Investment in bonds 2


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Project on Investment and bound
by :- inamdar.b.pawar
from :- B.V.I.M.E.D ( navi mumbai)

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Investment in bonds 2

  1. 1. SR. INDEX PG.NO. NO. Executive Summery 1 Introduction1.1 Objectives Of The Study1.2 Research Methodology 2 Conceptual framework2.1 Meaning and Definition2.2 Features of Bond2.3 Advantages and Disadvantages2.4 International bond market2.5 The development of International bond market2.6 Types of International bond market2.7 Eurobond Markets2.8 Eurocurrency Markets2.9 Credit Rating Agencies in the World2.10 Benefits to the investment in International Bond Market2.11 Valuation And Risk of the International bond market 3 Collection and Analysis of Data 4 Interpretation of Data 5 Conclusion 6 Suggestion and Recommendation Appendices Bibliography
  2. 2. EXECUTIVE SUMMERYInvestment is a commitment of money or capital to purchase financial instrument or otherassets in order to get profitable returns in the form of interest, income and appreciation ofvalue of an instrument. Investment is related for savings or differing consumption. Aninvestment involves a choice by an individual or an organization such as pension fund.Investment divided in 2 types i.e. in financial assets means Equities, Mutual fund, Bonds,Deposits, Cash equivalents etc… and the non financial assets i.e. Real estate and Gold. Thereis a various kinds of bonds are available to the investment in the market. A bond is a security which is debt instrument where the investors get their guaranteedreturn without any risk. Bond market is that where the bonds are traded. Trading of bonds aredone through stock exchange Stock exchange is regulated under SEBI. The vast majority ofinvestors are invested their money in municipal bonds. Mutual funds have a number ofadvantage s over the individual bond portfolios. Individual bonds are providing certainbenefit which compared with bond mutual fund.Prices of Bonds are crossly related for making change in interest rates. When interest ratesare increased, Price of bonds decreases. This is mostly happens because the prices of bondsfixed to the issuance. Most companies issue bonds in order to raise funds to fund projects thatrequire capital. The advantage to issuing bonds over stock is that the company doesnt haveto give up any partial control of the company or give up a portion of profits. The downside isthat they have to pay back the money, with interest. Having to make debt payments eachmonth will lower the profits of the company as long as they have debt outstanding as well aspossibly raise the risk that the company may fail due the higher expenses. This topic would help to get the knowledge about investment in bonds and bondmarket. In this topic I have given introduction about credit rating process which is used invarious kinds of agencies and valuation of bonds. The project also includes primary data andsecondary data.
  3. 3. CHAPTER NO.1 INRODUCTION A bond is a loan in the form of a security where the bond buyer lends money to thebond issuer. Interest payments are made at fixed intervals for a predetermined amount oftime and then the principal (the original money borrowed) is paid back at maturity. The term"bond" is technically reserved for debt issues where the repayment term is more than 10years. If the repayment term is more than 1 year but not more than 10 years then the debt iscalled a "note". If the repayment term is 1 year or less then the debt is called a "bill".Bonds are among the safest investments in the world. But no investment is entirely risk free.In fact, fixed-income investing has its own particular forms of risk: inflation, reinvestment,default, and downgrade. A bond price is inversely related to the change in interest rates. When interest ratewill raise, a bond price become falls. This is because bond coupon payments are fixed atissuance. When interest rates change, the price of each bond shifts, so that comparable bondintroduced with different coupon rates & provide to the investors with same yield tomaturity. Government bonds are less liquid than taxable bonds &have higher transactioncosts. A yield curve is simple representation of the relationship between the interest rate thata bond pays and when that bond matures. Learning how to read a yield curve -- and knowingthe significance of a flattening or inverted yield curve as well as how to calculate the spread -- is a crucial skill for fixed-income investors. Inflation can eat away at your investments. Buttheres a very safe investment from the U.S. Treasury Department that protects investors frominflation risk. The principal invested in TIPS, or Treasury Inflation-Protected Securities, is adjustedsemiannually to reflect rises in the Consumer Price Index. Zero-Coupon Bonds are sold at adeep discount to their face value. In many cases, interest is compounded and paid at maturityrather than during the life of the bond. In other cases, a financial institution "strips" theinterest payment from a fixed-income investment and resells it as a zero coupon.
  4. 4. Most companies issue bonds in order to raise funds to fund projects that requirecapital. The advantage to issuing bonds over stock is that the company doesnt have to giveup any partial control of the company or give up a portion of profits. The downside is thatthey have to pay back the money, with interest. Having to make debt payments each monthwill lower the profits of the company as long as they have debt outstanding as well aspossibly raise the risk that the company may fail due the higher expenses. Bonds are issuethrough federal government which is treasury bonds, state and municipal government issuesmunicipal bond and corporations issue corporate bonds. The latest on the municipal marketplace including our exclusive real-time priceinformation and ticker, in-depth market data, a variety of municipal bond indices, andrelevant economic indicators are available. Invaluable tools for the municipal bond investor.Comprehensive data on government and federal agency bonds including our real-time agencyprice information and ticker, key indices and important economic indicators. Check outdescriptions of the most significant issuers and their bond issuance programs. Use this data toguide your government and agency investment strategy. Timely data on corporate bonds including our real-time price information and ticker,in-depth market data, key corporate indices, and relevant economic indicators.
  5. 5. 1.2 OBJECTIVES OF THE STUDYTo understand the bond & International bond market.To study the different avenues of International bond market.To understand the benefits of investment in International bonds.To study the valuation and risks available of investment in International bonds.To study the worlds credit rating agencies of the International bond market.
  6. 6. 1.3 RESEARCH METHDOLOGYPrimary dataPrimary data is a term for data collected on source which has not been subjectedto processing or any other manipulation, it is known as raw data.Primary data have been collected on the basis of questionnaire on this relevanttopic.Secondary dataSecondary data is the data collected by someone other than the user. Secondarydata includes newspapers, books, etc. Research methodology Primary data Secondary data Surveys Books:- Debt market (Vipul Prakashan) 1. Sandeep Gupta 2. Sachin Bhandarkar Global Capital Market (Vipul Prakashan)
  7. 7. CHAPTER NO.2 PROFILEL&T Infrastructure Finance Company Limited Larsen & Toubro
  8. 8. 2.1 OVERVIEW OF THE COMPANY L&T Infrastructure Finance Company Limited (L&T Infra) is promoted by the engineeringand construction conglomerate Larsen & Toubro Limited (L&T) and L&T Finance HoldingsLimited (a subsidiary of L&T). L&T Infra, incorporated in 2006, is registered as a Non Banking Financial Company(NBFC) under the Reserve Bank of India (RBI) Act 1934, and is among the select fewfinancial institutions classified as an Infrastructure Finance Company (IFC). It was set upwith an initial capital of 500 crore (US$111 million) and has expanded at a rapid rate sinceinception. L&T Infra provides a wide range of customized debt & equity products as well as FinancialAdvisory Services for the development of infrastructure facilities in the country with a focuson power, roads, and telecom, oil & gas and port sectors. L&T Infra functions with high Corporate Governance standards and Independent Directorsconstituting 50% of its Board and the key committees. As a testimony to its strongcredentials and sound operating performance, L&T infra enjoys AA+ credit ratings by bothCARE and ICRA. L&T Infra operates from is Mumbai, Delhi, Chennai and Hyderabad centers - and ismanaged by a team of experienced banking professionals, under the guidance of an eminentBoard drawn from both L&T and banking industry.  Mission: a. Aim: To be a strategic business partner and a solution provider.
  9. 9. b. Purpose: To nurture human capital and develop leadership for professional excellence through meritocracy and continuous learning environment. Values: Customer orientation, teamwork, trust and transparency. Vision: "To be a dominant player in financial services, committed to constant innovation and sustained customer service to enhance shareholders wealth. LTF will foster trust, uphold integrity and radiate positive energy." About L&T Group: Larsen & Toubro Ltd is a USD 9.8 billion technology, engineering and construction group with operations spread across the globe. It was ranked as 14th by the Economic Times in their survey of the Top 500 Companies in India. Another feather in its cap was added when L&T was ranked 47th in the world in the June 2009 issue of Forbes-Reputation Institute‘s ―World‘s Most Reputable Companies‖ survey. In this survey, L&T was the only engineering and construction company in the world to have made it to the top 200. Having established its foothold in engineering and construction, electrical and electronics, industrial products and information technology, L&T forayed into the financial services space. Financial Services has been identified as a strategically important business for L&T Group. It has been L&T‘s vision to become a ‗wholesome‘ player in this area of business. With an entire range of products and service offerings, L&T‘s ‗Financial Services‘ initiative will cater to an entire spectrum of customers, and their various financial needs. About the Industry: INDUSTRY
  10. 10. The information in this section has not been independently verified by us, the Lead Managers or any of our or their respective affiliates or advisors. The information may not be consistent with other information compiled by third parties within or outside India. Industry sources and publications generally state that the information contained therein has been obtained from sources it believes to be reliable, but their accuracy, completeness and underlying assumptions are not guaranteed and their reliability cannot be assured. Industry and Government publications are also prepared based on information as of specific dates and may no longer be current or reflect current trends. Industry and Government sources and publications may also base their information on estimates, forecasts and assumptions which may prove to be incorrect. Accordingly, investment decisions should not be based on such information. CRISIL DISCLAIMER: CRISIL Limited has used due care and caution in preparing this report. Information has been obtained by CRISIL from sources which it considers reliable. However, CRISIL does not guarantee the accuracy, adequacy or completeness of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. No part of this report may be published / reproduced in any form without CRISILs prior written approval. CRISIL is not liable for investment decisions which may be based on the views expressed in this report. CRISIL Research operates independently of, and does not have access to information obtained by CRISILs Rating Division, which may, in its regular operations, obtain information of a confidential nature that is not available to CRISIL Research. Larsen & Toubro Limited (L&T) (NSE: LT, BSE: 500510) is an Indian multinational conglomerate company headquartered in Mumbai, India. The company has four main business sectors: technology, engineering, construction and manufacturing.
