This document discusses innovative financial instruments introduced by various institutions like the Reserve Bank of India and corporations in India and the United States. It provides details on instruments introduced by RBI like liquidity adjustment facility (repo and reverse repo), collateralized borrowing and lending obligations, and market stabilization scheme. It also describes corporate instruments in India like bonus debentures, zero coupon bonds, foreign currency convertible bonds, and shares with differential voting rights. The document further discusses financial instruments in the US that led to the 2008 financial crisis, such as collateralized debt obligations, mortgage-backed securities, credit default swaps, and subprime mortgages. It analyzes both the benefits and dangers of financial innovation.

1. Innovative Financial Instruments-B.V.Raghunandan,SVS College, BantwalDepartment of Commerce and Management Studies, University of CalicutFebruary 10,2010

2. Financial InstrumentThe basic documents issued to the large body of investors when an organisation or institution raises the funds from a large body of investorsStandardised document as per statute or governing institution containing features of the relation between the fund raiser and the userLimited formats

3. Innovation in the InstrumentAltering the terms of issue in a novel way in order to achieve the predetermined purpose

4. Purpose of InnovationDifferent Type of Credit Control and Macro-level Liquidity ManagementMatching Cash Flow Requirement of the Fund RaiserSatisfying other Objectives like Retaining Management ControlMore Effective Catering to the Needs of the InvestorsBetter Treasury Managment

5. RBI InitiativeLiquidity Adjustment Facility (LAF) {Repo and Reverse Repo}Collateralized Borrowing & Lending Obligations (CBLO)Market Stabilisation Scheme (MSS)Perpetual Bonds or Innovative Bonds

6. RBI-Liquidity Adjustment Facility (LAF)Repo and Reverse Repo as part of LAF since 2000Designed to form the Interest Rate Platform within which all short-term interest rates will lieTogether with CRR, it has become an effective short-term liquidity management toolNeeded to manage the unexpected movement of funds into and out of the country due to Hedge Funds and Others

7. RBI-CBLOIntroduced by CCIL in 2003A Wider Call Money MarketParticipation by Pledging specified securities with CCILParticipation by NBFCs and Corporate also apart from usual Call Money Market PlayersOne Day or moreBetter Treasury Management by CorporateBetter Profitability of BanksCheaper Market than Call Money Market

8. RBI-Market Stabilisation SchemeLaunched in 2004 through an MOU between RBI and the Central GovernmentPart of a Longer Period Sterilisation of MarketManaging Liquidity Problems arising out of Forex RemittancesRBI to issue after consultation with GovernmentSale of Treasury Bills and Dated Securities through AuctionBetter Fiscal Accountability as they are issued against cash maintained by the Government with RBI

9. Perpetual BondsIntroduced in 2005Issued by Scheduled Commercial Bankss15 year Tenure with a Roll on forever at the option of the BankPart of Tier I Capital of BanksEnabling the Banks to meet Basel Norm regarding Capital Adequacy RatioInsurance Companies are usually the investors

10. Corporate-IndiaBonus DebentureZero Coupon BondsFCCBMultiple Option BondsInfrastructure BondsCommercial PaperCertificate of DepositForex Backed Infrastructure BondsShares with Differential Voting RightsBonus Preference SharesTime SharePlantation ShareADR/GDRShares with Disproportionate Voting Rights

11. Bonus DebentureRewarding Shareholder by better Treasury ManagementHindustan Lever tried it in early 2000sAvoiding a Blown-up equity capital baseDid not enthuse the investors muchConcept did not catch the fancy of the market

12. Zero Coupon BondsInterest in the form of discount on the face value of bondsCross Border InvestmentTaxation benefitBetter Treasury Management since postponing the payment of interest on redemptionWhere convertibility alone is the consideration, saving of interest

13. Foreign Currency Convertible BondsProvisions of FEMAConvertibility is the creamCross Border InvestmentGained Popularity Recently

14. Multiple Option BondsReliance Industries pioneered it in IndiaAppealing to Different Requirements of Investors for Income PlanningFlexibility in Tax Planning of InvestorsPayment of Interest is staggered with varied optionsBecame Popular and adopted for Infrastructure Bonds also

15. Commercial Paper short-term securityRated instrumentIssued by listed companiesShort-term source of finance for corporatesBanks and other corporates investSBI-DFHI tried to create a secondary market, but failedSecurities are held until maturity

16. Certificate of DepositBanks allowed to issue COD by RBI since 1989 though US banks were issuing since 1961Tapping large deposits of corporates and HNITenure is short-term for 3 months to one yearHeld until maturitySBI-DFHI buys the CODsNo secondary market exists as SBI-DFHI is not able to accumulate sufficient CODs

17. Forex Backed Infrastructure Bonds In 2009, For the First time RBI invested with a private fundThe UK Subsidiary of India Infrastructure Finance Company Ltd issued the bondsThe RBI used its foreign exchange reserve to invest in the bondsIndian firms operating in foreign countries can augment the resources by issuing such bonds

18. Shares with Differential Voting RightsA product for the M&A eraLesser Dilution of management controlEach share carrying fraction of a voteShare issued at a discountDividend is more than the dividend on the normal sharesTata Motors issued in 2008 (one tenth of vote, 305 against 340 per share and 5% more dividend)-Gujarat NRE Coke in the same year

19. Bonus Preference SharesIn 2003, Sun Pharmaceuticals issued bonus preference sharesBetter cash managementBetter than bonus debentures as there is no compulsion of payment of interestDid not enthuse the shareholders like the bonus equity sharesDid not catch the fancy of the market

20. Time ShareProperty sharing for a certain number of days per yearUsed by Resorts in Tourist DestinationsSterling Group and a few other organisations tapped the market wellFancy ruled only for a few years

21. Plantation ShareCame out with big fanfarePromised fantastic returns in the distant futureMany gullible investors were taken for a rideLeast Liquid instrumentOnly a few firms have a token presence

22. ADR/GDRInstruments issued to foreign investors in lieu of the shares deposited with a custodian in the home countryMainly to get the instruments of Instruments of Indian companies listed in foreign boursesEnhanced the image of Indian companies and added a global perspectiveContributed to the volatility of Indian Market

23. Shares with Disproportionate Voting RightsNew Companies Bill is doing away with shares with differential voting rightsIn its place, shares with superior voting rights are being proposedHelping the promoters to ward off hostile take-oversLacking fairness

24. Dangers of InnovationCreating a hypeNot a proper study is made before the introductionComplexityComplexity leads to lack of correction of wrong stepsIT enabled financial system enables excesses which endanger the very survival of the firmShort term growth for higher managerial remuneration

25. Corporate-USACollateralised Debt Obligation (CDO) in 70sMortgage Backed Securities (MBOs) (pioneered by Larry Fink of First Boston Corporation in 1984)Sub-prime Mortgages in 1990s due to the popularity of MBOs resulting in lowering rates of interestCredit Default Swaps (CDS) invented by Blythe Masters JP Morgan Chase in 1997CDS reaching 62.1 trillion dollars in 2007(AIG being the main player)

26. The US Debacle2000-03 –Alan Greenspan cuts Fed Rates from 6% - 1%Banks go on a Lending Spree2004-Govt. Backed Lenders Fannie Mae, Ginnie Mae and Freddie Mac have nearly 20% of lending to sub-prime clients2005-CDS market soars with increase in housing sector boom2006-Interest Rates rise to 5+%2007-08-the bubble burst in the housing sector

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