Corporate Bonds

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. When one buys a corporate bond, one lends money to the "issuer," the company that issued the bond. In exchange, the company promises to return the money, also known as "principal," on a specified maturity date. Until that date, the company usually pays you a stated rate of interest, generally semiannually. While a corporate bond gives an IOU from the company, it does not have an ownership interest in the issuing company, unlike when one purchases the company's equity stock.

Need for Corporate Bonds
One of the announcements in the Budget 2005-06 was to appoint a high level expert committee on corporate bonds and securitization to look into the legal, regulatory, tax and market design issues in the development of corporate bond market.

A committee was formed under the Chairmanship of Dr. R.H. Patil to look into the factors inhibiting the development of an active debt market and recommend policy actions necessary to develop an appropriate market infrastructure for the growth of an active corporate bond market.
 

A few of the recommendations for the development of an active secondary market for corporate bonds are :-
	Establish a system to capture all information related to trading in corporate bonds as accurately and as close to execution as possible and disseminate it to the market in real time.
	Clearing and settlement of transactions in this market must adhere to the IOSCO standards.
	Based on increase of awareness amongst the participants to introduce online order matching system.
Yields Yield is a critical concept in bond investing, because it is the tool used to measure the return of one bond against another. It enables one to make informed decisions about which bond to buy. In essence, yield is the rate of return on bond investment. However, it is not fixed, like a bond’s stated interest rate. It changes to reflect the price movements in a bond caused by fluctuating interest rates. The following example illustrates how yield works.
	You buy a bond, hold it for a year while interest rates are rising and then sell it.
	You receive a lower price for the bond than you paid for it because, no one would otherwise accept your bond’s now lower-than-market interest rate.
	Although the buyer will receive the same amount of interest as you did and will also have the same amount of principal returned at maturity, the buyer’s yield, or rate of return, will be higher than yours, because the buyer paid less for the bond.
	Yield is commonly measured in two ways, current yield and yield to maturity.
Current yield
	The current yield is the annual return on the amount paid for a bond, regardless of its maturity. If you buy a bond at par, the current yield equals its stated interest rate. Thus, the current yield on a par-value bond paying 6% is 6%.
	However, if the market price of the bond is more or less than par, the current yield will be different. For example, if you buy a Rs. 1,000 bond with a 6% stated interest rate at Rs. 900, your current yield would be 6.67% (Rs. 1,000 x .06/Rs.900).
Yield to maturity It tells the total return you will receive if you hold a bond until maturity. It also enables you to compare bonds with different maturities and coupons. Yield to maturity includes all your interest plus any capital gain you will realize (if you purchase the bond below par) or minus any capital loss you will suffer (if you purchase the bond above par). Valuation of Corporate Bonds Corporate bonds tend to rise in value when interest rates fall, and they fall in value when interest rates rise. Usually, the longer the maturity, the greater is the degree of price volatility. By holding a bond until maturity, one may be less concerned about these price fluctuations (which are known as interest-rate risk, or market risk), because one will receive the par, or face, value of the bond at maturity. The inverse relationship between bonds and interest rates—that is, the fact that bonds are worth less when interest rates rise and vice versa can be explained as follows :-
	When interest rates rise, new issues come to market with higher yields than older securities, making those older ones worth less. Hence, their prices go down.
	When interest rates decline, new bond issues come to market with lower yields than older securities, making those older, higher-yielding ones worth more. Hence, their prices go up.
	As a result, if one sells a bond before maturity, it may be worth more or less than it was paid for.
