50 Percent Of 7th Pay Commission Arrears To Be Invested In Bond - Part II - Col Ranbir Lamba

Those who wants to know about government securities.. As government is likely to issue bonds for 50% of arrears .
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This is in continuation to previous posting on the subject. Innovative Approach.

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 How are the Government securities transactions reported?

15.1 Transactions undertaken between market participants in the OTC/telephone market are expected to be reported on the NDS platform within 15 minutes after the deal is put through over telephone. All OTC trades are required to be mandatorily reported on the secondary market module of the NDS for settlement. Reporting on NDS is a four stage process wherein the seller of the security has to initiate the reporting followed by confirmation by the buyer. This is further followed by issue of confirmation by the seller’s back office on the system and reporting is complete with the last stage wherein the buyer’s back office confirms the deal. The system architecture incorporates maker-checker model to preempt individual mistakes as well as misdemeanor.

 

15.2 Reporting on behalf of entities maintaining gilt accounts with the custodians is done by the respective custodians in the same manner as they do in case of their own trades i.e., proprietary trades. The securities leg of these trades settle in the CSGL account of the custodian. Once the reporting is complete, the NDS system accepts the trade. Information on all such successfully reported trades flow to the clearing house i.e., the CCIL.

 

15.3 In the case of NDS-OM, participants place orders (price and quantity) on the system. Participants can modify / cancel their orders. Order could be a bid for purchase or offer for sale of securities. The system, in turn will match the orders based on price and time priority. That is, it matches bids and offers of the same prices with time priority. The NDS-OM system has separate screen for the Central Government, State Government and Treasury bill trading. In addition, there is a screen for odd lot trading for facilitating trading by small participants in smaller lots of less than Rs. 5 crore (i.e., the standard market lot). The NDS-OM platform is an anonymous platform wherein the participants will not know the counterparty to the trade. Once an order is matched, the deal ticket gets generated automatically and the trade details flow to the CCIL. Due to anonymity offered by the system, the pricing is not influenced by the participants’ size and standing.

 

16. How do the Government securities transactions settle?

 

Primary Market

 

16.1 Once the allotment process in the primary auction is finalized, the successful participants are advised of the consideration amounts that they need to pay to the Government on settlement day. The settlement cycle for dated security auction is T+1, whereas for that of Treasury bill auction is T+2. On the settlement date, the fund accounts of the participants are debited by their respective consideration amounts and their securities accounts (SGL accounts) are credited with the amount of securities that they were allotted.

 

Secondary Market

 

16.2 The transactions relating to Government securities are settled through the member’s securities / current accounts maintained with the RBI, with delivery of securities and payment of funds being done on a net basis. The Clearing Corporation of India Limited (CCIL) guarantees settlement of trades on the settlement date by becoming a central counter-party to every trade through the process of novation, i.e., it becomes seller to the buyer and buyer to the seller.

 

16.3 All outright secondary market transactions in Government Securities are settled on T+1 basis. However, in case of repo transactions in Government securities, the market participants will have the choice of settling the first leg on either T+0 basis or T+1 basis as per their requirement.

 

17. What is shut period?

‘Shut period’ means the period for which the securities can not be delivered. During the period under shut, no settlements/ delivery of the security which is under shut will be allowed. The main purpose of having a shut period is to facilitate servicing of the securities viz., finalizing the payment of coupon and redemption proceeds and to avoid any change in ownership of securities during this process. Currently the shut period for the securities held in SGL accounts is one day. For example, the coupon payment dates for the security 6.49% CG 2015 are June 8 and December 8 of every year. The shut period will fall on June 7 and December 7 for this security and trading in this security for settlement on these two dates is not allowed.

 

18. What is Delivery versus Payment (DvP) Settlement?

 

Delivery versus Payment (DvP) is the mode of settlement of securities wherein the transfer of securities and funds happen simultaneously. This ensures that unless the funds are paid, the securities are not delivered and vice versa. DvP settlement eliminates the settlement risk in transactions. There are three types of DvP settlements, viz., DvP I, II and III which are explained below;

 

i. DvP I – The securities and funds legs of the transactions are settled on a gross basis, that is, the settlements occur transaction by transaction without netting the payables and receivables of the participant.

 

ii. DvP II – In this method, the securities are settled on gross basis whereas the funds are settled on a net basis, that is, the funds payable and receivable of all transactions of a party are netted to arrive at the final payable or receivable position which is settled.

