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Terms related to Government Securities

1. Zero Coupon Bonds

Bonds issued at discount and repaid at face value, the distinction 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 extremely volatile. The buyer of zero coupon bonds obtains one and only one payment, at maturity of the bond. On the contrary, 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.

2. Floating Rate Bond

Floating Rate Bond is an instrument whose periodic interest or dividend rates are indexed to a number of reference indexes 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 a few protections 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.

3. Tap Stock

A gilt edged security from an issue that has not been completely 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 lengthy dated stocks. These Stocks were set up by Government of India on July 29, 1994.

4. Partly Paid Stock

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

5. Capital Indexed Bonds

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

6. Auction

A special market in which there is one seller and several buyers. An auction sale is conducted by an auctioneer who allows 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 latest in India starting from June 2, 1992. The principal features of auction system in India are: wider participation in the bidding course, 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 give written and sealed quotations restricted to notified amounts and the undersubscribed portion of the notified sum devolving on the Primary Dealers (when underwriting) and/or RBI, which conducts the auction.

7. Par Value (face value; nominal value)

It is the nominal price of a share or security, if the market price 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.

8. Premium

An amount in surplus of the nominal value of the share, bond or security is called as premium.

9. Discount

The sum by which the market price of a security is below its par value is known as discount.

10. Multiple Price Auction

Under a various 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 disadvantage of the system is, occurrence of a phenomenon called winner's curse.

11. Uniform Price Auction

In the case of this auction, competitive bids are received 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 removes the problem of winner's curse.

12. Yield Curve

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

13. Yield

The income from an investment, the small yield of a fixed interest security is the interest it pays, expressed as a percentage of its par value. But, 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 the same as face value/market price x interest rate.

14. Cut-off Yield

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

15. Redemption Yield

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

16. Open Market Operations (OMO)

The buy or sale by a Government of bonds (gilt edged securities) in exchange for money. OMO is a flexible instrument of monetary rule 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.

17. Derivatives

A financial instrument that is valued according to the estimated 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 set up an open position; examples of derivatives are futures, options, swaps, etc.

18. Futures

Futures are agreement to purchase 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 exact purchase or sale and not an option to buy or sell. But, futures provide an opportunity for those who must purchase goods regularly to hedge against changes in price.

19. Options

The right to purchase 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 buyer 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 generally 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.

20. Swaps

The means by which intending parties can replace their cash flows, generally through the intermediary of a bank. A currency swap will allow 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 requirement (or receipts) for a given national principal for a defined period.

21. Strips

"STRIPS" stands for independently Traded Registered Interest and Principal of Securities Strips are created by separating the coupon from the principal and trading them independently. So, 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.

22. Bench-mark Rates

In developed markets, Treasury bill rates set the course of other short time 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 time rates. Since April 1997 Bank Rate has been set in motion as a bench-mark rate.

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