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Meaning:
Capital markets are markets where people, companies, and governments with
more funds than they need (because they save some of their income) transfer
those funds to people, companies, or governments who have a shortage of funds
(because they spend more than their income). Stock and bond markets are two
major capital markets. Capital markets promote economic efficiency by
channelling money from those who do not have an immediate productive use for
it to those who do.
Capital markets carry out the desirable economic function of directing capital to
productive uses. The savers (governments, businesses, and people who save
some portion of their income) invest their money in capital markets like stocks
and bonds. The borrowers (governments, businesses, and people who spend
more than their income) borrow the savers' investments that have been entrusted
to the capital markets.
For example, suppose A and B make Rs. 50,000 in one year, but they only
spend Rs.40,000 that year. They can invest the 10,000 - their savings - in a
mutual fund investing in stocks and bonds all over the world. They know that
making such an investment is riskier than keeping the 10,000 at home or in a
savings account. But they hope that over the long-term the investment will yield
greater returns than cash holdings or interest on a savings account. The
borrowers in this example are the companies that issued the stocks or bonds that
are part of the mutual fund portfolio. Because the companies have spending
needs that exceeds their income, they finance their spending needs by issuing
securities in the capital markets.
The Structure of Capital Markets
Primary markets:
The primary market is where new securities (stocks and bonds are the most
common) are issued. The corporation or government agency that needs funds
(the borrower) issues securities to purchasers in the primary market. Big
investment banks assist in this issuing process. The banks underwrite the
securities. That is, they guarantee a minimum price for a business's securities
and sell them to the public. Since the primary market is limited to issuing new
securities only, it is of lesser importance than the secondary market.
Secondary market:
The vast majority of capital transactions, take place in the secondary market. The
secondary market includes stock exchanges (like the New York Stock Exchange
and the Tokyo Nikkei), bond markets, and futures and options markets, among
others. All of these secondary markets deal in the trade of securities.
Securities:
Equity securities:
Stock is the type of equity security with which most people are familiar. When
investors (savers) buy stock, they become owners of a "share" of a company's
assets and earnings. If a company is successful, the price that investors are
willing to pay for its stock will often rise and shareholders who bought stock at a
lower price then stand to make a profit. If a company does not do well, however,
its stock may decrease in value and shareholders can lose money. Stock prices
are also subject to both general economic and industry-specific market factors. In
our example, if Carlos and Anna put their money in stocks, they are buying equity
in the company that issued the stock. Conversely, the company can issue stock
to obtain extra funds. It must then share its cash flows with the stock purchasers,
known as stockholders.
Debt securities:
Savers who purchase debt instruments are creditors. Creditors, or debt holders,
receive future income or assets in return for their investment. The most common
example of a debt instrument is a bond. When investors buy bonds, they are
lending the issuers of the bonds their money. In return, they will receive interest
payments (usually at a fixed rate) for the life of the bond and receive the principal
when the bond expires. National governments, local governments, water districts,
global, national, and local companies, and many other types of institutions sell
bonds.
One of the most important developments since the 1970s has been the
internationalization, and now globalization, of capital markets. Let's look at some
of the basic elements of the international capital markets.
The foreign exchange market was a very important part of the international
capital market during the late 1990s. Internationally traded stocks and bonds
have also been part of the international capital market. Since the late 1990s,
sophisticated communications systems have allowed people all over the world to
conduct business from wherever they are. The major world financial centres
include Hong Kong, Singapore, Tokyo, London, New York, and Paris, among
others.
Here is an example:
If the steel company in Sweden has a poor year for sales and profits, its
stock value decreases. Corporation ABC, which has not diversified, will have a
terrible return on its portfolio. The next year, the steel company may have a great
year, so ABC will have a terrific portfolio return.
Government agencies, including central banks, were also major players in the
international marketplace during the late 1990s. Central banks and other
government agencies borrowed funds from abroad. Governments of developing
countries borrowed from commercial banks, and state-run enterprises also
obtained loans from foreign commercial banks.
Many observers say we entered an era of global capital markets in the 1990s.
The process was attributable to the existence of offshore markets, which came
into existence decades prior because corporations and investors wanted to
escape domestic regulation. The existence of offshore markets in turn forced
countries to liberalize their domestic markets (for competitive reasons). This
dynamic created greater internationalization of the capital markets. Three primary
reasons account for this phenomenon.
First, citizens around the world (and especially the Japanese) began to increase
their personal savings. Second, many governments further deregulated their
capital markets since 1980. This allowed domestic companies more opportunities
abroad, and foreign companies had the opportunity to invest in the deregulated
countries. Finally, technological advances made it easier to access global
markets. Information could be retrieved quicker, easier, and cheaper than ever
before.
Developing countries, like all countries, must encourage productive investments
to promote economic growth. Thus, foreign savings, which many people simply
call foreign investment, can benefit developing countries.
In Indian context:
Recent situation
Recent financial problems in emerging economies have led to calls for a new
international financial architecture. Some of the problems are:
2. Higher energy and food prices, rising wages in emerging markets and the
weak US dollar which is driving up US import prices.
3. In emerging markets like India inflation is being driven above all by rising food
prices.
4. In recent months oil has breached the 130 US dollar per barrel mark, and thus
been a main driver of global inflationary pressure. Declining reserves in the oil-
producing countries, and low levels of investment and political problems could
tighten the supply situation still further, countering any efforts to improve energy
efficiency and further develop alternative energy sources. Production will not be
able to keep pace with growing demand, especially from Asia. So the oil price is
likely to remain high and continue rising in the long term."
