Does The Secondary Bond Market in India Exist?
The investment options have increased in the market over the years, and one of them is bonds. They not only keep the capital safe but also enhance the passive income levels of the investor. Like the stock market in India, bonds have two kinds of markets too, i.e., primary bond market and secondary bond market. Investors lookout for better investment avenues like bonds when the stock market goes south. Both government and corporate entities issue bonds to raise capital during a financial crunch.
The funds earned on bonds are used to pay the debts, invest in projects or budget for business expansions, etc. Also known as debt funds or debt securities, investors can purchase these instruments either in the primary market or in the secondary market. In the primary bond market, the debt securities are originated by bond issuing entities whereas, in the secondary bond market, investors make their move to buy or sell them.
One of the major reasons why investors swing to the bond market is that the volatility is less compared to the stock market. However, the percentage of return in the bond market is lesser than in the stock market. Sometimes, investors sell their bonds before the predetermined period for a myriad of reasons.
Bonds are priced at par value and market value. Also known as Face Value, the former pricing method of the bond is the offering made by the issuer to the investor upon maturity of the bond. For bondholders, this is the amount they are paid post maturity of the bond.
When it comes to market value, bond yields depend on the fluctuations of the market, and some other factors like call risk, interest-rate risk, inflation, yield curve, economy, etc. Both the yield of the bond and bond price are inversely proportional to each other and vice-versa. To know the bond’s yield value in its true state, compute it by dividing the annual coupon payment by the price of the bond.
Since the debt market deals with both government bonds and corporate bonds, they are supervised by two different regulators. While the government debt securities are regulated by the RBI, the corporate debt securities (both private and public sector undertakings) are regulated by SEBI. To buy or sell a bond in the secondary bond market in India, you need to have a Demat account and a bank account to process the transactions. This article further details the impact of the regulations on the secondary bond market.
Impact of Regulations on Secondary Bond Market
With investors witnessing the inevitable stock market volatility, NBFCs crisis and financial squeeze in the market, the bond market has flourished since. Case-in-point, the high-yield corporate bonds deliver substantial returns as the risk taken by the investor is high.
All the bonds in the market are ranked according to their rate of return, risk, and other factors. Standard & Poor and Moody are the most popular rating agencies that rank the bonds and other instruments based on their classes and designations. The rankings are done in the form of letters like A, AA, AAA, B, BB, BBB, C, etc. Investors make their investments in bonds by looking at these rankings.
The regulations in the financial market in India have changed drastically after the 2008 financial global crisis. As a result of shifts and in the secondary bond market in India as well. There were a set of norms drafted to stabilize the financial market irrespective of any types of shocks which are detailed below:
- Basel III: The Bank for International Settlements has prepared a set of standard international banking regulations to contribute to the stability of the financial space. Basel III accord is built on the foundation of Basel I and Basel II. The minimum capital required by the banks as per Basel III is 4.5% of common equity as opposed to 2% in Basel II. Besides, the capital portion required for tier 1 has surged to 6% in Basel III from 4% in Basel II. Additionally, the tier 3 computation is also eliminated from the picture under Basel III. Bond investors should have an affirmative impact under Basel III.
- Volcker Rule: In this rule, banks are not allowed to do any kind of investment and proprietary trading activities from their accounts. They are inhibited from buying or selling shares, derivatives, and other securities. The Volcker rule has also cast down the banks to make any speculative bets. As a result, it diminishes the liquidity in the bond market. So, when an investor decides to sell the bonds, banks find it arduous to find a buyer. Hence, the incessant price fluctuations and prolonged execution time are witnessed even in 10-year maturity bonds.
- Dodd-Frank Act Requirements: Generally, an initial margin is necessary for trades, so there’s a higher requirement for collateral. Only high liquid and high-quality bonds are taken into consideration than the bonds that take a haircut. With testing, the Dodd-Frank method aids in assessing whether banks have adequate capital to operate during financial shocks and economic instability.
Difference Between Primary and Secondary Market
Now that you have learned the basics of the secondary bond market and the regulations, it’s time to know the types of markets bonds are bought and sold. Bonds are issued in two markets, i.e., the primary bond market and the secondary bond market in India. In the primary bond market, the bonds are directly issued by the entities to the bond buyer to purchase.
They’ll be new issues of bonds by corporations and government entities. Here, the transactions take place between buyers and issuers of the bond. All the bonds issued in the primary market are first-time issues and were not previously offered to any investors. Upon bankruptcy, bondholders are the first ones to be preferred over shareholders.
On the other hand, the secondary market, it’s another platform where investors can purchase already issued and sold bonds. If you have a Demat account, you can directly make your purchase via the bond broker or any third party. In the primary market, you don’t have any intermediary whereas, in the secondary bond market, it does. Unlike the stock market, the secondary bond market isn’t as flexible as you think. Meaning, that if you place an order in the secondary bond market in India, the process and execution stretch further.
Tax-free PSU bonds are termed as more liquid and can be processed faster compared to other bonds. Following that, there are AAA-rated bonds which are highly liquid too. Bonds with less ratings are less liquid than bonds with a high rating. However, investors should keep the risk factor in mind whilst making their investment in bonds.
However, if you splurge on bonds that have fewer ratings, the entity should be able to pull off something amazing to restore its credibility. For investors, it’s pivotal to look at the yield-to-maturity of the bond as they are termed the returns on a bond. The yield and interest rates of the bonds are inversely proportional. In the end, investors should take the call on whether to keep the bonds till maturity to alleviate high risk or sell them in between & enjoy the returns it delivers, even if it’s negative.