Analysis of Fixed and Floating Interest Rates

Analysis of Fixed and Floating Interest Rates For Bonds of Power Grid Corporation of India Limited

Madhusudan Partani 91029

PGDM- 2009-11 FORE School of Management

New Delhi

Mr. Nalin Jain Professor, Marketing

FORE School of Management

Mr. K.C. Pant CM- Finance (Bonds)

Power Grid Corporation of India Limited

Under the Guidance of

Mr. Vinay Dutta Area Chair Person, Finance

FORE School of Management

Analysis of Fixed and Floating Interest Rates 2010

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Table of Contents Acknowledgement .................................................................................................................................. 5

Chapter I Introduction

Introduction .......................................................................................................................................... 11

Objectives ............................................................................................................................................. 12

Purpose of Study ................................................................................................................................... 13

Scope ..................................................................................................................................................... 14

Data ....................................................................................................................................................... 15

Review of Literature .............................................................................................................................. 16

Introduction .......................................................................................................................................... 19

Developments in Government Bond Market .................................................................................... 19

Corporate Bond Market .................................................................................................................... 20

Development of Equity Market vs. the Debt Market ....................................................................... 22

Chapter II Financial Statetement Analysis

Balance Sheet Analysis .......................................................................................................................... 26

Capital Composition .......................................................................................................................... 26

Sources and Application of Funds ..................................................................................................... 28

Share Capital ................................................................................................................................. 30

Share Holding Pattern ................................................................................................................... 30

Brief note on Initial Public Offering .............................................................................................. 32

Reserves ........................................................................................................................................ 33

Secured Loans ............................................................................................................................... 33

Unsecured Loans ........................................................................................................................... 35

Current Liability ............................................................................................................................. 36

Fixed Assets ................................................................................................................................... 37

Investments ................................................................................................................................... 38

Current Assets ............................................................................................................................... 39

Profit and Loss Analysis ......................................................................................................................... 40

Sales/ Operating Income ............................................................................................................... 41

Profits ............................................................................................................................................ 42

Dividends ....................................................................................................................................... 42

Cash Flow Analysis ................................................................................................................................ 44

Ratio Analysis ........................................................................................................................................ 47

Liquidity Ratio ................................................................................................................................... 47


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Current Ratio ................................................................................................................................. 47

Quick Ratio .................................................................................................................................... 48

Profitability Ratio .............................................................................................................................. 49

Operating Profit Margin (PBIDTM) ............................................................................................... 49

Net Profit Margin .......................................................................................................................... 50

Cash Profit Margin ........................................................................................................................ 50

Return on Capital Employed ......................................................................................................... 51

Return on Net Worth .................................................................................................................... 51

EPS ................................................................................................................................................. 52

Solvency Ratios ................................................................................................................................. 53

Debt- Equity Ratio ......................................................................................................................... 53

Intrest Coverage Ratio .................................................................................................................. 54

Activity Ratios ................................................................................................................................... 54

Receivables Turnover Ratio .......................................................................................................... 55

Inventory Turnover Ratio .............................................................................................................. 55

Fixed Asset Turnover Ratio ........................................................................................................... 55

Capital Market Behaviour ................................................................................................................. 56

P/E Multiple .................................................................................................................................. 56

Beta ............................................................................................................................................... 57

Chapter III Procedures in Bond Raising

Steps in Issuing Bonds ........................................................................................................................... 60

Dematerialization Process .................................................................................................................... 68

Listing Process ....................................................................................................................................... 70

Debt Servicing ....................................................................................................................................... 72

Chapter IV Characterstics of Bonds

Yield or IRR ............................................................................................................................................ 78

Current Yield ................................................................................................................................. 78

Yield to Maturity ........................................................................................................................... 78

Annualised Yield ............................................................................................................................ 78

Yield to Call / Put ........................................................................................................................... 79

Price- Yield Relationship ................................................................................................................... 79

Duration ................................................................................................................................................ 80

Macaulay’s Duration ..................................................................................................................... 80

Modified Duration ......................................................................................................................... 80


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Convexity ............................................................................................................................................... 81

Yield of PSU and GSec Bonds ................................................................................................................ 82

Duration of PSU and GSec Bonds .......................................................................................................... 90

Convexity of PSU and GSec Bonds ........................................................................................................ 95

Chapter V Analysis of Fixed and Floating Interest Rates

Introduction ........................................................................................................................................ 100

Fixed Intrest Rate ............................................................................................................................ 100

Floating Intrest Rate ........................................................................................................................ 102

Indian Issuers going for FRBs .......................................................................................................... 104

GOI Floating Rate Bonds ............................................................................................................. 104

Indian Railway Finance Corporation Limited (IRFCL) .................................................................. 105

Power Finance Corporation Limited, .......................................................................................... 105

ICICI Bank .................................................................................................................................... 106

Others ......................................................................................................................................... 106

The Debt Servicing for PGCIL’s Bonds ................................................................................................. 107

Floating Intrest for PGCIL’s Bonds....................................................................................................... 109

Assumptions .................................................................................................................................... 109

Selection of Bonds .......................................................................................................................... 109

Selection of Reference Rate ............................................................................................................ 110

Reset Period and Reference Period ................................................................................................ 113

Spread ............................................................................................................................................. 113

Floating Rate under Reference Rate of Average yield of 1 Year GSec ............................................ 114

Bond VIII ...................................................................................................................................... 114

Bond IX ........................................................................................................................................ 116

Bond X ......................................................................................................................................... 118

Bond XIII- Opt II ........................................................................................................................... 120

Bond XIV ...................................................................................................................................... 122

Floating Rate under Reference Rate of Average yield of 10 year GSec .......................................... 124

Bond VIII ...................................................................................................................................... 124

Bond IX ........................................................................................................................................ 125

Bond X ......................................................................................................................................... 127

Bond XIII- Opt-II ........................................................................................................................... 129

Bond XIV ...................................................................................................................................... 130

Floating Rate under Reference Rate of Average yield of 10 year GSec .......................................... 132


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Floating Rate under Reference Rate of Average yield of 10 year GSec- Average Spread of last 12

months ............................................................................................................................................ 135

Summary of Each Base Rate ........................................................................................................... 135

Factors Effecting The Selection Of Each Method ............................................................................ 137

Term ............................................................................................................................................ 137

Coupon Rate ................................................................................................................................ 137

Market Condition ........................................................................................................................ 138

Quantum of Loan ........................................................................................................................ 139

Repayment Structure .................................................................................................................. 139

Time of Issue ............................................................................................................................... 140

Chapter VI Findings and Recommendations

Critical Analysis of Alternatives ........................................................................................................... 142

Fixed Coupon Interest Rate ............................................................................................................ 142

Floating Rate ................................................................................................................................... 142

Fixed Coupon Rate with Option ...................................................................................................... 144

Recommendation ................................................................................................................................ 145

References .......................................................................................................................................... 146


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Table of Figures and Charts

FIGURE 1 TREND OF AVERAGE TRADE SIZE - WDM ......................................................................................................... 23

FIGURE 2 CAPITAL COMPOSITION FROM 1996 TO 2009 ................................................................................................... 27

FIGURE 3 SOURCES OF FUNDS- 2008-09 ....................................................................................................................... 28

FIGURE 4 APPLICATIONS OF FUNDS- 2008-09 ................................................................................................................ 29

FIGURE 5 TREND IN SHARE CAPITAL .............................................................................................................................. 30

FIGURE 6 SHARE HOLDING PATTERN AS ON 31ST DEC 2009 ............................................................................................. 31

FIGURE 7 SHARE HOLDING PATTERN ............................................................................................................................. 31

FIGURE 8TREND IN RESERVES AND SURPLUS ................................................................................................................... 33

FIGURE 9 TREND IN NON CONVERTIBLE DEBENTURES ....................................................................................................... 33

FIGURE 10 TREND IN TERM LOANS INSTITUTIONS ............................................................................................................ 34

FIGURE 11 TREND IN TERM LOANS BANKS ..................................................................................................................... 34

FIGURE 12 TREND IN DEFERRED CREDIT ......................................................................................................................... 34

FIGURE 13 TREND IN UNSECURED LOANS ....................................................................................................................... 35

FIGURE 14 DEBT COMPOSITION FROM 2003 TO 2009..................................................................................................... 36

FIGURE 15 TREND IN CURRENT LIABILITY........................................................................................................................ 36

FIGURE 16 TREND IN FIXED ASSETS ............................................................................................................................... 37

FIGURE 17 TREND IN INVESTMENTS .............................................................................................................................. 38

FIGURE 18 COMPARISON OF FIXED ASSETS AND INVESTMENTS ........................................................................................... 38

FIGURE 19 TREND IN COMPOSITION OF CURRENT ASSETS ................................................................................................. 39

FIGURE 20 MULTI STEP ANALYSIS OF INCOME ................................................................................................................. 40

FIGURE 21 TREND IN INCOMES .................................................................................................................................... 41

FIGURE 22 TREND IN DIFFERENT PROFITS ....................................................................................................................... 42

FIGURE 23 DIVIDEND TREND ....................................................................................................................................... 42

FIGURE 24 PROFIT APPROPRIATIONS OVER THE YEARS ...................................................................................................... 43

FIGURE 25 LIQUIDITY RATIOS ....................................................................................................................................... 48

FIGURE 26 OPERATING PROFIT MARGINS ...................................................................................................................... 50

FIGURE 27 NET PROFIT MARGINS................................................................................................................................. 51

FIGURE 28 EPS TREND ............................................................................................................................................... 52

FIGURE 29 DEBT EQUITY RATIO ................................................................................................................................... 53

FIGURE 30 INTEREST COVER RATIO ............................................................................................................................... 54

FIGURE 31 P/E RATIO ................................................................................................................................................ 57

FIGURE 32 RESIDUAL PLOT FOR BETA ............................................................................................................................ 58

FIGURE 33 YIELD CURVE OF PGXXX ............................................................................................................................. 88

FIGURE 34 YIELD CURVE OF GSEC 8.20% ...................................................................................................................... 88

FIGURE 35 YIELD CURVE OF PFC (S-57) ........................................................................................................................ 89

FIGURE 36 MODIFIED VS MACAULAY'S DURATION .......................................................................................................... 93

FIGURE 37 DURATION VS MATURITY ............................................................................................................................ 93

FIGURE 38 DURATION VS YIELD ................................................................................................................................... 94

FIGURE 39 DURATION VS CONVEXITY ............................................................................................................................ 97

FIGURE 40 COUPON RATE VS CONVEXITY (SAME MATURITY) ............................................................................................ 98

FIGURE 41 COUPON RATE VS CONVEXITY (SAME DURATION) ............................................................................................ 98

FIGURE 42 COUPON RATE OF PG VS GSEC RATE ........................................................................................................... 108

FIGURE 43 COUPON RATE OF PG VS AVG GSEC YIELD ................................................................................................... 108

FIGURE 44 TREND OF 10 YR GSEC YIELD ..................................................................................................................... 111

FIGURE 45 TREND OF 1YR GSEC YIELD ........................................................................................................................ 111

FIGURE 46 TREND OF COUPON RATES OF PG BONDS ..................................................................................................... 112


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FIGURE 47 RATES OF PG BONDS VS 1 YR GSEC YIELD .................................................................................................... 112

FIGURE 48 INTREST PAYMENTS UNDER FIXED AND FLOATING RATE FOR PGVIII FOR 1 YEAR GSEC AS REFERENCE RATE .............. 116

FIGURE 49 INTEREST PAYMENT UNDER FIXED AND FLOATING RATES FOR PGIX FOR 1 YEAR GSEC AS REFERENCE RATE ............... 118

FIGURE 50 INTEREST PAYMENT UNDER FIXED AND FLOATING RATES FOR PGX FOR 1 YEAR GSEC AS REFERENCE RATE ................ 120

FIGURE 51 INTEREST PAYMENTS UNDER FIXED AND FLOATING RATES FOR PGXIII FOR 1 YEAR GSEC AS REFERENCE RATE............ 121

FIGURE 52 INTEREST PAYMENTS UNDER FIXED AND FLOATING RATE FOR PGXIV FOR 1 YEAR GSEC AS REFERENCE RATE ............. 123

FIGURE 53 INTEREST PAYMENTS UNDER FIXED AND FLOATING RATE FOR PGIX FOR 10 YEAR GSEC AS REFERENCE RATE ............. 127

FIGURE 54 INTREST PAYMENTS UNDER FIXED AND FLOATING RATES FOR ALL BONDS FOR 10 YEAR GSEC AS BASE RATE ............. 134

FIGURE 55 COMPARISON OF FIXED AND FLOATING IN CASE OF ADVERSE MARKET CONDITIONS ............................................... 139


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Table of Tables

TABLE 1 CAPITAL COMPOSITION FROM 1996 TO 2009 .................................................................................................... 27

TABLE 2 SHARE HOLDING PATTERN FROM 2007 TO 2009 ................................................................................................ 31

TABLE 3 TOP 10 SHARE HOLDERS AS ON 29.01.2009 ..................................................................................................... 32

TABLE 4 CASH FLOW STATEMENT ................................................................................................................................. 45

TABLE 5 LIQUIDITY RATIOS .......................................................................................................................................... 48

TABLE 6 OPERATING PROFIT MARGINS .......................................................................................................................... 49

TABLE 7 NET PROFIT MARGINS .................................................................................................................................... 51

TABLE 8 RETURNS ...................................................................................................................................................... 52

TABLE 9 TURNOVER RATIOS ......................................................................................................................................... 56

TABLE 10 REGRESSION OUTPUT ................................................................................................................................... 57

TABLE 11 LIST OF BONDS SELECTED FOR STUDY ............................................................................................................... 83

TABLE 12 YIELD TO MATURITY OF PG XXXI .................................................................................................................... 85

TABLE 13 COMPUTATION OF YIELD OF GSEC BOND.......................................................................................................... 85

TABLE 14 YTM AND CURRENT YIELD OF ALL BONDS ........................................................................................................ 86

TABLE 15 MODIFIED AND MACAULAY'S DURATION OF PGXXXI ......................................................................................... 91

TABLE 16 MODIFIED AND MACAULAY'S DURATION OF GSEC ............................................................................................. 91

TABLE 17 MACAULAY'S AND MODIFIED DURATION OF ALL BONDS ..................................................................................... 92

TABLE 18 CONVEXITY OF PGXXXI ................................................................................................................................ 96

TABLE 19 CONVEXITY OF ALL BONDS............................................................................................................................. 97

TABLE 20 FRBS BY GOI ............................................................................................................................................ 105

TABLE 21 FRBS BY IRFC ........................................................................................................................................... 105

TABLE 22 FRBS BY PFC ............................................................................................................................................ 106

TABLE 23 FRBS BY ICICI BANK .................................................................................................................................. 106

TABLE 24 FRBS BY OTHERS ....................................................................................................................................... 106

TABLE 25 LIST OF BONDS SELECTED FOR ANALYSIS ......................................................................................................... 109

TABLE 26 DETERMINATION OF SPREAD FOR PGVIII FOR 1 YEAR GSEC AS REFERENCE RATE ................................................... 114

TABLE 27 FLOATING RATES FOR PGVIII FOR 1 YEAR GSEC AS REFERENCE RATE ................................................................... 115

TABLE 28 INTREST UNDER FIXED AND FLOATING RATES FOR PGVIII FOR 1 YEAR GSEC AS REFERENCE RATE .............................. 115

TABLE 29 CALCULATION OF SPREAD FOR PGIX FOR 1 YEAR GSEC AS REFERENCE RATE ......................................................... 116

TABLE 30 FLOATING RATES FOR PGIX FOR 1 YEAR GSEC AS REFERENCE RATE ..................................................................... 117

TABLE 31 INTEREST UNDER FIXED AND FLOATING RATES FOR PGIX FOR 1 YEAR GSEC AS REFERENCE RATE ............................... 117

TABLE 32 CALCULATION OF SPREAD FOR PGX FOR 1 YEAR GSEC AS REFERENCE RATE .......................................................... 119

TABLE 33 FLOATING RATES FOR PGX FOR 1 YEAR GSEC AS REFERENCE RATE ...................................................................... 119

TABLE 34 INTEREST UNDER FIXED AND FLOATING RATE FOR PGX FOR 1 YEAR GSEC AS REFERENCE RATE .................................. 119

TABLE 35 CALCULATION OF SPREAD FOR PGXIII FOR 1 YEAR GSEC AS REFERENCE RATE ....................................................... 121

TABLE 36 FLOATING RATES FOR PGXIII FOR 1 YEAR GSEC AS REFERENCE RATE ................................................................... 121

TABLE 37 INTEREST UNDER FIXED AND FLOATING RATES FOR PGXIII FOR 1 YEAR GSEC AS REFERENCE RATE ............................ 121

TABLE 38 CALCULATION OF SPREAD FOR PGXIV FOR 1 YEAR GSEC AS REFERENCE RATE ....................................................... 122

TABLE 39 FLOATING RATES FOR PGXIV FOR 1 YEAR GSEC AS REFERENCE RATE ................................................................... 122

TABLE 40 INTERESTS UNDER FIXED AND FLOATING RATES FOR PGXIV FOR 1 YEAR GSEC AS REFERENCE RATE ........................... 123

TABLE 41 FLOATING RATES FOR PGVIII FOR 10 YEAR GSEC ............................................................................................ 125

TABLE 42 INTERESTS UNDER FIXED AND FLOATING FOR PGVIII FOR 10 YEAR GSEC .............................................................. 125

TABLE 43 CALCULATION OF SPREAD FOR PGX FOR 10 YEAR GSEC AS REFERENCE RATE ........................................................ 126

TABLE 44 FLOATING RATES FOR PGIX FOR 10 YEAR GSEC AS REFERENCE RATE ................................................................... 126

TABLE 45 INTERESTS UNDER FIXED AND FLOATING FOR PGIX FOR 10 YEAR GSEC ................................................................ 127

TABLE 46 TOTAL INTREST UNDER FIXED AND FLOATING RATES FOR ALL BONDS UNDER 10 YEAR GSEC AS BASE RATE ................ 132


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TABLE 47 SUMMARY OF COSTS UNDER 1 YEAR GSEC AS BASE RATE .................................................................................. 135

TABLE 48 SUMMARY OF COSTS UNDER 10 YEAR GSEC AS BASE RATE ( COUPON PERIOD) ..................................................... 135

TABLE 49 SUMMARY OF COSTS UNDER 10 YEAR GSEC AS BASE RATE ( INTEREST PAYMENT PERIOD)....................................... 136


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Acknowledgement

The satisfaction and joy that accompanies the successful completion of a task is incomplete without

mentioning the names of those who extended their help and support in making it a success.

The Project Titled “Analysis of Fixed and Floating Rates of Bonds of Power Grid Corporation of India

Limited “has not been a success without the priceless support and assistance of Mr. K.C. Pant (Chief

Manager Finance-Bonds, Power Grid Corporation of India Limited), Mr. Sandesh Nagrare (Chief

Accountant- Bonds, Power Grid Corporation of India Limited) and Mr. S.V. Venkat (Chief Manager,

Finance-Bonds, Power Grid Corporation of India Limited).

I am greatly indebted to Prof. Vinay Dutta (Chairperson, Finance, FORE School of Management),

Prof. Kanhaiya Singh (Sr. Faculty, Finance, FORE School of Management) and Prof. Himanshu Joshi

(Faculty, Finance, FORE School of Management) for their invaluable guidance and direction provided

to me in the course of the study.

A special word of thanks to Prof. Nalin Jain (Faculty, Marketing, FORE School of Management), who

has been a constant support and guided me in the report.

I also wish to express my gratitude and gratefulness towards Mr. Ranjan Srivastav (AGM- Finance,

Power Grid Corporation of India Limited), Mr. V.C. Jagannathan (Executive Director-Finance, Power

Grid Corporation of India Limited) and also Mr. Venkat Krishna (Vice President, ICICI Securities

Primary Dealership Ltd)

Date: 12 May 2010

Place: New Delhi

Madhusudan Partani


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Chapter I

INTRODUCTION

Introduction

Purpose of Study

Objectives

Scope

Data

Review of Literature

Introduction to Bond Market


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Introduction

The project done with the Power Grid Corporation of India Limited in their Finance department,

Bonds Section, is a study on Cost and Benefit analysis of Fixed and Floating rate bonds. Intrest

payment under both the methods is computed for bonds with different characteristics (Maturity,

Coupon rate and Amount). Recommendation has been made on suitability of each method under

different conditions.

Also the Valuation and Convexity measures like Duration, Yield, Convexity have also been computed

for all the Bonds issued by Power Grid Corporation of India Limited and also few GSec Bonds and

other corporation bonds.

Also The Securities Exchange Board of India (SEBI), the regulator of Capital Markets, has made wide

array of policies and guidelines with respect to issue of bonds. Thus it is per se necessary to study

the procedural aspects of issuing bonds, the legal aspects and also the provisions and guidelines. The

scope of the study is extended to Debt-Servicing Process, listing process and dematerialisation

process. And Analysis of Financial statements using different tools like Horizontal analysis of Income

and Position Statement, Cash Flow Analysis, Ratio Analysis has been done.

Apart from the above mentioned aspects, the behaviour of GSec Yields, Comparison of interest rates

on bonds issued by Power Grid Corporation of India Limited with the Government Yield has also

been done.


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Objectives The Objectives of study are as follows:

Comparison of Cost of each bond in case of present system of fixed coupon rate with

Floating Coupon rate. And to study the suitability of each method for different kinds of

bonds having different maturity, different coupon rate and different loan quantum.

To study the Characteristics in terms of Macaulay’s Duration, Convexity, and YTM; of each

bond issued by PGCIL and also to compare the same with other GSec Bonds and other

corporate bonds.

To study and understand the procedural aspects of issuing the bonds, their listing, debt

servicing and dematerialisation.

Financial Performance Analysis of Power Grid Corporation of India Limited using different

techniques like Ratio Analysis, Cash Flow Analysis, Balance sheet and Profit and Loss

Analysis.

The secondary Objectives will be:

To study the behaviour of yields on 10 Year and 1 Year GSec papers

To Understand the Power sector and the value chain of the industry.


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Purpose of Study

Bonds have become one of the important sources for long term funds in the present scenario. The

central government, the state government, PSUs, Banks, and also Corporate issue bonds regularly to

raise long term funds. Along with the Primary Issues, the trading in Exchanges has also improved

rapidly. The average trade size has increase from Rs.6.64 Crores in 1994-95 to Rs.23.42 Crs in the

year 2009-10. Thus it is per se necessary to study the Bond market and also understand the growing

importance of Bonds as the source of long term finance.

It is by itself very indispensable to study the financial condition of the company, its financial strength

in terms of profitability, solvency, liquidity etc... To understand the company. Thus Financial

Statement Analysis has been done and study of Balance Sheet, profit and loss, Sources and

applications of funds, Cash flow analysis and also ratio analysis has been done.

As mentioned before, the Bonds have become one of the favoured preferences for the long term

funds. And Power Grid Corporation of India Limited issues Bonds periodically, thus to study the

Bonds and understand the mechanism, it was a necessity to understand the procedural aspects and

legal aspects of issuing the bonds. Thus a detailed study of each and every aspect of issue of bond

ranging from Approval, Listing, Dematerialisation, to Debt Servicing has been studied.

The bond market is not only flooded from supply side, but also there is a rapid growth on demand

side by many fresh players entering the market. The investors in Bonds include Banks, Insurance

companies, Mutual Funds, Provident Funds, Pension Funds and other such funds o different

companies. Thus it is necessary to study the characteristics of the bond and compute their Yields,

Duration, and Sensitivity by means of Convexity. And since there are different kinds of bonds issued

by different bodies, the comparison amongst them is also necessary.

The Power Grid Corporation of India Limited’s Debt structure has changed substantially over the

years. From 35% Unsecured Loans and 13% Secured loans in the total Capital Mix in the year 1996-

97, the composition has changed to 7% Unsecured and 58% Secured loans in the year 2009-10. And

of these 58%, approx 38% is comprised of Secured Bonds. As on 31st march 2010, the company has

Bonds outstanding worth Rs.21420.4 Crs and on these a total Intrest of Rs 1500 Crs is paid annually.

And the interest rate paid is fixed. In simple words the interest rate determined at the time of issue

is kept fixed throughout the tenure of the bond irrespective of the market condition. Alternatively

the company could even go for floating rate Bonds whose interest rate is floating i.e... Varies with

the market conditions. Thus a study has been done to compute the savings in cost under floating

rate mechanism. But since the regulations do not allow the company to take risk of fluctuations in

interest rates, and also in this competitive scenario, cost saving has became one of the most

important tool. Thus instead of floating rate, if the company issues the bonds at an appropriate and

at favourable time period, which lead to low coupon rate and ultimately cost savings has been also

studied.


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Scope

For the purpose of comparing the cost under fixed and floating Rate five bonds issued by Power Grid

Corporation of India Limited with different tenures, different repayment structure, different coupon

rates and different loan amounts were taken. And the Intrest on them under both the methods has

been computed from the date of issue to the latest Intrest payment has been computed taking

different spreads and different reference rates as per the Industry practices.

And for studying the duration, Yields and Sensitivity of the Bonds, all the Bonds issued by Power Grid

Corporation of India Limited and which are active are selected. Along with these Two GSec bonds

and bond series (S-57) issued by Power Finance Corporation has been selected.

For studying the procedural aspects, the steps of the issue, Dematerialisation, Rating, Listing etc

have been studied by referring to the process of issue of Power Grid Bonds XXX issued on 29th

September 2009.

And for the financial performance analysis, specific study has been done based on the financial

figures of the financial year 2008-09. The scope was not extended to the latest FY 2009-10 because

the audited results were not yet published till the preparation of this report. And for studying the

trend and growth, the figures of last 8 years starting from 2003 has been selected.


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Data

For the purpose of study the data has been collected from the Company’s Balance Sheets, The

details of Loans and Intrest payments schedules as provided from the internal records of the

company and also different correspondence letters, approval letters, legal documents as provided by

the company were used.

For historical yields on GSec Papers the data has been collected from Reuters Database1. And for

determining the spread for the purpose of deciding the floating rate, the data on spreads as

published by FIMMDA2 has been used. And also data published by RBI related to GSec and also the

Data from Indiastat has been used. For computing the Duration, Yields and Convexity, the present

value has been taken from the NSE websites WDM (Wholesale Debt Segment).

1 A premium Database which provides the data on Global Macro Economic Indicators

2 Fixed Income Money Market and Derivatives Association of India


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Review of Literature

For the purpose of understanding the concepts and having the thorough knowledge of Bonds and

also to have background knowledge of topics like Floating rate, to understand the valuation concepts

of bonds, the procedural aspects, different articles, papers, reports and other literature has been

studied. Some of the literature is:

WHAT PRACTITIONERS NEED TO KNOW.....? ABOUT DURATION AND CONVEXITY

Mark Kritzman, Windham Capital Management Financial Analysts Journal (Nov-Dec 1992)

The paper is on Duration and Convexity of Bonds. It has the concept of Macaulay’s Duration and the

author has explained why the time weighted PVs of future cash flows are to be considered instead of

just PVs. The author has also extended the scope of paper by discussing the property of Duration

that with constant YTM and Coupon Payments, the increase in Maturity will increase duration but

the rate of increase is lower.

Modified Duration, which measures sensitivity of price of bond to the changes in yield, does not

accurately predict the sensitivity for the larger changes in YTM. Thus he proposes to use Convexity as

measure of sensitivity. Convexity measures sensitivity of price of bond to the change in Duration.

Apart from the concept of Convexity and Duration, the author has also explained the application of

these measures in Portfolio management. How they can be used to leverage the price appreciation

in case of fall in rates by increasing the duration of the portfolio. Also how it can be used in hedging

the liabilities. The author has also shared how the portfolio can be immunized from interest rate

shifts by setting its duration equal to the investors’ holding g period.

In a nutshell, the paper introduces one to Duration and other valuation techniques and also it shows

the applicability of each. From this literature I am able to understand the concepts of Macaulay’s

Duration, Modified Duration, and Convexity and also their computation and inferences.

A “DURATION” FALLACY

Miles Livingston and John Caks The Journal of Finance (Vol XXXII No.1 March 1977)

As the title of the paper itself portrays that content is related to a fallacy in general opinion on

Duration. The authors wish to prove that duration is a function of the yield curve but the yield curve

is not the function of duration. Thus one cannot ‘correct the yield curve for the duration’ because

bonds with identical duration do not necessarily have identical yields. They have proved this by

comparing and analysing the two bonds of similar duration.

Also they have concluded that that if bonds with identical durations always have identical yields to

maturity, then the entire term structure of interest rates is determined by the first two rates; given


17

r1 and r2, we can calculate r3 and then (recursively) all subsequent forward rates. This result

contradicts experience and the theoretical work done on term structure.

‘POWER SECTOR IN INDIA’

WHITE PAPER ON IMPLEMENTATION CHALLENGES AND OPPORTUNITIES KPMG (Jan 2010)

It is an annual report on Power Sector published by KPMG. This paper throws light on Industry

overview, the value chain, and the different players in each business operation namely generation,

transmition and distribution. The paper also discusses the regulations in this sector which are paving

the way for private sector participation.

Also the challenges in this sector which needs to be tackled are also discussed. Some of the

prominent challenges are the Project Execution, The scarcity of fuel, Equipment shortage,

Manpower Shortage, problems in land acquisition and Environment clearance.

This paper helps in understanding the power sector in general, and its structure. And also the

challenges in that sector can be understood.

SEBI (DISCLOSURES AND INVESTORS PROTECTION) GUIDELINES, 2000

Securities Exchange Board of India, the sole regulator of Capital market in India, issues various

guidelines to regulate the capital market of the nation. The DIP Guidelines were issued for the

purpose of protecting investors from fraudulent practices by issuers and also to ensure maximum

disclosure.

It has guidelines with respect to Offer letter, its contents, the promoters share, lock-in period,

requirements for issuing IPOs, Guidelines on Advertising of issue, guidelines on Pricing of issue etc...

The copy of the above mentioned guidelines has many regulations which are not under purview of

my study. Thus only few aspects were studied. The review of them is as follows:

The objectives of these guidelines are:

i. Enhance level of protection of investors

ii. To increase transparency and efficiency of primary market

iii. To strengthen disclosure and eligibility norms of the issuer

iv. Rationalize and simplify operational procedures in primary market.

The guidelines on Book building process, Green Shoe Option, Disclosure requirement in the offer

document and guidelines pertaining to issue of Debentures were studied to have foreground

knowledge of various guidelines.


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INFORMATION MEMORANDUMS

Then Information Memorandum or Disclosure Document is similar to an invitation letter to the

investors, inviting them to invest in the issue. As per SEBI, this offer document must have all the

details as mentioned by it and which are important and material for investor. Thus it has the

company profile, the challenges and strengths, the financial history, latest financial data, share

holding pattern, details of previous issues of similar security etc... It also has the details of the issue,

the structure of issue, details on Open and close of issue, the details Arrangers, bankers, Registrar,

Trustee etc

By studying this document one can understand the company profile and its financial position in a

gist. Also every minute detail of a particular issue like the interest payment, the terms and

conditions, redemption details, listing details can be understood from this document.

For the purpose of understanding the issue structure and coupon rate determination, IMs of various

bonds of Power Grid Corporation of India Limited have been studied.

Also to understand the Intrest rate determination under Floating rate mechanism and the terms

under that mechanism, the IMs of previous issues of FRBs by firms including Power Finance

Corporation, Railway Finance Corporation Limited, ICICI Bank, IDBI Bank, and Kotak Mahindra etc...

were studied.

WORKING MANUAL FOR DOMESTIC RESOURCE PLANNING AND MOBILISATION

IN POWER GRID

The Power Grid Corporation of India Limited for its internal policies has a manual on Resources

rising. The document has the policies as defined by its Articles of Association and as vested by Board

with related to Borrowing power, the authority, accountability for activities related to resource rising

(including Term loans and Bonds).