Wholesale Debt Market The Wholesale Debt Market segment deals in fixed income securities and is fast gaining ground in an environment that has largely focussed on equities. The Wholesale Debt Market (WDM) segment of the Exchange commenced operations on June 30, 1994. This provided the first formal screen-based trading facility for the debt market in the country. This segment provides trading facilities for a variety of debt instruments including Government Securities, Treasury Bills and Bonds issued by Public Sector Undertakings/ Corporates/ Banks like Floating Rate Bonds, Zero Coupon Bonds, Commercial Papers, Certificate of Deposits, Corporate Debentures, State Government loans, SLR and Non-SLR Bonds issued by Financial Institutions, Units of Mutual Funds and Securitized debt by banks, financial institutions, corporate bodies, trusts and others. Large investors and a high average trade value characterize this segment. Till recently, the market was purely an informal market with most of the trades directly negotiated and struck between various participants. The commencement of this segment by NSE has brought about transparency and efficiency to the debt market, along with effective monitoring and surveillance to the market. Products & Services Reference Rates - FIMMDA-NSE MIBID MIBOR A reference rate is an accurate measure of the market price. In the fixed income market, it is an interest rate that the market respects and closely watches. It plays a useful role in a variety of situations. In particular, a call money reference rate can find the following applications:
	Traders can make many decisions as offsets compared with the prevailing reference rate.
	Derivatives require a clearly defined reference rate as a foundation, off which the pay-off from the derivative is defined.
	A variety of contracts can be structured as offsets from the future levels of a reference rate. The simplest example may be a floating rate bond that uses an interest rate which is a given 'n' offsets above a given reference rate.
Apart from its accuracy, such a reference rate needs to have other qualities. The methodology of collation and computation should be scientific, should eliminate noise, and resist manipulation. It should be from an unbiased source, be representative of the market, transparent, reliable and continuously available. Moreover, it should find applicability across a wide range of products. A reference rate, which embodies all these qualities, would be widely acceptable to the market as the benchmark rate. NSE Zero Coupon Yield Curve (ZCYC) With NSEIL's strong focus on debt market segment and the long felt need to create standardized market practices, NSEIL has embarked upon developing products that will be used by the market participants to address themselves to issues relating to this market segment. In its continuing effort to innovate, the Exchange has developed a 'Zero Coupon Yield Curve' (ZCYC) that will help in valuation of sovereign securities across all maturities irrespective of its liquidity. It aims to create uniform valuation standards in the market. The product has been developed keeping in mind the requirements of the banking industry, financial institutions, mutual funds, insurance companies, etc. that have substantial investment in sovereign papers. NSE ZCYC aims to help in improving Asset Liability Management of institutions with realistic valuations of portfolio of sovereign papers. It has been developed keeping in mind the emergence of a scientific forward curve for the market that will be useful in developing derivative products and STRIPS in the emerging scenario. NSE VaR for Government Securities Value-at-Risk (VaR) has been widely promoted by regulatory authorities as a way of monitoring and managing market risk and as a basis for setting regulatory minimum capital standards. The revised Basle Accord, implemented in January 1998, makes it mandatory for banks to use VaR as a basis for determining the amount of regulatory capital adequate for covering market risk beyond that required for credit risk. Within the realm of the fixed income portfolios of financial sector players, market related risk has become more relevant and important on account of their trading activities and market positions. For players in the Indian financial sector, the need to develop risk measurement models would prove critical as regulation progressively moves from uniform prudential standards to entity-specific risk coverage requirements. Specifically, the guidelines call for linking of each entity’s market risk capital charge to the riskiness of its assets as measured by the chosen VaR model. Accuracy of measurement would prove critical as regulation would not specify ‘a’ single model for measurement of risk; - the choice of model would be left to market participants who would also be required to furnish details of back-testing for the chosen VaR model. While a conservative estimate of risk would lead to very large capital holdings, a liberal estimate would result in inadequate coverage of loss and excessive number of model failures historically, which would in turn attract penalties from the regulator. It would therefore be in the interest of market participants to develop models that accurately measure the riskiness of their portfolios and furnish estimates of capital