These include the following-

1. Financial institutional bonds
2. Public sector unit bonds
3. Corporate bonds/debentures

As compared to the large size of government securities market both in terms of primary market as well as secondary market, the corporate bond market is not so big. The corporate bond market consists of issuers of three different categories- government owned financial institutions (FIs), government owned public sector units (PSUs) and private corporates. The FIs, which do not have access to retail deposits like banks, depend on bond issues for raising funds. There are highly rated and hence quote the lowest rate of funds. Next in line are the PSUs, though a lot of PSUs are in the high-risk category. Due to their poor financial condition, only the better managed PSUs approach the markets to raise the funds. The PSUs are also given an advantage in terms of tax breaks for the investors on investments in specified PSU bonds. These bonds referred to as tax-free bonds, obviously get traded at lower yields. Investments in rest of PSU bonds are taxed like any other bonds. Private corporates also access the bond market to raise funds. This phenomena has increased of late as the primary capital markets have been dull for the last two years. This has diverted a lot of corporates to issue bonds.

The investors in these markets are mainly banks, FIs, mutual funds etc. before 1997, banks faced a 5% ceiling on their investment in corporate debentures. Subsequently this has been removed. Simultaneously banks have been warned about their non-performing assets (NPAs) among their regular advance. This has forced a majority of them to invest in debentures giving a fillip to this market. Most of the bond issues are institutional in nature with the issuer approaching institutional investors and placing the bonds rather than making a public issue, mainly to save on issue expenses. The investment of FIIs in this category will have to fall within the overall limit of 49% for the equity funds, and 100% for debt funds. Trading in these bonds is quite thin with some activity confined to FI bonds, some PSU bonds and the top rated corporates.

The rates in these markets differ for different issuer categories. While top rated private corporates and PSUs are treated on par, FIs pay less coupon on their issues. In line with the general trend in the interest rates in the economy, the rates on these bonds have come down from the high levels in 1995 and 1996. This downward trend has been mainly due to higher liquidity with the banking system along with the new found enthusiasm of banks for bonds in comparison to loans due to capital adequacy requirements.