NISM Series X-A · Chapter 9: Investing in Fixed Income Securities

L1 · Foundation

Foundation — The bond ecosystem, embedded options and the ten risks

Why debt markets exist and their three Indian segments, the defining features of a bond, callable puttable and convertible bonds, and all ten risks of fixed income investing from interest rate risk through event risk.

15 min read · Worth 5% of the paper · Written from pages 152–184 of the official NISM workbook · Updated 18 September 2026

9.1 The debt market and its role

"The debt market enables borrowers, including GOVERNMENTS AND PRIVATE FIRMS, to issue debt securities... It plays a crucial role in economic growth by CHANNELING FUNDS FROM SAVERS TO INVESTORS willing to take risks."

"Unlike the equity market, DEBT INVESTMENTS ARE RELATIVELY SAFER as they are OFTEN SECURED BY PHYSICAL ASSETS. However, IN CASE OF DEFAULT, RECOVERING FUNDS CAN BE A LENGTHY LEGAL PROCESS, making a COMPANY'S GOODWILL A KEY FACTOR in honoring debt obligations."

"DEBT FINANCING involves BORROWING WITH FIXED OBLIGATIONS, whereas EQUITY FINANCING GRANTS OWNERSHIP RIGHTS."

The three segments of India's debt market

Segment	Contents
(a) Government securities	G-secs, T-bills, SDLs
(b) PSU and bank bonds	—
(c) Private sector instruments	Bonds, debentures and commercial papers

"A well-developed debt market requires STRONG LEGAL FRAMEWORKS AND CREDIT RISK ASSESSMENTS to attract investors."

9.2 The bond market ecosystem

"Since bonds create FIXED FINANCIAL OBLIGATIONS on the issuers, they are referred as FIXED INCOME SECURITIES."

The issuer's two promises: "1) PAY A FIXED AMOUNT OF INTEREST (known as COUPON) PERIODICALLY and 2) REPAY THE FIXED AMOUNT OF PRINCIPAL (known as FACE VALUE) AT THE DATE OF MATURITY. The fixed obligations of the security are THE MOST DEFINING CHARACTERISTIC of bonds."

"MOST BONDS MAKE SEMI-ANNUAL INTEREST PAYMENTS, though some may make annual, quarterly or monthly payments — "EXCEPT ZERO COUPON BONDS WHICH MAKE NO INTEREST PAYMENT."

Maturity and the money market boundary

"Bonds have FIXED MATURITY DATES beyond which THEY CEASE TO EXIST as a legal financial instrument (except PERPETUAL BONDS, which have NO MATURITY DATE)."

The three intrinsic features

"The COUPON, MATURITY PERIOD AND PRINCIPAL VALUE are important INTRINSIC FEATURES of a bond."

Coupon — "indicates the INTEREST INCOME that the bond holder will receive over the life (or holding period)"
Term to maturity — "the TIME PERIOD BEFORE A BOND MATURES. All G-Secs are normally COUPON BEARING and have SEMI-ANNUAL coupon payments with a TENOR OF BETWEEN 5 TO 30 YEARS. Maturity period is also known as TENOR OR TENURE"
Principal or par value — "the ORIGINAL VALUE OF THE OBLIGATION"

Price versus par

"Principal value of the bond is DIFFERENT from the bond's MARKET PRICE, EXCEPT when the coupon rate and the prevailing market rate of interest are EXACTLY THE SAME."

Condition	Result
Market interest rate ABOVE the coupon rate	"the bond will sell at a DISCOUNT to the par value"
Market rate BELOW the bond's coupon	"the bond will sell at a PREMIUM to the par value"

"The interest rate here is assumed to be FOR THE REMAINING MATURITY of the bond."

Multiple bond issues and the ISIN limit

"Unlike equity, COMPANIES CAN ISSUE MANY DIFFERENT BOND ISSUES OUTSTANDING AT THE SAME TIME. As per regulation, MAXIMUM 12 ISINs CAN MATURE IN ONE FINANCIAL YEAR. Companies RE-ISSUE EXISTING ISINs. For COMPLETELY NEW ISSUANCES (ISINs), the limit of 12 is applicable."

"These features of the bonds will be part of the INDENTURE" — defined in the chapter's footnote as "the LEGAL AGREEMENT BETWEEN TWO PARTIES, in case of bond indenture the two parties are the BOND ISSUER (BORROWER) AND THE INVESTORS (LENDER)."

