Debt Market Terminologies

Before we move forward with this module, we should know about some of the basic terminologies in Debt Markets, as these terms will appear frequently throughout the module.

Coupon:

A coupon payment on a bond is the periodic interest payment that a bondholder will receive periodically until the bond matures.

For example, if the coupon rate of a 5-year, ₹100 bond is 5%, its coupon payment will be ₹5, each year for the next 5 years.

Coupon Rate:

The coupon rate on a bond is the percentage of its par value that is paid to its bondholders periodically.

For example, if the annual coupon of a bond is ₹5, and the par value of that bond is ₹100, then its coupon rate is 5/100 = 5%. 

Note: The coupon rate of a bond is calculated on its par value and not on its current or issue price.

Yield To Maturity (YTM):

The YTM or Yield To Maturity of a bond is the total return a bond will generate if it’s held until maturity. It is also called the Redemption Yield. A bond’s YTM is different from its coupon rate. YTM is important because it enables investors to draw comparisons between different bonds of different maturities. Many investors make buying or selling decisions based on the YTM rates.

The formula for calculating YTM is as follows:

Let’s try and understand with an example:

Let’s assume that the Par Value of the bond is ₹1000, and the current market price of that bond is ₹920 with a coupon rate of 10%. The bond has a maturity of 10 years.

Now if we calculate the YTM of this bond, it will be:

₹100 + [(₹1,000- ₹920)/10]/(₹1,000+ ₹920)/2.

After solving the above equation, the YTM of this bond will be 11.25%.

In the above image, we can see the yield rates of a 10-year Government bond in India has been declining gradually.

Repo Rates:

A Repurchase Agreement (Repo), is an agreement between two parties in which one party agrees to sell a security to a counter-party and commits to buying that security at a later date at a specified (higher) price.

RBI uses the repo rate as a tool to control inflation and maintain the money supply in the Indian economy.

For example, if RBI lends a security for ₹100 and buys it back for ₹101.5, then 1.50% is the Repo Rate. Another important term while referring to repo rates is Haircut or Repo Margin. 

The haircut is the percentage difference between the market value of security and the amount loaned. 

Suppose, the market value of the security loaned by RBI in the previous example is ₹128. Then, the Haircut will be 28% (₹128-₹100).

A Reverse Repo Rate agreement refers to taking the opposite side in a Repo transaction.

In other words, when commercial banks lend to RBI, it is known as Reverse Repo.

India’s last 10-year Repo Rates:

source: tradingeconomics.com

India’s last 10-year Reverse Repo Rates:

source: tradingeconomics.com

Maturity:

The term maturity signifies the maturity of a bond or any other Debt instrument.

Different debt instruments have different maturity dates. For example, Coca-Cola initially issued a 100-year bond in 1993, meaning that the bond will mature in 2093. This is one of the longest tenure bonds ever issued. Argentina’s government also once issued a 100-year bond. Some bonds are perpetual in nature meaning that they don't have a maturity date. These are usually issued by banks for e.g. SBI

According to their maturity, bonds can be classified as:

A.Short-term bonds: These bonds have a maturity between 1 to 5 years.

B.Medium-term bonds: These bonds have a maturity between 5 to 10 years.

C.Long-Term Bonds: Long- term bonds have a maturity of more than 10 years.