Debt Some Perceptions A debt fund can earn

Debt - Some Perceptions A debt fund can earn a rate of return equivalent to interest rate nothing more and nothing less.

Debt - Objectives This module will q Explain the nature and working of some of the debt instrument we invest in. q Explain the determination of interest rates and relationship between interest rate and bond prices. q Explain the impact of fluctuating interest rates on fixed deposits.

Activity Time What’s the Good Word q 3 clues about Debt terminologies will appear on the screen q You need to guess the ‘good word’

What’s the Good Word q In this type of debt usually banks are borrowers and Insurance companies, mutual funds and banks are lenders. q Interest rates on an annualized basis fluctuate widely q Money is usually borrowed on an overnight basis.

What’s the Good Word q They are issued in denominations of 91 days and 364 days q They are the sovereign obligation of Government of India. q They are issued at a discount to face value.

What’s the Good Word q These instruments can be issued by government, public sector undertakings or Corporate. q They can be secured as well as unsecured. q They give a fixed coupon income.

What’s the Good Word q These instruments give you fixed rate of return q Value of the principal does not change with the change in interest rates. q Returns generated by these instruments are fully taxable.

What’s the Good Word q I go up when the inflation goes up and come down when it comes down. q I go up when there are more borrowers than lenders and come down when there are more lenders than borrowers. q My movement also depends upon global factors.

What’s the Good Word Role of Reserve Bank of India tries to maintain a balance between

Debt - Interest rates, growth & inflation

Debt - Interest rates and Bonds Relationship between interest rates and bond prices Old Bond New Bond Face Value Rs. 100 Interest Rate 7% Interest Rate 8% Which bond one will buy?

Debt - Interest rates and Bonds q Investors will start selling the 7% bond and investing in the 8% q This will reduce the price of the 7% bond as there is higher su

Debt - Interest rates and Bonds When the interest rates go up bond prices will fall.

Debt - Interest rates and Bonds Relationship between interest rates and bond prices. q If the price of the first bond falls to Rs. 99. 07 then the return earned on it will be 8% (I. e 107/1. 08) as the bond will continue to give a coupon of Rs. 7. q This will bring it on par with the second bond.

Debt - Interest rates and Bonds Relationship between interest rates and bond prices. Old New Face Value Rs. 100 Interest Rate 7% Interest Rate 6% Which bond one will buy?

Debt - Interest rates and Bonds q More and more Investors will start buying the 7% bond. q This will increase the price of the 7% bond as there is higher demand.

Debt - Interest rates and Bonds When the interest rates go down bond prices will rise.

Debt - Interest rates and Bonds Relationship between interest rates and bond prices. If the price of the first bond rises to Rs. 100. 94 then the return earned on it will be 6% (107/1. 06) as the bond will continue to give a coupon of Rs. 7. This will bring it on par with the second bond.

Debt - Interest rates and Bonds Relationship between maturity, risk and returns. q If the interest rates go up, the longer term bonds will fall higher than shorter term bonds due to compounding effect. q If the interest rates come down, the longer term bonds will appreciate higher than the shorter term bonds.

Debt - Interest rates and Bonds Relationship between maturity, risk and returns. q If the interest rates are expected to go up, it is better to buy short-term bonds. q If the interest rates are expected to come down, it is better to buy long-term bonds.

Debt – Fixed Deposits How different are fixed deposits? In fixed deposits the value of the principal does not change. However as the interest rates change, the interest rate offered on new deposits change. Interest offered on old deposits remains the same. Example: If a deposit was made in 2005 at a rate of 6. 5%, the interest rate offered on that deposit will continue to be same even now, when the rates have gone up. However interest rate on new deposits will be the current rate.

Debt – Fixed Deposits How different are fixed deposits? In an open economy like ours, interest rates are bound to fluctuate. If a fixed deposits offers 9. 5%, there is no guarantee that the same rate will be offered for deposits made next year. The fact that the interest on deposits is taxable, makes F. D returns equal to or slightly less than inflation.