 

iii. DvP III – In this method, both the securities and the funds legs are settled on a net basis and only the final net position of all transactions undertaken by a participant is settled.

Liquidity requirement in a gross mode is higher than that of a net mode since the payables and receivables are set off against each other in the net mode.

 

19. What is the role of the Clearing Corporation of India Limited (CCIL)?

The CCIL is the clearing agency for Government securities. It acts as a Central Counter Party (CCP) for all transactions in Government securities by interposing itself between two counterparties. In effect, during settlement, the CCP becomes the seller to the buyer and buyer to the seller of the actual transaction. All outright trades undertaken in the OTC market and on the NDS-OM platform are cleared through the CCIL. Once CCIL receives the trade information, it works out participant-wise net obligations on both the securities and the funds leg. The payable / receivable position of the constituents (gilt account holders) is reflected against their respective custodians. CCIL forwards the settlement file containing net position of participants to the RBI where settlement takes place by simultaneous transfer of funds and securities under the ‘Delivery versus Payment’ system. CCIL also guarantees settlement of all trades in Government securities. That means, during the settlement process, if any participant fails to provide funds/ securities, CCIL will make the same available from its own means. For this purpose, CCIL collects margins from all participants and maintains

 

‘Settlement Guarantee Fund’.

 

20. What is the ‘When Issued’ market?

 

'When Issued', a short term of "when, as and if issued", indicates a conditional transaction in a security notified for issuance but not yet actually issued. All "When Issued" transactions are on an "if" basis, to be settled if and when the security is actually issued. 'When Issued' transactions in the Central Government securities have been permitted to all NDS-OM members and have to be undertaken only on the NDS-OM platform. ‘When Issued’ market helps in price discovery of the securities being auctioned as well as better distribution of the auction stock. For urban cooperative banks, detailed guidelines have been issued in the RBI master circular UBD.BPD. (PCB). MC.No  /16.20.000/2009-10 dated July 01, 2009.

 

21. What are the basic mathematical concepts one should know for calculations involved in bond prices and yields?

The time value of money functions related to calculation of Present Value (PV), Future Value (FV), etc. are important mathematical concepts related to bond market. An outline of the same with illustrations is provided in the Box II below.

 

Box II

Time Value of Money

 

Money has time value as a Rupee today is more valuable and useful than a Rupee a year later.

The concept of time value of money is based on the premise that an investor prefers to receive a payment of a fixed amount of money today, rather than an equal amount in the future, all else being equal. In particular, if one receives the payment today, one can then earn interest on the money until that specified future date. Further, in an inflationary environment, a Rupee today will have greater purchasing power than after a year.

 

Present value of a future sum

 

The present value formula is the core formula for the time value of money.
The present value (PV) formula has four variables, each of which can be solved for:
Present Value (PV) is the value at time=0
Future Value (FV) is the value at time=n
i is the rate at which the amount will be compounded each period
n is the number of periods



An illustration

Taking the cash flows as;

Period (in Yrs)

1

2

3

Amount

100

100

100

Assuming that the interest rate is at 10% per annum; 

The discount factor for each year can be calculated as 1/(1+interest rate)^no. of years

The present value can then be worked out as Amount x discount factor

The PV of Rs.100 accruing after;

Year

Amount

discount factor

P.V.

1

100

0.9091

90.91

2

100

0.8264

82.64

3

100

0.7513

75.13

The cumulative present value = 90.91+82.64+75.13 = Rs.248.69

Net Present Value (NPV)

Net present value (NPV) or net present worth (NPW) is defined as the present value of net cash flows. It is a standard method for using the time value of money to appraise long-term projects. Used for capital budgeting, and widely throughout economics, it measures the excess or shortfall of cash flows, in present value (PV) terms, once financing charges are met. Use Advanced Financial Calculators.

Formula

Each cash inflow/outflow is discounted back to its present value (PV). Then they are summed. Therefore



In the illustration given above under the Present value, if the three cash flows accrues on a deposit of Rs. 240, the NPV of the investment is equal to 248.69-240 = Rs.8.69

22. How is the Price of a bond calculated? What is the total consideration amount of a trade and what is accrued interest?

The price of a bond is nothing but the sum of present value all future cash flows of the bond. The interest rate used for discounting the cash flows is the Yield to Maturity (YTM) (explained in detail in question no. 24) of the bond. Price can be calculated using the excel function ‘Price’ (please refer to Annex 4, serial no 5.).

