Recap of last session

Pattern of expansion funding in India Why FS in India is gaining momentum Need of financial markets Definitions and examples of
Financial Institutions Financial Markets Financial Instruments Financial Services

Business model / performance measures of

Bank
NBFC
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Functions of Financial System

Commercial banks
PSU, Foreign, Private banks included

Financial institutions
IFCI, ICICI, IDBI, State finance

corporations, EXIM, Nabard, IDFC, NHB etc

Insurance
LIC, GIC and 24 other private insurance companies

Mutual Funds
ICICI Pru, Reliance, Tempelton, Sahara etc DSP blackrock,

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Functions of Financial System

NBFC
HDFC, Sundaram, Kotak Mahindra, ILF&S

NBFS
CDSL, NSDL, CRISIL, CARE, ICRA

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Classification of Markets
Nature of Claim

(If you understand this chart, you will be a finance wiz.)

Debt Market

Equity Market

Maturity of Claim

Money Market

Capital Market

Seasoning of Claim

Primary Market

Secondary Market

Timing of delivery

Cash or spot Market

Forward/ future Markets

Organisation Structure

Over the counter market

Exchange Trade Market

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From 35,000 ft to ground level

Who can raise funds?

Private corporates Domestic International Government

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Domestic (I)

Fund Raising

Foreign (II)

Shares (A)

Debt (B)

Quasi (C)
Warrant (1)

Preference Shares

Debenture/ Bonds Term Loans

Convertible Pref Shares Convertible Bonds

Equity shares (1)

Public
Rights Private Placement

Private Placement (Unlisted Companies)

Initial Public Offering (a)

Further Public Offering

Preferential Issue (Listed Companies) Qualified Institutional Placement (Listed Companies)

Fresh Issue

Offer for Sale

Fresh Ozone. Transform Offer for Issue Sale

Domestic (I)

Fund Raising

Foreign (II)

Shares (A)

Debt (B)

Quasi (C)
Warrant (1)

Preference Shares

Debenture/ Bonds Term Loans

Convertible Pref Shares Convertible Bonds

Equity shares (1)

Public
Rights Private Placement

Private Placement (Unlisted Companies)

Initial Public Offering (a)

Further Public Offering

Preferential Issue (Listed Companies) Qualified Institutional Placement (Listed Companies)

Fresh Issue

Offer for Sale

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External Capital - Debt

Debt instruments, also called fixed income instruments, are contracts containing a promise to pay a future stream of cash to the investors who hold the contracts. The debt contract can be negotiable, a feature specified in the contract that permits its sale to another investor, or nonnegotiable, which prohibits sale to

another party.
A debt contract also establishes: The financial requirements and restriction that the borrower must meet.

The rights of the holder of the debt instruments if the borrower defaults

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Based on Participants
Wholesale comprising of investors like Banks, financial institutions, RBI, insurance Retail comprising of investors like individuals, pension funds, private trusts, NBFCs

and other legal entities.

companies, Mutual funds, corporates

and FIIs Outright sale/purchase OR a Repo

trade
Direct 25%, brokers 75% Instruments issued by Central

government in India account for close

to 90% of the trading volumes while those issues by State governments account for 3-4% of the Ozone. Transform trading

Based on Issuer

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Debentures and Bonds

Sita aur Geeta

How does the trading and mathematics of bonds happen?

Bonds
Bonds are tradable fixed income securities Lingo used in real market: 8% coupon, Maturity March 2018, FV of 100, available at 10% ytm at Rs 85 Clean price and Rs 88 dirty price This bond is good, the Macaulay Duration is 8 years!

