Governments (both central and the states) raise resources through issue of market loans regularly. As these are the liabilities of Government of India and the State Governments and because the repayment is made by RBI, investment in these securities is considered safe and riskfree. These securities are eligible as SLR investments. Since the date of maturity is specified in the securities, these are known as dated Government securities. The dated Government securities market in India has two segments :

1. Primary Market and

2. Secondary Market.

The Primary Market consists of the issuers of the securities, viz., Central and Sate Government. The secondary market includes commercial banks, financial institutions, insurance companies, Provident Funds, Trusts, individuals, Primary Dealers and Reserve Bank of India.

DFHI buys, stocks and trades these securities regularly. Thus as on any day government securities of any maturity can be purchased from or sold to DFHI. Though the securities are initially floated for long terms, those maturing in the near future can be bought as safe short term investments.

Investment in government securities is open to all types of investors including individuals and there is a very active secondary market. All dated Central and State Government securities are repo-able (can be traded in the repo market). Thus these instruments are very liquid.

Further, as in the case of T-Bills, the transactions can be concluded over telephone and investments parked in the Constituents SGL Account with DFHI itself till maturity or resale. During last few years, Government of India has issued new instruments such as Zero Coupon Bonds, Floating Rates Bonds, Partly-paid Stocks, Capital Index Bonds, Tap Stock, etc.

The money market is an integral part of the economy and it plays a vital role in the development of the economy. This is endorsed by the fact that in the less developed countries, money market too is undeveloped. Consequently, in the absence of well-developed money market in these countries great difficulty is experienced in pooling funds large enough to finance private enterprise. Up to the latter half of the Eighties he money market in India was lopsided. Reserve bank too the initiative and introduced financial sector reforms to make the money market broad-based and integrated. These details can be studied in the pages deal with Financial Sector Reforms

Bonds issued at discount and repaid at face value. The difference between the issue price and the redemption price represents the return to the investor. No periodic interest payment is made. Zero Coupon Bonds bear no reinvestment risk but they are prone to interest rate risk making their prices highly volatile. The buyer of zero coupon bonds receives one and only one payment, at maturity of the bond. In contrast, coupon bonds make a series of periodic coupon payments to the buyer as well as paying face value at maturity. Zero Coupon Bonds on auction basis was introduced in January 1994 by Government of India.

Floating Rate Bond is an instrument whose periodic interest or dividend rates are indexed to some reference index such as Treasury security etc. These instruments give a variable rate, a characteristic that allows both issuer and investor to share the risk inherent in changing interest rates. The volatility of interest rates have led to creation of these instruments designed to offer some protection to the players. Thus, Floating Rate Bonds enable investors to take advantage of movements in interest rates. Floating Rate Bonds were introduced by Government of India on September 29, 1995 linking it to the 364 day Treasury Bill rate.

A gilt edged security from an issue that has not been fully subscribed and is released into the market slowly when its market price reaches predetermined levels. Short taps are short dated stocks and long taps are long dated stocks. These Stocks were introduced by Government of India on July 29, 1994.

An innovative instrument was (Government stock auctioned on November 15, 1994) for which the payment is made in instalments. It is designed for institutions with regular flow of investible resources requiring regular investment outlets. The instrument has attracted good market response and is being traded actively.

These bonds were floated on December 29, 1997 on tap basis. The tap was kept open upto 28th January 1998 and an amount of Rs.704.52 crore was mobilised. These bonds are of four year maturity and carry a coupon rate of 6 per cent. The objective of the capital indexed bonds was to provide a complete hedge against inflation for the principal amount of the investment.

A special market in which there is one seller and many buyers. An auction sale is conducted by an auctioneer who permits buyers to bid one against other, the goods going to the highest bidder. The auction system for the sale of dated government securities is relatively new in India starting from June 2, 1992. The principal features of auction system in India are : wider participation in the bidding process, a number of instruments sold under the auction system (including 14 day, 91 day , 182 day and 364 day Treasury Bills and dated securities of Government of India); bidders provide written and sealed quotations restricted to notified amounts and the undersubscribed portion of the notified amount devolving on the Primary Dealers (when underwriting) and/or RBI, which conducts the auction.

It is the nominal price of a share or security. If the market value of a security exceeds the par value it is said to be above par; if it falls below the par value it is below par.

An amount in excess of the nominal value of the share, bond or security.

The amount by which the market price of a security is below its par value.

Under a multiple price auction, every bidder gets allocation according to his bid and apparently the issuer collects a premium from all bidders quoting lower than the cut-off yield. The drawbacks of the system is, occurrence of a phenomenon called winner's curse.

In the case of this auction, competitive bids are accepted at the minimum discounted price, called cut-off price, determined at the auction, irrespective of the bid-prices tendered, below/at the cut-off price. This system eliminates the problem of winner's curse.

A curve on a graph in which the yield of fixed interest securities is plotted against the length of time they have to run to maturity. The yield curve usually slopes upwards indicating that investors expect to receive a premium for holding securities that have a long time to run. However, when there are expectations of changes in interest rate, the slope of the yield curve may change.

The income from an investment. The nominal yield of a fixed interest security is the interest it pays, expressed as a percentage of its par value. However, the current yield (also called interest yield, running yield, earnings yield or flat yield) will depend on the market price of the stock. Thus current yield is equal to face value/market price x interest rate.

Cut-off yield is the yield at which or below which the bids are accepted.