5. Still it is believed that there may not be a recession in the USA, but a there
may not be a quick recovery either. In the Euro zone we are likely to see a
cooling-off of the economy in 2008 and 2009. Emerging markets should be able
to decouple further from the US economy and consolidate their growth at a high
level.
In the above conditions, International capital flows should not be restricted; they
benefit entrepreneurs and savers alike, with lower borrowing costs and greater
returns. The international flow of capital improves risk management, allows
consumption smoothing, improves financial-sector efficiency, and leads to
greater overall market discipline. Furthermore, capital flows have a stabilizing
effect on financial markets. Restricting international investment denies a country
those benefits; the result is slower growth and reduced standards of living.
1. The capital market serves as an important source for the productive use of
economy’s savings. It mobilizes the saving of the people for further
investment and thus avoids their wastage in unproductive uses.
2. It provides incentives to saving and facilitates capital formation by offering
suitable rates of interest as the price of capital.
3. It provides an avenue for investors, particularly the household sector to invest
in financial assets which are more productive than physical assets.
4. It facilitates increase in production and productivity in the economy and thus,
enhances the economic welfare of the society. Thus it facilitates “the
movement of stream of command over capital to the point of highest yield”
towards those who can apply them productively and profitably to enhance the
national income in the aggregate.
5. The operations of different institutions in the capital market induce economic
growth. They give quantitative and qualitative directions to the flow of funds
and bring about rational allocation of scarce resources.
6. A healthy capital market consisting of expert intermediaries promotes stability
in values of securities representing capital funds.
7. Moreover, it serves as an important source for technological up gradation in
the industrial sector by utilizing the funds invested by the public.
Thus, a capital market serves as an important link between those who save
and those who aspire to invest their savings.
DRAWBACKS OF FOREIGN CAPITAL
3) The global capital flows reduce the effectiveness of monetary policy they
are associated with the loss of monetary control at home. The current
surge in these flows has created a major worry for the regulatory
authorities about the global money.
5) The non economical costs of the foreign capital are also unaffordable. It is
well known but conveniently forgotten that the foreign capital creates a
larger number of very serious problems of foreign ownership and control
dumping of technology loss of autonomy of domestic policies dependence
hegemony and neo-colonialism.
7) The debt capital has its own problems expressions like debt trap debt
crisis debt bomb are now commonly used to convey the dangerous
situation in which the developing countries land themselves when they
depend in the foreign debt capital.
CAPITAL MARKET IN INDIA: -
Coming to Indian context, the term capital market refers to only stock markets as
per the common man's ideology, but the capital markets have a much broader
sense. Where as in global scenario, it consists of various markets such as:
1. Government securities market
2. Municipal bond market
3. Corporate debt market
4. Stock market
5. Depository receipts market
6. Mortgage and asset-backed securities market
7. Financial derivates market
8. Foreign exchange market
India has made its presence felt in the IFMs only after 1991-92. At present there
are over 50 companies in India, which have accessed the GDR route for raising
finance. The change in situation has been due to the following factors:
1. Improved perception of India’s economic reforms.
2. Improved export performance.
3. Healthy economic indicator.
4. Inflation at single digit.
5. Improved forex reserves.
6. Improved performance of Indian companies.
7. Improved confidence of FIIs.
Reliance was the first Indian company to issue GDR in 1992. Since 1993,
number of Indian companies successfully tapped the global capital markets &
raised capital through GDR or foreign currency bond issues. Though there was a
temporary setback due to Asian crisis in 1997. Since 1999 even IT majors have
stepped the bandwagon of international markets & raised capital. The average
size of the issue was around 75USD. And the total amount raised was around
USD 6.5billion. India has the distinction of having the largest number of
GDR/ADR issues by any country.
Depository Bank:
It is involved only in the issue of GDRs. It is responsible for issuing the actual
GDRs ,disseminating information from the issuer to the DR holders, paying any
dividends or other distributions & facilitating the exchange of GDRs into
underlying shares when presented for redemption.
Custodian:
The Custodian holds the shares underlying the GDRs on behalf of the depository
&is responsible for collecting rupee dividends on the underlying shares &
repatriation of the same to the depository in US dollars/foreign currency.
Sources of Capital
1. Private sources
2. Public sources
Both sources are very important to the economies of the world. Capital flows
result when funds are transferred across borders; the flows are recorded in the
balance of payments account. Read on for definitions, examples, and trends in
capital flows.
FDI or Foreign Direct Investment is any form of investment that earns interest in
enterprises which function outside of the domestic territory of the investor. FDIs
require a business relationship between a parent company and its foreign
subsidiary. Foreign direct business relationships give rise to multinational
corporations. For an investment to be regarded as an FDI, the parent firm needs
to have at least 10% of the ordinary shares of its foreign affiliates. The investing
firm may also qualify for an FDI if it owns voting power in a business enterprise
operating in a foreign country.
Types of Foreign Direct Investment: An Overview
1. Outward FDIs
2. Inward FDIs.
This classification is based on the types of restrictions imposed, and the various
prerequisites required for these investments.
Different economic factors encourage inward FDIs. These include interest loans,
tax breaks, grants, subsidies, and the removal of restrictions and limitations.
Factors detrimental to the growth of FDIs include necessities of differential
performance and limitations related with ownership patterns.
