) in return for the amount invested. The Indian debt market offers a variety of
debt instruments, offered by the Government and non-Government entities. The factors that
are propelling the growth of the market are:

• introduction of new instruments

• increased liquidity

• deregulation of interest rates

• improved settlement systems

The debt market in India comprises broadly two segments, viz.,

• Government Securities Market and

• Corporate Debt Market.

Major Players in the Indian Debt Market

• State governments and Central government. The largest segment of the Indian Debt market
consists of the Government of India securities where the daily trading volume is in excess of
 Rs.2000 crore, with instrument tenors ranging from short dated Treasury Bills to long dated
securities extending upto 30 years.
• Non-government entities like Banks, Financial Institutions, Insurance Companies, Mutual
Funds, Primary Dealers, Corporate entities.

Risks in the Indian Debt Market

The debt market features the usual risks associated with financial securities like:

• Credit risk. While corporate papers carry credit risk due to changing business conditions,
government securities are perceived to have zero credit risk. Credit Risk is the risk that the
issuer will not pay the coupon income and/ or the maturity amount on the specified dates. Credit
Ratings have been established by rating agencies to reflect their opinion of an issuer’s ability
and willingness to do so.
• Interest rate risk. Interest rate risk is present in all debt securities and depends on a variety of
macroeconomic factors. Interest Rate Risk is the risk that interest rates may rise, causing a fall
in value of traded debt instruments.
• Settlement risk. The risk that one party will fail to deliver the terms of a contract with another
party at the time of settlement is called settlement risk.All debt securities are settled within the
specified duration, excepting special cases like death of the holder, etc, in which case it may
be delayed till all the required formalities are completed.
• liquidity risk. The risk arising from the lack of possibility to either buy or sell a security
quickly as per one’s requirement is called liquidity risk. Debt securities have minimum
liquidity risk and can be easily bought and sold after due listing.

Debt Issue

A debt issue is a financial obligation that allows the issuer to raise funds by promising to repay
the lender at a certain point in the future and in accordance with the terms of the contract. A
debt issue is a fixed corporate or government obligation, such as a bond or debenture. Debt
issues also include notes, certificates, mortgages, leases, or other agreements between the issuer
(the borrower) and lender.

Features of a Debt Issue

• Corporations and municipal, state and federal governments offer debt issues as a means
of raising needed funds. Debt issues, such as bonds, are issued by corporations to raise
money for certain projects or to expand into new markets
• Municipalities, states, federal, and foreign governments issue debt to finance a variety
of projects such as social programs or local infrastructure projects. In exchange for the
loan, the issuer (borrower) must make payments to the investors (the lenders) in the
form of interest payments.
• The interest rate is often called the coupon rate, and coupon payments are made using
a predetermined schedule and rate.
• When the debt issue matures, the issuer repays the face value of the asset to the
investors.
• In terms of maturities of a debt issue, short-term bills typically have maturities between
one and five years; medium term notes mature between five and ten years; and long
term bonds generally have maturities longer than 10 years.

Cost of Debt
The interest rate paid on a debt instrument represents a cost to the issuer and a return to the
investor. The cost of debt represents the default risk of an issuer, and also reflects the level of
interest rates in the market. In addition, it is integral in calculating the weighted-average cost
of capital (WACC) of a company, which is a measure of the cost of equity and the after-tax
cost of debt.

The Process of Debt Issuance

For corporate entities:

• Issuing debt is a corporate action which a company's board of directors must approve.
If debt issuance is the best course of action for raising capital, and the firm has sufficient
 cash flows to make regular interest payments on the issue, the board would draft a
proposal which will be sent to investment bankers and underwriters.
• Corporate debt issues are commonly issued through the underwriting process in which
one or more securities firms or banks purchase the issue in its entirety from the issuer
and form a syndicate which is tasked with marketing and reselling the issue to interested
investors.
• The interest rate set on the bonds is based on the credit rating of the company and the
demand from investors. The underwriters impose a fee on the issuer in return for their
services.

For Government Securities:

• The process for government debt issues is different since these are typically issued in
an auction format. In the United States, for example, investors can purchase bonds
directly from the government through its dedicated website, TreasuryDirect.
• A broker is not needed, and all transactions, including interest payments, are handled
electronically. Debt issued by the government are considered to be the safest
investments, given that the issue is backed by the full faith and credit of the US
government.
• Since investors are guaranteed that they will receive any interest rate and face value on
the bond, interest rates on government issues tend to be lower than rates on corporate
bonds.

Compliances to be followed:-

(1) The Companies Act,2013 & the Companies( Share Capital and Debentures) Rules,
2014

Section 71 of the Companies Act, 2013 provides the condition for issue of debentures. A
debenture is a legal document that represents a secure means by which a creditor can lend
money to the debtor. A company may issue debentures with an option to convert such
debentures into shares, either wholly or partly at the time of redemption. The issue of
debentures with an option to convert such debentures into shares, wholly or partly, shall be
approved by a special resolution passed at a general meeting. This means debenture may be
non – convertible debenture or convertible debenture. Convertible debenture may either be
Fully Convertible Debenture (FCD) or Partly Convertible Debenture.

The companies is required to comply section 71 (Debentures) read with rule 18 of the
Companies (Share Capital and Debentures) Rules 2014.

