Different fixed income products
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The fixed-income category of securities generally encompasses bonds (including notes and debentures) and various types of money market instruments. What the different securities have in common is that they all represent debt of the issuer.
BONDS -A bond is a long-term, fixed-obligation debt security. A long-term debt security is commonly referred to as a bond if it is secured (collateralized) by a pledge of specific assets owned by the issuer, or as a debenture if it is backed by the general creditworthiness of the issuer. The details of a bond issue are outlined in a trust deed and written into a bond contract. Bonds are considered fixed-income securities because they impose fixed financial obligations on issuers in the form of regular interest payments and the return of principal on the date of maturity. If the issuer can no longer meet these obligations, the bond goes into default. The trust deed provisions then allow the bondholders to seize specified physical assets and sell them to recover their investment. These physical assets might include, for example, a building, a railway car, or any other physical property owned by the issuing company.
Types of Bonds
1. Fixed Rate Bonds
In Fixed Rate Bonds, the interest remains fixed through out the tenure of the bond. Owing to a constant interest rate, fixed rate bonds are resistant to changes and fluctuations in the market.
2. Floating Rate Bonds
Floating rate bonds have a fluctuating interest rate (coupons) as per the current market reference rate.
3. Zero Coupon Bonds
Zero Coupon Bonds do not pay any regular interest to the investors. In such types of bonds, issuers only pay the principal amount to the bond holders.
4. Inflation Linked Bonds
Bonds linked to inflation are called inflation linked bonds. The interest rate of Inflation linked bonds is generally lower than fixed rate bonds.
5. Perpetual Bonds
Bonds with no maturity dates are called perpetual bonds. Holders of perpetual bonds enjoy interest throughout.
6. Subordinated Bonds
Bonds which are given less priority as compared to other bonds of the company in cases of a close down are called subordinated bonds. In cases of liquidation, subordinated bonds are given less importance as compared to senior bonds which are paid first.
7. Debentures – A debenture, like other bonds, promises the payment of regular interest and the repayment of principal at maturity. However, in contrast to regular bonds, a debenture may be secured by something other than a physical asset. For this reason, de bentures are also called unsecured bonds. Debentures are typically secured by a general claim on residual assets or by the issuer’s credit rating.
8. Money Market Securities – Money market securities are a type of short-term fixed-income security, generally with terms of one year or less. Certain high-grade short-term bonds may trade as money market securities when their term is reduced to a year or less. For the most part, however, money market securities include Treasury bills (T-bills), commercial paper, certificates of deposit (CDs), and repos.
9. Treasury Bills- In India and most other jurisdictions, T-bills are issued for maturities of 91 days, 182 days, and 364 days. They are issued through an auction process managed by the Reserve Bank of India (RBI). Banks, mutual funds, insurance companies, provident funds, primary dealers, and other financial institutions bid in these auctions.
On the date of issue, the government borrows the face value less the interest amount, and on the maturity date it redeems the debt at face value. Thus, the difference between the face value and the issue price is the interest the issuer pays. In other words, investors receive the difference between face value and the issue price if they hold the T-bill from the date of issue up to maturity. In the financial environment, this payment method is known as discount-based remuneration.
10· Commercial Paper- Commercial paper (CP) is a debt instrument issued by a commercial enterprise. Maturity dates of commercial paper do not usually exceed 270 days from the date of issue. Commercial enterprises issue this type of debt instrument as an alternative to using a bank line of credit for payment of charges (in other words, to finance their short-term cash needs). Only issuers of high credit quality are present on the commercial paper market. To issue CP in India, issuers must obtain a credit rating of A3 or higher, according to the rating symbols prescribed by the Securities and Exchange Board of India (SEBI) for money market instruments; and the maturity can be from seven days to one year.
11. Certificates of Deposit- Certificates of deposit are short-term, tradable deposits issued by banks to raise funds. They are different from regular bank deposits in that they involve creation of securities, which makes the CD transferable before maturity. However, actual trading in CDs is extremely limited, with most investors preferring to hold them to maturity. In India, owing to restrictions on mutual funds holdings of bank deposits, liquid funds tend to hold CDs rather than bank deposits.
12. Small Savings Instruments (India)
A discussion of debt markets in India is not complete without coverage of the various savings schemes, called small savings instruments, which the Government of India has instituted to encourage investors to save regularly.
13. The government currently offers the following small savings instruments:
» Public Provident Fund (PPF)
» Senior Citizens’ Saving Scheme (SCSS)
» Monthly Income Scheme (MIS)
» National Savings Certificate (NSC)
» Post Office Schemes and Deposits Kisan Vikas Patra (KVP)
» Sukanya Samriddhi Account
» Gold Monetisation Scheme, 2015 Sovereign Gold Bond Scheme
The rate of interest on small savings instruments is dynamic and reflects the interest rates prevailing in the market. Rates are determined quarterly.