The document also has the procedure of rising funds through Bonds and also through term loan

from banks, the Debt Servicing, the book building process, conversion of bonds from Physical to

Demat, statutory compliance etc.

It also has the formats of each letter to be sent to various parties like Registrar, Arranger, Investor,

Stock Exchange, Depository etc... The guidelines by SEBI and the copy of internal guidelines are also

included.

Thus overview of fund raising process along with legal and procedural aspects can be understood

from this document.


19

Introduction

The debt market is much more popular than the equity markets in most parts of the world. In India

the reverse has been true. Nevertheless, the Indian debt market has transformed itself into a much

more vibrant trading field for debt instruments from the rudimentary market about a decade ago.

The sections below encompass the transformation of government and corporate debt markets in

India along with a comparison of the developments in equity market.

Developments in Government Bond Market

Prior to 1992, money was collected and lent according to Plan. Lacunae in institutional infrastructure

and inefficient market practices characterized the government securities market. In fact the sole

objective pursued was to keep the cost of government borrowing as low as possible. If planning

went awry, the government sent word to its banker. The central bank made a few phone calls to the

heads of banks and bonds were issued and the money arranged. No questions asked, no

explanations given. The GOI bond market did not use trading on an exchange. It featured bilateral

negotiation between dealers. The market thus lacked price-time priority and the bilateral

transactions imposed counterparty credit risk on participants. This narrowed down the market into a

“club” with homogeneous credit risk. This was the state of the government debt market in India ten

years ago.

The major thrust of Financial Reforms commenced in 1992. This was when the contours of the debt

market began taking shape. The idea of the financial reform movement was to have more and more

different markets and not necessarily have whole financial intermediation left to the banks. The

reform process attempted at doing away with regulations in favour of controls based on market

forces i.e. an era where the interest rates are governed more by the market forces of demand and

supply and less by centralized supervision. Slowly, but steadily, the market grew, adding fresh

players and novel instruments. Several measures have added greater transparency and have brought

the issuances closer to the market levels.

The major reforms that took place in the 1990’s were:

• Introduction of the auction system for sale of dated government securities in June1992. This

signalled the end of the era of administered interest rates.

• The RBI moved to computerize the SGL and implement a form of a ‘delivery versus payment’ (DvP)

system. The DvP enabled mitigating of settlement risk in securities and ensured the smoothness of

settlement by synchronizing the payment and delivery of securities.

• Innovative products in form of Zero Coupon Bonds and Capital Indexed Bonds (Ex. Inflation Linked)

were issued to attract a wider gamut of investors. However, the pace of innovation suffered due to

non-sophistication of the markets and lack of persistence with some of the new bonds like Inflation

Indexed bonds after the initial lukewarm response.


20

• The system of Primary Dealers was established in March 1995. These primary dealers have since

then acquired a large chunk of share in the GOI bond market and have played the role of market

makers.

• The RBI setup “trade for trade” regime, a strong regulatory system which required that every trade

must be settled with funds and bonds. All forms of netting were prohibited.

• Wholesale Debt Market (WDM) segment was set up at NSE; a limited degree of transparency came

about through the WDM at NSE, where roughly half the trading volume of India’s GOI bond market

is reported.

• The Ways And Means agreement put an end to issuance of ad hoc treasury bills, the government’s

favourite instrument of funding its profligacy.

• Interest Income in G-Secs was exempted from the purview of TDS.

• FIIs with 100% Debt Schemes were allowed to invest in GOI Securities and T-Bills while other FIIs

were allowed 30% investment in these instruments.

• Dematerialised forms of securities in G-Secs were done through the SGL and Constituents SGL

accounts.

The above-mentioned measures have served in bringing about greater market orientation of the

sovereign issues. This is particularly important as the sovereign borrowing parameters have a direct

bearing on the cost of capital for other non-sovereign issuers. The Primary market for G-Secs

registered an almost ten-fold increase between 1990-91 and 1998-99. The broadening of the market

was also apparent from the fact that RBI’s participation, as reflected by absorption of primary issues,

came down from 45.90% in 1992-93 to 0.74% in 1994-95.

Though significant improvements have been made in the primary market, the secondary market

continued to be plagued by certain shortcomings like dominance of a few players (acted as a

deterrent to lending width in the market), strategy of holding to maturity by leading players

(prevented the improvement in the depth of the market), the pre-1992 “telephone market”

continued to exist (prevents information dissemination and hence price discovery is limited) and low

retail participation in G-Secs continues to exist even today. Experts believe that there is tremendous

potential for widening the investor base for Government securities among retail investors. This

requires a two-pronged approach, increasing their awareness about Government securities as

adoption for investment and improving liquidity in the secondary market that will provide them with

an exit route. Also infrastructure is seen as the vital element in the further development and

deepening of the market.

Corporate Bond Market

In the last decade, market related borrowings by the corporate sector have remained depressed as a

plethora of Financial Institutions were available for disbursal of credit. These Institutions managed to

mobilize a significant amount of domestic savings and route them for corporate consumption.


21

Also the reforms abolished the office of the Controller of Capital Issues (CCI), which meant that

companies were free to price their equity issues as per the market appetite. This led to a slew of

primary issue of equity and the relative attractiveness of issue of debt yielded way to equities. In

fact, even debt issues were made with attached sweeteners like convertible portion of the fixed

income instrument. In addition, several relaxations in regulations post 1992 have encouraged Indian

corporate to raise debt from overseas capital markets leading to further shunning of the domestic

debt market by creditworthy issuers. Therefore, the corporate debt market in India has continued to

be dominated by the PSU’s.

In the recent past, the corporate debt market has seen high growth of innovative asset-backed

securities. The servicing of debt and related obligations for such instruments is backed by some sort

of financial assets and/or credit support from a third party. Over the years greater innovation has

been witnessed in the corporate bond issuances, like floating rate instruments, zero coupon bonds,

convertible bonds, callable (put-able) bonds and step-redemption bonds. For example, step bonds

issued by ICICI in 1998, paid progressively higher rates of interest as the maturity approached while

the IDBI’s step bond was issued with a feature to pay out the redemption amount in instalments

after an initial holding period. The deep discount bond issued by IDBI in the same year had two put

and call options before maturity.

What these innovative issues have done is that they have provided a gamut of securities that caters

to wider segment of investors in terms of maintaining a desirable risk-return balance. Over the last

five years, corporate issuers have shown a distinct preference for private placements over public

issues. This has further cramped the liquidity in the market. While private placement has grown 6.23

times to Rs. 62461.80 crores in 2000-2001 since 1995-96, the corresponding increase in public issues

of debt has been merely 40.95 percent from the 1995-96 levels.

The dominance of private placement in total issuances is attributable to a number of factors. First,

the lengthy issuance procedure for public issues, in particular, the information disclosure

requirements, provide a strong incentive for eligible entities to opt for the private placement route.

Secondly, the costs of a public issue are considerably higher than those for a private placement.

Thirdly, the amounts that can be raised through private placements are typically larger than those

that can be garnered through a public issue. Also, a corporate can expect to raise debt from the

market at finer rates than the prime-lending rate of banks and financial institutions only with an AAA

rated paper. This limits the number of entities that would find it profitable to enter the market

directly.

Thus the public issues market has over the years been dominated by financial institutions, which is

exemplified by the fact that ICICI and IDBI accounted for the entire debt offerings in 1998–99 and all

but one issue in 1999–2000. Another interesting fact is that in spite of dominating the public issues

market even financial institutions have raised significantly larger amounts through the private

placement route.

Further the secondary market for non-sovereign debt, especially corporate paper remains plagued

by inefficiencies. The primary problem is the total lack of market making in these securities, which

consequently lead to extremely poor liquidity. The biggest investors in this segment of the market,


22

namely LIC, GIC and UTI prefer to hold the instruments to maturity, thereby truncating the supply of

paper in the market.

The secondary market for corporate did receive a boost with the waiver on stamp duty payment on

transfer of debt securities, as long as they are dematerialized debentures, in the Finance Bill 2000.

Development of Equity Market vs. the Debt Market

During this decade of financial reforms development in equity market has been striking as compared

to relatively minor changes in the debt market. In terms of sheer market size, the equity market saw

a drop from 42% of GDP in 1993–94 to 28.6% of GDP in 2000-01. Over the same period, the GOI

bond market saw an increase in market size, fuelled by large fiscal deficits, from 28% of GDP in

1993–94 to 36.7% of GDP in 2000–01. Other things being equal, this should have generated an

improvement in liquidity of the GOI bond market and a reduction in liquidity in the equity market.

Instead, changes in market design on the equity market over this period gave the opposite outcome,

where the improvement in liquidity on the equity market was superior to that observed on the GOI

bond market. The reasons for this have been manifold:

• Foreign capital inflows into the GOI bond market are relatively undesirable to policy-makers. This is

in contrast with capital inflows into the equity market, where policy-makers seek to have the largest

possible capital inflows. Hence, infirmities in the market design on the GOI bond market do not

generate an important opportunity cost as far as harnessing foreign capital inflows are concerned.

• In the presence of “development finance institutions” and banks, firms in India are seen as having

access to debt financing, access to debt finance was therefore not seen as a major bottleneck

hindering investment. Hence, the lack of a liquid bond market was not keenly seen as a constraint in

investment and growth.

• In the case of the GOI bond market, the benefits from a non-transparent market with entry

barriers accrue primarily to banks and PDs. The PDs are largely the creation of RBI and public sector

banks have extremely close ties with RBI. The RBI is the regulator for G-Secs market.

Thus the development of equity markets took precedence over development of debt market in India

but the future does seem promising for the debt market.

The Bond market has been growing popularity over the years. This can be seen from the following

chart depicting the average trade value in Wholesale Debt Segment


23

Figure 1 Trend of Average Trade Size - WDM

From the above trend chart, the tremendous growth of trade in Debt segment can be clearly

demonstrated. The average trade size i.e. Value of each trade has increased from a meagre amount

of Rs. 30 Lacs in the June 1994 to Rs 7.24 Crores in June 2004 to 29.94 in March 2010. There has

been a multi fold

0.00

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Average Trade Size- WDM Segment


24

Chapter II

Financial Statement

Analysis

Balance Sheet Analysis

Profit and Loss Analysis

Cash Flow Analysis

Ratio Analysis


25

Financial Statements Analysis

To understand the performance of a concern and to forecast its financial position and financial

strength it is per se necessary to analyse its financial statements. Though a firm makes huge profits

but faces liquidity concerns and though a firm is poor profitability compared to others but yet is

rated as financially strong firm. Thus to comment on ones financial position and financial

performance, it is not possible to comment based on one parameter. Different parameters like

profits, activity, leverage, liquidity, Investments, turnovers, returns, ratios etc is to be analysed.

Different financial statements that can be analysed are Balance Sheet (Position Statement), Profit

and Loss Account (Performance Statement), Cash Flow Statement, Funds flow statement, Apart from

these there are some non-financial reports which are also part of Annual report of a company, and

they are Directors report, Industry Analysis, Auditors report, Third party disclosures, etc..

Some of the popular tools used for the effective analysis of the financial statements are

Multi-Step Analysis ( Balance Sheet, Profit and Loss and Cash Flows)

Common Size Analysis

Comparative Analysis ( Over the years or with Peers)

Index

Trend Analysis

Ratio Analysis


26

Balance Sheet Analysis

Balance Sheet is one of the most important sources for analysing the financial position of any

company. Some of the very important aspects that can be analysed using the Multi Step Analysis of

the Balance Sheet are Capital Composition, Sources and Application of Funds, Trends in Shareholding

Patterns, Trend of Self and Borrowed Funds. Composition of Loans, Trends in fixed assets, analysis of

Working capital etc....

Capital Composition Capital is one of the import and prime source of funds. It is a long term source and comprises of

Shareholders Capital (L1), Reserves (L2), Secured loans (L3) and Unsecured loans (L4).

From the flowing stacked area chart and also from the table following things can be interpreted:

The proportion of Share Capital in total capital is reducing every year. This implies the firm is

going on leveraging itself and trading on equity. It also implies the firm is not using its equity

route but either reinvesting the profits or borrowing loans. In the year 2007 though 10%

fresh equity was issued to the public by the route of IPO the proportion has reduced

because of continuous borrowings as Secured Debentures and Loans. The contribution has

reduced from 35 % in 1996 to just 9% in 2009.

The Reserves and Surplus which includes the reinvestment of profits as retained earnings

has been increasing from 16% to 25%. This implies firm is in the path of expansion and

instead of distributing the earnings in form of dividends to the shareholders it is retaining

and ploughing back the profits in the business.

There has been an exponential increase in the secured Loans which comprises of

Debentures, Loans from Banks and Loans from Institutions. The company to fulfil its Cap-Ex

requirements has a practice of issuing Secured Non Convertible Redeemable Debentures.

Also it takes term loans from banks and Loans from Multi-Lateral agencies like World Bank

and Asian Development Bank. The share of this source has increased from 13% to as high as

58%. But since the firm has security backed with these loans, it is most preferred by the

investors. But over the years in the same trend continues, there may be liquidity concerns

and also solvency issues. And a high financial risk is also attached with the loans as they

demand regular payment of interest and principal no matter if the financial performance is

good or bad. Default in payment impacts the rating and impairs borrowing ability.

The Loans from Unsecured Borrowings is regarded as the most risky source as there is no

security backed for it and also the interest rates are very high due to high risk. The

Unsecured loans have been on fall over the years. There has been a rise in the years 2001

and 2006 due to unexpected borrowing needs. But over the years the company is trying to

repay its unsecured loans which are very costly.

Overall the Capital Structure of the firm is changing over the years, from a less leveraged

firm of (D/E) less than 1; it has reached to leveraged ratio of 1.92. And also the proportion of

Secured loans has been on a rise to compensate the fall in equity and unsecured loans

contribution. But analysis of Absolute amounts of each source and also analysis of self and

borrowed funds need to be done for better understanding.


27

Figure 2 Capital Composition from 1996 to 2009

35.33%30.32% 28.68% 26.25% 22.55% 18.49%

13.08% 7.34%

13.33% 23.45% 27.17% 32.14% 36.55% 41.64% 48.73%

58.38%

16.03%

18.54%22.08%

23.78% 26.28% 25.53% 26.50%24.56%

35.31%

27.69%22.06% 17.82% 14.62% 14.34% 11.69% 9.72%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Capital Composition

Unsecured Loans Secured Loans Reserves Total Share Capital

Share Capital

Reserves Total

Secured Loans

Unsecured Loans

1996 35.31% 16.03% 13.33% 35.33%

1997 30.92% 17.45% 19.51% 32.12%

1998 27.69% 18.54% 23.45% 30.32%

1999 24.55% 19.83% 25.09% 30.52%

2000 22.06% 22.08% 27.17% 28.68%

2001 20.00% 24.53% 23.25% 32.23%

2002 17.82% 23.78% 32.14% 26.25%

2003 15.83% 24.48% 34.59% 25.10%

2004 14.62% 26.28% 36.55% 22.55%

2005 14.14% 26.04% 40.01% 19.81%

2006 14.34% 25.53% 41.64% 18.49%

2007 12.52% 23.60% 43.15% 20.73%

2008 11.69% 26.50% 48.73% 13.08%

2009 9.72% 24.56% 58.38% 7.34%

Table 1 Capital Composition from 1996 to 2009


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Sources and Application of Funds

Every firm has different sources of funds like share capital, reserves, Loans, Debentures, Current

liability, public borrowings etc... And the funds are borrowed for some specific applications like fixed

assets, Investments, Current Assets etc... An analysis of the sources is to be done for the purpose of

assessing the costs and also the applications to analyse the profitability. It is necessary to invest the

funds in profitable resources to earn good Return on Investment and fulfil the expectations of the

stake holders. Following pie-charts show the sources of funds and applications of the same for the

year 2008-09.

Figure 3 Sources of Funds- 2008-09

From the above chart on Sources of Funds, following interpretations can be made:

The company has just 28% of the sources as shareholders Funds (Non borrowed funds) this

implies the firm is highly leveraged. But seeing the nature of the business of the firm which is

into power transmission and with many projects regularly under implementation, it faces

high capital requirement. Thus it depends on the borrowed funds.

As mentioned earlier, the firm is a high growth firm thus has just 19% from Short term

sources like suppliers credit and customers advance.

Highest is being contributed by Secured Loans which has Non Convertible Debentures,

Deferred Credit and Term Loans.

The firm prefers to raise loan by issuing the Non Convertible Debentures because it has less

interest rate than term loans and are the availability of Option of moratorium period which

matches with the gestation period of the projects.

Share Capital8%

Reserves and Surplus20%

Unsecured Loans6%

Total Current Liabilities

19%

Non Convertible Debentures

28%

Term Loans (Institutions)

1%Term Loans (Banks)

1%

Deferred Credit17%

Secured Loans47%

Sources of Funds- 2008-09

Share Capital Reserves and Surplus Unsecured Loans

Total Current Liabilities Non Convertible Debentures Term Loans (Institutions)


29

Unsecured loans which are very costly due to high rates of interest when compared to

secured loans are just 6%.

The firm in the year 2009 has funds of Rs. 53787.32 Crores.

Figure 4 Applications of Funds- 2008-09

The application of funds implies the avenues where the investment is made to earn the revenue and

to carry on the activities as per the objectives of the business.

Being a capital intensive firm, the 57% of the funds are invested in Net Block i.e... Fixed

assets like Transmission Grids, transmitters etc...

As high as 25% of the resources are invested in Capital WIP (Work in progress), this signifies

that the company is in the path of expansion and is undertaking the projects. The Capital

WIP implies the funds given as advance to the contractors, the Under Construction buildings

and plants, etc...

Just 3% of the funds are into Investment and 15% in current assets. We can infer that either

the firm has operational excellence in Working capital management or since it is Under

Expansion stage the investment in short term assets is low.

From the Sources and Applications it can be analysed that 15% of short term Assets (CA) is wholly

financed by the Current liabilities which is 19%. This implies the firm is matching its short term

requirements with short term sources. This may be termed as aggressive strategy because the

Permanent and temporary working capital is being financed by the short term funds.

Net Block57%

Capital Work in Progress

25%

Investments3%

Total Current Assets15%

Applications of Funds- 2008-09

Net Block


Investments

Total Current Assets


30

Share Capital

After analysing the various sources and Applications of funds, it is now necessary to analyse the

trend in each component of the sources and application over the years. The share capital has been

increasing over the years; this is because of the companies borrowing from Government of India by

allotting the shares. Pre-Listing i.e... Before 2007, the company used to allotment shares for this

purpose. In the year 2008, there has been rise in shares allotted because of Initial Public Offer on

26th September 2007. Under the plan of Disinvestment of Public Undertakings, 10% of fresh shares

and 5% of government of India’s holding was issued to the public. In the year 2008 to 2009, the

number of shares and the share capital is constant implying no further issue of share capital is made.

However there is news of further disinvestment through FPO in the year 2010, so there may be

change in share capital in the year 2010-11.

Figure 5 Trend in Share Capital

Share Holding Pattern

Not only the share capital but also the holding pattern of the same shall be studied. Since Power

Grid Corporation is one of the Public Undertaking, the maximum holding is with the Government of

India. Only after September 2007, i.e... After the Disinvestment, the holding pattern was diluted. The

holding reduced to 86.37%. Through the issue, the Government of India (promoter) sold its 5% stake

and also fresh equity of 10% of the total share capital was issued. As on 31st of December 2009,

Institutional and Non Institutional investors have almost equal contribution of 7%.

0.00

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Share Capital

Share Capital


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Figure 6 Share Holding Pattern as on 31st Dec 2009

Share Holders 31-12-2009

31-03-2009

31-03-2008

19-04-2007

Government(Central / State) 86.37% 86.37% 86.37% 100.00%

Individuals / Hindu Undivided Family 0.00% 0.00% 0.00% 0.00%

Financial Institutions / Banks 1.13% 0.66% 0.37% 0.00%

Foreign Institutional Investors 1.62% 2.58% 2.89% 0.00%

Insurance Companies 3.68% 2.37% 0.97% 0.00%

Mutual Funds / UTI 0.66% 0.79% 0.65% 0.00%

Bodies Corporate 1.65% 1.69% 1.93% 0.00%

Individuals (up to Rs. 1 lakh) 4.17% 5.10% 6.10% 0.00%

Others 0.73% 0.45% 0.72% 0.00%

Table 2 Share Holding Pattern from 2007 to 2009

Figure 7 Share Holding Pattern

Government(Central / State)

86%

Non Promoter (Institution)

7%

Non Promoter (Non-Institution)

7%

Share Holding Pattern as on 31st Dec 2009


Non Promoter (Institution)

Non Promoter (Non-Institution)

31-12-2009

31-03-200931-03-2008

19-04-2007

Share Holding Pattern


Financial Institutions / Banks

Foreign Institutional Investors

Insurance Companies

Individuals holding upto Rs. 1 lakh


32

Name of Share Holder No. Of Shares ( of Rs. 10 each)

(%)

President Of India ( Ministry of Power) 3533637935 83.96% President Of India ( Ministry Of Development Of North East Region)

101269800 2.41%

Life Insurance Corporation Of India

60342943 1.43%

LIC Of India - Market Plus 48942430 1.16% LIC Of India Money Plus 38713829 0.92% Janus Contrarian Fund 32210129 0.77% LIC Of India Market Plus – 1 23728370 0.56% ICICI Prudential Life Insurance Company Ltd.

20647334 0.49%

Life Insurance Corporation Of India Profit Plus

8105330 0.19%

HDFC Standard Life Insurance Company Limited

5950579 0.14%

Total 3873548679 92.03%

Table 3 Top 10 Share Holders as on 29.01.20093

Some of the supposition that can be made analysing the holding pattern over the years and the Top

ten shareholders is:

The holding of promoter (Government) has reduced to 86.37% post IPO. But after that the

holding is constant implying no further dilution or no further issue has been made.

Over the years the holding of Individuals holding up to Rs. 1 lakh (i.e... Retail Investors) is

falling

Holding of Insurance Companies is increasing over the years, which implies that the

company is attracting that kind of clients.

Also the holdings by FIIs are on the fall and are compensated by holdings of Financial

Institutions which is increasing.

From the list of Top 10 shareholders and the proportion of their holdings, it can be very

clearly observed that the holding is very much skewed.

92% of total share capital is held by the top 10 shareholders. Thus the Ownership and

control is under few hands.

Brief note on Initial Public Offering

The corporation has come up with Initial Public Offer in the month September, 2007 with an issue

size up to573, 932,895 equity shares of Rs. 10 each for cash at a price of Rs. 52 per equity share

aggregating Rs. 2985crores. The issue comprised a fresh issue of up to 382,621,930 equity shares

and an offer for sale of up to191,310,965 equity shares by the President of India acting through the

Ministry of Power, Government of India. The issue comprised a net issue to the public of up to

559,954,895 equity shares and a reservation of up to 13,978,000 equity shares for subscription by

employees at the issue price. The issue comprised approximately 13.64% of the fully diluted post-

issue capital of POWERGRID.

3 Source: Final Disclosure Document for XXXI issue of Bonds of Power Grid (www.nseindia.com)

http://www.nseindia.com/


33

Reserves

Figure 8Trend in Reserves and Surplus

The Reserves in the form of General reserve, Capital Reserve, Share Premium, Debenture

Redemption reserve and Profit and Loss Account’s Credit balance are maintained. There has been

continuous increase in the reserves over the years. In the year 2008, the steep increase is

attributable to the share premium account started after the IPO. The shares were issued at a

premium of Rs. 42 per share. Overall, the company is able to retain the earnings and ploughing back

them to fund the capital expansion plans.

Secured Loans

The secured loans in specific to Power Grid Corporation of India Limited comprises of Debentures,

Loans from banks like Indian Overseas Bank, Corporation Bank, Punjab National Bank; Loans from

Institutes like Asian Development Bank, and World Bank (IBRD) and Deferred Credit.

Figure 9 Trend in Non Convertible Debentures

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Figure 10 Trend in Term Loans Institutions

Figure 11 Trend in Term Loans Banks

Figure 12 Trend in Deferred Credit

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2004 2005 2006 2007 2008 2009

Term Loans Institutions

Term Loans Institutions

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Term Loans Banks

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Deferred Credit / Hire Purchase

Deferred Credit / Hire Purchase


35

From the above facts and figures and the trend of growth over the years, following analysis can be

made:

There has been a constant increase in the amount of Loan from Non Convertible

debentures. From a mere amount of Rs. 1139 Crores in the year 2000-01, the amount has

exponentially increased to Rs. 15112 Crores in the year 2009-10.

Usually the firm issues Non Convertible, Secured, Taxable, and Redeemable Bonds with a

rating of AAA/ LAAA which implies the most secured investment being issued by the credit

rating agencies like CRISIL, CARE and ICRA. Due to the security, and Ratings, the firm is able

to attract funds at a lower rate than compared to the rate being paid in case of term loans.

At present as on 31st March 2010, the firm has issued 32 series of bonds and 26 Bonds are

active and interest is being paid on them.

The Term Loans from Institutions mainly has the loans from LIC at different rates. This

amount is depleting over the years as it is redeemed in equal instalments every year. And

also since they are raised at rate of 10% or high, the firm is proffering to repay the amount.

The Term Loans from Banks include loans from banks like ICICI, PNB, and IOB etc... Over the

years the loan from this source is also on the fall. This is mainly because the firm prefers to

issue bonds as they have a moratorium period of 3-4 years and also the Intrest rates are

lower there. And in case of Term loans the rates are linked to PLR and thus there are wide

fluctuations.

Loans in form of Deferred Credit or Hire Purchase are used to finance the Machines and

Plants purchase. Since the firm is expanding and has many projects under implementation

the machines and plants are being financed through this operation.

Unsecured Loans

Figure 13 Trend in Unsecured Loans

0

1000

2000

3000

4000

5000

6000

7000

Unsecured Loans

Unsecured Loans


36

The Unsecured loans have been in a constant range and they include Unsecured Bonds, Loans from

Institutions and Banks at a higher rate and without a security. In the year 2007, there has been a

steep increase in the secured loans because of Increase in borrowings from secured Bonds.

Figure 14 Debt Composition from 2003 to 2009

From the above chart it can be very clearly commented that the composition of secured loan has

been increasing over the years. This is mainly because of issuing of secured bonds and redemption of

unsecured bonds.

Current Liability

0%10%20%30%40%50%60%70%80%90%

100%

Debt-Composition

Unsecured Loans

Secured Loans

0

2000

4000

6000

8000

10000

12000

2003 2004 2005 2006 2007 2008 2009

Current Liability

Provisions

Current Liabilities

Figure 15 Trend in Current Liability


37

One of the component of sources of Funds and which is short term in nature is Current Liability.

Some of the observations that can be made are:

The Current Liabilities has increase from Rs. 1646 Crores in the year 2003-04 to as high as

Rs.10472 Crs in the year 2009-10.

Also the Proportion of Provisions for deferred tax and Debtors is increasing over the year.

This is mainly because of guidelines issued by CERC (Central Electricity Regulations Code),

which has the guidelines of making provisions as per the Tariff system for its customers who

are SEBs since the financial position of SEBs is not sound.

Fixed Assets

Figure 16 Trend in Fixed Assets

Some of the observations that can be made are:

The point that the firm is under a rapid expansion stage is very clear from the trend in

growth of fixed assets.

The Fixed assets have increased at an exponential rate. This is mainly because of the

National Grid project.

Also the firm has many projects under implementation stage thus has a high amount in

Capital Work in progress, which include the advances to the supplier of machinery, Under

construction plants and buildings etc...

0

5000

10000

15000

20000

25000

30000

35000

2009200820072006200520042003

Fixed Assets

Net Block



38

Investments

Figure 17 Trend in Investments

The firm has investments of its residual surplus in the income earning instruments. But since the

CREC guidelines do not permit them to invest in different Money market instruments like

Commercial papers, Certificate of Deposits etc... It is permitted to invest only into the safest and also

secured securities like fixed deposits. And also though the amount in investments is not much

fluctuating, but this must be compared with that of fixed assets. From the following chart, it is very

clearly evident that the firm invests its surplus into fixed assets than in investments. Only the surplus

which cannot be invested into capital creation is invested in those avenues. Also though the fixed

assets proportion is exponentially increasing, the proportion of investments is constant.

Figure 18 Comparison of Fixed Assets and Investments

0

500

1000

1500

2000

2500

2003 2004 2005 2006 2007 2008 2009

Investments

Investments

0

5000

10000

15000

20000

25000

30000

35000

40000

45000

2003 2004 2005 2006 2007 2008 2009

Fixed Assets: Investments

Fixed Assets

Investments


39

Current Assets

Figure 19 Trend in Composition of Current Assets

The short term applications of the funds are Current Assets. These are the assets which can be

converted to cash in less than a year. The current assets have been at an increase over the years.

Following analysis can be done:

The Cash and Bank balance, which signifies the actual cash in hand of the firm, has increased

over the years. From a negligible amount of Rs. 118 Crores in the year 2003-04 the balance

has increased to Rs. 2428 Crores in the year 2009-10. This implies that the firm has good

liquidity management and holds cash in hands. But this also implies that the firms

opportunity cost of holding cash is high since the same can be invested in other avenues and

get returns.

The Sundry debtors which were very high or the year 2003-04 have decreased over the years

and have increased in the year 2009-10. This could be due to the expansion in the

operations and also since the customers are mainly SEBs (State electricity Boards), whose

financial position is weak, thus the debtors have increased.

Being a capital intensive firm it has very least amount of Inventories which are in form of

spares, consumables etc... The amount is very negligible compared o the other components.

The Loans and advances have been increased. This can be because of short term loans to its

subsidiaries.

Overall, if we compare the current assets and Current liabilities position, the firm is able to

match the current assets and current liabilities and is adopting Matching approach of

working capital management by financing the short term needs by short term sources.

0

1000

2000

3000

4000

5000

6000

7000

8000

9000

2003 2004 2005 2006 2007 2008 2009

Current Assets

Loans and Advances

Inventories

Sundry Debtors

Cash and Bank


40

Profit and Loss Analysis

After analysing the components of balance sheet which depicts the financial positions of the firm, it

is also per se necessary to study the financial performance of the firm. The Profit and Loss account or

the Income Statement of the firm for the financial year very truly depicts the profitability of the firm.

The aspects like Operating Income, Sales, Profits and expenses can be analysed from this statement.

Figure 20 Multi Step Analysis of Income

Multi Step Analysis Implies analysing each and every component of the Profits and expenses. This

helps in analysing the behaviour of different costs namely, Depreciation, Non Operating Expenses,

Financial Expenses, Taxes etc...

Some of the analyses that can be made are:

The sales have been increasing over the year and the blue portion which depicts the

Operating Expenses; it is increasing at a variable rate with the increase in the sales.

The PBIDT (Operating Profit) is increasing in tandem with the sales.

The PBIT (Profit before Intrest and Taxes) is also increasing but the increase in the PBIT is

less than the increase in the sales in the year 2009 because of more than proportionate

increase in the operating expenses.

The purple segment which represents Intrest expenses have been at a raise over the years

because of high borrowings by the firm in form of Loans and debentures. The raise is

disallowing the firm to take advantage of operating leverage. But yet the proportionate

increase in PBDT or PBT is more than that of sales.

As discussed before the proportionate increase in PBDT (Profit before Depreciation and

Taxes) is more than the increase in Sale. This is because of the operating leverage enjoyed

by the firm due to presence of the fixed expenses in form of depreciation and Intrest.