(2) SEBI (Issue of Capital and Disclosure Requirements)Regulations, 2009

SEBI had issued SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009
(“ICDR Regulations”), to promote the development of a healthy capital market and to protect
the interests of investors in securities. SEBI carefully monitors the dealings and actions of
companies planning to raise money on the stock exchanges. The Regulations were notified on
September 3, 2009 and replace the Disclosure and Investor Protection (DIP) Guidelines 2000
that now stand rescinded.

Debt securities which are convertible, either partially or fully or optionally into listed or
unlisted equity shall be guided by the disclosure norms applicable to equity or other instruments
offered on conversion in terms of SEBI (Issue of Capital and Disclosure Requirements)
Regulations, 2009.

(3) SEBI( Issue and Listing of Debt Securities) Regulations, 2008

SEBI (Issue and Listing of Debt Securities) Regulations, 2008 pertaining to issue and listing
of debt securities which are not convertible, either in whole or part into equity instruments.
They provide for a rationalized disclosure requirements and a reduction of certain onerous
obligations attached to an issue of debt securities.

SEBI had notified amendments to the SEBI (Issue and Listing of Debt Securities) Regulations,
2008 (Debt Regulations) on November 13, 2012. SEBI has undertaken a series of reforms in
order to make regulatory framework for debt markets more robust. However, despite constant
regulatory efforts to improve the debt markets, the private placement of debt securities has been
highly unregulated. Therefore, SEBI has introduced additional disclosure requirements in the
recent amendment with a view to make the regulatory framework for private placement of debt
securities more robust, and to align the same with the disclosure requirements that are
applicable to public issuance of equity shares.
(4) SEBI (Listing Obligations and Disclosure Requirements) Regulations,2015 (“Listing
Regulations”)

The listing of securities is ensured by way of an agreement which is entered into between a
stock exchange and the issuing company. This agreement called listing agreement. All Listed
entities shall comply with the listing conditions as stipulated in Listing Regulations to provide
substantial information about the company to the stock exchanges on a daily basis. The
provisions of Chapter V from Regulation 49 to 62 of 'Listing Regulations' shall apply only to
a listed entity which has listed its ‘Non-convertible Debt Securities’ and/or ‘Non-Convertible
Redeemable Preference Shares’ on a recognised stock exchange in accordance with SEBI
(Issue and Listing of Debt Securities) Regulations, 2008 or SEBI (Issue and Listing of Non-
Convertible Redeemable Preference Shares) Regulations, 2013 respectively. The provisions of
chapter V shall also be applicable to “perpetual debt instrument” and “perpetual non-
cumulative preference share” listed by banks.

(5) RBI Guidelines

RBI guidelines allow banks to raise capital by issue of non-equity instruments such as Perpetual
Non-Cumulative Preference Shares (PNCPS) and innovative Perpetual Debt Instruments
(PDI).These instruments need to be in compliance with the specified criteria for inclusion in
Additional Tier I Capital. Further, these instruments inter-alia should be able to absorb loss
either through: (i) conversion to common shares at an objective pre-specified trigger point or
(ii) a write-down mechanism that allocates losses to the instruments at a pre-specified trigger
point. Whereas RBI vide circular dated September 01, 2014 on the “Implementation of Basel
III Capital Regulations in India – Amendments” has inter-alia allowed banks to issue
Additional Tier 1 (AT1) instruments to retail investors. Further, RBI vide its Master Circular
on Basel III Capital Regulations dated July 1, 2015 has also specified additional disclosure
requirements for PNCPS and PDIs.
Comparison

Difference between various kinds of Debt Instruments

Recent Debt Issues
Government of India

The Government of India issues Government Securities (G-Sec) which is a tradeable instrument issued
by the Central Government or the State Governments. It acknowledges the Government’s 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). G-Secs carry practically no risk of default and, hence, are called risk-free
gilt-edged instruments.

We would also come up with a Government Bond named as:-

“LGBT BOND”

Background and Objective of the bond:

This bond would be issued by the government of India to raise funds and use them in
implementing the initiatives for the upliftment of LGBT community. The funds raised would
be added to the LGBT upliftment fund and improve the availability of public services for them.
By investing in such bonds, the members of the LGBT community are uplifting themselves
and in a way its not a social service provided to them. This would also give them a feeling of
self-sustainability. The government would also build centres through the funds where members
of the LGBT community can come together and speak about the issues social issues faced by
them and spread awareness and help the government in better implementation of its laid
objectives for upliftment of the community.

Eligibility of the Bond:

Members of the LGBT community which includes:
• Lesbian
• Gay
• Bisexual
• Transgender
 Coupon (Interest Payable)
The Government of India would release these bonds with a coupon rate of 8% P.A. with the
effect of 3rd March, 2019.

Limit of Investment
There will be no maximum limit for investment in the Bonds.

Issue Price
The bond will be available at the face value of Rs 1000/- and multiples thereof and an issue of minimum
10 bonds.

Repayment
The bond shall be repaid after 2 years and no interest to be accrued after which.

Hence, the bond would be for the Risk averse investors looking for a stable return in negligible risk
investment seeing the current market scenario and volatility of the various economies throughout the
world.

Issuer

Government of India

Issue Structure

Opion 1 : Interest of 7.5% paid annually with a tenure of 2 years.

Option 2: Interest of 8.5% paid annually with a tenure of 5 years.

Option 3: Interest of 7% paid semi-annually with a tenure of 2.5 years.

Marketing Strategies:

• Advertisements thorough newspapers and social media platform like blogs and other social
media platforms.
• Advertisements through charities and development institutions.
• Advertisements through magazines and hoardings.
• LGBTQ communication firms
• Conferences organized for awareness.