Bonds It is one of the Instruments available in the debt markets.

It is a debt To be repaid Interest to be paid Riskier to over leverage

Issuer is very important as he/she comes with default risk based on his/her financial position Who issues: 1. Govt-Central/State (highest in value) 2. Municipalities 3. Corporates-public & private 4. Banks/financial institutions 5. NBFCs 6. P/E Firms

In India there are occasions when states have defaulted . In case of G-sec or govt bonds interest rates will be lower as the risks are also minimal State govt bonds or SDL state development loans issued by state govt. State has to give more coupon because of element of higher risk. The coupon payments are paid according to the ratings of the debt paper. Rating is done based on future expected cash flows and financial strength of the company. Issuer decides the coupon rate after rating. Pricing is based on risk free rate and default risk premium. Coupon/Principal coupon is periodical payment made by the issuer. Principal is also called face value par value Principal can be repaid in instalment or in bullet/balloon payment. Coupon is a regular payment. Term/maturity is the life of the bond-period during which bond will be serviced. 1-30yrs is the average period of the bond. Maturity period is higher coupon will be higher as risk will be higher.

Maturity period depends upon the need of the issuer and the expected cash flows of the issuer. Bonds can be short term intermediate long term 1-5/5-12/>12 yrs Payment of coupon may l be monthly, quarterly half yearly and annually. Mortgage backed securities are paid monthly. All bonds which give periodical payments have reinvestment risk. Indenture it is a prospectus/document containing the terms and conditions of the bonds . Term to maturity, coupon dates, and principal paid periodically. All these conditions are in indenture. Types of Bonds: 1. Serial bonds- bundle of bonds having different maturities 2. Bearer bonds-submit the coupons on due date to get the money. It can be passed on to anyone else and has higher liquidity. 3. Registered bonds-no need to submit to coupon but payment will be made automatically 4. Income bonds-if corporates income is less than x figure- interest will not be paid. Higher coupon will be paid because of high risk. Rail roads/ports/hospitals/water works. 5. Deferrable bonds-this will be issued by companies with long gestation period. Interest rates will be deferred if income falls. 6. Zero coupon bonds- redemption will be at par value. Issued at a discount. There is no reinvestment risk. Typically Govt issues zero coupon bonds. The coupon is paid at the end , bonds can be issued at face value also 7. Inflation protection bonds- interest payments are protected against inflation. Companies like HUL can issue this because it can pass on the cost to customers. Increased costs can be passed onto the customers. 8. Step up Bonds- the coupon rates will keep on increasing over a period of time. It will be issued by companies who are in initial implementation stage of projects. 9. Floaters- the rates are fixed based on libor + risk premium. This will vary as anchor/ base rate changes. They are coupons that are linked to benchmark rates or anchor rates. 10.Inverse floaters- When libor goes up coupon rates come down. Whereas libor comes down coupon rate go up.

11.Range notes- the interest on such bonds will be paid if the anchor rate remains s in the range mentioned It helps in fixing the cost of products and services as the range is defined. Sinking fund provision- it is created for redemption of liability in future. Whenever a company wants to lower the coupon rate, it goes for creation of a sinking fund as the risk of default is comparatively lower. Bonds may be issued with embedded options ( call/put options). Call options will have higher coupon rates. Put options will have lower coupon rates. Warrants A warrant is an option for the promoters to convert a particular number of shares at a future date at a price fixed now. Objective of issuing a warrant: Promoters shareholding will go up It leads to management stability Saves expenses of a fresh issue

Companies issue warrants when they need funds to expand.or for any of the objectives mentioned earlier. Warrants have options to buy shares or bonds. Companies will issue warrants to buy bonds for the following reasons: To maintain a certain level of debt/equity When the company is in a growing phase of the life cycle Option will be exercised depending upon the coupon rate and market rate

Types of warrants Detachable warrant- these warrants are traded . Non- detachable warrants not traded

Separate Trading Registered Interest Principles (STRIPS)- the principal and interest payments are separated. Mortgage backed securities (MBS) Categories of MBS Mortgage pass through- the cash flow passes from the mortgagee to SPVs to the bond holders. The pool of mortgage is small. Collateralised mortgage obligations- pool of mortgage is high

Asset backed securities- securitisation backed by loans like auto loans, education loans, SME loans etc, bearing a high rate of interest. The risk involved is higher. Collateralised debt obligations- it is a pool consisting of different securities. Duration Duration is a measurement to find in how many years the investor will get back his money as compared to the maturity of the bond. In case of a zero coupon bond, the duration would be the same as the term of the bond. In case of normal bonds with intermediate cash flows , duration would be less than the term Duration is important for financial institutions like banks. Higher the duration, higher is the risk in balance sheet. If duration is 1 year, a 1% change in the interest rate would lead to a 1% change in the bond value. If interest rates are high, shorter duration bonds are preferred and vice versa. However, to mitigate the risk, banks generally opt for short term bonds.