PATPBT

PBDTPBIT

PBIDT

Sales

0

5000

10000

15000

20000

25000

30000

2003 2004 2005 2006 2007 2008 2009

Multi-Step Analysis of Incomes

Sales

PBIDT

PBIT

PBDT

PBT

PAT


41

The Green proportion which corresponds to Depreciation is increasing due to continuous

additions in the fixed assets.

The PBT (Profit before Tax) which is arrived at after deducting the Depreciation from PBDT

and the PAT (profit After Tax) which is resultant after Tax amount is deducted from the PBT

are growing at a same tandem. This implies there has been no change in the Tax rate, which

is represented by the colour Sky Blue in the above chart.

Sales/ Operating Income

Figure 21 Trend in Incomes

Operating Income is one of the very vital sources of revenue for any firm. The profits, the activity

and all the important performance parameters are measured in relation to this factor. Some of the

observations that can be made from the above trend chart are:

The main object of the business as defined by the Memorandum of Association is to transmit

the power and it has been termed as CTU (Central Transmission Unit) by the Central

Government.

Since there are few competitors in form of SEBs and no firm with the similar size of Power

Grid Corporation of India Limited, thus it has a near monopoly in this sector.

The continuous increase in sales/ Transmission Income can be regarded to the fact that the

business is expansion.

In the year 2007, the firm entered into the business of Telecommunication ( leasing of over

head lines) and Consultancy ( consultancy to other countries and also consulting the Govt

project of RGGVY)

Seeing the growth of Operating Income from Rs.2103 Crores to Rs.6579 Crores between the

years 2003 and 2010, it can be remarked that the company has a good performance

0

1000

2000

3000

4000

5000

6000

7000

2003 2004 2005 2006 2007 2008 2009

Operating Income

Operating Income


42

Profits

Figure 22 Trend in different Profits

The Profits (Operating, Before Tax and After Tax) have been increasing over the last 7 years. But

some of the points to be observed are:

Though the Operating Profit (PBIT) has increased at a very tremendous rate, but the increase

in the PBT is not at the proportionate rate because of simultaneous increase in Non

Operating and Financial Expenses.

Also in the year 2003-04, the PBT (Profit before Tax) was less than the PAT (Profit after Tax)

because of Tax Credit and Tax Subsidy being provided by the Government.

Since 2005-06, the gap between PBT and PAT has been at a rise implying that the Tax

amount being paid by the company is increasing.

Dividends

Figure 23 Dividend Trend

0

500

1000

1500

2000

2500

3000

3500

4000

4500

5000

2003 2004 2005 2006 2007 2008 2009

Profits

PBIT

PBT

PAT

0

5

10

15

2003 2004 2005 2006 2007 2008 2009

of

Face

Val

ue

Dividends

Dividends


43

The dividends are one of the ways in which the company can return the earnings to the share

holders. The dividends depict the profitability of the company. From the above chart it can be

clearly seen that the dividends are growing over the year. Pre-2007, when Government of India (The

President of India) was the sole share holder/promoter, the number of shares issued to it kept on

changing every year. The capital requirement was funded by the government by means of Equity

capital infusion. Thus the dividend proportion has also increased. And in the year 2008 and 2009,

after the IPO, when apart from GoI, general public too participated in the shareholding pattern; the

dividend percentage has remained same. Also pre 2007, the face value of shares was Rs.100 and

from the year 2007 the face values of the shares have changed to Rs.10.

The analysis of the Dividend payment can be made more effective by studying the Retention and

payout ratio. It can be seen from the following graph that, the retention of profits which is

represented by the colour green, is very high in the initial years, but the payout ratio has increased

over the years and especially after the IPO (Disinvestment). But the retention ratio is always at least

60-70% which depicts that the firm is reinvesting and pooling back its earnings into the business

instead of distributing it to the shareholders. By this it also signals that the internal rate of return of

the firm is higher than the Share holders expectation thus the earnings are retained back.

Figure 24 Profit Appropriations over the years

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2003 2004 2005 2006 2007 2008 2009

2003 2004 2005 2006 2007 2008 2009

Payout 31.47 37.07 31.52 31.32 24.2 17.07 15.72

Retaintion 68.53 62.93 68.48 68.68 75.8 82.93 84.28

Profits Appropriation

Payout

Retaintion


44

Cash Flow Analysis

Cash is regarded as the blood of any business. A company may be highly profitable with high

balances in general and Capital reserve, with a good asset value and high Net worth. But the

situation will be worsening if cash positions are low. A firm with a very high profitability but with

constrained liquidity would face the problem of solvency. Thus it is per se necessary to analyse and

study the cash flows from various sources and also its application.

The Cash flow statement is divided into three parts namely Cash from Operating activities, cash from

Investing activities and cash from financial activities. The cash flow statement for the year 2009 and

2008 are:

Cash Flow Statement 200903 200803

Cash and Cash Equivalents at Beginning of the year 1865.59 1196.82

Cash Flow From Operating Activities

Net Profit before Tax & Extraordinary Items 2228.57 1730.53

Total Adjustments (PBT & Extraordinary Items) 3518.25 2111.69

Op. Profit before Working Capital Changes 5746.82 3842.22

Adjustment For WC Changes 1048.29 -629.48

Cash Generated from/(used in) Operations 6795.11 3212.74

Direct Taxes Paid -154.02 -221.91

Net Cash from Operating Activities 6641.09 2990.83

Cash Flow from Investing Activities

Purchased of Fixed Assets -770.82 0

Sale of Fixed Assets 0 261.01

capital WIP -8652.78 -6075.15

Sale of Investments 182.89 241.13

Interest Received 132.99 149.99

Dividend Received 19.54 5.39

Investment in Group Cos -39.5 -10.35

Others -29.07 84.67

Net Cash Used in Investing Activities -9156.75 -5343.31


45

Cash Flow From Financing Activities

Proceeds from Issue of shares (incl share premium) 0 1989.63

Proceed from 0ther Long Term Borrowings 7629.85 4118.71

Proceed from Short Term Borrowings 750 750

Of the Long Term Borrowings -1427.89 -1180.73

Of the short term Borrowings -750 -750

Dividend Paid -505.08 -464.28

Interest Paid -2532.09 -1339.55

Others -85.84 -102.53

Net Cash From Financing Activities 3078.95 3021.25

Net Inc/(Dec) in Cash and Cash Equivalent 563.29 668.77

Cash and Cash Equivalents at End of the year 2428.88 1865.59

Table 4 Cash Flow Statement

Some of the analyses that can be made from the above cash flow statement are:

The cash flows from operating activities, which imply the cash generated by performing the

business activities has increased from previous year. It has grown by approximately 122%

which is very positive.

Mainly there has been rise in cash flows from profits.

Also the cash from Working capital was negative in the previous year implying more current

assets were used in the previous year. But in the current year the cash from working capital

is negative, this implies that the cash has been generated from the Current liabilities.

The cash from Investing activity is negative this implies the firm is investing into assets and

other income generating investments.

The cash used in financing activities has increased by 71% over the previous year.

Fixed assets worth Rs. 770 Crores were purchased this year implying the firm is expanding its

scope of operation and also the fact that Assets worth Rs. 261 crores were sold last year and

the figure of sale has been 0 this year.

The Capital working Progress is very high at Rs.8 Thousand Crores. And also the amount has

increased by 42% over the previous year. The main reason behind this is the projects

undertaken by the company are of long completion and long implementation [period, thus

lot of amount gets blocked as WIP.

The firm is also generating some cash from the sale of Investments and also inform of

income on the investments like Intrest and dividends.

The cash from Financing activities include the cash generated from the resource raising

activities in form of loans shares etc... It also includes the repayments of the earlier loans

and the interest and dividends paid on them.

There has been not much change in the cash generated from financing activities; it has risen

by just 2 % over the previous year.


46

There has been a high amount being generated by issue of shares in the year 2007-08

because the shares were issued to public in form of IPO in the month of September, 2007.

The Long term borrowings in form of issue of debentures (Bonds) domestic and international

loans, has risen with a steep rate of 85% over the previous year.

Some amount is also used in repayment of the borrowed short and long term funds.

The amount used as repayment of interest towards the funds borrowed has also increased

by 89%. This is tandem with the rise in borrowed funds which has risen by 85%.

Overall the firm is generating cash from Financing and Operating Activities i.e. from its

normal business course and also from borrowings and using all the funds in Investment

activities like investing in fixed assets and other income generating investments.

Overall the cash balance has increased by 30% over the previous year.

Overall the cash flows are well managed, but the firm is unable to fulfil its requirements

from the operational activities and has to depend on borrowings. But since it is in rapid

expansion stage the borrowings are inevitable.


47

Ratio Analysis

After analysing the balance sheet, the analysis of sources and applications of funds, profit and loss

analysis and also the cash flow analysis, It is per se necessary to also analyse the financial ratios of

the company. The financial analysis as a detached without comparing the figures with each other is

incomplete analysis and will not lead to true analysis. Thus every figure must not only be analysed

over the years but must also be compared with the other components of the same year. It is a tool

used by individuals to conduct a quantitative analysis of information in a company's financial

statements. Ratios are calculated from current year numbers and are then compared to previous

years, other companies, the industry, or even the economy to judge the performance of the

company. Ratio analysis is predominately used by proponents of fundamental analysis.

Some of the important aspects of ratio analysis are to scrutinize the profitability, liquidity, solvency,

as well as the efficiency of the company. Some of the important classes of ratios are:

Liquidity Ratios

Profitability Ratios

Turnover / Activity Ratios

Solvency Ratio

In the following section, the ratios of above mentioned heads foe Power Grid Corporation of India

Limited will be computed for last 5 years from 2004-05 to 2008-09. Also these figures will be

compared with the Industry average. Since there are very few players in the power transmission, the

benchmark of power generation industry has been considered.

Liquidity Ratio

These set of ratios help in analysing the liquidity position of the company. They can be defined as a

class of financial metrics that is used to determine a company's ability to pay off its short-terms

debts obligations. Generally, the higher the value of the ratio, the larger the margin of safety that

the company possesses to cover short-term debts. Liquidity ratios provide information about a

firm's ability to meet its short-term financial obligations. They are of particular interest to those

extending short-term credit to the firm. Two frequently-used liquidity ratios are the current ratio (or

working capital ratio) and the quick ratio.

Current Ratio

The current ratio is the ratio of current assets to current liabilities:

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑅𝑎𝑡𝑖𝑜 = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

Short-term creditors prefer a high current ratio since it reduces their risk. Shareholders may prefer a

lower current ratio so that more of the firm's assets are working to grow the business. Typical values

for the current ratio vary by firm and industry. For example, firms in cyclical industries may maintain

a higher current ratio in order to remain solvent during downturns.


48

Quick Ratio

One drawback of the current ratio is that inventory may include many items that are difficult to

liquidate quickly and that have uncertain liquidation values. The quick ratio is an alternative measure

of liquidity that does not include inventory in the current assets. The quick ratio is defined as

follows:

𝑄𝑢𝑖𝑐𝑘 𝑅𝑎𝑡𝑖𝑜 = 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠 − 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑦

The current assets used in the quick ratio are cash, accounts receivable, and notes receivable. These

assets essentially are current assets less inventory. The quick ratio often is referred to as the acid

test.

The company’s Current Ratio and Quick ratio for the year 2009-10 is 0.79 and 0.77 times

respectively. This infers that the company’s current liability is not covered fully by the current assets.

In case of unforeseen demand for payment from the current liabilities arises, the company will not

be in a position to honour them as it does not has enough current assets. Also the quick ratio is less

than its idle point of 1. The quick ratio considers the quick ratio which can be converted into cash in

a very short term. The ratio less than 1 implies the company is unable to maintain enough

marketable assets to cover the current liabilities. But these ratios must also be compared with the

overall industry standards.

2008-09 2007-08 2006-07 2005-06 2004-05

Current Ratio 0.793768 0.799878 0.577718 0.605015 0.810153

Quick Ratio 0.765338 0.762923 0.54741 0.564984 0.752983

Industry- CA 1.66 1.58 1.48 1.61 1.56

Table 5 Liquidity Ratios

Figure 25 Liquidity Ratios

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

2008-09 2007-08 2006-07 2005-06 2004-05

Liquidity Ratio

Current Ratio

Quick Ratio

Industry- CA


49

After comparing the Current Ratio of Industry and the company along the years, it can be seen that,

the Current Asset ratio of the company is always lower than the standard level of the industry. This

implies that the liquidity position of the company vis a vis the industry standard is poor. Also though

the level fell in the year 2005-06 but has increase over the years after the year 2006-07. The Quick

ratio is also in tandem with the Current ratio implying that the company’s inventory level over the

year is constant. And the gap between these two ratios depicts the inventory position, and it can be

seen that the gap is less over the years, thus the average investment in inventory is very less.

Profitability Ratio

The profitability ratio is useful to measure the profitability of the company. Its ability to generate

returns on the capital invested. These can be understood as set of ratios that are used to assess a

business's ability to generate earnings as compared to its expenses and other relevant costs incurred

during a specific period of time. For most of these ratios, having a higher value relative to a

competitor's ratio or the same ratio from a previous period is indicative that the company is doing

well.

Profitability ratios show a company's overall efficiency and performance. We can divide profitability

ratios into two types: margins and returns. Ratios that show margins represent the firm's ability to

translate sales into profits at various stages of measurement. Ratios that show returns represent the

firm's ability to measure the overall efficiency of the firm in generating returns for its shareholders.

Operating Profit Margin (PBIDTM)

The Operating profit margin helps in determining the ability of the firm to convert what proportion

of the sales into the operating profit. The Operating profit here implies the Profits before Interest,

Depreciation and Tax (PBDIT). It is computed as:

𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟𝑔𝑖𝑛 = 𝑃𝐵𝐷𝐼𝑇

𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠

Alternatively, Instead of taking PBDIT as the Operating profit, PBDT i.e... Operating profit after

deducting the Intrest expenses also needs to be studied in this case, as the company has approx 60%

of its capital structure as borrowings and high proportion of the income is paid as interest. The PBDT

implies Profits Before Depreciation and Taxes.

For the year 2008-09, the PBDITM for the company and the industry standard was 89.08% and

36.37% respectively. And PBDTM for the company and the industry standard was 50.6 % and

28.24% respectively.

The figures for over the years for the company as well as the industry are:

2008-09 2007-08 2006-07 2005-06 2004-05

PBIDTM (%) 89.08 87.44 96.28 90.95 94.16

PBDTM (%) 50.6 58.41 64.52 60.83 61.7

PBIDTM (%)- Industry 36.37 29.96 28.66 37.09 39.73

PBDTM (%)- Industry 28.24 23.7 21.7 28.88 30.84

Table 6 Operating Profit Margins


50

Figure 26 Operating Profit Margins

From the figures it can be stated that the company’s profitability position is excellent. It is able to

maintain margins at a much higher level when compared to the industry standards. The main reason

behind this is the company’s diversified profile. It has not restricted itself to Power transmission, but

has also entered into Consultation and Telecom.

Also the PBIDTM and PBDTM are in tandem for the years before 2007-08. In the year 2007-08, the

PBDTM has decreased disproportionately when compared to PBDITM and the main reason behind

this is the company’s increased borrowing which leads to increased interest payment.

Net Profit Margin

Net Profit margin is the ration of Pat and the Net Sales. PAT implies the Profit before Tax which the

net profit generated after paying all the operating, financial and other charges. It is computed using

the formula

𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟𝑔𝑖𝑛 = 𝑃𝐴𝑇

𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠

The Net profit margin or PATM of the company and also the Industry in the year 2008-09 was at

25.69% and 17.4% respectively.

Cash Profit Margin

Net profit is the residual of Income after deducting all type of expenses. But A net profit generated

need not imply excess cash of that amount is added in the business. The cash profit and Net profit

would differ because there are few non-cash expenses like Depreciation which shall not be

considered in case of computing Cash profits. Thus it is necessary to also study the Cash profit

Margin. It is the ratio of Cash Profits to the Net Sales.

For the year 2008-09 he cash profit Margin of the company along with the Industry average was

42.42% and 24.98% respectively.

The trend of both the above mentioned margins over the years is

0

20

40

60

80

100

120

2008-09 2007-08 2006-07 2005-06 2004-05

Operating Profit Margin

PBIDTM (%)

PBDTM (%)

PBIDTM (%)-Industry

PBDTM (%)- Industry


51

2008-09 2007-08 2006-07 2005-06 2004-05

CPM (%) 42.42 52.3 57.48 55.74 56.81

PATM (%) 25.69 31.39 34.25 32.08 31.26

CPM (%)- Industry 24.98 19.98 19.47 26.96 28.3

PATM (%)- Industry 17.4 13.44 12.31 18.04 18.39

Table 7 Net Profit Margins

Figure 27 Net Profit Margins

In both the cases i.e... Cash profit Margin or The Net Profit Margin, the company figures are better

than the overall industry average. Also the cash profits are more than the Net profits; this shows

that a large amount of non- cash expenditure in way of depreciation and amortization is charged to

the profits.

Return on Capital Employed

Return on Capital Employed (ROCE) is used in finance as a measure of the returns that a company is

realising from its capital employed. It is commonly used as a measure for comparing the

performance between businesses and for assessing whether a business generates enough returns to

pay for its cost of capital. It is computed using

𝑅𝑂𝐶𝐸 = 𝐸𝐵𝐼𝑇

𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 − 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠

The ROCE for the company in the year 2008-09 was 12% as compared to 9.35% of Industry average.

Return on Net Worth

Return on Net Worth (RONW) or popularly known as Return on Equity (ROE) measures the rate of

return on the ownership interest (shareholders' equity) of the common stock owners. It measures a

firm's efficiency at generating profits from every unit of shareholders. ROE shows how well a

company uses investment funds to generate earnings growth. It is computed using the formula

𝑅𝑂𝑁𝑊 = 𝐸𝐵𝐼𝑇

𝑆𝑎𝑟𝑒 𝐶𝑎𝑝𝑖𝑡𝑎𝑙 + 𝑅𝑒𝑠𝑒𝑟𝑣𝑒𝑠

0

10

20

30

40

50

60

70

2008-09 2007-08 2006-07 2005-06 2004-05

Profit Margin

CPM (%)

PATM (%)

CPM (%)- Industry

PATM (%)- Industry


52

The RONW for the company and the Industry average in the year 2008-09 were 11.82% and 9%

respectively. Over the years, the RONW and ROCE trend can be seen from the following table.

2008-09 2007-08 2006-07 2005-06 2004-05

ROCE (%) 12 9.27 9.5 8.95 8.01

RONW (%) 11.82 11.74 11.77 10.65 8.99

ROCE (%)-Industry 9.35 9.09 9.38 8.8 9.44

RONW (%)-Industry 9.97 9.61 10.24 9.38 10.01

Table 8 Returns

EPS

EPS stands for Earnings per share. Similar to RONW which computes the percentage of earnings as

compared to the total net worth; EPS is a measure to determine the profits per share. It is ratio of

Net profits or Earnings Available to equity share holders and the No. of equity shares.

In case of Power Grid Corporation of India Limited there are no preference shares, so the total

earnings would be the earnings available to equity shareholders. And also in the year 2007, a 1

shares was split into 100 shares, thus the EPS needs to be adjusted for that period.

Figure 28 EPS Trend

The EPS of Rs.3.81 on a face value of Rs.10 is a good indicator. Also the EPS has been on a rise

over the years, depicting the profitability of the company.

2008-09 2007-08 2006-07 2005-06 2004-05

EPS 3.81 3.24 3.09 2.6962 2.4018

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

EPS


53

Solvency Ratios

Solvency ratios indicate the risk inherent in the company as a result of its debt. A good financial

analyst will also use solvency ratios to assess the debt profile of a company from its financial

statements, and analyze whether the company needs to undergo debt restructuring exercises such

as mortgage refinancing, debt consolidation, etc. In simple words the solvency ratio implies the

ratios that help investors assess a company’s ability to meet its long-term obligations. They also tell

investors how the company has been financed (debt or equity) and whether that is changing over

time.

Two most used Ratios are Leverage Ratio (D/E) and Interest Coverage Ratio.

Debt- Equity Ratio

Debt-Equity Ratio is one of the most popular ratios used in financial analysis of the company. It

shows how much the entity is trading on equity. It is the ratio of Borrowings and the owned capital.

Though a standard of 2 or 1.5 is considered as optimum, but it also differs based on industry and

business activity of the company. The Debt-Equity ratio of the company as on 31st March 2009 was

1.77. And based on unaudited figures the ratio was 2.11 as on 31st March 20104. Though it is high,

but it can be commented upon without comparing the same with the industry standard. The Debt

Equity of Power Generation Industry for the year 2008-09 is 0.75. But since the company is a Central

Transmitter Unit and also a sole large unit in the power transmission segment thus is into rapid

expansion and growth stage, the borrowings are very high.

The Debt Equity Ratio or Leverage Ratio over the years follows the following trend

Figure 29 Debt Equity Ratio

4 Source: The Information Memorandum of XXXII Issue.

2008-09 2007-08 2006-07 2005-06 2004-05

Debt-Equity Ratio 1.77 1.69 1.64 1.5 1.47

0.75

0.95

1.15

1.35

1.55

1.75

1.95

Debt-Equity Ratio


54

Intrest Coverage Ratio

A ratio used to determine how easily a company can pay interest on outstanding debt. The interest

coverage ratio is calculated by dividing a company's earnings before interest and taxes (EBIT) of one

period by the company's interest expenses of the same period. The formula used is

𝐼𝐶𝑅 = 𝐸𝐵𝐼𝑇

𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑃𝑎𝑦𝑚𝑒𝑛𝑡𝑠

The lower the ratio, the more the company is burdened by debt expense. When a company's

interest coverage ratio is 1.5 or lower, its ability to meet interest expenses may be questionable. An

interest coverage ratio below 1 indicates the company is not generating sufficient revenues to satisfy

interest expenses.

The Interest coverage ratio of the company is 1.88 times for the year 2008-09. And the trend for the

same is as follows:

Figure 30 Interest Cover Ratio

There has been steep fall in the coverage for the year 2008-09. This is mainly because of high

borrowings from the year 2007. And this borrowing has lead to high interest obligation.

Activity Ratios

Activity Ratios, as defined by Investopedia5 are, ‘Accounting ratios that measure a firm's ability to

convert different accounts within their balance sheets into cash or sales’.

Asset turnover ratios indicate of how efficiently the firm utilizes its assets. They sometimes are

referred to as efficiency ratios, asset utilization ratios, or asset management ratios. Three commonly

used asset turnover ratios are receivables turnover and inventory turnover and Fixed assets

Turnover ratio.

5 http://www.investopedia.com/terms/a/activityratio.asp

2008-09 2007-08 2006-07 2005-06 2004-05

Interest Cover Ratio 1.88 2.29 2.3 2.23 2.11

1.5

1.75

2

2.25

2.5

Interest Cover Ratio

http://www.investopedia.com/terms/a/activityratio.asp


55

Receivables Turnover Ratio

Receivables turnover is an indication of how quickly the firm collects its accounts receivables and is

defined as follows:

𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜 = 𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑐𝑐𝑜𝑢𝑛𝑡 𝑅𝑒𝑐𝑖𝑒𝑣𝑎𝑏𝑙𝑒𝑠

The receivables turnover often is reported in terms of the number of days that credit sales remain in

accounts receivable before they are collected. This number is known as the collection period. It is

the accounts receivable balance divided by the average daily credit sales, calculated as follows:

𝐷𝑒𝑏𝑡𝑜𝑟𝑠 𝐶𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑜𝑛 𝑃𝑒𝑟𝑖𝑜𝑑 =365

𝑅𝑒𝑐𝑖𝑒𝑣𝑎𝑏𝑙𝑒𝑠 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜

The Receivables Turnover ratio and the collection period for the company for the year 2007-08 are

5.32 times and 68.6 days respectively. This implies that on average debtors are converted into cash

in approx 69 days.

Inventory Turnover Ratio

Another major asset turnover ratio is inventory turnover. It is the cost of goods sold in a time period

divided by the average inventory level during that period:

𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜 = 𝐶𝑂𝐺𝑆

𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦

The inventory turnover often is reported as the inventory period, which is the number of day’s

worth of inventory on hand, calculated by dividing the inventory by the average daily cost of goods

sold:

𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑃𝑒𝑟𝑖𝑜𝑑 =365

𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜

The Inventory turnover ratio and the inventory holding period for this company for the year 2007-08

are 24.09 times and 15.15 days respectively.

Fixed Asset Turnover Ratio

This ratio depicts the ability of the entity to convert its fixed assets into cash (Sales). A financial ratio

of net sales to fixed assets. The fixed-asset turnover ratio measures a company's ability to generate

net sales from fixed-asset investments - specifically property, plant and equipment (PP&E) - net of

depreciation. A higher fixed-asset turnover ratio shows that the company has been more effective in

using the investment in fixed assets to generate revenues. It is computed using the formula

𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜 =𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐹𝑖𝑥𝑒𝑑 𝐴𝑠𝑠𝑒𝑡𝑠

𝑆𝑎𝑙𝑒𝑠


56

The ratio for the year 2008-09 is 0.17 times. This is a very low figure, but since the firm is a capital

intensive and has projects which are of longer gestation, so this figure can be justified.

The trend in the above discussed ratios over the years is summarised in the following table

Turnover Ratios 2008-09 2007-08 2006-07 2005-06 2004-05

Receivables 5.32 5.8 8.8 8.1 5.37

Collection Period 68.60902 62.93103 41.47727 45.06173 67.9702

Inventory 24.09 21.34 19.7 17.26 13.19

Inventory Holding Period 15.15152 17.10403 18.52792 21.14716 27.67248

Fixed Assets 0.17 0.14 0.13 0.13 0.12

Table 9 Turnover Ratios

Capital Market Behaviour

Since the shares of the company are listed on the stock exchanges and are also actively traded, it is

per se necessary to also analyse the behaviour of share prices. Some of the important ratios that can

be computed and analysed are P/E Multiple, Beta etc...

P/E Multiple

The P/E stands for Price to earnings Ratio. It signifies the relationship between the market price per

share and earnings per share. It can be computed using formula

𝑃/𝐸 =𝑀𝑃𝑆

𝐸𝑃𝑆

The P/E of the firm as on 31st Dec 2009 was 21.80. This implies the investor is willing to pay Rs. 21.80

for 1 Re of current earning.

In general, a high P/E suggests that investors are expecting higher earnings growth in the future

compared to companies with a lower P/E. However, the P/E ratio doesn't tell us the whole story by

itself. It's usually more useful to compare the P/E ratios of one company to other companies in the

same industry, to the market in general or against the company's own historical P/E. It would not be

useful for investors using the P/E ratio as a basis for their investment to compare the P/E of a

technology company (high P/E) to a utility company (low P/E) as each industry has much different

growth prospects.

Over the years the P/E has been


57

Figure 31 P/E Ratio

Beta

Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the

market as a whole. Beta is used in the capital asset pricing model (CAPM), a model that calculates

the expected return of an asset based on its beta and expected market returns... It is also known as

beta coefficient.

Beta is calculated using regression analysis, and you can think of beta as the tendency of a security's

returns to respond to swings in the market. A beta of 1 indicates that the security's price will move

with the market. A beta of less than 1 means that the security will be less volatile than the market

and beta of greater than 1 indicates that the security's price will be more volatile than the market.

The result of regression for Sensex Returns and Power Grid Corporation of India Limited’s shares

returns from 8th October 2007 to 31st April 20106 is as follows:

SUMMARY OUTPUT

Regression Statistics

Multiple R 0.664819

R Square 0.441985

Adjusted R Square

0.441074

Standard Error 0.022539

Observations 615

Coefficients Standard Error

t Stat P-value Lower 95% Upper 95%

Intercept 0.000388 0.000909 0.42683 0.669653 -0.0014 0.002173

Return-Market 0.839983 0.038121 22.03489 1.08E-79 0.76512 0.914845

Table 10 Regression Output

6 The data has been uploaded on online appendix. Please refer the Appendix page

21.00022.00023.00024.000

Sep-2008 Dec-2008 Mar-2009 Jun-2009 Sep-2009 Dec-2009

Sep-2008 Dec-2008 Mar-2009 Jun-2009 Sep-2009 Dec-2009

P/E 23.124 22.654 22.861 23.611 23.085 21.807

P/E


58

And the residual plot for the same is

Figure 32 Residual Plot for Beta

From the above results we can see that The Company’s shares are Low beta at 0.84. This implies for

every 1 percent change in the market returns (here Sensex), the returns on shares of the company

will change by 0.84 percent in the same direction.

Also the R-Square, which is 0.442, implies the 44% variations in the share price are explained by the

known factors that are due to market variations. In simple words 44% of the variations are

explained.

y = 0.84x + 0.0004R² = 0.442

-0.2

-0.15

-0.1

-0.05

0

0.05

0.1

0.15

0.2

0.25

-0.15 -0.1 -0.05 0 0.05 0.1 0.15 0.2

Residual Plot


59

Chapter III

Procedure of Bond

Raising

Steps in Issuing Bonds

Dematerialisation

Listing Process

Debt Servicing


60

Steps in Issuing Bonds

To understand the procedural aspects and legal aspects in raising bonds and also to have practical

exposure to actual raising process, a study of steps in issuing bonds is per se indispensible.

The need for funds is determined based on Cash flow projections of the year. The amount to be

financed by means of bonds is determined.

The process of raising funds though bonds start with:

Board Approval

A board meeting at beginning of the year is held where authority to raise loan by means of Bonds is

provided to the concerned person. The MoU between Ministry of power and PGCIL is also

considered. The Committee of Directors for Bonds is appointed and the authority with respect of

issuing of Bonds and all matters related to it are provided to the same by BoD. This is meeting is held

at the beginning of the financial year or at later date if needed.

Shortlist of Arrangers

The process of issue starts by selection of arrangers. The arrangers are similar to Merchant bankers

in the case of Bonds issue; they facilitate the process by bringing Investors for the issue. In Case of

PGCIL, the arrangers are selected based on Past records and their past participation. The arrangers

are selected based on their Rankings in PRIME Database. The rankings are allotted to the arrangers

based on their history of performance. The criteria for ranking is based on

Amount Arranged in between a period

% of Total issue being arranged by that particular Arranger

No. of issues being participated by the arranger.

This data can be generated from the website http://www.primedatabase.com/ by creating League

Table of arrangers. It provides Ranks to the arrangers based on the period selected by the user. From

the results top 10 or top 5 or the number as required are shortlisted.

Meeting of Committee of Directors for Bonds for Engagement of Arrangers

The meeting with Committee of Directors of Bonds (will be referred as Committee henceforth) is

held with the purpose to appoint the arrangers... The following points are covered in the Minutes of

Meeting prepared for the purpose of meeting:

Authority to raise loan of Amount Rs........, as approved by Board of Directors in the

General meeting in one or many trenches.

Approval that Committee may engage Merchant bankers of Power Grid IPO as

Arrangers for this issue too

Estimation of cash requirement and amount of Loan to be raised based on Cash

Flows (Actual and Projections)

http://www.primedatabase.com/


61

Appointing the shortlisted arrangers and also addition of other arrangers or

rejection of exiting from the list.

Thus shortlisted arrangers are invited and were also asked to quote for Arrangers fees

The Received quotes in sealed Envelope which is kept highly confidential and shall

be opened by a committee which has:

One representation from Corporate Finance

One representation from Company Secretariat

One representation from Corporate Planning

In case of any variation in fees, the arrangers are asked to match their fees with the

fee quoted by L-1 bidder. (Here L-1 implies the arranger biding lowest rate)

The arrangers fee (which is common for all arrangers) shall be charged on Amount

allotted by the issue and can be shared among the Arrangers.

The PGCIL proposes to appoint a minimum no. of Arrangers for each issue based on

the requirement.

The decisions on Appointment of arrangers, their fees etc shall be authorised by the

Committee

Thus the above points are discussed by the committee. This Minute of Meeting is signed by

Committee of Directors for Bonds.