  11. 11. L&T has an international presence, with a global spread of offices and factories, further supplemented by a comprehensive marketing and distribution network. The firm has more than 60 units in some 25 countries. Domestic business within India dominates, but the company is steadily growing its global operations with a focus on China and the Middle East. 2.2 HISTORY OF THE COMPANY Pre Independence The company was founded in Mumbai in 1938 by two Danish engineers, Henning Holck-Larsen and Soren Kristian Toubro. The first office was reportedly so small that only one of the partners could use it at a time. The company started off as a representative of Danish manufacturers of dairy equipment. However, with the start
  12. 12. of the Second World War in 1939 and the resulting restriction on imports, the partners started a small workshop to undertake jobs and provide service facilities. Germanys invasion of Denmark in 1940 stopped supplies of Danish products. This crisis forced the partners to start manufacturing dairy equipment indigenously. These products proved to be a success, and L&T came to be recognized as a reliable manufacturer with high standards. The war-time need to repair and refit ships offered L&T an opportunity, and led to the formation of a new company, Hilda Ltd., to handle these operations. L&T also started two repair and fabrication shops signaling the expansion of the company. The sudden internment of German engineers in India (due to suspicions caused by the War), who were to put up a soda ash plant for the TATA‘s, gave L&T a chance to enter the field of installation. In 1944, ECC was incorporated by the partners; the company at this time was focused on construction projects (Presently, ECC is the construction division of L&T). Around then, L&T decided to build a portfolio of foreign collaborations. By 1945, the Company represented British manufacturers of equipment used to manufacture products such as hydrogenated oils, biscuits, soaps and glass. In 1945, the company signed an agreement with Caterpillar Tractor Company, USA, for marketing earth moving equipment. At the end of the war, large numbers of war-surplus Caterpillar equipment were available at attractive prices, but the finances required were beyond the capacity of the partners. This prompted them to raise additional equity capital, and on 7th February 1946, Larsen & Toubro Private Limited was born. Post Independence
  13. 13. Independence and the subsequent demand for technology and expertise offered L&T the opportunity to consolidate and expand. Offices were set up in Kolkata (Calcutta), Chennai (Madras) and New Delhi. In 1948, fifty-five acres of undeveloped marsh and jungle was acquired in Powai, Mumbai. That uninhabitable swamp is presently a manufacturing landmark. In December 1950, L&T became a Public Company with a paid-up capital of Rs.2 million. The sales turnover in that year was Rs.10.9 million. Notable orders executed by the Company during this period included the Amul Dairy at Anand and Blast Furnaces at Rourkela Steel Plant. With the successful completion of these jobs, L&T emerged as the largest erection contractor in the country. In 1956, a major part of the companys Mumbai office moved to ICI House in Ballard Estate, Mumbai; which would later be purchased by the company and renamed as L&T House, its present Corporate Office. The sixties were also a decade of rapid growth for the company, and witnessed the formation of many new ventures: UTMAL (set up in 1960), Audco India Limited (1961), Eutectic Welding Alloys (1962) and TENGL (1963). In 1976, Holck-Larsen was awarded the Magsaysay Award for International Understanding in recognition of his contribution to Indias industrial development. He retired as Chairman in 1978. 2.3 OPERATING DIVISIONS Engineering and Construction Projects L&T‘s engineering and construction track record consists of implementation of turnkey projects in major core and infrastructure sectors of the Indian industry. L&T has formed a joint venture with Sapura Crest Petroleum Berhad, Malaysia for providing services to offshore construction industry worldwide. The joint venture will own and operate the LTS 3000, a Heavy Lift cum Pipe lay Vessel. L&T has more than 38000 employees in India.
  14. 14.  L&T Power L&T has set up an organization focused on opportunities in coal-based, gas-based and nuclear power projects. This business provides turnkey solutions for setting up utility power plants as well as co-generation and captive power plants on an EPC basis. It also provides power plant engineering services through L&T Sargent & Lundy, a joint venture of L&T and Sargent & Lundy, USA. L&T has formed two joint ventures with Mitsubishi Heavy Industries, Japan to manufacture super critical boilers and steam turbine generators. In 2008-09, significant progress was made in setting up manufacturing facilities for super critical boilers and turbines at Hazira, on Indias west coast. L&T has also signed a technical collaboration with Clyde Bergemann for electrostatic precipitators, a crucial BOP item in coal based thermal power plants. L&T Power offers turnkey solutions for large i.e. up to 1000 MW coal- based power plant projects based on supercritical standards and also offers the same capability in gas-based power plants. Similarly, the firm has the capability ofexecuting balance of plant packages for both subcritical and supercritical thermal projects on an EPC basis. Heavy engineering L&T is claimed to be among the top five fabrication companies in the world. The Heavy engineering division manufactures and supplies custom designed and engineered critical equipment and systems to the needs of core-sector industries and the defense sector. It is the preferred supplier of equipment for a select range of products, globally. L&T has a shipyard capable of constructing vessels of up to 150 meters long and displacement of 20000 tones at its heavy engineering complex at Hazira. The shipyard is geared up to take up construction of niche vessels such as specialized Heavy lift Cargo Vessels, CNG carriers, Chemical tankers, defense & Para military vessels and other role specific vessels.
  15. 15. Construction of specialized mid size vessels is being undertaken and capacity is being augmented by additional infrastructure such as ship lift system and additional outfitting workshops to extend the activities to ship repairs. The focus will be on construction of commercial vessels, warships for the navy and the coast guard. Construction ECC – Engineering, Construction & Contracts Division of L&T – is the major contributor of L&Ts share market. Currently, it is also listed as India‘s largest construction organization. L&T cover varied disciplines of construction – civil, mechanical, and electrical & instrumentation. The design wing of L&T ECC is called EDRC (Engineering Design and Research Centre). EDRC provides consultancy, design and total engineering solutions to customers. It carries out basic and detailed design for both residential and commercial projects. L&T has expanded its focus to the Middle East, South East Asia, Russia, CIS, Mauritius, African and SAARC countries. It also has keen interest in the markets of Indian Ocean rim countries, Africa and Latin America. Electrical and electronics L&T is an international manufacturer of a wide range of electrical and electronic products and systems. L&T also manufactures custom-engineered switchboards for industrial sectors like power, refineries, petrochemicals and cement. In the electronic segment, L&T offers a range of meters and provides control and automation systems for industries. Medical equipment and systems manufactured by L&T include advanced ultrasound scanners and patient monitoring systems, ESUs, Syringe pumps, Defibrillators, Ventilators, Anesthesia machines. Information technology Larsen & Toubro InfoTech Limited, a 100 per cent subsidiary of the L&T, offers software and services with a focus on Manufacturing, BFSI and
  16. 16. Communications and Embedded Systems. It also provides services in the embedded intelligence and e Engineering space. L&T InfoTech focuses on information technology and software services. Its clients include industry leaders like Marsh & McLennan, Standard Life, Travelers, Chevron, Free scale, Hitachi, Ingram Micro, Infineon, Sanyo, Lafarge, ABSA, P&G, Johnson and Johnson, City Group, Barclays, CORPUS, Marathon, Texas Instruments, Qualcomm, LG and Samsung among others. It offers services and solutions for the following industries: banking and financial services, insurance, energy and petrochemicals, manufacturing. L&T Machinery & Industrial Products L&T manufactures markets and provides service support for critical construction and mining machinery – surface miners, hydraulic excavators, aggregate crushers, loader backhoes and vibratory compactors; supplies a wide range of rubber processing machinery and injection molding machines; and manufactures and markets industrial valves and allied products and a range of sophisticated application- engineered welding alloys. This division provides solutions to: 1. Construction & Mining Equipment 2. Material Handling 3. Crushing Systems & Equipment 4. Hydraulic Equipment 5. Valves 6. Rubber Processing Machinery 7. Plastics Processing Machinery 8. Paper Machinery 9. Welding Products
  17. 17. 10. Castings 11. Wind-mill Components 12. Cutting Tools 2.4 MAIN OBJECT OF THE COMPANY1. To carry on the business of developing and providing wide range of financial products and services for the purpose of and in relation to the development and establishment of infrastructure projects and facilities, including without limitation, providing of various kinds of guarantees and credit enhancements and refinancing assurance including market making or providing of liquidity support of various kinds, development, encouragement and participation in securities market for infrastructure financing, development and implementation of various opportunities and schemes for domestic savers to participate in infrastructure development.2. To carry on the business of arranging or providing financial assistance in the form of lending or advancing money by way of a loan (including long-term loan), working capital finance, overdraft, cash credit, refinance or in any other form, independently or in association with any person, Government or any other agencies, whether incorporated or not, whether with or without security to institutions, banks, bodies corporate (whether or not incorporated), firms, associations authorities, bodies, trusts, agencies, societies or any other persons engaged in or in connection with either directly or indirectly or whether wholly or in part, for the purposes of infrastructure development work or providing infrastructure facilities or engaged in infrastructure activities, which shall include work or facility or providing of services in relation to or in connection with setting up,
  18. 18. development, construction, operation, maintenance, modernization, expansion and improvement of any infrastructure project or facility including roads, highways, railways, airports, airways, waterways, ports, transport systems, bridges, telecommunication and other communication systems, systems for generation or storage or transmission or distribution of power, irrigation and irrigation system, sewerage, water supply, sanitation, health, housing, development of commercial properties, tourism, education, oil and gas, food and agriculture infrastructure and setting up of industrial areas.3. To carry on the business of providing both in India and abroad, guarantees and counter guarantees, letters of credits, indemnities, loans and advances of all nature, underwriting, factoring, consultancy, formulating schemes for the purpose of mobilization of resources and other form of credit enhancement to companies engaged in development or financing of infrastructure work or activity, whether by way of personal covenant or by mortgaging or charging all or any part of the undertaking, property or asset of the company, both present and future, wheresoever‘s situate or in any other manner and in particular to guarantee the payment of any principal money, interests or other monies secured by or payable under contracts, obligations, debentures, bonds, debenture stock, mortgages, charges, repayment of capital monies and the payments of dividends in respect of stocks and shares or the performance of any other obligations by such companies.4. To carry on the business of consultancy services of all kinds and description, including syndication of loans, counseling and tie-up for project and working capital finance, syndication of financial arrangements whether in domestic or international markets, assisting in setting up of joint ventures, foreign currency lending and without prejudice to the generality of the foregoing to act as advisors for any Infrastructure development project of activity.