Bonds with embedded options

Type	Right held by	Effect
Callable bond	The ISSUER	"the right to REDEEM ALL OR PART of the outstanding bonds BEFORE the specified maturity date"
Puttable bond	The BONDHOLDER	"the right to SELL THE BOND BACK TO THE ISSUER at a PRE-DETERMINED PRICE on SPECIFIED DATES"
Convertible bond	The BONDHOLDER	"a PLAIN VANILLA BOND PLUS AN EMBEDDED EQUITY CONVERSION OPTION... the right to EXCHANGE THE BOND FOR A SPECIFIED NUMBER OF COMMON SHARES"

Why callable bonds hurt the investor: "Callable bonds are ADVANTAGEOUS TO THE ISSUER but they present investors with a HIGHER LEVEL OF REINVESTMENT RISK. The issuer will call the bond before its maturity ONLY WHEN THE INTEREST RATES FOR SIMILAR BONDS FALL in market. The investor will receive the face value BEFORE ITS MATURITY, and will be FORCED TO REINVEST THAT MONEY FOR THE REMAINING PERIOD AT LOWER INTEREST RATES."

"Puttable bonds are BENEFICIAL TO THE BONDHOLDER by GUARANTEEING A PRE-SPECIFIED SELLING PRICE at the redemption dates."

9.3 The ten risks of fixed income securities

"Government bonds are considered as RISK FREE and hence provide LOW RETURN while CORPORATE bonds in general being RISKIER provide HIGHER RETURNS. Entities like PUBLIC SECTOR UNDERTAKINGS OR BANKS are RELATIVELY LESS RISKY vis-à-vis the pure corporate firms and thus provide returns HIGHER THAN THE GOVERNMENT BONDS BUT LOWER THAN THE CORPORATE PAPERS."

9.3.1 Interest rate risk

"The price of the bond is INVERSELY RELATED to the interest rate movement. IF THE INTEREST RATE RISES, THE PRICE OF THE BOND WILL FALL."

"An investor holding bonds would face an EROSION IN VALUE if the interest rates rise and this can lead to a CAPITAL LOSS IF THE BONDS ARE SOLD BELOW THEIR PURCHASE PRICE."

9.3.2 Call risk

"the risk of a bond being PREMATURELY CALLED OR REPAID BY THE ISSUER exercising the right provided in the indenture."

"This typically happens when a company decides either to GO AS A ZERO-DEBT COMPANY or wants to REFINANCE ITS LIABILITIES WITH LOW COST OF BORROWING. This low cost may be possible if the company's CREDIT RATING HAS IMPROVED or if MARKET CONDITIONS have changed."

"The call risk makes the bond UNATTRACTIVE to the investor vis-à-vis a non-embedded option bond. The call risk INCREASES UNCERTAINTIES for the investor."

9.3.3 Reinvestment risk

"arises when the PERIODIC INCOME received from bonds is REINVESTED after their receipt AT THE RATE PREVAILING IN THE MARKET at the time of such receipts."

Note the tension the chapter draws out: "HIGHER INTEREST RATE vis-à-vis the coupon would mean CAPITAL LOSS in the market value of the bond IF THE INVESTOR WANTS TO SELL." Rising rates help reinvestment but hurt price; falling rates do the reverse.

9.3.4 Credit risk — and its three types

"Particularly for bonds issued by NON-GOVERNMENT CORPORATES, the repayment of the principal RELIES HEAVILY ON THE ISSUER'S ABILITY TO REPAY THAT DEBT."

Downgrade risk — "arises when the RATING OF AN ISSUER IS LOWERED AFTER THEY HAVE PURCHASED ITS BONDS. If a company's credit rating is downgraded... the issuing company FACES HIGHER COST FOR RAISING NEW RESOURCES. The existing bond holders would be facing this DROP IN PRICE of their bonds." The chapter's example: "the CASCADING EFFECT OF THE RATING DOWNGRADES IN THE IL&FS CASE IN AUGUST-SEPTEMBER 2018."

Spread risk — "Corporate bonds pay a SPREAD (depending on its Credit rating) over COMPARABLE GOVERNMENT SECURITIES as the risk increases. The spread KEEPS ON CHANGING DYNAMICALLY."

"The spread charged for HIGHER RATED PAPERS would be FAR LOWER compared to the LOWER RATED papers. In TIGHT LIQUIDITY SITUATIONS or when the general market condition is bad, the RISK APPETITE DROPS and THE SPREAD INCREASES."

Default risk — "the POSSIBILITY OF NON-PAYMENT OF COUPON OR PRINCIPAL WHEN DUE... While CREDIT RATINGS HELP TO MEASURE an issuer's risk of default, THERE IS STILL ALWAYS A RISK that some UNFORESEEN EVENT CAN FORCE THE ISSUER TO DEFAULT. THE SPREAD MEASURES THE DEFAULT RISK of a bond. JUNK BONDS with very high credit risk PAY VERY HIGH INTEREST RATES."

