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Innovative Financial Instruments-B.V.Raghunandan, SVS College, Bantwal
Department of Commerce and Management Studies, University of CalicutFebruary 10,2010
Financial Instrument
The basic documents issued to the large body of investors when an organisation or institution raises the funds from a large body of investors
Standardised document as per statute or governing institution containing features of the relation between the fund raiser and the user
Limited formats
Innovation in the Instrument
Altering the terms of issue in a novel way in order to achieve the predetermined purpose
Purpose of Innovation
Different Type of Credit Control and Macro-level Liquidity Management
Matching Cash Flow Requirement of the Fund Raiser
Satisfying other Objectives like Retaining Management Control
More Effective Catering to the Needs of the Investors
Better Treasury Managment
RBI Initiative
Liquidity Adjustment Facility (LAF) {Repo and Reverse Repo} Collateralized Borrowing & Lending
Obligations (CBLO) Market Stabilisation Scheme (MSS) Perpetual Bonds or Innovative
Bonds
RBI-Liquidity Adjustment Facility (LAF)
Repo and Reverse Repo as part of LAF since 2000
Designed to form the Interest Rate Platform within which all short-term interest rates will lie
Together with CRR, it has become an effective short-term liquidity management tool
Needed to manage the unexpected movement of funds into and out of the country due to Hedge Funds and Others
RBI-CBLO Introduced by CCIL in 2003 A Wider Call Money Market Participation by Pledging specified
securities with CCIL Participation by NBFCs and Corporate also
apart from usual Call Money Market Players
One Day or more Better Treasury Management by Corporate Better Profitability of Banks Cheaper Market than Call Money Market
RBI-Market Stabilisation Scheme
Launched in 2004 through an MOU between RBI and the Central Government
Part of a Longer Period Sterilisation of Market Managing Liquidity Problems arising out of
Forex Remittances RBI to issue after consultation with
Government Sale of Treasury Bills and Dated Securities
through Auction Better Fiscal Accountability as they are issued
against cash maintained by the Government with RBI
Perpetual Bonds
Introduced in 2005 Issued by Scheduled Commercial
Bankss 15 year Tenure with a Roll on forever
at the option of the Bank Part of Tier I Capital of Banks Enabling the Banks to meet Basel
Norm regarding Capital Adequacy Ratio
Insurance Companies are usually the investors
Corporate-India
Bonus Debenture Zero Coupon Bonds FCCB Multiple Option
Bonds Infrastructure Bonds Commercial Paper Certificate of Deposit Forex Backed
Infrastructure Bonds
Shares with Differential Voting Rights
Bonus Preference Shares
Time Share Plantation Share ADR/GDR Shares with
Disproportionate Voting Rights
Bonus Debenture
Rewarding Shareholder by better Treasury Management
Hindustan Lever tried it in early 2000s
Avoiding a Blown-up equity capital base
Did not enthuse the investors much Concept did not catch the fancy of
the market
Zero Coupon Bonds
Interest in the form of discount on the face value of bonds
Cross Border Investment Taxation benefit Better Treasury Management since
postponing the payment of interest on redemption
Where convertibility alone is the consideration, saving of interest
Foreign Currency Convertible Bonds Provisions of FEMA Convertibility is the cream Cross Border Investment Gained Popularity Recently
Multiple Option Bonds
Reliance Industries pioneered it in India
Appealing to Different Requirements of Investors for Income Planning
Flexibility in Tax Planning of Investors Payment of Interest is staggered with
varied options Became Popular and adopted for
Infrastructure Bonds also
Commercial Paper
short-term security Rated instrument Issued by listed companies Short-term source of finance for corporates Banks and other corporates invest SBI-DFHI tried to create a secondary
market, but failed Securities are held until maturity
Certificate of Deposit
Banks allowed to issue COD by RBI since 1989 though US banks were issuing since 1961
Tapping large deposits of corporates and HNI
Tenure is short-term for 3 months to one year
Held until maturity SBI-DFHI buys the CODs No secondary market exists as SBI-
DFHI is not able to accumulate sufficient CODs
Forex Backed Infrastructure Bonds In 2009, For the First time RBI
invested with a private fund The UK Subsidiary of India
Infrastructure Finance Company Ltd issued the bonds
The RBI used its foreign exchange reserve to invest in the bonds
Indian firms operating in foreign countries can augment the resources by issuing such bonds
Shares with Differential Voting Rights A product for the M&A era Lesser Dilution of management
control Each share carrying fraction of a vote Share issued at a discount Dividend is more than the dividend
on the normal shares Tata Motors issued in 2008 (one
tenth of vote, 305 against 340 per share and 5% more dividend)-Gujarat NRE Coke in the same year
Bonus Preference Shares
In 2003, Sun Pharmaceuticals issued bonus preference shares
Better cash management Better than bonus debentures as
there is no compulsion of payment of interest
Did not enthuse the shareholders like the bonus equity shares
Did not catch the fancy of the market
Time Share
Property sharing for a certain number of days per year
Used by Resorts in Tourist Destinations
Sterling Group and a few other organisations tapped the market well
Fancy ruled only for a few years
Plantation Share
Came out with big fanfare Promised fantastic returns in the
distant future Many gullible investors were taken
for a ride Least Liquid instrument Only a few firms have a token
presence
ADR/GDR
Instruments issued to foreign investors in lieu of the shares deposited with a custodian in the home country
Mainly to get the instruments of Instruments of Indian companies listed in foreign bourses
Enhanced the image of Indian companies and added a global perspective
Contributed to the volatility of Indian Market
Shares with Disproportionate Voting
Rights
New Companies Bill is doing away with shares with differential voting rights
In its place, shares with superior voting rights are being proposed
Helping the promoters to ward off hostile take-overs
Lacking fairness
Dangers of Innovation
Creating a hype Not a proper study is made before the
introduction Complexity Complexity leads to lack of correction of
wrong steps IT enabled financial system enables
excesses which endanger the very survival of the firm
Short term growth for higher managerial remuneration
Corporate-USA
Collateralised Debt Obligation (CDO) in 70s Mortgage Backed Securities (MBOs)
(pioneered by Larry Fink of First Boston Corporation in 1984)
Sub-prime Mortgages in 1990s due to the popularity of MBOs resulting in lowering rates of interest
Credit Default Swaps (CDS) invented by Blythe Masters JP Morgan Chase in 1997
CDS reaching 62.1 trillion dollars in 2007(AIG being the main player)
The US Debacle 2000-03 –Alan Greenspan cuts Fed
Rates from 6% - 1% Banks go on a Lending Spree 2004-Govt. Backed Lenders Fannie Mae,
Ginnie Mae and Freddie Mac have nearly 20% of lending to sub-prime clients
2005-CDS market soars with increase in housing sector boom
2006-Interest Rates rise to 5+% 2007-08-the bubble burst in the housing
sector
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