Some foreign direct investments involve the transfer of strategic assets. FDI
activities may also be carried out to ensure optimization of available opportunities
and economies of scale. In this case, the foreign direct investment is termed as
“efficiency-seeking.”
Benefits of FDIs:
It was observed during the financial problems of 1997-98 that the amount of
foreign direct investment made in these countries was pretty steady. The
other forms of cash inflows in a country like debt flows and portfolio equity
had suffered major setbacks.
The countries that get foreign direct investment from another country can also
develop the human capital resources by getting their employees to receive
training on the operations of a particular business.
It also opens up the export window that allows these countries the opportunity
to cash in on their superior technological resources. It has been possible for
the recipient countries to keep their rates of interest at a lower level.
It becomes easier for the business entities to borrow finance at lesser rates of
interest. The biggest beneficiaries of these facilities are the small and
medium-sized business enterprises.
Disadvantages of Foreign Direct Investment
At times it has been observed that certain foreign policies are adopted that
are not appreciated by the workers of the recipient country.
At times it has been observed that the governments of the host country are
facing problems with foreign direct investment. It has less control over the
functioning of the company that is functioning as the wholly owned
subsidiary of an overseas company.
This leads to serious issues. The investor does not have to be completely
obedient to the economic policies of the country where they have invested
the money. At times there have been adverse effects of foreign direct
investment on the balance of payments of a country.
Foreign Institutional Investors (FII) :
In countries like India, statutory agencies like SEBI have prescribed norms to
register FIIs and also to regulate such investments flowing in through FIIs. FEMA
norms includes maintenance of highly rated bonds (collateral) with security
exchange.
1. Pension Funds
2. Mutual Funds
3. Insurance Companies
4. Investment Trusts
5. Banks
6. University Funds
7. Endowments
8. Foundations
3. Trustees
Portfolio debt flows result from foreign investors buying domestic debt securities.
A German investor buying bonds in Canada is an example. Commercial bank
lending (loans from private financial institutions) is also portfolio debt. Portfolio
equity flows occur, similarly, when foreign investors purchase equity securities
domestically. A Japanese investor who purchases stock in the Brazilian stock
market is creating an equity capital flow into Brazil. ADRs and GDRs also fit into
this category.
FDI V/S FII”
FDI FII
Motive Motive behind FDI is to Motive behind FII is to
acquire controlling interest make (capital) gains
in a foreign entity or set up from investments. There
an entity with controlling is no intention to control
interest. the entity.
Source FDI investment comes FII investment come
from MNC’s and corporate from investors, mutual
so as to derive benefit of funds, portfolio
new market, cheaper management
resources (labor), companies and
efficiency and skills, corporate with pure
strategic asset seeking (oil motive of investment
fields) and time geography gains.
(BPO – Transcriptions)
Duration FDI investment is more FII is highly volatile.
enduring and has longer
time stability.
Form FDI generally comes as FII comes mainly
subsidiary or a joint through stock markets.
venture.
Purpose FDI is made with core FII’s sole criteria and
thought of business motive is gains on
philosophy of investments.
diversification, integration,
consolidation, and
expansion and/or core
business formation.
Calculation of gains is
always prime criteria but
never the sole criteria.
2. Public Sources of Capital.
Official non-concessional multilateral aid consists of loans from the World Bank,
regional development banks, and other intergovernmental agencies such as
multilateral organizations. The term "non-concessional" refers to the fact that
these loans are based on market rates, must be repaid, and are not partly grants.
By contrast, official non-concessional bilateral aid is loans from governments and
their central banks or other agencies. Export credit agency loans are also
included here. "Bilateral" refers to the fact that the entities providing the funding
provide aid only in their home country.
ODA refers in part to official public grants that are legally binding commitments
and provide a specific amount of capital available to disburse (give out) for which
no repayment is required. Concessional bilateral aid refers to aid from
governments, central banks, and export credit agencies that contains a partial
grant element (25% or more), or partially forgives the loan.
Instruments in
International Capital
Markets:
FCCB
ECB
International Equity Markets:
Funds can be raised in the primary market from the domestic market as well as
from international markets. After the reforms were initiated in 1991, one of the
major policy changes was allowing Indian companies to raise resources by way
of equity issues in the international markets. Earlier, only debt was allowed to be
raised from international markets. In the early 1990s foreign exchange reserves
had depleted and the country’s rating had been downgraded. This resulted in a
foreign exchange crunch and the government was unable to meet the import
requirement of Indian companies. Hence allowing companies to tap the equity
and bond market In Europe seemed a more sensible option. This permission
encourages Indian companies to become global.
India companies have raised resources from international capital markets
through
Introduction:
ADR stands for American Depository Receipt. Similarly, GDR stands for Global
Depository Receipt. Every publicly traded company issues shares – and these
shares are listed and traded on various stock exchanges. Thus, companies in
India issue shares which are traded on Indian stock exchanges like BSE (The
Stock Exchange, Mumbai), NSE (National Stock Exchange), etc. These shares
are sometimes also listed and traded on foreign stock exchanges like NYSE
(New York Stock Exchange) or NASDAQ (National Association of Securities
Dealers Automated Quotation).But to list on a foreign stock exchange, the
company has to comply with the policies of those stock exchanges.
Many times, the policies of these exchanges in US or Europe are much more
stringent than the policies of the exchanges in India. This deters these
companies from listing on foreign stock exchanges directly. But many good
companies get listed on these stock exchanges indirectly – using ADRs and
GDRs.
