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Chapter: Business Science : Merchant Banking and Financial Services : Issue Management Introduction

Global Debt Instruments

Following are some of the debt instruments that are popular in the international financial markets:

Global Debt Instruments


Following are some of the debt instruments that are popular in the international financial markets:


Income Bonds Interest income on such bonds is paid only where the corporate command adequate cash flows. They resemble cumulative preference shares in respect of which fixed dividend is paid only if there is profit earned in a year, but carried forward and paid in the following year. There is no default on income bonds if interest is not paid. Unlike the dividend on cumulative preference shares, the interest on income bond is tax deductible. These bonds are issued by Corporates that undergo financial restructuring.


Asset Backed Securities


These are a category of marketable securities that are collateralized by financial assets such as installment loan contracts. Asset backed financing involves a disinter- mediating process called ‘securitization’, whereby credit from financial intermediaries in the form of debentures  are sold to third parties to finance the pool. REPOS are the oldest asset backed security in our country. In USA, securitization has been undertaken for the following the oldest asset backed security in our country. In USA, securitization has been undertaken for the following: 1. Insured mortgages 2. Mortgage backed bonds 3. Student loans 4. Trade credit receivable backed bonds 5. Equipments leasing backed bonds 6. Certificates of automobile receivable securities 7. Small business administration loans 8. Credit and receivable securities.


Junk Bonds

Junk bond is a high risk, high yield bond which finances either a Leveraged Buyout (LBO) or a merger of a company in financial distress Junk bonds are popular in the USA and are used primarily for financing takeovers. The coupon rates range from 16 to 25 percent. Attractive deals were put together establishing their feasibility in terms of adequacy of cash flows to meet interest payments. Michael Milken (the junk bond king) of Drexel Burnham Lambert was the real developer of the market.


Indexed Bonds


These are the bonds whose interest payment and redemption value are indexed with movements in prices. Indexed bonds protect the investor from the eroding purchasing power of money because of inflation. For instance, an inflation-indexed bond implies that the payment of the coupon and/or the redemption value increases or decreases according to movements in prices. The bonds are likely to hedge the principal amount against inflation. Such bonds are designed to provide investors an effective hedge against inflation so as to enhance the credibility of the anti-inflationary policies of the Government. The yields of an inflation-indexed bond provide vital information on the expected rate of inflation. United Kingdom, Australia, and Canada have introduced index linked government securities as a segmented internal debt management operation with a view to increase the range of assets available in the system, provide an inflation hedge to investors, reduce interest costs and pick up direct signals, and the expected inflation and real rate of interest from the market.


Zero-Coupon Bonds (ZCBs)/Zero Coupons Convertible Debentures


Zero Coupon Bonds first came to be introduced in the U.S. securities market. Initially, such bonds were issued for high denominations. These bonds were purchased by large security brokers in large chunks, who resold them to individual investors, at a slightly higher price in affordable lots. Such bonds were called ―Treasury Investment Growth Receipts’(TIGRs) or ‘Certificate of Accruals on Treasury Securities’(CATSs) or ZEROs as their coupon rate is Zero.  Moreover, these certificates were sold to investors at a hefty discount and the difference between the face value of the certificate and the acquisition cost was the gain. The holders are not entitled for any interest except the principal sum on maturity.



Zero-Coupon Bonds offer a number of advantages as shown below a. No botheration of periodical interest payment for the issues b. The attraction of conversion of bonds into equity shares at a premium or at par, the investors usually being rewarded by way of a low premium on conversion c. There is only capital gains tax on the price differential and there is no tax on accrued income d. Possibility of efficient servicing of equity as there is no obligation to pay interest till maturity and the eventual conversion. Mahindra & Mahindra came out with the scheme of Zero Coupon Bonds for the first time in India along with 12.5 percent convertible bonds for part financing of its modernization and diversification scheme. Similarly, Deep Discount Bonds were issued by IDBI at Rs.2, 000 for a maturity of Rs.1 lakh after 25 years. These are negotiable instruments transferable by endorsement and delivery by the transferor. IDBI also offered Option Bonds which may be either cumulative or non-cumulative bonds where interest is payable either on maturity or periodically. Redemption is also offered to attract investors.


Floating Rate Bonds (FRBs)


Bonds that carry the provision for payment of interest at different rates for different time periods are known as ‘Floating Rate Bonds’. T in the Indian capital market. The SBI, while issuing such bonds, adopted a reference rate of highest rate of interest on fixed deposit of the Bank, provided a minimum floor rate payable at 12 percent p.a. and attached a call option to the Bank after 5 years to redeem the bonds earlier than the maturity period of 10 years at a certain premium. A major highlight of the bonds was the provision to reduce interest risk and assurance of minimum interest on the investment provided by the Bank.

Secured Premium Notes (SPNs)


Secured debentures that are redeemable of a premium over the issue price or face value are called secured premium notes. Such bonds have a lock-in period during which period no interest will be paid. It entitles the holder to sell back the bonds to the issuing company at par after the lock-in period. A case in point was the issue made by the TISCO in the year 1992, where the company wanted to raise money for its modernization program without expanding its equity excessively in the next few years. The company made the issue to the existing shareholders on a rights basis along with the rights issue. The salient features of the TISCO issue were as follows : 1. Face value of each SPN was Rs.300 2. No interest was payable during the first three years after allotment 3. The redemption started at the end of the fourth year of issue 4. Each of the SPN of Rs.300 was repaid in four equal annual installments of Rs.75, which comprised of the principal, the interest and the relevant premium. (Low interest and high premium or high interest and low premium, at the option to be exercised by the SPN holder at the end of the third year) 5. Warrant attached to each SPN entitled the holder the right to apply for or seek allotment of one equity share for cash payment of Rs.80 per share. Such a right was exercisable between first year and one.-and-a-half year after allotment by which time the SPN would be fully paid up. This instrument tremendously benefited TISCO, as there was no interest outgo. This helped TISCO to meet the difficulties associated with the cash generation. In addition, the company was able to borrow at a cheap rate of 13.65 percent as against 17 to 18 percent offered by most companies. This enabled the company to start redemption earlier through the generation of cash flow by the company’s projects. The investors had the flexibility of tax planning while investing in SDPNs. The company was also equally benefited as it gave more flexibility.


Euro Convertible Bonds


Bonds that give the holders of euro bonds to have the instruments converted into a wide variety of options such as the call option for the issuer and the put option for the investor, which makes redemption easy are called ‘Euro-convertible bonds’. A euro convertible bond essentially resembles the Indian convertible debenture but comes with numerous options attached. Similarly, a euro-convertible bond is an easier instrument to market than equity. This is because it gives the investor an option to retain his investments as a pure debt instrument in the event of the price of the equity share falling below the conversion price or where the investor is not too sure about the prospects of the company.


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Business Science : Merchant Banking and Financial Services : Issue Management Introduction : Global Debt Instruments |

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