| EQUITY
OR EsQUITY-LINKED ISSUES
Portfolio investments in the form of equity bonds can be attracted in the following ways:
»Country
funds
»Foreign
institutional investors investing directly in
the stock market
»Primary
issues of equity in markets abroad
Many Indian companies have already made the primary issues of equity capital to portfolio investors abroad. It can be done in many ways:
»Straight
equity issues
»Issues
of convertible bonds
»Issue
of bonds attached with warrant that allows the
holder to buy the issuer’s equity at a predetermined
rate
Convertible Bond Issues
There was a rapid growth in the Euro convertible equity bonds issues in the 1980s, with more than 600 outstanding issues, amounting to more than $50 billion. The institutional investors are attracted to convertible bonds because they receive some definite income, with the possibility of higher earnings, if the price of the equity increases over the rate at which the holder of the convertible bonds has the right to ask for conversion into equity. The mechanism of a warrant attached to a bond is similar to its operational aspects. In the heyday of the stock market boom in Japan, in the second half of the eighties, many Japanese issuers made successful forays in the market, even with coupons as low as 1 or 1.5 percent. In fact, Japanese issuers were successful not only in keeping the coupon on the bonds very low but also the conversion price at a premium over the current market price. In general, there is a trade-off between the coupon and the premium over the market price: a higher premium would require a higher coupon.
For Euro convertible equity bonds , the conversion can be done at the predetermined price by the investor, but after a year or two after the issue. The majority of issues are listed in the London or Luxembourg stock market, though actual trading is on over-the-counter basis. The size of a Euro convertible bond issue is $30-50 billion.
Straight Equity Issues
In the international markets, straight equity issues are made in the form of depository receipts. Three types of depository receipts are commonly used:
»American
Depository Receipts (ADRs) are meant to smooth
the progress of public issues and trading in the
United States.
»International
Depository Receipts (IDRs) are meant to facilitate
issues and trading in Europe.
»Global
Depository Receipts (GDRs) are used for issues
in the Euro market combined with private placement
in the United States. The primary and secondary
market is mainly in London/Luxembourg; most of
the trading is on an over-the-counter basis.
An international bank acting as a depository issues the depository receipts. Each depository receipt signifies a specified number of the company’s shares, which are held by a custodian appointed by the depository bank in the country of the company, which is the ultimate issuer of the shares. In the company’s books, the depository bank’s name appears as the holder of the shares. The depository receives the dividends from the company and redistributes them to the holders of the depository receipts after converting them into dollars at the existing rate of exchange. Like Eurobonds, GDRs too are bearer securities and trading/settlements are done by book entries through CEDEL or Euroclear. The depository receipts are negotiable with the original shares at any time, or after the lapse of a specified period. The exchanged shares could then be traded on the local stock market. The issue price of depository receipts is based on the market price of the original share at the time of issue. The underwriting fees and commissions work out to around 3.75 percent with the other expenses being similar to those in case of bond issues.
BOND ISSUE DRILL
The decision to issue bonds depends on whether the issue is a foreign bond or a Eurobond, and whether it is to be privately placed or to be sold to the public. Depending on this, the various steps involved in a bond issue would include the following:
»Appointment
of a group of managers/lead managers of the issue
»Appointment
of underwriters
»Completion
of regulatory requirements, as may be necessary
for the kind of issue proposed
»Pricing
of the issue
»The
actual issue
»A
tombstone, i.e. an advertisement recording the
issue of the bonds
The Benchmark Rate
The standard rate of interest for all fixed debts, including bonds, is the yield on government securities of corresponding maturities. Thus, the benchmark for fixed interest debt is the yield on US Government dollar bonds of parallel maturity. Similarly, the benchmark for fixed rate pound debt will be the yield on “gilts” of corresponding maturity.
On the subject of “corresponding maturity”, one point needs to be taken note of. In general, government equity bonds hold a refund of the principal, whereas most corporate loans carry installment repayments. Therefore, in such cases, the standard maturity of the loan should be calculated and the benchmark will be the yield on government bonds with a maturity equal to the weighted average maturity of the loan.
While the benchmark is the yield on government bonds, the fixed rate borrower reimburses a premium on this. The premium depends on the borrower’s credit standing and market appetite for his bonds.
For floating rate notes, the most popular yardstick is the LIBOR. LIBOR is the rate at which banks in London are willing to offer funds to other banks in the market. The actual rate is articulated as a spread over the benchmark and the appropriate rate changes every 3-6 months, depending on how LIBOR moves.
NOTE ISSUANCE FACILITIES
Note Issuance Facility (NIF) is a medium-term commitment on the part of underwriting banks, which obliges them to purchase any short-term notes, which the borrower is unable to sell in the market, at an agreed spread over a suitable benchmark. Once a note issuance facility is in place, the borrower can issue short-term paper and sell it in the capital market. To the extent, the borrower can sell notes at a spread lower than that at which the underwriters are committed to buy, this helps in reducing cost of borrowing. Another major advantage is that, since the notes are short-term, this may allow the borrower to access investors who may not be interested in committing medium-term funds but may be quite happy to buy short-term paper. The NIF can be used to diversify the investor base. To an extent, the NIF is something of a halfway mark between syndicated loans on the one hand and bond issues on the other. With some marginal variations in the basic structure of the facility, NIFs are also referred to as revolving underwriting facilities (RUFs), note purchase facilities or Euro note facilities. The NIF commitment is for 5-7 years, while the short-term paper issued under it is for maturities of 3 or 6 months. The short-term paper acts as a CD if the borrower is a bank, or promissory note for non-bank borrowers. The NIFs have found popularity because they allow the functions done by lenders in a syndicated credit to be performed by different entities, by separating the commitment to fund on the part of the underwriters and the actual purchase of paper by investors who could be different from the underwriters. Under an NIF, the underwriters, instead of committing themselves to buy the notes at the preset ceiling rate, agree instead to make available loans at the same rate.
EURO-COMMERCIAL PAPER (CP)
Like Euro notes under NIFs, CPs are short-term paper issued by non-bank borrowers. The principal distinguishing feature is that a bank does not underwrite CPs and the issuer, therefore, is one with very high credentials. The paper is issued in higher quantities such as $100,000, wherein large professional investors dominate the market. Although these can be issued in interest-bearing form, they are issued at a discount to face value and quoted in the secondary market on a yield basis.
Related
Articles
Equipment
finance
Auto
Finance
|