  20. 20. The following are the terms and conditions of the Bonds being offered, which will be incorporated into the company. Debenture Trust cum Hypothecation Deed and are subject to the provisions of the Companies Act, 1956 Application Form and other terms and conditions as may be incorporated in the Debenture Trust. Hypothecation Deed, Letter(s) of Allotment and/or Consolidated Bond certificate(s). The Bonds are classified as ―Long Term Infrastructure Bonds‖ and are being issued in terms of Section 80CCF of the Income Tax Act and the Notification. In accordance with Section 80CCF of the Income Tax Act, the amount, not exceeding ` 20,000 per annum, paid or deposited as subscription to long-term infrastructure bonds during the previous year relevant to the assessment year beginning April 01, 2011 shall be deducted in computing the taxable income of a resident individual or HUF. In the event that any Applicant applies for and is allotted long term infrastructure bonds in excess of ` 20,000 per annum (including long term infrastructure bonds issued by another entity), the foretasted tax benefit shall be available to such Applicant only to the extent of ` 20,000 per annum. Words and expressions defined in the Debenture Trust cum Hypothecation Deed and the Tripartite Agreements shall have the same meanings where used in these terms and conditions unless the context otherwise requires or unless otherwise stated. Any reference to ―Bondholders‖ or ―holders‖ in relation to any Bond held in dematerialized form shall mean the persons whose name appears on the beneficial owners list as provided by the Depositary and in relation to any Bond in physical form, such holder of the Bond, whose interest shall be as set out in a Consolidated Bonds Certificate and whose name is appearing in the Register of Bondholders. ISSUE PROCEDURE This section applies to all Applicants. Please note that all Applicants are required to make payment of the full Application Amount along with the Application Form.
  21. 21. The Prospectus and the Application Forms together with the Abridged Prospectus may be obtained from their Corporate Office or from the Lead Managers. In addition, Application Forms would also be made available to NSE where listing of the Bonds is sought, and to brokers, being members of NSE, upon their request.Application Form: Applicants are required to submit their applications through the Bankers to the Issue. Such Applicants shall only use the specified Application Form bearing the stamp of the Banker to the Issue or the Lead Managers for the purpose of making an application in terms of the Prospectus. While submitting the Application Form the investors should ensure that the date stamp on their counter foil matches with the date stamp on the part of the Application Form being retained by the Banker to the Issue.Who can Apply: The following categories of persons are eligible to apply in the Issue: • Indian nationals resident in India who are not minors in single or joint names (not more than three); and • Hindu Undivided Families or HUFs, in the individual name of the Karta. The Applicant should specify that the application is being made in the name of the HUF in the Application Form as follows: ―Name of Sole or First Applicant: XYZ Hindu Undivided Family applying through XYZ, where XYZ is the name of the Karta”. Applications by HUFs would be considered at par with those from individuals.Application Size: Applications are required to be for a minimum of 5 Bonds and multiple of 1 Bond thereafter.
  22. 22. For the purpose of fulfilling the requirement of minimum subscription of 5 Bonds, an Applicant may choose to apply for 5 Bonds of the same series or 5 Bonds across different series.Instructions for applying form: Applications must be:1. Made only in the prescribed Application Form.2. Completed in block letters in English as per the instructions contained herein and in the Application Form, and are liable to be rejected if not so completed.3. Applicants should note that the Bankers to the Issue will not be liable for errors in data entry due to incomplete or illegible Application Forms. In single name or in joint names (not more than three, and in the same order as their Depository Participant details).4. Applications are required to be for a minimum of 5 Bonds and in multiples of 1 Bond thereafter. For the purpose of fulfilling the requirement of minimum subscription of 5 Bonds, an Applicant may choose to apply for 5 Bonds of the same series or 5 Bonds across different series.5. Thumb impressions and signatures other than in English/ Hindi/ Marathi or any of the other languages specified in the Eighth Schedule to the Constitution of India must be attested by a Magistrate or Notarym Public or a Special Executive Magistrate under his official seal.6. No receipt would be issued by our Company for the Application money. However, the Bankers to the Issue, on receiving the applications will acknowledge receipt by stamping and returning the acknowledgment slip to the Applicant. While submitting the Application Form the investors should ensure that the date stamp on their counter foil matches with the date stamp on the part of the Application Form being retained by the Banker to the Issue.