The redemption yield or yield to maturity covers the current yield plus the capital gain or loss divided by the numbers of years to redemption.

The purchase or sale by a Government of bonds (gilt edged securities) in exchange for money. OMO is a flexible instrument of monetary policy through which the Central Bank of a country, on its own initiative, can alter the liquidity in the system by sale or purchase of marketable securities.

A financial instrument that is valued according to the expected price movements of an underlying asset, which may be a commodity, currency or a security. Derivatives can be used either to hedge a position or to establish an open position. Examples of derivatives are futures, options, swaps, etc.

An agreement to buy or sell a fixed quantity of a particular commodity, currency, or security for delivery at a fixed date in the future at a fixed price. Unlike an option, a futures contract involves a definite purchase or sale and not an option to buy or sell. However, futures provide an opportunity for those who must purchase goods regularly to hedge against changes in price.

The right to buy or sell a fixed quantity of a commodity, currency, security, etc. at a particular date at a particular price (also called exercise price). Unlike futures, the purchaser of an option is not obliged to buy or sell at the exercise price and will only do so if it is profitable; the purchaser may allow the option to lapse, in which case only the initial purchase price of the option is lost. An option to buy is known as a call option and is usually purchased in the expectation of a rising price; an option to sell is called a put option and is bought in the expectation of a falling price.

The means by which intending parties can exchange their cashflows, usually through the intermediary of a bank. A currency swap will enable parties to exchange the currency they possess for the currency they need. An interest rate swap (IRS) is an agreement between two parties to exchange interest obligations (or receipts) for a given national principal for a defined period.

"STRIPS" stands for separately Traded Registered Interest and Principal of Securities Strips are created by separating the coupon from the principal and trading them independently. Thus, if a conventional bond of five year maturity has ten semi annual coupon payments and one payment of principal, ten coupon STRIPS and one Principal STRIP will be created on stripping the bond.

In developed markets, Treasury Bill rates set the course of other short term rates in the system. In India, the cut-off yield rates arrived through the competitive bids received in the auctions of Treasury Bills have emerged as benchmark short term rates. Since April 1997 Bank Rate has been activated as a bench-mark rate.

It refers to a security being allowed to be traded in the market well before its actual date of issue, after the announcement about the issue.

Primary Dealers are market makers in government securities. In India 2 PDs (including DFHI) became fully operational from February 29, 1996, 4 PDs from June 11, 1996 and 4 PDs from February 6, 1999 and 3 PDs from April 1999 - taking total number of PDs to 13. They have a minimum threshold limit of Net Owned Funds of Rs.50 crore and are expected to strengthen the government securities market by acting as underwriters and market makers with commitments to bid in auctions and to offer two way quotes.(Presently system ofsatellite dealers is withdrawn and not in vogue)

Satellite Dealers form the second tier in government securities market after PDs and are expected to provide a retail outlet for government securities thereby encouraging voluntary holding of government securities among a wider investor base. They have a lower minimum requirement of net owned funds of Rs.5 crore. Nine Satellite Dealers have been registered with Reserve Bank of India as on November 18, 1997. RBI have since abolished the category of Satellite Dealers. There are now only primary Dealers.

Government may sell bonds by various ways. Some bone can be publicly placed, whereas some bonds may be sold directly to one or only to few buyers. When it is placed with few or one buyer it is referred to as private placements.

An Interest Rate Swap (IRS) is a financial contract between two parties exchanging or swapping a stream of interest payments for a 'notional principal' amount on multiple occasions during a specified period. Such contracts generally involve exchange of a 'fixed to floating' or 'floating to floating' rates of interest. Accordingly, on each payment date that occurs during the swap period-cash payments based on fixed/floating and floating rates, are made by the parties to one another.

A Forward Rate Agreement (FRA) is a financial contract between two parties to exchange interest payments for a 'notional principal' amount on settlement date , for a specified period from start date to maturity date . Accordingly , on the settlement date, cash payments based on contract (fixed) and the settlement rate, are made by the parties to one another. The settlement rate is the agreed bench-mark/ reference rate prevailing on the settlement date.

Scheduled commercial banks (excluding Regional Rural Banks), primary dealers (PDs), Mutual funds and all-India financial institutions (FIs) are free to undertake FRAs/IRS as a product for their own balance sheet management or for market making. Banks/FIs/PDs can also offer these products to corporates for hedging their (corporates) own balance sheet exposures.

The party intending to enter into IRS/FRA will have to collect all information/documents relating to status of the Counterparty, duly executed swap agreements etc.

1. Status of the counterparty:
   Before entering into a deal, first determine whether the counterparty has legal capacity, power and authority to enter into an interest rate swap transaction. The Memorandum and Articles of Association, Board resolution for authorisation of swap deals and signatures of authorised persons should be obtained and scrutinised. Also a suitable counterparty limit for entering into IRS/FRA has to be fixed.

2. Documentation :
   The counterparties should sign ISDA master agreement before entering into a swap deal. The parties should appropriately change the Schedule to the agreement according to the terms and conditions settled between them.

3. Accounting of IRS/FRA:
   The parties can enter into swap deals for hedging interest rate risk on their own portfolio or for market making. The parties should make clear distinction between swaps that are entered into for hedging their own balance sheet positions and more which are entered into for trading. The transactions for market making purposes should be marked to market (at least at fortnightly intervals), and those for hedging purposes could be accounted for on accrual basis.