Accrued interest is the interest calculated for the broken period from the last coupon day till a day prior to the settlement  date of the trade. Since the seller of the security is holding the security for the period up to the day prior to the settlement date of the trade, he is entitled to receive the coupon for the period held. During settlement of the trade, the buyer of security will pay the accrued interest in addition to the agreed price and pays the ‘consideration amount’.

An illustration is given below;

For a trade of Rs.5 crore (face value) of security 6.49%2015 for settlement date August 26, 2009 at a price of Rs.96.95, the consideration amount payable to the seller of the security is worked out below;

Here the price quoted is called ‘clean price’ as the ‘accrued interest’ component is not added to it.

Accrued interest:

The last coupon date being June 8, 2009, the number of days in broken period till August 25, 2009 (one day prior to settlement date) are 78.

The accrued interest on Rs.100 face value for 78 days

= 6.49x(78/360)

 

= Rs.1.4062

When we add the accrued interest component to the ‘clean price’, the resultant price is called the ‘dirty price’. In the instant case, it is 96.95+1.4062 = Rs.98.3562

The total consideration amount

= Face value of trade x dirty price

 

= 5,00,00,000 x (98.3562/100)

 

= Rs.4,91,78,083.33

23. What is the relationship between yield and price of a bond?

If interest rates or market yields rise, the price of a bond falls. Conversely, if interest rates or market yields decline, the price of the bond rises. In other words, the yield of a bond is inversely related to its price. The relationship between yield to maturity and coupon rate of bond may be stated as follows:

When the market price of the bond is less than the face value, i.e., the bond sells at a discount, YTM > current yield > coupon yield.

When the market price of the bond is more than its face value, i.e., the bond sells at a premium, coupon yield > current yield > YTM.

When the market price of the bond is equal to its face value, i.e., the bond sells at par, YTM = current yield = coupon yield.

24. How is the yield of a bond calculated?

24.1 An investor who purchases a bond can expect to receive a return from one or more of the following sources:

The coupon interest payments made by the issuer;Any capital gain (or capital loss) when the bond is sold; andIncome from reinvestment of the interest payments that is  interest-on-interest.

The three yield measures commonly used by investors to measure the potential return from investing in a bond are briefly described below:

i) Coupon Yield

24.2 The coupon yield is simply the coupon payment as a percentage of the face value. Coupon yield refers to nominal interest payable on a fixed income security like Government security. This is the fixed return the Government (i.e., the issuer) commits to pay to the investor. Coupon yield thus does not reflect the impact of interest rate movement and inflation on the nominal interest that the Government pays.

Coupon yield = Coupon Payment / Face Value

Illustration:
Coupon: 8.24
Face Value: Rs.100
Market Value: Rs.103.00
Coupon yield = 8.24/100 = 8.24%

ii) Current Yield

24.3 The current yield is simply the coupon payment as a percentage of the bond’s purchase price; in other words, it is the return a holder of the bond gets against its purchase price which may be more or less than the face value or the par value. The current yield does not take into account the reinvestment of the interest income received periodically.

Current yield = (Annual coupon rate / Purchase price)X100

Illustration:
The current yield for a 10 year 8.24% coupon bond selling for Rs.103.00 per Rs.100 par value is calculated below:
Annual coupon interest = 8.24% x Rs.100 = Rs.8.24
Current yield = (8.24/Rs.103)X100 = 8.00%

The current yield considers only the coupon interest and ignores other sources of return that will affect an investor’s return.

iii) Yield to Maturity

24.4 Yield to Maturity (YTM) is the expected rate of return on a bond if it is held until its maturity. The price of a bond is simply the sum of the present values of all its remaining cash flows. Present value is calculated by discounting each cash flow at a rate; this rate is the YTM. Thus YTM is the discount rate which equates the present value of the future cash flows from a bond to its current market price.  In other words, it is the internal rate of return on the bond. The calculation of YTM involves a trial-and-error procedure. A calculator or software can be used to obtain a bond’s yield-to-maturity easily (please see the Box III).

Box III

YTM Calculation

YTM could be calculated manually as well as using functions in any standard spread sheet like MS Excel.

Manual (Trial and Error) Method

Manual or trial and error method is complicated because Government securities have many cash flows running into future. This is explained by taking an example below.

Take a two year security bearing a coupon of 8% and a price of say Rs. 102 per face value of Rs. 100; the YTM could be calculated by solving for ‘r’ below. Typically it involves trial and error by taking a value for ‘r’ and solving the equation and if the right hand side is more than 102, take a higher value of ‘r’ and solve again. Linear interpolation technique may also be used to find out exact ‘r’ once we have two ‘r’ values so that the price value is more than 102 for one and less than 102 for the other value.

