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Innovative Financial Instruments-B.V.Raghunandan,SVS College, Bantwal<br />Department of Commerce and Management Studies, <br />University of Calicut<br />February 10,2010<br />
Financial Instrument<br />The basic documents issued to the large body of investors when an organisation or institution raises the funds from a large body of investors<br />Standardised document as per statute or governing institution containing features of the relation between the fund raiser and the user<br />Limited formats<br />
Innovation in the Instrument<br />Altering the terms of issue in a novel way in order to achieve the predetermined purpose<br />
Purpose of Innovation<br />Different Type of Credit Control and Macro-level Liquidity Management<br />Matching Cash Flow Requirement of the Fund Raiser<br />Satisfying other Objectives like Retaining Management Control<br />More Effective Catering to the Needs of the Investors<br />Better Treasury Managment<br />
RBI-Liquidity Adjustment Facility (LAF)<br />Repo and Reverse Repo as part of LAF since 2000<br />Designed to form the Interest Rate Platform within which all short-term interest rates will lie<br />Together with CRR, it has become an effective short-term liquidity management tool<br />Needed to manage the unexpected movement of funds into and out of the country due to Hedge Funds and Others<br />
RBI-CBLO<br />Introduced by CCIL in 2003<br />A Wider Call Money Market<br />Participation by Pledging specified securities with CCIL<br />Participation by NBFCs and Corporate also apart from usual Call Money Market Players<br />One Day or more<br />Better Treasury Management by Corporate<br />Better Profitability of Banks<br />Cheaper Market than Call Money Market<br />
RBI-Market Stabilisation Scheme<br />Launched in 2004 through an MOU between RBI and the Central Government<br />Part of a Longer Period Sterilisation of Market<br />Managing Liquidity Problems arising out of Forex Remittances<br />RBI to issue after consultation with Government<br />Sale of Treasury Bills and Dated Securities through Auction<br />Better Fiscal Accountability as they are issued against cash maintained by the Government with RBI <br />
Perpetual Bonds<br />Introduced in 2005<br />Issued by Scheduled Commercial Bankss<br />15 year Tenure with a Roll on forever at the option of the Bank<br />Part of Tier I Capital of Banks<br />Enabling the Banks to meet Basel Norm regarding Capital Adequacy Ratio<br />Insurance Companies are usually the investors<br />
Bonus Debenture<br />Rewarding Shareholder by better Treasury Management<br />Hindustan Lever tried it in early 2000s<br />Avoiding a Blown-up equity capital base<br />Did not enthuse the investors much<br />Concept did not catch the fancy of the market<br />
Zero Coupon Bonds<br />Interest in the form of discount on the face value of bonds<br />Cross Border Investment<br />Taxation benefit<br />Better Treasury Management since postponing the payment of interest on redemption<br />Where convertibility alone is the consideration, saving of interest<br />
Foreign Currency Convertible Bonds<br />Provisions of FEMA<br />Convertibility is the cream<br />Cross Border Investment<br />Gained Popularity Recently <br />
Multiple Option Bonds<br />Reliance Industries pioneered it in India<br />Appealing to Different Requirements of Investors for Income Planning<br />Flexibility in Tax Planning of Investors<br />Payment of Interest is staggered with varied options<br />Became Popular and adopted for Infrastructure Bonds also<br />
Commercial Paper<br /> short-term security<br />Rated instrument<br />Issued by listed companies<br />Short-term source of finance for corporates<br />Banks and other corporates invest<br />SBI-DFHI tried to create a secondary market, but failed<br />Securities are held until maturity<br />
Certificate of Deposit<br />Banks allowed to issue COD by RBI since 1989 though US banks were issuing since 1961<br />Tapping large deposits of corporates and HNI<br />Tenure is short-term for 3 months to one year<br />Held until maturity<br />SBI-DFHI buys the CODs<br />No secondary market exists as SBI-DFHI is not able to accumulate sufficient CODs <br />
Forex Backed Infrastructure Bonds<br /> In 2009, For the First time RBI invested with a private fund<br />The UK Subsidiary of India Infrastructure Finance Company Ltd issued the bonds<br />The RBI used its foreign exchange reserve to invest in the bonds<br />Indian firms operating in foreign countries can augment the resources by issuing such bonds<br />
Shares with Differential Voting Rights<br />A product for the M&A era<br />Lesser Dilution of management control<br />Each share carrying fraction of a vote<br />Share issued at a discount<br />Dividend is more than the dividend on the normal shares<br />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 <br />
Bonus Preference Shares<br />In 2003, Sun Pharmaceuticals issued bonus preference shares<br />Better cash management<br />Better than bonus debentures as there is no compulsion of payment of interest<br />Did not enthuse the shareholders like the bonus equity shares<br />Did not catch the fancy of the market<br />
Time Share<br />Property sharing for a certain number of days per year<br />Used by Resorts in Tourist Destinations<br />Sterling Group and a few other organisations tapped the market well<br />Fancy ruled only for a few years<br />
Plantation Share<br />Came out with big fanfare<br />Promised fantastic returns in the distant future<br />Many gullible investors were taken for a ride<br />Least Liquid instrument<br />Only a few firms have a token presence<br />
ADR/GDR<br />Instruments issued to foreign investors in lieu of the shares deposited with a custodian in the home country<br />Mainly to get the instruments of Instruments of Indian companies listed in foreign bourses<br />Enhanced the image of Indian companies and added a global perspective<br />Contributed to the volatility of Indian Market<br />
Shares with Disproportionate Voting Rights<br />New Companies Bill is doing away with shares with differential voting rights<br />In its place, shares with superior voting rights are being proposed<br />Helping the promoters to ward off hostile take-overs<br />Lacking fairness<br />
Dangers of Innovation<br />Creating a hype<br />Not a proper study is made before the introduction<br />Complexity<br />Complexity leads to lack of correction of wrong steps<br />IT enabled financial system enables excesses which endanger the very survival of the firm<br />Short term growth for higher managerial remuneration<br />
Corporate-USA<br />Collateralised Debt Obligation (CDO) in 70s<br />Mortgage Backed Securities (MBOs) (pioneered by Larry Fink of First Boston Corporation in 1984)<br />Sub-prime Mortgages in 1990s due to the popularity of MBOs resulting in lowering rates of interest<br />Credit Default Swaps (CDS) invented by Blythe Masters JP Morgan Chase in 1997<br />CDS reaching 62.1 trillion dollars in 2007(AIG being the main player)<br />
The US Debacle<br />2000-03 –Alan Greenspan cuts Fed Rates from 6% - 1%<br />Banks go on a Lending Spree<br />2004-Govt. Backed Lenders Fannie Mae, Ginnie Mae and Freddie Mac have nearly 20% of lending to sub-prime clients<br />2005-CDS market soars with increase in housing sector boom<br />2006-Interest Rates rise to 5+%<br />2007-08-the bubble burst in the housing sector<br />