  23. 23.  Issue structureThe following is a summary of the issue structure of the Issue, aggregating up to ` 1,000million with an option to retain an oversubscription of up to ` 3,000 million for allotmentof additional Bonds.Issue ParticularsParticulars Resident Individuals HUFs Minimum number of Bonds perapplication5Bonds and in multiples of 1 Bond thereafter. For the purpose of fulfilling the requirementof minimum subscription of 5 Bonds, an Applicant may choose to apply for 5 Bonds ofthe same series or 5 Bonds across different series. 5 Bonds and in multiples of 1 Bondthereafter. For the purpose of fulfilling the requirement of minimum subscription of 5Bonds, an Applicant may choose to apply for 5 Bonds of the same series or 5 Bondsacross different series.Terms of Payment: Full amount with the Application Form Full amount with theApplication FormMode of Allotment: Dematerialized ** Dematerialized **Trading Lot One (1) Bond One (1) Bond The Bonds are classified as ―Long Term Infrastructure Bonds‖ and are being issuedin terms of Section 80CCF of the Income Tax Act and the Notification. In accordancewith Section 80CCF of the Income Tax Act, the amount, not exceeding ` 20,000, paid ordeposited as subscription to long-term infrastructure bonds during the previous yearrelevant to the assessment year beginning April 01, 2011 shall be deducted in computingthe taxable income of a resident individual or HUF. In terms of Regulation 4(2) (b) of the Debt Regulations the Company will makepublic issue of the Bonds in the dematerialized form. However, in terms of Section 8 (1)
  24. 24. of the Depositories Act, the Company, at the request of the Investors who wish to holdthe Bonds in physical form will fulfill such request. Nature of the Bonds being issuedOur Company is offering the Bonds which shall have a fixed rate of interest. The Bondswill be issued with a face value of ` 1,000 each. Interest on the Bonds shall be payable onannual or cumulative basis depending on the series selected by the Bondholders asprovided below: Bond ParticularsFrequency of Interest: Annual, i.e. yearly payment of interest Cumulative, i.e.cumulative interest payment at the end of maturity or buyback, as applicableBuyback Facility: YesBuyback Date: First Working Day after 5 years from the Date of Allotment and firstWorking Day after 7 years from the Date of Allotment First Working Day after 5 yearsfrom the Date of Allotment and first Working Day after 7 years from the Date ofAllotment.Interest Rate: 8.20 % p.a. 8.30% p.a. compounded 81Maturity Date: 10 years from the Date of AllotmentMaturity Amount: 1,000 2,220Buyback Amount: 1,000 at the end of 5 years /1,000 at the end of 7 years1,490 at the end of 5 years /1,748 at the end of 7 years
  25. 25. Buyback Intimation Period: The period commencing from 6 months preceding theCorresponding Buyback Date and ending 3 months prior to the corresponding BuybackDateYield of the Bond on Maturity: 8.20 % p.a. 8.30% p.a. compounded annuallyYield of the Bond on Buyback: 8.20 % p.a. 8.30% p.a. compounded annually The yield on the Bonds(to be paid by the Issuer) shall not exceed the yield ongovernment securities of corresponding residual maturity, as reported by FIMMDA, ason the last working day of the month immediately preceding the month of the issue of theBonds. 2.7 SPECIMEN OF BOND NOTE
  27. 27. The L&T Infrastructure Bond opens in 7th February, 2011 and the issue willbe closed on 07th March, 2011. The total issue of Rs 100-crore non-convertibledebentures, offering a coupon of 8.20% per annum in the first series (series I) whichcan be redeemed after 5 years and 8.3% in the second series or (series II) can beredeemed after 7 years. This infrastructure bond is also almost same with other infrastructure bondsand the investor can claim tax benefit under section 80 CCF, which is allowed andadditional deduction of Rs. 20000 from the total income of the tax payer and thehighest tax bracket can save Rs. 6180 including education cases. Others also can getbenefit as per their tax brackets and this last time issue also may be welcomed by theinvestors.TAX SAVINGS INFRASTRUCTURE BONDS These are classified as infrastructure bonds under Section 80 CCF whichmeans that investing in them will reduce your taxable income by Rs. 20,000.This increases your effective yield because along with the interest you earn on theseinfrastructure bonds, you save on tax as well.These bonds are good for a maximum of Rs. 20,000 as far as the tax saving aspect isconcerned, so if you buy bonds worth Rs. 30,000 and nothing else, even then themaximum you can reduce from your taxable income is Rs. 20,000 because that is thecap on tax benefits on infrastructure bonds.L&T Infrastructure Bonds Features There are 4 series of L&T Bonds, and though these bonds have a term of 10years, there is an option of a buyback after 5 years or 7 years.The interest rates and effective yields of different plans are shown below: Series Tax 1 2 3 4 Bracket
  28. 28. Face —- Rs. 1,000 Rs. 1,000 Rs. 1,000 Rs. 1,000 Value Interest —- Annual Cumulative Annual Cumulative Payment Interest —- 7.75% 7.75% 7.50% 7.50% Rate Maturity —- 10 years 10 years 10 years 10 years Buyback —- 7 years 7 years 5 years 5 years in years Yield on 30.9% 15.23% 13.59% 17.20% 15.75% Buyback 20.6% 12.31% 11.36% 13.42% 12.58% 10.3% 9.86% 9.44% 10.23% 9.86%L&T Bonds Minimum Investment The minimum investment needed for you to invest in these bonds is Rs. 5,000because you have to apply for a minimum of 5 bonds, and the face value of each bondis Rs. 1,000.Open and Close Date Subscription opened on October 15th, and will close on November 2nd 2010.Credit Rating The L&T bonds have been rated CARE AA+ by CARE and LAA+ by ICRAwhich indicate high credit quality and that the rated instruments carry low credit risk.How can you invest in the L&T Infrastructure bonds? You can invest in these bonds either in the physical form or electronicallythrough brokers like ICICI Direct. You can buy a form through one of the severalagents across the country and invest in it through them as well.Here is a list of banks listed on their website that can give you more information aswell:
  29. 29. Axis Bank DBS Bank HDFC Bank HSBC Bank ICICI Bank IDBI Bank ING Bank SBI Bank They also have this cool link on their special website for this bond where youcan enter in your contact details and they will contact you and help you.If any of you do decide to contact them then I am really interested to know yourfeedback because I tried to get in touch with the numbers given in the IDFC website,and tried at least 10 times to no avail. I‘d like to know if this is any better.Tax on interest earned from the L&T Infrastructure bond The interest itself is not tax free. It‘s only the Rs. 20,000 you get reduced fromyour taxable salary that helps save tax.L&T Infrastructure bonds to list on NSE after 5 years The Bonds are proposed to be listed on NSE, and can be traded after the initial5 years lock-in period. After this lock-in period, the holders can also pledge theBonds with banks for availing financial assistance.A demat account to invest in these bonds
  30. 30. L&T will offer you the option to hold the Bonds either in Dematerialized or Physical Certificate form. NRIs can’t apply in the L&T Bonds Non-resident investors including NRIs, FIIs and OCBs are not eligible to participate in the Issue. CHAPTER NO. 3 CONCEPTUAL FRAMEWORK 3.1 MEANING AND DEFINITION A bond is known as a fixed income security which is a debt instrument created for apurpose of raising capital. They are essentially loan agreements between the bond issuer andan investor, in which bond issuer is obligated to pay a specified amount of money atspecified in future dates. A bond is like loan where the holder of the bond is lender, issuer of the bond isborrower. Bond provides the borrower with external funds to finance long term investment.Some bonds do not pay interest, but all bonds require a repayment of principal. The buyer
  31. 31. does not gain any kind of ownership rights to the issuer, unlike in case of equities. On theother hand the bond holder has a greater claim on an issuer income than share holder in caseof financial distress. A debt instrument issued for a period of more than one year with the purpose ofraising capital by borrowing. The Federal government, states, cities, corporations, and manyother type of institutions sells bond. Some bonds do not pay interest, but all bonds require arepayment of principal when an investor buys a bond, he/she becomes a creditor ofthe issuer. However, the buyer does not gain any kind of ownership rights to the issuer,unlike in the case of equities. On the hand, a bond holder has a greater claim on an issuers income thana shareholder in the case of financial distress (this is true for all creditors). Bonds are oftendivided into different categories based on tax status, credit quality, issuer type, maturity andsecured/unsecured and there are several other ways to classify bonds as well. U.S. Treasurybonds are generally considered the safest unsecured bonds, since the possibility ofthe Treasury defaulting on payments is almost zero. The yield from a bond is made up of three components: coupon interest, capitalgains and interest on interest (if a bond pays no coupon interest, the only yield will be capitalgains). Bonds are divided into different categories based on tax status, credit quality, issuertype, maturity and unsecured or secured.
