RIL’s Super Long

Bonds
-SAMIR GOYAL
B17046
BM SECTION-A

Samir Goyal (B17046)

Case Background
In 1997, Reliance Industries announced that they received offers amounting to
$250 million for its $100 million, 100-year external commercial borrowings issued
in the US market. The bonds, with the longest maturity offering by an Indian
sovereign or corporate body, had been priced at a yield of 10.6 per cent. These
bonds were issued as unsecured and had been raised without recourse to any
guarantees from government, banks or institutions. These bonds helped the
company to reduce its overall cost of capital. The 100-year bond did not give a put
option to the lenders. However, due to the enormous size of the company, RIL
became the first Indian private company to be rated by the international rating
agencies. RIL had already raised more than $900 million in the international fixed
income markets before issuing the super-long bonds in 1997.

RIL also tapped the US debt market with its five Yankee Bond issues for a total
sum of US $614 million. The maturities ranged from 10 to 100 years. Hence,
Reliance became the first corporate issuer of 50 to 100 year bonds from Asia; it
became the first issuer with split rating (due to the constraint of India’s sovereign
rating) in the world to issue a 100 year bond, to be among less than 30 issuers in
the world who have accessed the 100 year market in the last 4 years.

Discussion Questions:
Q1) How the RIL Super Bonds are expected to react to the interest changes
that are expected in the market?

Answer:

The market price of an individual bond will fluctuate in the opposite

direction of interest rates. For example, if you purchase a $10,000 bond at par
value (or face value) with a coupon (yield) of 4%, your annual income is $400. If
interest rates rise and a newly issued bond with an identical rating pays 4.5%, the
market value of your bond declines to $8,889. The market value declines so that if
you sell your bond, the buyer, who will be receiving $400 in interest per year, will
have a yield of 4.5% on his or her investment to match the prevailing market rate.
RIL Super Bonds are expected to react to the interest changes in the same way.
However, the effect will be muted since the maturity period is a long one (100
years) and the risk will spread over the entire period, thus making them safer to
fluctuations than the case of normal bonds.

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Q2) The fixed income investment professionals were still divided over whether
the 100-year bond issue was an indicator of a trend and evidence of confidence
in the economy or issuer, or merely a novelty item?

Answer:

100-year bond issuance can definitely be an indicator of an evidence of

confidence in the issuer company, otherwise who would buy a 100-year bond from
a company they didn't believe would last. For example, if there was especially high
demand for Disney's 100-year bond, this could mean that many people believe that
the company will still be around to pay out the bond in a century.

Q3) Why there is no put option or call option attached to the RIL’s 100-year
Super Long Bond?

Answer:

A put option on a bond is a provision that allows the holder of the bond the
right to force the issuer to pay back the principal on the bond. A put option gives
the bond holder the ability to receive the principal of the bond whenever they want
before maturity for whatever reason. If the bond holder feels that the prospects of
the company are weakening, which could lower its ability to pay off its debts, they
can simply force the issuer to repurchase their bond through the put provision. It
also could be a situation in which interest rates have risen since the bond was
initially purchased, and the bond holder feels that they can get a better return now
in other investments. The interest rate risk which is being borne by the bondholder
would have to be compensated by a higher yield-to-maturity. As a result, the Yield
to Maturity of bonds with a call option is higher when compared to a similar bond
without the call option. Thus, if put feature is present in a bond the risk for the
issuer increases, hence, corporations generally don’t give the put option if they are
able to raise funds easily.

Q4) what will be the income component and capital gain or loss component of
the bonds? How this can affect the decision to subscribe or not to subscribe
the bonds?

Answer:

Capital gain or loss

Any change in the interest rate brings about fluctuations in the bond prices,
mostly in the opposite direction. If the bondholder keeps the bond till maturity,
there will not be any capital loss or gain. However, if he/she decides to sell the
same, there will be a capital loss or gain depending upon the prevailing rates and
the yield to maturity rate.

Samir Goyal (B17046)

Interest Income
Interest is paid to the issuer depending on the coupon rate of the bonds. The
interests are paid annually or semi-annually, depending upon the terms and
conditions of the bonds. Here, in the case of super long bonds of RIL, 10.25%
interest is paid up every year on the face value to every bondholder. This is over
and above the premiums or discounts that are adjusted due to various reasons.

Q5) Based on the issued price of the bonds, what is the market acceptable
interest rate for a 100 year-borrowing? How this bond is expected to be in
demand on varying interest rate and inflation rate regimes?

Answer:

The super long bonds issued by RIL paid a coupon rate of 10.25% with a
maturity of 100 years and were subscribe at the YTM of 10.6%. Given these
details, it can be safely assumed that the market acceptable interest rates of these
bonds, for a corporation with the same credit rating, will be 10.6% at the prevailing
interest rates, or we can say that the spread of such a bond issue will be 3.8% over
the benchmark of US treasury bills rate.