1. The company deposits a large number of its shares with a bank located in the
country where it wants to list indirectly. The bank issues receipts against
these shares, each receipt having a fixed number of shares as an underlying
(Usually 2 or 4).
2. These receipts are then sold to the people of this foreign country (and anyone
who are allowed to buy shares in that country). These receipts are listed on
the stock exchanges.
3. They behave exactly like regular stocks – their prices fluctuate depending on
their demand and supply, and depending on the fundamentals of the
underlying company.
4. These receipts, which are traded like ordinary stocks, are called Depository
Receipts. Each receipt amounts to a claim on the predefined number of
shares of that company. The issuing bank acts as a depository for these
shares – that is, it stores the shares on behalf of the receipt holders.
1. ADR - American Depositary Receipt
Definitions:
Meaning:
Pricing of ADR:
Dividend payments:
When dividends are paid, the custodian bank receives it and withholds any
foreign taxes, exchanges it for U.S. dollars, then sends it to the depositary bank,
which then sends it to the investors. The depositary bank, being a U.S. bank,
handles most of the interaction with the U.S. investors, such as rights offerings,
stock splits, and stock dividends, but sponsored ADR investors may receive
communications, such as financial statements, directly from the company.
Risks involved:
How It Works/Example:
Broker/dealers don't always start the ADR creation process, but when they do, it
is referred to as an unsponsored ADR program (meaning the foreign company
itself has no active role in the creation of the ADRs). By contrast, foreign
companies that wish to make their shares available to U.S. investors can initiate
what are called sponsored ADR programs. Most ADR programs are sponsored,
as foreign firms often choose to actively create ADRs in an effort to gain access
to American markets.
ADRs are issued and pay dividends in U.S. dollars, making them a good way for
domestic investors to own shares of a foreign company without the complications
of currency conversion. However, this does not mean ADRs are without currency
risk. Rather, the company pays dividends in its native currency and the issuing
bank distributes those dividends in dollars -- net of conversion costs and foreign
taxes -- to ADR shareholders. When the exchange rate changes, the value of the
dividend changes.
For example, let's assume the ADRs of XYZ Company, a French company, pay
an annual cash dividend of 3 euros per share. Let's also assume that the
exchange rate between the two currencies is even -- meaning one Euro has an
equivalent value to one dollar. XYZ Company's dividend payment would
therefore equal $3 from the perspective of a U.S. investor. However, if the euro
were to suddenly decline in value to an exchange rate of one euro per $0.75,
then the dividend payment for ADR investors would effectively fall to $2.25. The
reverse is also true. If the euro were to strengthen to $1.50, then XYZ Company's
annual dividend payment would be worth $4.50.
Levels of ADRs
For a Level I ADR program the receipts issued in the US are registered with
the SEC, but the underlying shares are held in the depositary bank are not
registered with the SEC. They must partially adhere to Generally Accepted
Accounting Principles (GAAP) used in the USA.
Level II ADRs are those in which both the ADRs and the underlying shares
(that already trade in the foreign company’s domestic market) are registered
with the SEC. They must also partially adhere to the Generally Accepted
Accounting Principles.
Level III ADRs must adhere fully to the GAAP and the underlying shares held
at the Depositary Bank are typically new shares not those already trading in
the foreign company’s domestic currency.
2. GDRs Global Depository Receipts
Definitions:
Meaning:
Prices of GDRs are often close to values of related shares, but they are traded
and settled independently of the underlying share. Normally 1 GDR = 10 Shares
The Global Depository Receipts issued may be listed on any of the Overseas
Stock Exchanges, or Over the Counter Exchanges or through Book Entry
Transfer Systems prevalent abroad and such receipts may be purchased,
possessed and freely transferable
Issue structure of the Global Depositary Receipts
(1) A Global Depository Receipt may be issued for one or more underlying
shares or bonds held with the Domestic Custodian Bank.
(2) The Foreign Currency Convertible Bonds and Global Depository Receipts
may be denominated in any freely convertible foreign currency.
(3) The ordinary shares underlying the Global Depository Receipts and the
shares issued upon conversion of the Foreign Currency Convertible Bonds will
be denominated only in Indian currency.
(4) The following issue will be decided by the issuing company with the Lead
Manager to the issue, namely:-
(d) The rate of interest payable on Foreign Currency Convertible Bonds; and
(e) The conversion price, coupon, and the pricing of the conversion options of the
Foreign Currency Convertible Bonds.
(5) There would be no lock-in-period for the Global Depository Receipts issued
under this scheme
India entered the international arena in May 1992, with the first
GDR issue by Reliance Industries Limited, which collected US b$150 million.
This was followed by Grasim Industries’ offer of US $90 million in November.
Then, the GDR markets witnessed a lull till 1993-end in the wake of the securities
scam and the consequent fall in the domestic markets, during which time the only
Indian offering came from HINDALCO in July 1993, which raised US $72 million.
The end of 1993 saw a flood of Indian paper hit the Euro markets with Bombay
Dyeing, Mahindra and Mahindra, SPIC and Sterlite Industries raising funds. This
boom continued till mid-1995, after which a combination of factors – political
instability, falling markets, reduced profitability due to a liquidity crunch - pulled
down the GDR market again, till the end of 1996, during which time, the only
notable exception was the US $370 million offering by the State Bank of India.
