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Financial Management 1
RIL’s Super-Long Bonds
Case Background
During the years 1996-97, Reliance Industries Limited was responsible for manufacturing a
full 3% of India’s Gross Domestic Product and nearly 5% of the India’s exports. RIL was the
source of 10% of the indirect tax revenues of the Government of India, and commanded 15%
of the weightage of the Sensex. It made 30% of the total profits of all the private companies in
India put together.
Reliance Industries Limited went public in the year 1978. In the year 1997, RIL entered the US
debt markets with its five Yankee Bond issues for a total sum of US$ 614 Million. The maturity
periods for these debts were spread across the range of 10 to 100 years. RIL, post the issue of
these debts, became the first corporate issuer of long term bonds from Asia, it also became the
first issuer with a split rating to issue 100 year bonds.
Reliance Industries Limited until 1996-97 raised a total of $914 million in the international
fixed market which led to lowering of its average cost of capital and increase in the average
maturity. The average maturity of debt has more than doubled thereby bringing the maturity
profile closer to the economic life of the underlying productive assets. The interest rates were
around the lower end when RIL approached the market further lowering the costs.
During 1995, Standard & Poor, Moody’s Investor Services Inc. and National Association of
Insurance Commissioners rated RIL for the first time. IN 1996, Moody’s and NAIC retained
their ratings of “Baa3 Investment Grade” and “NAIC 2 Investment Grade” respectively
whereas S&P upgraded its rating from “BB+ Stable Outlook” to “BB+ Positive Outlook”.
Financial Aspects of the Case
Following are the key financial aspects associated with the case:
In the forthcoming section we will analyse the volatility of the bonds issued by RIL.
1.) How are the RIL Super Bonds expected to react to the interest changes that are expected
in the market?
A change in the interest rates has only a modest impact on the value of short term cash
flows, but much greater impact on the distance cash flows. Thus the price of long term
bonds are vary way more than the short term bonds on changes in the interest rates.
Therefore a 100 year bond will have much higher fluctuations as compared to a 20 year
bond. RIL’s super bonds will have higher variation as compared to the bonds issued by
RIL with lower maturity periods.
Refer Exhibit 1 for price versus interest rate calculations of the 20 year Bond
2.) Does the 100 year bond issue indicate a trend and evidence of confidence in the
economy or issuer or merely a novelty item?
The demand for such long bonds are indeed seen as a sentiment for a specific company.
A buyer would not take a 100 year long bond if he knows that the company under no
circumstance would survive for such a long time. In this case, post the liberalisation in
1991, the economy was looking up with Reliance Industries Ltd. Being the flagbearer
of the Indian private firms.
The growing positive sentiment is reflected in the fact that Reliance did manage to raise
considerable amount through such super long bonds.
3.) Why there is no put option or call option attached to RIL’s 100 year super long bond?
The idea behind issuing a super long bond as RIL did is to pull bondholders who are
looking forward to long and stable return on the bond. The understanding being that the
company would be doing well in the long run and would continue to be in business until
the maturity time. Putting a call or put option basically undermines the long term trust
that the firm is seeking from the investors. As it would allow the bondholders to pull
out their money or for the firm to call back the bond issue thereby undoing the whole
idea of issuing a super long bond.
4.) 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?
Income component for a bond is the amount received in the form of interest received
whereas the capital gain or loss is the change in the bond price at the time of maturity.
For the given super bond of coupon value at 10.25%, the total PV of the cash flow
stands at $96.7 Million, hence the bonds will have a total price of $96.7 Million which
will increase to $100 Million on maturity. Hence there is a net capital gain for the given
bond unless the interest rates fall enough.
Capital Loss = (P1 – P0 / P0)*100
= 100 – 96.7 / 96.7 = 3.41%
Income component = Interest received over the course of the bond
= $96694040.29
5.) Based on the issue 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?
The market acceptable interest rate for a 100 year borrowing would be anywhere below
the coupon rate for the bond which is 10.25%.
Fall in the interest appreciates the value of the bond, hence in case of interest rates
falling, there will be higher demand for the bond. However, an all time low interest rate
would also mean that the bond prices would be at their highest points, hence the prices
are expected to only fall beyond one point as the interest rates can only go up from the
all-time low value.