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Understanding basics of Bonds

Coupon Yield
Stated interest payment made on the bond . If depicted in Rs is Coupon and as % of face

Face value
Principal amount that is promised to be paid post the tenure of the bond, also called Par value

value called Coupon rate

Maturity
The specified date on which the principal amount of the bond is paid

Yield to Maturity
The required rate in the market on a bond . Mathematics in next few slides

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Understanding basics of Bonds

Current Yield
It is not same as YTM, but simply Coupon / current market price of bond

Premium Bond
When Interest falls and the market price of bond is higher than the face vale of the bond, it is called premium bond

Indenture
Written agreement between the

Other terms
Seniority Sinking fund Trustee, early redemption Call make whole bond NPV of FCF Put Covenants Controls with lenders

corporation and its creditors. Also called

deed of trust. Lenders appoint a trustee

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Understanding basics of Bonds

Clean Price
After netting accrued interest. If the trade happens in between dates of coupon exercise

Dirty Price
Before netting accrued interest. If the trade

happens in between dates of coupon exercise

Macaulay Duration
Time taken to recover initial investment i.e. payback period

Modified duration
Time change in Macaulay for every 1%
change in yield

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Mathematics of Bonds

Bond price is philosophically

YTM that you desire (closer to the current interest) Discounting factor NPV of future cash flows with 0 Terminal value

How to compute YTM

Trial and error to find r Use excel Yield (settlement, maturity, rate, price, redemption, frequency, basis)

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Typical Bond certificate

Trustee : The Western India Trustee Rights of default : Trustee/ SEBI Registered: Yes Denomination : Rs 5000 Amount issued : Rs 350 Crores with green shoe options Issue Date : 26th March 2005 Offered: At par Coupon: 5.8% payable on March 1st Seniority: Ranks Pari Passu with unsecured Debt Maturity: 5 years from date of issue Debenture redemption reserve: Not required Callable: No Puttable: No Rating : ICRA LAAA Ozone. Transform

Types of Bonds
Deep discount / Zero coupon
Do not carry coupon rate. Issued at steep discount over face value.

Floating rates
Interest linked to benchmark rate like T bills. In 1993, SBI came with 1st such bond. Protects against inflation risk, makes it less volatile especially for borrowers whose profits are linked to interest

IDBI issued deep discount bond in 1996 with

face value of Rs 2 lakhs at 5300- 25 years . Helps in saving in between cash flows. However, balloon payments may make it risky

Commodity linked
Payoff= F( selective commodities). 1886 standard Oil corp has issued. Protects sellers of commodities and users of

Embedded value
Convertible Callable Puttable

commodities . The payout was say USD 1000+ 25*( Price of Oil -10) Ozone. Transform

Types of Bonds
Extendable notes
Short term, giving an option of redeeming or renewing at maturity at prevailing rates. Reduces cost of transactions and issues

Structured notes (hera Pheri)

Debt obligation that is derived from another debt instrument. US treasury bought 30 years non cancelable bonds, stripped them to create series of zero coupon bond. The 1st zero was backed with interest payment schedules. Securatised debt instruments also is part of the same

Inverse floaters
14% - Libor. Very high sensitive to interest rates fluctuations

Junk Bonds
high yield bonds Lower rating and give 4% higher interest or so . India has made it official since 2007

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Types of Bonds
Floaters
Floating rate coupon, based on T benchmarking

Cat Bond
Protection against terrorism! FIFA 2006

Perpetual Bonds tier 1

As the name suggests, these are bonds which do not have any maturity date and are hence perpetual. Since they are never redeemed, such debt instruments give the issuers the comfort that equity capital offers in their capital base. Hence treated as equity by issuers, particularly the banks

Diaspora bonds
Sovereign debt instrument to raise financing from a countrys overseas diaspora. Israel and India have raised $35-40 billion with diaspora bonds.

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Innovation at work

GDP index bonds : A GDP-indexed bond is a sovereign bond whose interest rate and/or repayments vary with a countrys rate of economic growth.

Global Emerging Markets Local Currency Bond Program (GEMLOC) :

GEMLOC is a US$ 5 billion local currency bond for investment in up to 40

emerging bond markets.23, launched in October 2007 by the World Bank Group together with private partners. Lottery Bond Interest is not cash but lottery

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Innovation at work
Motorolas LYON Bonds : 20 year, Zero coupon, callable , puttable and convertible! (can it be more simpler!!)

Death Spiral Bond: Convertible Debt, when bondholder can convert into fixed value of
shares not quantity

Asset backed- Small loans packaged together also called Pass through certificates

Reverse floaters- Adjustable rates based on market interests

Pay in Kind- Interest in form of bonds and not cash Rate sensitive bond- Coupon changes with credit rating

Longetivity bonds Bonds whose payments are linked to the proportion of population
surviving
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