Currently, there are over 1600 Depository Receipt programmes for companies
from over 60 countries. Companies have round that the establishment of a
depository receipt programme offers numerous advantages. The primary reasons
why a company would establish a depository receipt programme can be divided
into. the following considerations:
Access to capital markets outside the home market to provide a mechanism
for raising capital or as a vehicle for an acquisition.
Enhancement of company visibility by. enhancement of image of the
company’s products, services or financial instruments in a marketplace
outside its home country.
Expanded shareholder base which may increase or stabilize the share price
May increase local share, price as a result of global demand/ trading through
a broadened and a more diversified investor exposure.
Increase potential liquidity by enlarging the market for the company’s shares.
Adjust share price to trading market comparables through Ratio
Enhance shareholder communications and enable employees to invest easily
in the parent company.
Benefits to an Investor
Both ADR and GDR are depository receipts, and represent a claim on the
underlying shares. The only difference is the location where they are traded.If
the depository receipt is traded in the United States of America (USA), it is
called an American Depository Receipt, or an ADR. If the depository receipt is
traded in a country other than USA, it is called a Global Depository Receipt,
or a GDR. While ADRs are listed on the US stock exchanges, the GDRs are
usually listed on a European stock exchange.
ADRs and GDRs are not for investors in India – they can invest directly in the
shares of various Indian companies. But the ADRs and GDRs are an
excellent means of investment for NRIs and foreign nationals wanting to
invest in India. By buying these, they can invest directly in Indian companies
without going through the hassle of understanding the rules and working of
the Indian financial market – since ADRs and GDRs are traded like any other
stock, NRIs and foreigners can buy these using their regular equity trading
accounts!
Which Indian companies have ADRs and / or GDRs?
Some of the best Indian companies have issued ADRs and / or GDRs. Below is a
partial list.
In India FCCB are issued in accordance with guidelines and regulations framed
under FEMA Act by the RBI and schemes notified by the Ministry of Finance,
Government of India. An FCCB issue by a company is governed by FEM
(Transfer or Issue of any Foreign Security) Regulations, 2004 (hereinafter
‘Regulations’) and Issue of Foreign Currency Convertible Bonds and Ordinary
Shares (through Depository Receipt Mechanism) Scheme, 1993 (hereinafter ‘the
Scheme’). The comprehensive guidelines issued on External Commercial
Borrowings (ECB) vide A.P. (DIR Series) Circular No. 5 dated August 1, 2005
(hereinafter ‘ECB Guidelines’) are also applicable to FCCB issue. In other words
the FCCB are required to be issued in accordance with the Scheme. They will
also have to adhere to the Regulations. Further they must be meeting the
requirements of the ECB guidelines.
Indian corporate companies are allowed to raise foreign loans for financing
infrastructure projects. The last are used as a residual source after exhausting
external equity as a main source of finance for large value projects.
International Bond Markets:
What is a bond?
Bonds are debt. They are debt because when an investor buys a bond they are
effectively loaning the bond’s issuer a sum of money and that issuer is incurring a
debt. So the issuer – or seller of the bond - is a borrower and the investor - or
buyer of the bond - is a lender.
The price paid for the bond is the money the investor is loaning the issuer. And,
like most other loans, when you buy a bond the borrower pays you interest for as
long as the loan is outstanding and then – at the end of the agreed period of the
loan – pays you the loan back.
The bond market (also known as the debt, credit, or fixed income market) is a
financial market where participants buy and sell debt securities, usually in the
form of bonds. As of 2006, the size of the international bond market is an
estimated $45 trillion, of which the size of the outstanding U.S. bond market debt
was $25.2 trillion. Average daily trading volume in the U.S. bond market takes
place between broker-dealers and large institutions in a decentralized, over-the-
counter (OTC) market. However, a small number of bonds, primarily corporate,
are listed on exchanges.
Market structure:
However, the New York Stock Exchange (NYSE) is the largest centralized bond
market, representing mostly corporate bonds. The NYSE migrated from the
Automated Bond System (ABS) to the NYSE Bonds trading system in April 2007
and expects the number of traded issues to increase from 1000 to 6000.
1. Foreign bonds:
These bonds are issued within a particular country and denominated in the
currency of that country, but the issuer is a non-resident.
2. Eurobonds:
These are bonds issued outside the country of the currency in which such bonds
are denominated. For instance US dollars denominated bonds issued in Europe,
called as “Eurodollar Bonds.”
During 1950s, Russians were earning dollars from the sell of gold and other
commodities and wanted to use them to buy grains and other products from the
west, mainly from the US. However, they didn’t want to keep these dollars on
deposits with the banks in New York, as they were apprehensive that the US
government might freeze the deposits if the cold war intensified. They
approached the banks in Britain and France who accepted these dollar deposits.
These deposits were in Europe, so ‘euro’ and were dollar deposits so,
‘EuroDollar’ deposits. Later on till 1980s, such deposits were by and large in
Europe only. Since 1990, the markets have expanded geographically and also in
volume, but the prefix ‘Euro’ has still remained. It strictly and really means
‘offshore’ and not necessarily always referred to Europe.
Euronotes are notes issued outside the country in whose currency they are
denominated. Euronotes consist of Euro-commercial paper (ECPs) and Euro-
Medium-term notes (EMTNs). Commercial papers are unsecured short-term
promissory notes issued by finance companies and some industrial companies.
EMTNS are medium-term funds guaranteed by financial institutions with the
short-term commitment by investors. Global bonds are bonds sold inside as well
as outside the country in whose currency they are denominated. For example,
dollar-denominated bonds sold in New York and Tokyo are called dollar global
bonds.