9.3.5 Liquidity risk

"the risk that the investor WOULD NOT BE ABLE TO SELL THE INVESTMENT AT THE TIME OF NEED... When liquidity is tight, "investors have to FIRE SELL THE ASSET AT A MUCH LOWER PRICE."

"LIQUIDITY RISK IS VERY COMMON ON LONG-TERM BONDS. SHORT-TERM INSTRUMENTS ARE MORE LIQUID as they are like cash instruments... BETTER THE CREDIT QUALITY of the bond e.g. G-SEC OR AAA RATED CORPORATE BOND, LOWER IS THE IMPACT COST."

9.3.6 Exchange rate risk

"Bonds issued in FOREIGN CURRENCY are exposed to currency risk. When the issuer has to pay back principal or coupon, the company has to ACQUIRE FOREIGN CURRENCY FROM THE MARKET. The cost of acquiring such foreign exchange MAY INCREASE IF THE DOMESTIC CURRENCY HAS DEPRECIATED."

"MASALA BONDS issued by Indian entities expose the investors to the Exchange rate risk as THE RUPEE AMOUNT IS FIXED and the investors who are FOREIGN ENTITIES would receive INDIAN RUPEE and have to BUY THE FOREIGN CURRENCY FOR REPATRIATION."

9.3.7 Inflation risk

"if suddenly the INFLATION RATE INCREASES, the cost of goods would increase and THE REAL RETURN COMES DOWN. The NOMINAL RETURN MAY REMAIN THE SAME but the REAL INCOME after adjustment of inflation would be FAR LOWER."

"A FIXED RATE BOND DOES NOT TAKE INTO ACCOUNT CHANGING FUTURE SCENARIOS while a FLOATING RATE BOND CAN TAKE CARE of such changes. When expected inflation levels are higher, investors prefer FLOATING RATE BONDS OR INFLATION-INDEXED BONDS. However, the ISSUANCE QUANTUM / MARKET SEGMENT for floating rate bonds and inflation-indexed bonds IS LIMITED."

9.3.8 Volatility risk

"affects the bonds WITH EMBEDDED OPTIONS. The pricing of an embedded option bond TAKES INTO ACCOUNT THE VOLATILITY LEVEL to price the same."

9.3.9 Political or legal risk

"The bonds WITH TAX BENEFITS would be exposed to such risks. TAX FREE BONDS MAY BECOME TAXABLE because changes in Government rules would impact the price, "but THIS IS UNLIKELY."

"if an issuer decides NOT TO PAY A COUPON due to its TIGHT CASH POSITION or plans to ROLL OVER ITS DEBT or PAY A COUPON IN THE FORM OF NEW BONDS, this can lead to SUBSTANTIAL VALUE CHANGE. Government changing REPATRIATION RULES may affect the foreign bond investors."

9.3.10 Event risk

"an UNEXPECTED OR UNPLANNED EVENT that FORCES THE VALUE OF AN INVESTMENT TO DROP SUBSTANTIALLY. Certain events may force companies to SEEK MORATORIUM ON REPAYMENT."

"during the recent COVID-19 PANDEMIC, THE TRAVEL INDUSTRY WAS SEVERELY IMPACTED and MANY COMPANIES COULD NOT SERVICE THEIR DEBT. This type of risk is DIFFERENT FOR EACH SECTOR and the amount of exposure DEPENDS ON THE SECTOR."

Think of it like this

A long bond becomes a money market security in the end

The classification is by remaining maturity, not original maturity, and the chapter spells out the consequence: "bonds with A YEAR OR LESS maturity are termed as MONEY MARKET SECURITIES... Thus, LONG TERM BONDS AS THEY MOVE TOWARDS MATURITY BECOME MONEY MARKET SECURITIES." A ten-year bond issued in 2016 is a capital market instrument for nine years and a money market instrument for its final twelve months. The label travels with the clock, not with the issue.

Discount or premium tells you where rates have gone since issue

A bond trades at par only "when the coupon rate and the prevailing market rate of interest are EXACTLY THE SAME." Otherwise, if "the market interest rate is ABOVE the coupon rate, the bond will sell at a DISCOUNT"; if the market rate is below the coupon, it sells at a premium. So a bond priced at 106 is telling you that rates have fallen since it was issued — its old coupon is now generous, and buyers pay extra for it.

