Bond Valuation (Mark-to-Market)
The process of valuing bonds at their current fair market value based on prevailing yields rather than amortised cost, as required by Ind AS 109 for financial instruments classified under FVTPL (Fair Value Through Profit or Loss) or FVOCI (Fair Value Through Other Comprehensive Income) categories, resulting in unrealised gains or losses flowing through income or equity respectively.
Bond valuation under India's Ind AS 109 (Financial Instruments) framework was fundamentally different from the pre-Ind AS treatment where many debt securities were carried at amortised cost. Ind AS 109 required entities to classify debt instruments into three categories based on business model and cash flow characteristics, each with distinct valuation treatment.
Amortised Cost: applied when the entity's business model was to collect contractual cash flows and the instrument's cash flows were solely principal and interest. Under this method, the bond was valued at face value adjusted for unamortised premium or discount using the effective interest rate (EIR) method. No mark-to-market (MTM) impact arose — only the accrued interest and EIR amortisation flowed through the income statement. Banks' held-to-maturity (HTM) portfolios conceptually followed this treatment, subject to RBI limits.
FVOCI (Fair Value Through Other Comprehensive Income): applied when the business model was both to collect cash flows and to sell the instrument. The bond was carried at fair value — its price based on current market yields. Changes in fair value flowed through OCI (Other Comprehensive Income, a component of equity), not the income statement. Interest income was still recognised in profit and loss using EIR. Upon sale, the cumulative OCI was recycled to profit and loss.
FVTPL (Fair Value Through Profit or Loss): applied to all other instruments, including trading portfolios. Daily fair value changes flowed directly through profit and loss, creating income statement volatility. Mutual funds in India — being measured at NAV — applied FVTPL treatment to their entire portfolio of debt securities, which is why daily NAV movements in debt funds reflected interest rate changes.
For mutual fund investors, understanding FVTPL treatment explained why a gilt fund's NAV fell when yields rose (bond prices moved inversely with yields) and rose when yields fell. The MTM mechanism also explained the difference between YTM (the expected return if held to maturity) and the actual realised return over a shorter period.