EUROCURRENCY MARKETS:
The dominant euro currency is US dollars with dollar weakness other currency
particularly the Deutcshe mark and Swiss Frank- increased in importance. In
Eurodollar markets, banks accept deposits from depositors, mainly corporate
depositors. They also place these Eurodollars to other banks.
For instance, Citibank may accept deposit from a company Alcoa. Citibank would
place this as a deposit to Barclays bank. Barclays to Chase bank. Chase may
ultimately lend it to Unilever group, a corporate house. Eurocurrency transactions
may be classified as corporate to bank on one hand and bank to another bank on
the other hand.
Short term debt instrument
1.Banker’s acceptance BA
This is a form of short-term borrowing in which the borrower sells securities to the
lender with an agreement to buy them back at a later date. That is why it is called
REPO. The repurchase price and selling price are the same. But the original
seller has to pay interest while repurchasing the securities. The amount of
interest depends on demand–supply conditions. Repos may be overnight repos
or of longer maturity.
DOCUMENTATION:
The following are the documents generally needed for an euro issue:
1. Prospectus:
2. Depository Agreement:
This is the agreement between the issuing company & the overseas depository
providing a set of rules for withdrawal of depositors & for their conversion into
shares. Voting rights are also defined.
3. Underwriting agreement:
The underwriters play the role of ‘assurers’ as they undertake to pick up the
GDRs at a predetermined price depending on the market response.
4. Subscription Agreement:
The Lead manager & the syndicated members form a part of the investors who
subscribe to GDRs or bonds as per this agreement.
5. Custodian Agreement:
It is an agreement between the depository & the custodian. The depository & the
custodian determine the process of conversion of underlying shares into DRs &
vice versa.
While the trust deed is a standard document which provides for duties &
responsibilities of trustees, this agreement enables the paying & conversion
agency ( performing banking function) undertaking to service the bonds till
conversion.
7. Listing Agreement:
Most of the companies prefer Luxemburg stock exchange for listing purposes, as
the modalities are simplest. The listing agents have the responsibility of fulfilling
the listing requirement of a chosen stock exchange.
What are some reasons for a company to cross list its shares?
A company hopes to: (1) allow foreign investors to buy their shares in their home
market; (2) increase the share price by taking advantage of the home country’s
rules and regulations; (3) provide another market to support a new issuance in
the foreign market; (4) establish a presence in that country in the instance that it
wishes to conduct business in that country; (5) increase its visibility to its
customers, creditors, suppliers, and host government; and (6) compensate local
management and employees in the foreign affiliates.
The Securities Industry and Financial Markets Association classifies the broader
bond market into five specific bond markets.
• Corporate
• Government & Agency
• Municipal
• Mortgage Backed, Asset Backed, and Collateralized debt obligation
• Funding
Bond market participants are similar to participants in most financial markets and
are essentially either buyers (debt issuer) of funds or sellers (institution) of funds
and often both.
Participants include:
• Institutional investors;
• Governments;
• Traders; and
• Individuals
Because of the specificity of individual bond issues, and the lack of liquidity in
many smaller issues, the majority of outstanding bonds are held by institutions
like pension funds, banks and mutual funds. In the United States, approximately
10% of the market is currently held by private individuals.
For market participants who own a bond, collect the coupon and hold it to
maturity, market volatility is irrelevant; principal and interest are received
according to a pre-determined schedule.
But participants who buy and sell bonds before maturity are exposed to many
risks, most importantly changes in interest rates. When interest rates increase,
the value of existing bonds falls, since new issues pay a higher yield. Likewise
when interest rates decrease, the value of existing bonds rise since new issues
pay a lower yield. This is the fundamental concept of bond market volatility:
changes in bond prices are inverse to changes in interest rates. Fluctuating
interest rates are part of a country's monetary policy and bond market volatility is
a response to expected monetary policy and economic changes.
Bond indices:
A number of bond indices exist for the purposes of managing portfolios and
measuring performance, similar to the S&P 500 or Russell Indexes for
stocks. The most common American benchmarks are the Lehman
Aggregate, Citigroup BIG and Merrill Lynch Domestic Master. Most
indices are parts of families of broader indices that can be used to measure
global bond portfolios, or may be further subdivided by maturity and/or
sector for managing specialized portfolio Issuing bonds
The amount on which the issuer pays interest and which has to be repaid at the
end.
2. Issue price
The price at which investors buy the bonds when they are first issued, typically
$1,000.00. The net proceeds that the issuer receives are calculated as the issue
price, less issuance fees, times the nominal amount.
3. Maturity date
The date on which the issuer has to repay the nominal amount. As long as all
payments have been made, the issuer has no more obligations to the bond
holders after the maturity date.
4. Tenure
The length of time until the maturity date is often referred to as the term or tenure
or maturity of a bond. The maturity can be any length of time, although debt
securities with a term of less than one year are generally designated money
market instruments rather than bonds. Most bonds have a term of up to thirty
years. Some bonds have been issued with maturities of up to one hundred years,
and some even do not mature at all. In early 2005, a market developed in euros
for bonds with a maturity of fifty years. In the market for U.S. Treasury securities,
there are three groups of bond maturities:
The interest rate that the issuer pays to the bond holders. Usually this rate is
fixed throughout the life of the bond. It can also vary with a money market index,
such as LIBOR,(London Inter Bank Offered Rate) or it can be even more exotic.
