|
 |
|
 |
|
|
|
| Home > Learning Centre >
Valuing Securities in Debt Funds |
|
|
I. Why Valuation ?
Mr.
Patel's Maruti car is a year old. With the blitzkrieg of new car
launches Mr Patel was really tempted to upgrade his Maruti to a Palio
or an Indica by selling off his existing Maruti car. Being an
accountant he found that taking the mentioned depreciation rate of 20%
as per the Income Tax rules, the value of his Maruti bought initially
for Rs 250,000 was now 200,000. He gathered that as per this he would
have to invest another Rs 50,000 for a new Indica.
Mr
Patel armed with this information decided to cross check this with his
second car dealer and found to his utter surprise that the best he was
getting was Rs 175,000. However as per the IT rules the car should give
him Rs 200,000, Mr Patel argued.
The dealer patiently explained to him that the price of a second hand car depends on a host of factors.
Obvious factors like usage, mileage and present condition of the car apart, extraneous market factors like
• The demand for a second hand cars
• The availability of newer models in a similar price range
• The availability of older models in a similar price range
Mr.
Patel returned a wiser man that day having learnt a new fact that a
fair valuation is one that has to take into account market realities.
II. Debt funds and Valuation
Debt funds like any other asset are driven by the same basic tenet. A fair valuation is one that has to take into account market realities at prices that are market driven.
A debt fund at any given point in time holds different debt instruments. Thus the NAV, which reflects the value of all the underlying assets in the portfolio, to be fair and correct should take into account the market price of each of the instruments that comprise the portfolio. This process where each asset is valued at current market prices is called "Marking to Market".
Marking to market has become very essential as it indicates the financial health of a portfolio. To a large extent this procedure indicates the amount of risk the fund carries.
Essentially any portfolio can either have liquid or illiquid securities. While valuing liquid securities is a no-brainer as the prices can be taken from the exchanges, valuation does assume great significance when it comes to valuing illiquid securities.
The problem of valuation gets compounded when it comes to valuing debt securities in India. The absence of a broad based market resulted that trades were concentrated around a few securities.
A Debt fund at any given point of time can hold three different types of assets.
• Government securities
• Corporate debentures with a residual maturity of more than 6 months
• Money market instruments and corporate debentures with a residual maturity of less than 6 months
Different categories of assets are marked to market in different ways depending mainly on the liquidity of the asset. As a thumb rule, higher the credit, higher the liquidity. Consequently the most liquid among debt instruments are the securities issued by the Government as the risk is sovereign.
III. Bond Valuation
The
value of a bond can be defined as the present value of the future cash
flows discounted at an appropriate rate. The cash flows expected from
the bond are made up of
a) Coupon payments and
b) Redemption of Principal.
Bond Price= C/(1+i) + C/(1+I)2 + C/(1+I)3+ …..+ C/(1+I)n +M/(1+I)n
Where C = Coupon Payments
M = Redemption Amount
N = Number of Coupon Payments
i = Discounting rate or the yield of the bond.
IV. Yield or the Discounting Rate
The
price of the bond depends significantly on the rate which is used to
discount the future cash flows. To get a uniform pricing for various
debt instruments a matrix known as the CRISIL Bond Valuer maintained
and developed by CRISIL and approved by SEBI is used for bond
valuation.
V. Valuing Government Securities
Government
securities are marked to market on a daily basis. Since the G Sec
market in our country is the most liquid segment of our debt markets,
it is possible to get a price of G-Secs on any given day. Hence the
G-sec portion of the portfolio is marked to market on a daily basis at
the last traded price. Earlier fund houses used differing sources
ranging from NSE to the RBI's SGL. However circa March 2002 it is
mandatory for all fund houses to use prices provided by CRISIL.
CRISIL uses the Spread over Benchmark concept while valuing non traded government securities.
Any
event like an interest rate change triggers the rise or fall of
government securities. But the impact is not similar across all G-Secs.
The impact depends on a host of factors chiefly duration, coupon rate
and the liquidity level of the security.
Benchmarks
are set up for different tenor buckets e.g. securities with 1-2 years
outstanding maturity, 2-3 years 3-4 years and so on. For each of these
tenor buckets benchmarks are identified based on the turnover,
frequency of trading in the secondary market.
These prices are provided by CRISIL on a daily basis.