In an era when long term interest rates are greater than the short term
interest rates, a bondholder holding these bonds will able to have a greater income
by investing in these bonds as compared to the shorter term securities. Also when
the expectation of inflation is higher the interest rates on longer term securities go
up, which will also increase the returns for the bondholder. Hence, when either
longer term interest rates or expected inflation or both is higher, the demand for
these bonds would be higher.

However, if the expected inflation or longer term interest rates or both is

low, the interest income on short term securities would be more attractive for the
investors and the demand of these securities would then be low during those times.

Q6) How these bonds value are going to get affected by volatile FOREX rates?
How investors will protect themselves from this?

Answer:

Though it might not be perfectly right to say, but the Bond price and the
Currency moves share High correlation due to the fact that the Bond prices are
mainly driven by the aftershocks of currency moves.

When a high yielding currency (like AUD) drops, the value of its Bond
prices might rise and vice versa. The same is the case when there prevails a global
risk-off sentiment. During these times, high yielding currencies gain and the Bond
prices drop as some of the market players would have already liquidated the higher

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yielding bonds with the fear that central bankers might intervene to control the
currency moves.

Hence, Both the Bond prices and Currency are inversely related but to say
that in isolation isn’t a wise advise.

Currency risk does not arise only from holding a foreign currency bond
issued by an overseas entity. It exists any time an investor holds a bond that is
denominated in a currency other than the investor’s domestic currency, regardless
of whether the issuer is a local institution or a foreign entity.

Q7) Why RIL launched these bonds in the international market denominating
in USD? Is it that Indian market was not matured enough or large enough to
accommodate these bonds?

Answer:

Lower interest rates, increasing investor appetite for Indian papers and a
strategy to diversify exposures into different currencies have prompted many
Indian companies to make their debut in international bond markets. The
international debt markets are easily accessible to large Indian corporates who are
also widening currencies of issuance to tap a wider investor base.

In this case too, RIL must have been looking to tap on the low interest rate
of the US Market. Also, the risk appetite and funding capability of foreign markets
is much more than the Indian Market. This might have prompted RIL to go for the
launching bond in the international market denominating in USD.

Q8) What if the 100-year RIL Bonds was designed as a ZCB?

Answer:

A zero coupon bond is a type of bond that doesn't make a periodic interest
payment. In bond investing, the term 'coupon' refers to the interest rate repaid
periodically to the bondholder. When Tom buys the bond, it will have a face value,
which represents how much money he'll receive from the bond issuer at maturity.
Since Tom won't be receiving any periodic interest payments, the only time he'll
receive payment from the issuer is when the bond matures. When the bond is
originally issued, the purchase price is intentionally set low to motivate investors to
buy.

Maturity dates and interest rates dictate the price of zero coupon bonds.
When interest rates are high, the purchase price is lower. A maturity date far off in
the future will also cause the zero coupon bond to have a lower price compared to

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one that's maturing sooner. The interest rate remains fixed throughout the life of
the zero coupon bond, so the price to buy the bond has to change throughout its life
to match equivalent yields already out there in the market.

Zero coupon bond prices are typically calculated using semi-annual periods
(twice a year) because bonds that offer a coupon often pay interest twice a year.
So, calculating the price of a zero coupon bond this way allows Tom to compare
investing in this zero coupon bond to investing in a traditional bond.

If these 100year long bonds are issued at the YTM of 10.6 as Zero Coupon
Bonds (ZCB) RIL would only get USD4.21 as proceeds for a USD100,00 of face
value. As coupon payments are implied in the face value that is repaid at the time
of redemption the value of a ZCB is very close to zero as compared to a bond that
pays a coupon.

As a result, if ZCB are issued the proceeds will be insufficient to fund the
projects that the company wishes to invest in.

Q9) How the price-yield curve of RIL bonds (as stated in exhibit 1) differ
from each other?

Answer:

The price-yield curve relates the annual yield on a coupon bond to its price.
Coupon payments are a fixed percentage of the face value of a bond and are
typically paid semi-annually. At maturity, the holder of a bond receives the last
coupon payment, in addition to the face value.
In our case, 5 Yankee bonds were issued by RIL, each with a different
coupon rates, maturity period and amount. The price-yield curve for each would
vary. There might also be fluctuations due to the changes in the interest rates.

Q12) Which of the bonds in Exhibit 1, will have the greatest price volatility,
assuming that each bond is trading to offer the same YTM?

Answer:

The change in the price of the bonds with higher maturity period is higher
as compared to others. Also, it can be observed that the volatility of the price
changes is the least when the YTM of the bond is close to the coupon rate paid by
the bond.
Thus, if we assume that all the bonds currently trade at the YTM of 9%, we
can say that volatility of price changes would be the highest in either of the bonds
with a coupon of 10.25%, 10.375% or 10.5%. Also, if we take into consideration
the time to maturity the super long bonds with the maturity of 100 years would
have the highest volatility among these bonds. Hence, the price volatility of super
long bonds is the highest among the bonds issued by RIL.

Samir Goyal (B17046)