6.) How these bond values are going to get affected by volatile FOREX rates? How
investors will protect themselves from this?
International bonds are usually issued to gain from lower interest rates. For a volatile
forex rates, the currency fluctuations can bring added instability to the bond values.
Currency risk arises when an investor holds a bond denominated in a currency other
than the domestic currency of the investor.
For example, a slide in the currency in which your bond is denominated will lead to
lower total returns, similarly a rise in the currency will boost the total returns. Investors
protect themselves from these fluctuations by hedging the currency risk by currency
forwards or current options. Currency forwards is basically a binding contract the locks
the exchange rate for the purchase or sale of a currency on a future date. Currency
options provide the buyer an option to buy or sell a specified currency at a specified
exchange rate on or before a specified date.
7.) Why RIL launched these bond in the international market denominating in USD? Is it
that Indian market was not matured enough or large enough to accommodate these
bonds?
The Indian market would have very few or no takers for such long bonds, leaving the
option to issue the bonds in the international market. Now while issuing bonds in the
international market US dollar is considered to the safest bet, as it is highly unlikely to
slide in value as against other currencies thereby providing protection from the currency
risk, at the same time bonds issued in USD would also ensure a higher number of
potential buyers.
8.) What if the 100 year RIL bonds were designed as ZCB?
The idea behind buying a 100 year bond is to ensure a steady return of money for a long
time. For a zero coupon bond, interest and the principal amount is paid only at the time
of maturity. Therefore a 100 year bond designed as ZCB would mean that the
bondholders would not receive any money for a period of 100 years. Such an investment
is essentially meaningless from point of view of the investors as they would have to
wait too long to receive any return from the bond.
Therefore, we can say that there would be no takers for a zero coupon bond if they have
such a long maturity period.
9.) How the price yield curve of RIL bonds are stated in exhibit 1 differ from each other?
The price yield curves for a long term bonds display a much higher sensitivity when
compared to the bonds with shorter maturity periods. Below are the yield curves plotted
for two of the bonds with maturity period of 20 years and one with 100 year.
20 Year Bond at 10.375% coupon rate
180000000
160000000
140000000
120000000
Axis Title
100000000
80000000
60000000
40000000
20000000
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Interest Rate
Series1 Series2
150000000
100000000
50000000
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Interest Rate
Series1 Series2
As can be observed the variability of the bond price is much higher for the long term
bond.
Refer Exhibit 1 for Price and Cash Flow Calculations
10.) Given historical interest rates (in exhibit 2) which of the RIL bonds would have given
better income and capital gain?
The interest rates have fallen gradually for the last 30 years from more than 15 percent
to less than 3 percent. The bonds having been issued in 1996-97 were apparently issued
in a higher interest environment. Therefore, if we assume that the interest rates would
remain stable on the lower side of the spectrum, we can say that the bond prices would
have appreciated maximum for the long term bonds. Therefore the 100 year bond would
give a better income and capital gain unless the interest rates get back up by the time
maturity approaches.
11.) What will be the change in price of the bonds shown in exhibit 1 if the interest rates
change up or down by 1 percent?
We can determine the change in the price of the bonds for a given interest rate level.
Below are the figures for each of the bonds issued for the interest rate of 5%.
12.) Which of the bonds in exhibit 1 will have the greatest price volatility, assuming that
each bond is trading to offer the YTM?
The long term bonds have higher volatility as any change in the interest rate has more
impact on distance cash flows than short term cash flows. Therefore out of the bonds
mentioned in exhibit 1, the 100 year bond will have maximum volatility. This can also
be observed for the changes in the price of the bond for 5% interest levels where the
maximum change can be observed for the 100 year bond.