102 = 4/(1+r/2)1+ 4/(1+r/2)2 + 4/(1+r/2)3 + 104/(1+r/2)4

Spread Sheet Method using MS Excel

In the MS Excel programme, the following function could be used for calculating the yield of periodically coupon paying securities, given the price.

YIELD (settlement,maturity,rate,price,redemption,frequency,basis)

Wherein;

Settlement is the security's settlement date. The security settlement date is the date on which the security and funds are exchanged.Maturity is the security's maturity date. The maturity date is the date when the security expires.

Rate is the security's annual coupon rate.
Price is the security's price per Rs.100 face value.
Redemption is the security's redemption value per Rs.100 face value.
Frequency is the number of coupon payments per year. (2 for Government bonds in India)
Basis is the type of day count basis to use. (4 for Government bonds in India which uses 30/360 basis)

25. What are the day count conventions used in calculating bond yields?

Day count convention refers to the method used for arriving at the holding period (number of days) of a bond to calculate the accrued interest. As the use of different day count conventions can result in different accrued interest amounts, it is appropriate that all the participants in the market follow a uniform day count convention.

For example, the conventions followed in Indian market are given below.

Bond market: The day count convention followed is 30/360, which means that irrespective of the actual number of days in a month, the number of days in a month is taken as 30  and the number of days in a year is taken as 360.

Money market: The day count convention followed is actual/365,  which means that the actual number of days in a month is taken for number of days(numerator) whereas the number of days in a year is taken as 365 days. Hence, in the case of Treasury bills, which are essentially money market instruments, money market  convention is followed.

26. How is the yield of a Treasury Bill calculated?

It is calculated as per the following formula



Wherein;

P – Purchase price
D – Days to maturity
Day Count: For Treasury Bills, D = [actual number of days to maturity/365]

Illustration
Assuming that the price of a 91 day Treasury bill at issue is Rs.98.20, the yield on the same would be



After say, 41 days, if the same Treasury bill is trading at a price of Rs. 99, the yield would then be



Note that the remaining maturity of the treasury bill is 50 days (91-41).

27. What is Duration?

27.1 Duration (also known as Macaulay Duration) of a bond is a measure of the time taken to recover the initial investment in present value terms. In simplest form, duration refers to the payback period of a bond to break even, i.e., the time taken for a bond to repay its own purchase price.  Duration is expressed in number of years. A step by step approach for working out duration is given in the Box IV below.

Box: IV

Calculation for Duration

First, each of the future cash flows is discounted to its respective present value for each period. Since the coupons are paid out every six months, a single period is equal to six months and a bond with two years maturity will have four time periods.

Second, the present values of future cash flows are multiplied with their respective time periods (these are the weights). That is the PV of the first coupon is multiplied by 1, PV of second coupon by 2 and so on.

Third, the above weighted PVs of all cash flows is added and the sum is divided by the current price (total of the PVs in step 1) of the bond. The resultant value is the duration in no. of periods. Since one period equals to six months, to get the duration in no. of year, divide it by two. This is the time period within which the bond is expected to pay back its own value if held till maturity.

Illustration:

Taking a bond having 2 years maturity, and 10% coupon, and current price of Rs.102, the cash flows will be (prevailing 2 year yield being 9%):

Time period (years)

1

2

3

4

Total

Inflows (Rs.Cr)

5

5

5

105

 

PV at an yield of 9%

4.78

4.58

4.38

88.05

101.79

PV*time

4.78

9.16

13.14

352.20

379.28

Duration in number of periods = 379.28/101.79 = 3.73
Duration in years = 3.73/2 = 1.86 years

More formally, duration refers to:

the weighted average term (time from now to payment) of a bond's cash flows or of any series of linked cash flows.The higher the coupon rate of a bond, the shorter the duration (if the term of the bond is kept constant).Duration is always less than or equal to the overall life (to maturity) of the bond.Only a zero coupon bond (a bond with no coupons) will have duration equal to its maturity.the sensitivity of a bond's price to interest rate (i.e., yield) movements.

Duration is useful primarily as a measure of the sensitivity of a bond's market price to interest rate (i.e., yield) movements. It is approximately equal to the percentage change in price for a given change in yield. For example, for small interest rate changes, the duration is the approximate percentage by which the value of the bond will fall for a 1% per annum increase in market interest rate. So a 15-year bond with a duration of 7 years would fall approximately 7% in value if the interest rate increased by 1% per annum. In other words, duration is the elasticity of the bond's price with respect to interest rates.