Invitation for Quote to selected Arrangers

After the approval by the committee on the selection of arrangers, an invitation letter is sent to the

arrangers. Some of the important contents of the letter are

The details on Issue Size, type of issue, type of debentures and proposed time of

issue. In this case it was Issue of Non Convertible, Redeemable, Taxable, and

Secured Bonds of PGCIL.... issue, the issue size being Rs..... Crores with a green shoe

option. And the type of issue being private placement and the proposed time.......

The arrangers shall be registered with SEBI

Intimation of appointing them as arrangers for the issue and also requesting them to

quote for the Arrangers fees as percentage (%).

The address of Issuer to whom the quote letter/ acceptance letter shall be mailed or

sent by courier in a closed envelope is also mentioned

The deadline by which the letters shall be reached is also mentioned.

The time of opening the letters was also mentioned.

The invitation letter shall in no way construed as indication for appointment.

This letter is mailed to the shortlisted arrangers.

Letter of Acceptance with Quotes by the Arrangers

The arrangers after receiving the Letter of appointments reply back their acceptance and also their

quote for Arrangers fees on their Letter head. The received letters are then reviewed and based on

the quote for the arranger’s fees, the arrangers quoting lowest fees are selected, keeping the


62

number of arrangers up to the minimum number as permitted by the committee. In case if similar

bids are not received, the arrangers are asked to come in consensus with the L-1 bidder.

The reply letters along with the envelope is documented.

Recommendation of Bid Opening Committee

After the quotes are received, the envelopes are opened by the committee formed for this purpose

having 3 persons, one from Corporate Planning, Company Secretariat and Corporate Finance each.

The committee, based on the quotes for arranger’s fee as quoted by the arrangers, will recommend

the final arranger fee and also the selected arrangers.

These Recommendations are to be signed by the members of the Committee formed for opening

the Envelopes and also by The Committee of Directors of Bonds.

Letter of Appointment to the Arrangers

Based on the recommendations of the Bid Opening committee and henceforth approved by the

Committee, the letters of appointment is sent to each of the selected arranger. The letter usually has

following points:

Intimation of appointing them as the arranger

Also the names of co-arrangers

The Arrangers Fee approved by the Committee

Also a request to meet for the discussion on Issue Structure, Programme and Timing

of the issue

A request to reply back the acceptance by sending back the duplicate copy of the

letter with duly acceptance.

Meeting with Arrangers

A meeting with the Arrangers is held at Power Grid Corporate office, Gurgaon to discuss the issue

structure, plan of issue, the discussion on timing, the Intrest rate, Cap and Floor rate, etc... . In this

meeting based on the Current G-Sec yield, Corporate Bonds yield and spread, Liquidity conditions in

market, RBI policies, Issues of other corporate and PSUs, etc... The arrangers suggest the interest

rate band depending upon the interest band as fixed by other PSUs whose issues are live in the

market. Usually the Cap rate is fixed and the floor rate is kept open to take advantage of market

condition.

Letter to Trustee

A letter is sent to the Trustee who can act as Trustee for the Bondholders of the present issue. The

letter has the details of the issue like security details, issue size etc... Also a request is made for

consent for acting as Trustee. A draft consent letter, which the Trustee shall reply back for

communicating the consent of approval, is attached with the letter. The Trustee is acting as IDBI


63

Trusteeship since XII issue of Bonds7. Though the same Trustee is appointed for every issue, but a

separate letter is to be sent for each issue.

Letter to Banker

A letter is sent to the proposed Banker who can act as Banker to the Issue. The letter has the details

of the issue like security details, issue size etc... Also a request is made for consent for acting as

Banker to the Issue. A draft consent letter, which the Banker shall reply back for communicating the

consent of approval, is attached with the letter. The Indian Overseas Bank acts as the banker to

issue.

Letter to Registrar and Transfer Agent (RTA)

A letter is sent to the Registrar who can act as Registrar for an issue. The letter has the details of the

issue like security details, issue size etc... Also a request is made for consent for acting as RTA. A

draft consent letter, which the Registrar shall reply back for communicating the consent of approval,

is attached with the letter. The RTA for Power Grid Corporation of India Limited Bonds is MCS Ltd.

Letter to Credit Rating Agencies

As per SEBI’s guidelines with respect to issue of debentures and also with respect to Disclosures, an

issuer must get credit rating from at least two credit rating agencies and shall also communicate the

rating in the Information memorandum. Thus a letter to Credit rating agencies is sent for

Revalidating the Credit rating which was assigned by the respective Credit rating Agency before. The

letter has the issue details, the details of the security, issue size, etc... The details of rating provided

at beginning of the year along with the loan amount are also shared (backed by the reference to the

letter no. and letter date). A request is made for the issue of fresh letter of credit rating.

The Power Grid Corporation of India Limited takes the rating from 3 agencies namely, ICRA, CARE

and CRISIL.

Letter from Trustee

A consent to act as Trustee, specifying the issue details is sent to BoD by the trustee. The content is

same as provided by issuer as draft letter. Trustee also authorises the issuer to forward the letter to

NSE or any stock exchange where bonds will be listed

Letters from Credit Rating Agencies

Revalidation letters from credit rating agency are received. The letter has reference to previous

letter from issuer. It also confirms the rating of the security to be issued. It has following conditions:

Rating specific to terms and conditions of the specific issue.

Any change shall be brought into notice of the rating agency.

Right to suspend, withdraw, or revise the rating at any time on the basis of new

information or unavailability of any information.

Rating should not be treated as recommendation to buy.

7 Prior to this, Indian Overseas Bank acted as the Trustee


64

Any information on delay/default in payment of interest shall be timely

communicated.

The letter also has a condition that if the instrument rated is not issued within 10 months in case of

ICRA or 6 months in case of CARE and CRISIL, then the rating would stand withdrawn.

Letter from Banker

A consent to act as the Banker to issue, specifying the issue details is sent to BoD by the banker. The

content is same as provided by issuer as draft letter. Trustee also authorises the issuer to forward

the letter to NSE or any stock exchange where bonds will be listed.

Letter to Banker

After receiving the consent of acting as banker to issue, a letter is sent to banker is sent by the

issuer. The letter has details such as issue size, reference to the consent letter, and details of

payment specifications. The letter also mentions the proposed collection centres and a request is

made to inform the respective branch heads of the collection centre to make necessary

arrangements. A request for intimating the branch head to collect the cheques in high value clearing

zone is also made in the letter.

Declaration by Board of Directors

A declaration by the Directors undertaking that No statement made in Disclosure Document is

contrary to the provisions of Companies Act, 1956 or SEBI Act, 1992 or rules made there under or

guidelines/ Notification issued.

This declaration is signed by the Board of Directors. The Board consist of

Chairman and Managing Director

Director (Finance)

Director (Operations)

Director (Projects)

Request letter to NSE for in Principle Approval

After preparing the Draft Disclosure document, a request letter to National Stock Exchange for In

Principle Approval of getting the Bonds listed in WDM (Wholesale Debt market) of NSE. The letter

has following details

The proposed date of issue

The Issue Size, type of issue,

Enclosures: Draft Disclosure Document and also a digital copy of the document in

PDF format for the purpose of uploading the same on website

Intimation of sending the final copy of Disclosure Document in due course time

Undertaking that Disclosure Document being prepared in compliance with

Notification dated 6th December 2008 issued by Securities Exchange Board of India

(Issue and Listing of Debt Securities) regulations 2008.


65

Undertaking that company will execute the new listing agreement with NSE after the

allotment is done

And finally a request for an In-Principle approval.

In-Principle Approval from NSE

The National Stock Exchange issues the In-principle Approval to PGCIL for the issue. The In-principle

approval is approval that the bonds may be listed on the exchange but it is a conditional approval

and not a commitment. Only on fulfilment of all compliances and conditions the bonds will be listed.

The letter has

Intimation of Grant of In principle Approval with specifying Nature of Bonds, Face

Value and Issue Size

Also the conditions for Listing and provisions of Securities Exchange Board of India

(Issue and Listing of Debt Securities) regulations 2008.

Draft- Disclosure Document

Covering Letter to Disclosure Document to Arrangers

A covering letter to Draft Disclosure Document is sent to the arrangers. Also Application forms and

Letter of commitment (Draft) is sent to the Investors. According to Sec 67 of Companies Act, not

more than 49 can participate in case of Private Placement. Thus only 49 application forms are

printed and 4 applications are sent to each arrangers and the rest are kept by Power Grid. These are

issued to the arrangers in case of further requirement.

Letters of Commitment

It is a Letter given by Investors to the Power Grid on their letter head. The draft of the same is

provided by the Power grid. This letter has an undertaking that a specific number of bonds shall be

applied by the Investor at a particular rate when the issue is made and bonds are allotted. It is an

irrevocable commitment. In the letter a commitment to invest number of bonds, minimum of 10

bonds and a multiple of 5 thereafter,

@ Coupon Rate (it can be any rate between the spread i.e... Floor and Cap rate)

@ rate higher than the coupon rate

OR

@ Cut-Off rate

The letter also has an undertaking by Investors to pay for the bonds allotted in form of Cheque/

Demand draft (High Value Clearing) or RTGS

The Investors shall send their bids to the Power Grid by means of Fax or in person in between the

Issue open and Issue Closing time.

The offer cannot be revoked unless superseded by a subsequent letter from the investor before the

closing of the issue.


66

Book Building

For the purpose of determining a Cut-Off interest rate at which the bonds shall be issued, a Book

Building procedure is carried out. A work sheet with details of all the bids of investors is prepared.

The Worksheet has the following information:

Date of Bid

Name of the Investor

Form No.

Name of the Arranger

Amount that will be invested at different rates

Cut Off Rate

Cap Rate

Floor Rate

Different rates within the spread

Total Amount of Investment

While Recording the Bids, the same bid amount shall be recorded under all the interest rates at and

above the quoted rate by the investor. The rationale behind this is since he is ready to invest an

amount at a quoted rate; he will be ready to invest the same amount at a higher rate. For Instance, if

a firm X quoted for 30 Bonds i.e... Rs 45 Crs @ 8.7%, the amount Rs 45 Crs will be recorded under

the interest rates 8.7%, 8.78% and also 8.8%

Also if an investor quoted an amount under Cut-Off rate, the amount shall be recorded under all the

interest rates since he is indifferent to invest at any rate. For Instance a firm Y quoted 20 Bonds i.e...

Rs 30 Crs at Cut-Off rate, then the amount Rs 30 Crs shall be recorded under all the interest rates

i.e... 8.6%, 8.65%, 8.7%, 8.78% and 8.8%.

In case of a revised bid, the previous bid is stroked off and the new offer is recorded.

The rate under which the maximum amount is being invested is apportioned as Cut-off rate. This is

the rate at which the bonds will be issued.

In case if the issue is over-subscribed i.e... Exceed the limits then the allotment is bone in the

following order:

Full allotment to the Investor quoted lowest coupon rate

The investors quoting at the Cut-Off rate

For investors investing at a same coupon rate, earlier bid will be allotted first

In case of a tie with respect to coupon rate and also the date of bid, the allotment is

done pro-rata basis.

Agenda for Meeting of Committee of Directors for Bonds

After determining the cut-off rate and list of investors, the Committee of Directors for Bonds meets.

Following points are to be discussed in the meeting.

Details of the arranger’s fee


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Names of the Arrangers

Summary of the Investors and their Investments

Summary of proposed Allotment

Also decision on form of allotment. Here it is done in D-Mat (electronic Mode)

Letters to Arrangers

After the allotment is approved by the Committee, a letter to all the arrangers is sent. It has

Information on Applications

Allotment Details

Requesting them to intimate their investors for filling and submitting application

along with the application money.

Also the payment details like payment shall be made by Cheque/demand drafts or

RTGS by the.......... (Deadline date)

The cheques/ DDs shall be of High value clearing

Also the Account details and IFSC Code of Banker to Issue is communicated for the

purpose of RTGS payment. The account details are “Power Grid Corporation of India

Ltd. C.A. No. 1408 Bonds XXX-Issue”8 and IFSC Code of Banker to Issue, here, Indian

Overseas Bank, and Parliament Road, New Delhi is IOBA0000762

Also the Annexure of list of investors along with the allotment details is

communicated

The report of facsimile sent to the Arrangers is also documented.

Letters to Investors

An intimation letter to each investor to whom the allotment is done is sent. Also request is made to

send their application forms along with the Application money. It has details on Allotment, the Cut-

Off rate of Interest, Payment details, the last date for payment etc... In case if an Investor makes

payment by means of RTGS, only the application letter can be sent to Power Grids Office through the

arrangers. This letter is Carbon Copied to the respective arrangers of the Investors.

Details from Banker to Issue

After the pay-in date i.e... Last date for payment of application, the banker to issue communicates

the receipts of funds with specific to the issue. It provides details of Funds received Towards the

Issue Account along with the date of receipt.

Final Allotment Meeting

The agenda for this meeting is:

Details of the allotment

Details on Mutual funds participated

Any material issue

List of the Investors with the allotment details

8 The name of account for each bond series differs


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Dematerialization Process

As per SEBI Guidelines all the securities in form of equity or debt shall be issued only in De-Mat (read

dematerialised) form. Thus it is per se indispensable to understand the process of dematerializing

i.e...converting the securities into electronic form.

The process starts by:

Tri-Partite Agreement between Depository, Issuer and RTA

A Tri-Partite agreement between each depository and RTA and issuer is entered before an issue.

Once signed agreement will; be valid for all the issues unless any change in Terms or change in the

party or any new regulations is made. Two agreements each with NSDL and CDSL are made. The RTA

(Registrar and Transfer Agent) is MCS services.

Letter to NSDL and CDSL

A letter is sent to the depository, here, National Securities Depository Limited (NSDL) and CDSL

(Central Depository Services Limited) with a request to allot ISIN (International Securities

Identification Number), an unique identification number, for the securities to be issued. The Details

of STRPPs are also communicated since each STRPP has different maturity period and thus will have

different ISIN code. The Pay-In date and also the deemed date of allotment is mentioned. This

communication is mailed before the closing of books. The MCF (Master file Creation Form) for the

purpose of allotment of ISIN code is also attached. Intimation that the Corporate Action file shall be

sent separately is also made. A true copy of extract of resolution approved by the Committee of

Directors for Bonds is also attached.

The ISIN code is a 12 digit Alpha-Numeric code. The first three characters are alphabets which

represent the Nation of Origin (for Indian securities it is INE), the next five characters are issuer

specific (like 752E0 for Power Grid and 002A0 for Reliance Industries) and the last four are specific to

characteristics of security like Equity, Secured Debentures, and Maturity etc...

The MCF file has details like Name of the Entity (issuer), contact details, security details, debenture

trustee details, type of placement, issue size, stock exchange details, registrar details etc…

Some of the attachments along with the letters are:

Articles of Association of the firm

Memorandum of Association

Certificate of Incorporation and Certificate of Commencement

Audited Accounts of last three years

Trust deed

Offer Document (Disclosure Document)

In-Principal approval for Listing from NSE

Copy of board resolution


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Corporate Action

A request is made to execute the corporate action to the credit the following securities to the

accounts in NSDL. The details provided are ISIN of securities, Allotment date, Security description,

face value per security, and Distinctive number. Since no security is being issued in physical form

there will not be any distinctive number...

Also allotment details like number of securities and number of records with NSDL, CDSL and Physical

form are also shared.

Undertaking that all the necessary approvals have been obtained is also mentioned. The resolution

by the Committee and ISIN wise details of securities is enclosed along with the letter.

Letters from NSDL and CDSL

Reply letters from both the depositories are received. It communicates that as per the Corporate

Action executed, the details of Bonds credited/debited on the systems. The details like ISIN, ISIN

Description, Records, Quantity, and Execution date are communicated to the issuer. The records are

number of distinct entities holding the security.

Details of Demat Allotment

The allotment details of the issue are prepared by the issuer for the purpose of records. Details like:

ISIN

Name of the Investor

Details of Security (STRPP wise)

Date of allotment

Date of Maturity

DP name

DP Id

Client Id

No. of STRPPs of that particular STRPP (A-L)

Total amount for that particular STRPP (i.e...Rs. 12.5 lacs X No. of STRPPs)

House/ Non House (House implies Investor and the DP are same)


70

Listing Process

All the bonds issued by the company are listed with NSE under WDM segment. Since the bonds can

be listed only after they are issued and allotted to the investors, they are issued as proposed to be

listed to the investors.

The short summary of listing process is as follows:

Approval for Listing Agreement with NSE from Board

Listing Agreement with PGCIL and NSE

Letter to NSE (Undertaking)

Letter to NSE (Fees details)

Letter from NSE (Intimation of Listing)

Letter to NSE (Covering letter for Trust Deed)

The process of Listing starts with the In-Principle Approval from NSE taken before issuing the bonds.

The In-principle approval signifies that the bonds shall be listed after they are allotted on an

condition that, all the procedurals, policies and guidelines are followed.

After the shares are allotted, approval is taken from the Board for the [purpose of creating a listing

agreement with NSE. The Listing Agreement is signed on a stamp paper. It has all the clauses,

undertakings and policies with respect to the listing guidelines as mentioned by SEBI. This agreement

is to be signed by The Board and also by the company secretary.

After the listing agreement is signed, this agreement along with the application form, the company

contact details, the details of Bond structure and also the STRPP details are to be attached.

A checklist is provided by the NSE, to ensure that all the formalities have been furnished and also all

the required documents are attached with the application form.

Along with the Listing agreement and the application form, a separate letter is sent to NSE stating

that:

Undertaking that all the guidelines as issued by SEBI (Issues and Listing of Debt Securities),

Regulations, 2008, provisions of Companies Act, 1956 have been followed.

Undertaking that Trust deed has not yet been executed and shall submit the true copy as

soon as it is done.

Also an undertaking that the Offer document has been prepared as per SEBI ( Issues and

Listing of Debt Securities), Regulations, 2008

Apart from the above documents, a separate letter is sent to NSE regarding the Fee details. The

letter has the details of the previous listings of PGCIL Bonds, details of present listing along with the

maturity value, date of allotment etc... And since the fees is paid at the maximum cap of Rs. 7.5 Lakh

in advance, no further fees is needed to be paid for the present listing. Also a request is made to list

the present issue of bonds at WDM segment.


71

After, all the documents are submitted to NSE and all the formalities are fulfilled; an Intimation

letter from NSE is received stating that, the securities as specified in the agreement are duly listed

on WDM segment with effect from a date as mentioned.

After this the bonds are listed on the WDM segment of NSE and the investors are allowed to trade.

And NSE provides the monthly statistics of for daily price and the volume.

But after the trust deed is executed, a covering letter along with the Trust deed is sent to the NSE.


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Debt Servicing

The bonds are issued with a specific payment structure pre defined at the time of issue and

mentioned in the offer document/ information memorandum. For instance a bond may be issued

with the structure as Intrest paid half yearly with 3 years moratorium and 10 equal instalments. In

this case the Bond is divided into 10 STRPPs (Separately Transferable Redeemable Principal parts)

redeemable each year after 3 years of the issue. And the interest is paid on every 6 months on the

amount outstanding.

Also the interest payment and redemption date are also pre determined. Usually both the dates are

kept as the date on which the bonds are issued. The issue date of the bond series becomes its Intrest

and principal payment date.

By and large, the company issues its bonds with following structure:

3 year moratorium period + 10 equal instalments

1 year moratorium + 5 equal instalment

4 year moratorium + 12 equal instalments

5 years moratorium + 10 equal instalment

As on 31st of March, 2010, the total number of Bonds outstanding was 26, from series No.VI to XXXI,

(excluding the series no. VII), which is redeemed.

Thus the company has regular interest payments and principal payments scheduled over the year

depending upon the issue date. (The details of each bond along with the coupon rate, payment

structure and payment date has been made available in online appendix)

Before understanding the process, some of the terms need to be mentioned

Record Date

The bonds of the company are listed on NSE- WDM (Wholesale Debt market) Segment and are

traded. Thus the holding changes after every trade. For the purpose of payment of interest and

redemption of STRPPs, the book of transfers is closed a month before the scheduled interest

payment date. And the BO position as on the record date is considered and the interest is paid to

the holder on or before the Record date.

BO Position

The Beneficiary Owner position is the list of beneficial owners to whom the interest is to be paid. It

may or may not be the list of actual owner. For instance a person holding the security on record date

will be included in the BO position statement though he sells it after the record date. This position is

provided by the registrar to the company on record date of each issue.


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Registrar

Registrar and Transfer agent is the party who records all the transfers took place. He is expected to

maintain a register of holders of each Bond along with the STRPP details and should update the

register after every transfer taking place. He is also required to provide the BO Position statement

whenever company asks for it.

Demat and Physical Holding

SEBI has necessitated that, all the issues of fresh equity and debentures must be in Demat Form. The

Demat (Dematerialised) implies in digital form instead of physical form. In this case the bonds are

traded electronically through the route of depositories. But the initial issues of bonds till XII issue,

the bonds were issued in Physical form i.e... In form of Physical Bond certificates. In this case the

transfers take place at individual level and the information is provided to the Registrar by either of

the investor.

Depository

Depository as the name signifies, it acts as the depository of the physical certificates of the

dematerialised securities. It is reservoir of the physical securities and issues dematerialised securities

replacing the physical form. And also it acts as the central body for transferring the securities into

different accounts based on the trading takes place. In India the two central depositories are

National Securities Depository Limited (NSDL) and Central Depository Services (India) Limited (CDSL).

Depository Participant (DP)

Depository Participant is similar to a commercial bank, if the Depository is regarded as Central bank.

It acts as the middleman between the investor and the central depository. It facilitates the trades of

his clients and holds his securities in Demat form on his behalf and maintains an account. The DPs

can be commercial banks, private brokers, Broker institutes etc... Some of the DPs in India are ICICI

Bank, Religare Securities, Motilal Oswal Securities Ltd., and Anand Rathi etc...

DP ID

The DP ID is the unique identification of each Depository participant. As similar to Bank code

required for a banking transaction, DP ID is requisite for any transaction in securities in Demat form.

Client ID

As mentioned before, each DP has clients. These clients are normal investors including individuals,

corporations and associations etc... The client ID is unique account number for the Demat account of

each client. This number is required for transferring securities in the clients account.

IFSC Code

The IFSC code stands for Indian Financial System Code. It is a unique code for each financial

institution in India. It is an 11 digit code, of which the first 4 represents bank code; the fifth character

is at present ‘0’ for all, which may be changed for further codes. The next 6 characters represent the


74

Branch code. This unique code is used for reference of each branch of a bank. It is used for purpose

of Fund transfers in case of RTGS payment.

RTGS and NEFT

RTGS stands for Real Time Gross Settlement. The funds between banks can be transferred by way of

NEFT (National Electronic Fund Transfer) or RTGS. In case of NEFT, there is limitation in way of

transfer of funds. NEFT settlement takes place 6 times a day during the week days (9.30 am, 10.30

am, 12.00 noon. 1.00 pm, 3.00 pm and 4.00 pm) and 3 times during Saturdays (9.30 am, 10.30 am

and 12.00 noon). Any transaction initiated after a designated settlement time would have to wait till

the next designated settlement time.

RTGS system is a funds transfer mechanism where transfer of money takes place from one bank to

another on a "real time" and on "gross" basis. This is the fastest possible money transfer system

through the banking channel. Settlement in "real time" means payment transaction is not subjected

to any waiting period. The transactions are settled as soon as they are processed. "Gross settlement"

means the transaction is settled on one to one basis without bunching with any other transaction.

Considering that money transfer takes place in the books of the Reserve Bank of India, the payment

is taken as final and irrevocable. But in case of RTGS, the funds are transferred on Gross basis, i.e...

Funds are transferred as soon as the fund is received. But RTGS can be used only in case if amount

exceeds Rs. 1 lakh.

PAN

PAN stands for Permanent Account Number. It is unique code allotted by Central Board of Direct

Taxes (CBDT) for each tax payer. According to CBDT, the PAN number should be disclosed for all the

transactions exceeding Rs. 50,000. PAN is a 10 digit code of which the first five are Alpha, the next

four are Numerical and the last is an alphabet. And of these, the fourth character represents the

type of assessee. According to Income Tax Act 1961 Assessee is a' as a person by whom any tax or

any other sum of money is payable under this Act, and includes - Company (C), Association of person

(A), Person (P), HUF (H), Trust (T), Government (G). And the fifth character can be the last name of

the surname in case of person or the first name of the entity in case of company or association or

rest.

UTR No.

UTR stands for Unique Transaction Reference number. It is generated in case of a RTGS Transaction.

It is a 16 digit unique code used for future reference of any NEFT/ RTGS Transaction.

After understanding the above discussed terms, the Debt Servicing process can be understood

easily. The process of debt servicing starts with:

Master RTGS File

A Master RTGS file is maintained by the company which has details of all the investors of all the

bonds. It includes the details of all the previous as well as current investors. And the data required


75

for payment of interest like IFSC code, Account No. etc are taken from this file. The file has details

like:

Index No. : Unique no. for each investor for easy reference

Name of the Investor or Beneficiary

Bank name

IFSC code of the Bank Branch

Branch Name

Account Number of the Investor

MICR code

Contact person and his email and phone number

PAN Number

DP ID and

Client ID

BO position from RTA

After the record date of each issue, the BO position of that issue is requested from RTA. For Instance

for the issue XXV, whose interest payment is due on 12th June, the BO Position is asked from the RTA

in month of May. The BO position for Demat is provided in a digital copy and for the physical holding

(Remat) the statement is provided in a physical format. The details like DP Id, Client ID, name of the

Investor and his holdings are provided in the BO Position.

Checking the Availability of Details if the Beneficiary

After receiving the names of beneficial owners to whom the interest is to be remitted, the required

details for remitting the amount like IFSC code, Account Number, Bank and its Branch etc... are to be

gathered. For this purpose, first the Master RTGS file is referred to collect the data.

Call for Details

In case if the details of the BO are not available in the Master RTGS file, then in that case, a letter or

email is sent to the BOs asking for the details like Bank Name, Branch name, IFSC Code, Client ID, DP

ID, Account Number, PAN, Contact person and his contact number and email, etc...

The received details in reply from the BOs are indexed and the Master RTGS file is updated. In some

cases even after the letter or email, the BO does not respond, thus calls are to be made to them to

get the details.

List of Beneficiaries is sent to Bank

The list of beneficiaries to whom the interest and principal repayment is given to the banker with the

details required for RTGS or payment through cheque. The amount to be paid is also mentioned and

a cheque for the lump sum amount is given to the banker. The banker takes the responsibility of

remitting the funds to individuals as per the list given to it. IDBI bank acts as the banker for remitting

the funds.


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The company directs the Bank to remit the funds mostly by RTGS because it is most economical

method and also the safest and quickest mode of transfer. And also since most of the cases the

payment exceeds rs.1 lakh making the RTGS possible. Sometimes even NEFT mode is also used.

In case if the Beneficiaries Branch does not have RTGS facility or if he is unable to provide IFSC

details and wishes to receive the amount by cheque, post dated cheques are sent to such investors.

Payment Details from Banker

After the payment is made, the Bank provides the payment details for each issue separately under

RTGS and through cheque. It provides details like UTR No., Amount, Instrument status as in whether

the schedule has been generated or not, and Beneficiary description, beneficiary’s Bank and branch,

IFSC code etc... in case of RTGS payment.\And in case if payment is made through cheques, the

details like Beneficiary name, Instrument Number ( the cheque number), Instrument amount,

Instrument date, Instrument status and liquidation date. The status may be paid or Unpaid

depending upon the encashment of the cheque. The status remains unpaid till the cheque is

presented for payment by the beneficiary’s bank or till the cheque is expired.

Reconciliation

After the details of payment are received, the Bonds department reconciles the total payment

through RTGS route and by Cheques mode with the total amount of cheque given to the bank for

the purpose.

In case of deviation, the entries are reconciled with the BO list provided to the bank.

In case of Single Investor

The Power Grid Corporation of India Limited issues its bonds by route of Private Placement. Thus

sometimes, the whole issue size is mobilised by single investor and usually it is Life Insurance

Corporation of India Limited (LIC). In this case since the interest and principal of that specific issue is

to be paid to the single party, the payment is made by the company itself and this job is not done

through the IDBI bank. The payment is made to it by RTGS. For instance in case of XVIII, XX and XXIV

issue, the sole investor is LIC, thus the payment is made to it directly.


77

Chapter IV

Characteristics of

Bonds

Yield

Duration

Convexity

Yield of PSU and GSec Bonds

Duration of PSU and GSec Bonds

Convexity of PSU and GSec Bonds


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Yield or IRR

The yield on any investment is the interest rate that will make the present value of the cash flows

from the investment equal to the present value (i.e... the price an investor pays to buy the

investment). Mathematically the yield cab be computed as

𝑃 =𝐶𝐹1

1 + 𝑦 +

𝐶𝐹2

(1 + 𝑦)2 +

𝐶𝐹3

(1 + 𝑦)3 + …… . . +

𝐶𝐹𝑁

(1 + 𝑦)𝑁

Here P= Present value

CF= Cash Flows (Intrest as well as principal for each year)

y = IRR/ Yield to Maturity

N = Tenure

There are different measures for the yield commonly quoted by the dealers and used by the

portfolio managers. Some of the Conventional measures are

Current Yield

As the name signifies it is the yield for the current period. It relates the annual cash flow to the

current market price. But here only Intrest receipt is considered and the other gains which affects

the yield like capital gain, discount price etc are ignored. The time value of money is also ignored.

Thus

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑌𝑖𝑒𝑙𝑑 = 𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑜𝑢𝑝𝑜𝑛 𝐼𝑛𝑡𝑟𝑒𝑠𝑡

𝑀𝑎𝑟𝑘𝑒𝑡 𝑃𝑟𝑖𝑐𝑒

This measure is commonly used by short term investors and also more suitable for short tenure

bonds.

Yield to Maturity

Yield to maturity is also the IRR of the future Cash Inflows as discussed before. Unlike the Current

yield, here all the gains in form of Intrest as well as Capital redemption are considered. Also the Time

value of money is considered. The formula for the same is

𝑃 =𝐶

1 + 𝑦 +

𝐶

(1 + 𝑦)2 +

𝐶

(1 + 𝑦)3 + …… . . +

𝐶

(1 + 𝑦)𝑁 +

𝑀𝑁

(1 + 𝑦)𝑁

Here P= Price the Investor paid to get the Investment

C= Coupon Payment (half yearly or annual)

M = Principal Payment (Maturity value)

N= Number of Periods (Tenure X frequency)

Annualised Yield

In the above formula the payments may be annual or half yearly or even monthly. Thus the yield

obtained using above formula needs to be annualised if the payments are not on annual basis. Thus

the formula for the same is


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𝑌 = (1 + 𝑦𝑚 ) − 1

Here Y= Annualised Yield

m= Frequency of payments (2 for half yearly and 12 for Monthly)

Yield to Call / Put

The bonds may be issued with the option of Call or Put. In case of option with Call, the issuer has the

right to call back the bond and pre-pay the amount after a predetermined period. The issuer uses

this option in case of availability of alternative sources of cheaper funds. The investor is under

obligation to sell the bonds if the issuer exercises the option.

Similarly the Bonds can be issued with the Put Option where the Investor is given right to sell the

Bonds i.e... Put the bonds to the issuer at any time after a predetermined period. The investor uses

this option in case if he has more profitable avenues to invest when compared to the bonds.

Thus the Yield is computed for different options like Yield to First call (for the bonds which are not

presently callable), Yield to next call (for the bonds which are currently callable), Yield to Refunding,

etc.... Yield to Worst is the lowest yield rate of every possible call and put date.

