Bond MarketsSome Interesting Features

Kandarp mehta

Icfaian business school, ahmedabad

Yield Curve of Indian Bonds• A plot of the yield (YTM) on various debt instruments against the time to

maturity. This is known as the yield curve

• Under normal circumstances, bonds with longer time to maturity will offer a greater return as there is a far greater element of uncertainty and therefore, risk (high risk-high return)

• Understanding the forces that shape the yield curve, investors can make qualified decisions in selecting bonds

• The yield curve’s slope changes as various factors affect the pricing of debt market instruments

• For example take a yield curve that is flat instead of the normal upward sloping curve. In such a scenario, if you were confident that normalcy would return to the markets, you should sell long-term bonds and buy short-term bonds

Source: Debt to Date,SHCIL,Issue no.14

Factors Affecting Yield Curve

• The monetary policy

• Economic growth

• Fiscal Policy

• inflation

• fact-sheet India

• Asian Bond Markets - Some Signals

Monetary Policy

Tight Monetary policy

Selling of bonds

Reduction in price of

Bonds

Yield Curve steepens

Liberal Monetary policy

Buying of bonds

Increase in price of Bonds

Yield Curve Flattens

Interest rates also have a negative relationship with the slope of the yield curve

Poor Economic Condition

Lower / poor allocation of

capital

Banks saddled with surplus

funds

Surplus money diverted to

Debt Market

Economic Growth

Increase in Bond prices / Reduced

Yields

Sudden increase in Bond Market Turnover which is largely attributable to Value increase should not be perceived is revival of Economy. It may be a “False-Boom”.

Fiscal Policy

Higher Fiscal Deficit

Higher interest rates

Steep yield curve

Lower Fiscal Deficit

Lower interest rates

Flat yield curve

Precarious Financial Situation

Short Term Rates > Long Term rates

Steep and negatively

sloped yield curve

Improving Economic Situation

Short Term Rates < Long Term rates

Positively sloped yield curve

(Degree of slope will depend upon

intensity of expectations)

Inflation

• Inflation affects both the long term and the short term yields.

Increase in inflation

Real Rate of Return declines

Expected yield goes up to

cover up the decline

Yield curve will be

flattened

Fact sheet India

• Poor run at equity markets made debt markets more attractive.

• However, it remains to be seen whether the demand is more of short-term instrument or for long-term instruments.

Fact sheet - India (Contd…)

• Gross fiscal deficit (Q1 - FY 02) - Rs 422 bn • Gross fiscal deficit (Q1 - FY 01) - Rs 251 bn (68% increase)

• Reason for the increase• over 40% drop in revenue receipts - caused by a 54% dip in

corporate tax collections - which was on account of lower earnings by the corporate

• This clearly points to the slowing economy. Also, the actual expenditure of the government at Rs 651 bn was higher by 14% compared to 1QFY01

Fact sheet - India (contd..)Try to make inferences from the data given below

(Rs bn)

YearGross Fiscal

DeficitMarket

borrowings*

Other borrowings and

liabilities

91 days Treasury bills $

External Finance

1991-92 363 75 165 69 541992-93 402 37 189 123 531993-94 603 289 153 110 511994-95 577 203 328 10 361995-96 602 331 170 98 31996-97 602 200 306 132 301997-98 889 325 563 -9 111998-99 1,133 690 427 -2 191999-00 (RE) 1,089 771 349 35 92000-01(BE) 1,113 764 349 - 0

Internal Finance

Fact sheet - India (contd..)Try to make inferences from the data given below

(Rs bn) No of issue Amount No of issue Amount No of issue AmountDebentures 12 19.7 12 23.9 10 24Prospects 6 10.2 9 22.6 9 23.7Rights 6 9.4 3 1.2 1 0.3Convertible 10 14.7 5 1.9 2 0.5Prospects 4 5.2 2 0.6 1 0.2Rights 6 9.4 3 1.2 1 0.3Non-convertible 2 5 7 22 8 23.5Prospects 2 5 7 22 8 23.5Rights - - - - - -

FY98 FY99 FY00

Asian Bond Markets

Crisis Barometer

The Last Word...

• “For creation of a stable, strong and liquid Bond market, it is essential for any country to construct a reliable and stable Yield Curve”.

– Robert Becker (McKinsey)