Domestic bond

The simplest kind of bond. An Indian company raises rupees from Indian investors in the Indian market.

All 3 things line up. The issuer is Indian, the market is Indian, the currency is the rupee.

That alignment is what makes it a domestic bond, and it is also what makes it straightforward. The company earns rupees and repays rupees, so no exchange rate can turn a manageable debt into an unmanageable one.

The moment any one of the 3 moves offshore, the bond stops being domestic. The workbook calls everything else an external bond.

The 4 questions. Section 2.2.2 says the domestic-versus-external classification "hinges on the aspects a) Who is issuing the bond? b) In which country's bond market is the bond being issued? c) What is the currency in which the bond is being issued? d) What is the home currency of the country in which the bond is being issued?"

Those 4 questions are the whole framework, and the answers to them separate a domestic bond from a foreign bond and a euro bond.

The definition. "Domestic Bonds are issued by authorised entities of a country, in the bond markets of their home country, denominated in their own home currency."

Set against it: "External Bonds are issued by authorised entities of a country, in foreign markets (also sometimes referred to as offshore markets), and in a currency that is different than their home currency."

What follows from being domestic. No currency risk for the issuer. The workbook makes this point from the other side when it explains external bonds: an Indian issuer of dollar bonds needs more rupees to repay if the dollar appreciates. A domestic bond carries none of that exposure.

Who issues and who regulates. Section 2.2.2 lists debentures, bonds and notes as issued by companies, government, special purpose vehicles and other entities, to institutional and individual investors, with RBI, SEBI, the regulators under the Companies Act, the MCA and the NCLT in the frame.

2 figures worth carrying. The workbook notes that bonds are "more related to government as an issuer with longer maturities beyond 10 years," known as GILTs in the UK, while debentures relate more to corporates. And short-term debt instruments "are used to raise debt for periods not exceeding one year" — treasury bills, commercial paper and certificates of deposit.

A terminology warning. The workbook stresses that the words are not interchangeable across countries: "Bonds is an umbrella term in US, and Debentures in UK." It advises analysts to read the features of the specific instrument rather than rely on the label.

Illustrative. An Indian manufacturer raises Rs 500 crore of 7-year non-convertible debentures at 8.5%, listed on an Indian exchange and sold to Indian mutual funds and insurers. A domestic bond on all 4 tests: Indian issuer, Indian market, rupees, and the rupee is the home currency of the market.

Annual interest is Rs 42.5 crore, and it stays Rs 42.5 crore whatever the rupee does.

Now compare the same Rs 500 crore raised as a dollar bond in the United States at 5.0% — cheaper on the face of it, which is why the workbook says emerging market issuers prefer such currencies.

At Rs 83 to the dollar, Rs 500 crore = about USD 60.2 million
Annual interest at 5.0%            = USD 3.01 million = Rs 25.0 crore

Rs 25 crore against Rs 42.5 crore. The dollar bond looks Rs 17.5 crore a year cheaper.

Then the rupee moves to Rs 92.

Interest      : USD 3.01 mn × 92 = Rs 27.7 crore
Principal due : USD 60.2 mn × 92 = Rs 554 crore, against Rs 500 crore borrowed

The company now owes Rs 54 crore more principal than it raised, purely from the exchange rate. The domestic bond could not have done that. This is the currency risk the workbook attaches to foreign currency borrowing, and the absence of it is the defining commercial feature of a domestic bond.

Section 2.2.2 (Debentures/Bonds/Notes) introduces the domestic-versus-external split, and chapter 3 (Terminology in Equity and Debt Markets) returns to it.

The examinable content is the 4-question framework and the 3 resulting categories: domestic, foreign and euro. Expect a scenario giving an issuer, a market and a currency and asking which category the bond falls into. A domestic bond is the easy case, and getting it right depends on remembering that all 3 of issuer, market and currency must be home.

• All 3 must align. Home issuer, home market, home currency. An Indian company issuing rupee bonds outside India is not a domestic bond — the workbook classes rupee-denominated offshore paper as a masala bond, which is a euro bond.
• Domestic is the opposite of external, not of foreign. External bonds split further into foreign bonds and euro bonds. Domestic sits outside that split entirely.
• "Bond", "debenture" and "note" do not mean the same thing everywhere. Bonds is the umbrella term in the US, debentures in the UK, and the workbook tells analysts to read the instrument rather than the name.
• Beyond 10 years for government bonds; not exceeding 1 year for short-term instruments. 2 different figures from the same section.
• A domestic bond has no currency risk for the issuer, which is not the same as having no risk. Credit risk, interest rate risk and call risk are all still there.