Price- Yield Relationship

A Fundamental property of a bond is that the price changes in the opposite direction from the

change in yield. The reason or the justification for the same could be, the present price is discounted

future cash flow of the bond and the discount rate being used is the required yield. In case of

increase in the yield i.e... The discount rate increases and leads to the fall in the present value of the

future cash flows which leads o fall in the price and vice versa.


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Duration

A bond's maturity measures the time to receipt of the final principal repayment and, therefore, the

length of time the bondholder is exposed to the risk that interest rates will increase and devalue the

remaining cash flows. Although it is typically the case that, the longer a bond's maturity, the more

sensitive its price is to changes in interest rates, this relationship does not always hold. Maturity is an

inadequate measure of the sensitivity of a bond's price to changes in interest rates, because it

ignores the effects of coupon payments and prepayment of principal.

Duration is the measure for the sensitivity of the Bonds. As discussed before there is a negative

relationship between yield and price. A change in yield would lead to a change in price. Thus the

duration measures the impact of change in yield on change in price.

Macaulay’s Duration

Dr. Fedrick Macaulay has coined this term and used this measure rather than a maturity as a proxy

for the average length of the time that a bond investment is outstanding. Macaulay recognized this

distinction and determined that the time to receipt of each cash flow should be weighted, not by the

relative magnitude of the cash flow, but by the present value of its relative magnitude. Macaulay's

duration, therefore, equals the average time to receipt of a bond's cash flows, in which each cash

flow's time to receipt is weighted by its present value as a percentage of the total present value of

all the cash flows. The sum of the present values of all the cash flows, of course, equals the price of

the bond. The formula for the same is

𝑀𝑎𝑐𝑎𝑢𝑙𝑎𝑦 𝐷𝑢𝑟𝑎𝑡𝑖𝑜𝑛 =

1𝐶1 + 𝑦

+ 2𝐶

(1 + 𝑦)2 + …… . + 𝑛𝐶

(1 + 𝑦)𝑛+

𝑛𝑀(1 + 𝑦)𝑛

𝑃

Here C= Coupon Inflows

y = IRR/ Yield

M= Maturity Amount (Redemption Amount)

n= Number of Periods

P= Price

Modified Duration

The ratio of Macaulay’s Duration to (1+yield) is commonly termed as Modified Duration. The Modified duration is the approximate percentage change in price for a given change in yield. Although Macaulay conceived of duration as a measure of the effective life of a bond, it can be modified to measure the sensitivity of a bond's price to changes in the yield to maturity. The modification simply requires dividing Macaulay's duration by the quantity one plus the yield to maturity,

𝑀𝑜𝑑𝑖𝑓𝑖𝑒𝑑 𝐷𝑢𝑟𝑎𝑡𝑖𝑜𝑛 =𝑀𝑎𝑐𝑎𝑢𝑙𝑎𝑦′𝑠 𝐷𝑢𝑟𝑎𝑡𝑖𝑜𝑛

(1 + 𝑦)


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Convexity

The duration is the measure of volatility. But it depicts a linear relationship between the Price and

yield. But in reality it is not a case. The relationship between Yield and the price may not be linear

and it could be collinear. Thus the Convexity is the second derivative measure of relationship

between [rice and the yield.

In finance, convexity is a measure of the sensitivity of the duration of a bond to changes in interest

rates. There is an inverse relationship between convexity and sensitivity - in general, the higher the

convexity, the less sensitive the bond price is to interest rate shifts, the lower the convexity, the

more sensitive it is.

As discussed before Duration is a linear measure or 1st derivative of how the price of a bond

changes in response to interest rate changes. As interest rates change, the price is not likely to

change linearly, but instead it would change over some curved function of interest rates. The more

curved the price function of the bond is, the more inaccurate duration is as a measure of the interest

rate sensitivity.

Convexity is a measure of the curvature or 2nd derivative of how the price of a bond varies with

interest rate, i.e. how the duration of a bond changes as the interest rate changes. Specifically, one

assumes that the interest rate is constant across the life of the bond and that changes in interest

rates occur evenly. Using these assumptions, duration can be formulated as the first derivative of

the price function of the bond with respect to the interest rate in question. Then the convexity

would be the second derivative of the price function with respect to the interest rate.

The formula for computing the convexity is

𝐶𝑜𝑛𝑣𝑒𝑥𝑖𝑡𝑦 = 𝑡 𝑡 + 1 𝐶 1 + 𝑟 𝑡+2

100 /𝑚2

Here t= Time period No.

CF= Cash Flow (Interest and Principal)

r = Yield

m= Frequency of Debt Servicing

In actual markets the assumption of constant interest rates and even changes is not correct, and

more complex models are needed to actually price bonds. However, these simplifying assumptions

allow one to quickly and easily calculate factors which describe the sensitivity of the bond prices to

interest rate changes.


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Yield of PSU and GSec Bonds

Bonds have become a very important source of long term funds for Government of India (Both

Central and State Government) and also the corporations including private sector and also public

sector. Different issuers have different structure of their bond with different repayment structure,

differing interest rates and different terms. For Instance the GSec (acronym for the securities issued

by Government of India through Reserve Bank of India) is repaid at the end of tenure where as

bonds of Power Grid Corporation of India Limited are repaid in 12 equal instalments. Also the

frequency of Intrest payment would differ and they may be quarterly, half yearly or even annual.

Thus it is per se necessary to compute yields and other parameters of different bonds.

Selection of Bonds

For the purpose of study all the bonds which are issued by the Power Grid Corporation of India

Limited till date and are yet to be redeemed are considered. Apart from this two bonds of the Power

Finance Corporation which have similar issue and redemption date with that of two Power Grid

Corporation of India Limited’s bonds and also two GSec bonds having similar Maturity to that of the

two selected PFC Bonds are selected.

The summary of the bonds selected is

Bond Description

Date of Issue Tenure Average Tenure

Redemption Date

Duration to Maturity ( Yrs)

Coupon Rate

Present Value ( Rs. Crores)

PGXIII 31.07.2002 15 9 31-7-2017 7.333333333 8.63% 1.133466

PGXIV 17.07.2003 12 7 17-7-2015 5.297222222 6.10% 0.705981

PGXV 23.02.2004 15 9 23-2-2019 8.897222222 6.68% 1.139539

PGXVI 18.02.2005 13 8 18-2-2018 7.883333333 7.10% 1.122116

PGXVII 22.09.2005 13 8 22-9-2018 8.477777778 7.39% 1.27544

PGXVIII 09.03.2006 15 9 09-3-2021 10.94166667 8.15% 1.375

PGXIX 24.07.2006 15 9 24-7-2021 11.31666667 9.25% 1.4997551

PGXX 07.09.2006 15 9 07-9-2021 11.43611111 8.93% 1.5

PGXXI 11.10.2006 15 9 11-10-2021 11.53055556 8.73% 1.5046713

PGXXII 07.12.2006 15 9 07-12-2021 11.68611111 8.68% 1.494723

PGXXIII 09.02.2007 15 9 09-2-2022 11.85833333 9.25% 1.5

PGXXIV 26.03.2007 15 9 26-3-2022 11.98888889 9.95% 1.5

PGXXV 12.06.2007 15 9 12-6-2022 12.2 10.10% 1.4917073

PGXXVI 07.03.2008 15 9 07-3-2023 12.93611111 9.30% 1.5

PGXXVII 31.03.2008 15 9 31-3-2023 13 9.47% 1.5065713

PGXXVIII 15.12.2008 15 9 15-12-2023 13.70833333 9.33% 1.568498

PGXXIX 12.03.2009 15 9 12-3-2024 13.95 9.20% 1.535168

PGXXX 29.09.2009 15 9 29-9-2024 14.49722222 8.80% 1.517222

PGXXXI 25.02.2010 15 9 25-2-2025 14.90277778 8.90% 1.507589

PGXXXII 29.03.2010 15 9 29-3-2025 14.99722222 8.84% 1.5


83

PFC ( S-57) 07-08-2009 15 10 07-08-2024 14.35277778 8.60% 99.43469

PFC 8.85%

2021(S-XXVIII) 31-05-2006 15 10 31-05-2021 11.16666667 8.85% 100.089

GOI LOAN 10.25% 2021

30-05-2001 15 15 30-05-2021 11.16666667 10.25% 115.259

GOI LOAN 8.20% 2024 OIL BOND

15-09-2009 15 15 15-09-2024 14.45833333 8.20% 999

Table 11 List of Bonds selected for Study

Bond Description: The PG implies bonds issued by Power Grid Corporation of India Limited and the

subsequent roman number implies the series number of the bond. Each bond issue is numbered and

given an identification nomenclature. For Power Grid Corporation of India Limited till date it has

issued 32 bond series. Similarly for Power Finance two bonds of 28th series and 57th series are

selected. And the last two entries are the bond issued by Central Government of India.

Date of Issue: This date is relevant to compute the tenure, average tenure and also all the payments

of interest and capital redemption are made with reference to the date of issue.

Tenure: The tenure is the absolute number of years between the issue date and the redemption

date. It is the period for which the bond will remain active and servicing of debt needs to be done.

Average Tenure: Bonds may be issued with a moratorium period followed by Instalment payment.

For example the Power Grid Corporation of India Limited issues bonds with the moratorium period

of 4 years and followed by 12 equal annual instalments. Thus in this case, for the initial 3 years only

interest will be paid and from the year 4 onwards along with the interest the 12th part of loan

amount will be repaid. Thus the average tenure will be 3 years + 12/2 years i.e... 9 years. And in case

of Power Finance’s Bond Series 5710, the repayment is done in 3 equal 5 yearly instalments. Thus

though the tenure is 15 years, the average tenure will be 10 years And in case of G-Sec the amount

is repaid at end of tenure thus the tenure and average tenure will be same.

Redemption Date: As the name clearly signifies it is the date on which the whole principal

outstanding is to be redeemed. This date is useful in computing the Years to Maturity.

Duration to Maturity: Duration to maturity implies number of years remained for the bond to

mature. It is just a gap between Today’s date and the maturity date. This figure is relevant for the

investor as he can know the period for which the bond is to be held. Also the volatility and sensitivity

is the function of years remained for maturity.

Coupon Rate: The coupon rate is the rate of Intrest the issuer pays on the face value of the

outstanding bond. This coupon rate may be determine by the issuer or is determined by the Book

Building process. It is one of the important parameter in determining the yield, duration and

convexity.

9 The Present value is the Index value as published by NSE in its Monthly Trade history. In this case the face

value has been taken as 100. 10

Source: The Information memorandum published for before the specific issue of PFC,


84

Present Value: The present value is last traded price of the bond. Though the bond market is not

much developed in India, the trading of these bonds takes place in Wholesale Debt Market (WDM)

of NSE. And the bonds issued by Power Grid Corporation of India Limited are in form of 12 STRPPs

(Separately Tradable Redeemable Principal Parts) which have different maturity period since one

STRPP is redeemable every year after the moratorium period. Also the trading takes place differently

for each STRPP. And since the cost of each Bond is Rs. 1.5 Crores, the value of each STRPP will be Rs.

12.5 lakh. Similarly in case of Bonds of Power Finance, the Bond consists of 3 STRPPs redeemable

every 5 years. The assumptions and process of computation of present values is as follows:

From the data available at NSE website11, the present value of each STRPP was taken

Average of all the outstanding STRPPs of each bond was computed. For Instance the bond

PGXIV has 6 STRPPs outstanding, thus the average of the 6 is considered as the present

value

In case if any STRPP is not traded, the present value is taken as 100. The NSE has the

practice of publishing Indexed present value. Since Bonds have different face values ranging

from Rs 10 lakh to Rs.2 Crores, the values is published with the base as 100. Thus the

Present value of 99 implies the value is down by 1% from its actual face value and vice versa

for the case of 101.

In case of Power Grid Corporation of India Limited Bonds the index value is multiplied with

the face value of the partial bond i.e... (Sum of Face values of the outstanding STRPPs). For

Instance for PGXVI series the face value of Bonds was Rs. 1.5 Crores with 10 STRPPs thus the

face value of each STRPP is Rs 15 Lakh. As on 31st March 2010, the no. of STRPPs

outstanding is 8. Thus the Index value was multiplied by Rs. 1.2 Crores i.e... 8X15 Lakh.

Computation of Yield to Maturity

For computing the Yield to Maturity all the future cash flows need to be forecasted. Since the

coupon rate is predetermined and also the redemption schedule is predefined, the cash flows can be

determined easily. In case of Floating rate, since there is uncertainty on the rate of interest,

estimation of margin needs to be done.

Following is the computation of Yield for the bond PGXXXI, which has 4 years Moratorium period

with 12 equal instalments to be annually at a coupon rate of 8.90%. The table of future cash flows

and the present value as on 31st March 2010 is used to compute IRR (Yield to maturity).

Year Interest Principal Opening Balance

Total Payments

2010 0 0 0 -1.50759

2011 0.1335 0 1.5 0.1335

2012 0.1335 0 1.5 0.1335

2013 0.1335 0 1.5 0.1335

2014 0.1335 0.125 1.5 0.2585

2015 0.122375 0.125 1.375 0.247375

2016 0.11125 0.125 1.25 0.23625

11

The Monthly Trading report of WDM Segment for March 2010 available on www.nse-india.com

http://www.nse-india.com/


85

2017 0.100125 0.125 1.125 0.225125

2018 0.089 0.125 1 0.214

2019 0.077875 0.125 0.875 0.202875

2020 0.06675 0.125 0.75 0.19175

2021 0.055625 0.125 0.625 0.180625

2022 0.0445 0.125 0.5 0.1695

2023 0.033375 0.125 0.375 0.158375

2024 0.02225 0.125 0.25 0.14725

2025 0.011125 0.125 0.125 0.136125

Table 12 Yield to Maturity of PG XXXI

Using the IRR Function of the column ‘Total Payments’ Yield to Maturity is computed; in the year

2010 the negative value is the present value of the bond. The negative value implies it is outflow for

the Investor and for the subsequent years the amounts are inflows.

The Yield to Maturity of this Bond as on 31st March 2010 is 8.816%. The yield is less than the Coupon

rate because the present value is more than the face value. This implies that the investor is paying

more amount than the value of that bond.

Similarly in case of GSec Bonds whose redemption is on maturity after 20 years with years to

maturity being 12 years with the coupon rate of 10.25%.

Year Intrest Principal Opening Balance

Total Payments( C)

2010 0 0 0 -115.25

2010 10.25 0 100 10.25

2011 10.25 0 100 10.25

2012 10.25 0 100 10.25

2013 10.25 0 100 10.25

2014 10.25 0 100 10.25

2015 10.25 0 100 10.25

2016 10.25 0 100 10.25

2017 10.25 0 100 10.25

2018 10.25 0 100 10.25

2019 10.25 0 100 10.25

2020 10.25 0 100 10.25

2021 10.25 100 100 110.25

Table 13 Computation of Yield of GSec Bond

The Yield to Maturity of this Bond as on 31st March 2010 is 8.205%.


86

Computation of Current Yield

The Current Yield as defined before is the yield to the investor for one year. If holds the bonds or any

investment for the period of 1 year. It is just a ratio of Coupon rate and the face value. Thus say for

Bond PGXXXI the Current yield will be 8.86% for the coupon rate of 8.90% and present value of Rs.

1.5075 Crores. And for the GSec Bond with coupon rate of 10.25%, the Current Yield is 8.89%

because of its high market value.

Similarly Yield to Maturity and Current Yield of all the Bonds are as follows:

Bond Duration to Maturity

Coupon Rate

Face Value (Rs. Crs.)

Present Value (Rs. Crs.)

YTM Current Yield

XXXII 14.997222 8.84% 1.5 1.5 8.840% 8.84%

XXXI 14.902778 8.90% 1.5 1.507589 8.816% 8.86%

XXX 14.497222 8.80% 1.5 1.517222 8.612% 8.70%

XXVIII 13.708333 9.33% 1.5 1.568498 8.521% 8.92%

XXVII 13 9.47% 1.5 1.5065713 9.382% 9.43%

XXVI 12.936111 9.30% 1.5 1.5 9.300% 9.30%

XXV 12.2 10.10% 1.5 1.4917073 10.215% 10.16%

XXIX 13.95 9.20% 1.5 1.535168 8.780% 8.99%

XXIV 11.988889 9.95% 1.5 1.5 9.950% 9.95%

XXIII 11.858333 9.25% 1.5 1.5 9.250% 9.25%

XXII 11.686111 8.68% 1.5 1.494723 8.758% 8.71%

XXI 11.530556 8.73% 1.5 1.5046713 8.661% 8.70%

XX 11.436111 8.93% 1.5 1.5 8.930% 8.93%

XVIII 10.941667 8.15% 1.5 1.375 8.150% 8.89%

XVII 8.4777778 7.39% 1.375 1.27544 8.873% 7.97%

XVI 7.8833333 7.10% 1.35 1.122116 8.995% 8.54%

XV 8.8972222 6.68% 1.2 1.139539 6.359% 7.03%

XIX 11.316667 9.25% 1.125 1.4997551 9.254% 6.94%

XIV 5.2972222 6.10% 0.75 0.705981 8.153% 6.48%

XIII 7.3333333 8.63% 1 1.133466 5.141% 7.61%

PFC ( S-57) 14.352778 8.60% 100* 99.4346* 8.691% 8.65%


14.458333 8.20% 100* 99* 8.335% 8.28%

GOI LOAN 10.25% 2021 11.166667 10.25% 100* 115.25* 8.205% 8.89%

Table 14 YTM and Current Yield of All Bonds

Some of the important analysis is:

For all the Bonds, if market value is less than the present face value (i.e. Face Value less

redeemed value), the Yield to Maturity will be more than the coupon rate. The rationale

behind this is that the investor to own the security is paying more amount than its Face

value. Thus the overall yield will be less than the coupon rate. And the Yields will be more if

the face value is less than the face value.


87

Similar is the case with the Current Yield. The coupon rate is calculated on the face value

whereas the investor will calculate his yield on his investment which is based on market

value, thus lower the market value, higher the Yield.

From the above chart it is clearly visible that both the yields are lower than the coupon rate

when the difference in Present market Value and the present face value is positive. In other

words when the present value is more than the face value.

Also the current yield is less than the Yield to Maturity in case of a small difference, but The

current yield will be more than the YTM in case of a large difference, this is because, the

large difference will promise high returns in short term if the security is held for short

duration but in case of a long duration, the present high returns will be normalised and the

overall YTM will be reduced.

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

-2 0 2 4 6 8 10 12 14 16 18

Co

up

on

/ Y

ield

Difference in PV and FV

Yield- Coupon-Price

Coupon Rate

YTM

Current Yield

0.000%

2.000%

4.000%

6.000%

8.000%

10.000%

12.000%

3 5 7 9 11 13 15 17

Yie

lds

Years to Maturity ( Yrs.)

Maturity- Yields

YTM

Current Yield


88

From the relationship between the Yield and the Duration (years to maturity), it can be seen

that, less the duration to Maturity, more deviation in Current Yield and YTM. The Yield to

maturity is computed by calculating the future cash flows, in case if the present value is

higher and the years for which the cash flows are to be estimated are less, this would lead to

lower yields. And the reverse situation in a vice versa case.

Price-Yield Relationship

A fundamental principle of an option free bond (i.e... a bond without any call / put option embedded

with it) is that the price of the bond changes in a direction opposite to that of change in the required

yield for the bond. But the relationship may be linear, collinear or quadratic. Thus it is necessary to

determine the price-yield relationship. This relationship when plotted on a graph will give Yield-

Curve. The Yield Curve is used by the investors and also valuators of the bond to measure the

volatility and also the sensitivity.

The Price Yield curve for PGXXX bond which has a coupon rate of 8.80% and Maturity of 15 years is

Figure 33 Yield Curve of PGXXX

Similarly the Yield curve for GSec Bond of coupon rate 8.20% and Maturity of 14.5 years is

Figure 34 Yield Curve of GSec 8.20%

0

0.5

1

1.5

2

2.5

3

0.00% 5.00% 10.00% 15.00% 20.00% 25.00% 30.00% 35.00% 40.00%

Pri

ce

Yield

Yield Curve -PGXXX

PRICE

0

50

100

150

200

0.000% 5.000% 10.000% 15.000% 20.000% 25.000%

Pri

ce

Yield

Yield Curve- GSec 8.20%

Price


89

And the Yield Curve for PFC Bond 57 of Coupon rate of 8.60% and the Maturity of 14.5 Years

(approx.)

Figure 35 Yield Curve of PFC (S-57)

From the above three yield curves of different Bonds namely of Power Grid Corporation of India

Limited , Government of India and Power Finance Corporation, some of the observations that can be

made are:

The Yield Curve of all the three Bonds is curvilinear and not exact linear.

The Curve of PG Bond is curvilinear for the higher prices and is linear for the lower prices.

This implies, the yield would be less responsive to the rise in price but it will be high

responsive to the fall in price.

The GSec Bond is perfectly curvilinear because of its redemption pattern. IT is redeemed as a

bullet payment after its tenure unlike the Power Grid Corporation of India Limited bonds

which are redeemed in instalments.

The sensitivity and convexity of the bonds can be measured with more accuracy using tools

like Convexity, Modified Duration etc...

0

50

100

150

200

0% 3% 6% 9% 12% 15% 18% 21% 24% 27% 30% 33% 36% 39%

Pri

ce

Yield

Yield Curve - PFC Bond 57

Price


90

Duration of PSU and GSec Bonds

After computing and analysing the Yield of each bond and Yield curve, it is also necessary to analyse

the Duration of the selected bonds. As mentioned before the Macaulay’s Duration is effective

tenure of the bonds. In simple words it is time period after which the investor will receive back his

investment at a particular yield to maturity. Macaulay's duration, therefore, equals the average time

to receipt of a bond's cash flows, in which each cash flow's time to receipt is weighted by its present

value as a percentage of the total present value of all the cash flows.

As mentioned before, The Macaulay’s Duration is Time weighted, present values of the future cash

flows. Thus to compute the Macaulay’s Duration, The cash flows must be multiplied by the

respective time period, and its present value needs to be computed. The ratio of sum of the present

values of Time weighted future cash flows and the current price of that bond results in Macaulay’s

Duration. Thus the formula used is:

𝑀𝑎𝑐𝑎𝑢𝑙𝑎𝑦 𝐷𝑢𝑟𝑎𝑡𝑖𝑜𝑛 =

1𝐶1 + 𝑦

+ 2𝐶

(1 + 𝑦)2 + …… . + 𝑛𝐶

(1 + 𝑦)𝑛+

𝑛𝑀(1 + 𝑦)𝑛

𝑃

Here C= Coupon Inflows

y = IRR/ Yield

M= Maturity Amount (Redemption Amount)

n= Number of Periods

P= Price

And Modified Duration which shows the sensitivity of the bond prices with respect to the yield. In

other words it shows the change in price with the change in Yield. It is computed by dividing the

Macaulay’s Duration by 1+Yield i.e... (1+y)

Following is the computation of Macaulay’s Duration and Modified Duration for the bond PGXXXI,

which has 4 years Moratorium period with 12 equal instalments to be annually at a coupon rate of

8.90%. The table of future cash flows and the present value as on 31st March 2010 was used to

compute IRR (Yield to maturity). And the same IRR is used to discount and get the present values of

time weighted Cash flows.

Period (N)

Year Total Payments (C)

(1+r)^n r=8.816%

N*C N*C/(1+r)^n

0 2010 -1.50759 1 0 0

1 2011 0.1335 1.088162 0.1335 0.122684

2 2012 0.1335 1.184098 0.267 0.225488

3 2013 0.1335 1.28849 0.4005 0.310829

4 2014 0.2585 1.402087 1.034 0.737472

5 2015 0.247375 1.525698 1.236875 0.810694

6 2016 0.23625 1.660208 1.4175 0.853809

7 2017 0.225125 1.806576 1.575875 0.872299


91

8 2018 0.214 1.965848 1.712 0.870871

9 2019 0.202875 2.139162 1.825875 0.853547

10 2020 0.19175 2.327756 1.9175 0.823755

11 2021 0.180625 2.532976 1.986875 0.784403

12 2022 0.1695 2.75629 2.034 0.737949

13 2023 0.158375 2.999291 2.058875 0.686454

14 2024 0.14725 3.263716 2.0615 0.631642

15 2025 0.136125 3.551453 2.041875 0.574941

Sum (1) 9.896837

Price(Present Value) (2) 1.507589

Macaulay’s Duration= (1)/ (2) 6.564678

Modified Duration 6.032811

Table 15 Modified and Macaulay's Duration of PGXXXI

The Macaulay’s Duration is sum of the discounted time weighted values of the future cash flows as

on 31st March 2010. In this case the present value being Rs. 1.507589 Crores, The Macaulay’s

Duration is 6.564678 years. This implies the investor at the present yield of 8.816%, can get back his

investment in 6.5 years, though the years to maturity are 15 years.

And the Modified Duration, which is ratio of Macaulay’s Duration and 1+Yield to maturity, is

6.032811. This implies for every 1 basis point change in the yield, the price will change in a reverse

direction by 6 basis points. Similarly in case of GSec Bonds whose redemption is on maturity after 20

years with years to maturity being 12 years with the coupon rate of 10.25%.

Period (N)

Year Total Payments ( C)

(1+r)^n r=8.205%

N*C N*C/(1+r)^n

0 2010 -115.25 1 0 0

1 2010 10.25 1.08204869 10.25 9.472771505

2 2011 10.25 1.17082937 20.5 17.50895609

3 2012 10.25 1.26689438 30.75 24.27195225

4 2013 10.25 1.37084141 41 29.90863839

5 2014 10.25 1.48331715 51.25 34.55093872

6 2015 10.25 1.60502138 61.5 38.31724657

7 2016 10.25 1.73671128 71.75 41.31371789

8 2017 10.25 1.87920617 82 43.63544636

9 2018 10.25 2.03339257 92.25 45.36753068

10 2019 10.25 2.20022977 102.5 46.58604357

11 2020 10.25 2.38075574 112.75 47.35891128

12 2021 110.25 2.57609363 1323 513.5682892

Sum (1) 891.8604425

Price(Present Value) (2) 115.25*

Macaulay’s Duration= (1)/ (2) 7.738485401

Modified Duration 7.151698

Table 16 Modified and Macaulay's Duration of GSec


92

Here the present value is in index points as published by NSE WDM Segment. This index implies for

the face value of 100 points, the present value in market is 115.25 points. For simplicity and accuracy

in calculation, 100 have been used as the face value for computing the coupon payments.

The Macaulay’s Duration turns up to 7.74 years (Approx) and Modified Duration is 7.15. Every one

basis point increase in the yield would lead to 7.74 basis point fall in the price.

Similarly the Macaulay’s Duration and Modified Duration of each of the Bonds is summarised in the

following table:

Bond Duration to Maturity (Years)

Coupon Rate

YTM Macaulay's Duration

Modified Duration

XIV 5.2972222 6.10% 8.153% 3.128941 2.89307

XVI 7.8833333 7.10% 8.995% 3.782077 3.469942

XIII 7.3333333 8.63% 5.141% 3.919007 3.72737

XVII 8.4777778 7.39% 8.873% 4.099708 3.765581

XV 8.8972222 6.68% 6.359% 4.269027 4.013794

XVIII 10.941667 8.15% 8.150% 4.720113 4.364413

XXIV 11.988889 9.95% 9.950% 4.760437 4.329638

XIX 11.316667 9.25% 9.254% 4.850537 4.439701

XXIII 11.858333 9.25% 9.250% 4.850878 4.440163

XX 11.436111 8.93% 8.930% 4.893468 4.492305

XXII 11.686111 8.68% 8.758% 4.919947 4.523764

XXI 11.530556 8.73% 8.661% 4.926986 4.534258

XXV 12.2 10.10% 10.215% 5.295218 4.804435

XXVII 13 9.47% 9.382% 5.413836 4.949495

XXVI 12.936111 9.30% 9.300% 5.432109 4.969907

XXIX 13.95 9.20% 8.780% 6.037437 5.550137

XXVIII 13.708333 9.33% 8.521% 6.057109 5.58152

XXXI 14.902778 8.90% 8.816% 6.564678 6.032811

XXXII 14.997222 8.84% 8.840% 6.567683 6.034255

XXX 14.497222 8.80% 8.612% 6.60183 6.07838

PFC ( S-57) 14.352778 8.60% 8.691% 6.761574 6.220913

GOI LOAN 10.25% 2021

11.166667 10.25% 8.205% 7.738485 7.151698


14.458333 8.20% 8.335% 8.049266 7.429977

Table 17 Macaulay's and Modified Duration of All Bonds

From the above table of summary, some of the observations that can be made are:

Modified and Macaulay’s duration are less than Maturity. This implies that, though the

security has a longer maturity, but the investor can get back his investment sooner than the

redemption date.

And also, the Modified duration is always less than the Macaulay’s Duration.


93

Figure 36 Modified Vs Macaulay's Duration

For same maturity bonds, Lower the coupon greater the duration

With all factors constant, Longer the maturity, greater the modified duration

Figure 37 Duration Vs Maturity

With all factors constant, Lower the coupon rate, greater the modified duration

With all factors constant, Lower the yield, greater the modified duration

0

1

2

3

4

5

6

7

8

9

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23

Du

rati

on

Duration

Macaulay's Duration

Modified Duration

0

1

2

3

4

5

6

7

0 5 10 15 20

Mat

uri

ty

Duration

Duration- Maturity

Macaulay's Duration

Modified Duration


94

Figure 38 Duration Vs Yield

Also, it can be seen that, among the Power grid bonds and PFC bonds and also GSec bonds,

the Power grid Bonds have less Duration, both the Macaulay’s and modified are less.

Though the years to Maturity and coupon rate are almost same for PGXXX, PFC (S-57) and

GOI LOAN 8.20% 2024 OIL BOND, the Macaulay’s Duration and Modified Duration differ and

it is lowest for the PGXXX followed by PFC (S-57) and then GOI Loan 8.20%. The main reason

behind this is the repayment structure. In case of Power Grid, the repayment of principal is

done annually after 3 years, and in case of PFC the principal is repaid in each 5 years and in

case of GOI, it is paid only on maturity. Thus the repayment also affects the Bonds Duration.

4

5

6

7

8

7.000% 8.000% 9.000% 10.000%

Du

rati

on

Yield

Duration- Yield

Macaulay's Duration

Modified Duration


95

Convexity of PSU and GSec Bonds

Convexity is the measure of sensitivity of duration of bond to the change in yield. As discussed

before, the Modified Duration also measures the sensitivity of bond price to the change in Yield. But

the modified duration predicts the relationship more accurately in case of small change in the yield.

There is a scope of error in case of larger change in the yield. Thus Convexity measures the

sensitivity of Duration, which further predicts the sensitivity of bonds.

Duration is a linear measure or 1st derivative of how the price of a bond changes in response to

interest rate changes. As interest rates change, the price is not likely to change linearly, but instead it

would change over some curved function of interest rates. The more curved the price function of the

bond is, the more inaccurate duration is as a measure of the interest rate sensitivity.

Convexity is a measure of the curvature or 2nd derivative of how the price of a bond varies with

interest rate, i.e. how the duration of a bond changes as the interest rate changes. Specifically, one

assumes that the interest rate is constant across the life of the bond and that changes in interest

rates occur evenly. Using these assumptions, duration can be formulated as the first derivative of

the price function of the bond with respect to the interest rate in question. Then the convexity

would be the second derivative of the price function with respect to the interest rate.

In actual markets the assumption of constant interest rates and even changes is not correct, and

more complex models are needed to actually price bonds. However, these simplifying assumptions

allow one to quickly and easily calculate factors which describe the sensitivity of the bond prices to

interest rate changes.

