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Capital Market – Types of Bonds

Ways to raise money from Market

Borrow Money (Debt)
  • Bonds
  • Junk Bonds
  • Gilt Edged Bonds
  • Bearer bonds
  • Bank Loan
Give Partnership (Equity) 
  • IPO Shares
  • Venture Capitalist
  • Angel Investors fund

 

Debt Types

  • Bonds, Debentures, Loans, ECB, T-Bills, Commercial Papers, Certificate of deposits
  • Creditor to company & First claim during liquidation
  • Yield (rate of return) and the maturity always inversely related

 

Bonds

  • Carry fixed interest payable every year by the company
  • For e.g. To whoever pays me Rs. 1000, I’ll pay annual 10% interest rate (Rs. 100)
  • And after 5 years, I’ll also repay the principle amount Rs. 1000
  • SEBI Rule If bond maturity > 18 months then getting credit rating is mandatory

 

Junk Bonds (High Yield Bond)
  • Credit rating companies like CRISIL, S&P, Moody’s etc. give credit ratings (AA, A, BBB, C, D etc.) to a bond based on reliability & market value of a company
  • If any Bond gets “C” or “D” rating, it means it is not creditworthy & may default on this loan; hence not much people will not invest in it.
  • Hence to allure investors they provide various schemes or higher Interest rates on bands
  • For e.g. “If you give me Rs. 1000, I’ll give you 25% interest rate per year”

 

Gilt Edged Securities
  • Government Securities & Treasury Bills (via RBI) & well-known companies with high credit ratings issues bonds
  • High credit ratings assure an investor of its credibility & hence Gilt edged securities pay low rates generally 4% annually

 

Bearer Bonds
  • Same as regular bonds, but don’t have “Holder’s Name” on them, instead have coupons attached with them.
  • So, if anyone doesn’t want to withdraw the whole money, he can cut a few coupons and sell them to a broker to withdraw partial amount.

 

Bond Yield

  • Bond yield to maturity Total ROI of buyer on maturity
  • If bond price decreases, Bond yield increases
  • For ex. Bond value is Rs. 1000 for 10 % annually
  • Hence initial bond yield is 10% for first investor
  • If he sells it to second investor at Rs. 900 then his bond yield will be 10/900 11%

 

Factors deciding Bond Yield
  • Assured return with good credit rating Low bond yield
  • Bankruptcy rumour in market for a company panic sales by investors Bond yield goes high
  • Credit rating down next time have to offer higher interest rate Junk bond

 


Debt Instruments

  • Credit rating Gilt securities vs Junk bonds
  • Bond vs Debenture
  • Optionally fully convertible debentures (OFCD)
  • Other types of Debentures
  • Inflation indexed bonds (IIB)

 

Credit rating for Sovereign Bonds (Rating of Countries)

  • Credit rating companies like CRISIL, S&P, Moody’s etc. also give credit ratings (AA, A, BBB, C, D etc.) to countries based on their eco-political conditions
  • India hold a credit rating in medium risk category just above the junk status
Factors affecting credit rating
  • Fiscal deficit
  • Inflation
  • Infrastructure
  • Foreign investment
  • GDP growth

Credit rating India

Bond vs Debenture

  • Bond is the terminology used in England while debenture is the terminology used in America
  • The term bond is used for a Government or PSU security while the term debenture is used for private companies securities
  • In India, Bondholders are secured by access to the underlying asset in case of default by the issuer.
  • Debentures, on the other hand, are unsecured, with debenture holders not having recourse to assets in the case of default by the debenture issuer.

 

Optionally fully-convertible debentures (OFCD)

  • Investors have option to change Debentures to Shares
  • If debentures are changed to shares then from companies point of view
  • No further interest payment headache
  • No profit to the company No share
  • Will only share dividend when company makes profit
  • If debentures are changed to shares then from investors point of view
  • If company makes higher profit
  • He will get bigger dividend

Bond Debentures

Other Types of Debentures

  • Non-Convertible debentures
  • Partially convertible debentures 100 Debenture – Rs. 70 (Non-convertible) + Rs. 30 ( Can be converted to Equity)
  • Fully convertible debentures 100 Debenture Fully converted to equity (No Choice)
  • Optionally convertible debentures Choice after two years For ex. 1 Debenture = 3 shares
  • Redeemable vs irredeemable before Maturity period
  • Fixed interest rate vs Index-linked interest rate (Sensex etc.)

 

Inflation Indexed Bonds – Primary Market Operations

Interest Rate: Real vs. Nominal

Inflation Indexed Bonds

Why Gold consumption bad?
  • Saving from Gold is not being used for capital expansion
  • Gold import high Trade deficit high
  • Current Account Deficit increases Rupee value decreases Crude oil price increases
  • Crude oil price increases Petrol, Diesel price increases Inflation increases
  • Real Interest rate becomes even more (negative) More Gold consumption
  • This vicious cycle continues Leading state to hyperinflation
  • Can not ban Gold import ban Leads to smuggling
  • Solution Provide new investment avenues with positive REAL interest rate

 

Inflation Indexed Bonds

  • Inflation Indexed Bonds works on the principle of WPI Inflation Rate + X % Profit
  • Compounded half yearly & can be traded at secondary market viz. from one investor to the other

Inflation Indexed Bonds India

IIB (Inflation indexed bonds) IINSS-C (Inflation Indexed National Savings  Securities-Cumulative)
  • For Institutional Investors (80%) + Retailers (20%)
  • For Only retail investors viz.
  • Individual / NRI
  • HUF (Hindu undivided family)
  • Charity organizations
  • Educational bodies
  • Direct sold by RBI
  • RBI via. Nationalized banks
  • Matures Period of 10 years
  • Penalty if redeemed early
  • Matures Period of 10 years
  • Senior citizen has been given some relief in redeeming terms
  • Compounded half yearly
  • 1.44% + WPI (2004)
  • Compounded half yearly
  • 1.5% + CPI (Combined) 2010 base year
  • Can be traded in secondary market
  • Capital gain tax applies
  • None
  • NA

 

Inflation indexed bonds losing shine
  • Mutual funds invested heavily in IIBs during high inflation period
  • But WPI is falling gradually since 2015
  • Hence net interest rate of IIB stands out near 4 %
  • Hence players exiting the game.

 

Credit Default Swap

  • Insurance policy on bonds paying a certain premium
  • When company defaults & even on liquidation can’t recover the money than insurance company will pay the investor.
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