Analysis of fixed and floating interest rates

Analysis of Fixed and
Floating Interest Rates
For Bonds of Power Grid Corporation of India Limited

Under the Guidance of

Mr. Nalin Jain Mr. K.C. Pant
Professor, Marketing CM- Finance (Bonds)
FORE School of Management Power Grid Corporation of India Limited

Mr. Vinay Dutta
Area Chair Person, Finance
FORE School of Management

Madhusudan Partani
91029
PGDM- 2009-11
FORE School of Management
New Delhi

Analysis of Fixed and Floating Interest Rates 2010

Table of Contents
Acknowledgement .................................................................................................................................. 5
Chapter I Introduction
Introduction .......................................................................................................................................... 11
Objectives ............................................................................................................................................. 12
Purpose of Study ................................................................................................................................... 13
Scope ..................................................................................................................................................... 14
Data ....................................................................................................................................................... 15
Review of Literature.............................................................................................................................. 16
Introduction .......................................................................................................................................... 19
Developments in Government Bond Market.................................................................................... 19
Corporate Bond Market .................................................................................................................... 20
Development of Equity Market vs. the Debt Market ....................................................................... 22
Chapter II Financial Statetement Analysis
Balance Sheet Analysis .......................................................................................................................... 26
Capital Composition .......................................................................................................................... 26
Sources and Application of Funds ..................................................................................................... 28
Share Capital ................................................................................................................................. 30
Share Holding Pattern ................................................................................................................... 30
Brief note on Initial Public Offering .............................................................................................. 32
Reserves ........................................................................................................................................ 33
Secured Loans ............................................................................................................................... 33
Unsecured Loans ........................................................................................................................... 35
Current Liability ............................................................................................................................. 36
Fixed Assets ................................................................................................................................... 37
Investments................................................................................................................................... 38
Current Assets ............................................................................................................................... 39
Profit and Loss Analysis......................................................................................................................... 40
Sales/ Operating Income............................................................................................................... 41
Profits ............................................................................................................................................ 42
Dividends....................................................................................................................................... 42
Cash Flow Analysis ................................................................................................................................ 44
Ratio Analysis ........................................................................................................................................ 47
Liquidity Ratio ................................................................................................................................... 47

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Current Ratio ................................................................................................................................. 47
Quick Ratio .................................................................................................................................... 48
Profitability Ratio .............................................................................................................................. 49
Operating Profit Margin (PBIDTM) ............................................................................................... 49
Net Profit Margin .......................................................................................................................... 50
Cash Profit Margin ........................................................................................................................ 50
Return on Capital Employed ......................................................................................................... 51
Return on Net Worth .................................................................................................................... 51
EPS................................................................................................................................................. 52
Solvency Ratios ................................................................................................................................. 53
Debt- Equity Ratio ......................................................................................................................... 53
Intrest Coverage Ratio .................................................................................................................. 54
Activity Ratios ................................................................................................................................... 54
Receivables Turnover Ratio .......................................................................................................... 55
Inventory Turnover Ratio .............................................................................................................. 55
Fixed Asset Turnover Ratio ........................................................................................................... 55
Capital Market Behaviour ................................................................................................................. 56
P/E Multiple .................................................................................................................................. 56
Beta ............................................................................................................................................... 57
Chapter III Procedures in Bond Raising
Steps in Issuing Bonds ........................................................................................................................... 60
Dematerialization Process .................................................................................................................... 68
Listing Process ....................................................................................................................................... 70
Debt Servicing ....................................................................................................................................... 72
Chapter IV Characterstics of Bonds
Yield or IRR ............................................................................................................................................ 78
Current Yield ................................................................................................................................. 78
Yield to Maturity ........................................................................................................................... 78
Annualised Yield ............................................................................................................................ 78
Yield to Call / Put ........................................................................................................................... 79
Price- Yield Relationship ................................................................................................................... 79
Duration ................................................................................................................................................ 80
Macaulay’s Duration ..................................................................................................................... 80
Modified Duration......................................................................................................................... 80

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Convexity............................................................................................................................................... 81
Yield of PSU and GSec Bonds ................................................................................................................ 82
Duration of PSU and GSec Bonds .......................................................................................................... 90
Convexity of PSU and GSec Bonds ........................................................................................................ 95
Chapter V Analysis of Fixed and Floating Interest Rates
Introduction ........................................................................................................................................ 100
Fixed Intrest Rate ............................................................................................................................ 100
Floating Intrest Rate........................................................................................................................ 102
Indian Issuers going for FRBs .......................................................................................................... 104
GOI Floating Rate Bonds ............................................................................................................. 104
Indian Railway Finance Corporation Limited (IRFCL) .................................................................. 105
Power Finance Corporation Limited, .......................................................................................... 105
ICICI Bank .................................................................................................................................... 106
Others ......................................................................................................................................... 106
The Debt Servicing for PGCIL’s Bonds ................................................................................................. 107
Floating Intrest for PGCIL’s Bonds....................................................................................................... 109
Assumptions.................................................................................................................................... 109
Selection of Bonds .......................................................................................................................... 109
Selection of Reference Rate ............................................................................................................ 110
Reset Period and Reference Period ................................................................................................ 113
Spread ............................................................................................................................................. 113
Floating Rate under Reference Rate of Average yield of 1 Year GSec ............................................ 114
Bond VIII ...................................................................................................................................... 114
Bond IX ........................................................................................................................................ 116
Bond X ......................................................................................................................................... 118
Bond XIII- Opt II ........................................................................................................................... 120
Bond XIV ...................................................................................................................................... 122
Floating Rate under Reference Rate of Average yield of 10 year GSec .......................................... 124
Bond VIII ...................................................................................................................................... 124
Bond IX ........................................................................................................................................ 125
Bond X ......................................................................................................................................... 127
Bond XIII- Opt-II........................................................................................................................... 129
Bond XIV ...................................................................................................................................... 130
Floating Rate under Reference Rate of Average yield of 10 year GSec .......................................... 132

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Floating Rate under Reference Rate of Average yield of 10 year GSec- Average Spread of last 12
months ............................................................................................................................................ 135
Summary of Each Base Rate ........................................................................................................... 135
Factors Effecting The Selection Of Each Method............................................................................ 137
Term ............................................................................................................................................ 137
Coupon Rate................................................................................................................................ 137
Market Condition ........................................................................................................................ 138
Quantum of Loan ........................................................................................................................ 139
Repayment Structure .................................................................................................................. 139
Time of Issue ............................................................................................................................... 140
Chapter VI Findings and Recommendations
Critical Analysis of Alternatives........................................................................................................... 142
Fixed Coupon Interest Rate ............................................................................................................ 142
Floating Rate ................................................................................................................................... 142
Fixed Coupon Rate with Option ...................................................................................................... 144
Recommendation................................................................................................................................ 145
References .......................................................................................................................................... 146

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Table of Figures and Charts

FIGURE 1 TREND OF AVERAGE TRADE SIZE - WDM ......................................................................................................... 23
FIGURE 2 CAPITAL COMPOSITION FROM 1996 TO 2009 ................................................................................................... 27
FIGURE 3 SOURCES OF FUNDS- 2008-09 ....................................................................................................................... 28
FIGURE 4 APPLICATIONS OF FUNDS- 2008-09 ................................................................................................................ 29
FIGURE 5 TREND IN SHARE CAPITAL .............................................................................................................................. 30
FIGURE 6 SHARE HOLDING PATTERN AS ON 31ST DEC 2009 ............................................................................................. 31
FIGURE 7 SHARE HOLDING PATTERN ............................................................................................................................. 31
FIGURE 8TREND IN RESERVES AND SURPLUS ................................................................................................................... 33
FIGURE 9 TREND IN NON CONVERTIBLE DEBENTURES ....................................................................................................... 33
FIGURE 10 TREND IN TERM LOANS INSTITUTIONS ............................................................................................................ 34
FIGURE 11 TREND IN TERM LOANS BANKS ..................................................................................................................... 34
FIGURE 12 TREND IN DEFERRED CREDIT ......................................................................................................................... 34
FIGURE 13 TREND IN UNSECURED LOANS....................................................................................................................... 35
FIGURE 14 DEBT COMPOSITION FROM 2003 TO 2009..................................................................................................... 36
FIGURE 15 TREND IN CURRENT LIABILITY........................................................................................................................ 36
FIGURE 16 TREND IN FIXED ASSETS ............................................................................................................................... 37
FIGURE 17 TREND IN INVESTMENTS .............................................................................................................................. 38
FIGURE 18 COMPARISON OF FIXED ASSETS AND INVESTMENTS ........................................................................................... 38
FIGURE 19 TREND IN COMPOSITION OF CURRENT ASSETS ................................................................................................. 39
FIGURE 20 MULTI STEP ANALYSIS OF INCOME................................................................................................................. 40
FIGURE 21 TREND IN INCOMES .................................................................................................................................... 41
FIGURE 22 TREND IN DIFFERENT PROFITS ....................................................................................................................... 42
FIGURE 23 DIVIDEND TREND ....................................................................................................................................... 42
FIGURE 24 PROFIT APPROPRIATIONS OVER THE YEARS ...................................................................................................... 43
FIGURE 25 LIQUIDITY RATIOS....................................................................................................................................... 48
FIGURE 26 OPERATING PROFIT MARGINS ...................................................................................................................... 50
FIGURE 27 NET PROFIT MARGINS................................................................................................................................. 51
FIGURE 28 EPS TREND ............................................................................................................................................... 52
FIGURE 29 DEBT EQUITY RATIO ................................................................................................................................... 53
FIGURE 30 INTEREST COVER RATIO ............................................................................................................................... 54
FIGURE 31 P/E RATIO ................................................................................................................................................ 57
FIGURE 32 RESIDUAL PLOT FOR BETA ............................................................................................................................ 58
FIGURE 33 YIELD CURVE OF PGXXX ............................................................................................................................. 88
FIGURE 34 YIELD CURVE OF GSEC 8.20% ...................................................................................................................... 88
FIGURE 35 YIELD CURVE OF PFC (S-57) ........................................................................................................................ 89
FIGURE 36 MODIFIED VS MACAULAY'S DURATION .......................................................................................................... 93
FIGURE 37 DURATION VS MATURITY ............................................................................................................................ 93
FIGURE 38 DURATION VS YIELD ................................................................................................................................... 94
FIGURE 39 DURATION VS CONVEXITY ............................................................................................................................ 97
FIGURE 40 COUPON RATE VS CONVEXITY (SAME MATURITY) ............................................................................................ 98
FIGURE 41 COUPON RATE VS CONVEXITY (SAME DURATION) ............................................................................................ 98
FIGURE 42 COUPON RATE OF PG VS GSEC RATE........................................................................................................... 108
FIGURE 43 COUPON RATE OF PG VS AVG GSEC YIELD ................................................................................................... 108
FIGURE 44 TREND OF 10 YR GSEC YIELD ..................................................................................................................... 111
FIGURE 45 TREND OF 1YR GSEC YIELD ........................................................................................................................ 111
FIGURE 46 TREND OF COUPON RATES OF PG BONDS ..................................................................................................... 112

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FIGURE 47 RATES OF PG BONDS VS 1 YR GSEC YIELD .................................................................................................... 112
FIGURE 48 INTREST PAYMENTS UNDER FIXED AND FLOATING RATE FOR PGVIII FOR 1 YEAR GSEC AS REFERENCE RATE .............. 116
FIGURE 49 INTEREST PAYMENT UNDER FIXED AND FLOATING RATES FOR PGIX FOR 1 YEAR GSEC AS REFERENCE RATE ............... 118
FIGURE 50 INTEREST PAYMENT UNDER FIXED AND FLOATING RATES FOR PGX FOR 1 YEAR GSEC AS REFERENCE RATE ................ 120
FIGURE 51 INTEREST PAYMENTS UNDER FIXED AND FLOATING RATES FOR PGXIII FOR 1 YEAR GSEC AS REFERENCE RATE............ 121
FIGURE 52 INTEREST PAYMENTS UNDER FIXED AND FLOATING RATE FOR PGXIV FOR 1 YEAR GSEC AS REFERENCE RATE ............. 123
FIGURE 53 INTEREST PAYMENTS UNDER FIXED AND FLOATING RATE FOR PGIX FOR 10 YEAR GSEC AS REFERENCE RATE ............. 127
FIGURE 54 INTREST PAYMENTS UNDER FIXED AND FLOATING RATES FOR ALL BONDS FOR 10 YEAR GSEC AS BASE RATE ............. 134
FIGURE 55 COMPARISON OF FIXED AND FLOATING IN CASE OF ADVERSE MARKET CONDITIONS............................................... 139