The name coupon originates from the fact that in the past, physical bonds were
issued had coupons attached to them. On coupon dates the bond holder would
give the coupon to a bank in exchange for the interest payment.
6. coupon dates
The dates on which the issuer pays the coupon to the bond holders. In the U.S.,
most bonds are semi-annual, which means that they pay a coupon every six
months. In Europe, most bonds are annual and pay only one coupon a year.
8. Optionality:
A bond may contain an embedded option; that is, it grants option-like features to
the holder or the issuer:
9. Callability:
Some bonds give the issuer the right to repay the bond before the maturity date
on the call dates; see call option. These bonds are referred to as callable bonds.
Most callable bonds allow the issuer to repay the bond at par. With some bonds,
the issuer has to pay a premium, the so called call premium. This is mainly the
case for high-yield bonds. These have very strict covenants, restricting the issuer
in its operations. To be free from these covenants, the issuer can repay the
bonds early, but only at a high cost.
10. Puttability
Some bonds give the holder the right to force the issuer to repay the bond before
the maturity date on the put dates;
The dates on which callable and Puttable bonds can be redeemed early. There
are four main categories.
A Bermudan callable has several call dates, usually coinciding with coupon
dates.
A European callable has only one call date. This is a special case of a
Bermudan callable.
An American callable can be called at any time until the maturity date.
A death put is an optional redemption feature on a debt instrument allowing
the beneficiary of the estate of the deceased to put (sell) the bond (back to
the issuer) in the event of the beneficiary's death or legal incapacitation. Also
known as a "survivor's option".
Sinking fund provision of the corporate bond indenture requires a certain
portion of the issue to be retired periodically. The entire bond issue can be
liquidated by the maturity date. If that is not the case, then the remainder is
called balloon maturity. Issuers may either pay to trustees, which in turn call
randomly selected bonds in the issue, or, alternatively, purchase bonds in
open market, then return them to trustees.
Types of bonds:
1. Fixed rate bonds have a coupon that remains constant throughout the life of
the bond.
2. Floating rate notes (FRN's) have a coupon that is linked to an Index. Common
Indices include: money market indices, such as LIBOR or Euribor, or CPI (the
Consumer Price Index). Coupon examples: three month USD LIBOR + 0.20%, or
twelve month CPI + 1.50%. FRN coupons reset periodically, typically every one
or three months. In theory, any Index could be used as the basis for the coupon
of an FRN, so long as the issuer and the buyer can agree to terms.
3. High yield bonds are bonds that are rated below investment grade by the
credit rating agencies. As these bonds are more risky than investment grade
bonds, investors expect to earn a higher yield. These bonds are also called junk
bonds.
4. Zero coupon bonds do not pay any interest. They are issued at a substantial
discount from par value. The bond holder receives the full principal amount on
the redemption date.
An example of zero coupon bonds are Series E savings bonds issued by the
U.S. government. Zero coupon bonds may be created from fixed rate bonds by a
financial institutions separating "stripping off" the coupons from the principal. In
other words, the separated coupons and the final principal payment of the bond
are allowed to trade independently.
5. Inflation linked bonds: in which the principal amount is indexed to inflation. The
interest rate is lower than for fixed rate bonds with a comparable maturity.
However, as the principal amount grows, the payments increase with inflation.
The government of the United Kingdom was the first to issue inflation linked Gilts
in the 1980s. Treasury Inflation-Protected Securities (TIPS) and I-bonds are
examples of inflation linked bonds issued by the U.S. government.
Other indexed bonds, for example equity linked notes and bonds indexed on a
business indicator (income, added value) or on a country's GDP.
6. Asset-backed securities are bonds whose interest and principal payments are
backed by underlying cash flows from other assets. Examples of asset-backed
securities are mortgage-backed securities (MBS's), collateralized mortgage
obligations (CMOs) and collateralized debt obligations (CDOs).
7. Subordinated bonds are those that have a lower priority than other bonds of
the issuer in case of liquidation. In case of bankruptcy, there is a hierarchy of
creditors. First the liquidator is paid, then government taxes, etc. The first bond
holders in line to be paid are those holding what is called senior bonds. After they
have been paid, the subordinated bond holders are paid. As a result, the risk is
higher. Therefore, subordinated bonds usually have a lower credit rating than
senior bonds. The main examples of subordinated bonds can be found in bonds
issued by banks, and asset-backed securities.
8. Perpetual bonds are also often called perpetuities. They have no maturity
date. The most famous of these are the UK Consol, which are also known as
Treasury Annuities or Undated Treasuries. Some of these were issued back in
1888 and still trade today. Some ultra long-term bonds (sometimes a bond can
last centuries: West Shore Railroad issued a bond which matures in 2361 (i.e.
24th century)) are sometimes viewed as perpetuities from a financial point of
view, with the current value of principal near zero.
10. Bear bond, often confused with Bearer bond, is a bond issued in Russian
roubles by a Russian entity in the Russian market.
11. Registered bond is a bond whose ownership (and any subsequent
purchaser) is recorded by the issuer, or by a transfer agent. It is the
alternative to a Bearer bond. Interest payments, and the principal upon
maturity, are sent to the registered owner.
12. Municipal bond is a bond issued by a state, U.S. Territory, city, local
government, or their agencies. Interest income received by holders of municipal
bonds is often exempt from the federal income tax and from the income tax of the
state in which they are issued, although municipal bonds issued for certain
purposes may not be tax exempt.
