The debt market in India is vast, representing a significant portion of the financial landscape. The bond market in India is currently valued at about $2.34 trillion, making it a fairly sizable market for debt.
Government bonds account for $1.83 trillion, while corporate bonds account for $510 billion. Beginning in March 2018, the total amount of outstanding bonds has grown dramatically throughout the years, by 77%, with corporate bonds growing by 53% and government bonds by 85%.
Let’s take a tour of the world of debt investments to better understand their potential and power.
What is a debt instrument?
Debt instruments are essentially loans that individuals or organisations provide to others in exchange for a promise to pay back the borrowed money with interest over time.
The borrower commits to repaying the lender following a predetermined timetable, along with an additional sum as interest.
Notable instances include bonds, where investors loan funds to corporations or governments, and certificates of deposit (CDs), wherein individuals deposit money with banks for a specified duration at a designated interest rate.
These instruments offer a way to invest or save money while earning additional income through interest payments.
Features of debt instruments
- Interest income: Lenders earn extra money, called interest, in exchange for lending their funds. The interest rate is usually predetermined and agreed upon in advance.
- Plenty of options: Debt instruments are available in different types, including bonds, certificates of deposit (CDs), and Treasury bills, offering investors a range of options to select the one that aligns with their preferences.
- Safety and stability: They are generally considered less risky compared to stocks because the repayment terms are typically more predictable and stable.
- Income generation: Debt instruments can be a way for investors to generate a regular income stream, making them appealing to those seeking a steady return on their investment.
Types of debt instruments
- Bonds: The most popular type of debt security is a bond, which entails investing money in corporate or governmental projects in exchange for a set rate of return.
In times of falling market interest rates, they are preferred because they resemble fixed-income contracts. Corporate bonds, convertible bonds, government securities bonds, sovereign gold bonds, RBI bonds, zero-coupon bonds, and inflation-linked bonds are all available in India.
- Debentures: Debentures are issued by big businesses and government agencies in order to raise capital. They are comparable to bonds but have different securitization terms.
Although they are not given voting rights, they are typically transferable, appear on balance sheets, and are reflected in share capital.
- Fixed deposits: Provided by both banks and non-banking financial institutions, fixed deposits offer more attractive interest rates compared to standard savings accounts.
The interest rate is predetermined and remains constant throughout the deposit’s tenure, which can range from a week to several years.
- Certificates of Deposit (CDs): CDs are time deposits made available by financial institutions, most notably banks. They are almost risk-free, have fixed terms from a few months to several years, and have a fixed interest rate. They are insured while offering a secure means of investing.
- Commercial papers (CP): CPs are short-term debt instruments that are used by businesses to raise capital for periods longer than a year. Promissory notes that do not exceed the relevant credit rating period for the borrower are issued and usually mature within a year.
CPs are typically offered in denominations of ₹ 5 lakhs or multiples of it.
- Mortgages: These secured loans, often used to finance property purchases, enable borrowers to spread payments over an extended period, with lenders earning interest. In case of default, lenders possess the right to seize and sell assets to recover loaned funds.
- Government securities: The Reserve Bank of India issues State and Central Government Securities, along with Treasury Bills, on the government’s behalf. These are risk-free and backed by a sovereign guarantee. Investors can redeem them at face value upon maturity, with interest paid semi-annually.
- National Savings Certificates (NSCs): The Department of Post issues NSCs, which are long-term, fixed-interest securities safeguarded by the Indian government. They have a fixed annual return of 7.70% and come to maturity in six years.
Every six months, interest is calculated and added to the original principal amount. NSCs are eligible for tax breaks under Section 80C of the Income Tax Act, and no tax is deducted at the source.
Also Read: Exploring the bond market for beginners
Debt instruments in India and its importance
India’s robust debt market, one of Asia’s largest, is vital for funding the developing economy. It encompasses government securities and bonds issued by public sector entities, government bodies, financial institutions, banks, and corporations.
Debt instruments, like Bonds, Debentures, Commercial Papers, Certificates of Deposit, and Government Securities (G secs), represent future cash flows, serving as tradeable forms of loans.
In India, debt instruments are critical for boosting capital, investing, and safeguarding against financial risks, and they play a critical role in financing both the private sector and government initiatives, maximising economic stability.
Types of risks associated with debt instruments
- Interest rate risk: This risk arises due to market interest rate fluctuations. If you hold a fixed-rate debt instrument and interest rates increase, your investment’s value may decline because newer bonds with higher interest rates become more attractive.
- Credit risk: Often termed as default risk, credit risk pertains to the possibility that the issuer of the debt instrument might not fulfil its commitment to make interest payments or repay the principal amount as agreed upon.
- Liquidity risk: Liquidity risk is about the ease of trading debt instruments. Longer-term or lower-rated debt can be less liquid, making quick sales at preferred prices difficult and potentially causing losses when urgent cash is required.
A debt fund is a type of mutual fund that puts money in fixed-income tools like corporate and government bonds, corporate debt securities, and money market instruments.
The returns of some debt funds are explained below. For example, Aditya Birla Sun Life’s Short-term fund has a risk rating of 4, which suggests a moderate level of risk. This fund has generated a return of 4.75% to date.
Whereas, the Axis short-term fund has an average annual return of 4.70%. Bank of India’s short-term fund has had an impressive average annual return of 26.94% in the year 2022.
Investing in debt instruments can be a smart move for many reasons. They offer stability and steady returns, making them a great choice for those looking to balance risk in their investment portfolio.
Whether you’re a conservative investor or seeking diversification, debt instruments can play a valuable role in your financial strategy.
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