Understanding Bonds – Part4

Today we will discuss about different types of bonds. In India, there are several types of bonds available to investors, including ones that are only sold privately and a tax-savings bond that releases the investor of a tax burden.


Public Sector Undertaking Bonds (PSU Bonds):


If you're looking for a medium- to long-term investment in the Indian bond market, a Public Sector Undertaking bond can be a good choice. PSUs are issued and backed by the government of India, but they are usually sold on a private basis. The Indian government targets investors themselves and offers the bonds to these isnvestors at fixed rates.


Corporate Bonds:


A company can issue bonds just as it can issue stock. Large corporations have a lot of flexibility as to how much debt they can issue: the limit is whatever the market will bear.These are more traditional bond instruments, which are offered by private corporations in India for terms that can last up to 15 years. Corporate bonds are characterized by higher yields because there is a higher risk of a company defaulting than a government. The upside is that they can also be the most rewarding fixed-income investments because of the risk the investor must take on. The company's credit quality is very important: the higher the quality, the lower the interest rate the investor receives. There are two other of corporate bond. One is convertible bond which the holder can convert into stock, and the other is callable bond which allow the company to redeem an issue prior to maturity.

Financial Institutions and Banks :


Bonds issued by financial institutions and banks in India are a vibrant financial instrument and make up more than 80 percent of the bond market. Bonds issued by financial institutions and banks are regulated well and come with good bond ratings. Large-scale investors are some of the most important investors in this category.


Emerging Markets Bonds:


These bonds, issued by the Indian government, are issued abroad as hard currency to raise capital for economic development. What's different about these bonds is that they are usually issued in U.S. dollars or the Euro, which can make them more attractive to investors in those countries. Also making these EM bonds attractive is the interest rate, which while high is typically paid by the issuer. The risk comes in that countries like India have a lower credit rating and the success of the bonds is tied to the success of the country's economic development.

Tax-Savings Bonds:


The Indian government issues special bonds that allow its citizens to be either partially or fully released from paying taxes. Most of them are issued by India's Reserve Bank. The upside for the investor is that by purchasing this bond, they are released from paying taxes on the related interest income, as long as they hold the bond until it matures.


Zero-coupon Bond:


This is a type of bond that makes no coupon payments during the holding period but instead is issued at a considerable discount to par value. For example, let's say a zero-coupon bond with a Rs 1,000 par value and 10 years to maturity is trading at Rs 600; you'd be paying Rs 600 today for a bond that will be worth Rs 1,000 in 10 years.

Regards,

Arvind Trivedi

Certified Financial Planner

Understanding Bond – Part 3

In the part-2 we had learned the basic characteristics of bonds. Today we will understand about price fluctuation of bonds. Often we investor confuse about bond pricing. Bonds price fluctuate with prevailing market interest rate. For understand bond pricing, first we need to understand concept of yield.

Yield Concept:

Yield is a figure that shows the return you get on a bond. The formula of calculating simple yield is : yield = coupon amount/price. When we buy a bond at par or face value, yield is equal to the interest rate. When we purchase it below or more from face value then yield change accordingly our trade price.
For an example : If you buy a bond with a 10% coupon at its Rs 1,000 par value, the yield is 10% (100/1,000). But if the price goes down to Rs 800, then the yield goes up to 12.5% (100/800). This happens because you are getting the same guaranteed Rs100 on an asset that is worth Rs 800. Conversely, if the bond goes up in price to Rs1,200, the yield reduce to 8.33% (100/1,200).

Yield to Maturity (YTM):

In the above yield concept we have learnt calculation in very simple form. In real yield is calculated as YTM. YTM is a more advanced yield calculation that shows the total return you will receive if you hold the bond till maturity.

YTM consider all the interest payments (coupon payment) you will receive and assumes that you will reinvest these interest payments at the same rate as the current yield on the bond plus any gain or loss according to purchase rate. Calculation of YTM we learn in next part of this series. Now at this point we should understand that YTM is more accurate and enables us to compare bonds with different maturities and coupons.

Bond's price and its yield are inversely related. When price goes up, yield goes down and when price goes down the yield goes up.

As we have discussed the factors of face value, coupon, maturity, issuers and yield in past bond series. All of these characteristics of a bond play a role in its price. But there are one more important factor that influences a bond more and that is prevailing interest rates in the economy. When interest rates rise, the prices of bonds in the market fall, older bond’s yield increase and newer bonds being issued with higher coupons. When interest rates fall, the prices of bonds in the market rise, older bond’s yield decrease and newer bonds being issued with lower coupons.

I hope till now we have learnt about YTM concept in initial level. In next part we will discuss about different types of bonds.