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Table of Tables

TABLE 1 CAPITAL COMPOSITION FROM 1996 TO 2009 .................................................................................................... 27
TABLE 2 SHARE HOLDING PATTERN FROM 2007 TO 2009 ................................................................................................ 31
TABLE 3 TOP 10 SHARE HOLDERS AS ON 29.01.2009 ..................................................................................................... 32
TABLE 4 CASH FLOW STATEMENT ................................................................................................................................. 45
TABLE 5 LIQUIDITY RATIOS .......................................................................................................................................... 48
TABLE 6 OPERATING PROFIT MARGINS .......................................................................................................................... 49
TABLE 7 NET PROFIT MARGINS .................................................................................................................................... 51
TABLE 8 RETURNS...................................................................................................................................................... 52
TABLE 9 TURNOVER RATIOS......................................................................................................................................... 56
TABLE 10 REGRESSION OUTPUT ................................................................................................................................... 57
TABLE 11 LIST OF BONDS SELECTED FOR STUDY ............................................................................................................... 83
TABLE 12 YIELD TO MATURITY OF PG XXXI.................................................................................................................... 85
TABLE 13 COMPUTATION OF YIELD OF GSEC BOND.......................................................................................................... 85
TABLE 14 YTM AND CURRENT YIELD OF ALL BONDS ........................................................................................................ 86
TABLE 15 MODIFIED AND MACAULAY'S DURATION OF PGXXXI ......................................................................................... 91
TABLE 16 MODIFIED AND MACAULAY'S DURATION OF GSEC ............................................................................................. 91
TABLE 17 MACAULAY'S AND MODIFIED DURATION OF ALL BONDS ..................................................................................... 92
TABLE 18 CONVEXITY OF PGXXXI ................................................................................................................................ 96
TABLE 19 CONVEXITY OF ALL BONDS............................................................................................................................. 97
TABLE 20 FRBS BY GOI ............................................................................................................................................ 105
TABLE 21 FRBS BY IRFC ........................................................................................................................................... 105
TABLE 22 FRBS BY PFC ............................................................................................................................................ 106
TABLE 23 FRBS BY ICICI BANK .................................................................................................................................. 106
TABLE 24 FRBS BY OTHERS ....................................................................................................................................... 106
TABLE 25 LIST OF BONDS SELECTED FOR ANALYSIS ......................................................................................................... 109
TABLE 26 DETERMINATION OF SPREAD FOR PGVIII FOR 1 YEAR GSEC AS REFERENCE RATE ................................................... 114
TABLE 27 FLOATING RATES FOR PGVIII FOR 1 YEAR GSEC AS REFERENCE RATE ................................................................... 115
TABLE 28 INTREST UNDER FIXED AND FLOATING RATES FOR PGVIII FOR 1 YEAR GSEC AS REFERENCE RATE .............................. 115
TABLE 29 CALCULATION OF SPREAD FOR PGIX FOR 1 YEAR GSEC AS REFERENCE RATE ......................................................... 116
TABLE 30 FLOATING RATES FOR PGIX FOR 1 YEAR GSEC AS REFERENCE RATE ..................................................................... 117
TABLE 31 INTEREST UNDER FIXED AND FLOATING RATES FOR PGIX FOR 1 YEAR GSEC AS REFERENCE RATE............................... 117
TABLE 32 CALCULATION OF SPREAD FOR PGX FOR 1 YEAR GSEC AS REFERENCE RATE .......................................................... 119
TABLE 33 FLOATING RATES FOR PGX FOR 1 YEAR GSEC AS REFERENCE RATE ...................................................................... 119
TABLE 34 INTEREST UNDER FIXED AND FLOATING RATE FOR PGX FOR 1 YEAR GSEC AS REFERENCE RATE .................................. 119
TABLE 35 CALCULATION OF SPREAD FOR PGXIII FOR 1 YEAR GSEC AS REFERENCE RATE ....................................................... 121
TABLE 36 FLOATING RATES FOR PGXIII FOR 1 YEAR GSEC AS REFERENCE RATE ................................................................... 121
TABLE 37 INTEREST UNDER FIXED AND FLOATING RATES FOR PGXIII FOR 1 YEAR GSEC AS REFERENCE RATE ............................ 121
TABLE 38 CALCULATION OF SPREAD FOR PGXIV FOR 1 YEAR GSEC AS REFERENCE RATE ....................................................... 122
TABLE 39 FLOATING RATES FOR PGXIV FOR 1 YEAR GSEC AS REFERENCE RATE................................................................... 122
TABLE 40 INTERESTS UNDER FIXED AND FLOATING RATES FOR PGXIV FOR 1 YEAR GSEC AS REFERENCE RATE ........................... 123
TABLE 41 FLOATING RATES FOR PGVIII FOR 10 YEAR GSEC ............................................................................................ 125
TABLE 42 INTERESTS UNDER FIXED AND FLOATING FOR PGVIII FOR 10 YEAR GSEC.............................................................. 125
TABLE 43 CALCULATION OF SPREAD FOR PGX FOR 10 YEAR GSEC AS REFERENCE RATE ........................................................ 126
TABLE 44 FLOATING RATES FOR PGIX FOR 10 YEAR GSEC AS REFERENCE RATE ................................................................... 126
TABLE 45 INTERESTS UNDER FIXED AND FLOATING FOR PGIX FOR 10 YEAR GSEC ................................................................ 127
TABLE 46 TOTAL INTREST UNDER FIXED AND FLOATING RATES FOR ALL BONDS UNDER 10 YEAR GSEC AS BASE RATE ................ 132

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TABLE 47 SUMMARY OF COSTS UNDER 1 YEAR GSEC AS BASE RATE.................................................................................. 135
TABLE 48 SUMMARY OF COSTS UNDER 10 YEAR GSEC AS BASE RATE ( COUPON PERIOD) ..................................................... 135
TABLE 49 SUMMARY OF COSTS UNDER 10 YEAR GSEC AS BASE RATE ( INTEREST PAYMENT PERIOD)....................................... 136

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Acknowledgement

The satisfaction and joy that accompanies the successful completion of a task is incomplete without
mentioning the names of those who extended their help and support in making it a success.

The Project Titled “Analysis of Fixed and Floating Rates of Bonds of Power Grid Corporation of India
Limited “has not been a success without the priceless support and assistance of Mr. K.C. Pant (Chief
Manager Finance-Bonds, Power Grid Corporation of India Limited), Mr. Sandesh Nagrare (Chief
Accountant- Bonds, Power Grid Corporation of India Limited) and Mr. S.V. Venkat (Chief Manager,
Finance-Bonds, Power Grid Corporation of India Limited).

I am greatly indebted to Prof. Vinay Dutta (Chairperson, Finance, FORE School of Management),
Prof. Kanhaiya Singh (Sr. Faculty, Finance, FORE School of Management) and Prof. Himanshu Joshi
(Faculty, Finance, FORE School of Management) for their invaluable guidance and direction provided
to me in the course of the study.

A special word of thanks to Prof. Nalin Jain (Faculty, Marketing, FORE School of Management), who
has been a constant support and guided me in the report.

I also wish to express my gratitude and gratefulness towards Mr. Ranjan Srivastav (AGM- Finance,
Power Grid Corporation of India Limited), Mr. V.C. Jagannathan (Executive Director-Finance, Power
Grid Corporation of India Limited) and also Mr. Venkat Krishna (Vice President, ICICI Securities
Primary Dealership Ltd)

Date: 12 May 2010

Place: New Delhi

Madhusudan Partani

9


Chapter I
INTRODUCTION

 Introduction
 Purpose of Study
 Objectives
 Scope
 Data
 Review of Literature
 Introduction to Bond Market

10


Introduction

The project done with the Power Grid Corporation of India Limited in their Finance department,
Bonds Section, is a study on Cost and Benefit analysis of Fixed and Floating rate bonds. Intrest
payment under both the methods is computed for bonds with different characteristics (Maturity,
Coupon rate and Amount). Recommendation has been made on suitability of each method under
different conditions.

Also the Valuation and Convexity measures like Duration, Yield, Convexity have also been computed
for all the Bonds issued by Power Grid Corporation of India Limited and also few GSec Bonds and
other corporation bonds.

Also The Securities Exchange Board of India (SEBI), the regulator of Capital Markets, has made wide
array of policies and guidelines with respect to issue of bonds. Thus it is per se necessary to study
the procedural aspects of issuing bonds, the legal aspects and also the provisions and guidelines. The
scope of the study is extended to Debt-Servicing Process, listing process and dematerialisation
process. And Analysis of Financial statements using different tools like Horizontal analysis of Income
and Position Statement, Cash Flow Analysis, Ratio Analysis has been done.

Apart from the above mentioned aspects, the behaviour of GSec Yields, Comparison of interest rates
on bonds issued by Power Grid Corporation of India Limited with the Government Yield has also
been done.

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Objectives
The Objectives of study are as follows:

 Comparison of Cost of each bond in case of present system of fixed coupon rate with
Floating Coupon rate. And to study the suitability of each method for different kinds of
bonds having different maturity, different coupon rate and different loan quantum.
 To study the Characteristics in terms of Macaulay’s Duration, Convexity, and YTM; of each
bond issued by PGCIL and also to compare the same with other GSec Bonds and other
corporate bonds.
 To study and understand the procedural aspects of issuing the bonds, their listing, debt
servicing and dematerialisation.
 Financial Performance Analysis of Power Grid Corporation of India Limited using different
techniques like Ratio Analysis, Cash Flow Analysis, Balance sheet and Profit and Loss
Analysis.

The secondary Objectives will be:

 To study the behaviour of yields on 10 Year and 1 Year GSec papers
 To Understand the Power sector and the value chain of the industry.

12


Purpose of Study

Bonds have become one of the important sources for long term funds in the present scenario. The
central government, the state government, PSUs, Banks, and also Corporate issue bonds regularly to
raise long term funds. Along with the Primary Issues, the trading in Exchanges has also improved
rapidly. The average trade size has increase from Rs.6.64 Crores in 1994-95 to Rs.23.42 Crs in the
year 2009-10. Thus it is per se necessary to study the Bond market and also understand the growing
importance of Bonds as the source of long term finance.

It is by itself very indispensable to study the financial condition of the company, its financial strength
in terms of profitability, solvency, liquidity etc... To understand the company. Thus Financial
Statement Analysis has been done and study of Balance Sheet, profit and loss, Sources and
applications of funds, Cash flow analysis and also ratio analysis has been done.

As mentioned before, the Bonds have become one of the favoured preferences for the long term
funds. And Power Grid Corporation of India Limited issues Bonds periodically, thus to study the
Bonds and understand the mechanism, it was a necessity to understand the procedural aspects and
legal aspects of issuing the bonds. Thus a detailed study of each and every aspect of issue of bond
ranging from Approval, Listing, Dematerialisation, to Debt Servicing has been studied.

The bond market is not only flooded from supply side, but also there is a rapid growth on demand
side by many fresh players entering the market. The investors in Bonds include Banks, Insurance
companies, Mutual Funds, Provident Funds, Pension Funds and other such funds o different
companies. Thus it is necessary to study the characteristics of the bond and compute their Yields,
Duration, and Sensitivity by means of Convexity. And since there are different kinds of bonds issued
by different bodies, the comparison amongst them is also necessary.

The Power Grid Corporation of India Limited’s Debt structure has changed substantially over the
years. From 35% Unsecured Loans and 13% Secured loans in the total Capital Mix in the year 1996-
97, the composition has changed to 7% Unsecured and 58% Secured loans in the year 2009-10. And
of these 58%, approx 38% is comprised of Secured Bonds. As on 31st march 2010, the company has
Bonds outstanding worth Rs.21420.4 Crs and on these a total Intrest of Rs 1500 Crs is paid annually.
And the interest rate paid is fixed. In simple words the interest rate determined at the time of issue
is kept fixed throughout the tenure of the bond irrespective of the market condition. Alternatively
the company could even go for floating rate Bonds whose interest rate is floating i.e... Varies with
the market conditions. Thus a study has been done to compute the savings in cost under floating
rate mechanism. But since the regulations do not allow the company to take risk of fluctuations in
interest rates, and also in this competitive scenario, cost saving has became one of the most
important tool. Thus instead of floating rate, if the company issues the bonds at an appropriate and
at favourable time period, which lead to low coupon rate and ultimately cost savings has been also
studied.

13


Scope

For the purpose of comparing the cost under fixed and floating Rate five bonds issued by Power Grid
Corporation of India Limited with different tenures, different repayment structure, different coupon
rates and different loan amounts were taken. And the Intrest on them under both the methods has
been computed from the date of issue to the latest Intrest payment has been computed taking
different spreads and different reference rates as per the Industry practices.

And for studying the duration, Yields and Sensitivity of the Bonds, all the Bonds issued by Power Grid
Corporation of India Limited and which are active are selected. Along with these Two GSec bonds
and bond series (S-57) issued by Power Finance Corporation has been selected.

For studying the procedural aspects, the steps of the issue, Dematerialisation, Rating, Listing etc
have been studied by referring to the process of issue of Power Grid Bonds XXX issued on 29 th
September 2009.

And for the financial performance analysis, specific study has been done based on the financial
figures of the financial year 2008-09. The scope was not extended to the latest FY 2009-10 because
the audited results were not yet published till the preparation of this report. And for studying the
trend and growth, the figures of last 8 years starting from 2003 has been selected.

14


Data

For the purpose of study the data has been collected from the Company’s Balance Sheets, The
details of Loans and Intrest payments schedules as provided from the internal records of the
company and also different correspondence letters, approval letters, legal documents as provided by
the company were used.

For historical yields on GSec Papers the data has been collected from Reuters Database1. And for
determining the spread for the purpose of deciding the floating rate, the data on spreads as
published by FIMMDA2 has been used. And also data published by RBI related to GSec and also the
Data from Indiastat has been used. For computing the Duration, Yields and Convexity, the present
value has been taken from the NSE websites WDM (Wholesale Debt Segment).

1
A premium Database which provides the data on Global Macro Economic Indicators
2
Fixed Income Money Market and Derivatives Association of India

15


Review of Literature

For the purpose of understanding the concepts and having the thorough knowledge of Bonds and
also to have background knowledge of topics like Floating rate, to understand the valuation concepts
of bonds, the procedural aspects, different articles, papers, reports and other literature has been
studied. Some of the literature is:

WHAT PRACTITIONERS NEED TO KNOW .....? ABOUT DURATION AND CONVEXITY

Mark Kritzman, Windham Capital Management
Financial Analysts Journal (Nov-Dec 1992)

The paper is on Duration and Convexity of Bonds. It has the concept of Macaulay’s Duration and the
author has explained why the time weighted PVs of future cash flows are to be considered instead of
just PVs. The author has also extended the scope of paper by discussing the property of Duration
that with constant YTM and Coupon Payments, the increase in Maturity will increase duration but
the rate of increase is lower.