charge that would provide adequate cover. An important consideration in this context is that setting up of risk measurement systems by each individual participant for estimating portfolio risk under alternative models and scenarios would involve significant costs. In line with its endeavour to develop market infrastructure, NSE has taken initiative in developing a VaR system for measuring the market risk inherent in Government of India (GoI) securities. The NSE-VaR system builds on the NSE database of daily yield curves - the NSE-ZCYC is now well accepted in terms of its conceptual soundness and empirical performance, and is increasingly being used by market participants as a basis for valuation of fixed income instruments. The NSE-VaR system provides measures of VaR using 5 alternative methods - variance-covariance (normal) and historical simulation methods, together with weighted normal, weighted historical simulation and the recently developed extreme value method [a technical paper explaining these methods is available on the NSE website]. While the first set of methods are easier to implement and therefore more popular, they may not provide accurate assessment of risk in volatile market conditions. To this end, we provide estimates based on the latter set of methods that are specifically suited for this purpose. Together, the 5 methods would provide a range of options for market participants to choose from. Constituent SGL Account SGL stands for 'Subsidiary General Ledger' account. It is a facility provided by RBI to large banks and financial institutions to hold their investments in Government securities and Treasury bills in the electronic book-entry form. Such institutions can settle their trades for securities held in SGL through a Delivery-versus-Payments (DVP) mechanism which ensures movement of funds and securities simultaneously. As all investors in Government securities do not have an access to the SGL accounting system, RBI has permitted such investors to hold their securities in physical stock certificate form. They may also open a Constituent SGL account with any entity authorised by RBI for this purpose and thus avail of the DVP settlement. Such client accounts are referred to as Constituent SGL accounts. Due to the wholesale nature of the market, retail investors usually loose their competitive strength due to their physical holdings. Further, absence of a common settlement agency makes it difficult for the retail investors to settle these transactions on a bilateral basis. To redress the problems faced by retail participants in the market, NSCCL offers Constituent SGL facility to such participants. RBI has allowed NSCCL to open SGL and current accounts for this purpose. RBI has also permitted PFs/Trusts to open their accounts with NSCCL vide its letter PDO.SGL.07.18.21/ 97/98 dated March 30, 1998. NSCCL is also taking steps to setup a common clearing and settlement framework for its SGL constituents. This endeavour will help the market to have uniform settlement procedures and will help evolve the market to a higher plane. NSE Government Securities Index The increased activity in the government securities market in India and simultaneous emergence of mutual (gilt) funds has given rise to the need for a well-defined Bond Index to measure returns in the bond market. The NSE-Government Securities Index prices components off the NSE Benchmark ZCYC, so that movements reflect returns to an investor on account of change in interest rates only, and not those arising on account of the impact of idiosyncratic factors. The index is available from January 1, 1997 to the present. The index would provide a benchmark for portfolio management by various investment managers and gilt funds. It could also form the basis for designing index funds and for derivative products such as options and futures. Salient features of the Index:
	The base date for the index is 1st January 1997 and the base date index value is 100
	The index is calculated on a daily basis from 1st January 1997 onwards; weekends and holidays are ignored.
	The index uses all Government of India bonds issued after April 1992. These were issued on the basis of an auction mechanism that imparted some amount of market-relatedness to their pricing. Bonds issued prior to 1992 were on the basis of administered interest rates.
	Each day, the prices for all these bonds are estimated off the NSE Benchmark-ZCYC for the day.
	The constituents are weighted by their market capitalisation.
	Computations are based on arithmetic and not geometric calculations.
	The index uses a chain-link methodology i.e. today's values are based on the previous value times the change since the previous calculations. This gives the index the ability to add new issues and also remove old issues when redeemed.
	Coupons and redemption payments are assumed to be re-invested back into the index in proportion to the constituent weights.
	Both the Total Returns Index and the Principal Returns Index are computed.
	The indices provided are: Composite, 1-3, 3-8, 8+ years, TB index, GS index
More details available in the Technical Paper NSE G-Sec Index for the day As on 25-September-2007   Index Total Returns Index Principal Returns index Avg. Coupon Avg. Residual Maturity Portfolio YTM Portfolio Duration Portfolio Modified Duration