Analyzing Various Types Of Debt Instruments Existing Finance Essay

Analyzing Various Types Of Debt Instruments Existing Finance testINTRODUCTIONFirst chapter describes the basis behind doing this see. Then, it examines the objectives of this study and some limitations of the study. bearing OF THE STUDYThe purpose of this study is to poll conglome commit types of Debt instruments existing. It aims to develop an intelligence of the growth of the topic. It to a fault includes the impact of these instruments on the country and on various companies.OBJECTIVES OF THE STUDYThe primary(prenominal) objectives of this paper be To conduct a study on the requirement of debt instrumentsTo understand why debts instruments atomic hail 18 grandTo analyze these instrumentsLIMITATIONS OF STUDYDue to lack of information for sale the graphs and the statistics shown argon of preliminary age (2007-2008)As the info was gathered from secondary sources, the authority of the data could non be tested.Another problem was knowledge constraint and this subject i s an attempt to gather as much of relevant data as possible.However, every effort was made to ensure that these do not in some(prenominal) way adversely affect the results of the study.INTRODUCTIONThe debt market places today argon a major source of financing than the banking system. It is any market seat where debt instruments atomic number 18 traded. It establishes a planned environment where the debts atomic number 18 traded amongst the engageed infracties. The debt markets be known by other names based on the types of instruments ar traded. For example when municipal or corporate dumbfound argon traded, debt market is called cling market whereas if notes or securities or mortgages argon traded market is called honorable mention market.The debt market is three times expectantr than stock/equity market. The debt markets atomic number 18 categorized into two other markets called m iodiney market and seat of government market. notes market is a subsection of the fix ed income market. It specializes in short- marge debts with the adulthood of one- stratum. Capital markets specialize in eagle-eyed- shape debts. It is a market in which financial instruments are traded by the institutions and individuals. Institutions or organizations in either offstage or commonplace sectors sell securities to raise capital in these markets. both(prenominal) these equipment casualty are mistakenly applied.In crown market assets (including equities) are taken into consideration and they are amortized over the end of time. Money market is to a greater extent of debts which are readily sold at price predictable within short time. exclusively it is very difficult to distinguish in the midst of money and non-money based on one socio-economic class due date line. most of the debt instruments are traded Over-the-counter and not through exchanges. They are traded in an electronic network market where the brokers or dealers act as mediators. Money markets are not accessible by low-spirited investors except through MFs. corpo in truth associates or groups or even individual investors may participate in the debt market. in that location may be very little fight among how corporate associates or an individual participate depending on the regulations of the government. The pursuance rate are the price of the money which increases with the increase in the demand to dramatise money. The debt market is influenced by credit-worthiness of the borrower, landmark-to-maturity, security for loan and many a(prenominal) a(prenominal) other factors. But government also tries to regulate the chase rates to stimulate the economies with drop focus on inflation.The of import advantage of debt market is the degree of chance associated with the investment opportunity is very low. For the investors who avoid participating in the riskier ventures in which there is less or smaller returns favors confederations and similar investments. A monumenta l fare of money is earned even of returns are not juicy in the debt market.WHAT ARE DEBT INSTRUMENTS?For every individual financial planning is an important task. For the preservation of capitulum tot up the investors should distribute a major attribute of their investments in debt instruments.A debt instrument is an electronic financial responsibleness or any paper that permits an issuing ships corporation to raise funds by guarantee it to pay back a loaner in accordance with the terms and conditions of a contract. The predetermined conditions which are mentioned in the contract are the periodicity and rate of interest and the date stamp of the repayments of the principal amount.Debt instrumentsare an easier way forparticipants and markets fare the rights ofdebt obligations from one party to another. Debt obligationtransferability increases fluidity and gives creditors a means of barter debt obligationsonthe market. Without debt instruments acting as a means to facilit ate trading, debt is an obligation from one party to another. When a debt instrument is utilize as a medium to facilitate debt trading, debt obligations grass be moved from one party to another quickly and efficiently.In Indian Securities market, the term impound is used for debt instrument abandoned by central and state government and the term debenture stick to is used for the instruments troubled by private sectors.OBJECTIVE OF DEBT INSTRUMENTpreservation of principal amount and getting modest returns is the main objective of the debt funds.Investors tactile property for both short-term and gigantic-term investments. There are many instruments available in the market so one can choose comfortably any or mix of instruments according to its requirements.FEATURES OF DEBT INSTRUMENTSThe features of the instruments areSafety of the principal amountGuaranteed returns for the investors.Some of these instruments also qualify for tax rebates under fragment 80C.Currently 8-9% in terest per annum are quoted for medium to long-term binds