The support of the Debt Market

We already know that the capital markets are designed with the purpose of connecting the people who need money for projects and the people who have money to invest in the same.

This way of raising finance may involve 2 routes- Equity and Debt.

While equity often takes the spotlight, it's the less-heralded world of debt that forms the quiet backbone of finance. Today, lets understand about the domain of the debt market.

The debt market is the oldest of the financial markets, the crux of the market is- investor lends the organization money, the organizations borrow said money for its needs and promises to pay the money back to the investor along with interest. This is done through the issuance of debt instruments. Debt instruments are securities that have 2 parts- a principal and interest. The investor lends the money hence called lender, the organization borrowing that money issues a debt instrument hence called issuer. These instruments have a time expiry an interest rate for payment of interest. Different types of entities can issue different types of debt instruments.

Who can issue debt instrument?

• Central and State Governments

• Banks

• Corporate Institutions

• Financial Institutions like NBFCs

What are debt instruments?

• Government Securities: Commonly called as “G-secs” are securities issued by the Government of India. It included Treasury bills, Sovereign Gold Bonds State Development loans. Out of this lot, the infamous ones are Treasury Bills and Sovereign Gold Bonds.

• Bonds: Bonds are issued by entities that need to raise funds to finance their projects, operations and growth plans. Government Bonds are used for financing infrastructure and development projects.

• Debentures: Debentures are very similar to bonds but are majorly issued by companies for their expansion projects.

• Corporate Fixed Deposits: Mostly used by NBFCs, corporate and Banks to finance their expansion projects and long-term projects these are instruments that work very similarly to that of FDs in banks.

• Commercial Papers: These are promissory notes issued by companies acknowledging their debt to the lender and promising to pay the principal back along with interest.

Why choose the Debt Market?

This is segment offers one of the most attractive investment opportunities for investors considering long term reliability, safety and certainty of returns in the securities issued. For all the above good reasons, these securities are often bought by investors for maintaining a well-balanced portfolio involving debt and equity.

Debt market offers:

1. Certainty of Returns: The debt market instruments offer regular stable interest payouts, investors to partake in this market because of the certainty of the returns that they can expect out of the instruments.

2. Lesser Volatility: Compared to the equity market instruments, debt instruments are less volatile in their value.

3. Tax deductions: Investing in Sovereign Gold Bonds, NSCs and treasury bills issued by the government grants you tax benefits, which are not found in equity market instruments.

4. Well balanced portfolio: Debt instruments provide stability at lesser risk. This nature of the instruments is often a good balance for investing in risk bearing instruments. A lot of finance investment professionals recommend a diversified and balanced portfolio in equity and debt.

Debt markets have a positive impact on the entire economy of the country. It is also used for measuring and dealing with interest rate matters. It serves as a base for interest rate calculation in the country and helps us identify good securities. The interest rate guaranteed by the government on their securities is used in calculation of risk free rate of return in the country which serves as a base for investment decisions in the country.

Risks in the Debt Markets:

The debt market offers instruments that are stable with certainty of returns this does not mean that the debt market is free of risks. The risks involved may be negligent but have to considered before making an investment decision. The risks are:

a. Default risk: The risk involved in which the issuing organisation is not able to pay their obligation-payment of interest and principal and default on the payment.

b. Interest Rate risk: The most important risk while considering the debt investment. It is the risk involved with the change in the interest rates prevailing in the market.

c. Reinvestment risk: Risk involved with lack of options for investment of the proceeds from the securities which may arise in the future.

Eg: Probability of decrease in the interest rates in the future leads to lack of options to invest interest received from debentures.

Trading in debt instruments shall have added risks like counterparty risks and price risk.

Why don’t you hear about the Debt markets like the Stock markets!

Instruments traded in this markets have negligible risks involved and always are used by investors for diversification of their portfolios or for even creating a stable source of return on their investments. The excitement in the Debt markets is not the same as that of the stock markets due to the high volatility, risk and price changes involved.

These are strategic instruments and typically used by financial institutions for raising money for long term projects or for investing in the same and attaining stability of income preventing risks arising due to market volatility. Since the funds required by such projects are huge, the retail investors with lesser income find it difficult to invest in these instruments because of the size of minimum subscription. This has made this market less sought out by the retail investors hence creating lack of involvement in this market. This might be one of the major reasons for lack of awareness about this market who lose out on benefits of the other debt instruments involved in this market.

The reduction in minimum lot size of T-bills by RBI, SGB and NSC tax, deductions, a higher interest rates offered by NBFCs has given support to the retail investors and increased information seeking of the debt segment by retail investors for all possible investment opportunities involved in this market.

Conclusion:

The debt market is an important yet overlooked area of investing among retail investors for lack of excitement, knowledge and it provides investors with safer and reliable investment opportunities. If you are a risk averse investor or just an investor looking for diversification of your portfolio, debt instruments could be worth considering. Even if there are negligent risks involved, one should always consider their risk tolerance and goals before investing. Only post due diligence and alignment with risk and goals one should make any investment decision in any financial instrument

Authored By

Sudarshan Seshadri Iyengar

(B.Com Student and ICWA Finalist)