Modified Duration, which measures sensitivity of price of bond to the changes in yield, does not
accurately predict the sensitivity for the larger changes in YTM. Thus he proposes to use Convexity as
measure of sensitivity. Convexity measures sensitivity of price of bond to the change in Duration.

Apart from the concept of Convexity and Duration, the author has also explained the application of
these measures in Portfolio management. How they can be used to leverage the price appreciation
in case of fall in rates by increasing the duration of the portfolio. Also how it can be used in hedging
the liabilities. The author has also shared how the portfolio can be immunized from interest rate
shifts by setting its duration equal to the investors’ holding g period.

In a nutshell, the paper introduces one to Duration and other valuation techniques and also it shows
the applicability of each. From this literature I am able to understand the concepts of Macaulay’s
Duration, Modified Duration, and Convexity and also their computation and inferences.

A “DURATION” FALLACY

Miles Livingston and John Caks
The Journal of Finance (Vol XXXII No.1 March 1977)

As the title of the paper itself portrays that content is related to a fallacy in general opinion on
Duration. The authors wish to prove that duration is a function of the yield curve but the yield curve
is not the function of duration. Thus one cannot ‘correct the yield curve for the duration’ because
bonds with identical duration do not necessarily have identical yields. They have proved this by
comparing and analysing the two bonds of similar duration.

Also they have concluded that that if bonds with identical durations always have identical yields to
maturity, then the entire term structure of interest rates is determined by the first two rates; given

16

r1 and r2, we can calculate r3 and then (recursively) all subsequent forward rates. This result
contradicts experience and the theoretical work done on term structure.

‘POWER SECTOR IN INDIA’

WHITE PAPER ON IMPLEMENTATION CHALLENGES AND OPPORTUNITIES
KPMG (Jan 2010)

It is an annual report on Power Sector published by KPMG. This paper throws light on Industry
overview, the value chain, and the different players in each business operation namely generation,
transmition and distribution. The paper also discusses the regulations in this sector which are paving
the way for private sector participation.

Also the challenges in this sector which needs to be tackled are also discussed. Some of the
prominent challenges are the Project Execution, The scarcity of fuel, Equipment shortage,
Manpower Shortage, problems in land acquisition and Environment clearance.

This paper helps in understanding the power sector in general, and its structure. And also the
challenges in that sector can be understood.

SEBI (DISCLOSURES AND INVESTORS PROTECTION) GUIDELINES, 2000

Securities Exchange Board of India, the sole regulator of Capital market in India, issues various
guidelines to regulate the capital market of the nation. The DIP Guidelines were issued for the
purpose of protecting investors from fraudulent practices by issuers and also to ensure maximum
disclosure.

It has guidelines with respect to Offer letter, its contents, the promoters share, lock-in period,
requirements for issuing IPOs, Guidelines on Advertising of issue, guidelines on Pricing of issue etc...

The copy of the above mentioned guidelines has many regulations which are not under purview of
my study. Thus only few aspects were studied. The review of them is as follows:

The objectives of these guidelines are:

i. Enhance level of protection of investors
ii. To increase transparency and efficiency of primary market
iii. To strengthen disclosure and eligibility norms of the issuer
iv. Rationalize and simplify operational procedures in primary market.

The guidelines on Book building process, Green Shoe Option, Disclosure requirement in the offer
document and guidelines pertaining to issue of Debentures were studied to have foreground
knowledge of various guidelines.

17

INFORMATION MEMORANDUMS

Then Information Memorandum or Disclosure Document is similar to an invitation letter to the
investors, inviting them to invest in the issue. As per SEBI, this offer document must have all the
details as mentioned by it and which are important and material for investor. Thus it has the
company profile, the challenges and strengths, the financial history, latest financial data, share
holding pattern, details of previous issues of similar security etc... It also has the details of the issue,
the structure of issue, details on Open and close of issue, the details Arrangers, bankers, Registrar,
Trustee etc

By studying this document one can understand the company profile and its financial position in a
gist. Also every minute detail of a particular issue like the interest payment, the terms and
conditions, redemption details, listing details can be understood from this document.

For the purpose of understanding the issue structure and coupon rate determination, IMs of various
bonds of Power Grid Corporation of India Limited have been studied.

Also to understand the Intrest rate determination under Floating rate mechanism and the terms
under that mechanism, the IMs of previous issues of FRBs by firms including Power Finance
Corporation, Railway Finance Corporation Limited, ICICI Bank, IDBI Bank, and Kotak Mahindra etc...
were studied.

WORKING MANUAL FOR DOMESTIC RESOURCE PLANNING AND MOBILISATION
IN P OWER GRID

The Power Grid Corporation of India Limited for its internal policies has a manual on Resources
rising. The document has the policies as defined by its Articles of Association and as vested by Board
with related to Borrowing power, the authority, accountability for activities related to resource rising
(including Term loans and Bonds).

The document also has the procedure of rising funds through Bonds and also through term loan
from banks, the Debt Servicing, the book building process, conversion of bonds from Physical to
Demat, statutory compliance etc.

It also has the formats of each letter to be sent to various parties like Registrar, Arranger, Investor,
Stock Exchange, Depository etc... The guidelines by SEBI and the copy of internal guidelines are also
included.

Thus overview of fund raising process along with legal and procedural aspects can be understood
from this document.

18


Introduction

The debt market is much more popular than the equity markets in most parts of the world. In India
the reverse has been true. Nevertheless, the Indian debt market has transformed itself into a much
more vibrant trading field for debt instruments from the rudimentary market about a decade ago.

The sections below encompass the transformation of government and corporate debt markets in
India along with a comparison of the developments in equity market.

Developments in Government Bond Market

Prior to 1992, money was collected and lent according to Plan. Lacunae in institutional infrastructure
and inefficient market practices characterized the government securities market. In fact the sole
objective pursued was to keep the cost of government borrowing as low as possible. If planning
went awry, the government sent word to its banker. The central bank made a few phone calls to the
heads of banks and bonds were issued and the money arranged. No questions asked, no
explanations given. The GOI bond market did not use trading on an exchange. It featured bilateral
negotiation between dealers. The market thus lacked price-time priority and the bilateral
transactions imposed counterparty credit risk on participants. This narrowed down the market into a
“club” with homogeneous credit risk. This was the state of the government debt market in India ten
years ago.

The major thrust of Financial Reforms commenced in 1992. This was when the contours of the debt
market began taking shape. The idea of the financial reform movement was to have more and more
different markets and not necessarily have whole financial intermediation left to the banks. The
reform process attempted at doing away with regulations in favour of controls based on market
forces i.e. an era where the interest rates are governed more by the market forces of demand and
supply and less by centralized supervision. Slowly, but steadily, the market grew, adding fresh
players and novel instruments. Several measures have added greater transparency and have brought
the issuances closer to the market levels.

The major reforms that took place in the 1990’s were:

• Introduction of the auction system for sale of dated government securities in June1992. This
signalled the end of the era of administered interest rates.

• The RBI moved to computerize the SGL and implement a form of a ‘delivery versus payment’ (DvP)
system. The DvP enabled mitigating of settlement risk in securities and ensured the smoothness of
settlement by synchronizing the payment and delivery of securities.

• Innovative products in form of Zero Coupon Bonds and Capital Indexed Bonds (Ex. Inflation Linked)
were issued to attract a wider gamut of investors. However, the pace of innovation suffered due to
non-sophistication of the markets and lack of persistence with some of the new bonds like Inflation
Indexed bonds after the initial lukewarm response.

19

• The system of Primary Dealers was established in March 1995. These primary dealers have since
then acquired a large chunk of share in the GOI bond market and have played the role of market
makers.

• The RBI setup “trade for trade” regime, a strong regulatory system which required that every trade
must be settled with funds and bonds. All forms of netting were prohibited.

• Wholesale Debt Market (WDM) segment was set up at NSE; a limited degree of transparency came
about through the WDM at NSE, where roughly half the trading volume of India’s GOI bond market
is reported.

• The Ways And Means agreement put an end to issuance of ad hoc treasury bills, the government’s
favourite instrument of funding its profligacy.

• Interest Income in G-Secs was exempted from the purview of TDS.

• FIIs with 100% Debt Schemes were allowed to invest in GOI Securities and T-Bills while other FIIs
were allowed 30% investment in these instruments.

• Dematerialised forms of securities in G-Secs were done through the SGL and Constituents SGL
accounts.

The above-mentioned measures have served in bringing about greater market orientation of the
sovereign issues. This is particularly important as the sovereign borrowing parameters have a direct
bearing on the cost of capital for other non-sovereign issuers. The Primary market for G-Secs
registered an almost ten-fold increase between 1990-91 and 1998-99. The broadening of the market
was also apparent from the fact that RBI’s participation, as reflected by absorption of primary issues,
came down from 45.90% in 1992-93 to 0.74% in 1994-95.

Though significant improvements have been made in the primary market, the secondary market
continued to be plagued by certain shortcomings like dominance of a few players (acted as a
deterrent to lending width in the market), strategy of holding to maturity by leading players
(prevented the improvement in the depth of the market), the pre-1992 “telephone market”
continued to exist (prevents information dissemination and hence price discovery is limited) and low
retail participation in G-Secs continues to exist even today. Experts believe that there is tremendous
potential for widening the investor base for Government securities among retail investors. This
requires a two-pronged approach, increasing their awareness about Government securities as
adoption for investment and improving liquidity in the secondary market that will provide them with
an exit route. Also infrastructure is seen as the vital element in the further development and
deepening of the market.

Corporate Bond Market

In the last decade, market related borrowings by the corporate sector have remained depressed as a
plethora of Financial Institutions were available for disbursal of credit. These Institutions managed to
mobilize a significant amount of domestic savings and route them for corporate consumption.

20

Also the reforms abolished the office of the Controller of Capital Issues (CCI), which meant that
companies were free to price their equity issues as per the market appetite. This led to a slew of
primary issue of equity and the relative attractiveness of issue of debt yielded way to equities. In
fact, even debt issues were made with attached sweeteners like convertible portion of the fixed
income instrument. In addition, several relaxations in regulations post 1992 have encouraged Indian
corporate to raise debt from overseas capital markets leading to further shunning of the domestic
debt market by creditworthy issuers. Therefore, the corporate debt market in India has continued to
be dominated by the PSU’s.

In the recent past, the corporate debt market has seen high growth of innovative asset-backed
securities. The servicing of debt and related obligations for such instruments is backed by some sort
of financial assets and/or credit support from a third party. Over the years greater innovation has
been witnessed in the corporate bond issuances, like floating rate instruments, zero coupon bonds,
convertible bonds, callable (put-able) bonds and step-redemption bonds. For example, step bonds
issued by ICICI in 1998, paid progressively higher rates of interest as the maturity approached while
the IDBI’s step bond was issued with a feature to pay out the redemption amount in instalments
after an initial holding period. The deep discount bond issued by IDBI in the same year had two put
and call options before maturity.

What these innovative issues have done is that they have provided a gamut of securities that caters
to wider segment of investors in terms of maintaining a desirable risk-return balance. Over the last
five years, corporate issuers have shown a distinct preference for private placements over public
issues. This has further cramped the liquidity in the market. While private placement has grown 6.23
times to Rs. 62461.80 crores in 2000-2001 since 1995-96, the corresponding increase in public issues
of debt has been merely 40.95 percent from the 1995-96 levels.

The dominance of private placement in total issuances is attributable to a number of factors. First,
the lengthy issuance procedure for public issues, in particular, the information disclosure
requirements, provide a strong incentive for eligible entities to opt for the private placement route.
Secondly, the costs of a public issue are considerably higher than those for a private placement.
Thirdly, the amounts that can be raised through private placements are typically larger than those
that can be garnered through a public issue. Also, a corporate can expect to raise debt from the
market at finer rates than the prime-lending rate of banks and financial institutions only with an AAA
rated paper. This limits the number of entities that would find it profitable to enter the market
directly.

Thus the public issues market has over the years been dominated by financial institutions, which is
exemplified by the fact that ICICI and IDBI accounted for the entire debt offerings in 1998–99 and all
but one issue in 1999–2000. Another interesting fact is that in spite of dominating the public issues
market even financial institutions have raised significantly larger amounts through the private
placement route.

Further the secondary market for non-sovereign debt, especially corporate paper remains plagued
by inefficiencies. The primary problem is the total lack of market making in these securities, which
consequently lead to extremely poor liquidity. The biggest investors in this segment of the market,

21

namely LIC, GIC and UTI prefer to hold the instruments to maturity, thereby truncating the supply of
paper in the market.

The secondary market for corporate did receive a boost with the waiver on stamp duty payment on
transfer of debt securities, as long as they are dematerialized debentures, in the Finance Bill 2000.

Development of Equity Market vs. the Debt Market

During this decade of financial reforms development in equity market has been striking as compared
to relatively minor changes in the debt market. In terms of sheer market size, the equity market saw
a drop from 42% of GDP in 1993–94 to 28.6% of GDP in 2000-01. Over the same period, the GOI
bond market saw an increase in market size, fuelled by large fiscal deficits, from 28% of GDP in
1993–94 to 36.7% of GDP in 2000–01. Other things being equal, this should have generated an
improvement in liquidity of the GOI bond market and a reduction in liquidity in the equity market.
Instead, changes in market design on the equity market over this period gave the opposite outcome,
where the improvement in liquidity on the equity market was superior to that observed on the GOI
bond market. The reasons for this have been manifold:

• Foreign capital inflows into the GOI bond market are relatively undesirable to policy-makers. This is
in contrast with capital inflows into the equity market, where policy-makers seek to have the largest
possible capital inflows. Hence, infirmities in the market design on the GOI bond market do not
generate an important opportunity cost as far as harnessing foreign capital inflows are concerned.

