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Recap of last session

Pattern of expansion funding in India

Why FS in India is gaining momentum

Need of financial markets

Definitions and examples of

Financial Institutions

Financial Markets

Financial Instruments

Financial Services

Business model / performance measures of

Bank

NBFC

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Functions of Financial System

Commercial banks

PSU, Foreign, Private banks included

Insurance

LIC, GIC and 24 other private insurance

companies

Financial institutions

IFCI, ICICI, IDBI, State finance

corporations, EXIM, Nabard, IDFC, NHB

etc

Mutual Funds

ICICI Pru, Reliance, DSP blackrock,

Tempelton, Sahara etc

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Functions of Financial System

NBFC

HDFC, Sundaram, Kotak Mahindra, ILF&S

NBFS

CDSL, NSDL, CRISIL, CARE, ICRA

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Nature of Claim Debt Market Equity Market

Maturity of Claim Money Market Capital Market

Seasoning of Claim Primary Market Secondary Market

Timing of delivery Cash or spot Market Forward/ future Markets

OrganisationStructure

Over the counter market Exchange Trade Market

Classification of Markets (If you understand this chart, you will be a finance wiz.)

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From 35,000 ft to ground level

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Who can raise funds?

Private corporates

Domestic

International

Government

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Foreign (II)

Fund

Raising

Rights Private

PlacementPublic

Initial Public Offering

(a)Further PublicOffering

Fresh

Issue

Offer for

Sale

Fresh

Issue

Offer for

Sale

Qualified Institutional Placement

(Listed Companies)

Preferential Issue

(Listed Companies)

Private Placement

(Unlisted Companies)

Preference

Shares

Term Loans

Debenture/ Bonds

Convertible Bonds

Convertible Pref Shares

Domestic (I)

Debt (B)Shares (A) Quasi (C)

Equity shares

(1)

Warrant (1)

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Foreign (II)

Fund

Raising

Rights Private

PlacementPublic

Initial Public Offering

(a)Further PublicOffering

Fresh

Issue

Offer for

Sale

Fresh

Issue

Offer for

Sale

Qualified Institutional Placement

(Listed Companies)

Preferential Issue

(Listed Companies)

Private Placement

(Unlisted Companies)

Preference

Shares

Term Loans

Debenture/ Bonds

Convertible Bonds

Convertible Pref Shares

Domestic (I)

Debt (B)Shares (A) Quasi (C)

Equity shares

(1)

Warrant (1)

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External Capital - Debt

Debt instruments, also called fixed income instruments, are contracts containing

a promise to pay a future stream of cash to the investors who hold the

contracts.

The debt contract can be negotiable, a feature specified in the contract that

permits its sale to another investor, or nonnegotiable, which prohibits sale to

another party.

A debt contract also establishes:

The financial requirements and restriction that the borrower must meet.

The rights of the holder of the debt instruments if the borrower defaults

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Based on Participants

Wholesale

comprising of investors like Banks,financial institutions, RBI, insurance

companies, Mutual funds, corporates

and FIIs

Outright sale/purchase OR a Repo

trade

Direct 25%, brokers 75%

Instruments issued by Centralgovernment in India account for close

to 90% of the trading volumes while

those issues by State governments

account for 3-4% of the trading

Retail

comprising of investors like individuals,

pension funds, private trusts, NBFCs

and other legal entities.

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Based on Issuer

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Debentures and Bonds

Sita aur Geeta

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How does the trading and mathematics of bonds

happen?

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Bonds

Bonds are tradable fixed income securities

Lingo used in real market: 8% coupon, Maturity March 2018, FV of

100, available at 10% ytm at Rs 85 Clean price and Rs 88 dirty

price

This bond is good, the Macaulay Duration is 8 years!

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Understanding basics of Bonds

Coupon Yield

Stated interest payment made on the bond .