For computing the convexity following formula is used:

𝐶𝑜𝑛𝑣𝑒𝑥𝑖𝑡𝑦 = 𝑡 𝑡 + 1 𝐶 1 + 𝑟 𝑡+2

100 /𝑚2

Here:

t= corresponding period of the payment, (1 for first payment)

C= Coupon Flows

r= Yield to Maturity

m= frequency of Intrest payment in a year (2 for half yearly)

Following page has the computation of Convexity for the bond PGXXXI, which has 4 years

Moratorium period with 12 equal instalments to be annually at a coupon rate of 8.90%. The table of

future cash flows and the present value as on 31st March 2010 was used to compute IRR (Yield to

maturity). And the same IRR is used as discount rate (r).


96

Period Year Total Payments

1/(1+r)^t+2 t(t+1)C t(t+1)C / (1+r)^t+2)

0 2010 -1.50759 0.843226 0 0

1 2011 0.1335 0.774313 0.267 0.206741481

2 2012 0.1335 0.711031 0.801 0.569535759

3 2013 0.1335 0.652921 1.602 1.045979356

4 2014 0.2585 0.59956 5.17 3.099725703

5 2015 0.247375 0.55056 7.42125 4.085845154

6 2016 0.23625 0.505565 9.9225 5.016468269

7 2017 0.225125 0.464247 12.607 5.852761609

8 2018 0.214 0.426306 15.408 6.568519178

9 2019 0.202875 0.391465 18.25875 7.147667886

10 2020 0.19175 0.359472 21.0925 7.582169706

11 2021 0.180625 0.330094 23.8425 7.870264977

12 2022 0.1695 0.303117 26.442 8.015008446

13 2023 0.158375 0.278344 28.82425 8.023055926

14 2024 0.14725 0.255596 30.9225 7.903664961

15 2025 0.136125 0.234707 32.67 7.667877721

Sum 80.65528613

(Sum/100)/m2 0.806552861

Table 18 Convexity of PGXXXI

The convexity of the above bonds turns up to 0.806; this implies a one basis point change in yield

would lead to 0.806 basis points change in duration.

Similarly the Convexity of the other bonds is as summarised in the following table:

Bond Duration to Maturity

Coupon Rate YTM Convexity

XIV 5.2972222 6.10% 8.153% 0.10768

XVI 7.8833333 7.10% 8.995% 0.24911

XIII 7.3333333 8.63% 5.141% 0.19280

XVII 8.4777778 7.39% 8.873% 0.32667

XV 8.8972222 6.68% 6.359% 0.28267

XVIII 10.941667 8.15% 8.150% 0.42211

XXIV 11.988889 9.95% 9.950% 0.46356

XIX 11.316667 9.25% 9.254% 0.48399

XXIII 11.858333 9.25% 9.250% 0.48399

XX 11.436111 8.93% 8.930% 0.49372

XXII 11.686111 8.68% 8.758% 0.50151

XXI 11.530556 8.73% 8.661% 0.49994

XXV 12.2 10.10% 10.215% 0.54853

XXVII 13 9.47% 9.382% 0.57145

XXVI 12.936111 9.30% 9.300% 0.57785


97

XXIX 13.95 9.20% 8.780% 0.68333

XXVIII 13.708333 9.33% 8.521% 0.67719

XXXI 14.902778 8.90% 8.816% 0.80655

XXXII 14.997222 8.84% 8.840% 0.81014

XXX 14.497222 8.80% 8.612% 0.81255

PFC ( S-57) 14.352778 8.60% 8.691% 0.59129

GOI LOAN 10.25% 2021 11.166667 10.25% 8.205% 0.65486


14.458333 8.20% 8.335% 0.76856

Table 19 Convexity of All Bonds

From the above summary of convexity of different bonds, some of the analyses that can be made

are:

Higher the convexity implies more sensitive the prices of the bonds are.

For the bonds, whose present value is more than its face value (this can be verified by

looking at Coupon rate and YTM, if YTM is more than Coupon rate implies the Present value

is less than the face value and vice versa), the Convexity is low, this signifies that, since the

price is already high, the sensitivity of the same is decreased.

Also in case if Present value is less than the face value (i.e... YTM is less than the coupon

rate), the Convexity is high implying that the sensitivity of the price is high.

Also it can be seen that, there is a Direct relationship between the Years to Maturity and

Convexity. In other words Bonds with more years to mature are more sensitive when

compared to the bonds with shorter maturity. This is mainly because of uncertainty of the

yield to be remaining constant, and thus the change in yield would impact the prices highly.

Figure 39 Duration Vs Convexity

Also among the bonds having same maturity, there is inverse relationship between the

Coupon rate and the convexity. The higher the coupon rate, lesser the convexity. This is

0

2

4

6

8

10

12

14

16

0.00000 0.20000 0.40000 0.60000 0.80000 1.00000

Ye

ars

to M

atu

rity

Convexity

Duration-Convexity


98

bacause, since all the bonds will be matured in the same year, the bonds with higher coupon

rate will be less sensitive to the changes in intrest rates ( Yield) and the oppostie trend in

case of bo0nds with lower coupon rate.

Figure 40 Coupon Rate Vs Convexity (Same Maturity)

And for the Bonds having same Duration, there exist a positive relationship between Coupon

rate and the Convexity.

Figure 41 Coupon Rate Vs Convexity (Same Duration)

8.60%

8.80%

9.00%

9.20%

9.40%

9.60%

9.80%

10.00%

10.20%

0.46000 0.47000 0.48000 0.49000 0.50000 0.51000

Co

up

on

Rat

e

Convexity

Coupon Rate- Convexity-Maturity

6.00%

6.50%

7.00%

7.50%

8.00%

8.50%

9.00%

0.20000 0.25000 0.30000 0.35000 0.40000 0.45000 0.50000 0.55000

Co

up

on

Rat

e

Convexity

Coupon Rate-Convexity-Duration


99

Chapter V

Analysis of Fixed and

Floating Intrest Rates

Introduction to Fixed and

Floating Rate

Debt Servicing of PGCIL Bonds

Floating Interest for PGCIL

Bonds

Factors Effecting the Selection

of Each Method


100

Introduction

Bonds (Debentures) are the avenues of the investment for the investors. They are similar to

securities on which a regular income can be generated. And these are issued by the corporate, the

exchequer or by any Public undertaking or Municipal bodies etc... They act as source of funds for the

issuer. They are similar to loans but instead of taking from a sole institute or a consortium, the bonds

are raised from wide range of public. And the issuer pays regular interest on these bonds. This

interest is determined by either the Issuer or the investor or by both. The rate determined is termed

as Coupon rate. This coupon rate can be either fixed at the time or issue or it can be even floating.

In specific to India, the bonds are issued by The Central Government in form of Zero coupon

securities (Treasury Bills), bonds of tenure 1 year, 3 years, 5 years, 10 years, 15 years and even 20

years, by the state government, PSUs ( Public Sector Undertakings) and also private players. These

are of different maturity and also different repayment structure. For instance the GSec (central Govt

Securities) are redeemed only on their maturity and interest is paid half yearly, the corporate bonds

are repaid in equal annual or 3 year or even 5 year instalments with some moratorium period. And

the interest is paid either half yearly or yearly. But the bonds issued by them are usually of fixed

interest rate. But in a recent past, central Government and also some corporate have issued the

bonds at fixed rate. Now let us understand the meanings of fixed and floating rates.

Fixed Intrest Rate

As the name very clearly signifies that the interest rate in this case is fixed and will remain the same

for throughout the life of the bond say 15 years or so. In this case the coupon rate is attached to the

nomenclature of bonds and the coupon rate is paid annually or semi annually on the face value of

bond outstanding. For Instance a bond PGC 8.80% 2025 (S-XXX) implies the bond issued by Power

Grid Corporation of India Limited which will mature in the year 2025 and coupon rate of 8.8% will be

paid annually/ semi-annually as defined in the Information memorandum.

The Coupon rate is determined by the process of Book Building in case of Private Placement or it can

be even fixed by the issuer. However the rationale to set the fixed coupon rate and its process is as

follows:

I. Credit rating on the Security to be issued from 2 or more Credit Rating Agencies shall be

obtained as per the SEBI (Disclosure and Investors’ Protection) Guidelines, 2000 amended on

14th August 2003.

II. At the time of opening of the issue, the prevailing rate on Government securities of same

tenure that of the security to be issued, is considered. This can be the coupon rate of latest

issue of the similar bond by GoI or Average of last 5 or so issues.

III. Also the prevailing conditions of economy in general and in specific the condition of money

market is also considered. The high liquidity is considered as favourable and also any policies

of RBI or any announcements in the recent future or during the time of issue are also

considered.

IV. Also the Bank lending rate ( PLR) is considered


101

V. The coupon rate of other corporate bodies issues also impact the coupon rate determination

of the present issue.

VI. After the above factors are considered, the interest rate on GSec is taken as base rate and a

spread is added to it.

VII. Since the GSec issued by the government is considered as the safest and secured

investment, a spread is to be added to its coupon rate based on the security and the rating

of the bond.

VIII. The spread is widely influenced by the factors like security on the bond, the credibility of the

issuer, the market conditions, issues of other players etc.

IX. In India, The FIMMDA ( The Fixed Income and Money Market Derivatives Association), a

association to co-ordinate and also promote the Money market Instruments like Commercial

papers, Certificate of Credit, Bonds, etc..., provides the spread for each kind of security and

for each duration.

X. Thus based on the tenure of the bonds and the rating on that bond, a spread is obtained.

The spread published by the FIMMDA is already adjusted with all the factors affecting the

interest rate.

XI. Thus a range of interest rate is defined based on interest rate determined by adding spread

to GSec rate.

XII. The range may be defined by defining just the floor or ceiling rate and keeping the other end

open.

XIII. Usually the floor rate is kept open to take advantage of sudden change in economic

conditions, where the issuer could be in a position to get a rate lower than the defined rate.

And the ceiling rate is fixed to avoid more escalation of rate towards upper end.

XIV. After the range is defined, by the process of bidding the coupon rate is determine and this

rate is kept fixed for the whole tenure of the bond.

The fixed interest rate has many benefits attached to it. Some of them are:

The payment towards interest rate is fixed and the issuer can prepare a budget well in

advance. And also repayment schedule can be prepared.

It is preferred by the investors as a fixed income is promised every year and the risk of rates

falling down can be avoided.

Also this kind of investments is preferred by the investors seeking for regular and non-

fluctuating. These include the provident Funds, Pension Funds and Gratuity Funds, which

form majority in the investors group.

For the issuer, there is indemnity of hike in rates due to unfavourable circumstances.

Along with the aforesaid merits, there are some demerits attached to it like

In case of down turn in economy, there will be fall in all the interest rates and also the fall in

performance of the business leading to unattractive cash flows. But even in this case the

interest to be paid on the bonds remains at the same level.

The interest for the whole tenure is based on the conditions of money market and the

economy at the time of issue. The later conditions are not reflected.

Even for the investor, there is scope of demerit if the security is issued at the time when the

condition of economy was poor and the interest rate fixed was very low. And this will not


102

increase even though the general interest rate is increased due to improvement in the

economic conditions.

The issuer may end up paying high debt obligation in case of fixed interest rate and cannot

take the advantage of fluctuations and trends in other rates.

Thus to avoid the demerits of the Fixed Intrest rate, some issuer go for the FRBs (Floating rate

Bonds).

Floating Intrest Rate

It is clear from the term that, the interest rate is floating and not fixed. In this case the interest rate

will be adjusted periodically based on the benchmark rate. In this case for every interest payment

period the interest rate is determined based on the benchmark rates and a spread is added to it.

Unlike Fixed interest rates where the coupon rate was determined at the time of issue, in this case it

cannot be predetermined. The nomenclature in this kind will be GOI FLOATING RATE +0.14% 2014,

this implies the bond is issued by the Government of India, will be matured in the year 2014 and the

spread is +0.14%. This implies that 0.14% will be added to the benchmark rate for every reset period.

The Benchmark rate and the reset period are determined by the issuer and are shared in their

disclosure document. Usually the reset period is based on the frequency of interest payment. For

instance, in the above case the reset period was 6 months because the interest is paid semi-

annually. And the Benchmark rate was average yield of last 5 T-Bills (Treasury bills) issued by the

Government preceding the reset date.

As in case of fixed interest rate, the coupon rate was determined based on the bidding by the

investor, in the case of floating rate, the spread is determined by the bidding process.

A Benchmark or a Reference Rate is a rate that is an accurate measure of the market price. In the

fixed income market, it is an interest rate that the market respects and closely watches. A

benchmark rate should be from an unbiased source, be representative of the market, transparent,

reliable and continuously available and most importantly be widely acceptable to the market as the

benchmark rate

Such benchmark rates issued by unbiased sources are the Treasury Bill (T-Bill) rate issued by the

Government of India, the bank rate as decided by the Reserve Bank of India, the Mumbai Interbank

Offering Rate (MIBOR) released by the National Stock Exchange of India and GOI Securities. Thus

specifically for the Bonds the base rate can be any of the following:

Coupon rate of similar tenure GSec Bond issued preceding the reset date.

Average of Coupon rate of last 5 similar tenure GSec Bonds issued preceding the reset date.

Average yield of last 5 Treasury Bills of maturity of 364 days issued preceding the reset date.

( for annual interest payment)

Average yield of last 5 Treasury Bills of maturity of 180 days issued preceding the reset date.

( for semi annual interest payment)


103

Average of Yields of similar tenure GSec bonds for the last 12 months preceding the reset

date.

Average of Yields of similar tenure GSec bonds for the last 6 months preceding the reset

date. ( for semi annual interest payment)

Average daily yield of similar tenure GSec bonds for a month preceding the reset date.

Average Yield of 1 year GSec for the 3 days preceding the reset date.

The above stated base rates are not exclusive and exhaustive. Different issuers take different base

rates based on the structure of the repayment, the tenure of the bonds etc...

The Reset Date is the date on which the interest rate is reset based on the base rate and the spread

pre determined. The frequency of reset date could be quarterly, half yearly or even annually based

on the interest payment date. Sometimes the reset date may be annually where as the interest is

paid semi annually and vice versa. The determination of reset date depends on the issuers wish.

And the Spread can be either negative or positive i.e... The interest rate can be less than the base

rate or more than that. Usually it is positive signifying that the bonds must pay more interest than

the GSec yield as there is risk attached to it. The spread is predetermined at the time of issue and

remains same for the life of the bond. And the spread can be determined by the bidding by the

investors participating. But the base range is estimated with the help of average spread as published

by FIMMDA or the difference in base rate and the prevailing rate on similar bonds during the time of

issue.

Some of the benefits of Floating rate are:

The issuer can take advantage of movement in general interest rates and condition of

market.

No matter whatever is the condition of economy during the issue, the later on interest rates

are truly represented by the state of the economy.

The investors risk is minimised as the returns are based on the market conditions and the

opportunity cost is negligible.

Also the floating rate minimises the fluctuation in prices. Floating Rate funds are protective

funds and shield your investments from interest rate fluctuations.

In a declining interest rate scenario older securities issued at higher coupon rates (interest paid on

the face value of a debt instrument) appear much more attractive than the ones that are currently

issued. Consequently older higher interest bearing securities would go at a premium. Thus long term

income funds by virtue of their investments in longer maturing securities would see a rise in their

Net Asset Values.

However, when interest rates are on the rise newer securities appear more attractive than the ones

that were issued earlier, as they offer higher coupons than their predecessors. The lesser paying

older securities therefore will be sold at a discount. So the same income fund with a majority of

investment in longer maturing securities, now start earning you lesser as newer securities continues

to earn higher returns than the ones in the portfolio.


104

This bearish scenario lasts as long as interest rates continue to show an upward trend. It is during

these times that floating rate funds offer the best utility.

Some of the demerits are:

The investor is exposed to fluctuations in interest rates.

He cannot pre plan the expenses towards financial charges well in advance

Since the interest rates fluctuates, the investor class looking for fixed and regular income (

including PF Funds and gratuity fund) may not be attracted.

Though both the methods have some merits and some demerits, it can be concluded on which

method is to be used. Suitability of each mechanism is based on the tenure of bond, amount of

interest to be paid, the market condition during the issue etc.....

Indian Issuers going for FRBs

Though most of the Indian issuers of Bonds go for the fixed coupon rate, there are few players who

also go for Floating rate like Government of India issued few of its bonds under floating rate and also

Power Finance Corporation of India, a NBFC to finance power project has also issued one of its bonds

with floating rate. But one must observe that both the above mentioned issuers do not issue only

floating rate but they also issue some of the bonds based on the tenure and condition of economy

with floating rate option. Also the structure of repayment, the benchmark and its determination

differ in each case.

Some of the prominent issuers of FRBs and their issue structure are as follows:

GOI Floating Rate Bonds

As mentioned before the Government of India issues the floating rate bonds along with the fixed

rate. It has issued its first FRB on 02nd of July, 2002 at a spread o =).34% (+3 basis points) over the

yield of last 5 T-Bills issued preceding the Intrest payment date. The tenure of these bonds was 15

years, maturing on 02nd of July, 2017.

As per NSE’s Monthly Trading history provided by its Wholesale Debt Segment, as on 31st March,

2010, there are 8 FRBs issued by Government active on the exchange. Each had different maturity

and different spreads. But the interest on these is paid half yearly with reset period of 6 months.

The benchmark for all the cases was Average yield on last 5- Treasury Bills of 364 Days maturity

issued immediately preceding the Reset date. The summary of all those issues is as follows:

Issue Description Spread Issue Dt. Mat Dt. Maturity

( years)

Cpn Freq

GOI FLOATING RATE +0.13% 2011 +0.13% 08-Aug-03 08-Aug-11 8 Half-Yearly

GOI FLOATING RATE +0.09% 2012 +0.09% 10-Nov-03 10-Nov-12 9 Half-Yearly

GOI FRB +0.45% 2013 +0.45% 10-Sep-04 10-Sep-13 9 Half-Yearly

GOI FLOATING RATE +0.14% 2014 +0.14% 20-May-03 20-May-14 11 Half-Yearly

GOI FLOATING RATE +0.19% 2015 +0.19% 02-Jul-04 02-Jul-15 11 Half-Yearly

GOI FLOATING RATE +0.50% 2015 +0.50% 10-Aug-04 10-Aug-15 11 Half-Yearly


105

GOI FRB +0.04% 2016 +0.04% 07-May-04 07-May-16 12 Half-Yearly

GOI FLOATING RATE +0.34% 2017 +0.34% 02-Jul-02 02-Jul-17 15 Half-Yearly

Table 20 FRBs by GOI12

Indian Railway Finance Corporation Limited (IRFCL)

The Indian Railway Finance Corporation is a separate unit established for the purpose of finance the

projects related to building and development and also maintenance of railway. The company is a

Government of India undertaking. Along with the fixed coupon rate bonds, it also issues the floating

rate bonds.

The maturity o the bonds issued is 5 years. And in one case the bond series issued was in form of

STRPP (Separately Transferable Redeemable, principal parts) which are redeemed in equal annual

instalments. And the benchmark rate for these bonds is INBMK rate for relevant GSec of relevant

maturity as published by The Reuters. Since the interest payment is semi-annual, the interest rate is

reset in a period of six months. The summary of issues by this company, as provided by NSE (WDM)

as on 31st march 2010 is:


( years)

Redemption Reference Rate

IRFC +0.37% 2010

(S- 49)

+0.37% 22-Jun-05 22-Jun-10 5 Bullet INBMK of 5 Yr GSec

IRFC -0.10% 2010

(SER-49)

-0.10% 22-Jun-05 22-Jun-10 5 Bullet INBMK of 5 Yr GSec

IRFC +5.60% 2010

(SERIES-50)

+5.60% 25-Aug-5 25-Aug-10 5 Bullet (5 yr INBMK) – (1Yr

INBMK)

IRFC -0.10% 2020

(SER-49)

-0.10% 22-Jun-05 22-Jun-20 15 STRPPs INBMK of GOI relevant

Maturity for each STRPP

Table 21 FRBs by IRFC12

In the above table, for the series 50, the spread seems to be very high, but in this case the

benchmark is determined as the difference between INBMK of 5 year GSec and INBMK of 1 year

GSec. In other words the spread is added to the excess yield on 5 year GSec over the 1 year GSec. In

case if the Floating rate turns out to be negative, no interest is paid.

Also in case of Series 49 Option III (Maturity of 15 years); the redemption is in form of different

STRPPs having different maturity. Thus in that case the interest is determined separately for each

STRPP by taking Reference Rate as INBMK of similar maturity GSec for each STRPP.

Power Finance Corporation Limited,

PFC, a Government of India Undertaking, is a Non Banking Finance Company, established with the

object of financing Power projects in the country. It also issues the bonds regularly and till date it has

issued around 60 series of Bonds. Apart from issuing bonds under fixed coupon rate, it also issues its

bonds as FRBs.

The tenure of bonds range from 3 years to 10 years, and the reset period is six months for semi-

annual Intrest payment and 12 months for annual interest payments. The reference rate is different

12 Source: www.nse-india.com/Debt/WDM

http://www.nse-india.com/Debt/WDM


106

for each series. It is MIBOR (Mumbai Inter Bank Offer Rate), or YINCMT or even difference between

1 yr INBMK and 5 yr INBMK. The summary of the past FRBs by PFCL is as follows:


( years)

Cpn Freq Reference Rate

PFC +5.70% 2010

(S- XXIV)

+5.70% 01-Sep-05 01-Sep-10 5 Half-

Yearly 5 yr INBMK - 1Yr INBMK

PFC MIB +2.15% 2011

(S-XLVI)

+2.15% 29-May-08 29-May-11 3 Yearly MIBOR

PFC 1YINCMT+1.35% 12

(S-60-A)

+1.35% 20-Nov-09 20-Nov-12 3 Yearly 1 YINCMT

PFC 1YINCMT+1.79% 19

(S-60-B)

+1.79% 20-Nov-09 20-Nov-19 10 Yearly 1 YINCMT

Table 22 FRBs by PFC13

ICICI Bank

ICICI Bank, the largest private sector bank in India, issues both the fixed and floating rate bonds. The

summary of its issues is:


( years)

Reference

Rate

ICICI BK +0.60%2010(S-DFE05FRB +0.60% 28-Feb-05 31-May-10 5 1 Yr INBMK

ICICIBK+0.50% 2011(S-DJN05FRB) +0.50% 29-Jun-05 29-Apr-11 6 1 Yr INBMK

Table 23 FRBs by ICICI Bank13

Others

Apart from the above mentioned, many other corporate issue the Floating rate Bonds. And the list

includes:

UTI Bank,

IDFC (Infrastructure Development Finance Company Limited),

Kotak Mahindra Bank ,

EXIM Bank ( Export Import Bank of India),

IDBI ( Industrial Development Bank of India),

CITI Bank,

Sundaram Finance

The issue details of some of the above mentioned issuers are as follows:


( years)

Reference Rate

EXIM BK +0.33% 2010 (SER-I03) +0.33% 09-Aug-05 09-Aug-10 5 Avg Yield on 1 Yr GSec for 3 days

IDFC +1.50% 2017 (S-PP6/2008) +1.50% 16-May-07 16-May-17 10 MIBOR

KOTAK MAH BK +0.55% 2012 (S-

I)

+0.55% 22-Aug-05 22-Aug-12 7 1 Yr INBMK

Table 24 FRBs by Others13

13 Source: www.nse-india.com/Debt/WDM

http://www.nse-india.com/Debt/WDM


107

The Debt Servicing for PGCIL’s Bonds

The Power Grid Corporation of India Limited issues bonds with fixed coupon rate determined by the

book building procedure. The average maturity of most of the bonds is 15 years (4 years of

moratorium and then repayment of loan in 12 equal annual; instalments). Apart from this it has also

issued different structure bonds of 6 years Maturity ( 1 year moratorium and 6 annual equal

repayments), 12 years maturity ( 3 years moratorium and 10 equal annual repayments) etc... The

details of all the bonds issued by PGCIL till date along with its repayment structure are attached in

the appendix.

The interest rate is determined based on the prevailing interest rate on 10 year GSec ( for a 15 year

PG bond, since the average tenure turns up to be 9 years because of equally annual repayments) and

a spread defined by FIMMDA for a AAA rated bond for 10 years is added to define a range for

bidding by investors. Then the rate obtained by the book building process is taken as the coupon

rate.

Following chart depicts the relationship between the prevailing interest rates on GSec Securities and

the Coupon rate of PGCIL Bonds.

The blue line depicts the coupon rates of each issue of bonds and the green line depicts the coupon

rate of GSec bonds issued immediately before the PGCIL bonds were issued and having same

redemption year and also same maturity. The data is taken from the NSE website’s WDM segment

and also from the Data published by RBI on the outstanding GSec.

From the below chart we can see that for most of the issues the coupon rate on bonds of the

company was more than the coupon rate of GSec of similar tenure issued before the issue of

PGCIL’s bonds. Some of the points to be noticed are:

In case of XIV issue the Coupon Rate is very much close to the Coupon rate of GSec. The

coupon rate of bond is 6.10% whereas the rate of GSec is 6.07%. This is mainly because of

gap of one month. The GSec was issued on June 6th 2003 and was of Maturity of 15 years

whereas the PGCIL bond was issued on 17th July, 2003 and was with maturity of 12 years.

Since no GSec of 12 years was issued in the immediate past, this GSec is considered. Also

the Coupon rate is set lower because of its lesser maturity than the GSec.

In case of X issue of PGCIL Bonds, the Coupon rate is lower than the GSec rate (highlighted

by the circle). This is unusual in normal scenario. This was mainly because of excess

borrowing by the government.

The gap between the blue and green line is spread. Over the years the spread is more or less

constant and the average spread is 0.75%. In other words the Coupon rate on an average is

set 75 basis points above the GSec rate.


108

Figure 42 Coupon Rate of PG Vs GSec Rate14

From the following chart we study the behaviour of Coupon rates of each bond with the average

yield on GSec. Here the Yield on GSec is the data published by RBI and is yield on all the GSec of all

the maturities. The blue line which depicts the Coupon rate of each bond series is always more than

the red line which represents the Average GSec yield for the year. Also the gap between them,

termed as spread, is more or less constant and the movement is in tandem.

Figure 43 Coupon Rate of PG Vs Avg GSec Yield15

14 Source: http://www.rbi.org.in/scripts/PublicationsView.aspx?id=9483 ; www.nse-India.com (WDM

Segment)

15 Source: www.Indiastat.com and www.nse-india.com

0.00%1.00%2.00%3.00%4.00%5.00%6.00%7.00%8.00%9.00%

10.00%11.00%12.00%13.00%14.00%

Coupon Rate Vs Gsec Rate

Coupon Rate- PG Bonds Interest on Govt Securtiy

5.00%6.00%7.00%8.00%9.00%

10.00%11.00%12.00%13.00%

Coupon Rate Vs Avg Gsec Yield

Rate P.A. Avg Yield of GS

http://www.rbi.org.in/scripts/PublicationsView.aspx?id=9483


http://www.indiastat.com/



109

Floating Intrest for PGCIL’s Bonds As mentioned before the Power Grid Corporation of India Limited has issued till date 32 series of

bonds and all at fixed coupon rate. Thus a study is being made to analyse the interest cost if the

company has gone for the floating rate.

Assumptions Some of the assumptions taken for the purpose of computation and analysis of Floating rate costs

are as follows:

Though the Floating rate deemed to have some additional costs for the company in terms of

arrangers’ fees, internal records maintenance, database for computing reference rate, etc...

But after speaking to the concerned persons in the company, it has been found that there

will not be any substantial additional expenses in case of floating rate.

It is assumed that the Arrangers, as usual will quote a 0% fees because of Ratings (highest

rating) and also good credibility of the company.

The company already has the Reuters database and subscribed to the FIMMDA access, thus

it need not incur additional expenses for determination of reference rate and spread.

For determining the spread in case of floating rate, as mentioned before usually the spread

is determined by way of bidding or is determined by the merchant bankers and the issuer

based on the market conditions. Since the calculations are made backward, thus the spread

is computed based on the discussion with the Merchant banker16 on the actual industry

practices of determining the spread.

For computing the floating rate for each period, three different reference rates are taken

based on other company’s practices.

Selection of Bonds For the purpose of comparison under fixed and floating rates, the bonds on which the interest has

been made for 8 or more periods have been selected, so that a good study can be done. Also bonds

of different tenure, different repayment structure and different coupon rates have been taken so

that a comprehensive study for each kind of bond can be done. The details of Bonds selected are as

follows:

Bond Description

Date of Loan Drawn

Coupon Rate

Redemption Date

Maturity (Yrs.)

Intrest Payment

Loan Amount (Rs. Crs)

Repayment Structure

Bonds VIII Issue

27-04-2000 10.35% 4/2014 14 Half-Yrly 20.00 5 Yr.Moratorium + 10 Eq Ann.Inst

Bonds IX Issue

22-08-2000 12.25% 8/2012 12

Half-Yrly 576.50 3 Yr.Moratorium + 10 Eq Ann.Inst

Bonds X Issue

21-06-2001 10.90% 6/2015 14 Annual 761.52 3 Yr.Moratorium + 12 Eq Ann.Inst

Bonds XIII-Issue


Bonds XIV-Issue


Table 25 List of Bonds selected for Analysis

16

Mr. Venkat Krishna, VP, ICICI Securities Primary Dealership Limited


110

The above list has each kind of bond:

Meagre loan Amount

Half Yearly Intrest Payment

Longer Maturity of 14 years

Shorter Maturity of 6 years

Low coupon rate

Based on the above selection suitability of Fixed or Floating rate for each kind of bond can be

studied. And as mentioned before, the bonds that are issued in the year 2000, 2001, 2002 and 2003

are selected because the interest is already paid on them under fixed rate and now study can be

made under floating rate for the bonds.

Selection of Reference Rate

As mentioned before in case of a floating rate there is a Reference or Benchmark rate, based on

which the floating interest rate is determined. For computation of floating rate following reference

rates were considered.

I. Average Monthly yield of 10 Year GSec preceding the reset month

II. Average Yield of 10 year GSec for 12 months preceding the reset month.

Average Yield of 10 year GSec for 6 months preceding the reset month ( for Semi Annual

Intrest Payment)

III. Average of 1 Year GSec for the past 3 days preceding the reset date.

From the above three options, the option I, which is average of GSec yield for the month preceding

reset month, will depict the market condition of only the month immediately preceding the reset

month. But since the interest is paid for the 6 months or the 12 months, the base rate should truly

reflect the conditions of those 6 or 12 months.

In the Option II, this is Average Yield of 10 years GSec for the 12 months preceding the reset month

for the Annual Intrest payment and 6 months for semi-annual interest payment. On an assumption

that, the investor is a long term investor and has invested in the bonds for purpose of income and

not trade, 10 years GSec is considered. Also all the above selected bonds except one have an

average tenure of 9 years or 10 years, thus Yield on 10 years GSec is comparable.

Following Graph will depict the annualised yields of 10 years GSec monthly and also the moving

average from the period April 1998 to April 2010.


111

Figure 44 Trend of 10 Yr GSec Yield17

From the above graph, it can be clearly seen that, if we take monthly data as base rate, there are lots

of fluctuations and also the interest will get widely affected by the state of economy and market

conditions of a particular month. But in the other case, if average of the 12 or 6 months is taken, the

condition of market for the whole 12 or 6 months is taken care of. Thus Option I is not considered.

And In the option III, which is yield on one year GSec for the preceding 3 days of reset date. Here the

assumptions are

The investor is not a long term investor and is holding the security for a short term period.

Thus for him the interest must be based on the one year GSec.