• In the presence of “development finance institutions” and banks, firms in India are seen as having
access to debt financing, access to debt finance was therefore not seen as a major bottleneck
hindering investment. Hence, the lack of a liquid bond market was not keenly seen as a constraint in
investment and growth.

• In the case of the GOI bond market, the benefits from a non-transparent market with entry
barriers accrue primarily to banks and PDs. The PDs are largely the creation of RBI and public sector
banks have extremely close ties with RBI. The RBI is the regulator for G-Secs market.

Thus the development of equity markets took precedence over development of debt market in India
but the future does seem promising for the debt market.

The Bond market has been growing popularity over the years. This can be seen from the following
chart depicting the average trade value in Wholesale Debt Segment

22


Average Trade Size- WDM Segment
35.00

30.00

25.00
Rs. Crores

20.00

15.00

10.00

5.00

0.00

Jun-04
Jun-94

Jun-96

Jun-98

Jun-00

Jun-02

Jun-06

Jun-08
Oct-95

Oct-97

Oct-99

Oct-01

Oct-03

Oct-05

Oct-07

Oct-09
Feb 99
Feb-95

Feb-97

Feb-01

Feb-03

Feb-05

Feb-07

Feb-09
Figure 1 Trend of Average Trade Size - WDM

From the above trend chart, the tremendous growth of trade in Debt segment can be clearly
demonstrated. The average trade size i.e. Value of each trade has increased from a meagre amount
of Rs. 30 Lacs in the June 1994 to Rs 7.24 Crores in June 2004 to 29.94 in March 2010. There has
been a multi fold

23


Chapter II
Financial Statement
Analysis

 Balance Sheet Analysis
 Profit and Loss Analysis
 Cash Flow Analysis
 Ratio Analysis

24


Financial Statements Analysis
To understand the performance of a concern and to forecast its financial position and financial
strength it is per se necessary to analyse its financial statements. Though a firm makes huge profits
but faces liquidity concerns and though a firm is poor profitability compared to others but yet is
rated as financially strong firm. Thus to comment on ones financial position and financial
performance, it is not possible to comment based on one parameter. Different parameters like
profits, activity, leverage, liquidity, Investments, turnovers, returns, ratios etc is to be analysed.

Different financial statements that can be analysed are Balance Sheet (Position Statement), Profit
and Loss Account (Performance Statement), Cash Flow Statement, Funds flow statement, Apart from
these there are some non-financial reports which are also part of Annual report of a company, and
they are Directors report, Industry Analysis, Auditors report, Third party disclosures, etc..

Some of the popular tools used for the effective analysis of the financial statements are

 Multi-Step Analysis ( Balance Sheet, Profit and Loss and Cash Flows)
 Common Size Analysis
 Comparative Analysis ( Over the years or with Peers)
 Index
 Trend Analysis
 Ratio Analysis

25


Balance Sheet Analysis

Balance Sheet is one of the most important sources for analysing the financial position of any
company. Some of the very important aspects that can be analysed using the Multi Step Analysis of
the Balance Sheet are Capital Composition, Sources and Application of Funds, Trends in Shareholding
Patterns, Trend of Self and Borrowed Funds. Composition of Loans, Trends in fixed assets, analysis of
Working capital etc....

Capital Composition
Capital is one of the import and prime source of funds. It is a long term source and comprises of
Shareholders Capital (L1), Reserves (L2), Secured loans (L3) and Unsecured loans (L4).

From the flowing stacked area chart and also from the table following things can be interpreted:

 The proportion of Share Capital in total capital is reducing every year. This implies the firm is
going on leveraging itself and trading on equity. It also implies the firm is not using its equity
route but either reinvesting the profits or borrowing loans. In the year 2007 though 10%
fresh equity was issued to the public by the route of IPO the proportion has reduced
because of continuous borrowings as Secured Debentures and Loans. The contribution has
reduced from 35 % in 1996 to just 9% in 2009.
 The Reserves and Surplus which includes the reinvestment of profits as retained earnings
has been increasing from 16% to 25%. This implies firm is in the path of expansion and
instead of distributing the earnings in form of dividends to the shareholders it is retaining
and ploughing back the profits in the business.
 There has been an exponential increase in the secured Loans which comprises of
Debentures, Loans from Banks and Loans from Institutions. The company to fulfil its Cap-Ex
requirements has a practice of issuing Secured Non Convertible Redeemable Debentures.
Also it takes term loans from banks and Loans from Multi-Lateral agencies like World Bank
and Asian Development Bank. The share of this source has increased from 13% to as high as
58%. But since the firm has security backed with these loans, it is most preferred by the
investors. But over the years in the same trend continues, there may be liquidity concerns
and also solvency issues. And a high financial risk is also attached with the loans as they
demand regular payment of interest and principal no matter if the financial performance is
good or bad. Default in payment impacts the rating and impairs borrowing ability.
 The Loans from Unsecured Borrowings is regarded as the most risky source as there is no
security backed for it and also the interest rates are very high due to high risk. The
Unsecured loans have been on fall over the years. There has been a rise in the years 2001
and 2006 due to unexpected borrowing needs. But over the years the company is trying to
repay its unsecured loans which are very costly.
 Overall the Capital Structure of the firm is changing over the years, from a less leveraged
firm of (D/E) less than 1; it has reached to leveraged ratio of 1.92. And also the proportion of
Secured loans has been on a rise to compensate the fall in equity and unsecured loans
contribution. But analysis of Absolute amounts of each source and also analysis of self and
borrowed funds need to be done for better understanding.

26


Capital Composition
100%
14.34% 11.69% 9.72%
17.82% 14.62%
90% 22.06%
27.69%
80% 24.56%
35.31% 26.50%
26.28% 25.53%
70% 23.78%
22.08%
18.54%
60%
16.03%
50% 58.38%
40% 13.33% 23.45% 27.17% 32.14% 36.55% 41.64% 48.73%
30%

20%
30.32% 28.68% 26.25%
10% 35.33% 22.55% 18.49%
13.08% 7.34%
0%
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Unsecured Loans Secured Loans Reserves Total Share Capital

Figure 2 Capital Composition from 1996 to 2009

Share Reserves Secured Unsecured
Capital Total Loans Loans

1996 35.31% 16.03% 13.33% 35.33%
1997 30.92% 17.45% 19.51% 32.12%
1998 27.69% 18.54% 23.45% 30.32%
1999 24.55% 19.83% 25.09% 30.52%
2000 22.06% 22.08% 27.17% 28.68%
2001 20.00% 24.53% 23.25% 32.23%
2002 17.82% 23.78% 32.14% 26.25%
2003 15.83% 24.48% 34.59% 25.10%
2004 14.62% 26.28% 36.55% 22.55%
2005 14.14% 26.04% 40.01% 19.81%
2006 14.34% 25.53% 41.64% 18.49%
2007 12.52% 23.60% 43.15% 20.73%
2008 11.69% 26.50% 48.73% 13.08%
2009 9.72% 24.56% 58.38% 7.34%
Table 1 Capital Composition from 1996 to 2009

27


Sources and Application of Funds

Every firm has different sources of funds like share capital, reserves, Loans, Debentures, Current
liability, public borrowings etc... And the funds are borrowed for some specific applications like fixed
assets, Investments, Current Assets etc... An analysis of the sources is to be done for the purpose of
assessing the costs and also the applications to analyse the profitability. It is necessary to invest the
funds in profitable resources to earn good Return on Investment and fulfil the expectations of the
stake holders. Following pie-charts show the sources of funds and applications of the same for the
year 2008-09.

Total Current
Sources of Funds- 2008-09
Liabilities Term Loans
19% (Institutions)
1%
Term Loans (Banks)
Unsecured Loans Non Convertible 1%
6% Debentures
Secured 28%
Loans Deferred Credit
47% 17%
Reserves and Surplus
20%

Share Capital Reserves and Surplus Unsecured Loans
Total Current Liabilities Non Convertible Debentures Term Loans (Institutions)

Share Capital
8%

Figure 3 Sources of Funds- 2008-09

From the above chart on Sources of Funds, following interpretations can be made:

 The company has just 28% of the sources as shareholders Funds (Non borrowed funds) this
implies the firm is highly leveraged. But seeing the nature of the business of the firm which is
into power transmission and with many projects regularly under implementation, it faces
high capital requirement. Thus it depends on the borrowed funds.
 As mentioned earlier, the firm is a high growth firm thus has just 19% from Short term
sources like suppliers credit and customers advance.
 Highest is being contributed by Secured Loans which has Non Convertible Debentures,
Deferred Credit and Term Loans.
 The firm prefers to raise loan by issuing the Non Convertible Debentures because it has less
interest rate than term loans and are the availability of Option of moratorium period which
matches with the gestation period of the projects.

28

 Unsecured loans which are very costly due to high rates of interest when compared to
secured loans are just 6%.
 The firm in the year 2009 has funds of Rs. 53787.32 Crores.

Applications of Funds- 2008-09
Total Current
Assets
Investments 15%
3% Net Block
Capital Work in Progress
Capital
Net Block
Work in Investments
57%
Progress Total Current Assets
25%

Figure 4 Applications of Funds- 2008-09

The application of funds implies the avenues where the investment is made to earn the revenue and
to carry on the activities as per the objectives of the business.

 Being a capital intensive firm, the 57% of the funds are invested in Net Block i.e... Fixed
assets like Transmission Grids, transmitters etc...
 As high as 25% of the resources are invested in Capital WIP (Work in progress), this signifies
that the company is in the path of expansion and is undertaking the projects. The Capital
WIP implies the funds given as advance to the contractors, the Under Construction buildings
and plants, etc...
 Just 3% of the funds are into Investment and 15% in current assets. We can infer that either
the firm has operational excellence in Working capital management or since it is Under
Expansion stage the investment in short term assets is low.

From the Sources and Applications it can be analysed that 15% of short term Assets (CA) is wholly
financed by the Current liabilities which is 19%. This implies the firm is matching its short term
requirements with short term sources. This may be termed as aggressive strategy because the
Permanent and temporary working capital is being financed by the short term funds.

29

Share Capital
After analysing the various sources and Applications of funds, it is now necessary to analyse the
trend in each component of the sources and application over the years. The share capital has been
increasing over the years; this is because of the companies borrowing from Government of India by
allotting the shares. Pre-Listing i.e... Before 2007, the company used to allotment shares for this
purpose. In the year 2008, there has been rise in shares allotted because of Initial Public Offer on
26th September 2007. Under the plan of Disinvestment of Public Undertakings, 10% of fresh shares
and 5% of government of India’s holding was issued to the public. In the year 2008 to 2009, the
number of shares and the share capital is constant implying no further issue of share capital is made.
However there is news of further disinvestment through FPO in the year 2010, so there may be
change in share capital in the year 2010-11.

Share Capital
4,500.00
4,000.00
3,500.00
3,000.00
2,500.00
2,000.00 Share Capital
1,500.00
1,000.00
500.00
0.00
2003 2004 2005 2006 2007 2008 2009

Figure 5 Trend in Share Capital

Share Holding Pattern

Not only the share capital but also the holding pattern of the same shall be studied. Since Power
Grid Corporation is one of the Public Undertaking, the maximum holding is with the Government of
India. Only after September 2007, i.e... After the Disinvestment, the holding pattern was diluted. The
holding reduced to 86.37%. Through the issue, the Government of India (promoter) sold its 5% stake
and also fresh equity of 10% of the total share capital was issued. As on 31 st of December 2009,
Institutional and Non Institutional investors have almost equal contribution of 7%.

30


Share Holding Pattern as on 31st Dec 2009
Non Promoter
(Institution) Non Promoter (Non-
7% Institution)
7%

Government(Central / State)
Non Promoter (Institution)
Government(Central Non Promoter (Non-Institution)
/ State)
86%

Figure 6 Share Holding Pattern as on 31st Dec 2009

Share Holders 31-12- 31-03- 31-03- 19-04-
2009 2009 2008 2007
Government(Central / State) 86.37% 86.37% 86.37% 100.00%
Individuals / Hindu Undivided Family 0.00% 0.00% 0.00% 0.00%
Financial Institutions / Banks 1.13% 0.66% 0.37% 0.00%
Foreign Institutional Investors 1.62% 2.58% 2.89% 0.00%
Insurance Companies 3.68% 2.37% 0.97% 0.00%
Mutual Funds / UTI 0.66% 0.79% 0.65% 0.00%
Bodies Corporate 1.65% 1.69% 1.93% 0.00%
Individuals (up to Rs. 1 lakh) 4.17% 5.10% 6.10% 0.00%
Others 0.73% 0.45% 0.72% 0.00%
Table 2 Share Holding Pattern from 2007 to 2009

Share Holding Pattern
Government(Central /
State)
Financial Institutions /
Banks
Foreign Institutional
31-12-2009 Investors
Insurance Companies
31-03-2009
31-03-2008
Individuals holding upto
19-04-2007
Rs. 1 lakh

Figure 7 Share Holding Pattern

31

Name of Share Holder No. Of Shares (%)
( of Rs. 10 each)
President Of India ( Ministry of Power) 3533637935 83.96%
President Of India ( Ministry Of Development Of North East 101269800 2.41%
Region)
Life Insurance 60342943 1.43%
Corporation Of India
LIC Of India - Market Plus 48942430 1.16%
LIC Of India Money Plus 38713829 0.92%
Janus Contrarian Fund 32210129 0.77%
LIC Of India Market Plus – 1 23728370 0.56%
ICICI Prudential Life 20647334 0.49%
Insurance Company Ltd.
Life Insurance 8105330 0.19%
Corporation Of India Profit Plus
HDFC Standard Life 5950579 0.14%
Insurance Company Limited
Total 3873548679 92.03%
3
Table 3 Top 10 Share Holders as on 29.01.2009

Some of the supposition that can be made analysing the holding pattern over the years and the Top
ten shareholders is:

 The holding of promoter (Government) has reduced to 86.37% post IPO. But after that the
holding is constant implying no further dilution or no further issue has been made.
 Over the years the holding of Individuals holding up to Rs. 1 lakh (i.e... Retail Investors) is
falling
 Holding of Insurance Companies is increasing over the years, which implies that the
company is attracting that kind of clients.
 Also the holdings by FIIs are on the fall and are compensated by holdings of Financial
Institutions which is increasing.
 From the list of Top 10 shareholders and the proportion of their holdings, it can be very
clearly observed that the holding is very much skewed.
 92% of total share capital is held by the top 10 shareholders. Thus the Ownership and
control is under few hands.

