Fixed Income Security in Indian context

World Of Finance by Vijaya Sai.M

What does Fixed Income Security mean?

An investment that provides a return in the form of fixed periodic payments and the eventual return of principal at maturity. Unlike a variable-income security, where payments change based on some underlying measure such as short-term interest rates, the payments of a fixed-income security are known in advance.

Kinds of Fixed Income Securities:

1.Government securities,

2.Corporate bonds,

3.Commercial paper,

4.Treasury bills,

5.Strips etc.

Fixed Income  Securities relevance in Indian context:

Government Securities( G-Sec ) :

In India G- Secs are issued by the Central Government , State Governments and Semi Government Authorities such as  municipalities, port trusts, state electricity boards and public sector corporations.  The Central and State Governments raise money through these securities to finance the creation of new infrastructure as well as to meet their current cash needs.  Since these are issued by the government, the risk of default is minimal. Therefore, interest rates on these securities often serve as a benchmark for the level of interest rates in the economy. Other issuers may price  their offerings by `marking up’ this benchmark rate to reflect the credit risk specific to them.

These securities may have maturities ranging from five to twenty years.   These are fixed income securities, which  pay interest every six months.  The Reserve Bank of India manages the issues of the securities. These securities are sold in the primary market mainly through the auction mechanism. The RBI notifies issue of a new   tranche of securities. Prospective buyers submit their bids. The RBI decides to accept bids based on a cut off price.

The G -secs are primarily bought by the institutional investors. The biggest investors are commercial banks who invest in G-secs to meet the regulatory requirement to maintain a certain percentage of Statutory Liquidity Ratio (SLR) as well as an investment vehicle. Insurance companies, provident funds, and mutual funds are the other large investors. The Primary Dealers perform the function of market makers through buying and selling activities.

The Government of India also borrows short term funds for up to one year.  This is through the issue of Treasury Bills which are sold at a discount to the face value and redeemed at the full face value.

Commercial bonds or Debentures:

Debentures have a fixed maturity   and pay a fixed or a floating rate of interest during their lifetime.  The company has an obligation to pay interest and the principal amount on the due dates regardless of its profitability position.  The debenture holders are not members of the company and do not have any say in the management of the company.  Since these carry a predefined rate of return, there is no scope for any major capital appreciation.  However, in case of fixed rate debentures, their market price moves inversely with the direction of interest rates. The debenture issues are rated by the professional credit rating agencies regarding the payment of interest and the  repayment of the capital amount. Apart from the `plain vanilla’ variety of debentures (periodic payment of interest during their currency and repayment of capital on maturity), a number of variations have been devised. For example, zero coupon bonds  are issued at a discount to their face value and redeemed at the full face value. The difference constitutes return for the investor.