Also since the interest is paid for annual or semi-annual period, the base rate must also

reflect the representation of the movements in Sort term Securities ( 1 year GSec)

The following graph portrays the movement of Annualised yield of 1 year GSec on daily basis for the

period between 01-01-1998 to 30-04-2010

Figure 45 Trend of 1Yr GSec Yield

17

Source: Reuters Database

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00A

pr-

19

98

Sep

-19

98

Feb

-19

99

Jul-

19

99

Dec

-19

99

May

-20

00

Oct

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04

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04

May

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05

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06

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7

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r-2

00

8

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-20

08

Feb

-20

09

Jul-

20

09

Dec

-20

09

10 Year Gsec Yield

CLOSE Moving Average ( 12 months)

0.002.004.006.008.00

10.0012.0014.00

Jan

-19

98

Jul-

19

98

Jan

-19

99

Jul-

19

99

Jan

-20

00

Jul-

20

00

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01

Jul-

20

01

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02

Jul-

20

02

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-20

03

Jul-

20

03

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04

Jul-

20

04

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05

Jul-

20

05

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06

Jul-

20

06

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07

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20

07

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08

Jul-

20

08

Jan

-20

09

Jul-

20

09

Jan

-20

10

IN1YT=RR


112

From both the graphs showing trend of each 10 year and 1 year GSec Yield, it can be seen that, the

yield is fluctuating over the period and the benefits of fluctuation can be taken.

And if we analyse the Coupon rate of PGCIL Bonds Movement of the issues till date, the trend is as

follows,

Figure 46 Trend of Coupon Rates of PG Bonds

The curve if compared with the GSec yield it can be seen that the movement in the line is in tandem

with the movement of yield. Thus if the company goes for the floating instead of fixed, this can be

justified by the following graph.

Figure 47 Rates of PG Bonds Vs 1 Yr GSec Yield

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

PGBonds

0.000%

2.000%

4.000%

6.000%

8.000%

10.000%

12.000%

14.000% 1 Yr Gsec Yield Vs PG Bonds

IN1YT=RR PG Rate


113

Some of the points to be mentioned are:

The Blue Circles and Rhombus represent the Coupon rate on the PGCIL Bonds and the red

line depicts the daily yield on 1 year GSec Yield.

The Blue Circles represent the Coupon rate of Bonds selected for the study.

The blue circles are selected in such a case that they represent both at a low yield and also

at a high yield.

From the period Jan 2009 onwards the yield has been very low when compared to the

coupon rate.

And the gap between the Blue Dots and the red line is considered as the spread. The spread

has been increasing by the fall in Yield from Jan-2008 onwards.

Also for first four issues, the corporate payment was half yearly. Thus the interest rate was

annualised to have a better comparison with the annualised yield.

Reset Period and Reference Period

One of the three main parameters to be determined is the Reset period. It is the period at which the

Intrest rate is reset as per the reference rate. In case of Floating rate, though it is termed as floating,

but the Intrest rate does not change daily, it is reset and calculated at a predetermined period. In

our case the reset date is 12 months in case of Annual interest payment and is 6 months for Semi-

Annual Intrest payment.

Though the interest rate is reset every 12/6 months, but the reference period is also to be

determined. In simple words, the reference period implies, for the purpose of computation of base

rate the data pertaining to which period shall be taken.

In this case, following two situations are considered:

1. Data pertaining to the period preceding the coupon period. For Instance, in case of Semi

annual interest payment falling due on 22nd August 2003, then the coupon period starts

from 22nd February 2003. Thus Average yield of 6 months preceding the 22nd February 2003

will be considered. i.e... August 2002 to January 2003 will be considered.

2. The second option is, data pertaining to the period preceding the Intrest payment date. For

Instance, in case of Semi annual interest payment falling due on 22nd August 2003, then the

average yield of 6 months preceding the 22nd August 2003 will be considered. i.e... February

2003 to July 2003 will be considered.

For the present study both the reference periods have been considered.

Spread

The last parameter to be determined in case of Floating rate is the spread. Depending upon the

reference rate selected, the spreads will be different. And as mentioned before, the spread will

remain constant for the whole tenure of the Bond. Thus it is very crucial thing to determine the

spread. Usually in actual cases a range is to be determined, and the exact spread is determined

based on the bidding process. But for the purpose of study, based on discussion with the


114

experienced persons and merchant bankers on the actual practice in the industry is understood and

in consultation with them the spread is determined using relevant past data.

For purpose of Option II ( 12/ 6 months average yield of 10 years GSec), the spread is taken as

average spread for AAA Bonds for the tenure of 10 years for last 5 days preceding the date of issue.

For the purpose of Option III (3 days average of yield on 1 year GSec), the spread is taken as

difference between base rate as on date of issue and the coupon rate. The rationale behind this is,

since the coupon rate is determined by adding the Spread to the prevailing interest rate on 10 years

GSec, just the gap between the 1 year GSec and the Coupon rate can be taken as spread.

Floating Rate under Reference Rate of Average yield of 1 Year GSec

Bond VIII

Date of Issue: 27th April, 2000

Intrest Payment: Semi Annually

Coupon Rate: 10.35%

Loan Amount: Rs. 20 Crores

Repayment: 5 years Moratorium and 10 equal Instalments

Maturity: 27th April, 2014

Determination of Spread

Since the date of issue is 27th April, 2000, the average yields of 3 days preceding i.e... 24th, 25th and

26th April, 2000 is computed and the difference between the average and coupon rate is calculated

and the difference turned up to be 1.036% or 103.6 basis points. The computation is as follows:

Date Yield-1yr GSec Average yield Coupon Rate Spread

26-04-2000 9.291

25-04-2000 9.306 9.3140% 10.35% 1.03600%

24-04-2000 9.345 931.40% Table 26 Determination of Spread for PGVIII for 1 year GSec as Reference Rate

Computation of Floating Rate

Average Yield of 1 years GSec ( 3 days preceding Intrest rate)

Intrest Payment Reference Period Average Govt yield Spread

Floating rate

Fixed rate

27-Oct-00 Oct- 23, 24, 25 10.39233% 1.036% 11.428% 10.35%

Apr-01 Apr- 23, 24, 26 8.88833% 1.036% 9.924% 10.35%

Oct-01 Oct- 23, 24, 25 6.89533% 1.036% 7.931% 10.35%

Apr-02 Apr- 23, 24, 26 6.17367% 1.036% 7.210% 10.35%

Oct-02 Oct- 23, 24, 25 5.64967% 1.036% 6.686% 10.35%

Apr-03 Apr- 23, 24, 25 5.12000% 1.036% 6.156% 10.35%

Oct-03 Oct- 22, 23, 24 4.71800% 1.036% 5.754% 10.35%

Apr-04 Apr- 21, 22, 23 4.48700% 1.036% 5.523% 10.35%


115

Oct-04 Oct- 21, 25, 26 5.52533% 1.036% 6.561% 10.35%

Apr-05 Apr- 21, 25, 26 5.68333% 1.036% 6.719% 10.35%

Oct-05 Oct- 24, 25, 26 5.82767% 1.036% 6.864% 10.35%

Apr-06 Apr- 24, 25, 26 6.22600% 1.036% 7.262% 10.35%

Oct-06 Oct- 20, 23, 26 6.99133% 1.036% 8.027% 10.35%

Apr-07 Apr- 24, 25, 26 7.86667% 1.036% 8.903% 10.35%

Oct-07 Oct- 24, 25, 26 6.85867% 1.036% 7.895% 10.35%

Apr-08 Apr- 23, 24, 25 7.85000% 1.036% 8.886% 10.35%

Oct-08 Oct- 22, 23, 24 7.37800% 1.036% 8.414% 10.35%

Apr-09 Apr- 22, 23, 24 4.07600% 1.036% 5.112% 10.35%

Oct-09 Oct- 22, 23, 26 4.47700% 1.036% 5.513% 10.35%

Apr-10 Apr- 22, 23, 26 4.92367% 1.036% 5.960% 10.35% Table 27 Floating rates for PGVIII for 1 year GSec as Reference Rate

Notes:

Though the bond will mature in the year 2014, the interest payment till 27th April 2010 can

be compared because of unavailability of data.

In case of reference period, the three days preceding the interest payment date is

considered. Thus in this case, since the interest is to be paid on 27th of August and April, the

reference period should be 24th, 25th and 26th. But in case, if wither of 3 days is a holiday,

and no trade has been taken place the working days preceding to the holiday is considered.

Comparison of Intrest on Fixed and Floating Rate (Rs Crs.)

Intrest Payment-Fixed Intrest Payment-Floating

Year Opening Balance Redemption Interest Year

Opening Balance Redemption Interest

Oct-00 20 0 1.035 Oct-00 20 0 1.142833

Apr-01 20 0 1.035 Apr-01 20 0 0.992433

Oct-01 20 0 1.035 Oct-01 20 0 0.793133

Apr-02 20 0 1.035 Apr-02 20 0 0.720967

Oct-02 20 0 1.035 Oct-02 20 0 0.668567

Apr-03 20 0 1.035 Apr-03 20 0 0.6156

Oct-03 20 0 1.035 Oct-03 20 0 0.5754

Apr-04 20 0 1.035 Apr-04 20 0 0.5523

Oct-04 20 0 1.035 Oct-04 20 0 0.656133

Apr-05 20 2 1.035 Apr-05 20 2 0.671933

Oct-05 18 0 0.9315 Oct-05 18 0 0.61773

Apr-06 18 2 0.9315 Apr-06 18 2 0.65358

Oct-06 16 0 0.828 Oct-06 16 0 0.642187

Apr-07 16 2 0.828 Apr-07 16 2 0.712213

Oct-07 14 0 0.7245 Oct-07 14 0 0.552627

Apr-08 14 2 0.7245 Apr-08 14 2 0.62202

Oct-08 12 0 0.621 Oct-08 12 0 0.50484

Apr-09 12 2 0.621 Apr-09 12 2 0.30672

Oct-09 10 0 0.5175 Oct-09 10 0 0.27565

Apr-10 10 2 0.5175 Apr-10 10 2 0.297983

17.595 12.57485 Table 28 Intrest under Fixed and Floating rates for PGVIII for 1 year GSec as Reference Rate


116

Figure 48 Intrest Payments under Fixed and Floating Rate for PGVIII for 1 year GSec as Reference Rate

From the above table and chart, it is clearly visible that, the company would have been able to save

Rs. 5, 02,015,000 (Rs.50.2 Million) if it had issued the bond at floating rate. Also from the we can see

that, during the moratorium period, during which the project is not yet operational, the interest

payment in case of Floating rate ( as depicted by red line) is very less when compared to the same

under fixed rate ( represented by the line blue). And the payment towards interest (if the principal

payment is ignored) the amount towards debt obligation is always less in case of floating rate except

the initial interest payment.

Bond IX

Date of Issue: 22nd August, 2000

Intrest Payment: Semi Annually

Coupon Rate: 12.25%

Loan Amount: Rs. 576.50 Crores


Maturity: 22nd August, 2012


Since the date of issue 22nd August, 2000, the average yield of 3 working days preceding i.e... 16th,

17th and 18th August, 2000 is computed and the difference between the average and coupon rate is

calculated and the difference turned up to be 1.52% or 152 basis points. The computation is as

follows:

Date Yield-1yr GSec Average yield Coupon rate Spread

18-08-2000 10.751

17-08-2000 10.839 10.730% 12.25% 1.5203300%

16-08-2000 10.599 10.72967 Table 29 Calculation of Spread for PGIX for 1 year GSec as Reference Rate

0

0.2

0.4

0.6

0.8

1

1.2

Oct

-00

Au

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Jun

-02

Ap

r-0

3

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Dec

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Oct

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g-0

6

Jun

-07

Ap

r-0

8

Feb

-09

Dec

-09

VIII ( 1 Yr Gsec)

Intrest Payment-Fixed

Intrest Payment-Floating


117



Intrest Payment Reference Period Average Govt yield Spread Floating rate Fixed rate

22-Feb-01 Feb- 15, 16, 20 9.32% 1.520% 10.8393% 12.25%

22-Aug-01 Aug- 16, 17, 20 7.18% 1.520% 8.7040% 12.25%

Feb-02 Feb- 19, 20, 21 6.37% 1.520% 7.8920% 12.25%

Aug-02 Aug- 19, 20, 21 6.02% 1.520% 7.5433% 12.25%

Feb-03 Feb- 19, 20, 21 5.92% 1.520% 7.4447% 12.25%

Aug-03 Aug- 19, 20, 21 4.97% 1.520% 6.4947% 12.25%

Feb-04 Feb- 17, 19, 20 4.56% 1.520% 6.0797% 12.25%

Aug-04 Aug- 17, 18, 19 5.33% 1.520% 6.8503% 12.25%

Feb-05 Feb- 17, 18, 20 5.74% 1.520% 7.2627% 12.25%

Aug-05 Aug- 17, 18, 19 5.70% 1.520% 7.2180% 12.25%

Feb-06 Feb- 17, 20, 21 6.89% 1.520% 8.4110% 12.25%

Aug-06 Aug- 17, 18, 21 6.86% 1.520% 8.3820% 12.25%

Feb-07 Feb- 19, 20, 21 7.62% 1.520% 9.1403% 12.25%

Aug-07 Aug- 16, 17, 21 7.15% 1.520% 8.6723% 12.25%

Feb-08 Feb- 19, 20, 21 7.55% 1.520% 9.0713% 12.25%

Aug-08 Aug- 18, 20, 21 9.30% 1.520% 10.8230% 12.25%

Feb-09 Feb- 17, 18, 19 4.80% 1.520% 6.3250% 12.25%

Aug-09 Aug- 18, 20, 21 4.64% 1.520% 6.1567% 12.25%

Feb-10 Feb- 17, 18, 19 5.04% 1.520% 6.5573% 12.25% Table 30 Floating Rates for PGIX for 1 year GSec as Reference Rate

Comparison of Interest on Fixed and Floating Rate (Rs Crs.)




Feb-01 576.5 0 35.3106 Feb-01 576.5 0 31.24437

Aug-01 576.5 0 35.3106 Aug-01 576.5 0 25.08927

Feb-02 576.5 0 35.3106 Feb-02 576.5 0 22.74868

Aug-02 576.5 0 35.3106 Aug-02 576.5 0 21.74365

Feb-03 576.5 0 35.3106 Feb-03 576.5 0 21.45924

Aug-03 576.5 57.65 35.3106 Aug-03 576.5 57.65 18.72087

Feb-04 518.85 0 31.7796 Feb-04 518.85 0 15.77217

Aug-04 518.85 57.65 31.7796 Aug-04 518.85 57.65 17.77147

Feb-05 461.2 0 28.2485 Feb-05 461.2 0 16.7477

Aug-05 461.2 57.65 28.2485 Aug-05 461.2 57.65 16.6447

Feb-06 403.55 0 24.7174 Feb-06 403.55 0 16.97129

Aug-06 403.55 57.65 24.7174 Aug-06 403.55 57.65 16.91277

Feb-07 345.9 0 21.1864 Feb-07 345.9 0 15.8082

Aug-07 345.9 57.65 21.1864 Aug-07 345.9 57.65 14.99879

Feb-08 288.25 0 17.6553 Feb-08 288.25 0 13.07405

Aug-08 288.25 57.65 17.6553 Aug-08 288.25 57.65 15.59864

Feb-09 230.6 0 14.1243 Feb-09 230.6 0 7.292721

Aug-09 230.6 57.65 14.1243 Aug-09 230.6 57.65 7.098633

Feb-10 172.95 0 10.5932 Feb-10 172.95 0 5.670451

497.8798 321.3677 Table 31 Interest under Fixed and Floating Rates for PGIX for 1 year GSec as Reference Rate


118

Figure 49 Interest Payment under Fixed and Floating rates for PGIX for 1 year GSec as Reference Rate

In this case the Intrest under floating rate is much lower than the fixed rate. The main reasons are

When this series was issued the market conditions were not favourable.

Due to hike in CRR, the Bank rates and GSec rates hiked up,

Most of the nationalised banks increased their PLR

60% of Annual borrowings by GoI during the current year amounting to approx. Rs.1,20,000

Crores is yet to be raised

All the above mentioned points may bring an upward pressure in GSec rates thus the coupon

rate was fixed with the spread of 75 basis points over the prevailing rate of 10 years GSec.

The company would have been able to save up to Rs.176, 51, 21,000 (Rs. 1.765 Billion) if it had

issued the bond at floating rate. Also the amount towards debt obligation both in case of fixed and

floating rate is falling over the period because of equal redemption towards principal.

Bond X

Date of Issue: 21st June, 2001

Intrest Payment: Annual

Coupon Rate: 10.90%



Maturity: 21st June, 2015

0.0000

5.0000

10.0000

15.0000

20.0000

25.0000

30.0000

35.0000

40.0000Fe

b-0

1

Dec

-01

Oct

-02

Au

g-0

3

Jun

-04

Ap

r-0

5

Feb

-06

Dec

-06

Oct

-07

Au

g-0

8

Jun

-09

IX ( 1 Yr Gsec)




119


Since the date of issue 21st June, 2001, the average yield of 3 working days preceding i.e... 18th, 19th

and 20th June, 2001 is computed and the difference between the average and coupon rate is

calculated and the difference turned up to be 2.69% or 269 basis points. The computation is as

follows:


20-06-2001 8.151

19-06-2001 8.20 8.21% 10.90% 2.69%

18-06-2001 8.276 8.209 Table 32 Calculation of Spread for PGX for 1 year GSec as Reference Rate


Average Yield of 1 years GSec ( 3 days preceding Interest rate)

Interest Payment Reference Period Average Govt yield Spread Floating rate Fixed rate

21-Jun-02 June 20, 19, 18 6.756% 2.69% 9.447% 10.90%

Jun-03 June 20, 19, 18 5.070% 2.69% 7.761% 10.90%

Jun-04 June 18, 17, 1618

3.994% 2.69% 6.685% 10.90%

Jun-05 June 20, 17, 161

5.738% 2.69% 8.429% 10.90%

Jun-06 June 20, 19, 161

6.988% 2.69% 9.679% 10.90%

Jun-07 June 20, 19, 18 7.863% 2.69% 10.554% 10.90%

Jun-08 June 20, 19, 18 8.421% 2.69% 11.112% 10.90%

Jun-09 June 19, 18, 171

4.124% 2.69% 6.815% 10.90% Table 33 Floating rates for PGX for 1 year GSec as Reference Rate


Interest Payment-Fixed Interest Payment-Floating



Jun-02 761.52 0 83.00568 Jun-02 761.52 0 71.93826

Jun-03 761.52 0 83.00568 Jun-03 761.52 0 59.10157

Jun-04 761.52 63.46 83.00568 Jun-04 761.52 63.46 50.90761

Jun-05 698.06 63.46 76.08854 Jun-05 698.06 63.46 58.8418

Jun-06 634.6 63.46 69.1714 Jun-06 634.6 63.46 61.42293

Jun-07 571.14 63.46 62.25426 Jun-07 571.14 63.46 60.27812

Jun-08 507.68 63.46 55.33712 Jun-08 507.68 63.46 56.4134

Jun-09 444.22 63.46 48.41998 Jun-09 444.22 63.46 30.27359

560.2883 449.1773 Table 34 Interest under fixed and floating Rate for PGX for 1 year GSec as Reference Rate

18

Since one of the 3 days preceding the interest payment day was a holiday, the days preceding the holiday has been considered.


120

Figure 50 Interest Payment under Fixed and Floating Rates for PGX for 1 year GSec as Reference Rate

The Bond series was issued during June 2001, which was characterised by favourable market

condition. The coupon rate was fixed after considering the spread of 65 to 90 basis points above the

GSec of similar maturity. Thus the company was able to issue its bonds at a coupon rate of 10.90%.

But if the interest payment is compared with that of Floating rate there is a scope of savings of

Rs.111,11,111,000 ( Approx Rs.1.1 Billion)

Also if we see the interest rates, there has been a dip in the interest rate under floating rate in the

year 2003, 2004 and 2009, leading to a huge gap between both the methods.

Bond XIII- Opt II

Date of Issue: 31st July, 2002

Intrest Payment: Annually

Coupon Rate: 7.85%


Repayment: 1 year Moratorium and 6 equal Instalments

Maturity: 31st July, 2008


Since the date of issue 31st July, 2002, the average yield of 3 working days preceding i.e... 26th, 29th

and 30th July, 2000 is computed and the difference between the average and coupon rate is

calculated and the difference turned up to be 1.794% or approx 180 basis points. The computation is

as follows:

0

10

20

30

40

50

60

70

80

90

X ( 1 Yr Gsec)

Interest Payment-Fixed

Interest Payment-Floating


121


30-07-2002 6.087

29-07-2002 6.091 6.056% 7.85% 1.79400%

26-07-2002 5.99 6.05600 Table 35 Calculation of Spread for PGXIII for 1 year GSec as Reference Rate




31-Jul-03 Jul- 25, 28, 29 4.8430% 1.7940% 6.6370% 7.85%

Jul-04 Jul- 28, 29, 30 4.8477% 1.7940% 6.6417% 7.85%

Jul-05 Jul- 25, 26, 29 5.8010% 1.7940% 7.5950% 7.85%

Jul-06 Jul- 26, 27, 28 6.9283% 1.7940% 8.7223% 7.85%

Jul-07 Jul- 26, 27, 30 6.7923% 1.7940% 8.5863% 7.85%

Jul-08 Jul- 28, 29, 30 9.4020% 1.7940% 11.1960% 7.85% Table 36 Floating Rates for PGXIII for 1 year GSec as Reference Rate





Jul-03 250.5 41.75 19.66425 Jul-03 250.5 41.75 16.62569

Jul-04 208.75 41.75 16.38688 Jul-04 208.75 41.75 13.86448

Jul-05 167 41.75 13.1095 Jul-05 167 41.75 12.68365

Jul-06 125.25 41.75 9.832125 Jul-06 125.25 41.75 10.92472

Jul-07 83.5 41.75 6.55475 Jul-07 83.5 41.75 7.169588

Jul-08 41.75 41.75 3.277375 Jul-08 41.75 41.75 4.67433

68.82488 65.94246 Table 37 Interest Under Fixed and Floating rates for PGXIII for 1 year GSec as Reference Rate

0

5

10

15

20

25

XIII- Opt-II ( 1 Yr Gsec)



Figure 51 Interest Payments under Fixed and Floating Rates for PGXIII for 1 year GSec as Reference Rate


122

The bond was issued at the coupon rate of 7.85% and is one the lower rates among the all PGCIL

Bonds. This is mainly because of its short tenure and also favourable market conditions.

Since the bond is issued for a short duration of 6 years and also due to low coupon rate there is a

nominal saving of Rs. 2,88,242,000 (Approx Rs. 28 Million). Also since the floating rate is pertaining

to a small period, there have been not many fluctuations. Thus the pattern of outflows with respect

to interest payment under both the methods viz fixed and floating is almost same.

Bond XIV

Date of Issue: 17th July, 2003

Intrest Payment: Annually

Coupon Rate: 6.10%

Loan Amount: Rs. 699 Crores

Repayment: 1 year Moratorium and 12 equal Instalments

Maturity: 17th July, 2015


Since the date of issue 17th July, 2003, the average yield of 3 working days preceding i.e... 14th, 15th

and 16th July, 2003 is computed and the difference between the average and coupon rate is

calculated and the difference turned up to be 5.87% or approx 587 basis points. The computation is

as follows:


16-07-2003 5.028

15-07-2003 5.027 5.0273% 6.10% 1.072700%

14-07-2003 5.027 5.0273 Table 38 Calculation of Spread for PGXIV for 1 year GSec as Reference Rate




17-Jul-04 Jul- 14, 15, 16 4.800% 1.073% 5.8724% 6.10%

Jul-05 Jul- 13, 14, 15 5.844% 1.073% 6.9170% 6.10%

Jul-06 Jul- 14, 13, 12 7.006% 1.073% 8.0790% 6.10%

Jul-07 Jul- 16, 13, 12 6.972% 1.073% 8.0450% 6.10%

Jul-08 Jul- 14, 15, 16 9.459% 1.073% 10.5317% 6.10%

Jul-09 Jul- 14, 15, 16 3.948% 1.073% 5.0210% 6.10% Table 39 Floating Rates for PGXIV for 1 year GSec as Reference Rate


123





Jul-04 761.52 0 46.45272 Jul-04 761.52 0 44.71925

Jul-05 761.52 0 46.45272 Jul-05 761.52 0 52.67459

Jul-06 761.52 63.46 46.45272 Jul-06 761.52 63.46 61.52345

Jul-07 698.06 63.46 42.58166 Jul-07 698.06 63.46 56.15916

Jul-08 634.6 63.46 38.7106 Jul-08 634.6 63.46 66.83417

Jul-09 571.14 63.46 34.83954 Jul-09 571.14 63.46 28.67713

255.49 310.5878 Table 40 Interests under Fixed and Floating rates for PGXIV for 1 year GSec as Reference Rate

Figure 52 Interest Payments under Fixed and Floating Rate for PGXIV for 1 year GSec as Reference Rate

At the time of the issue the yield in Govt Bonds dipped to lows. The interest rates on GSec also fell

by around 115 basis points. The yield on the govt Bonds of 10 year maturity fell 5.75% indicating a 45

basis points fall. Thus the company was able to issue the bonds at a very low coupon rate of just

6.10% which is the lowest rate among all the series of bonds issued till date by the Power Grid

Corporation of India Limited.

Thus in this case it is highly beneficial for the firm to go for fixed rate. The company would have

ended up paying excess of amount Rs. 55, 09, 77,000 (Approx 550 million) towards interest rate if it

had gone for floating rate.

0

20

40

60

80

100

120

XIV (1 yr Gsec)




124

Floating Rate under Reference Rate of Average yield of 10 year GSec After analysing the costs under the floating rate with reference rate as INBMK 1 Year GSec Yield, the

study has been done by taking reference rate as average yield of 10 year GSec for the 12 months.

Most of the bonds has the repayment structure of 4 years of Moratorium Period and then followed

by 12 annual equal repayment of the principle parts. Thus the average tenure turns up to 9 years.

Since there is no GSec of tenure 9 years, 10 years GSec can be taken as benchmark.

Intrest payment, floating rate and the total payment under both the cases Fixed and floating for

each bond is explained in the following part. Also the reference period is yield of GSec for the 6

months preceding the coupon period for the semi-annual interest payments ( and 12 months for

annual interest payments), and the rate will be determined at the beginning of coupon period.

Bond VIII


In this case, since the spread was not available for the preceding 6 months of the month of issue,

the spread of AAA Bonds over 10 year GSec Bond as published by FIMMDA ( Fixed Income and

Monet Market Association) , for the days preceding the opening of offer has been taken as the

spread. Though this spread is for the purpose of Fixed Coupon rate, the same spread is considered

for the floating rate despite the fact that there is less risk for the investors in case of floating rate as

the rate determined is truly reflected by the prevailing market conditions.

During the issue of this series, Market expected a cut in CRR and a fall in GSec ate due to the cut in

CRR. But the situation reversed and though the CR fell, but the rate on GSec 10 years papers

increased. Of the total issue size just 10% was proclaimed. And though the Intrest rates on GSec

increased to 10.70%, the coupon rate was fixed at 10.35%

Though the spread was negative, the spread of 100 basis point (1%) has been taken as the principle

of conservatism.


Average Yield for 10Yrs GSec( 6 Months preceding Coupon period)


Oct-00 Oct 99 to Mar 00 11.03% 1.00% 12.026% 10.35%

Apr-01 Apr 00 to Sep 00 11.11% 1.00% 12.108% 10.35%

Oct-01 Oct 00 to Mar 01 10.78% 1.00% 11.777% 10.35%

Apr-02 Apr 01 to Sep 01 9.49% 1.00% 10.493% 10.35%

Oct-02 Oct 01 to Mar 02 7.86% 1.00% 8.863% 10.35%

Apr-03 Apr 02 to Sep 02 7.37% 1.00% 8.369% 10.35%

Oct-03 Oct 02 to Mar 03 6.28% 1.00% 7.280% 10.35%

Apr-04 Apr 03 to Sep 03 5.57% 1.00% 6.574% 10.35%

Oct-04 Oct 03 to Mar 04 5.17% 1.00% 6.174% 10.35%

Apr-05 Apr 04 to Sep 04 5.79% 1.00% 6.793% 10.35%

Oct-05 Oct 04 to Mar 05 6.77% 1.00% 7.772% 10.35%

Apr-06 Apr 05 to Sep 05 7.07% 1.00% 8.075% 10.35%

Oct-06 Oct 05 to Mar 06 7.27% 1.00% 8.268% 10.35%

Apr-07 Apr 06 to Sep 06 7.82% 1.00% 8.824% 10.35%

Oct-07 Oct 06 to Mar 07 7.73% 1.00% 8.732% 10.35%


125

Apr-08 Apr 07 to Sep 07 8.03% 1.00% 9.029% 10.35%

Oct-08 Oct 07 to Mar 08 7.75% 1.00% 8.746% 10.35%

Apr-09 Apr 08 to Sep 08 8.57% 1.00% 9.574% 10.35%

Oct-09 Oct 08 to Mar 09 6.57% 1.00% 7.567% 10.35%

Apr-10 Apr 09 to Sep 09 6.90% 1.00% 7.901% 10.35%

Oct-10 Oct 09 to Mar 10 7.57% 1.00% 8.571% 10.35% Table 41 Floating Rates for PGVIII for 10 Year GSec





Oct-00 20 0 1.035 Oct-00 20 0 1.2026

Apr-01 20 0 1.035 Apr-01 20 0 1.210817

Oct-01 20 0 1.035 Oct-01 20 0 1.177733

Apr-02 20 0 1.035 Apr-02 20 0 1.049267

Oct-02 20 0 1.035 Oct-02 20 0 0.886317

Apr-03 20 0 1.035 Apr-03 20 0 0.83685

Oct-03 20 0 1.035 Oct-03 20 0 0.728

Apr-04 20 0 1.035 Apr-04 20 0 0.6574

Oct-04 20 0 1.035 Oct-04 20 0 0.617417

Apr-05 20 2 1.035 Apr-05 20 2 0.679317

Oct-05 18 0 0.9315 Oct-05 18 0 0.69948

Apr-06 18 2 0.9315 Apr-06 18 2 0.726705

Oct-06 16 0 0.828 Oct-06 16 0 0.661467

Apr-07 16 2 0.828 Apr-07 16 2 0.70588

Oct-07 14 0 0.7245 Oct-07 14 0 0.611205

Apr-08 14 2 0.7245 Apr-08 14 2 0.631995

Oct-08 12 0 0.621 Oct-08 12 0 0.52477

Apr-09 12 2 0.621 Apr-09 12 2 0.57446

Oct-09 10 0 0.5175 Oct-09 10 0 0.378325

Apr-10 10 2 0.5175 Apr-10 10 2 0.395067

Oct-10 8 0 0.414 Oct-10 8 0 0.34282

18.009 15.29789 Table 42 Interests under Fixed and Floating for PGVIII for 10 Year GSec

Bond IX


In this case, the spread is calculated as the average spread for the 6 months preceding the issue

month for AAA Bonds for 10 years Duration as published by FIMMDA. The Spread turns up at 0.75%

or 75 basis points. The computation is as follows:

Avg Spread for AAA Bonds for 10 Years

Jul-00 74

Jun-00 77

May-00 72

Apr-00 80


126

Mar-00 70

Feb-00 75

Avg. 74.66667

Table 43 Calculation of Spread for PGX for 10 year GSec as Reference Rate19




Feb-01 Feb-00 to Jul-00 10.79% 0.75% 11.5442% 12.25%

Aug-01 Aug-00 to Jan-01 11.22% 0.75% 11.9663% 12.25%

Feb-02 Feb-01 to Jul-01 9.86% 0.75% 10.6057% 12.25%

Aug-02 Aug-01 to Jan-02 8.41% 0.75% 9.1612% 12.25%

Feb-03 Feb-02 to Jul-02 7.47% 0.75% 8.2233% 12.25%

Aug-03 Aug-02 to Jan-03 6.66% 0.75% 7.4127% 12.25%

Feb-04 Feb-03 to Jul-03 5.84% 0.75% 6.5890% 12.25%

Aug-04 Aug-03 to Jan-04 5.18% 0.75% 5.9262% 12.25%

Feb-05 Feb-04 to Jul-04 5.47% 0.75% 6.2200% 12.25%

Aug-05 Aug-04 to Jan-05 6.63% 0.75% 7.3803% 12.25%

Feb-06 Feb-05 to Jul-05 6.91% 0.75% 7.6580% 12.25%

Aug-06 Aug-05 to Jan-06 7.15% 0.75% 7.8960% 12.25%

Feb-07 Feb-06 to Jul-06 7.73% 0.75% 8.4753% 12.25%

Aug-07 Aug-06 to Jan-07 7.66% 0.75% 8.4125% 12.25%

Feb-08 Feb-07 to Jul-07 8.04% 0.75% 8.7875% 12.25%

Aug-08 Aug-07 to Jan-08 7.83% 0.75% 8.5817% 12.25%

Feb-09 Feb-08 to Jul-08 8.24% 0.75% 8.9945% 12.25%

Aug-09 Aug-08 to Jan-09 7.23% 0.75% 7.9823% 12.25%

Feb-10 Feb-09 to Jul-09 6.72% 0.75% 7.4667% 12.25%

Aug-10 Aug-09 to Jan-10 7.37% 0.75% 8.1248% 12.25% Table 44 Floating Rates for PGIX for 10 year GSec as Reference Rate

Since the spread is very low because of Heavy borrowing by Government, the floating rate is very

low and is always less than the fixed interest rate.