Regards,

Arvind Trivedi

Certified Financial Planner

Understanding Bonds – Part 2

After the introduction of the basic concept of the bonds, today we are trying to explore characteristics of a bonds.

Face Value / Par Value:

The face value is also known as the par value or principal. It is the amount of money a bond holder will get back once a bond matures. Corporate bonds normally have a par value of Rs 1,000, but this amount can be much greater for government bonds. Now the confusing part is that the price of the bond. A newly issued bond usually sells at par value. After issuing, its price would be fluctuates due to many economic conditions till the maturity date. If it trades above the face value, it is said to be in premium and when it trades below from the face value, it is said to be in discount.

Maturity Date:

The maturity date is the date on which the investor will get back face value or par value from the issuer. In general, maturity date can be range from one day to 30 years or even more than 30 years depend on the bond’s term and condition. Obviously a bond that matures in one year is much more predictable and less risky than a bond that matures in 20 years. So the longer the time to maturity, the higher the interest rate. If all things are being equal, a longer term bond will fluctuate more than a shorter term bond.

Coupon rate or Interest rate:

Coupon rates or interest rates both are same. It is the amount the bondholder will receive as interest payments till maturity date as per predefined condition maintained in the bond. Most bonds pay interest in every six months, but many pay also monthly, quarterly or annually. The coupon is expressed as a percentage of the par value or face value. For example if a bond pays a coupon of 10% and its par value is Rs 1,000, then it will pay Rs 100 of interest in a year.

If coupon rate fix till the maturity then this bond is called as fixed coupon bonds. When the interest rate (coupon rate) is linked to the market rates through an index then it is known as floating rate bonds.

Issuer:

It is the most important factor to know ‘Who is the issuer of the bond?’.The issuer of a bond is a crucial factor to consider before purchase any bond. First check the issuer's stability and credit for getting paid back coupon and face value. For example, the Indian government is far more secure than any corporation. Its default risk (the chance of the debt not being paid back) is extremely small. That is the reason Indian government securities are known as risk free assets. The reason behind this is that a government will always be able to bring in future revenue through taxation. If the issuer is non govt organisation, it must continue to make profits, which should be more than guaranteed coupon and face value.

There are also a bond rating agencies which helps investors determine a company's credit risk at the time of purchasing bond. Blue chip firms have a high rating, while risky companies have a low rating. There are many popular rating agencies. Few of them are Moody, Standard and Poor , Crisil and Fitch Ratings.

If the company falls below a certain credit rating, its grade changes from investment quality to junk status. Junk bonds are the bonds whose issuer companies in some sort of financial difficulty. Because they are so risky, they have to offer much higher yields than any other debt. So every time investor should not be in trap of higher coupon rate from these type of junk bond companies. It is better to be avoid such type of bond.

In next part of the bond series we will discuss about bond yield, price in more detail.

Regards,

Arvind Trivedi

Certified Financial Planner

Will RBI going for another rate cut......?

Now market experts, industry leaders, economists are thinking about that “Is RBI going to another rate cut on this 18^th June ?” This is the big question in mind of everyone. The People’s Bank of China, the central bank, cut the official one-year borrowing rate by 25 basis points to 6.31 percent and the one-year deposit rate by a similar amount to 3.25 percent. Now that China has done, India which has seen its economic growth take a major hit, is now under more pressure to follow suit. Ever since RBI Deputy Governor  Subir Gokarn hinted that there is now more elbow room to cut policy rates thanks to lower global crude oil prices and weakening core inflation, hopes have been running high.
India’s economic growth slumped in the January-March quarter to a nine-year low of 5.3 per cent confirming an economic slowdown and sending negative signal across the industry. The disappointing GDP figures require an immediate action by the central bank while the market is also expecting the government to roll out certain measures.

In the last monetary policy, RBI cut the repo rate (its main policy rate) for the first time in nearly three years in April by a steeper-than-expected 50 basis points (100 basis points = 1 percentage point.) At that time, the central bank warned that further rate cuts could be difficult because of persistent threats to inflation from food and fuel prices.

Due to sharp slide in growth, there might be pressure on the central bank to place the issue of growth before inflationary concerns. While expectations for a rate cut grow, many economists and traders say only policy reforms by the government can revive growth. Now interest rate cuts by the RBI are only a quick fix to growth. Without fiscal tightening only rate cut in RBI monetary policy will likely increase inflation further and lead to economic instability.
Now time has come our government should make some major policy decision and should not depend on our central bank’s policy.

