Things you should know about the fixed income market
The debt market in India consists of mainly two categories—the government securities (g-secs) markets comprising central government and state government securities, and the corporate bond market. The g-secs are the most dominant category of debt markets and form a major part of the market in terms of outstanding issues, market capitalization, and trading value.
In order to finance its fiscal deficit, the government floats fixed income instruments and borrows money by issuing g-secs that are sovereign securities issued by the Reserve Bank of India (RBI) on behalf of the Government of India. The corporate bond market (also known as the non-gsec market) consists of financial institutions (FI) bonds, public sector units (PSU) bonds, and corporate bonds/debentures.
Listed below are the various terminologies used in the fixed income market:
Coupon: A coupon payment on a bond is a periodic interest payment that the bondholder receives during the time between when the bond is issued and when it matures. Coupons are normally described in terms of the coupon rate, which is calculated by adding the total amount of coupons paid per year and dividing by the bond's face value.
Maturity: Maturity refers to the term of the bond i.e. the date on which the issuer has to repay the principal amount to the bondholder.
Yield to maturity: The Yield to maturity (YTM) is the internal rate of return or the discount rate at which the sum of all future cash flows from the bond (coupons and principal) is equal to the price of the bond.
Modified duration: Modified duration is the price sensitivity of interest rate and is the percentage change in price for a unit change in interest rate. Suppose the modified duration of a bond is 5 years and interest rate falls by 10 bps (0.1%) then bond price will rise by 50 bps (0.5%) and vice versa.
Hold to maturity: A held to maturity security is a debt security that is purchased with the intention of holding the investment till maturity.
Reinvestment risks: The risk resulting from the fact that future interest or dividends proceeds will have to be reinvested at a lower interest rate.
Basis points: 100 basis points = 1%
Yield curve: Yield curve is a curve showing several interest rates across different maturity period (2 month, 2 year, 20 year, etc...) for a similar debt security.
Repo rate: The rate at which the RBI lends money to commercial banks is called repo rate.
Reverse repo rate: The rate at which the RBI borrows money from commercial banks.
Inflation: It refers to an increase in the price level resulting in a decrease in the purchasing capacity.
Wholesale Price Index (WPI): An index that measures and tracks the changes in price of goods in the stages before the retail level.
Consumer Price Index (CPI): A measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food and medical care.
Fiscal deficit: When a government’s total expenditure exceed the revenue that it generates (excluding money from borrowings).
Trade deficit: The amount of goods and services that a country imports that is in excess of the amount of goods and services it exports.
Current Account Deficit (CAD): CAD occurs when a country’s total imports of goods, services and transfers are greater than the country’s total export of goods, services and transfers.