The issuer calls when it suits the issuer

Callable bonds look harmless until you notice the timing. "The issuer will call the bond ONLY WHEN THE INTEREST RATES FOR SIMILAR BONDS FALL." So the investor gets his money back at exactly the moment when reinvesting it is worst — "forced to reinvest that money for the remaining period at lower interest rates." The option is exercised against you by design, which is why "call risk makes the bond UNATTRACTIVE to the investor vis-à-vis a non-embedded option bond." A put, held by the bondholder, works the same way in reverse.

Hold to maturity kills one risk and maximises another

Two sentences from adjacent sections that must be read together. On interest rate risk: "HOLD TILL MATURITY CAN OBVIATE INTEREST RATE RISK BECAUSE ON MATURITY, YOU RECEIVE WHAT WAS INITIALLY CONTRACTED." On reinvestment risk: "IF AN INVESTOR WANTS TO HOLD THE SECURITY TILL MATURITY, THEN REINVESTMENT RISK IS VERY HIGH." Holding to maturity protects the principal but leaves you exposed on every coupon you must redeploy. There is no arrangement that escapes both.

Rising rates: good for your coupons, bad for your price

The chapter puts the two effects of a rate move in direct tension. Rising rates mean coupons "would be reinvested at a higher rate that would be beneficial", but simultaneously "higher interest rate vis-à-vis the coupon would mean CAPITAL LOSS in the market value of the bond if the investor wants to sell." Price risk and reinvestment risk pull in opposite directions — which is precisely the insight that duration and immunisation build on.

IL&FS, and the word "cascading"

The chapter chooses its illustration of downgrade risk carefully: "the CASCADING EFFECT of the rating downgrades in the IL&FS case in August-September 2018." A downgrade does two things at once — "the issuing company faces higher cost for raising new resources", and "the existing bond holders would be facing this drop in price of their bonds." A rating is not a passive opinion; changing it changes the borrower's cost and the holder's wealth in the same moment.

Spreads widen exactly when you need them not to

Spread risk has a cruel timing property: "In tight liquidity situations or when the general market condition is bad, the risk appetite drops in the market and THE SPREAD INCREASES." So corporate bond prices fall hardest when markets are already stressed and selling is already difficult — and the effect is graded by quality, since "the spread charged for higher rated papers would be far lower compared to the lower rated papers."

Masala bonds move the currency risk to the lender

Normally a foreign currency bond puts the exchange risk on the issuer, who "has to acquire foreign currency from the market" to pay. Masala bonds invert this: "the RUPEE AMOUNT IS FIXED and the investors who are FOREIGN ENTITIES would receive INDIAN RUPEE and have to BUY THE FOREIGN CURRENCY FOR REPATRIATION." The Indian borrower repays in rupees and sleeps soundly; the overseas lender carries the rupee. Naming the currency of the contract decides who bears the risk.