Regards,

Arvind Trivedi

Certified Financial Planner

Understanding Bonds – Part 1

When we think about investment, the first thing comes in the people’s mind that they should invest in the share market or real estate for making rapid and huge profit. Stories of investors gaining great wealth in the stock market and real estate are common. The other side for bond market, the picture is different and not very exciting for common investor. People are not much excited about bond market due to lack of knowledge and less media coverage. People often think bonds are much more boring - especially during bull markets, when they seem to offer less return compared to stocks.

In the bear market investors want invest in bonds for safety and stability. In my opinion, for many investors it makes sense to have at least part of their portfolio invested in bonds. So we are starting a series of articles related bonds in the many parts to understand  what bonds are, the different types of bonds and their important characteristics, how they behave, how to purchase them.

In our lives we need money at some point and we borrow that money from our relatives, friends or banks. Just like that companies need money for expand of business and government need money for development and welfare for citizen. The solution is to raise required money by issuing bonds (or other debt instruments) to a public market. Basically, A bond is nothing more than a loan for which you are the lender and companies or govt are borrower. The companies and government that sells a bond is known as the issuer (borrower).

As in simple case borrower pay some interest to lender for lending money at predetermined rate and specified time. In case of bond the interest rate is often known as the “coupon rate”. The date on which the issuer (borrower) has to repay the borrowed amount known as “maturity date “ and  borrowed money know as “face value” of bond . Bonds are known as fixed income securities because you know the exact amount of cash you'll get back if you hold the security until maturity. For example, if you buy a bond with a face value of Rs 1,000, a coupon of 8%, and a maturity of 10 years. It means you'll receive a total of Rs 80 (Rs 1,000 * 8%) of interest per year for the next 10 years. If bonds pay interest semi-annually, you'll receive two payments of Rs 40 in a year for 10 years. When the bond matures after 10 year, you'll get your Rs 1,000 back on maturity date.

Difference between Debt and Equity:

The main difference between bonds and equity are that bonds are debt and stocks are equity. By owning equity (stock) an investor becomes an owner in a company. It means owner of stocks has right of voting and the right to share future profits if any.   By purchasing debt (bonds) an investor becomes a creditor to the corporation (or government). The primary advantage of being a creditor is that you have a higher claim on assets than shareholders. In the case of bankruptcy, a bondholder will get paid before a shareholder. However, the bondholder only entitled for principal amount (face value of bond) and interest (coupon amount). Bondholder does not share in the profits if a company does well in future.

It means debts are lower risky instrument with lower return and stocks are higher risky instrument but uncertain return. Now the question is for whom debt instruments are suitable and for whom stocks (equities) are good. For retired person who need fixed income with capital protection debt instruments are ideal. For those who are worried about of stock market volatility in near term and don’t want risk to wipe out of capital amount debt instruments are suitable. These instruments are the best option for short term horizon’s investment with lower risk.

In the next article we will understand bonds in more detail.

Regards,

Arvind Trivedi

Certified Financial planner

New guidelines for Health Insurance

IRDA has come up with momentous regulations which will change the health insurance industry workings if the draft is implemented without watering it down. TPAs' role will get marginalized and hence they may try to scuttle the implementation in its current form

Insurance Regulatory and Development Authority (IRDA) has finally issued draft health insurance regulations addressing several areas of concern. The draft covers product design, renewability, portability, file and use procedures, protection of policyholders' interest, servicing of health insurance policy, third party administrators (TPA), contract between insurer and hospitals and so on.

The important points in IRDA guidelines are related to following:

