BOND MARKET & DERIVATIVE

MARKET

BOND MARKET

WHAT IS A BOND?• A bond is a debt security, similar to an I.O.U.

When you purchase a bond, you are lending money to a government, municipality, corporation, federal agency or other entity known as the issuer.

• Bonds issued by corporations or the US government are usually taxable.

• Bonds issued by state governments or municipalities are usually exempt from tax.

VARIABLES THAT EFFECT VALUE

MATURITY

REDEMPTION FEATURES

CREDIT RATINGS

INTEREST RATEPRICE

YIELD

TAX STATUS

MATURITY• Short term bonds• Medium term

bonds• Long term bonds

REDEMPTION FEATURES

• Bond with a redemption provision usually have higher return to compensate for the risk that the bonds might be called early. CALL Option: provisions that allow or require the

issuer to repay the investors’ principal at a specified date before maturity.

PUT Option: option of requiring the issuer to repurchase the bonds, at a specified time, prior to maturity.

CREDIT RATINGS• Determined by CRA • Each of the agencies

assigns its ratings based on an in-depth analysis.

Credit Risk Moody's Standard and

Poor's Fitch

Prime Aaa AAA AAA

Excellent Aa AA AA

Upper Medium A A A

Lower Medium Baa BBB BBB

Speculative Ba BB BB

Very Speculative B, Caa B, CCC, CC B, CCC, CC, C

Default Ca, C D DDD, DD, D

Credit Ratings

INTEREST RATES• FIXED• FLOATING• PAYABLE AT

MATURITY

PRICE• The amount you pay

for the bond–Newly issued bonds–Traded bonds

YIELD1)Yield is a return2)Two types of yields: Current yield: Yield to maturity:

• From the time a bond is originally issued until the day it matures, its price in the marketplace will fluctuate according to changes in market conditions or credit quality. The constant fluctuation in price is true of individual bonds-and true of the entire bond market-with every change in the level of interest rates typically having an immediate, and predictable, effect on the prices of bonds.

YIELD (Linking price and yield)

• Most important thing to remember!!

* When prevailing interest rates rise

* When prevailing prices fall

YIELD (Linking interest rate and maturity)

• Price fluctuation• Yield curve

TAXABLE STATUS• U.S Treasury

bonds• Municipal bonds

INTEREST RATE-INFLATION

• Inflation – Erodes a bonds value.

• Reasons of rise in interest rates.

• Effect of rising interest rate on bond market.

CONT…• Interest rates rise due to:

– The Federal Reserve trying to slow economic growth

– through market forces acting in anticipation of interest rate moves

**Since rising interest rates push bond prices down, the bond market tends to react negatively to reports about strong economic growth.

TYPES OF BONDS• Municipal:• Corporate:• Zero-Coupon:

DERIVATIVE MARKET

WHAT IS DERIVATIVE MARKET?

• Financial derivatives are financial instruments whose prices are derived from the prices of other financial instruments which are also know as underlying. It relates to equities, loans, bonds, interest rates and currencies.

TYPES OF DERIVATIVES

OPTIONS

SWAPSFUTURES

OPTIONS• Option contract• Buying –call • Selling –put • Types

• In finance, an option is a contract which gives the owner the right, but not the obligation, to buy or sell an underlying asset or instrument at a specified strike price on or before a specified date. The seller incurs a corresponding obligation to fulfill the transaction, that is to sell or buy, if the long holder elects to "exercise" the option prior to expiration. The buyer pays a premium to the seller for this right. An option which conveys the right to buy something at a specific price is called a call; an option which conveys the right to sell something at a specific price is called a put. Both are commonly traded, though in basic finance for clarity the call option is more frequently discussed, as it moves in the same direction as the underlying asset, rather than opposite, as does the put.

FUTURES• Future contract • Buyer –long• Seller –short • What is traded ?

SERVICES RENDERED• Provide hedging facilities to buyers and

sellers to protect them against unpredictable price fluctuations over time.

• Introduce an element of stability market prices.

• Indicate expected future prices.

SWAPS• It is an agreement between

two parties to exchange sequences of cash flows for a set period of time.

• The Market Began in 1981 & has been Growing ever since.

• Swaps market is regulated by SDMA.

• Highly Flexible & can be customized to the parties.

• Cost of transacting in the market is fairly low.

• Private transaction between 2 parties.

ADVANTAGES OF SWAP AGREEMENT

DISADVANTAGES OF SWAP AGREEMENT

• Requires finding a Counter-party willing to accept the terms.

• An Illiquid Market (require consent of counter-party to terminate).

• Unregulated: lots of potential Credit Risks.

IMPORTANCE• To minimize risk.• To protect the interest of individual and

institutional investors.• Offers high liquidity and flexibility.• Does not create new risk and minimizes

existing ones.• Lowers transaction cost.• Provides information on market movement.• Provides wide choice of hedging.• Convenient, low cost and simple to operate.

MADE BY:

• MOHIT SHAH – 45• ARZOO SHAH – 41• VISHAL JAIN – 24• SEJAL ZAVERI – 58• POOJA GOKANI – 12• IMRAN PATEL – 35