  32. 32. Zero Mortgage Coupon Easy Exit Bond Bond Bond Floating Disaster Rate Bond Bond Capital Stepped Indexed Coupon Bond Bond Dual Commod Convertib ity Bond le BondIndustrial Converti Revenue ble Bond: Bond Types of Bonds DeepPremium Discount Bond Bond Subordin Discount ated Bond Bond Investme Guarante nt Grade ed Bond Bond High Yield Indexed Bond Bond Fixed Option Income Callable Tender Bond Bond Bond
  33. 33. 3.2 TYPES OF BONDZero Coupon Bond: This bond is issued at a discount and repaid at face value. No periodic interests paid at the time of maturity difference between the issue price and the redemptionprice presents the return of the holder.Deep Discount Bond: This bond is issued at a very high discount on its face value and a face value ispaid at the time of maturity. IDBI and SIDBI had issued this instrument. IDBI hadissued deep discount bond of face value of Rs. 1 lack at price of Rs. 2,700/- with amaturity period of 25 years. The bond appreciates to its face value over the maturityperiod of 25 years. Alternatively, the investor can withdraw their money from theinvestment periodically after 5 years.Convertible Bond: This bond gives option to the investor to convert the bond into equity at fixeddetermined prices.Dual Convertible Bond: The dual convertible bond is convertible into either equity shares ordebentures at the option of the investor.Stepped Coupon Bond: Under stepped coupon bonds the interest rates are stepped up or down duringthe tenure of bond. The main advantage to the investor is the attraction of the higherrate of interest in case of general rise in interest.Disaster Bond:
  34. 34. These are the issued by the companies and the institutions to share the risk andexpand the capital to link of investors return with size of investor‘s losses, the smallerreturns and vice-versa.Easy Exit Bond: Easy Exit bonds are bonds which provide liquidity and easy to exit rout to theinvestor by the way of redemption where investor can get ready encashment in caseof need to withdraw before maturity.Floating Rate Bond: In this case interest is not fixed and allowed to float depending upon marketconditions. This instrument is used by the issuer to hedge themselves against thevolatility in interest rates.Capital Indexed Bond: These bonds are inflation protection securities. Such bonds therefore providegood hedge against inflation risk. The return to the investors in these bonds isconnected with the wholesale price index.Commodity Bond: Commodity bonds are bonds issued to the share the risk and profitability offuture commodity prices with the investors. For example, Petro bonds, Gold bonds,Silver bonds etc…Industrial Revenue Bond: These are the issued by financial institutions in connection with thedevelopment of the industrial facilities. These may become attractive if certainincome tax and wealth tax concessions are offered.Premium Bond:
  35. 35. A bond is traded above its par value. A bond will trade at a premium when itoffers a coupon rate that is higher than prevailing interest rates. This is becauseinvestors want a higher yield, and will pay more for it.Discount Bond: A bond that is issued for less than its par (face) value, or a bond currentlytrading for less than its par value. The "discount" in a discount bond doesntnecessarily mean that investors get a better yield than the market is offering, just aprice below par. Depending on the length of time until maturity, zero-coupon bondscan be issued at very large discount to par, sometimes more than 50%.Mortgage Bond: Mortgage bonds offer the investor a great deal of protection in that theprincipal is secured by a valuable asset that could theoretically be sold off to coverthe debt. However, because of this inherent safety, the average mortgage bond tendsto yield a lower rate of return than traditional corporate bonds that are backed only bythe corporation promise and ability to pay.Investment Grade Bond: A bond which is relatively safe, having a high bond rating such as BBB orabove.High Yield Bond: A high paying bond with a lower credit rating than investment-gradecorporate bonds, Treasury bonds and municipal bonds. Because of the higher risk of
  36. 36. default, these bonds pay a higher yield than investment grade bonds. Based on thetwo main credit rating agencies, high-yield bonds carry a rating below BBB or fromS&P, and below Baa from Moodys. Bonds with ratings at or above these levels areconsidered investment grade. Credit ratings can be as low as D (currently in default),and most bonds with C ratings or lower carry a high risk of default; to compensatefor this risk, yield will typically very high.Fixed Income Bond: Fixed income refers to any type of investment that is not equity, whichobligates the borrower/issuer to make payments on a fixed schedule, even if thenumber of the payments may be variable. The term fixed income is also applied to apersons income that does not vary with each period. This can include income derivedfrom fixed-income investments such as bonds and preferred stocks or pensions thatguarantee a fixed income. When pensioners or retirees are dependent on their pensionas their dominant source of income, the term "fixed income" can also carry theimplication that they have relatively limited discretionary income or have littlefinancial freedom to make large expenditures.Callable Bond: A callable bond (also called redeemable bond) is a typeof bond (debt security) that allows the issuer of the bond to retain the privilege ofredeeming the bond at some point before the bond reaches the date of maturity. Inother words, on the call date(s), the issuer has the right, but not the obligation, to buyback the bonds from the bond holders at a defined call price. Technically speaking,the bonds are not really bought and held by the issuer but are instead cancelledimmediately.Option Tender Bond: When this occurs, the issuer must pay par to the holder, and the holder losesany future coupon payments that he/she might otherwise have been due. Anadvantage to a variable-rate demand note from the holders standpoint is the fact that
  37. 37. the holder may reinvest the par value in a new bond in a time of rising interest rates.This protects the holder from certain type of interest.Indexed Bond:A bond or other fixed-rate security with an interest rate that varies accordingto inflation. An inflation-indexed bond, for example, may pay a fixed coupon plus anadditional coupon with the amount adjusted every so often according to someinflation indicator, such as the Consumer Price Index. If these securities are heldto maturity, then the investor guarantees that the return will exceed the rate ofinflation. Inflation-indexed securities exist to provide a low-risk investment vehicle inwhich the return is guaranteed not to fall below the rate of inflation.Guaranteed Bond: A type of bond in which the interest and principal on the bond are guaranteedto be paid by a firm other than the issuer of the bond. This guarantee limits the impacton bondholders if the issuer of bond goes in default. For example, in Canada, bondsissued by crown corporations are guaranteed by the federal government. If the issuerdefaults on the debt obligation, the government is on the hook for the interest andprincipal payments.Subordinated Bond: A class of bond that, in the event of liquidation, is prioritized lower than otherclasses of bonds. For example, a subordinate bond may be an unsecured bond, whichhas no collateral. Should the issuer be liquidated, all secured bonds andsimilar debts must be repaid before the subordinated bond is repaid. 3.3 FEATURES OF BONDNominal, principal or face amount: It is the amount which the issuer pays interest and which has to be repaid atthe end of maturity.
  38. 38. Issue price: It is the price at which investors buy bonds when they are first issued, typically $1, 00,000. The net proceeds that the issuer receives are calculated as the issue price, less issuance fees, times the nominal amount. Maturity date: It is the date on which the issuer has to repay the nominal amount. As a long as all payment have been made, the issuer has no more obligations to bond holders after the maturity date. Coupon is the interest rate: This is the rate which the issuer pays to the bond holder; usually this rate is fixed throughout the life of the bond. It can also vary with the money market index. Coupon dates: This are dates which the issuer pays on coupon to the bond holders. In U.S, most bonds are semi-annual, which means that they pay the coupon every six months. Indenture: It is the document where specifying the rights of the bond holder. In U.S. most bonds are semi-annual, which means they pay a coupon in every six months. In Europe, most bonds are annual and pay only one coupon a year. Optionality: In optionality the bond may contain embedded potion i.e., it‘s grant option likefeatures the buyer or issuer: 1. Call ability: Some bonds give the issuer the right to repay the bond before the maturity date on the call dates; see call option. These bonds are referred to as callable bonds. Most callable bonds allow the issuer to repay the bond at par. With some bonds, the issuer has to pay a premium, the so called call premium.
  39. 39. This is mainly the case for high- yield bonds. These have very strict covenants, restricting the issuer in its operations. To be free from these covenants, the issuer can repay the bonds early, but only at a high cost. 2. Putt ability: Some bonds give the bond holder the right to force the issuer to repay the bond before the maturity date on the put dates; see put option. 3. Call dates and put dates: The dates on which callable and putt able bonds can be redeemed early. There are four main categories. A Bermudan callable has several call dates, usually coinciding with coupon dates. A European callable has only one call date. This is a special case of a Bermudan callable. An American callable can be called at any time until the maturity date. A death put is an optional redemption feature on a debt instrument allowing the beneficiary of the estate of the deceased to put (sell) the bond (back to the issuer) in the event of the beneficiarys death or legal incapacitation also known as a "survivors option".Maturity date: Sinking the fund provision of the corporate bond indenture requires a certainportion of issue to be retired periodically. The entire bond issue can be liquidated bythe maturity date. If that is not the case, then reminder called balloon maturity issuermay either to pay trustees, which is turn call randomly selected bonds in the issue oralternatively purchase bonds in the open market, then return them to trustees.Convertible bond: Here a bondholder exchanges a bond to a number of shares of the issuerscommon stock.
  40. 40. Exchangeable bond: It allows for exchange to shares of a corporation other than the issuer. 3.4 ADVANTAGES OF BONDSBonds pay higher interest rates than savings accounts.Bonds usually offer a relatively safe return of principal.Bonds often have less volatility (price fluctuations) than stocks, especially short-termbonds.Bonds offer regular income.Bonds are sold in small dollar amounts (U.S. Savings Bonds—$25, $50).Bonds need less careful attention in management than other alternative investments.Bond interest from municipal bonds can be exempt from federal income taxes andpossibly from state and local income taxes.
  41. 41. DISADVANTAGES OF BONDS Bonds offer no hedge against inflation because inflation causes interest rates to rise which then cause bond prices to fall. Bond prices can be quite volatile because market interest rates vary after a bond is issued. Bonds over the long term have lower returns than stocks. Bond prices may swing 20% or more if selling bonds before maturity. Speculators might see this as an opportunity but conservative investors will need to ignore price changes if planning to hold to maturity. Individual bonds do not compound their interest. However, this is possible with bond mutual funds. Taxes will be owed on capital gains/losses (selling before maturity) and interest unless the bonds are tax-exempt. 3.5 BOND MARKET IN INDIA The Indian financial system is not well developed and diversified. One major missingelement is an active, liquid and large debt market. In terms of outstanding issued amount,Indian debt market ranks as the third largest in Asia, next only to that of Japan and SouthKorea. Further in terms of the primary issues of debt instruments, Indian debt market is a quitlarge. The government continues to be larger borrower unlike South Korea where the privatesector is main borrower. If we compare with the size of Indian GDP with the outstanding sizeof the debt inflation, Indian debt market is not very much underdeveloped. The gross domestic savings rate in the Indian economy is reasonably satisfactoryaround 23%. According to RBI‘s annual studies on savings, about 78% of the aggregatefinancial savings of the household sector were invested in fixed income assets. The averageIndian household has great appetite for debt instrument provided they are packaged properly.The main financial instruments popular with the households are bank deposits, provident
  42. 42. funds, insurance, income oriented mutual funds, and postal saving schemes. However, theshare of fixed income instruments that could be traded on secondary market which isnegligible. The main reason for this is an active secondary market in debt instruments.Investors are not willing to invest in tradable instruments as they lack required liquidity. It isthus a typical case of ―chicken and egg problem‖. Since there is not enough number of issues and the floating stock in the secondarymarket is very small there is hardly any trading in them? Currently almost 98% of thesecondary market transactions in debt instruments relate to government securities, treasurybills and bonds of public sector companies. The quality of secondary market debt trading isvery poor if we compare it with the quality of the secondary market in equities. Debt marketslack the required transparency, liquidity, and depth. With reference to the usual standards oryardsticks of market efficiency the Indian debt markets would not score more than 30% ofthe marks that the Indian equity markets would score. The US has one of the most active secondary markets in both government andcorporate bonds. The trading volume in the US debt market is said to be on an average tentimes the size of the equity trading. In India the average daily trading in debt during the last year was about one tenth ofthe average daily trading in equities. These comparisons bring out the underdeveloped natureof the Indian debt markets. The secondary debt market suffers from several infirmities It ishighly non-transparent compared to the equity market. It is highly fragmented since theownership titles of government securities are fragmented in 714 offices of the RBI, whichacts as a depository for the government debt including the treasury bills. A seller from NewDelhi cannot trade in Mumbai market since security held in RBI office in New Delhi cannotbe easily transferred to Mumbai office of RBI and vice-versa. Since the current small orderbook stands fragmented city-wise the price Discovery process does not throw up the bestpossible prices. Bond markets link issuers having long-term financing needs with investorswilling to place funds in long-term, interest-bearing securities.