Feb-01 576.5 0 35.31063 Feb-01 576.5 0 33.27606

Aug-01 576.5 0 35.31063 Aug-01 576.5 0 34.49296

Feb-02 576.5 0 35.31063 Feb-02 576.5 0 30.57083

Aug-02 576.5 0 35.31063 Aug-02 576.5 0 26.40706

Feb-03 576.5 0 35.31063 Feb-03 576.5 0 23.70376

Aug-03 576.5 57.65 35.31063 Aug-03 576.5 57.65 21.36701

Feb-04 518.85 0 31.77956 Feb-04 518.85 0 17.09351

19 Source: www.fimmda.org

http://www.fimmda.org/


127

Aug-04 518.85 57.65 31.77956 Aug-04 518.85 57.65 15.37396

Feb-05 461.2 0 28.2485 Feb-05 461.2 0 14.34332

Aug-05 461.2 57.65 28.2485 Aug-05 461.2 57.65 17.01905

Feb-06 403.55 0 24.71744 Feb-06 403.55 0 15.45193

Aug-06 403.55 57.65 24.71744 Aug-06 403.55 57.65 15.93215

Feb-07 345.9 0 21.18638 Feb-07 345.9 0 14.65809

Aug-07 345.9 57.65 21.18638 Aug-07 345.9 57.65 14.54942

Feb-08 288.25 0 17.65531 Feb-08 288.25 0 12.66498

Aug-08 288.25 57.65 17.65531 Aug-08 288.25 57.65 12.36833

Feb-09 230.6 0 14.12425 Feb-09 230.6 0 10.37066

Aug-09 230.6 57.65 14.12425 Aug-09 230.6 57.65 9.20363

Feb-10 172.95 0 10.59319 Feb-10 172.95 0 6.4568

Aug-10 172.95 57.65 10.59319 Aug-10 172.95 57.65 7.02595

508.473 352.3295 Table 45 Interests under Fixed and Floating for PGIX for 10 Year GSec

Figure 53 Interest Payments under Fixed and Floating Rate for PGIX for 10 year GSec as Reference Rate

Bond X

Computation of Spread


May-01 110

Apr-01 100

Mar-01 78

Feb-01 106

Jan-01 111

Dec-00 104

Avg. 101.5

Source: www.fimmda.org

0

5

10

15

20

25

30

35

40

Feb

-01

No

v-0

1

Au

g-0

2

May

-03

Feb

-04

No

v-0

4

Au

g-0

5

May

-06

Feb

-07

No

v-0

7

Au

g-0

8

May

-09

Feb

-10

IX ( 10 Yrs Gsec)





128




Jun-02 Jun 00 - May 01 7.82% 1.015% 8.84% 10.90%

Jun-03 Jun 01 - May 02 7.13% 1.015% 8.15% 10.90%

Jun-04 Jun 02 - May 03 6.61% 1.015% 7.62% 10.90%

Jun-05 Jun 03 - May 04 5.37% 1.015% 6.38% 10.90%

Jun-06 Jun 04 - May 05 6.59% 1.015% 7.61% 10.90%

Jun-07 Jun 05 - May 06 8.17% 1.015% 9.19% 10.90%

Jun-08 Jun 06 - May 07 10.63% 1.015% 11.65% 10.90%

Jun-09 Jun 07 - May 08 10.77% 1.015% 11.79% 10.90%

Jun-10 Jun 08 - May 09 12.13% 1.015% 13.15% 10.90%





Jun-02 761.52 0 83.00568 Jun-02 761.52 0 67.30631

Jun-03 761.52 0 83.00568 Jun-03 761.52 0 62.0569

Jun-04 761.52 63.46 83.00568 Jun-04 761.52 63.46 58.05955

Jun-05 698.06 63.46 76.08854 Jun-05 698.06 63.46 44.54903

Jun-06 634.6 63.46 69.1714 Jun-06 634.6 63.46 48.27085

Jun-07 571.14 63.46 62.25426 Jun-07 571.14 63.46 52.46397

Jun-08 507.68 63.46 55.33712 Jun-08 507.68 63.46 59.12484

Jun-09 444.22 63.46 48.41998 Jun-09 444.22 63.46 52.35725

Jun-10 380.76 63.46 41.50284 Jun-10 380.76 63.46 50.05883

601.7912 494.2475

0

10

20

30

40

50

60

70

80

90

X ( 10 yr Gsec )




129

Bond XIII- Opt-II



Jun-02 138

May-02 127

Apr-02 173

Mar-02 200

Feb-02 198

Jan-02 159

Avg. 165.8333




Interest Payment

Reference Period Average Govt yield Spread Floating rate Fixed rate

Jul-03 Jul 01 - Jun 02 8.11% 1.658% 9.77% 7.85%

Jul-04 Jul 02 - Jun 03 6.39% 1.658% 8.05% 7.85%

Jul-05 Jul 03 - Jun 04 5.28% 1.658% 6.94% 7.85%

Jul-06 Jul 04 - Jun 05 6.70% 1.658% 8.36% 7.85%

Jul-07 Jul 05 - Jun 06 7.33% 1.658% 8.99% 7.85%

Jul-08 Jul 06 - Jun 07 7.88% 1.658% 9.54% 7.85%





Jul-03 250.5 41.75 19.66425 Jul-03 250.5 41.75 24.47293

Jul-04 208.75 41.75 16.38688 Jul-04 208.75 41.75 16.80431

Jul-05 167 41.75 13.1095 Jul-05 167 41.75 11.5839

Jul-06 125.25 41.75 9.832125 Jul-06 125.25 41.75 10.46606

Jul-07 83.5 41.75 6.55475 Jul-07 83.5 41.75 7.508501

Jul-08 41.75 41.75 3.277375 Jul-08 41.75 41.75 3.983458

68.82488 74.81915



130

Bond XIV



Jun-03 50

May-03 50

Apr-03 50

Mar-03 76

Feb-03 86

Jan-03 77

Avg. 64.83333




Interest Payment

Reference Period Average Govt yield Spread

Floating rate

Fixed rate

Jul-04 Jul 02 - Jun 03 6.39% 0.648% 7.04% 6.10%

Jul-05 Jul 03 - Jun 04 5.28% 0.648% 5.93% 6.10%

Jul-06 Jul 04 - Jun 05 6.70% 0.648% 7.35% 6.10%

Jul-07 Jul 05 - Jun 06 7.33% 0.648% 7.98% 6.10%

Jul-08 Jul 06 - Jun 07 7.88% 0.648% 8.53% 6.10%

Jul-09 Jul 07 - Jun 08 7.91% 0.648% 8.56% 6.10%

Jul-10 Jul 08 - Jun 09 7.17% 0.648% 7.82% 6.10%

0

5

10

15

20

25

30

Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08

XIII-Opt II ( 10 Yr Gsec)





131





Jul-04 761.52 0 46.45272 Jul-04 761.52 0 53.61075

Jul-05 761.52 0 46.45272 Jul-05 761.52 0 45.13123

Jul-06 761.52 63.46 46.45272 Jul-06 761.52 63.46 55.94227

Jul-07 698.06 63.46 42.58166 Jul-07 698.06 63.46 55.72066

Jul-08 634.6 63.46 38.7106 Jul-08 634.6 63.46 54.1391

Jul-09 571.14 63.46 34.83954 Jul-09 571.14 63.46 48.90415

Jul-10 507.68 63.46 30.96848 Jul-10 507.68 63.46 39.69068

286.4584 353.1388

0

10

20

30

40

50

60

XIV (10 Yr Gsec)




132

Floating Rate under Reference Rate of Average yield of 10 year GSec In the previous section, the reference period was taken a 6/12 months preceding the coupon period.

But the interest payment in case of reference period of 6/12 months preceding the interest payment

has also been calculated and analysed.

The spread has determined by the same method as used in the previous section ( i.e. average spread

of 6 months preceding the month of issue) as published by FIMMDA. The computation has been

added to the online appendix. And the summary of total interest in each method is as follows:

Average Yield for 10Yrs GSec( Preceding Interest Payment)

(Rs. Crs)

Bond Maturity Interest paid till Spread Under Fixed

Under Floating

VIII 14 Apr-10 1.000% 17.595 14.59242333

IX 12 Feb-10 0.750% 497.8798 334.674

X 14 Jun-09 1.015% 560.2883 464.861

XIII-Opt-II 6 Jul-08 1.658% 68.8249 71.826

XIV 12 Jul-09 0.648% 255.49 320.4026

Table 46 Total Intrest Under Fixed and Floating Rates for All Bonds under 10 Year GSec as Base Rate

And the Intrest trends of each Bond are as follows:

0

0.2

0.4

0.6

0.8

1

1.2

1.4

Oct

-00

Au

g-0

1

Jun

-02

Ap

r-0

3

Feb

-04

Dec

-04

Oct

-05

Au

g-0

6

Jun

-07

Ap

r-0

8

Feb

-09

Dec

-09

VIII ( 10 Yrs Gsec)*




133

0

5

10

15

20

25

30

35

40

Feb

-01

No

v-0

1

Au

g-0

2

May

-03

Feb

-04

No

v-0

4

Au

g-0

5

May

-06

Feb

-07

No

v-0

7

Au

g-0

8

May

-09

Feb

-10

IX ( 10 Yrs Gsec)*



0

10

20

30

40

50

60

70

80

90

X ( 10 Yr Gsec)*



0

5

10

15

20

25


XIII- Opt II (10 yr Gsec)*




134

Figure 54 Intrest Payments Under Fixed and Floating Rates for All Bonds for 10 year GSec as Base Rate

0

10

20

30

40

50

60

70


XIV (10Yrs Gsec)*




135

Floating Rate under Reference Rate of Average yield of 10 year GSec-

Average Spread of last 12 months

Alternate study of interest cost by taking different spread has also been done. In the previous case,

where average spread of previous 6 months preceding the issue month was considered. But since

the reference rate is calculated by taking the average yield of 10 yr GSec for preceding 12 months,

the spread also need to be taken for the period of 12 months.

Among the 5 issues selected namely, VIII, IX, X, XIII-Opt-II and XIV, the Intrest on the Issue Series VIII

is paid half yearly, thus spread for 12 months need not be calculated. And for Series IX and X, due to

unavailability of data, the spread has not been computed for 12 months preceding the issue month.

Thus for issue Series XIII-Opt II and XIV, the spread as published by FIMMDA for AAA rated PSU

Bonds with reference to 10 year GSec paper for the 12 months preceding the issue month has been

considered. The costs under each case (fixed and floating) is summarised in the table.

Summary of Each Base Rate The total interest payment till date under both fixed and floating rate for the selected 5 issues has

been summarised in the following table.

Average Yield for 10Yrs GSec( Preceding Interest Payment) (Rs. Crs)

Bond Maturity Interest paid till Spread

Under Fixed

Under Floating Savings

VIII 14 Apr-10 1.00% 18.009 15.29789 2.71111

IX 12 Feb-10 0.75% 497.8798 334.674 163.2059

X 14 Jun-09 1.015% 560.2883 464.8609 95.42745

XIII-Opt-II 6 Jul-08 1.658% 68.82488 71.82599 -3.00112

1.507%20

68.82488 73.49 -4.66512

XIV 12 Jul-09 0.648% 255.49 320.3901 -64.9001

0.711%2

255.49 323.0287 -67.5387 Table 47 Summary of Costs under 1 Year GSec as Base Rate

Average Yield for 10Yrs GSec( Preceding Coupon period) (Rs. Crs)


Under Fixed


VIII 14 Apr-10 1.00% 17.59500 14.59242 3.002577

IX 12 Aug-10 0.75% 508.473 352.3925 156.0805

X 14 Jun-10 1.015% 601.7912 494.247 107.5442

XIII-Opt-II 6 Jul-08 1.658% 68.82488 74.81652 -5.99164

1.507%2

68.82488 70.4959 -1.67103

XIV 12 Jul-10 0.648% 286.4584 353.1248 -66.6663

0.711%2

286.4584 356.0833 -69.6249 Table 48 Summary of Costs under 10 Year GSec as Base Rate ( Coupon Period)

20

Spread is determined taking previous 12 months’ average of Spread as published by FIMMDA


136

Average Yield of 1 years GSec ( 3 days preceding Intrest rate) (Rs. Crs)


Under Fixed


VIII 14 Apr-10 1.04% 17.585 12.57485 5.01015

IX 12 Feb-10 1.52% 497.8798 321.3677 176.5121

X 14 Jun-09 2.690% 560.2883 449.1773 111.111

XIII-Opt-II 6 Jul-08 1.794% 68.82488 65.9424 2.882475

XIV 12 Jul-09 1.073% 255.49 310.5878 -55.0978 Table 49 Summary of Costs under 10 Year GSec as Base Rate ( Interest Payment Period)


137

Factors Effecting the Selection of Each Method

From the above computation and comparison of Intrest payments under all the three benchmarks

rates with different spreads for different kinds of bonds differing with each other on the basis of

coupon rate, the quantum of loan and also the duration (Maturity). Some of the analysis that can be

made is:

The selection of different mechanism of paying interest Viz Fixed or Floating rate is influenced by

some of the following factors.

Term

Term implies the tenure of the bond. It is the maturity of the bond, after which the whole principal is

redeemed. For the bonds having short term maturity, the fixed coupon rate is suitable. This can be

validated from the above summary of results, where Bond XII-Opt II, which has the tenure of 6 years,

has interest payments under fixed coupon rate lower than that of payment under floating rate.

The rationale behind the floating rate is, the fluctuations, both short terms as well as long term are

normalised over the life of the bond. Thus in case of longer maturities, the fluctuations, both ups

and downs, are covered, thus on an average the payments under floating rate is normalised. But in

case of short duration bonds the floating rate may be either very low or very high based on the

period it belongs to.

In the above chart, depicting the floating and fixed rate for the Bond Series XIII which has the tenure

of 6 Years, it can be seen that though the interest rate in case of floating rate was less than that of

fixed in the initial years, . In this case, since the tenure of short term, the fluctuations of both Ups

and downs are not covered within the period.

Coupon Rate

Coupon rate is the interest rate attached to the bond. The coupon rate exists only in case of fixed

Intrest rate. Under floating rate, since the interest rate is reset after every period, thus a fixed

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

PG XIII- 1Year Gsec

1 Year Gsec + Spread PGXIII

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

PG XIII- 10Year Gsec

10 Year Gsec + Spread PGXIII


138

coupon rate cannot be determined. The coupon rate is one of the important factors that affect the

decision of selecting fixed under floating rate.

In case, if the company is able to issue at a lower coupon rate, it will be beneficial for the company

to go for fixed rate. This is because, no matter whatever are the market conditions, in the future, the

company will be needed to pay the low pre-determined rate.

To explain, if we consider the Series XIV, which is issued at a coupon rate of 6.10%, the Floating rate

turns up to be unfavourable. From the following chart, it can be seen that the security is issued when

the Bond is issued just before the GSec rate was at its lowest. Thus the floating rate exceeds the

fixed rate for the subsequent years. Thus when the GSec yield is at its lowest, it is preferable to go

for fixed coupon rate.

Market Condition

But since the coupon rate is determined based on the market conditions at the time of the issue, the

prevailing GSec rate and the spread, thus the market conditions during the time of issue is also an

important factor to consider.

If the market conditions are favourable, characterised, with adequate liquidity, low interest rates

etc... The prevailing GSec rats will be low and also the spread will be low resulting in low coupon

rate. And the benefit of this favourable condition can be enjoyed throughout the tenure of the bond.

But in case if the market conditions are not favourable, downturn in the economy, high borrowings

by the government, unfavourable policies by the RBI, would lead to high coupon rate. And though

this unfavourable condition lasts just for a month or a year, but the effect of the same shall be beard

over the long term.

Also the spread is determined based on the prevailing market conditions, and under both the cases

i.e... Fixed and floating the spread is kept fixed. But under floating rate, the reference rate keeps on

adjusting and thus there shall be benefits of savings.

0.000%

2.000%

4.000%

6.000%

8.000%

10.000%

12.000%

XIV- 1 Yr Gsec

1Yr Gsec + Spread XIV

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

12.00%

XIV- 10 Year Gsec

10 Yr Gsec + Spread XIV


139

For instance, in case of IX issue, when this series was issued the market conditions were not

favourable. Some of the events affecting the interest rates were

Due to hike in CRR, the Bank rates and GSec rates hiked up,

Most of the nationalised banks increased their PLR

60% of Annual borrowings by GoI during the current year amounting to approx. Rs.1,20,000

Crores is yet to be raised

All the above mentioned points may bring an upward pressure in GSec rates thus the coupon

rate was fixed with the spread of 75 basis points over the prevailing rate of 10 years GSec.

Thus, the rate determined was at 12.25%. And in this case, if the company had issued floating rate,

the effect of unfavourable conditions had to be suffered only for a year or so, and there would have

been savings under the floating rate.

Figure 55 Comparison of Fixed and Floating in case of Adverse Market conditions

From the graph, it can be commented that, floating rate is beneficial in case when market conditions

are not favourable. From the date of issue to the last interest payment date, the floating rate is

lower than the fixed coupon rate.

Quantum of Loan

The quantum of loan is also a component to be considered. For a loan of small amount, no matter

whatever be the coupon rate and whatever be the tenure, there will be very less losses or gains in

case of going to floating rate. Thus the company can be indifferent between fixed or floating rate.

Thus, in case of Bond series VIII, the loan amount of Rs20 Crores at the coupon rate of 10.35%, very

low saving of Rs.2 crores or Rs.5 crores depending upon different base rates can be seen, under the

floating rate.

Repayment Structure

Repayment structure determines the schedule of repayment of the principal and payment of

interest. Almost all the bonds of Power Grid Corporation of India Limited has initial moratorium

0.0000%

2.0000%

4.0000%

6.0000%

8.0000%

10.0000%

12.0000%

14.0000%

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

XII Issue

Gsec+Spread

XII


140

period followed by equal annual instalments for the principal payment. Thus the interest is paid for

the whole amount initially and then the payment is done on the outstanding balance which keeps on

reducing over the years.

Thus in case of floating rate, if the market conditions are favourable at the time of issue and

becomes adverse at the end, the company will get benefitted, as a low interest is paid on whole

amount and a higher interest is paid on the less amount. But in case of a reverse condition, i.e...

Market conditions being unfavourable at the initial years and then followed by the favourable

scenario, the fixed coupon rate is advisable.

Time of Issue

The timing of issue is very crucial for deciding the method of interest rate. The scenario of market

widely differs within a period of a month or so. If a month has scheduled government borrowings,

any awaited policy announcements, liquidity conditions etc..., the interest rates on GSec will be high

leading to the high coupon rate.


141

Critical Analysis of Alternatives

Recommendations

Chapter VI

Findings and

Recommendations


142

Critical Analysis of Alternatives Based on the above discussed calculations and their analysis, some of the alternatives for the

purpose of issuing bonds are as follows:

Fixed Coupon Interest Rate The company can go for the fixed coupon rate for some of its bonds based on the market conditions

and the suitability of the rate. In this case the coupon rate fixed by the process of book-bidding will

remain constant for throughout the life of the bond. The company can take benefits of the

favourable market conditions at the time of the issue for the whole life of the bond. But there is also

a risk attached to it, as it is highly skewed towards the market condition and the prevailing interest

rates at the time of the issue, and the company may need to suffer if the market conditions are not

favourable.

Some of the merits of this mechanism are:

Since the interest rate is fixed at the time of issue, the company can easily forecast the

interest obligations for the future and budget the same.

The zero variation in the income in way of interest attracts the client base belonging to Fixed

Income group. In India majority of investors is comprised of Retirement funds like Provident

Fund, Pension Plan, Superannuation funds etc. Thus this kind of plan can assure maximum

acceptance.

This kind of mechanism is very beneficial, if the conditions of the market are favourable and

are characterised with low interest rates. Thus the coupon rate fixed at the time of issue

which remain fixed shall lead to lot of savings.

This is suitable for a company which is very conservative.

Some of the Cons attached to this type of method are:

The company cannot take the advantage of fluctuations in the interest rates due to the shift

in economic conditions and other favourable events.

The coupon rate determined at the time of issue does not reflect the market conditions of

the subsequent years.

If the issue comes out at a period when the market conditions are adverse, the coupon rate

determined will be very high because of high interest rates as well as high spreads. And the

rate determined will remain constant for the whole tenure leading to heavy costs.

Floating Rate

As against the case of fixed Coupon rate where the interest rate is determined at the time of issue

and is kept fixed, in case of Floating Interest Rate, the interest rate does not remain constant and is

reset after every predetermined reset period. In this case the interest paid for the period is truly

represented by the market conditions and the prevailing interest rates for that period. But there is

risk of fluctuation of interest rates and these may be very low or very high. Thus this method can be

used for few bonds based on the market situation, tenure of the bond and also the quantum of the

loan.


143

The rate is determined based on the reference rate. And this reference rate can be yield on a

Treasury bill, Yield on 1 year GSec paper, or 10 year GSec paper, or even Bank rates like MIBOR. The

selection of either of the reference rates depend on the kind of security, its maturity, its features in

terms of risk, raying etc. And also the decision is on the discretion of the issuer and the advice of

merchant bankers.

Some of the points in support of Floating rate are:

The company can take advantage of Intrest rate fluctuations, and pay the interest as per the

prevailing interest rates in the economy.

In case if the market conditions are not favourable at the time of issue, the interest paid on

the security for the subsequent years will not be much influenced by the market conditions

of the issue period.

For the investor, this kind of securities are attractive and preferable by them, since the

returns on the security are truly represented by the market conditions and are similar to the

opportunity cost21 of the investment.

Since the interest paid for any period is truly represented by that period’s condition and also

since the trading is allowed in the bonds, an investor can hold the security for short term

and need not hold it till the maturity.

Some of the points against this method are:

This method is characterised with fluctuations in Income for the investors, thus it may be

less attractive for the Fixed and Regular Income class of the investors (Viz Retirement benefit

Funds).

Also, since the interest payments for the future cannot be forecasted, the budgeting of

funds cannot be done effectively.

But this can be solved by maintain a provision account for some fixed coupon rate or as

some margin added to the past floating rate on the outstanding balance.

For the companies which are very conservative and least prefers the variations in the

expenses, this method is least attractive.

The benefit of favourable conditions at the time of issue vanishes in this method.

Though the interest rates are truly represented by the prevailing market conditions, but the

spread is determined based on the prevailing spread at the time of issue. Thus there is some

influence of market conditions at the time of issue.

21

The returns which he would have received in case of investing in any alternate avenues.


144

Fixed Coupon Rate with Option As mentioned before, one of the demerits of fixed coupon rate is, in case of high interest rates at the

time of issue, the same coupon rate is paid for throughout the tenure even though the market has

become favourable. This can be avoided if the bonds are issued with an option attached to it.

The option is the Option for the option holder to execute his option of Buy or sell, and the other

party is under obligation to fulfil the option. In this case the option holder has the option but he is

not under obligation to exercise his option. The Option can be compared with the person holding the

Ticket to a cinema. In this case the ticket holder has the right to watch the movie if he wishes to and

the Theatre management cannot deny him from his right and is under obligation to show him the

cinema. But also the Ticket holder is not at all under the obligation of watching the movie and the

management cannot force him to watch the movie.

The company can issue the Bonds with the Call Option with the company or Put option with the

investor. The Call option implies that the Option holder has the right to buy the security in a

predetermined period and at a predetermined price. And the other party is under obligation to sell

them whenever the Call option is exercised.

And the Put option implies that the Option holder has the right to sell the security at a

predetermined price after a predetermined period. But he is not under obligation to exercise the

right. But the other party is under obligation to buy the security in case if the holder exercises the

Option.

The Company can also attach the Option with the Bonds. If the company is expecting a fall in interest

rates after a period of five years, or in case if the current interest rates are very high but the raising

of loan cannot be postponed, in this case the Bonds can be issued with a Call Option with the

company to buy the Bonds after a predetermined period.

In case if the interest rates fall after the predetermined Hold-In period, the Company can call for the

bonds and repay the bondholders and then can raise the fresh bonds at a low coupon rate.

Some of the Merits attached to it are:

Apart from the merits in case of fixed coupon rate, the coupon rate if is set at a very high

rate due to unfavourable market conditions, the company can redeem the bonds of high

coupon rate and can swap the amount with a low coupon rate bonds by issuing the fresh

bonds.

Also, since the Investors do not have the Put Option the uncertainty of Disbursements in

case of sudden selling of bonds by investors is avoided.

But since the put option is not provided to the investors, in case of rise in the interest rates than the

coupon rate, the investor do not has the option of selling these bonds to the company and re-invest

the funds in a better avenue. This makes the instrument less attractive.


145

Recommendation

After comparing the interest costs under Fixed and Floating Rates for a array of bonds having

different characteristics like

Meagre loan Amount

Half Yearly Intrest Payment

Longer Maturity of 14 years

Shorter Maturity of 6 years

Low coupon rate

Though the behaviour and pattern of the yields of GSec papers are very fluctuation and do not

follow a fixed pattern, very accurate recommendations could not be given. But based on the trend of

last 10 years GSec yield trend, some of the recommendations that can be made on the suitability of

each kind bond are:

The company can go for Fixed Intrest rate if the market conditions are favourable at the time

of issue.

Also for the meagre loan amount, the company can be indifferent between the Fixed and

the Floating rate.

If the bonds are issued for a very short term period, the behaviour of the GSec yield will

influence the decision. If the issue is made at the period when the yield is high, the floating

rate will be suitable because the yield curve would fall for the subsequent years and only the

fall will be covered within the tenure because of short term maturity bond.

But in case if the curve is already at its low, fixed rate must be preferred for the short tenure

bonds, because in case of floating rate, only the rise will be covered.

For a longer maturity bond, Fixed interest is to be preferred if the yield curve of the GSec is

at its low, and the floating is to be preferred if the yield curve is at its high.

The method of interest determination is not affected by the frequency of interest payment.

Be it half yearly or annually.

In case of recession, the yield of GSec, the interest rates are low; the investors become

prudent and prioritise the security to the returns. Thus at such conditions, fixed coupon rate

can be issued as the company will be able to attract investment at low coupon rate.

Also since as per CERC Guidelines, for the purpose of Tariff determination, the company shall

provide the interest expenses, if the company goes for the floating rate, the interest

payments will vary every year, thus a provision account can be maintained.

The company can also issue the Call Option Embedded Bonds if the market conditions are

not favourable at the time of issue.

The Intrest rates on GSec paper and the Yield curve is affected by some of the economic

events like announcement of budget, announcement of monetary policy by RBI etc... Thus in

case of fixed coupon rates, the timing of the issue must be planned and thus the advantage

of favourable market condition can be taken.


146

References

Bond & Money Markets: Strategy, Trading, Analysis, First South Asian Edition, Moorad Choudhry

Bond Markets, Analysis, and Strategies, Fifth Edition, Frank J. Fabozzi

CORPORATE CREDIT RATINGS A Note on Methodology- by ICRA

Financial Data from Company’s Annual report- 2008-09

http://en.wikipedia.org/wiki/Reverse_Greenshoe Visited on 11th April

http://www.equitymaster.com/detail.asp?date=9/6/2003&story=2 Visited on 3rd April

http://www.equitymaster.com/research-it/sector-info/power/ Visited on 3rd April

http://www.investopedia.com/terms/g/greenshoe.asp Visited on 11th April

http://www.jagoinvestor.com/2010/03/floating-rate-mutual-funds-%E2%80%93-how-when-and-

why.html visited on 26th April, 2010

http://www.linkedin.com/answers/finance-accounting/corporate-debt/FIN_CDT/327845-24854458

Visited on 7th April

http://www.powermin.nic.in/indian_electricity_scenario/introduction.htm Visited on 3rd April

http://www.sundarandco.com/sebi03.htm Visited on 11th April

http://www.youtube.com/watch?v=NV0S8pKvje8&feature=related Visited on 14th April

http://www.youtube.com/watch?v=tJLR3se4Pa4 Visited on 14th April

Offer Document of Power Grid Corporation of India Limited’s Bond series XII, IX, XXIX and XXXI.

Offer Documents of FRBs of ICICI Limited, Power Finance Corporation of India Limited, Kotak

Mahindra Limited, Indian Railway Finance Corporation of India Limited.

Red Herring Prospectus of Power Grid Corporation of India Limited’s IPO of September, 2007.

Securities and Exchange Board Of India (Disclosure And Investor Protection) Guidelines, 2000

Power Sector in India -White paper on Implementation Challenges and Opportunities” – KPMG

Repos in corporate bonds under consideration, says Sebi”- Newswire18 / Mumbai September 11, 2009,

Some of the data bases used are:

Capitaline

http://nse-india.com/

Reuters

www.FIMMDA.org

www.indiastat.com

http://en.wikipedia.org/wiki/Reverse_Greenshoe%20Visited%20on%2011th%20April

http://www.equitymaster.com/detail.asp?date=9/6/2003&story=2%20%20%20%20%20Visited%20on%20%203rd%20April

http://www.equitymaster.com/research-it/sector-info/power/%20%20%20%20%20%20%20Visited%20on%203rd%20April

http://www.investopedia.com/terms/g/greenshoe.asp%20Visited%20on%2011th%20April

http://www.jagoinvestor.com/2010/03/floating-rate-mutual-funds-%E2%80%93-how-when-and-why.html%20%20visited%20on%2026th%20April,%202010

http://www.jagoinvestor.com/2010/03/floating-rate-mutual-funds-%E2%80%93-how-when-and-why.html%20%20visited%20on%2026th%20April,%202010

http://www.linkedin.com/answers/finance-accounting/corporate-debt/FIN_CDT/327845-24854458%20%20Visited%20on%207th%20April

http://www.linkedin.com/answers/finance-accounting/corporate-debt/FIN_CDT/327845-24854458%20%20Visited%20on%207th%20April

http://www.powermin.nic.in/indian_electricity_scenario/introduction.htm%20%20Visited%20on%203rd%20April

http://www.sundarandco.com/sebi03.htm%20Visited%20on%2011th%20April

http://www.youtube.com/watch?v=NV0S8pKvje8&feature=related%20%20Visited%20on%2014th%20April

http://www.youtube.com/watch?v=tJLR3se4Pa4%20Visited%20on%2014th%20April

http://nse-india.com/


http://www.indiastat.com/

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