Brief note on Initial Public Offering
The corporation has come up with Initial Public Offer in the month September, 2007 with an issue
size up to573, 932,895 equity shares of Rs. 10 each for cash at a price of Rs. 52 per equity share
aggregating Rs. 2985crores. The issue comprised a fresh issue of up to 382,621,930 equity shares
and an offer for sale of up to191,310,965 equity shares by the President of India acting through the
Ministry of Power, Government of India. The issue comprised a net issue to the public of up to
559,954,895 equity shares and a reservation of up to 13,978,000 equity shares for subscription by
employees at the issue price. The issue comprised approximately 13.64% of the fully diluted post-
issue capital of POWERGRID.

3
Source: Final Disclosure Document for XXXI issue of Bonds of Power Grid (www.nseindia.com)

32

Reserves

Reserves and Surplus
12000
10000
8000
6000
4000 Reserves Total

2000
0

Figure 8Trend in Reserves and Surplus

The Reserves in the form of General reserve, Capital Reserve, Share Premium, Debenture
Redemption reserve and Profit and Loss Account’s Credit balance are maintained. There has been
continuous increase in the reserves over the years. In the year 2008, the steep increase is
attributable to the share premium account started after the IPO. The shares were issued at a
premium of Rs. 42 per share. Overall, the company is able to retain the earnings and ploughing back
them to fund the capital expansion plans.

Secured Loans

The secured loans in specific to Power Grid Corporation of India Limited comprises of Debentures,
Loans from banks like Indian Overseas Bank, Corporation Bank, Punjab National Bank; Loans from
Institutes like Asian Development Bank, and World Bank (IBRD) and Deferred Credit.

Non Convertible Debentures
20000
15000
10000
5000
0

Non Convertible Debentures

Figure 9 Trend in Non Convertible Debentures

33


Term Loans Institutions
1000
800
600
400
200
0
2004 2005 2006 2007 2008 2009

Term Loans Institutions

Figure 10 Trend in Term Loans Institutions

Term Loans Banks
1000

500

0
2004 2005 2006 2007 2008 2009

Term Loans Banks

Figure 11 Trend in Term Loans Banks

Deferred Credit / Hire Purchase
10000

8000

6000
Deferred Credit / Hire
4000
Purchase
2000

0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009

Figure 12 Trend in Deferred Credit

34

From the above facts and figures and the trend of growth over the years, following analysis can be
made:

 There has been a constant increase in the amount of Loan from Non Convertible
debentures. From a mere amount of Rs. 1139 Crores in the year 2000-01, the amount has
exponentially increased to Rs. 15112 Crores in the year 2009-10.
 Usually the firm issues Non Convertible, Secured, Taxable, and Redeemable Bonds with a
rating of AAA/ LAAA which implies the most secured investment being issued by the credit
rating agencies like CRISIL, CARE and ICRA. Due to the security, and Ratings, the firm is able
to attract funds at a lower rate than compared to the rate being paid in case of term loans.
 At present as on 31st March 2010, the firm has issued 32 series of bonds and 26 Bonds are
active and interest is being paid on them.
 The Term Loans from Institutions mainly has the loans from LIC at different rates. This
amount is depleting over the years as it is redeemed in equal instalments every year. And
also since they are raised at rate of 10% or high, the firm is proffering to repay the amount.
 The Term Loans from Banks include loans from banks like ICICI, PNB, and IOB etc... Over the
years the loan from this source is also on the fall. This is mainly because the firm prefers to
issue bonds as they have a moratorium period of 3-4 years and also the Intrest rates are
lower there. And in case of Term loans the rates are linked to PLR and thus there are wide
fluctuations.
 Loans in form of Deferred Credit or Hire Purchase are used to finance the Machines and
Plants purchase. Since the firm is expanding and has many projects under implementation
the machines and plants are being financed through this operation.

Unsecured Loans

Unsecured Loans
7000
6000
5000
4000
3000
Unsecured Loans
2000
1000
0

Figure 13 Trend in Unsecured Loans

35

The Unsecured loans have been in a constant range and they include Unsecured Bonds, Loans from
Institutions and Banks at a higher rate and without a security. In the year 2007, there has been a
steep increase in the secured loans because of Increase in borrowings from secured Bonds.

Debt-Composition
100%
90%
80%
70%
60%
50% Unsecured Loans
40%
30% Secured Loans
20%
10%
0%

Figure 14 Debt Composition from 2003 to 2009

From the above chart it can be very clearly commented that the composition of secured loan has
been increasing over the years. This is mainly because of issuing of secured bonds and redemption of
unsecured bonds.

Current Liability

Current Liability
12000

10000

8000

6000 Provisions

4000 Current Liabilities

2000

0
2003 2004 2005 2006 2007 2008 2009

Figure 15 Trend in Current Liability

36

One of the component of sources of Funds and which is short term in nature is Current Liability.
Some of the observations that can be made are:

 The Current Liabilities has increase from Rs. 1646 Crores in the year 2003-04 to as high as
Rs.10472 Crs in the year 2009-10.
 Also the Proportion of Provisions for deferred tax and Debtors is increasing over the year.
This is mainly because of guidelines issued by CERC (Central Electricity Regulations Code),
which has the guidelines of making provisions as per the Tariff system for its customers who
are SEBs since the financial position of SEBs is not sound.

Fixed Assets

Fixed Assets
35000
30000
25000
20000
Net Block
15000
Capital Work in Progress
10000
5000
0
2003 2004 2005 2006 2007 2008 2009

Figure 16 Trend in Fixed Assets

Some of the observations that can be made are:

 The point that the firm is under a rapid expansion stage is very clear from the trend in
growth of fixed assets.
 The Fixed assets have increased at an exponential rate. This is mainly because of the
National Grid project.
 Also the firm has many projects under implementation stage thus has a high amount in
Capital Work in progress, which include the advances to the supplier of machinery, Under
construction plants and buildings etc...

37

Investments

Investments
2500

2000

1500

1000 Investments

500

0
2003 2004 2005 2006 2007 2008 2009

Figure 17 Trend in Investments

The firm has investments of its residual surplus in the income earning instruments. But since the
CREC guidelines do not permit them to invest in different Money market instruments like
Commercial papers, Certificate of Deposits etc... It is permitted to invest only into the safest and also
secured securities like fixed deposits. And also though the amount in investments is not much
fluctuating, but this must be compared with that of fixed assets. From the following chart, it is very
clearly evident that the firm invests its surplus into fixed assets than in investments. Only the surplus
which cannot be invested into capital creation is invested in those avenues. Also though the fixed
assets proportion is exponentially increasing, the proportion of investments is constant.

Fixed Assets: Investments
45000
40000
35000
30000
25000
Fixed Assets
20000
15000 Investments
10000
5000
0
2003 2004 2005 2006 2007 2008 2009

Figure 18 Comparison of Fixed Assets and Investments

38

Current Assets

Current Assets
9000
8000
7000
6000
Loans and Advances
5000
Inventories
4000
3000 Sundry Debtors
2000 Cash and Bank
1000
0
2003 2004 2005 2006 2007 2008 2009

Figure 19 Trend in Composition of Current Assets

The short term applications of the funds are Current Assets. These are the assets which can be
converted to cash in less than a year. The current assets have been at an increase over the years.

Following analysis can be done:

 The Cash and Bank balance, which signifies the actual cash in hand of the firm, has increased
over the years. From a negligible amount of Rs. 118 Crores in the year 2003-04 the balance
has increased to Rs. 2428 Crores in the year 2009-10. This implies that the firm has good
liquidity management and holds cash in hands. But this also implies that the firms
opportunity cost of holding cash is high since the same can be invested in other avenues and
get returns.
 The Sundry debtors which were very high or the year 2003-04 have decreased over the years
and have increased in the year 2009-10. This could be due to the expansion in the
operations and also since the customers are mainly SEBs (State electricity Boards), whose
financial position is weak, thus the debtors have increased.
 Being a capital intensive firm it has very least amount of Inventories which are in form of
spares, consumables etc... The amount is very negligible compared o the other components.
 The Loans and advances have been increased. This can be because of short term loans to its
subsidiaries.
 Overall, if we compare the current assets and Current liabilities position, the firm is able to
match the current assets and current liabilities and is adopting Matching approach of
working capital management by financing the short term needs by short term sources.

39


Profit and Loss Analysis

After analysing the components of balance sheet which depicts the financial positions of the firm, it
is also per se necessary to study the financial performance of the firm. The Profit and Loss account or
the Income Statement of the firm for the financial year very truly depicts the profitability of the firm.
The aspects like Operating Income, Sales, Profits and expenses can be analysed from this statement.

Multi-Step Analysis of Incomes
30000

25000
Sales
20000
PBIDT
15000 PBIT

10000 Sales PBDT
PBIDT PBT
5000 PBIT
PBDT PAT
PBT
0 PAT
2003 2004 2005 2006 2007 2008 2009

Figure 20 Multi Step Analysis of Income

Multi Step Analysis Implies analysing each and every component of the Profits and expenses. This
helps in analysing the behaviour of different costs namely, Depreciation, Non Operating Expenses,
Financial Expenses, Taxes etc...

Some of the analyses that can be made are:

 The sales have been increasing over the year and the blue portion which depicts the
Operating Expenses; it is increasing at a variable rate with the increase in the sales.
 The PBIDT (Operating Profit) is increasing in tandem with the sales.
 The PBIT (Profit before Intrest and Taxes) is also increasing but the increase in the PBIT is
less than the increase in the sales in the year 2009 because of more than proportionate
increase in the operating expenses.
 The purple segment which represents Intrest expenses have been at a raise over the years
because of high borrowings by the firm in form of Loans and debentures. The raise is
disallowing the firm to take advantage of operating leverage. But yet the proportionate
increase in PBDT or PBT is more than that of sales.
 As discussed before the proportionate increase in PBDT (Profit before Depreciation and
Taxes) is more than the increase in Sale. This is because of the operating leverage enjoyed
by the firm due to presence of the fixed expenses in form of depreciation and Intrest.

40

 The Green proportion which corresponds to Depreciation is increasing due to continuous
additions in the fixed assets.
 The PBT (Profit before Tax) which is arrived at after deducting the Depreciation from PBDT
and the PAT (profit After Tax) which is resultant after Tax amount is deducted from the PBT
are growing at a same tandem. This implies there has been no change in the Tax rate, which
is represented by the colour Sky Blue in the above chart.

Sales/ Operating Income

Operating Income
7000

6000

5000

4000

3000 Operating Income

2000

1000

0
2003 2004 2005 2006 2007 2008 2009

Figure 21 Trend in Incomes

Operating Income is one of the very vital sources of revenue for any firm. The profits, the activity
and all the important performance parameters are measured in relation to this factor. Some of the
observations that can be made from the above trend chart are:

 The main object of the business as defined by the Memorandum of Association is to transmit
the power and it has been termed as CTU (Central Transmission Unit) by the Central
Government.
 Since there are few competitors in form of SEBs and no firm with the similar size of Power
Grid Corporation of India Limited, thus it has a near monopoly in this sector.
 The continuous increase in sales/ Transmission Income can be regarded to the fact that the
business is expansion.
 In the year 2007, the firm entered into the business of Telecommunication ( leasing of over
head lines) and Consultancy ( consultancy to other countries and also consulting the Govt
project of RGGVY)
 Seeing the growth of Operating Income from Rs.2103 Crores to Rs.6579 Crores between the
years 2003 and 2010, it can be remarked that the company has a good performance

41

Profits

Profits
5000
4500
4000
3500
3000
PBIT
2500
2000 PBT
1500 PAT
1000
500
0
2003 2004 2005 2006 2007 2008 2009

Figure 22 Trend in different Profits

The Profits (Operating, Before Tax and After Tax) have been increasing over the last 7 years. But
some of the points to be observed are:

 Though the Operating Profit (PBIT) has increased at a very tremendous rate, but the increase
in the PBT is not at the proportionate rate because of simultaneous increase in Non
Operating and Financial Expenses.
 Also in the year 2003-04, the PBT (Profit before Tax) was less than the PAT (Profit after Tax)
because of Tax Credit and Tax Subsidy being provided by the Government.
 Since 2005-06, the gap between PBT and PAT has been at a rise implying that the Tax
amount being paid by the company is increasing.

Dividends

Dividends
15

10
of Face Value

5 Dividends

0
2003 2004 2005 2006 2007 2008 2009

Figure 23 Dividend Trend

42

The dividends are one of the ways in which the company can return the earnings to the share
holders. The dividends depict the profitability of the company. From the above chart it can be
clearly seen that the dividends are growing over the year. Pre-2007, when Government of India (The
President of India) was the sole share holder/promoter, the number of shares issued to it kept on
changing every year. The capital requirement was funded by the government by means of Equity
capital infusion. Thus the dividend proportion has also increased. And in the year 2008 and 2009,
after the IPO, when apart from GoI, general public too participated in the shareholding pattern; the
dividend percentage has remained same. Also pre 2007, the face value of shares was Rs.100 and
from the year 2007 the face values of the shares have changed to Rs.10.

