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

Popularity of convertible euro bonds

A convertible bond issue allows an Indian company far greater flexibility to tap the Euro market and ensures that the issue has a better market reception than would be possible for a direct equity issue.

Popularity of convertible euro bonds


A convertible bond issue allows an Indian company far greater flexibility to tap the Euro market and ensures that the issue has a better market reception than would be possible for a direct equity issue. Moreover, newly industrialized countries such as Korea have chosen the convertible bond market as a stepping-stone to familiarity and acceptance of their industrial companies in the international market. The convertible bonds offer the following advantages:


a. Protection: Euro convertible bonds are favored by international investors as it offers them the advantage of protection of their wealth from erosion. This is possible because the conversion is only an option, which the investors may choose to exercise only if it works to their benefit. This facility is not available for equity issues.

b. Liquidity: Convertible bond market offers the benefit of the most liquid secondary market for new issues. Fixed income funds as well as equity investment managers purchase convertible bonds.


c.Flexibility: The feature of flexibility in structuring convertible bonds allows the company to include some of the best possible clauses of investors’ protection by incorpo0rating the unusual features of equity investments. A case in point is the issues made by the Korean corporate sector, which contained a provision in the issue of convertible euro bonds. The provision entitled the holders to ensure the due compliance of the liberalization measures that had already been announced within a specified period of time. Such a provision enabled the investor to opt for a put‘ option.


d. Attraction investment: The issue of convertible debentures facilitates removal of many of the unattractive features of equity investment. For investors, convertible bond market makers are the principal sources of liquidity in their securities.


Bond Issue Indian Experience


In recent times, all-India financial institutions have come to design and introduce special and innovative bond instruments exclusively structured on the investors’ preferences and funds requirement of the issuers. The emphasis from the issuer’s view point is the resource mobilization and not risk exposure. Several financial institutions such as the IDBI, the ICICI, etc. are engaged in the sale of such bonds. A brief description of some these bonds are presented below:

1. IDBIs Zero Coupon Bonds, 1996:


These bonds are sold at a discount and are paid no interest. It is of great advantage to issuers as it is not required for them to make periodic interest payment.


2. IDBIs Regular Income Bonds, 1996:


These were the bonds issued by the IDBI as 10-year bonds carrying a coupon of 16 percent, payable half-yearly. The bonds provided an annualized yield equivalent to 16.64 percent. The bonds, which were priced at Rs.5, 000 can be redeemed at the end of every year, after the third year allotment. There was also a call option that entitled the IDBI to redeem the bonds five years from the date of allotment.


3. Retirement Bonds, 1996:


The IDBI Retirements Bonds were issued at a discount. The issue targeted investors who are planning for retirement. Under the scheme,. Investors get a monthly income for 10 years after the expiry of a wait period, the wait period being chosen by the investor. Thereafter, the investors also get a lump sum amount, which is the maturity value of the bond.


4. IFCIs Bonds, 1996


These bonds include:


a. Deep Discount Bonds –Issued for a face value of Rs.1 lakh each.


b. Regular Income and Retirement Bonds –They had a five-year tenure, a semiannual yield of 16 percent and a front-end discount of 4 percent. The bonds had three-year put option and an early bird incentive of 0.75 percent.


c.  Step-up Liquid Bond –The five-year bonds with a put option every year with a return of 16 percent, 16.25 percent, 16.5 percent, 16.75 percent, and 17 percent at the end of every year.


d. Growth Bond –An investment of Rs.20, 000 per bond under this scheme entitles investors to


a  Rs.1 lakh face-value bond maturing after 10 years. Put options can be exercised at the end of 5 and 7 years respectively. If exercised, the investor gets Rs.43, 500 after 5 years and Rs.60, 000 after a 7 year period.


e.  Lakhpati Bond –The maturity period of these bonds varied from l5 to 10 years, after which the investor gets Rs.1 lakh. The initial investment required was Rs.20,000 for 10 years maturity,


Rs,.23,700 for 9 years, Rs,28,000 for 8 years, Rs.33,000 for 7 years, Rs.39,000 for 6 years and Rs.46,000 for 5 years maturity.


5. ICICIs Bonds, 1997 ICICI came out with as many as five bonds in March 1997. These are encash bonds, index bonds, regular income bonds, deep discount bonds, and capital gain bonds. The bonds were aimed at meeting the diverse needs of all categories of investors, besides contributing to the widening of the bond market so as to bring the benefits of these securities to even the smallest investors.


a.  Capital gains bond - Also called infrastructure bonds incorporated the capital gains tax relaxations under Section 54EA of the Income Tax Act announced in the Union Budget for 1997-98. They are issued for 3 and 7 years maturity. 20 percent rebate was available under Section 88 of the I.T. Act for investors on the amount invested in the capital gains bonds up to a maximum of Rs.70, 000. They can avail benefit under Section 88. The annual interest rate worked out to 13.4 percent while the annual yield came to 20.7 percent. However, investment through stock invest will not qualify for the rebate.


Encash Bond –The five-year encash bonds were issued at a face value of Rs.2,000 and can be redeemed at par across the country in 200 cities during 8 months in a year after 12 months.

The bond had a step-up interest every year from 12 to 18.5 percent and the annualized yield at maturity for the bond works out to 15.8 percent. The encashing facility, however, is available only to the original bondholders. The bonds not only offer higher return but also help widen the banking facilities to investors. The secondary market price of the bonds is likely to be favorably influenced by the step-up interest that results in an improved YTM every year.


c. Index Bond –It gives the investor both the security of the debt instrument and the potential of the appreciation in the return on the stock market. Priced at Rs.6,000 the index bond has two parts:


Part A is a deep discount bond of the face value of Rs.22,000 issued for a 12 year period. Its calculated yield was 15.26 percent. It also has a call and a put option attached to it assuring the investor a return of Rs.9, 300 after 6 years option is exercised.


Part B is a detachable index warrant issued for 12 years and priced at Rs.2,000. The yield was linked to the BSE SENSEX. The face value of the bond will appreciate the number of times the SENSEX has appreciated. The investors‘ returns will be treated as capital gains.

6. Tax Free Bonds: The salient features of the tax-free Government of India bonds to be issued from October 1, 2002 are as follows:


a. Interest rate –The bonds will carry an interest rate of 7 percent.


b. Tax exemption –The bonds will be exempt from Income-tax and Wealth-tax.


c. Maturity –The bonds will have a maturity period of six years.


d. Ceiling –The bonds investment will have no ceiling.


e. Tradability - The bonds will not be traded in the secondary market.


f.  Investors –The eligible investors include individuals and Hindu Undivided Families, NRIs are not eligible for investing in these bonds.


g. Issue price Bonds will be issued for a minimum amount of Rs.1,000 and its multiples.


h. Maturity value –The cumulative maturity value of the bond will be Rs.1.511 at the end of six years.


i.  Form of issue –The bonds will be both in demat form as well as in the traditional form of stock certificates. Option once chosen cannot be changed.


j.  Transferability –Bonds will not be transferable except by way of gift to relatives as defined in the Companies Act.


k. Collaterals –The bonds cannot be used as collaterals for obtaining loans from banks, financial institutions and non-banking financial companies.

l. Nomination –A sole holder or a sole surviving holder of the bond being an individual can


make a nomination.


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