Terminology in Debt Market

A bond is a debt instrument issued by a corporation, government or other entity to raise capital. The issuer promises to pay a fixed coupon (interest) at regular intervals and to return the face value (also called par value) on the maturity date. In India, most bonds have a face value of INR 1,000, but the market price can be higher (premium) or lower (discount) depending on interest‑rate movements.

The coupon rate is expressed as a percentage of the face value and determines the periodic cash flow to the bondholder. For example, a 7% annual coupon on a INR 1,000 bond pays INR 70 per year, usually split into semi‑annual payments of INR 35 each. The maturity period can range from a few months (commercial paper) to 30 years (long‑term government bonds).

Exam candidates must differentiate between the face value (a contractual amount) and the market price (the price at which the bond trades). Many questions test whether you know that coupon calculations use the face value, while yield calculations use the market price. Remember: the coupon amount never changes after issuance, even if the bond trades at a discount or premium.

• Face value – contractual repayment amount at maturity.
• Coupon – periodic interest based on face value.

Bond prices are quoted in two ways: clean price and dirty price. The clean price excludes any interest that has accrued since the last coupon payment, while the dirty price adds this accrued interest. In Indian markets, the quoted price on exchanges is usually the clean price; the dirty price is what the buyer actually pays.

Accrued interest represents the interest earned by the seller for the period they held the bond after the last coupon date. It is calculated proportionally based on the number of days elapsed in the coupon period. The formula uses the coupon amount, days elapsed and total days in the period.

For the exam, you will be asked to convert between clean and dirty prices, or to compute accrued interest when given settlement dates. Pay attention to whether the question states “quoted price” (clean) or “settlement price” (dirty). Misreading this leads to incorrect yield calculations.

Yield measures help analysts compare bonds with different coupons, maturities and credit quality. The simplest is the Current Yield, which looks only at the annual coupon relative to the market price. It ignores capital gains or losses that occur if the bond is held to maturity.

The more comprehensive measure is Yield to Maturity (YTM). YTM assumes the bond is held until it matures and that all coupon payments are reinvested at the same rate. Because the exact YTM equation is iterative, the NISM syllabus provides an approximate formula that is sufficient for most exam calculations.

Other yields include Yield to Call (used for callable bonds) and Yield Spread (difference between a corporate bond’s yield and a risk‑free benchmark). Remember to identify which yield the question is targeting – the presence of call dates or embedded options signals YTM‑to‑Call.

Duration measures the weighted average time to receive the bond’s cash flows and indicates price sensitivity to interest‑rate changes. A higher duration means the bond’s price will move more for a given change in yields. The NISM syllabus often refers to Macaulay duration and Modified duration – the latter adjusts for the yield level.

Convexity captures the curvature of the price‑yield relationship. While duration provides a linear approximation, convexity improves accuracy for larger interest‑rate movements. In exam questions, convexity is rarely required to be calculated, but you should know its qualitative impact: higher convexity reduces price volatility.

Credit risk is reflected through credit ratings assigned by agencies such as CRISIL, ICRA, or Moody’s. A higher rating (AAA) indicates lower default risk and typically results in a lower yield spread over government securities. Remember that the rating hierarchy (AAA > AA > A > BBB > BB > B > CCC) is a frequent multiple‑choice theme.

Callable bonds give the issuer the right to redeem the bond before maturity, usually at a specified call price. This feature benefits the issuer when interest rates fall, but adds reinvestment risk for the investor. The presence of a call option reduces the bond’s price and increases its yield.

Putable bonds allow the investor to sell the bond back to the issuer at a predetermined price before maturity. This protects the holder if rates rise, leading to a higher price and lower yield compared with non‑putable bonds.

Convertible bonds can be exchanged for a predetermined number of equity shares. They combine debt and equity characteristics, offering upside potential while retaining fixed‑income features. The conversion premium and ratio are key exam parameters.

Zero‑coupon bonds do not pay periodic coupons. They are issued at a deep discount and mature at face value. Yield is derived entirely from the price appreciation, making the YTM calculation straightforward but requiring careful handling of compounding periods.