• Entry and exit age - All health insurance policies shall provide for entry age at least up to 65 years. All health insurance policies shall not have an exit age for renewal of the policies, once the proposal is accepted, provided the policy is continuously renewed without a break.
• Cumulative bonus to be mentioned in the policy document
• Mediclaim denial grounds to be given in writing
• Reward a favourable claim ratio
• Refund on pre-insurance med check-ups - A proposal resulting into a policy shall reimburse at least 50% of the medical exam cost.
• Separate grievance cell for senior citizens
• Increase in premium must be in writing and must be justified
• Claims independent of multiple fixed benefit policies - The insurer shall make the claim payments independent of payments received under other similar polices.
• If two or more policies are taken by  an insured during a period from one or  more  insurers,  where the  purpose  of  such  policies  is  to  indemnify  the  treatment costs, the insurer shall not apply the contribution clause but the  policyholder shall have an option to chose insurer with whom the claim is to  be settled. In all such cases, the insurer shall be obliged to settle the claim without insisting for contribution clause.
• Insurers  may  provide  coverage  to  non-allopathic  treatments  provided  the treatment has been undergone in a government hospital or in any institute recognized  by  the government.
• Any  product  that  is  being  offered  in  the  market  by  insurance  companies shall not be allowed to be withdrawn  in respect of the existing customers of  the  product,  unless,  the  existing  customers  are  given  an  option  to switch to a similar product under specific written consent.
• Uncomplicated one page customer information sheet to cover key benefits, exclusions and grievance mechanisms.
• Renewal cannot be denied randomly
• Waiting period for pre-existing diseases (PED) be clearly specified
• Claim settlement within 30 days
• Insurer to make direct payment to the hospital and policyholder (not through TPA). Cheques will have to be written by the insurance company and send to hospital (for cashless) and policyholder (for reimbursement). It means that cheques cannot be held by TPAs as a float.
• ID card to have logo of the insurance company. In  case  the  policy  is  renewed,  provisions  to  be  established  by the  insurer  to  ensure  there  shall  not  be  any  need  for  re-issue  of  fresh cards provided there is no change in the details of the policyholder. It means auto-renewal of same ID cards.
• Agreement between the TPA and insurance company to be registered with IRDA
• Seamless transfer of policies services by an existing TPA to the new TPA
• Claim settlement - Specific ground of settlement and denial of claim must be mentioned
• All insurers shall have an agreement directly with the hospitals to establish the list of network providers. The insurer  shall  be  responsible  for  carrying  out  an empanelment  process  of  hospitals  or  health  care  providers  to  provide  cashless facility to the policyholder. The TPA role is effectively marginalised.

Regards,

Arvind Trivedi

Certified Financial Planner

Impact of current falling of  Indian Rupee against US Dollar

We all are witnessing falling value of  the Indian rupee against the US dollar. Our policy maker and economists are trying to find out the way to come out from this situation with their best efforts. RBI has become mute spectator as it has no more options to stop this fall. The windfall from a 23% drop in the value of the rupee against the dollar in the last one year has impacted our equity market, debt position of the corporates , fiscal deficit , capital inflow, import and export figure and overall economic environment. It is very difficult to analyze the overall impact of the falling rupee but here in this article we are trying to study the major impact of falling rupee to the some extent.

Impact on Export and Import Industry

In normal sense, a depreciating rupee should have made Indian exports cheaper and more competitive. But in this fall exporters are not happy due to a combination of shrinking global markets and rising import content of Indian exports, a weakening rupee does not necessarily translate into enhanced exports. Worse, because imports are largely inelastic, with oil and gold accounting for 44% of India’s purchases from overseas, declining exports can only mean that the trade deficit would widen, putting further pressure on the balance of payments.

A weak rupee should make exports cheaper and imports costlier. Both these should have a positive impact on the trade deficit and current account deficit, which is somehow not happening. A part of the problem is that over the past few years, the composition of India’s exports has changed in favour of value-added products, in contrast with the past when primary products and textiles products dominate in import segment. While sectors such as engineering, chemicals, and gems and jewellery have been the key drivers of India’s exports, due to a high import content in such products, the depreciation of the rupee does not fully translate into gains for exporters.

It is a big challenge for India to assess the fair value of its currency. Sometimes, speculators can take the currency far away from its fair value. The rupee depreciation will also put additional pressure on domestic inflation by making imports costlier. A 10% depreciation could have an impact of 140 basis points on inflation over a period of time. (A basis point is one-hundredth of a percentage point)

Impact on debt

On account of their aggressive global expansion strategy and the need to find cheaper sources of funds, as opposed to depending on costly domestic credit, Indian companies have taken dollar-denominated loans. The weakening of the rupee is expected to significantly raise their debt burden in rupee terms. Many information technology (IT) firms do see a benefit in their rupee revenue and, therefore, their margins and profitability, but for quite a few quarters now, the concern has shifted to the revenue front— particularly in Europe and the US.

Impact on capital inflow

Policy paralysis and an inability to pursue serious fiscal correction are great worry for foreign investors, particularly institutional investors. There is a risk of capital inflows holding out due to fears of a weakening rupee, which triggers another round of currency depreciation, setting off another round of a negative macroeconomic response. This has resulted in diminished capital inflows, which in turn have only increased the pressure on the rupee, pushing it down to a record low of 56.38 on 24 May.

Outlook

Since India is globally more integrated than it was in the past—not just in terms of merchandise trade, but also in the actual movement of people and a rapidly expanding corporate footprint . The uncertainty surrounding Europe, struggling with a debt crisis, has only made the outlook that much bleaker. A current account deficit that’s above 3% of GDP will be difficult to finance. The medium-term target should be to bring the deficit below that level. According to many analysts if the overall macroeconomic situation does not change, it is likely that the rupee will remain weak.

Regards,

Arvind Trivedi

Certified Financial planner