The analysis of the Dividend payment can be made more effective by studying the Retention and
payout ratio. It can be seen from the following graph that, the retention of profits which is
represented by the colour green, is very high in the initial years, but the payout ratio has increased
over the years and especially after the IPO (Disinvestment). But the retention ratio is always at least
60-70% which depicts that the firm is reinvesting and pooling back its earnings into the business
instead of distributing it to the shareholders. By this it also signals that the internal rate of return of
the firm is higher than the Share holders expectation thus the earnings are retained back.

Profits Appropriation
100%
90%
80%
70%
60%
50%
40%
30%
Payout
20%
10% Retaintion
0%
2003 2004 2005 2006 2007 2008 2009

2003 2004 2005 2006 2007 2008 2009
Payout 31.47 37.07 31.52 31.32 24.2 17.07 15.72
Retaintion 68.53 62.93 68.48 68.68 75.8 82.93 84.28

Figure 24 Profit Appropriations over the years

43


Cash Flow Analysis

Cash is regarded as the blood of any business. A company may be highly profitable with high
balances in general and Capital reserve, with a good asset value and high Net worth. But the
situation will be worsening if cash positions are low. A firm with a very high profitability but with
constrained liquidity would face the problem of solvency. Thus it is per se necessary to analyse and
study the cash flows from various sources and also its application.

The Cash flow statement is divided into three parts namely Cash from Operating activities, cash from
Investing activities and cash from financial activities. The cash flow statement for the year 2009 and
2008 are:

Cash Flow Statement 200903 200803

Cash and Cash Equivalents at Beginning of the year 1865.59 1196.82

Cash Flow From Operating Activities

Net Profit before Tax & Extraordinary Items 2228.57 1730.53

Total Adjustments (PBT & Extraordinary Items) 3518.25 2111.69

Op. Profit before Working Capital Changes 5746.82 3842.22

Adjustment For WC Changes 1048.29 -629.48

Cash Generated from/(used in) Operations 6795.11 3212.74

Direct Taxes Paid -154.02 -221.91

Net Cash from Operating Activities 6641.09 2990.83

Cash Flow from Investing Activities

Purchased of Fixed Assets -770.82 0

Sale of Fixed Assets 0 261.01

capital WIP -8652.78 -6075.15

Sale of Investments 182.89 241.13

Interest Received 132.99 149.99

Dividend Received 19.54 5.39

Investment in Group Cos -39.5 -10.35

Others -29.07 84.67

Net Cash Used in Investing Activities -9156.75 -5343.31

44

Cash Flow From Financing Activities

Proceeds from Issue of shares (incl share premium) 0 1989.63

Proceed from 0ther Long Term Borrowings 7629.85 4118.71

Proceed from Short Term Borrowings 750 750

Of the Long Term Borrowings -1427.89 -1180.73

Of the short term Borrowings -750 -750

Dividend Paid -505.08 -464.28

Interest Paid -2532.09 -1339.55

Others -85.84 -102.53

Net Cash From Financing Activities 3078.95 3021.25

Net Inc/(Dec) in Cash and Cash Equivalent 563.29 668.77

Cash and Cash Equivalents at End of the year 2428.88 1865.59

Table 4 Cash Flow Statement

Some of the analyses that can be made from the above cash flow statement are:

 The cash flows from operating activities, which imply the cash generated by performing the
business activities has increased from previous year. It has grown by approximately 122%
which is very positive.
 Mainly there has been rise in cash flows from profits.
 Also the cash from Working capital was negative in the previous year implying more current
assets were used in the previous year. But in the current year the cash from working capital
is negative, this implies that the cash has been generated from the Current liabilities.
 The cash from Investing activity is negative this implies the firm is investing into assets and
other income generating investments.
 The cash used in financing activities has increased by 71% over the previous year.
 Fixed assets worth Rs. 770 Crores were purchased this year implying the firm is expanding its
scope of operation and also the fact that Assets worth Rs. 261 crores were sold last year and
the figure of sale has been 0 this year.
 The Capital working Progress is very high at Rs.8 Thousand Crores. And also the amount has
increased by 42% over the previous year. The main reason behind this is the projects
undertaken by the company are of long completion and long implementation [period, thus
lot of amount gets blocked as WIP.
 The firm is also generating some cash from the sale of Investments and also inform of
income on the investments like Intrest and dividends.
 The cash from Financing activities include the cash generated from the resource raising
activities in form of loans shares etc... It also includes the repayments of the earlier loans
and the interest and dividends paid on them.
 There has been not much change in the cash generated from financing activities; it has risen
by just 2 % over the previous year.

45

 There has been a high amount being generated by issue of shares in the year 2007-08
because the shares were issued to public in form of IPO in the month of September, 2007.
 The Long term borrowings in form of issue of debentures (Bonds) domestic and international
loans, has risen with a steep rate of 85% over the previous year.
 Some amount is also used in repayment of the borrowed short and long term funds.
 The amount used as repayment of interest towards the funds borrowed has also increased
by 89%. This is tandem with the rise in borrowed funds which has risen by 85%.
 Overall the firm is generating cash from Financing and Operating Activities i.e. from its
normal business course and also from borrowings and using all the funds in Investment
activities like investing in fixed assets and other income generating investments.
 Overall the cash balance has increased by 30% over the previous year.
 Overall the cash flows are well managed, but the firm is unable to fulfil its requirements
from the operational activities and has to depend on borrowings. But since it is in rapid
expansion stage the borrowings are inevitable.

46


Ratio Analysis

After analysing the balance sheet, the analysis of sources and applications of funds, profit and loss
analysis and also the cash flow analysis, It is per se necessary to also analyse the financial ratios of
the company. The financial analysis as a detached without comparing the figures with each other is
incomplete analysis and will not lead to true analysis. Thus every figure must not only be analysed
over the years but must also be compared with the other components of the same year. It is a tool
used by individuals to conduct a quantitative analysis of information in a company's financial
statements. Ratios are calculated from current year numbers and are then compared to previous
years, other companies, the industry, or even the economy to judge the performance of the
company. Ratio analysis is predominately used by proponents of fundamental analysis.

Some of the important aspects of ratio analysis are to scrutinize the profitability, liquidity, solvency,
as well as the efficiency of the company. Some of the important classes of ratios are:

 Liquidity Ratios
 Profitability Ratios
 Turnover / Activity Ratios
 Solvency Ratio

In the following section, the ratios of above mentioned heads foe Power Grid Corporation of India
Limited will be computed for last 5 years from 2004-05 to 2008-09. Also these figures will be
compared with the Industry average. Since there are very few players in the power transmission, the
benchmark of power generation industry has been considered.

Liquidity Ratio

These set of ratios help in analysing the liquidity position of the company. They can be defined as a
class of financial metrics that is used to determine a company's ability to pay off its short-terms
debts obligations. Generally, the higher the value of the ratio, the larger the margin of safety that
the company possesses to cover short-term debts. Liquidity ratios provide information about a
firm's ability to meet its short-term financial obligations. They are of particular interest to those
extending short-term credit to the firm. Two frequently-used liquidity ratios are the current ratio (or
working capital ratio) and the quick ratio.

Current Ratio
The current ratio is the ratio of current assets to current liabilities:

=

Short-term creditors prefer a high current ratio since it reduces their risk. Shareholders may prefer a
lower current ratio so that more of the firm's assets are working to grow the business. Typical values
for the current ratio vary by firm and industry. For example, firms in cyclical industries may maintain
a higher current ratio in order to remain solvent during downturns.

47

Quick Ratio
One drawback of the current ratio is that inventory may include many items that are difficult to
liquidate quickly and that have uncertain liquidation values. The quick ratio is an alternative measure
of liquidity that does not include inventory in the current assets. The quick ratio is defined as
follows:

−
=

The current assets used in the quick ratio are cash, accounts receivable, and notes receivable. These
assets essentially are current assets less inventory. The quick ratio often is referred to as the acid
test.

The company’s Current Ratio and Quick ratio for the year 2009-10 is 0.79 and 0.77 times
respectively. This infers that the company’s current liability is not covered fully by the current assets.
In case of unforeseen demand for payment from the current liabilities arises, the company will not
be in a position to honour them as it does not has enough current assets. Also the quick ratio is less
than its idle point of 1. The quick ratio considers the quick ratio which can be converted into cash in
a very short term. The ratio less than 1 implies the company is unable to maintain enough
marketable assets to cover the current liabilities. But these ratios must also be compared with the
overall industry standards.

2008-09 2007-08 2006-07 2005-06 2004-05
Current Ratio 0.793768 0.799878 0.577718 0.605015 0.810153
Quick Ratio 0.765338 0.762923 0.54741 0.564984 0.752983
Industry- CA 1.66 1.58 1.48 1.61 1.56
Table 5 Liquidity Ratios

Liquidity Ratio
1.8
1.6
1.4
1.2
Current Ratio
1
2008-09 2007-08 2006-07 2005-06 2004-05 Quick Ratio
0.8
Industry- CA
0.6
0.4
0.2
0

Figure 25 Liquidity Ratios

48

After comparing the Current Ratio of Industry and the company along the years, it can be seen that,
the Current Asset ratio of the company is always lower than the standard level of the industry. This
implies that the liquidity position of the company vis a vis the industry standard is poor. Also though
the level fell in the year 2005-06 but has increase over the years after the year 2006-07. The Quick
ratio is also in tandem with the Current ratio implying that the company’s inventory level over the
year is constant. And the gap between these two ratios depicts the inventory position, and it can be
seen that the gap is less over the years, thus the average investment in inventory is very less.

Profitability Ratio

The profitability ratio is useful to measure the profitability of the company. Its ability to generate
returns on the capital invested. These can be understood as set of ratios that are used to assess a
business's ability to generate earnings as compared to its expenses and other relevant costs incurred
during a specific period of time. For most of these ratios, having a higher value relative to a
competitor's ratio or the same ratio from a previous period is indicative that the company is doing
well.

Profitability ratios show a company's overall efficiency and performance. We can divide profitability
ratios into two types: margins and returns. Ratios that show margins represent the firm's ability to
translate sales into profits at various stages of measurement. Ratios that show returns represent the
firm's ability to measure the overall efficiency of the firm in generating returns for its shareholders.

Operating Profit Margin (PBIDTM)
The Operating profit margin helps in determining the ability of the firm to convert what proportion
of the sales into the operating profit. The Operating profit here implies the Profits before Interest,
Depreciation and Tax (PBDIT). It is computed as:

=

Alternatively, Instead of taking PBDIT as the Operating profit, PBDT i.e... Operating profit after
deducting the Intrest expenses also needs to be studied in this case, as the company has approx 60%
of its capital structure as borrowings and high proportion of the income is paid as interest. The PBDT
implies Profits Before Depreciation and Taxes.

For the year 2008-09, the PBDITM for the company and the industry standard was 89.08% and
36.37% respectively. And PBDTM for the company and the industry standard was 50.6 % and
28.24% respectively.

The figures for over the years for the company as well as the industry are:

2008-09 2007-08 2006-07 2005-06 2004-05
PBIDTM (%) 89.08 87.44 96.28 90.95 94.16
PBDTM (%) 50.6 58.41 64.52 60.83 61.7
PBIDTM (%)- Industry 36.37 29.96 28.66 37.09 39.73
PBDTM (%)- Industry 28.24 23.7 21.7 28.88 30.84
Table 6 Operating Profit Margins

49


Operating Profit Margin
120

100
PBIDTM (%)
80
PBDTM (%)
60

40 PBIDTM (%)-
Industry
20 PBDTM (%)- Industry

0
2008-09 2007-08 2006-07 2005-06 2004-05

Figure 26 Operating Profit Margins

From the figures it can be stated that the company’s profitability position is excellent. It is able to
maintain margins at a much higher level when compared to the industry standards. The main reason
behind this is the company’s diversified profile. It has not restricted itself to Power transmission, but
has also entered into Consultation and Telecom.

Also the PBIDTM and PBDTM are in tandem for the years before 2007-08. In the year 2007-08, the
PBDTM has decreased disproportionately when compared to PBDITM and the main reason behind
this is the company’s increased borrowing which leads to increased interest payment.

Net Profit Margin
Net Profit margin is the ration of Pat and the Net Sales. PAT implies the Profit before Tax which the
net profit generated after paying all the operating, financial and other charges. It is computed using
the formula

=

The Net profit margin or PATM of the company and also the Industry in the year 2008-09 was at
25.69% and 17.4% respectively.

Cash Profit Margin
Net profit is the residual of Income after deducting all type of expenses. But A net profit generated
need not imply excess cash of that amount is added in the business. The cash profit and Net profit
would differ because there are few non-cash expenses like Depreciation which shall not be
considered in case of computing Cash profits. Thus it is necessary to also study the Cash profit
Margin. It is the ratio of Cash Profits to the Net Sales.

For the year 2008-09 he cash profit Margin of the company along with the Industry average was
42.42% and 24.98% respectively.

The trend of both the above mentioned margins over the years is

50

2008-09 2007-08 2006-07 2005-06 2004-05
CPM (%) 42.42 52.3 57.48 55.74 56.81
PATM (%) 25.69 31.39 34.25 32.08 31.26
CPM (%)- Industry 24.98 19.98 19.47 26.96 28.3
PATM (%)- Industry 17.4 13.44 12.31 18.04 18.39
Table 7 Net Profit Margins

Profit Margin
70

60

50
CPM (%)
40
PATM (%)
30
CPM (%)- Industry
20
PATM (%)- Industry
10

0
2008-09 2007-08 2006-07 2005-06 2004-05

Figure 27 Net Profit Margins

In both the cases i.e... Cash profit Margin or The Net Profit Margin, the company figures are better
than the overall industry average. Also the cash profits are more than the Net profits; this shows
that a large amount of non- cash expenditure in way of depreciation and amortization is charged to
the profits.