What is Modified Duration?

27.2 Modified duration (MD) is a modified version of Macaulay Duration. It refers to the change in value of the security to one per cent change in interest rates (Yield). The formula is



Illustration

In the above example given in Box IV, MD = 1.86/(1+0.09/2) = 1.78

What is PV 01?

27.3 PV01 describes the actual change in price of a bond if the yield changes by one basis point (equal to one hundredth of a percentage point). It is the present value impact of 1 basis point (0.01%) movement in interest rate. It is often used as a price alternative to duration (a time measure). Higher the PV01, the higher would be the volatility (sensitivity of price to change in yield).

Illustration

From the modified duration (given in the illustration under 27.2), we know that the security value will change by 1.78% for a change of 100 basis point (1%) change in the yield. In value terms that is equal to 1.78*(102/100) = Rs.1.81.

Hence the PV01 = 1.81/100 = Rs. 0.018, which is 1.8 paise. Thus, if the yield of a bond with a Modified Duration of 1.78 years moves from say 9% to 9.05% (5 basis points), the price of the bond moves from Rs.102 to Rs.101.91 (reduction of 9 paise, i.e., 5x1.8 paise).

What is Convexity?

27.4 Calculation of change in price for change in yields based on duration works only for small changes in prices. This is because the relationship between bond price and yield is not strictly linear i.e., the unit change in price of the bond is not proportionate to unit change in yield. Over large variations in prices, the relationship is curvilinear i.e., the change in bond price is either less than or more than proportionate to the change in yields. This is measured by a concept called convexity, which is the change in duration of a bond per unit change in the yield of the bond.

28. What are the important guidelines for valuation of securities?

28.1 For the Cooperative banks, investments classified under 'Held to Maturity' (HTM) category need not be marked to market and will be carried at acquisition cost unless it is more than the face value, in which case the premium should be amortized over the period remaining to maturity. The individual scrip in the ‘Available for Sale’ (AFS) category in the books of the cooperative banks will be marked to market at the year-end or at more frequent intervals. The individual scrip in the ‘Held for Trading’ (HFT) category will be marked to market at monthly or at more frequent intervals. The book value of individual securities in AFS and HFT categories would not undergo any change after marking to market.

28.2 Central Government securities should be valued by taking the prices/ yields put out by the Fixed Income Money Market and Derivatives Association of India (FIMMDA) and the Primary Dealers Association of India (PDAI) jointly on the website of the FIMMDA. Prices of all Central Government securities are given out everyday while prices and yield curve for valuation are given at the end of every month. For example, the FIMMDA valuation of a Central Government security, 7.46%2017 as on March 31, 2009 was Rs.101.69. If a cooperative bank was holding the same security in AFS or HFT categories at a book value of Rs.102, the bank would be required to book a depreciation of Rs.0.31 per Rs.100 face value of holding. If the total holding was Rs. 1 crore, the total depreciation to be booked would be Rs.31,000/-.

28.3 State Government and other securities are to be valued by adding a spread on the Central Government security yield of the corresponding residual maturity. Currently, a spread of 25 basis points (0.25%) is added while valuing State Government securities, special securities (oil bonds, fertilizer bonds, SBI bonds, etc.) whereas for corporate bonds the spreads given by the FIMMDA need to be added. An illustration of valuation taking a State Government bond is given in the Box V below.

Box: V

Valuation of securities

Illustration for valuation of State Government Bonds
Security – 7.32% A.P.SDL 2014
Issue date – December 10, 2004
Maturity date – December 10, 2014
Coupon – 7.32%
Date of valuation – March 31, 2008

Procedure

Valuation of the above bond involves the following steps

Find the residual maturity of the bond to be valued.Find the Central Government security yield for the above residual maturity.Add appropriate spread to the above yield to get the yield for the securityCalculate the price of the security using the derived yield above.

Step i.

Since valuation is being done on March 31, 2008, we need to find out the number of years from this date to the maturity date of the security, December 10, 2014 to get the residual maturity of the security. This could be done manually by counting the number of years and months and days. However, an easier method is to use MS. Excel function ‘Yearfrac’ wherein we specify the two dates and basis (please refer to Annex 4 on Excel functions for details). This gives us the residual maturity of 6.69 years for the security.

Step ii.

