Innovative Financial Instruments-B.V.Raghunandan, SVS College, Bantwal

Department of Commerce and Management Studies, University of CalicutFebruary 10,2010

Financial Instrument

The basic documents issued to the large body of investors when an organisation or institution raises the funds from a large body of investors

Standardised document as per statute or governing institution containing features of the relation between the fund raiser and the user

Limited formats

Innovation in the Instrument

Altering the terms of issue in a novel way in order to achieve the predetermined purpose

Purpose of Innovation

Different Type of Credit Control and Macro-level Liquidity Management

Matching Cash Flow Requirement of the Fund Raiser

Satisfying other Objectives like Retaining Management Control

More Effective Catering to the Needs of the Investors

Better Treasury Managment

RBI Initiative

Liquidity Adjustment Facility (LAF) {Repo and Reverse Repo} Collateralized Borrowing & Lending

Obligations (CBLO) Market Stabilisation Scheme (MSS) Perpetual Bonds or Innovative

Bonds

RBI-Liquidity Adjustment Facility (LAF)

Repo and Reverse Repo as part of LAF since 2000

Designed to form the Interest Rate Platform within which all short-term interest rates will lie

Together with CRR, it has become an effective short-term liquidity management tool

Needed to manage the unexpected movement of funds into and out of the country due to Hedge Funds and Others

RBI-CBLO Introduced by CCIL in 2003 A Wider Call Money Market Participation by Pledging specified

securities with CCIL Participation by NBFCs and Corporate also

apart from usual Call Money Market Players

One Day or more Better Treasury Management by Corporate Better Profitability of Banks Cheaper Market than Call Money Market

RBI-Market Stabilisation Scheme

Launched in 2004 through an MOU between RBI and the Central Government

Part of a Longer Period Sterilisation of Market Managing Liquidity Problems arising out of

Forex Remittances RBI to issue after consultation with

Government Sale of Treasury Bills and Dated Securities

through Auction Better Fiscal Accountability as they are issued

against cash maintained by the Government with RBI

Perpetual Bonds

Introduced in 2005 Issued by Scheduled Commercial

Bankss 15 year Tenure with a Roll on forever

at the option of the Bank Part of Tier I Capital of Banks Enabling the Banks to meet Basel

Norm regarding Capital Adequacy Ratio

Insurance Companies are usually the investors

Corporate-India

Bonus Debenture Zero Coupon Bonds FCCB Multiple Option

Bonds Infrastructure Bonds Commercial Paper Certificate of Deposit Forex Backed

Infrastructure Bonds

Shares with Differential Voting Rights

Bonus Preference Shares

Time Share Plantation Share ADR/GDR Shares with

Disproportionate Voting Rights

Bonus Debenture

Rewarding Shareholder by better Treasury Management

Hindustan Lever tried it in early 2000s

Avoiding a Blown-up equity capital base

Did not enthuse the investors much Concept did not catch the fancy of

the market

Zero Coupon Bonds

Interest in the form of discount on the face value of bonds

Cross Border Investment Taxation benefit Better Treasury Management since

postponing the payment of interest on redemption

Where convertibility alone is the consideration, saving of interest

Foreign Currency Convertible Bonds Provisions of FEMA Convertibility is the cream Cross Border Investment Gained Popularity Recently

Multiple Option Bonds

Reliance Industries pioneered it in India

Appealing to Different Requirements of Investors for Income Planning

Flexibility in Tax Planning of Investors Payment of Interest is staggered with

varied options Became Popular and adopted for

Infrastructure Bonds also

Commercial Paper

short-term security Rated instrument Issued by listed companies Short-term source of finance for corporates Banks and other corporates invest SBI-DFHI tried to create a secondary

market, but failed Securities are held until maturity

Certificate of Deposit

Banks allowed to issue COD by RBI since 1989 though US banks were issuing since 1961

Tapping large deposits of corporates and HNI

Tenure is short-term for 3 months to one year

Held until maturity SBI-DFHI buys the CODs No secondary market exists as SBI-

DFHI is not able to accumulate sufficient CODs

Forex Backed Infrastructure Bonds In 2009, For the First time RBI

invested with a private fund The UK Subsidiary of India

Infrastructure Finance Company Ltd issued the bonds

The RBI used its foreign exchange reserve to invest in the bonds

Indian firms operating in foreign countries can augment the resources by issuing such bonds

Shares with Differential Voting Rights A product for the M&A era Lesser Dilution of management

control Each share carrying fraction of a vote Share issued at a discount Dividend is more than the dividend

on the normal shares Tata Motors issued in 2008 (one

tenth of vote, 305 against 340 per share and 5% more dividend)-Gujarat NRE Coke in the same year

Bonus Preference Shares

In 2003, Sun Pharmaceuticals issued bonus preference shares

Better cash management Better than bonus debentures as

there is no compulsion of payment of interest

Did not enthuse the shareholders like the bonus equity shares

Did not catch the fancy of the market

Time Share

Property sharing for a certain number of days per year

Used by Resorts in Tourist Destinations

Sterling Group and a few other organisations tapped the market well

Fancy ruled only for a few years

Plantation Share

Came out with big fanfare Promised fantastic returns in the

distant future Many gullible investors were taken

for a ride Least Liquid instrument Only a few firms have a token

presence

ADR/GDR

Instruments issued to foreign investors in lieu of the shares deposited with a custodian in the home country

Mainly to get the instruments of Instruments of Indian companies listed in foreign bourses

Enhanced the image of Indian companies and added a global perspective

Contributed to the volatility of Indian Market

Shares with Disproportionate Voting

Rights

New Companies Bill is doing away with shares with differential voting rights

In its place, shares with superior voting rights are being proposed

Helping the promoters to ward off hostile take-overs

Lacking fairness

Dangers of Innovation

Creating a hype Not a proper study is made before the

introduction Complexity Complexity leads to lack of correction of

wrong steps IT enabled financial system enables

excesses which endanger the very survival of the firm

Short term growth for higher managerial remuneration

Corporate-USA

Collateralised Debt Obligation (CDO) in 70s Mortgage 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 interest

Credit Default Swaps (CDS) invented by Blythe Masters JP Morgan Chase in 1997

CDS reaching 62.1 trillion dollars in 2007(AIG being the main player)

The US Debacle 2000-03 –Alan Greenspan cuts Fed

Rates from 6% - 1% Banks go on a Lending Spree 2004-Govt. Backed Lenders Fannie Mae,

Ginnie Mae and Freddie Mac have nearly 20% of lending to sub-prime clients

2005-CDS market soars with increase in housing sector boom

2006-Interest Rates rise to 5+% 2007-08-the bubble burst in the housing

sector

THANK YOU