Key terms in this chapter

Callable bond: A bond giving the issuer the right to redeem before maturity. It is exercised when interest rates fall, forcing the investor to reinvest at lower rates, which is why it raises reinvestment risk.
Call money: Overnight unsecured interbank lending, restricted in India to Scheduled Commercial Banks and Primary Dealers, dealt on NDS-CALL and settled by RBI.
Call risk: The risk of a bond being prematurely called or repaid by the issuer, typically when the issuer wants to become debt-free or refinance at a lower cost after a rating upgrade or a change in market conditions.
Cash Management Bills: Very short-term unstructured T-bills maturing within 91 days, launched in 2010 to meet temporary mismatches in the government's cash flow.
Certificate of Deposit: An instrument issued against funds deposited at a bank or eligible FI, in Rs 1 lakh multiples. Banks issue up to one year, financial institutions up to three years.
Clean price: The price of a bond excluding accrued interest. The market trades on clean price and all yield and price formulas use it.
Commercial Paper: Short-term unsecured discounted funding for corporates, in Rs 5 lakh multiples for 7 days to one year, requiring typically the second highest credit rating and a minimum net worth.
Convertible bond: A plain vanilla bond plus an embedded equity conversion option, giving the holder the right to exchange it for a specified number of common shares.
Convexity: A measure of the degree of curve in the relationship between bond prices and bond yields, since the price-yield movement is non-linear.
Coupon: The fixed amount of interest the issuer agrees to pay periodically. Most bonds pay semi-annually, except zero coupon bonds which pay no interest at all.
Coupon yield: Coupon payment divided by face value. It is the nominal interest payable and does not change with market price.
Current yield: Annual coupon divided by the current market price, times 100. For an 8.24 per cent bond at Rs 103 it is 8 per cent.
Day count convention: The method for arriving at the holding period used to calculate accrued interest. Indian bonds use 30/360 while the money market, including T-Bills, uses actual/365.
Default risk: The possibility of non-payment of coupon or principal when due. The spread measures it, and junk bonds with very high default risk pay very high interest rates.
DICGC insurance: Deposit insurance of up to Rs 5 lakh per depositor per bank, covering all deposits and interest held across branches of that bank.
Dirty price: The sum of clean price and accrued interest, being the amount the buyer actually pays. Also called the full price or invoice price.
Downgrade risk: The risk that an issuer's rating is lowered after the bonds are purchased, raising the issuer's cost of new funds and lowering the price of existing bonds. The IL&FS downgrades of August-September 2018 are the chapter's example.
Effective yield: The equivalent rate producing the same final amount at the end of one year if simple interest were applied, as against the nominal or stated rate. A 4.20 per cent annual coupon paid monthly is worth 4.28 per cent.
Event risk: An unexpected or unplanned event forcing an investment's value to drop substantially, such as the Covid-19 impact on the travel industry. Exposure differs by sector.
Indenture: The legal agreement between the bond issuer, who is the borrower, and the investors, who are the lenders. It contains the bond's features.
Interest rate risk: The risk that bond prices fall when interest rates rise, since the two are inversely related. Holding till maturity obviates it, because on maturity the investor receives what was contracted.
Inverted yield curve: A curve where short-term rates exceed long-term rates, caused by high policy rates to curb demand or by severe asset liability mismatch. It indicates the economy may go into recession.
Macaulay duration: The time taken to recover the initial investment in present value terms, expressed in years. It is always less than or equal to maturity, and equal only for a zero coupon bond.
Masala Bonds: Rupee denominated bonds issued by Indian entities where the rupee amount is fixed, so foreign investors receive rupees and must buy foreign currency for repatriation, bearing the exchange rate risk themselves.
Modified duration: Macaulay duration divided by one plus the periodic interest rate, showing the percentage change in price for a change in interest rates. It is generally lower than Macaulay duration.
Notice and term money: Extensions of the interbank call market: notice money is uncollateralized lending beyond overnight and up to 14 days; term money runs from 15 days to one year.
Par value: The face value promised as principal at maturity, typically Rs 100 for a government bond and Rs 10,000 for a corporate bond. Also the redemption value for a plain vanilla bond.
Puttable bond: A bond giving the holder the right to sell it back to the issuer at a pre-determined price on specified dates, guaranteeing a selling price.
PVIF: Present Value Interest Factor, the sum of all discount factors. Bond value equals coupon times PVIF plus par value times the final discount factor.
Reinvestment risk: The risk that interest rates may decrease during the life of the bond, so periodic coupons are reinvested at lower rates. It is very high for an investor holding to maturity.
Repo: Also called a ready forward contract, borrowing funds by selling securities with an agreement to repurchase at a future date, the interest being built into the repurchase price. Reverse repo is the opposite, being collateralized lending.
Sovereign Gold Bond: A gold-linked government security denominated in units of one gram, paying a fixed semi-annual coupon on nominal value and redeemed at the simple average IBJA closing price of 999 purity gold over the previous three business days.
Spread risk: The risk that the spread a corporate bond pays over comparable government securities widens. Spreads are lower for higher rated papers and increase when liquidity is tight or risk appetite drops.
STRIPS: Separate Trading of Registered Interest and Principal of Securities: zero coupon bonds created by breaking down a G-Sec's cash flows, attractive to retail investors because they carry zero reinvestment risk.
Triparty repo (TREP): A repo with a Triparty Agent handling collateral selection, payment, settlement and custody. CBLO was converted into TREP on 5 November 2018; TREPS borrowings are exempt from CRR/SLR and the security acquired is SLR eligible.
Uday bonds: Special securities issued by State Governments for the financial turnaround of power distribution companies. Unlike ordinary State Government Securities, Uday bonds are not eligible for SLR.
Volatility risk: A risk affecting bonds with embedded options, since the pricing of such bonds takes the volatility level into account.
Yield curve: A plot of the relationship between time and interest rate, whose slope gives the relative risk premia for time. It takes four shapes: normal, inverted, flat and humped.
Yield to call: The estimated rate of return for bonds held to the first call date. Yield to put is its exact opposite, with papers trading by adjusting maturity to the first put date.
Yield to Maturity: The discount rate equating the present value of a bond's future cash flows to its current market price. It is the expected return if held to maturity, and the bond's internal rate of return, found by trial and error.

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Original explanatory writing based on the official NISM workbook for Series X-A, which is published and copyrighted by NISM. Check figures against the current edition at nism.ac.in.

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