whereas it is 6-7% returns for short-term depositsNowadays, many banks provide funds sweep-in /sweep-out facility where a balance beyond a certain limit automatically gets converted into a fixed deposit and banks pay the fixed deposit interest on it. This can be an option for a short-term horizon.There are three main features of debt instrumentsMaturityCoupon headlinerMaturityMaturity refers to the date on which the bond matures. It is the date on which the borrower agrees to repay the principal amount. marches-to-maturity refers to the number of courses remaining for the bond to mature. It changes every day from the date of the issue to the maturity of the bond. It is also called the tenure or term of the bond.CouponCoupon tempo refers to the periodic payment of interest made by the issuer of the bond to the lender of the bond. Coupons are declared either by stating the number (example 8%) or with a benchmark rate (examp le MIBOR+0.5%). It is usually represented as a percentage of the face value or the par value of the bond.PrincipalIt is the amount which is borrowed. It is the face or the par value of the bond. The product of the coupon rate and principal is the coupon.For example a GS CG2008 11.40% bond refers to a Central Government bond maturing in the year 2008, and paying a coupon of 11.40%. Since Central Government bonds bemuse a face value of Rs.100, and normally pay coupon semi-annually, this bond will pay Rs. 5.70 as six- periodical coupon, until maturity, when the bond will be ransomed.The term to maturity of a bond can be calculated on any date, as the length between much(prenominal)(prenominal) a date and the date of maturity. It is also called the term or the tenor of the bond. For instance, on February 17, 2004, the term to maturity of the bond maturing on may 23, 2008 will be 4.27 years. The general day count crowd in bond market is 30/360European which assumes total 360 days in a year and 30 days in a month. There is no rigid classification of bonds on the basis of their term to maturity. by and large bonds with tenors of 1-5 years are called short-term bonds bonds with tenors ranging from 4 to 10 years are medium term bonds and above 10 years are long term bonds. In India, the Central Government has issued up to 30 year bonds.CHARACTERISTICS OF DEBT INSTRUMENTSThe primary characteristics of debt instruments areIssuance of an instrument is easyAny telephoner with or without past track record can issue these instruments come out of interest are fixed or floatingFixed commitments are inspectd on operateDebt instruments may be flexible in the period of repayment or nature of interest but they impose fixed commitments on servicing or business. Failure to do servicing of these instruments would be termed as default with adverse effects on the companys stand in the financial sector.Risk is lowInvestors in such instruments being creditors of the company have priority over equity and preference part holders in receiving return (in the form of interest) in such instruments. These carries priority claim on the assets of the firm (if secured) in the event of bankruptcy.TYPES OF DEBT INSTRUMENTSThere are various debt instruments. The debt instruments can be categorized into long-term and short-term debt depending on the time for which the amount has been raise or the repayment period. The debt instruments are mentioned as followsCUsersdellDesktopdebtinst.bmp yearn term DebtLong-term debts are mainly bonds and debentures with the tenure greater than one year.DebenturesA debenture is an instrument of debt executed by the company acknowledging its obligation to repay the sum at a specified rate and also carrying an interest. Company can raise loan capital from debenturesA debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the mon ey elevated by the debentures becomes a part of the companys capital structure, it does not become share capital.The main characteristics of debentures areFixed interest instrument with changeable period of maturityMay or may not be listed on stock exchange, if listed they should be rated by any of the credit place agencies chosen by SEBI drive out be either offered for subscription or privately placedA debenture redemption reserve has to be maintained when offered for subscriptionThe period of maturity varies from 3 to 10 years and may also be more for cast offs having naughty gestation periodTypes of debenturesVarious types of debentures are as followsNon redeemable debentures (NCD) richly convertible debentures (FCD)Partially convertible debentures (PCD)NCDs are those in which total amount if instrument in redeemed by the lender whereas FCDs are those in which the whole value of the instrument is converted into equity. The conversion price is given when the instrument is bor rowed. PCDs are those in which part of the instrument is redeemed and part of it is converted into equity. Conversion price is the price of each equity share received by converting the par or face value of the debenture. The number of equity shares exchangeable per unit of the convertible security i.e. debentures is called the conversion ratio. The period of time after which the debenture is converted into equity is called the conversion period. The convertible instruments are generally used to stem the sudden outflow of the capital at the time of maturity of the instrument causing temporary liquidity problems. Alternately, the company has to raise funds from a different source or issue fresh instruments to tide over and also has to bear the traffic hails in the process. Debentures might be either callable or puttable. Callable debenture is a debenture in which the issuing company has the option of redeeming the security before the specified redemption date at a pre-determined pri ce. Similarly, a puttable security is a security where the holder of the instrument has the option of getting it redeemed before maturity.BondsA bond is a debt security in which authorized borrower or issuer owes the lender or the