  43. 43. A mature Domestic bond market offers a wide range of opportunities for funding theGovernment and the private sector, with the government bond market typically creatingopportunities for other issuers. The market for government securities is defined as the marketfor tradable securities issued by the central government. The primary focus is on the marketfor Bonds, which are tradable securities of longer maturity (usually one year or More). Thesebonds typically carry coupons (interest payments) for specified (for example, quarterly)periods of the maturity of the bond. The market for Treasury bills (securities with a maturityof less than a year) and other special securities is considered here in the context ofdeveloping a long-term bond market. INDIA’s BOND MARKET NEEDS TO BULK UPAccording to Andrew Mac Askill and Anurag Joshi ―The governments ambitious $1 trillioninfrastructure program wont succeed without a more robust corporate bond market.‖The Infidelity Economy Previous Issue Next Issue
  44. 44. Infrastructure Development Finance, a company formed by the Indian government tolend to energy and road projects, just sold 29.3 billion rupees ($640 million) in 10-year tax-exempt bonds the sale closely follows Indian Overseas Banks successful issuance of 15-yeardebt. Thats pretty routine in most countries. For India, though, the deals were encouraging toinvestors, who cant find enough Indian corporate bonds to buy, according to bankers whodid not want to be quoted."India really needs to develop a bond market for long-term funding," says Michael Queen,chief executive officer of 3i Group, Europes biggest publicly traded private equity firm,which plans a $1.5 billion fund to invest in Indias infrastructure in the next six months. "Mybiggest concern when investing in India is the availability of debt capital."Indias corporate bond market, about 30 percent the size of Chinas, is failing to expand at therate analysts say is needed for the government to meet its target of building infrastructure.India has about $200 billion of corporate bonds outstanding, Bloomberg data show,compared with Chinas corporate bond market of $614 billion, according to AsianDevelopment Bank figures.
  45. 45. Prime Minister Manmohan Singh has proposed about $1 trillion of investment in thefive years through 2017 to upgrade the countrys crumbling road and power networks, whosedefects the Finance Ministry says shave 2 percentage points from growth. Singh plans toraise about 50 percent of the spending from private capital. The best way to tap private capital for infrastructure is through long-term bonds,which offer fixed, predictable costs. "The success of the governments very ambitiousinfrastructure program hinges on developing an adequate bond market," says D.H. PaiPanandiker, president of RPG Foundation, an economic policy group in New Delhi. Thoughbank loans are more available than bonds in India, theyre generally more expensive thanbond offerings. Besides, bankers in India are reluctant to fund infrastructure projects sincethey take so long to pay off. The government shoulders part of the blame for the corporate bond markets dwarfishstatus. Regulations raise the cost of issuing bonds and rules limit foreign investment. Pensionfunds and insurance companies—typically among the biggest buyers of corporate debt inother countries—are restricted in how much they can invest in bonds. That shrinks thepotential market for the bonds and forces companies to offer higher rates to attract buyers. Policymakers are trying to make amends. Theyve introduced credit default swaps soinvestors can gauge more accurately the risk of buying corporate bonds. Singhs governmenthas also allowed foreign funds to buy more corporate debt and has introduced a 20,000-rupeetax exemption for investors buying bonds to support infrastructure projects. Allowing banks to guarantee bonds would lower companies funding costs andincrease investor confidence in the bond market. Lifting caps on foreign insurance andpension companies operating in India would broaden the investor base. Even with these additional reforms, India would have a long way to go. Itsoutstanding corporate debt is only 3.3 percent of its gross domestic product, vs. 10.6 percentin China. Therefore, India needs to develop a more robust corporate bond market if thegovernments $1 trillion infrastructure program is to succeed.
  46. 46. 3.6 CREDIT RATING OF BONDS IN CREDIT RATING AGENCIES Introduction: Credit ratings provide a measure of the creditworthiness of debt securities toinvestors. Each of the RAs considers a number of factors to determine ratings, includingfirm‐ and security‐specific factors, market factors, regulatory and legal factors, andmacroeconomic trends. Their ratings intend to provide a means of comparison of creditrisk across asset classes and time. The ratings from different agencies measure slightly different credit riskcharacteristics.S&P and Fitch, for example, base their ratings on the probability of default. Moody‘s, incontrast, bases its ratings on expected loss, which is equal to the product of (1) theprobability of default and (2) the proportion of the investment that investors on averagelose in the event of default. However, investors and regulators tend to view the ratings ofthe major RAs as roughly equivalent. The ratings are divided into two categories: bonds rated BBB‐ and above areconsidered investment grade; bonds rated below BBB‐ are speculative grade (sometimes
  47. 47. also called junk). When rating a structured product like an RMBS or CDO, the RAsestimate the probability of default or expected loss of the bond and compare it tobenchmarks for each of their ratings. Credit Rating Agencies in India: In India, at present, there are four credit Rating Agencies: i) Credit Rating and Information Services of India Limited (CRISIL). ii) Investment Information and Credit Rating Agency of India Limited (ICRA). iii) Credit Analysis and Research Limited (CARE). iv) Duff and Phelps Credit Rating of India (Pvt.) Ltd. CRISIL: This was set-up by ICICI and UTI in 1988, and rates debt instruments. Nearly half of its ratings on the instruments are being used. CRISILs market share is around 75%. It has launched innovative products for credit risks assessment viz., counter party ratings and bank loan ratings. CRISIL rates debentures, fixed deposits, commercial papers, preference shares and structure obligations. Of the total value of instruments rated, debentures accounted for 3 1.196, fixed deposits for 42.3%and commercial paper 6.6%. CRISIL publishes CRISIL rating in SCAN that is a quarterly publication in Hindi and Gujarati, besides English. CRISIL evaluation is carried out by professionally qualified persons and includes data collection, analysis and meeting with key personnel in the company to discuss strategies, plans and other issues that may effect ,evaluation of the company. The rating, process ensures confidentiality. Once, the company decides to use rating; CRISIL is obligated to monitor the rating over the life of the debt instrument.