VI. Valuing Corporate Securities
Debt
securities like bonds, debentures are valued differently depending on
whether they are traded or non- traded and additionally depending on
the value of the traded securities.
The
valuation for the traded securities of traded value in excess of Rs 5
crores is done based on the YTM. The YTM is calculated on the last
traded price and is maintained till the next CRISIL matrix.
Thinly
traded securities and non-traded securities valued at more Rs 5 crores
and with a residual maturity of more than 182 days are valued using the
Crisil Bond Valuer.
The
Crisil Bond Valuer uses a benchmark YTM built using GOI Sec as the base
for each duration bucket. There are 7 duration buckets starting from
0.5 to > 6 years. CRISIL provides a matrix of yields across various
duration buckets (the topmost row in the table below) and rating
categories (the leftmost column) on a weekly basis.
Here is how it works.
When
deciding the price of a corporate debenture the key is to determine the
yield of the debenture. CRISIL arrives at this table after taking into
account various macro and micro economic factors and the repaying
capacity. Once the yield is known the price computation is easily
accomplished.
|
| 23/10/2002 |
Average |
0.5-1 |
1.0-2.0 |
2.0-3.0 |
3.0-4.0 |
4.0-5.0 |
5.0-6.0 |
>6.0 |
| Gilt |
6.46% |
5.85% |
6.01% |
6.17% |
6.31% |
6.54% |
7.05% |
7.28% |
| AAA |
7.21% |
0.75% |
0.87% |
0.83% |
0.80% |
0.78% |
0.59% |
0.64% |
| AA+ |
7.58% |
1.11% |
1.16% |
1.08% |
1.05% |
1.14% |
1.11% |
1.19% |
| AA |
7.95% |
1.45% |
1.43% |
1.40% |
1.40% |
1.63% |
1.54% |
1.62% |
| AA- |
8.47% |
1.95% |
1.89% |
1.86% |
1.89% |
2.15% |
2.10% |
2.26% |
| A+ |
9.15% |
2.60% |
2.62% |
2.62% |
2.65% |
2.84% |
2.73% |
2.78% |
| A |
9.73% |
3.00% |
3.18% |
3.22% |
3.30% |
3.52% |
3.39% |
3.33% |
| A- |
10.66% |
3.70% |
4.16% |
4.31% |
4.28% |
4.41% |
4.31% |
4.28% |
| BBB+ |
11.59% |
4.47% |
5.03% |
5.22% |
5.25% |
5.38% |
5.28% |
5.28% |
|
| |
If
you buy a bond at face value, its rate of return, or yield, is just the
coupon rate. However, after they're first issued, bonds rarely sell for
exactly face value. The yield differs from the coupon. While the coupon
rate is the stated interest rate offered by the debenture and is always
calculated on the principal value, the yield is often the return that
one would get considering the future interest flows and the prevailing
interest rate scenario.
To
give an example using the above matrix say a corporate debenture issued
by a Corporate rated AA+ with a residual duration of 2.5 years would be
calculated as under. The yield of this will be the benchmark yield plus
the markup depending on the bucket the debenture falls into. Therefore
yield used for valuation would be 6.17(benchmark)+1.08(spread) =7.25%.
All
corporate debentures that fall in a particular slot within the matrix
are valued at rates specified by CRISIL matrix. Additionally the fund
house is at a liberty to add a discretionary discount/premium upto
+100/-50 bps for rated paper with duration upto 2 yrs and upto +75/-25
bps for rated paper with duration over 2 yrs.
In
case of an unrated paper the fund house needs to assign an internal
credit rating which is then used for valuation. In this case the yield
would be marked up by adding 50 basis points for securities having a
duration upto two years and by 25 basis points for securities of
duration higher than two years.
VII. Valuing Money Market instruments
Money market instruments and corporate debentures with residual maturity of less than 6 months are valued by amortization. The difference between the face value and the cost is amortised over the life of the instrument. SEBI has provided that all money market instruments and corporate debentures maturing within 6 months have to be valued on a cost plus accrual basis instead of marking to market.
So the next time you decide to invest in a fund you know what to look out for.
Valuation therefore is a critical element of the entire funds management business. It takes time and hence funds have cut-off times so that all transactions for the day can be accounted for the days NAV. Any transaction that gets missed out implies that the resulting NAV is not the accurate NAV. It is for this reason that AMFI along with SEBI has started getting stricter on adherence to cut-off times.
|
| |
| |
| |
|
|
labs