1. TRADING STRATEGIES FOR DEBT MARKET T Ramji thisisramji@gmail.com

2. Coverage of the Presentation Fixed Income Market Concept of Yield Yield Curve Analysis

3. FIXED INCOME MARKET

4. FINANCIAL MARKET MONEY MARKET FOREX MARKET CAPITAL MARKET CALLREPOTERMCPs,CDs,Bills DEBT MARKET G-SECSBONDS

5. Trading in Fixed Income Market Telephone Based Market Types of Deals Direct Deals Brokered Deals Asking for a quote Showing the side Asking for two way Quote Conventions Generation of a quote depends upon buying/selling pressure Settlement standardized on T + 1 basis Checking of Quotes Closing the Deal

6. Calculation of Settlement Amount Principal Amount is calculated as follows: Face Value x Price 100 e.g. Rs 1 crore face value is purchased at Rs 100.50. The principal amount will be Rs 1,00,00,000 x 100.50 = Rs 1,00,50,000 100 Accrued Interest: The interest accrued since last interest payment date has to be paid by buyer to seller

7. Calculation of Settlement Amount No of days for accrued interest: 30/360 day count convention is used : Every month is assumed to have 30 days and the year is assumed to have 360 days E.g 7.40% GOI 2012 Interest payment dates 03/05 and 03/11 Settlement date is 1 st July No of days will be calculated as: May : ( 30 – 2) = 28 days * May is assumed to have 30 days June : 30 days

8. Calculation of Settlement Amount No of days for accrued interest : 58 days Accrued interest = 58 x 7.40 x 1,00,00,000 = 1,19,222.22 360 x 100 Total consideration amount = Principal amount + Accrued Interest = 1,00,50,000 + 1,19,222.22 = 1,01,69,222.22

9. Concept of Yield

10. Current Yield Current Yield is the annual return on the bond based on the purchase price. = Coupon Rate x 100 Purchase Price E.g. 11.50% GOI 2011 at a price of Rs 128 11.50 = 8.98% 128 Discount Bonds - Current Yield > Coupon Premium Bonds - Current Yield < Coupon. Par Bonds – Current Yield = Coupon

11. Yield To Maturity A Bond is seen as a series of Cash flows All the Cash flows on a bond are discounted to the present value using Present Value Discount Factors The rate at which the Present Value of the Future Cash Flows are equated to the Market Price of the Bond is the called as the Yield to Maturity (YTM). YTM is nothing but the IRR on the bond

12. Sources of Cash Flows The return from a bond consists of 3 components: The regular interest receipts in the form of coupons The interest from the reinvestment of such receipts The capital gain / loss upon maturity or upon selling the bond

13. Yield To Maturity The return that is earned if held till maturity The YTM on an instrument is dependent upon a number of factors like: *Coupon Rate; *Premium/Discount on the bond; *Frequency of the compounding; *Balance maturity of the bond; *Redemption Value of the Instrument;

14. There is an inverse relationship between price of the security and its Yield to Maturity. E.g. 10.20% GOI 2007 with a face value of Rs 100 is issued at Rs 110 On 1 st Jan 2005, the YTM is calculated as: Yield To Maturity

15. Calculation of YTM Trial Value of YTM = 6.45 Time period IP DateCouponDiscoun t factor Discounted cash flow 1 12 Jan 05 5.100.96884.9407 2 12 Jul 05 5.100.93854.7863 3 12 Jan 06 5.100.90924.6368 4 12 Jul 06 5.100.88084.4919 5 12 Jan 07 5.100.85324.3516 6 12 Jul 07 105.100.826686.8747 110.0819

16. Calculation of YTM Time period IP DateCouponDiscoun t factor Discounted cash flow 1 12 Jan 05 5.100.96854.9395 2 12 Jul 05 5.100.93804.7840 3 12 Jan 06 5.100.90854.6334 4 12 Jul 06 5.100.87994.4876 5 12 Jan 07 5.100.85224.3463 6 12 Jul 07 105.100.825486.7486 109.9393 Trial Value of YTM = 6.50

17. Calculation of YTM Time period IP DateCouponDiscoun t factor Discounted cash flow 1 12 Jan 05 5.100.96864.9400 2 12 Jul 05 5.100.93824.7850 3 12 Jan 06 5.100.90884.6348 4 12 Jul 06 5.100.88034.4894 5 12 Jan 07 5.100.85274.3485 6 12 Jul 07 105.100.825986.8023 110.00 Trial Value of YTM = 6.48

18. Bonds & Yields Bond & Yields have inverse relationship Bond Prices fall on rise in yields Bond Prices rise on fall in yields You should have a long position in a falling yield scenario and short position in a rising yield scenario In India, shorting in the cash market is prohibited by RBI

19. Yield Curve Analysis

20. Yield Curve Yield Curve is plot of YTM versus the no of years to maturity

21. Yield Curve Steepness of the Curve Steep Curve Flat Curve Inverted Curve Slope of the Curve Shifts in the Yield Curve Parallel Shift Non-Parallel Shift

22. Trading Strategies Strategy 1: Kinks in yield curve  Buy 10.47% 2015  Buy 10.47% 2015 and sell 10.71% 2016

23. Maturity & Rate Sensitivity Longer Maturity Bonds are more sensitive to interest rate changes than shorter maturity bonds A 1% Decline in yield results in Price Rise of Rs 0.95 in a 1 year bond (2006 maturity) Price Rise of Rs 15 in a 30 year bond (2034 maturity) You should have a longer maturity bonds in your books in a falling yield scenario and shift to short maturity bonds in a rising yield scenario

24. Coupon & Rate Sensitivity Low Coupon Bonds are more sensitive to interest rate changes than high coupon bonds Zero Coupon Bonds have the highest price sensitivity You should run a portfolio of low coupon stocks in a falling yield scenario and high coupon stocks in a rising yield scenario

25. Embedded Options Embedded options affect the pricing Bonds with Put Option command a premium to other bonds Bonds with Call Option trade at a discount to other bonds Bonds with both Call & Put Option are priced as shorter term instruments If a 10 Year Bond has a Call & Put Option at the end of 5 Years, the bond is traded at prevailing 5 Year Yields

26. Debt Research Tracking of Liquidity Parameters Daily Call & Repo Rates Call Volumes LAF Volumes CBLO Volumes Refinance Availment Inflows from Coupon Payments & Redemptions Outflows from Auctions, OMOs etc FII investments RBI intervention in FX market

27. Debt Research Tracking Macro-Economic Parameters Deposit Growth & Credit Offtake Interest Rate Stance Inflation Government Fiscal Conditions Tax Collection Expenditure Levels WMA levels Money Supply Balance of Payments Condition of Equity Market Political Situation