  48. 48.  ICRA: ICRA was promoted by IFCI in 1991. During the year 1996-97, ICRA rated 261 debt instruments of manufacturing companies, finance companies and financial institutions equivalent to Rs. 12,850 crore as compared to293 instruments covering debt volumeofRs.75,742 crore in 1995-96. This showed a decline of 83.0% over the year in the volume of rated debt instruments. Of the total amount rated cumulatively until March-end 1997, the share in terms of number of instruments was 28.5% for debentures (including long term instruments), 49.4% for Fixed Deposit programmed (including medium- term instruments), and and22.1% for Commercial Paper Programmed (including short term instruments). The corresponding figures of amount involved for these three broad rafted categories were 23.8%for debentures, 52.2% for fixed deposits, and24.0% for Commercial Paper. The factors that ICRA takes into consideration for rating depend on the nature of borrowing entity. The inherent protective factors, marketing strategies, competitive edge, competence and effectiveness of management, human resource development policies and practices, hedging of risks, trends in cash flows and potential liquidity, financial flexibility, asset quality and past record of servicing of debt as well as government policies affecting the industry are examined. Besides determining the credit risk associated with a debt instrument, ICRA has also formed a group under Earnings Prospects and Risk Analysis (EPRA). Its goal is to provide authentic information on the relative quality of the equity. This requires examination of almost all parameters pertaining to the fundamentals of the company including relevant sectoral perspectives. This qualitative analysis is reinforced and completed by way of the unbiased opinion and informed perspective of one analyst and wealth of judgment of committee members. ICRA opinions help the issuing company to broaden the
  49. 49. market for their equity. As the name recognition is replaced by objective opinion, the lesser know companies are also able to access the equity market. CARE: CARE is a credit rating and information services company promoted by IDBI jointly with investment institutions, banks and finance companies. The company commenced its operations in October 1993. In January1994, CARE commenced publication of CAREVIEW, a quarterly journal of CARE ratings. In addition to the rationale of all accepted ratings, CAREVIEW often carries special features of interest to issuers of debt instruments, investors and other market players. Bond / Credit Rating Agencies: Currently, there are three credit agencies that set the standards for bond quality ratings: Moodys, Standard and Poors, and Fitch Ratings. To make matters a little more complicated, each agency has a slightly different bond rating system. Fortunately, these differences also work to the investors advantage because all three bond rating agencies issue an alert when they are considering a change in a companys bond rating. That means the investor has access to a lot of information about a companys credit risk from several points of view. For Moodys, this alert system is termed Under Review. For S&P its called CreditWatch, and Fitch simply calls it Rating Watch. These terms are used to alert investors to a possible, or pending, change in a companys bond rating ―Bond Rating Credit Code‖. There are roughly ten different credit ratings, or grades, that each agency publishes. The ratings range from Investment Grade to In Default. In addition, each company offers refinements, or additional granularity, to these codes such as a plus or minus sign to indicate direction or relative standing within a particular rating category. The following bond rating table shows the relative rating system for all three bond rating agencies. Bond Rating Grades:
  50. 50. Credit Risk Moodys Standard and Poors Fitch RatingsInvestment GradeHighest Quality Aaa AAA AAAHigh Quality Aa AA AAUpper Medium A A AMedium Baa BBB BBBNot Investment GradeLower Medium Ba BB BBLower Grade B B BPoor Grade Caa CCC CCCSpeculative Ca CC CCNo Payments / C D CBankruptcyIn Default C D DNote to Bond Rating Table: Moodys uses a modifier of 1, 2, or 3 to show relative standingin a category. Standard and Poors and Fitch Ratings use a modifier of plus or minus.  Bond Ratings Affect Profits: The impact of credit ratings on a companys ability to raise capital can be enormous. Some of these changes might sound like subtle differences, but to
  51. 51. companies looking to borrow money on the market, each little movement adds to, or lowers, their cost of borrowing in terms of interest rates and interest expense. When a companys credit rating is lowered, it is more expensive for that company to borrow money due to higher interest expense payable on the bonds. In turn, these higher expenses result in lower earnings per share, or a lowering of the companys overall profitability.  Investment grade: A bond is considered investment grade or IG if its credit rating is BBB- or higher by Standard & Poors or Baa3 or higher by Moodys or BBB (low) or higher by DBRS. Generally they are bonds that are judged by the rating agency as likely enough to meet payment obligations that banks are allowed to invest in them. Ratings play a critical role in determining how many companies and other entities that issue debt, including sovereign governments; have to pay to access credit markets, i.e., the amount of interest they pay on their issued debt. The threshold between investment-grade and speculative-grade ratings has important market implications for issuers borrowing costs. Bonds that are not rated as investment-grade bonds are known as high yield bonds or more derisively as junk bonds. The risks associated with investment-grade bonds (or investment- grade corporate debt) are considered noticeably higher than in the case of first-class government bonds. The difference between rates for first-class government bonds and investment-grade bonds is called investment-grade spread. It is an indicator for the markets belief in the stability of the economy. The higher these investment-grade spreads (or risk premiums) are, the weaker the economy is considered. 2.8 VALUATION OF BONDS Bond valuation is the determination of the fair price of a bond. As with any securityor capital investment, the theoretical fair value of a bond is the present value of the stream ofcash flows it is expected to generate. Hence, the value of a bond is obtained by discounting
  52. 52. the bonds expected cash flows to the present using an appropriate discount rate. In practice,this discount rate is often determined by reference to similar instruments, provided that suchinstruments exist. If the bond includes embedded options, the valuation is more difficult andcombines option pricing with discounting. Depending on the type of option, the optionprice as calculated is either added to or subtracted from the price of the "straight" portion.This total is then the value of the bond; the various yields can then be calculated for the totalprice. 1. A technique for determining the fair value of a particular bond. Bond valuation includes calculating the present value of the bonds future interest payments, also known as its cash flow, and the bonds value upon maturity, also known as its face value or par value. 2. Bond valuation is only one of the factors investors consider in determining whether to invest in a particular bond. Other important considerations are: the issuing companys creditworthiness, which determines whether a bond is investment-grade or junk; the bonds price appreciation potential, as determined by the issuing companys growth prospects; and prevailing market interest rates and whether they are projected to go up or down in the future. As above, the fair price of a straight bond is usually determined by discounting itsexpected cash flows at the appropriate discount rate. The formula commonly applied isdiscussed initially. Although this present value relationship reflects the theoretical approachto determining the value of a bond, in practice its price is (usually) determined with referenceto other, more liquid instruments. The two main approaches, Relative pricing and Arbitrage-free pricing, are discussed next.  Concepts of Time Value of Money
  53. 53. The value of money received today is different from the value of money received after some time in future. An important financial principle is that the value of money is time dependent. This principle is based on the following reasons:1. Inflation: Under the inflationary conditions the value of money, expressed in terms of its purchasing power over goods and services, declines.2. Risk: Analysis of risk plays a significant role in investment appraisal Re.1 now is certain Re.1 tomorrow is less certain.3. Personal Consumption Preference: Money, like any other desirable commodity, has value because many investors have strong preference for immediate rather than delayed consumption.4. Investment opportunities: Money, like any other desirable commodity, has value. Given choice of Rs.100 now or same amount in one year‘s time, it always preferable to take Rs.100 now because it could be invested over the next year say, at 18% interest rate to produce Rs.118 at the end of 1 year. In other words present value of Rs.118 receivable one year hence is Rs.100. Basic methods relating to Time Value of Money1. Present value approach:Below is the formula for calculating a bonds price, which uses the basic present value(PV) formula for a given discount rate (This formula assumes that a coupon payment hasjust been made;F = face value iF = contractual interest rateC = F * iF = coupon payment (periodic interest payment)
  54. 54. N = number of payments i = market interest rate, or required yield, or observed / appropriate yield to maturity M = value at maturity, usually equals face value P = market price of bond If the market price of bond is less than its face value (par value), the bond is selling at a discount. Conversely, if the market price of bond is greater than its face value, the bond is selling at a premium.2. Relative price approach: Under this approach, the bond will be priced relative to a benchmark, usually a government security; see Relative valuation. Here, the yield to maturity on the bond is determined based on the bonds Credit rating relative to a government security with similar maturity or duration; see Credit. The better the quality of the bond, the smaller the spread between its required return and the YTM of the benchmark. This required return, i in the formula, is then used to discount the bond cash flows as above to obtain the price.3. Arbitrage-free pricing approach:
  55. 55. Under this approach, the bond price will reflect its arbitrage-free price. Here, each cash flow (coupon or face) is separately discounted at the same rate as a zero-coupon bond corresponding to the coupon date, and of equivalent credit worthiness (if possible, from the same issuer as the bond being valued, or if not, with the appropriate credit spread). Here, in general, we apply the rational pricing logic relating to "Assets with identical cash flows". In detail: (1) the bonds coupon dates and coupon amounts are known with certainty. Therefore (2) some multiple (or fraction) of zero-coupon bonds, each corresponding to the bonds coupon dates, can be specified so as to produce identical cash flows to the bond. Thus (3) the bond price today must be equal to the sum of each of its cash flows discounted at the discount rate implied by the value of the corresponding ZCB. Were this not the case, (4) the arbitrageur could finance his purchase of whichever of the bond or the sum of the various ZCBs was cheaper, by short selling the other, and meeting his cash flow commitments using the coupons or maturing zeroes as appropriate. Then (5) his "risk free", arbitrage profit would be the difference between the two values.4. Stochastic calculus approach: The following is a partial differential equation (PDE) in stochastic calculus which is satisfied by any zero-coupon bond. This methodology recognizes that since future interest rates are uncertain, the discount rate referred to above is not adequately represented by a single fixed number. The solution to the PDE is given in [4]
  56. 56. Where is the expectation with respect to risk-neutral probabilities,and R(t,T) is a random variable representing the discount rate; see also Martingalepricing.Practically, to determine the bond price, specific short rate models are employed here.However, when using these models, it is often the case that no closed form solutionexists, and a lattice-or simulation-based implementation of the model in question isemployed. The approaches commonly used are:a. the CIR modelb. the Black-Derman-Toy modelc. the Hull-White modeld. the HJM frameworke. the Chen model Clean and dirty price: When the bond is not valued precisely on a coupon date, the calculated price, using the methods above, will incorporate accrued interest: i.e. any interest due to the owner of the bond since the previous coupon date; see day count convention. The price of a bond which includes this accrued interest is known as the "dirty price" (or "full price" or "all in price" or "Cash price"). The "clean price" is the price excluding any interest that has accrued. Clean prices are generally more stable over time than dirty prices. This is because the dirty price will drop suddenly when the bond goes "ex interest" and the purchaser is no longer entitled to receive the next coupon payment. In many markets, it is market practice to quote bonds on a clean-price basis. When a purchase is settled, the accrued interest is added to the quoted clean price to arrive at the actual amount to be paid. Yield and price relations: Once the price or value has been calculated, various yields - which relate the price of the bond to its coupons - can then be determined.