If depicted in Rs is Coupon and as % of face

value called Coupon rate

Maturity

The specified date on which the principal

amount of the bond is paid

Face value

Principal amount that is promised to be paid

post the tenure of the bond, also called Par

value

Yield to Maturity

The required rate in the market on a

bond . Mathematics in next few slides

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Understanding basics of Bonds

Current Yield

It is not same as YTM, but simply Coupon /

current market price of bond

Indenture

Written agreement between the

corporation and its creditors. Also called

deed of trust. Lenders appoint a trustee

Premium Bond

When Interest falls and the market price

of bond is higher than the face vale of the

bond, it is called premium bond

Other terms

Seniority

Sinking fund Trustee, early redemption

Call make whole bond NPV of FCF

Put

Covenants Controls with lenders

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Understanding basics of Bonds

Clean Price

After netting accrued interest. If the trade

happens in between dates of coupon exercise

Dirty Price

Before netting accrued interest. If the trade

happens in between dates of coupon exercise

Macaulay Duration

Time taken to recover initial investment i.e.

payback period

Modified duration

Time change in Macaulay for every 1%

change in yield

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Mathematics of Bonds

Bond price is philosophically

YTM that you desire (closer to the current interest)

Discounting factor

NPV of future cash flows with 0 Terminal value

How to compute YTM

Trial and error to find r

Use excel

Yield (settlement, maturity, rate, price, redemption, frequency, basis)

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Typical Bond certificate

Trustee : The Western India Trustee

Rights of default : Trustee/ SEBI

Registered: Yes

Denomination : Rs 5000

Amount issued : Rs 350 Crores with green shoe options

Issue Date : 26th March 2005

Offered: At par

Coupon: 5.8% payable on March 1st

Seniority: Ranks Pari Passu with unsecured Debt

Maturity: 5 years from date of issue

Debenture redemption reserve: Not required Callable: No

Puttable: No

Rating : ICRA LAAA

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Types of Bonds

Deep discount / Zero coupon

Do not carry coupon rate. Issued at steep

discount over face value.

IDBI issued deep discount bond in 1996 with

face value of Rs 2 lakhs at 5300- 25 years .

Helps in saving in between cash flows.

However, balloon payments may make it risky

Commodity linked

Payoff= F( selective commodities). 1886

standard Oil corp has issued. Protects

sellers of commodities and users of

commodities . The payout was say USD

1000+ 25*( Price of Oil -10)

Floating rates

Interest linked to benchmark rate like T bills.

In 1993, SBI came with 1st such bond.

Protects against inflation risk, makes it less

volatile especially for borrowers whose

profits are linked to interest

Embedded valueConvertible

Callable

Puttable

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Types of Bonds

Extendable notes

Short term, giving an option of redeeming or

renewing at maturity at prevailing rates.

Reduces cost of transactions and issues

Inverse floaters

14% - Libor. Very high sensitive to

interest rates fluctuations

Structured notes (hera Pheri)

Debt obligation that is derived from another

debt instrument. US treasury bought 30 years

non cancelable bonds, stripped them to create

series of zero coupon bond. The 1st zero was

backed with interest payment schedules.

Securatised debt instruments also is part of

the same

Junk Bondshigh yield bondsLower rating and give

4% higher interest or so . India has

made it official since 2007

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Types of Bonds

Floaters

Floating rate coupon, based on T

benchmarking

Cat Bond

Protection against terrorism! FIFA 2006

Perpetual Bonds tier 1

As the name suggests, these are bonds which do

not have any maturity date and are hence

perpetual. Since they are never redeemed, such

debt instruments give the issuers the comfort that

equity capital offers in their capital base. Hence

treated as equity by issuers, particularly the banks

Diaspora bonds

Sovereign debt instrument to raise financing from a

countrys overseas diaspora. Israel and India have

raised $35-40 billion with diaspora bonds.

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Innovation at work

GDP index bonds : A GDP-indexed bond is a sovereign bond whose

interest rate and/or repayments vary with a countrys rate of economic

growth.

Global Emerging Markets Local Currency Bond Program (GEMLOC) :

GEMLOC is a US$ 5 billion local currency bond for investment in up to 40

emerging bond markets.23, launched in October 2007 by the World Bank

Group together with private partners.

Lottery Bond Interest is not cash but lottery

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Innovation at work

Motorolas LYON Bonds : 20 year, Zero coupon, callable , puttable and convertible! (can

it be more simpler!!)

Death Spiral Bond: Convertible Debt, when bondholder can convert into fixed value of

shares not quantity

Asset backed- Small loans packaged together also calledPass through certificates

Reverse floaters- Adjustable rates based on market interests

Pay in Kind- Interest in form of bonds and not cash

Rate sensitive bond- Coupon changes with credit rating

Longetivity bonds Bonds whose payments are linked to the proportion of population

surviving