holder a debt and is obliged to repay the principal amount and interest at maturity. It is a loan in the form of securities having varying terminologies The issuer is alike to the borrower, the bond holder to the lender, and the coupon to the interest. It enables the issuer to finance long-term investments with external funds.Bonds and stocks are both securities, but the major difference between the two is that stock-holders are the owners of the company (i.e., they have an equity stake), whereas bond-holders are lenders to the issuing company. Another difference is that bonds usually have a defined term, or maturity, after which the bond is redeemed, whereas stocks may be outstanding indefinitely. An exception is a consol bond, is a perpetuity bond (i.e ., bond with no maturity).There may be many types of bonds- such as infrastructure, regular income, deep discounts or tax savings.These are instruments having fixed interest rate and a definite period of maturity. The main difference between bonds and debentures is that debenture is secured and bond is not. Hence bonds have high gearer(prenominal) rate of interest than debentures.There are many kinds of bonds available such asFloating rate or fixed rate bonds graduate(prenominal) yield bondsSubordinated bondsPerpetual bondsAsset-backed securitiesBearer bondZero Coupon bondsRegistered bondInflation linked bondsBook entry bondsMunicipal bondsWar bondLottery bondMedium term loanThese are loans wide for a period of 2 to 5 years. The purposes for which these loans are issued are poor gestation projects The short gestation projects could be for purchase of balancing equipment, for incremental expansion of capacity.Refinancing of loans in case of very long projects where the repayment of the term loans might occur prior to sufficient cash flows being generated by the project.For meeting any other medium term shortfall in funding arising out of an acquisition or bulleted repayment of a large loan, etcThe methods for issuing medium term loans are similar to those required for project finance.In case of meeting a medium term mismatches not linked to a project or equipment, the financing decision would be on the basis of a cash flow analysis indicating the get for such medium term funding and an analysis of overall lucrativeness and financial to the business to provide lender comfort. Other than these aspects, the procedures for availing Medium Term loans follows the requirements sought by the lenders in case of Project financing/ long term lending.Public DepositsThese are those deposits that are achieved by many small and large firms from the public. The public deposits are issued mainly to finance the working capital requirements of the firm. The rate of interest o ffered varies with time period of the public deposits. The rate of interest which is mostly offered by the companies on the deposits made on one year is 8-9%, for two year deposits rate is 9-10% and for three years rate offered is 10-11%. For public deposits there are some rules which the companies have to follow according to Companies Amendment Rules 19783 years is the maximum period of maturity for public deposits whereas 6 months is stripped periodFor NBFC 5 years is the maximum period of maturityThe companies accept to disclose the information regarding the financial position and performance10% of the deposits bring to be kept aside by the companies every year by 30th April by the companies having public deposits. This will mature by thirty-first March next year.Advantages enjoyed by companiesSimple and Easy process in gaining public depositNo restrictive agreementReasonable cost incurred after taxNo collateralDisadvantagesVery limited funds raisedShort period of maturityAdva ntages enjoyed by investorsHigher rate of interestShorter maturity periodDisadvantagesNo tax exemptionNo collateralShort-term debtsThe debts which are raised for less than one year are short-term debts. These are categorized into market instruments and financial assist granted by NBFC, Commercial Banks and Term Lending Institutions focusing on the short term needs of a business.Commercial PaperThese are unsecured promissory notes. These are issued by those companies having high credit ratings. The maturity of CPs is 1 to 270 days. They are issued at face value and redeemed at face value. CPs can be issued by companies, which have a minimum networth of Rs.4 crores and needs a mandatory credit rating of minimum A2 (ICRA), P2 (Crisil), D2 (Duff Phelps) and PR2 (Credit Analysis Research). The rating should not be more than 2 months old. It can be issued for a minimum amount of Rs.25 lakhs and more in multiples of Rs.5 lakh.Since the companies are not pledging any collateral, only com panies having high credit-worthiness are allowed to issue CPs. They are usually sold at discounts and have higher interest repayments dates than bonds.AdvantagesFlexibility in maturityLower cost of capital with high credit ratingsDisadvantagesIt brings down credit limits of the banksVery restrictive about payoff of CPsLimited to blue chip companiesInter-Corporate Deposits (ICDs)These are funds raised by corporate companies from other corporate. This is a form of dis-intermediated financing, where corporate with surplus funding directly lend to those in need of funding of such funds and thereby save on the spreads that banks would have charged in borrowing from one to lend to the other.This is very efficient means of investment. The ICDs outlet was very poor in India. In early nineties companies raised funds from public without even identifying the projects for investments.These sums were then deployed in the ICDs market where the borrowers more often than not invested in the nai l downing financial assets (shares) or real estate. Often monies were lent to group companies for propping up the shares of different companies of the group. The end of the boom in financial and real assets saw significant amounts of defaults in ICDs and a virtual closure of the market.