Exhibit 1
Yield Curve Data for 20 year Bond (in $ Millions)
Cash
Year Flow 3% 4% 5% 6% 7% 8% 9%
1 10.38 10.07 9.98 9.88 9.79 9.70 9.61 9.52
2 10.38 9.78 9.59 9.41 9.23 9.06 8.89 8.73
3 10.38 9.49 9.22 8.96 8.71 8.47 8.24 8.01
4 10.38 9.22 8.87 8.54 8.22 7.92 7.63 7.35
5 10.38 8.95 8.53 8.13 7.75 7.40 7.06 6.74
6 10.38 8.69 8.20 7.74 7.31 6.91 6.54 6.19
7 10.38 8.44 7.88 7.37 6.90 6.46 6.05 5.68
8 10.38 8.19 7.58 7.02 6.51 6.04 5.61 5.21
9 10.38 7.95 7.29 6.69 6.14 5.64 5.19 4.78
10 10.38 7.72 7.01 6.37 5.79 5.27 4.81 4.38
11 10.38 7.50 6.74 6.07 5.47 4.93 4.45 4.02
12 10.38 7.28 6.48 5.78 5.16 4.61 4.12 3.69
13 10.38 7.06 6.23 5.50 4.86 4.31 3.81 3.38
14 10.38 6.86 5.99 5.24 4.59 4.02 3.53 3.10
15 10.38 6.66 5.76 4.99 4.33 3.76 3.27 2.85
16 10.38 6.47 5.54 4.75 4.08 3.51 3.03 2.61
17 10.38 6.28 5.33 4.53 3.85 3.28 2.80 2.40
18 10.38 6.09 5.12 4.31 3.63 3.07 2.60 2.20
19 10.38 5.92 4.92 4.11 3.43 2.87 2.40 2.02
20 10.38 5.74 4.74 3.91 3.23 2.68 2.23 1.85
Price 154.35% 141.00% 129.30% 119.00% 109.91% 101.86% 94.71%
10% 11% 12% 13% 14% 15% 16% 17% 18% 19% 20%
9.43 9.35 9.26 9.18 9.10 9.02 8.94 8.87 8.79 8.72 8.65
8.57 8.42 8.27 8.13 7.98 7.84 7.71 7.58 7.45 7.33 7.20
7.79 7.59 7.38 7.19 7.00 6.82 6.65 6.48 6.31 6.16 6.00
7.09 6.83 6.59 6.36 6.14 5.93 5.73 5.54 5.35 5.17 5.00
6.44 6.16 5.89 5.63 5.39 5.16 4.94 4.73 4.54 4.35 4.17
5.86 5.55 5.26 4.98 4.73 4.49 4.26 4.04 3.84 3.65 3.47
5.32 5.00 4.69 4.41 4.15 3.90 3.67 3.46 3.26 3.07 2.90
4.84 4.50 4.19 3.90 3.64 3.39 3.16 2.95 2.76 2.58 2.41
4.40 4.06 3.74 3.45 3.19 2.95 2.73 2.53 2.34 2.17 2.01
4.00 3.65 3.34 3.06 2.80 2.56 2.35 2.16 1.98 1.82 1.68
3.64 3.29 2.98 2.70 2.45 2.23 2.03 1.84 1.68 1.53 1.40
3.31 2.97 2.66 2.39 2.15 1.94 1.75 1.58 1.42 1.29 1.16
3.01 2.67 2.38 2.12 1.89 1.69 1.51 1.35 1.21 1.08 0.97
2.73 2.41 2.12 1.87 1.66 1.47 1.30 1.15 1.02 0.91 0.81
2.48 2.17 1.90 1.66 1.45 1.28 1.12 0.98 0.87 0.76 0.67
2.26 1.95 1.69 1.47 1.28 1.11 0.97 0.84 0.73 0.64 0.56
2.05 1.76 1.51 1.30 1.12 0.96 0.83 0.72 0.62 0.54 0.47
1.87 1.59 1.35 1.15 0.98 0.84 0.72 0.61 0.53 0.45 0.39
1.70 1.43 1.20 1.02 0.86 0.73 0.62 0.53 0.45 0.38 0.32
1.54 1.29 1.08 0.90 0.75 0.63 0.53 0.45 0.38 0.32 0.27
88.33% 82.62% 77.50% 72.88% 68.71% 64.94% 61.51% 58.39% 55.53% 52.92% 50.52%