Corporate Finance II

Capital Index Bonds

Masala Bonds
Negative Coupon Bonds
Triple Option Convertible Debentures
Commercial Papers
Credit Default Swaps

A Presentation By:
Tushar Agarwal (A036)
Varun Jain (A037)
Vibhor Shah (A038)
Yash Agarwal (A039)

Indexed linked bonds

Inflation indexed bonds (IIBs)- a financial instrument which can act as
a hedge against inflation. IIBs are highly potent instruments which
can provide a stable investment return in a rising inflation scenario
They are thus designed to cut out the inflation risk of an investment.
The first known inflation-indexed bond was issued by the
Massachusetts Bay Companyin 1780.
In India, Capital Index Bond was issued in 1993
In the year 2013-14 the Government of India raised around
Rs.579000 cr. through the issues of IIBs

Features of IIBs
fixed real coupon rate and a nominal principal value that is
adjusted for inflation. This rate is determined by the
auctions in the primary market.
Periodic coupon payments are paid on adjusted principal
Half yearly payment of coupon
On maturity, the adjusted principal or the face value,
whichever is higher, is paid to the investors.

 Individual investors can invest from Rs.10,000 to Rs.2 crore.

There are no tax concessions for investing in these bonds.
Presumably, tax will be deducted at source on these
investments. This might be a disadvantage for the investors
These instruments can be used for SLR compliances of banks
with RBI.
The FIIs investing in IIBs are subject to a cap of 25 billion $

IIBs IN INDIA
The RBI is issuing inflation indexed bonds which are linked with
WPI
The invested principal is adjusted as per the prevailing WPI rates
and a fixed interest rate is paid on the adjusted principal.
Adjusted principal = [(inflation index at a given point of time)
divided by (inflation index at the time of deposit)] multiplied by
(principal amount)
Interest being paid = Adjusted principal multiplied by coupon
rate

Example
Consider the following example, in which the initial
investment (in 2004-05) is Rs 10,000, historic WPI data is
from 2004-2005 (taken as 100) and the coupon rate is
assumed at 3 per cent.

Adjuste
d
Coupon Interest
Year
WPI
principa rate
paid
l
3 per
2005-06 104.47 10,447
313.41
cent
3 per
2006-07 111.35 11,135
334.05
cent
3 per
2007-08 116.63 11,663
349.89
cent
3 per
2009-09 126.02 12,602
378.06
cent
3 per
2009-10 130.81 13,081
392.43
cent
3 per
2010-11 143.32 14,332
429.96
cent
3 per
2011-12 156.13 15,613
468.39
cent
Assuming a maturity period of 8 years; total
interest payment = Rs 2,666.19; adjusted
principal at maturity = Rs 15,613;total
amount received on maturity = Rs

Masala Bonds
Masala bond refers to a bond through which Indian entities can raise money from
foreign markets in rupee, and not in foreign currency.
Raised only in overseas market
Always issued by the international financial corporation (IFC)
Bonds are raised in Indian rupees but the settlement in US dollar, Us dollar being
dominant currency .
IFC plays a key role in conversation and settlement
1st bond to to be issued at London stock exchange , which is an overseas market
Hdfc was the first bank to take advantage of Masala Bonds.

Benefits to Corporates
Low interest rates
Not subject to forex fluctuation risks
Access to wide investor base
Helps in diversification of portfolio

Benefits to Investors
Higher interest rates than dollar denominated bonds
Allows betting on forex fluctuations
Credible option owing to the backing of IFC

Example : HDFC
HDFC raised 1st Masala Bond
Coupon rate 8.33%
Maturing in 37 months
HDFC originally issued Rs 2,000 crore of bonds, with an intention of retaining Rs 1,000 cr. of
over-subscription.
The final order book was Rs 8,673 cr. from 48 accounts, which is 2.9 times of the amount,
including the over allotment option. Of the bonds, 86 per cent was taken by Asian investors,
while the remainder was claimed by European ones.
Institutional investors made up 82 per cent of allocations and private banks 18 per cent, HDFC
said in a statement.
Credit Suisse,NomuraandAxis Bankacted as the joint book-runners and lead managers for
the issuance, which was listed on the London Stock Exchange.

Negative Coupon Bonds

The negative-coupon concept violates a long-held economic presumption that
interest rates cannot go below 0 percent.
Mostly issued in countries going through deflationary phase or yields go below
0%
People are willing to pay coupons just to hold the bonds which are supposed to
be very safe.
The euro-zones inflation is currently -0.3 percent. The most recent release
shows inflation at -0.1 percent in the United States.
The core reason rational investors accept built-in negative returns on their
capital is because they believe deflationary forces will accelerate moving
forward, and interest rates will become even more negative.

Negative Coupon Bonds

Buyers of a bond with a negative yield can profit if rates fall
further, the bond appreciates and they can sell before maturity.
Japan has made around 52bn yen ($464 million) from negative
coupon bonds from 2014. Prices of securities are so high that
Ministry of finance sells them for more than it costs to pay
interest.
Germany recently issued 10yr Bonds with negative yield of
-0.05% because yield were down in the last couple weeks
below 0%.

Commercial Papers
Short Term Debt Instrument / Money Market
Entered Indian markets in 1990 on the back of LPG reforms.
Issuers Corporates, PDs and FIs
Interest rates on CPs are considerably lower than the
traditional forms of working capital borrowings like bank
credit
Maturity Period: Minimum 7days
Maximum 1 year
This helps to match expected cash inflows

 Issued in multiples of Rs. 5 lakh or multiples thereof.

The CP amount should be raised within 2 weeks from the date of
issue.
CPs can be held either in the form of promissory notes or in
dematerialized form. Banks, FIs and PDs can hold CP only in
dematerialized form.
Issued at a discount to the face value and redeemed at the face
value, difference being the interest earned.
Mandatory to obtain a credit rating (Minimum P2 on CRISIL)

Commercial Papers
Issuers Of CP

Leasing & Finance Cos.

(70%)

Manufacturing Cos.
(15%)

Financial
Institutions
(15%)

* Market Share in Commercial Paper markets during

the decade 2000-01 to 2010-11

Credit Default Swaps (CDS)

A type of credit derivative
Invented by Blythe Masters from JP Morgan in 1994
Designed to transfer the exposure of risk of fixed income products to a
third party
There are minimum 3 parties involved in a CDS:
1.) Debt Security Issuer
2.) Debt Security Subscriber/ CDS Buyer
3.) CDS Seller
The CDS buyer makes premium payments to CDS seller up to the date of
maturity of the bond.

Credit Default Swaps (CDS)

In return, the seller agrees to insure the CDS buyers risk against
the default of debt security issuer.
CDS is generally taken out against municipal bonds, emerging
market bonds, mortgage backed securities and corporate bonds.
CDS draw their backing from the fact that the debt issuer has no
way of guaranteeing sound financial position at the time of the
maturity.
CDS are also traded in the secondary market but are
unregulated i.e. traded OTC.

Triple Option Convertible

Debentures
Issued only by Reliance Petroleum Limited(RPL) in 1993 to
finance a project worth Rs 51.3 billion
Was rated BB+ (safe to invest) when it was issued and had a
FV of Rs 60.
Payment of Rs 40 after allotment was spread over 36 months
The FV was split into 3 parts
No interest paid to holders till the 5th year or after

 Instead 2 options given to holders in Sep 1997 which were as

follows
Option 1 - Keep NCDs and sell warrants
Option 2 Surrender NCDs and warrants for conversion to 2 equity
shares

NCDs would be partly redeemed in the 6th, 7th and 8th year of issue.

Resulted in an annualised yield of above 14%