Return on Capital Employed
Return on Capital Employed (ROCE) is used in finance as a measure of the returns that a company is
realising from its capital employed. It is commonly used as a measure for comparing the
performance between businesses and for assessing whether a business generates enough returns to
pay for its cost of capital. It is computed using

=
−

The ROCE for the company in the year 2008-09 was 12% as compared to 9.35% of Industry average.

Return on Net Worth
Return on Net Worth (RONW) or popularly known as Return on Equity (ROE) measures the rate of
return on the ownership interest (shareholders' equity) of the common stock owners. It measures a
firm's efficiency at generating profits from every unit of shareholders. ROE shows how well a
company uses investment funds to generate earnings growth. It is computed using the formula

=
+

51

The RONW for the company and the Industry average in the year 2008-09 were 11.82% and 9%
respectively. Over the years, the RONW and ROCE trend can be seen from the following table.

2008-09 2007-08 2006-07 2005-06 2004-05
ROCE (%) 12 9.27 9.5 8.95 8.01
RONW (%) 11.82 11.74 11.77 10.65 8.99
ROCE (%)-Industry 9.35 9.09 9.38 8.8 9.44
RONW (%)-Industry 9.97 9.61 10.24 9.38 10.01
Table 8 Returns

EPS
EPS stands for Earnings per share. Similar to RONW which computes the percentage of earnings as
compared to the total net worth; EPS is a measure to determine the profits per share. It is ratio of
Net profits or Earnings Available to equity share holders and the No. of equity shares.

In case of Power Grid Corporation of India Limited there are no preference shares, so the total
earnings would be the earnings available to equity shareholders. And also in the year 2007, a 1
shares was split into 100 shares, thus the EPS needs to be adjusted for that period.

EPS
4.5
4
3.5
3
2.5
2
1.5
1
0.5
0
2008-09 2007-08 2006-07 2005-06 2004-05
EPS 3.81 3.24 3.09 2.6962 2.4018

Figure 28 EPS Trend

The EPS of Rs.3.81 on a face value of Rs.10 is a good indicator. Also the EPS has been on a rise
over the years, depicting the profitability of the company.

52

Solvency Ratios

Solvency ratios indicate the risk inherent in the company as a result of its debt. A good financial
analyst will also use solvency ratios to assess the debt profile of a company from its financial
statements, and analyze whether the company needs to undergo debt restructuring exercises such
as mortgage refinancing, debt consolidation, etc. In simple words the solvency ratio implies the
ratios that help investors assess a company’s ability to meet its long-term obligations. They also tell
investors how the company has been financed (debt or equity) and whether that is changing over
time.

Two most used Ratios are Leverage Ratio (D/E) and Interest Coverage Ratio.

Debt- Equity Ratio

Debt-Equity Ratio is one of the most popular ratios used in financial analysis of the company. It
shows how much the entity is trading on equity. It is the ratio of Borrowings and the owned capital.
Though a standard of 2 or 1.5 is considered as optimum, but it also differs based on industry and
business activity of the company. The Debt-Equity ratio of the company as on 31st March 2009 was
1.77. And based on unaudited figures the ratio was 2.11 as on 31st March 20104. Though it is high,
but it can be commented upon without comparing the same with the industry standard. The Debt
Equity of Power Generation Industry for the year 2008-09 is 0.75. But since the company is a Central
Transmitter Unit and also a sole large unit in the power transmission segment thus is into rapid
expansion and growth stage, the borrowings are very high.

The Debt Equity Ratio or Leverage Ratio over the years follows the following trend

Debt-Equity Ratio
1.95

1.75

1.55

1.35

1.15

0.95

0.75
2008-09 2007-08 2006-07 2005-06 2004-05
Debt-Equity Ratio 1.77 1.69 1.64 1.5 1.47

Figure 29 Debt Equity Ratio

4
Source: The Information Memorandum of XXXII Issue.

53

Intrest Coverage Ratio
A ratio used to determine how easily a company can pay interest on outstanding debt. The interest
coverage ratio is calculated by dividing a company's earnings before interest and taxes (EBIT) of one
period by the company's interest expenses of the same period. The formula used is

=

The lower the ratio, the more the company is burdened by debt expense. When a company's
interest coverage ratio is 1.5 or lower, its ability to meet interest expenses may be questionable. An
interest coverage ratio below 1 indicates the company is not generating sufficient revenues to satisfy
interest expenses.

The Interest coverage ratio of the company is 1.88 times for the year 2008-09. And the trend for the
same is as follows:

Interest Cover Ratio
2.5

2.25

2

1.75

1.5
2008-09 2007-08 2006-07 2005-06 2004-05
Interest Cover Ratio 1.88 2.29 2.3 2.23 2.11

Figure 30 Interest Cover Ratio

There has been steep fall in the coverage for the year 2008-09. This is mainly because of high
borrowings from the year 2007. And this borrowing has lead to high interest obligation.

Activity Ratios

Activity Ratios, as defined by Investopedia5 are, ‘Accounting ratios that measure a firm's ability to
convert different accounts within their balance sheets into cash or sales’.

Asset turnover ratios indicate of how efficiently the firm utilizes its assets. They sometimes are
referred to as efficiency ratios, asset utilization ratios, or asset management ratios. Three commonly
used asset turnover ratios are receivables turnover and inventory turnover and Fixed assets
Turnover ratio.

5
http://www.investopedia.com/terms/a/activityratio.asp

54

Receivables Turnover Ratio
Receivables turnover is an indication of how quickly the firm collects its accounts receivables and is
defined as follows:

=

The receivables turnover often is reported in terms of the number of days that credit sales remain in
accounts receivable before they are collected. This number is known as the collection period. It is
the accounts receivable balance divided by the average daily credit sales, calculated as follows:

365
=

The Receivables Turnover ratio and the collection period for the company for the year 2007-08 are
5.32 times and 68.6 days respectively. This implies that on average debtors are converted into cash
in approx 69 days.

Inventory Turnover Ratio
Another major asset turnover ratio is inventory turnover. It is the cost of goods sold in a time period
divided by the average inventory level during that period:

=

The inventory turnover often is reported as the inventory period, which is the number of day’s
worth of inventory on hand, calculated by dividing the inventory by the average daily cost of goods
sold:

365
=

The Inventory turnover ratio and the inventory holding period for this company for the year 2007-08
are 24.09 times and 15.15 days respectively.

Fixed Asset Turnover Ratio
This ratio depicts the ability of the entity to convert its fixed assets into cash (Sales). A financial ratio
of net sales to fixed assets. The fixed-asset turnover ratio measures a company's ability to generate
net sales from fixed-asset investments - specifically property, plant and equipment (PP&E) - net of
depreciation. A higher fixed-asset turnover ratio shows that the company has been more effective in
using the investment in fixed assets to generate revenues. It is computed using the formula

=

55

The ratio for the year 2008-09 is 0.17 times. This is a very low figure, but since the firm is a capital
intensive and has projects which are of longer gestation, so this figure can be justified.

The trend in the above discussed ratios over the years is summarised in the following table

Turnover Ratios 2008-09 2007-08 2006-07 2005-06 2004-05
Receivables 5.32 5.8 8.8 8.1 5.37
Collection Period 68.60902 62.93103 41.47727 45.06173 67.9702
Inventory 24.09 21.34 19.7 17.26 13.19
Inventory Holding Period 15.15152 17.10403 18.52792 21.14716 27.67248
Fixed Assets 0.17 0.14 0.13 0.13 0.12
Table 9 Turnover Ratios

Capital Market Behaviour

Since the shares of the company are listed on the stock exchanges and are also actively traded, it is
per se necessary to also analyse the behaviour of share prices. Some of the important ratios that can
be computed and analysed are P/E Multiple, Beta etc...

P/E Multiple
The P/E stands for Price to earnings Ratio. It signifies the relationship between the market price per
share and earnings per share. It can be computed using formula

/ =

The P/E of the firm as on 31st Dec 2009 was 21.80. This implies the investor is willing to pay Rs. 21.80
for 1 Re of current earning.

In general, a high P/E suggests that investors are expecting higher earnings growth in the future
compared to companies with a lower P/E. However, the P/E ratio doesn't tell us the whole story by
itself. It's usually more useful to compare the P/E ratios of one company to other companies in the
same industry, to the market in general or against the company's own historical P/E. It would not be
useful for investors using the P/E ratio as a basis for their investment to compare the P/E of a
technology company (high P/E) to a utility company (low P/E) as each industry has much different
growth prospects.

Over the years the P/E has been

56


P/E
24.000
23.000
22.000
21.000
Sep-2008 Dec-2008 Mar-2009 Jun-2009 Sep-2009 Dec-2009

Sep-2008 Dec-2008 Mar-2009 Jun-2009 Sep-2009 Dec-2009
P/E 23.124 22.654 22.861 23.611 23.085 21.807

Figure 31 P/E Ratio

Beta

Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the
market as a whole. Beta is used in the capital asset pricing model (CAPM), a model that calculates
the expected return of an asset based on its beta and expected market returns... It is also known as
beta coefficient.

Beta is calculated using regression analysis, and you can think of beta as the tendency of a security's
returns to respond to swings in the market. A beta of 1 indicates that the security's price will move
with the market. A beta of less than 1 means that the security will be less volatile than the market
and beta of greater than 1 indicates that the security's price will be more volatile than the market.

The result of regression for Sensex Returns and Power Grid Corporation of India Limited’s shares
returns from 8th October 2007 to 31st April 20106 is as follows:

SUMMARY OUTPUT

Regression Statistics
Multiple R 0.664819
R Square 0.441985
Adjusted R 0.441074
Square
Standard Error 0.022539
Observations 615

Coefficients Standard t Stat P-value Lower 95% Upper
Error 95%
Intercept 0.000388 0.000909 0.42683 0.669653 -0.0014 0.002173
Return-Market 0.839983 0.038121 22.03489 1.08E-79 0.76512 0.914845
Table 10 Regression Output

6
The data has been uploaded on online appendix. Please refer the Appendix page

57

And the residual plot for the same is

y = 0.84x + 0.0004
Residual Plot R² = 0.442

0.25

0.2

0.15

0.1

0.05

0
-0.15 -0.1 -0.05 0 0.05 0.1 0.15 0.2
-0.05

-0.1

-0.15

-0.2

Figure 32 Residual Plot for Beta

From the above results we can see that The Company’s shares are Low beta at 0.84. This implies for
every 1 percent change in the market returns (here Sensex), the returns on shares of the company
will change by 0.84 percent in the same direction.

Also the R-Square, which is 0.442, implies the 44% variations in the share price are explained by the
known factors that are due to market variations. In simple words 44% of the variations are
explained.

58


Chapter III
Procedure of Bond
Raising

 Steps in Issuing Bonds
 Dematerialisation
 Listing Process
 Debt Servicing

59


Steps in Issuing Bonds

To understand the procedural aspects and legal aspects in raising bonds and also to have practical
exposure to actual raising process, a study of steps in issuing bonds is per se indispensible.

The need for funds is determined based on Cash flow projections of the year. The amount to be
financed by means of bonds is determined.

The process of raising funds though bonds start with:

Board Approval

A board meeting at beginning of the year is held where authority to raise loan by means of Bonds is
provided to the concerned person. The MoU between Ministry of power and PGCIL is also
considered. The Committee of Directors for Bonds is appointed and the authority with respect of
issuing of Bonds and all matters related to it are provided to the same by BoD. This is meeting is held
at the beginning of the financial year or at later date if needed.

Shortlist of Arrangers

The process of issue starts by selection of arrangers. The arrangers are similar to Merchant bankers
in the case of Bonds issue; they facilitate the process by bringing Investors for the issue. In Case of
PGCIL, the arrangers are selected based on Past records and their past participation. The arrangers
are selected based on their Rankings in PRIME Database. The rankings are allotted to the arrangers
based on their history of performance. The criteria for ranking is based on

 Amount Arranged in between a period
 % of Total issue being arranged by that particular Arranger
 No. of issues being participated by the arranger.

This data can be generated from the website http://www.primedatabase.com/ by creating League
Table of arrangers. It provides Ranks to the arrangers based on the period selected by the user. From
the results top 10 or top 5 or the number as required are shortlisted.

Meeting of Committee of Directors for Bonds for Engagement of Arrangers

The meeting with Committee of Directors of Bonds (will be referred as Committee henceforth) is
held with the purpose to appoint the arrangers... The following points are covered in the Minutes of
Meeting prepared for the purpose of meeting:

 Authority to raise loan of Amount Rs........, as approved by Board of Directors in the
General meeting in one or many trenches.
 Approval that Committee may engage Merchant bankers of Power Grid IPO as
Arrangers for this issue too
 Estimation of cash requirement and amount of Loan to be raised based on Cash
Flows (Actual and Projections)

60

 Appointing the shortlisted arrangers and also addition of other arrangers or
rejection of exiting from the list.

Thus shortlisted arrangers are invited and were also asked to quote for Arrangers fees
 The Received quotes in sealed Envelope which is kept highly confidential and shall
be opened by a committee which has:
 One representation from Corporate Finance
 One representation from Company Secretariat
 One representation from Corporate Planning
 In case of any variation in fees, the arrangers are asked to match their fees with the
fee quoted by L-1 bidder. (Here L-1 implies the arranger biding lowest rate)
 The arrangers fee (which is common for all arrangers) shall be charged on Amount
allotted by the issue and can be shared among the Arrangers.
 The PGCIL proposes to appoint a minimum no. of Arrangers for each issue based on
the requirement.
 The decisions on Appointment of arrangers, their fees etc shall be authorised by the
Committee

Thus the above points are discussed by the committee. This Minute of Meeting is signed by
Committee of Directors for Bonds.