To find the Central Government yield for 6.69 years, we derive it by interpolating the yields between 6 years and 7 years, which are given out by FIMMDA. As on March 31, 2008, FIMMDA yields for 6 and 7 years are 7.73% and 7.77% respectively. The yield for the 6.69 years is derived by using the following formula.



Here we are finding the yield difference for 0.69 year and adding the same to the yield for 6 years to get the yield for 6.69 years. Also notice that the yield has to be used in decimal form (e.g., 7.73% is equal to 7.73/100 which is 0.0773)

Step iii.

Having found the Central Government yield for the particular residual maturity, we have to now load the appropriate spread to get the yield of the security to be valued. Since the security is State Government security, the applicable spread is 25 basis points (0.25%). Hence the yield would be 7.76%+0.25% = 8.01%.

Step iv.

The price of the security will be calculated using the MS Excel function ‘Price’ (Please see the details in Annex 4). Here, we specify the valuation date as March 31, 2008, maturity date as December 10, 2014, rate as 7.32% which is the coupon, yield as 8.01%, redemption as 100 which is the face value, frequency of coupon payment as 2 and basis as ‘4’ (Pl. see example 3 in Annex 4). The price we get in the formula is Rs.96.47 which is the value of the security.

If the bank is holding Rs.10 crore of this security in its portfolio, the total value would be 10*(96.47/100) = 9.647 crore.

28.4 In the case of corporate bonds, the procedure of valuation is similar to the illustration given in Box V above. The only difference is the spread that need to be added to the corresponding yield on central government security will be higher (instead of the fixed 25 bps for State Government securities), as published by the FIMMDA from time to time. FIMMDA gives out the information on corporate bonds spreads for various rated bonds. While valuing a bond, the appropriate spread has to be added to the corresponding CG yield and the bond has to be valued using the standard ‘Price’ formula.

For example, assuming that a ‘AAA’ rated corporate bond is having same maturity as that of the State Government bond in Box V, the applicable yield for valuation will be 7.73%+ 2.09% (being the spread given by FIMMDA) which is 9.82%. With the same parameters as in the Box V, the value of the bond works out to Rs.87.92.

29. What are the risks involved in holding Government securities? What are the techniques for mitigating such risks?

Government securities are generally referred to as risk free instrumentsas sovereigns are not expected to default on their payments. However, as is the case with any financial instrument, there are risks associated with holding the Government securities. Hence, it is important to identify and understand such risks and take appropriate measures for mitigation of the same. The following are the major risks associated with holding Government securities.

29.1 Market risk – Market risk arises out of adverse movement of prices of the securities that are held by an investor due to changes in interest rates. This will result in booking losses on marking to market or realizing a loss if the securities are sold at the adverse prices. Small investors, to some extent, can mitigate market risk by holding the bonds till maturity so that they can realize the yield at which the securities were actually bought.

29.2 Reinvestment risk – Cash flows on a Government security includes fixed coupon every half year and repayment of principal at maturity. These cash flows need to be reinvested whenever they are paid. Hence there is a risk that the investor may not be able to reinvest these proceeds at profitable rates due to changes in interest rate scenario.

29.3 Liquidity risk – Liquidity risk refers to the inability of an investor to liquidate (sell) his holdings due to non availability of buyers for the security, i.e., no trading activity in that particular security. Usually, when a liquid bond of fixed maturity is bought, its tenor gets reduced due to time decay. For example, a 10 year security will become 8 year security after 2 years due to which it may become illiquid. Due to illiquidity, the investor may need to sell at adverse prices in case of urgent funds requirement. However, in such cases, eligible investors can participate in market repo and borrow the money against the collateral of the securities.

Risk Mitigation

29.4 Holding securities till maturity could be a strategy through which one could avoid market risk. Rebalancing the portfolio wherein the securities are sold once they become short term and new securities of longer tenor are bought could be followed to manage the portfolio risk. However, rebalancing involves transaction and other costs and hence needs to be used judiciously. Market risk and reinvestment risk could also be managed through Asset Liability Management (ALM) by matching the cash flows with liabilities. ALM could also be undertaken by matching the duration of the cash flows.

Advanced risk management techniques involve use of derivatives like Interest Rate Swaps (IRS) through which the nature of cash flows could be altered. However, these are complex instruments requiring advanced level of expertise for proper understanding. Adequate caution, therefore, need to be observed for undertaking the derivatives transactions and such transactions should be undertaken only after having complete understanding of the associated risks and complexities
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