13. Book-entry bond is a bond that does not have a paper certificate. As
physically processing paper bonds and interest coupons became more
expensive, issuers (and banks that used to collect coupon interest for depositors)
have tried to discourage their use. Some book-entry bond issues do not offer the
option of a paper certificate, even to investors who prefer them.
14. Lottery bond is a bond issued by a state, usually a European state. Interest
is paid like a traditional fixed rate bond, but the issuer will redeem randomly
selected individual bonds within the issue according to a schedule. Some of
these redemptions will be for a higher value than the face value of the bond.
15. War bond is a bond issued by a country to fund a war.
16. Convertible bond lets a bondholder exchange a bond to a number of shares
of the issuer's common stock.
17. Exchangeable bond allows for exchange to shares of a corporation other
than the issuer.
Eligibility for issue of Convertible bonds or ordinary shares of issuing
company
Government Bonds
Corporate Bonds
A company can issue bonds just as it can issue stock. Large corporations have a
lot of flexibility as to how much debt they can issue: the limit is whatever the
market will bear. Generally, a short-term corporate bond is less than five years;
intermediate is five to 12 years, and long term is over 12 years. Corporate bonds
are characterized by higher yields because there is a higher risk of a company
defaulting than a government. The company's credit quality is very important: the
higher the quality, the lower the interest rate the investor receives.
Other variations on corporate bonds include convertible bonds, which the holder
can convert into stock, and callable bonds, which allow the company to redeem
an issue prior to maturity.
SYNDICATED LENDING:
Syndicate members play different roles. Some just lend money. Others also
facilitate the process. It is common to speak of an arranger, lead bank or lead
lender that originates the loan, forms the syndicate and processes payments.
Most syndicated loans are floaters, paying a spread over Libor, but other
structures abound. Fixed-rate term loans, revolving lines of credit and even
letters of credit are syndicated. Loans may be structured specifically to appeal to
institutional investors.
2. Underwriting bank
The bank that
Commits to supplying the funds to the borrwoer -if necessary from its own
resources if the loan is not fully subscribed.
May be the arranging bank or another bank.
Not all syndicated loans are fully underwritten.
Risk: the loan may not be fully subscribed.
3. Participating bank
1. Pre-mandate phase
The prospective borrower may liaise with a single bank or it may invite
competitive bids from a number of banks.
the lead bank needs to:
Identify the needs of the borrower.
Design an appropriate loan structure.
Develop a persuasive credit proposal.
Obtain internal approval.
Milestone: award of the mandate.
3. Post-closure phase
The agent now handles the day-to-day running of the loan facility.
Pricing
Syndicated loans, like most loans, pose credit risk for the lenders. This can be
extreme, as with some leveraged buyouts or loans to some sovereigns. Credit
risk is assessed as with any other bank loan. Lenders rely on detailed financial
information disclosed by the borrower. As syndicated loans are bank loans, they
have higher seniority in insolvency than bonds.
GAAP:
GAAP principles, which are updated regularly to reflect the latest accounting
methodologies, are the definitive source of accounting guidelines that companies
rely on when preparing their financial statements. The standards are established
and administered by the American Institute of Certified Public Accountants
(AICPA) and the Financial Accounting Standards Board (FASB).
GAAP rules and procedures are what govern corporate accountants when they
present the details of a company's financial operations. These details can be
found in such places as quarterly balance sheets or income statements, 10-Q
filings, or annual reports.
Examples of GAAP measures include net earnings, gross income, and net cash
provided by operating activities.
Why it Matters:
Many companies, for example, often use earnings before interest, taxes,
depreciation, and amortization (EBITDA) as a core measure of performance.
However, non-GAAP financial measures exclude operating and statistical
measures such as employee counts and ratios calculated using numbers
calculated in accordance with GAAP.
It has been argued that certain factors- the large size of the Indian market, the
intrinsic strength of Indian corporate and India well established and well
functioning stock exchanges are conductive to a substantial inflow or foreign
equity buy not foreign debt. The success of some Indian companies to float
GDRs and euro convertibles during the early 1990s is said to indicate this good
potential.
1. Foreign capital is said to fill the domestic saving gap to reduce the foreign
exchange barrier and to provide superior physical and managerial technology.
2. The major forms of foreign are bilateral and multilateral (official) concessional
assistance and private commercial debt and equity capital.
3. Eurodollars are deposits which are US dollar denominated and held at banks
located outside the U.S
4. The bonds floated in the domestic market and domestic currency by a non
resident entity is called foreign bonds.
Eurocurrency market consists of banks that accept deposits and make loans in
foreign currencies outside the country of issue.
Euronote issue facilities (EIF) are notes issued outside the country in whose
currency they are denominated.
Euro commercial paper (ECP) are unsecured short-term promissory notes sold
by finance companies and certain industrial companies.
Contagion, as used in this chapter, is where problems at one bank affect other
banks in the market.
Federal funds are reserves traded among US commercial banks for overnight
use.
Universal bank is one in which the financial corporation not only sells a full
scope of financial services but also owns significant equity stakes in institutional
investors.
International capital market consists of the international bond market and the
international equity market.
International bonds are those bonds that are initially sold outside the country of
the borrower.
Global bonds are bonds sold inside as well as outside the country in whose
currency they are denominated.
Currency-option bonds are bonds whose holders are allowed to receive their
interest income in the currency of their option from among two or three
predetermined currencies at a predetermined exchange rate.
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