FINANCIAL MARKETS - BOND AND CURRENCY Bond Markets A bond is an instrument that typically carries a specific rate of interest (Coupon), that the issuer agrees to pay the bone holder; as well as a promise to repay the principal on maturity. Unlike the stock market, the bond market is largely an institutional market, with limited retail (individual) participation. Government Bonds constitute the major bulk of the bonds issued and traded in these markets. You also have state government bonds and bonds issued by companies called corporate bonds. Bonds are traded primarily OTC, though there are some corporate bonds traded on the exchange as well. Participants in the Bond Market 1. Governments & Corporations Government - They are the issuers of bond; to raise money. Corporations - They also issue bonds; to raise money. 2. Commercial Banks They are the main subscribers to the bond issues for their own books (trading) or on behalf of clients. 3. Investment Managers/ Mutual Funds They manage wealth of corporations and individuals and are also subscribers to there bond issues. 4. Depository Agency & Clearing Corporation They perform a role similar to that in stock markets; though the specific institutions are different. Example, Government Bonds are settled in demat form through Clearing Corporation of India Ltd (CCIL) and the Depository Agent is the RBI. For Stock Markets, equivalent entities are National Securities Clearing Corporation Ltd. (NSCL) & NSDL or CDSL. 1 | Page
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FINANCIAL MARKETS - BOND AND CURRENCY
Bond Markets
A bond is an instrument that typically carries a specific rate of interest (Coupon), that the issuer agrees to pay the bone holder; as well as a promise to repay the principal on maturity.
Unlike the stock market, the bond market is largely an institutional market, with limited retail (individual) participation.
Government Bonds constitute the major bulk of the bonds issued and traded in these markets. You also have state government bonds and bonds issued by companies called corporate bonds.
Bonds are traded primarily OTC, though there are some corporate bonds traded on the exchange as well.
Participants in the Bond Market
1. Governments & Corporations
Government - They are the issuers of bond; to raise money.
Corporations - They also issue bonds; to raise money.
2. Commercial Banks
They are the main subscribers to the bond issues for their own books (trading) or on behalf of clients.
3. Investment Managers/ Mutual Funds
They manage wealth of corporations and individuals and are also subscribers to there bond issues.
4. Depository Agency & Clearing Corporation
They perform a role similar to that in stock markets; though the specific institutions are different.
Example,
Government Bonds are settled in demat form through Clearing Corporation of India Ltd (CCIL) and the Depository Agent is the RBI.
For Stock Markets, equivalent entities are National Securities Clearing Corporation Ltd. (NSCL) & NSDL or CDSL.
5. RBI
It is the central bank of the country that regulates the bond market.
Role of various Market Participants
Like in the stock markets, one need to be a member, an authorized dealer in the bond markets to trade in them. Banks and institutions play the role of authorized dealers in these markets.
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Case
• Commercial Banks
• Retail Investors
• Mutual Funds
• None of the above
Retail Investors
Bond Pricing
Bond Pricing change due to various factors affecting demand and supply (interest rates, time to maturity, etc.).
Price of a bond is the present value of all its future cash flows.
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Present Value of Money
If you want to get a known sum of money in the future (Future Value- FV) after a time period t, what is the principal you must invest today, or in other words, what is its present value.
PV = FV/(1+r/100)^t
Where,
FV = Future Value
r = Interest Rate
t = Time Period in Years
The process of computing the present value is also called discounting, as the PV is at a discount (less) as compared to the FV.
The 'r' here is also referred to as the discount rate.
Bond Pricing: Step 1
The first step in bond pricing is to determine the cash flows on the bone. There are a series of cash flows.
Bond Pricing: Step 2
The next step is to find the present value of each of future cash flows.
To find the present value, we need an 'r' or discount rate. The discount rate to be taken is the market yield for the bond.
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Formula for bond pricing will be the present value formula.
Case
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Valuation of the Bond
To find how much money you have made.
Money Markets
The money market is similar to the bond market and even considered a part of it; as money market instruments are also of the fixed income or debt category.
The difference from the bond market is in the tenor or maturity period. Money Market instruments are very short-term instruments, unlike bonds and dubuntures.
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Treasury bills (T-Bills), Commercial Papers (CPs), Certificate of Deposit (CDs) are all money market instruments.
Summary
Foreign Exchange Markets
Foreign Exchange Markets are markets where foreign currencies are bought and sold.
Exporters need to sell the foreign currency they receive for their exports.
Importers need to buy foreign currency to pay for the imports. Even individuals travelling abroad need to buy foreign currency for their expenses overseas.
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Currency trading is primarily conducted in the OTC market that is directly between the dealers. However currency derivatives such as futures and options are traded on the exchange,
Who are the players? Which are the most traded currencies?
24 Hour Market
A unique feature of the currency market is that it is a 24 hour market. That is there is a price always available for the major currencies, 24 hours a day.
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Another feature is that,
Defining an Exchange Rate
Foreign exchange rates express the value of one currency in terms of another.
An exchange rate involves two currencies:
• A Based or Fixed currency, which is the currency being priced.
• A Quoted or Variable currency, the currency used to express the price
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What determines the exchange rate and how does it change?
The exchange rate at any time depends upon the demand-supply equation for the different currencies. This in turn depends upon the relative strength of the economies with respect to the other major economies and trading partners.