  57. 57.  Yield to Maturity: The yield to maturity is the discount rate which returns the market price of the bond; it is identical to r (required return) in the above equation. YTM is thus the internal rate of return of an investment in the bond made at the observed price. Since YTM can be used to price a bond, bond prices are often quoted in terms of YTM. To achieve a return equal to YTM, i.e. where it is the required return on the bond, the bond owner must: I. Buy the bond at price P0, II. Hold the bond until maturity, and III. Redeem the bond at par. Coupon yield: a. The coupon yield is simply the coupon payment (C) as a percentage of the face Value (F). b. Coupon yield = C / F c. Coupon yield is also called nominal yield. Current yield: The current yield is simply the coupon payment (C) as a percentage of the (current) bond price (P). Current yield = C / P0. Relationship: The concept of current yield is closely related to other bond concepts, including yield to maturity, and coupon yield. The relationship between yield to maturity and the coupon rate is as follows: I. When a bond sells at a discount, YTM > current yield > coupon yield. II. When a bond sells at a premium, coupon yield > current yield > YTM. III. When a bond sells at par, YTM = current yield = coupon yield amt
  58. 58.  Price sensitivity: The sensitivity of a bonds market price to interest rate (i.e. yield) movements is measured by its duration, and, additionally, by its convexity. Duration is a linear measure of how the price of a bond changes in response to interest rate changes. It is approximately equal to the percentage change in price for a given change in yield, and may be thought of as the elasticity of the bonds price with respect to discount rates. For example, for small interest rate changes, the duration is the approximate percentage by which the value of the bond will fall for a 1% per annum increases in market interest rate. So the market price of a 17-year bond with a duration of 7 would fall about 7% if the market interest rate (or more precisely the corresponding force of interest) increased by 1% per annum. Convexity is a measure of the "curvature" of price changes. It is needed because the price is not a linear function of the discount rate, but rather a convex function of the discount rate. Specifically, duration can be formulated as the first derivative of the price with respect to the interest rate, and convexity as the second derivative (see: Bond duration closed-form formula; Bond convexity closed-form formula). Continuing the above example, for a more accurate estimate of sensitivity, the convexity score would be multiplied by the square of the change in interest rate, and the result added to the value derived by the above linear formula. ACCOUNTING TREATMENT: In accounting for liabilities, any bond discount or premium must be amortized over the life of bond. Amount of each period is calculated through the formula.
  59. 59. an + 1 = amortization amount in period number "n+1" an + 1 = | iP − C | (1 + i)n Bond Discount or Bond Premium = | F − P | = a1 + a2 + ... + aN Bond Discount or Bond Premium = .2.9 REGULATIONS OF SEBI FOR DEBT SECURITIES AND ISSUERS ISSUE REQUIREMENTS FOR PUBLIC ISSUES: (1) No issuer shall make any public issue of debt securities if as on the date of filing of draft offer document and final offer document as provided in these regulations, the issuer or the person in control of the issuer, or its promoter, has been restrained or prohibited or debarred by the Board from accessing the securities market or dealing in securities and such direction or order is in force. (2) No issuer shall make a public issue of debt securities unless following conditions are satisfied, as on the date of filing of draft offer document and final offer document as provided in these regulations, (a) It has made an application to one or more recognized stock exchanges for listing of such securities therein: Provided that where the application is made to more than one recognized stock exchanges, the issuer shall choose one of them as the designated stock exchange provided further that where any of such stock exchanges have nationwide trading terminals, the issuer shall choose one of them as the designated stock exchange. (b) It has obtained in-principle approval for listing of its debt securities on the recognized stock exchanges where the application for listing has been made.
  60. 60. (c) Credit rating has been obtained from at least one credit rating agency registered with the Board and is disclosed in the offer document: Provided that where credit ratings are obtained from more than one credit rating agencies, all the ratings, including the unaccepted ratings, shall be disclosed in the offer document. (d) It has entered into an arrangement with a depository registered with the Board for dematerialization of the debt securities that are proposed to be issued to the public, in accordance with the Depositories Act, 1996 and regulations made there under.(3) The issuer shall appoint one or more merchant bankers registered with the Board atleast one of whom shall be a lead merchant banker.(4) The issuer shall appoint one or more debenture trustees in accordance with theprovisions of Section 117B of the Companies Act, 1956 (1 of 1956) and Securities andExchange Board of India (Debenture Trustees) Regulations, 1993.(5) The issuer shall not issue debt securities for providing loan to or acquisition ofshares of any person who is part of the same group or who is under the samemanagement.(6) For the purposes of sub-regulation (5):- (a) two persons shall be deemed to be ―part of the same group‖ if they belong to the same group within the meaning of clause (ef) of section 2 of the Monopolies and Restrictive Trade Practices Act, 1969 (54 of 1969) or if they own ―inter-connected undertakings‖ within the meaning of clause (g) of section 2 of that Act; (b) The expression ―under the same management‖ shall have the meaning derived from sub-section (1B) of section 370 of the Companies Act, 1956 (1 of 1956).DISCLOSURES IN THE OFFER DOCUMENT
  61. 61. (1) The offer document shall contain all material disclosures which are necessary for the subscribers of the debt securities to take an informed investment decision.(2) Without prejudice to the generality of sub-regulation (1), the issuer and the lead merchant banker shall ensure that the offer document contains the following: The disclosures specified in Schedule II of the Companies Act, 1956;FILLING FOR DRAFT DOCUMENT(1) No issuer shall make a public issue of debt securities unless a draft offer documenthas been filed with the designated stock exchange through the lead merchant banker.(2) The draft offer document filed with the designated stock exchange shall be madepublic by posting the same on the website of the designated stock exchange for seekingpublic comments for a period of seven working days from the date of filing the draftoffer document with such exchange.(3) The draft offer document may also be displayed on the website of the issuer,merchant bankers and the stock exchanges where the debt securities are proposed to belisted.(4) The lead merchant banker shall ensure that the draft offer document clearly specifiesthe names and contact particulars of the compliance officer of the lead merchant bankerand the issuer including the postal and email address, telephone and fax numbers.(5) The Lead Merchant Banker shall ensure that all comments received on the draftoffer document are suitably addressed prior to the filing of the offer document with theRegistrar of Companies.(6) A copy of draft and final offer document shall also be forwarded to the Board for itsrecords, simultaneously with filing of these documents with designated stock exchange.
  62. 62. (7) The lead merchant banker shall, prior to filing of the offer document with theRegistrar of Companies, furnish to the Board a due diligence certificate as per ScheduleII of these regulations.(8) The debenture trustee shall, prior to the opening of the public issue, furnish to theBoard a due diligence certificate as per Schedule III of these regulations.MODE OF DISCLOSURE OF OFFER DOUCUMENT(1) The draft and final offer document shall be displayed on the websites of stockexchanges and shall be available for download in PDF / HTML formats.(2) The offer document shall be filed with the designated stock exchange, simultaneouslywith filing thereof with the Registrar of Companies, for dissemination on its website priorto the opening of the issue.(3) Where any person makes a request for a physical copy of the offer document, thesame shall be provided to him by the issuer or lead merchant banker.ADVERTISEMENT FOR PUBLIC ISSUES(1) The issuer shall make an advertisement in a national daily with wide circulation, onor before the issue opening date and such advertisement shall, amongst other things,contain the disclosures as per Schedule IV.(2) No issuer shall issue an advertisement which is misleading in material particular orwhich contains any information in a distorted manner or which is manipulative ordeceptive.(3) The advertisement shall be truthful, fair and clear and shall not contain a statement,promise or forecast which is untrue or misleading.(4) Any advertisement issued by the issuer shall not contain any matters which areextraneous to the contents of the offer document.
  63. 63. (5) Any corporate or product advertisement issued by the issuer during the subscriptionperiod shall not make any solicitation.ARBRIDGE PROSPECTUS AND APPLICATION FORMS(1) The issuer and lead merchant banker shall ensure that: (a) Every application form issued by the issuer is accompanied by a copy of theabridged prospectus; (b) The abridged prospectus shall not contain matters which are extraneous to thecontents of the prospectus; (c) Adequate space shall be provided in the application form to enable the investorsto fill in various details like name, address, etc.ELECTRONIC ISSUENCEAn issuer proposing to issue debt securities to the public through the on-line system ofthe designated stock exchange shall comply with the relevant applicable requirements asmay be specified by the Board.UNDERWRITINGA public issue of debt securities may be underwritten by an underwriter registered withthe Board and in such a case adequate disclosures regarding underwriting arrangementsshall be disclosed in the offer document.REDEMPTION AND ROLE OVER(1) The issuer shall redeem the debt securities in terms of the offer document.