Invitation for Quote to selected Arrange rs

After the approval by the committee on the selection of arrangers, an invitation letter is sent to the
arrangers. Some of the important contents of the letter are

 The details on Issue Size, type of issue, type of debentures and proposed time of
issue. In this case it was Issue of Non Convertible, Redeemable, Taxable, and
Secured Bonds of PGCIL.... issue, the issue size being Rs..... Crores with a green shoe
option. And the type of issue being private placement and the proposed time.......
 The arrangers shall be registered with SEBI
 Intimation of appointing them as arrangers for the issue and also requesting them to
quote for the Arrangers fees as percentage (%).
 The address of Issuer to whom the quote letter/ acceptance letter shall be mailed or
sent by courier in a closed envelope is also mentioned
 The deadline by which the letters shall be reached is also mentioned.
 The time of opening the letters was also mentioned.
 The invitation letter shall in no way construed as indication for appointment.

This letter is mailed to the shortlisted arrangers.

Letter of Acceptance with Quotes by the Arrangers

The arrangers after receiving the Letter of appointments reply back their acceptance and also their
quote for Arrangers fees on their Letter head. The received letters are then reviewed and based on
the quote for the arranger’s fees, the arrangers quoting lowest fees are selected, keeping the

61

number of arrangers up to the minimum number as permitted by the committee. In case if similar
bids are not received, the arrangers are asked to come in consensus with the L-1 bidder.

The reply letters along with the envelope is documented.

Recommendation of Bid Opening Committee

After the quotes are received, the envelopes are opened by the committee formed for this purpose
having 3 persons, one from Corporate Planning, Company Secretariat and Corporate Finance each.
The committee, based on the quotes for arranger’s fee as quoted by the arrangers, will recommend
the final arranger fee and also the selected arrangers.

These Recommendations are to be signed by the members of the Committee formed for opening
the Envelopes and also by The Committee of Directors of Bonds.

Letter of Appointment to the Arrangers

Based on the recommendations of the Bid Opening committee and henceforth approved by the
Committee, the letters of appointment is sent to each of the selected arranger. The letter usually has
following points:

 Intimation of appointing them as the arranger
 Also the names of co-arrangers
 The Arrangers Fee approved by the Committee
 Also a request to meet for the discussion on Issue Structure, Programme and Timing
of the issue
 A request to reply back the acceptance by sending back the duplicate copy of the
letter with duly acceptance.

Meeting with Arrangers

A meeting with the Arrangers is held at Power Grid Corporate office, Gurgaon to discuss the issue
structure, plan of issue, the discussion on timing, the Intrest rate, Cap and Floor rate, etc... . In this
meeting based on the Current G-Sec yield, Corporate Bonds yield and spread, Liquidity conditions in
market, RBI policies, Issues of other corporate and PSUs, etc... The arrangers suggest the interest
rate band depending upon the interest band as fixed by other PSUs whose issues are live in the
market. Usually the Cap rate is fixed and the floor rate is kept open to take advantage of market
condition.

Letter to Trustee

A letter is sent to the Trustee who can act as Trustee for the Bondholders of the present issue. The
letter has the details of the issue like security details, issue size etc... Also a request is made for
consent for acting as Trustee. A draft consent letter, which the Trustee shall reply back for
communicating the consent of approval, is attached with the letter. The Trustee is acting as IDBI

62

Trusteeship since XII issue of Bonds7. Though the same Trustee is appointed for every issue, but a
separate letter is to be sent for each issue.

Letter to Banker

A letter is sent to the proposed Banker who can act as Banker to the Issue. The letter has the details
of the issue like security details, issue size etc... Also a request is made for consent for acting as
Banker to the Issue. A draft consent letter, which the Banker shall reply back for communicating the
consent of approval, is attached with the letter. The Indian Overseas Bank acts as the banker to
issue.

Letter to Registrar and Transfer Agent (RTA)

A letter is sent to the Registrar who can act as Registrar for an issue. The letter has the details of the
issue like security details, issue size etc... Also a request is made for consent for acting as RTA. A
draft consent letter, which the Registrar shall reply back for communicating the consent of approval,
is attached with the letter. The RTA for Power Grid Corporation of India Limited Bonds is MCS Ltd.

Letter to Credit Rating Agencies

As per SEBI’s guidelines with respect to issue of debentures and also with respect to Disclosures, an
issuer must get credit rating from at least two credit rating agencies and shall also communicate the
rating in the Information memorandum. Thus a letter to Credit rating agencies is sent for
Revalidating the Credit rating which was assigned by the respective Credit rating Agency before. The
letter has the issue details, the details of the security, issue size, etc... The details of rating provided
at beginning of the year along with the loan amount are also shared (backed by the reference to the
letter no. and letter date). A request is made for the issue of fresh letter of credit rating.

The Power Grid Corporation of India Limited takes the rating from 3 agencies namely, ICRA, CARE
and CRISIL.

Letter from Trustee

A consent to act as Trustee, specifying the issue details is sent to BoD by the trustee. The content is
same as provided by issuer as draft letter. Trustee also authorises the issuer to forward the letter to
NSE or any stock exchange where bonds will be listed

Letters from Credit Rating Agencies

Revalidation letters from credit rating agency are received. The letter has reference to previous
letter from issuer. It also confirms the rating of the security to be issued. It has following conditions:

 Rating specific to terms and conditions of the specific issue.
 Any change shall be brought into notice of the rating agency.
 Right to suspend, withdraw, or revise the rating at any time on the basis of new
information or unavailability of any information.
 Rating should not be treated as recommendation to buy.

7
Prior to this, Indian Overseas Bank acted as the Trustee

63

 Any information on delay/default in payment of interest shall be timely
communicated.

The letter also has a condition that if the instrument rated is not issued within 10 months in case of
ICRA or 6 months in case of CARE and CRISIL, then the rating would stand withdrawn.

Letter from Banker

A consent to act as the Banker to issue, specifying the issue details is sent to BoD by the banker. The
content is same as provided by issuer as draft letter. Trustee also authorises the issuer to forward
the letter to NSE or any stock exchange where bonds will be listed.

Letter to Banker

After receiving the consent of acting as banker to issue, a letter is sent to banker is sent by the
issuer. The letter has details such as issue size, reference to the consent letter, and details of
payment specifications. The letter also mentions the proposed collection centres and a request is
made to inform the respective branch heads of the collection centre to make necessary
arrangements. A request for intimating the branch head to collect the cheques in high value clearing
zone is also made in the letter.

Declaration by Board of Directors

A declaration by the Directors undertaking that No statement made in Disclosure Document is
contrary to the provisions of Companies Act, 1956 or SEBI Act, 1992 or rules made there under or
guidelines/ Notification issued.

This declaration is signed by the Board of Directors. The Board consist of

 Chairman and Managing Director
 Director (Finance)
 Director (Operations)
 Director (Projects)

Request letter to NSE for in Principle Approval

After preparing the Draft Disclosure document, a request letter to National Stock Exchange for In
Principle Approval of getting the Bonds listed in WDM (Wholesale Debt market) of NSE. The letter
has following details

 The proposed date of issue
 The Issue Size, type of issue,
 Enclosures: Draft Disclosure Document and also a digital copy of the document in
PDF format for the purpose of uploading the same on website
 Intimation of sending the final copy of Disclosure Document in due course time
 Undertaking that Disclosure Document being prepared in compliance with
Notification dated 6th December 2008 issued by Securities Exchange Board of India
(Issue and Listing of Debt Securities) regulations 2008.

64

 Undertaking that company will execute the new listing agreement with NSE after the
allotment is done
 And finally a request for an In-Principle approval.

In-Principle Approval from NSE

The National Stock Exchange issues the In-principle Approval to PGCIL for the issue. The In-principle
approval is approval that the bonds may be listed on the exchange but it is a conditional approval
and not a commitment. Only on fulfilment of all compliances and conditions the bonds will be listed.

The letter has

 Intimation of Grant of In principle Approval with specifying Nature of Bonds, Face
Value and Issue Size
 Also the conditions for Listing and provisions of Securities Exchange Board of India
(Issue and Listing of Debt Securities) regulations 2008.

Draft- Disclosure Document

Covering Letter to Disclosure Document to Arrangers

A covering letter to Draft Disclosure Document is sent to the arrangers. Also Application forms and
Letter of commitment (Draft) is sent to the Investors. According to Sec 67 of Companies Act, not
more than 49 can participate in case of Private Placement. Thus only 49 application forms are
printed and 4 applications are sent to each arrangers and the rest are kept by Power Grid. These are
issued to the arrangers in case of further requirement.

Letters of Commitment

It is a Letter given by Investors to the Power Grid on their letter head. The draft of the same is
provided by the Power grid. This letter has an undertaking that a specific number of bonds shall be
applied by the Investor at a particular rate when the issue is made and bonds are allotted. It is an
irrevocable commitment. In the letter a commitment to invest number of bonds, minimum of 10
bonds and a multiple of 5 thereafter,

@ Coupon Rate (it can be any rate between the spread i.e... Floor and Cap rate)
@ rate higher than the coupon rate
OR
@ Cut-Off rate

The letter also has an undertaking by Investors to pay for the bonds allotted in form of Cheque/
Demand draft (High Value Clearing) or RTGS

The Investors shall send their bids to the Power Grid by means of Fax or in person in between the
Issue open and Issue Closing time.

The offer cannot be revoked unless superseded by a subsequent letter from the investor before the
closing of the issue.

65

Book Building

For the purpose of determining a Cut-Off interest rate at which the bonds shall be issued, a Book
Building procedure is carried out. A work sheet with details of all the bids of investors is prepared.
The Worksheet has the following information:

 Date of Bid
 Name of the Investor
 Form No.
 Name of the Arranger
 Amount that will be invested at different rates
 Cut Off Rate
 Cap Rate
 Floor Rate
 Different rates within the spread
 Total Amount of Investment

While Recording the Bids, the same bid amount shall be recorded under all the interest rates at and
above the quoted rate by the investor. The rationale behind this is since he is ready to invest an
amount at a quoted rate; he will be ready to invest the same amount at a higher rate. For Instance, if
a firm X quoted for 30 Bonds i.e... Rs 45 Crs @ 8.7%, the amount Rs 45 Crs will be recorded under
the interest rates 8.7%, 8.78% and also 8.8%

Also if an investor quoted an amount under Cut-Off rate, the amount shall be recorded under all the
interest rates since he is indifferent to invest at any rate. For Instance a firm Y quoted 20 Bonds i.e...
Rs 30 Crs at Cut-Off rate, then the amount Rs 30 Crs shall be recorded under all the interest rates
i.e... 8.6%, 8.65%, 8.7%, 8.78% and 8.8%.

In case of a revised bid, the previous bid is stroked off and the new offer is recorded.

The rate under which the maximum amount is being invested is apportioned as Cut-off rate. This is
the rate at which the bonds will be issued.

In case if the issue is over-subscribed i.e... Exceed the limits then the allotment is bone in the
following order:

 Full allotment to the Investor quoted lowest coupon rate
 The investors quoting at the Cut-Off rate
 For investors investing at a same coupon rate, earlier bid will be allotted first
 In case of a tie with respect to coupon rate and also the date of bid, the allotment is
done pro-rata basis.

Agenda for Meeting of Committee of Directors for Bonds

After determining the cut-off rate and list of investors, the Committee of Directors for Bonds meets.
Following points are to be discussed in the meeting.

 Details of the arranger’s fee

66

 Names of the Arrangers
 Summary of the Investors and their Investments
 Summary of proposed Allotment
 Also decision on form of allotment. Here it is done in D-Mat (electronic Mode)

Letters to Arrangers

After the allotment is approved by the Committee, a letter to all the arrangers is sent. It has

 Information on Applications
 Allotment Details
 Requesting them to intimate their investors for filling and submitting application
along with the application money.
 Also the payment details like payment shall be made by Cheque/demand drafts or
RTGS by the.......... (Deadline date)
 The cheques/ DDs shall be of High value clearing
 Also the Account details and IFSC Code of Banker to Issue is communicated for the
purpose of RTGS payment. The account details are “Power Grid Corporation of India
Ltd. C.A. No. 1408 Bonds XXX-Issue”8 and IFSC Code of Banker to Issue, here, Indian
Overseas Bank, and Parliament Road, New Delhi is IOBA0000762
 Also the Annexure of list of investors along with the allotment details is
communicated
 The report of facsimile sent to the Arrangers is also documented.

Letters to Investors

An intimation letter to each investor to whom the allotment is done is sent. Also request is made to
send their application forms along with the Application money. It has details on Allotment, the Cut-
Off rate of Interest, Payment details, the last date for payment etc... In case if an Investor makes
payment by means of RTGS, only the application letter can be sent to Power Grids Office through the
arrangers. This letter is Carbon Copied to the respective arrangers of the Investors.

Details from Banker to Issue

After the pay-in date i.e... Last date for payment of application, the banker to issue communicates
the receipts of funds with specific to the issue. It provides details of Funds received Towards the
Issue Account along with the date of receipt.

Final Allotment Meeting

The agenda for this meeting is:

 Details of the allotment
 Details on Mutual funds participated
 Any material issue
 List of the Investors with the allotment details

8
The name of account for each bond series differs

67


Dematerialization Process

As per SEBI Guidelines all the securities in form of equity or debt shall be issued only in De-Mat (read
dematerialised) form. Thus it is per se indispensable to understand the process of dematerializing
i.e...converting the securities into electronic form.

The process starts by:

Tri-Partite Agreement between Depository, Issuer and RTA

A Tri-Partite agreement between each depository and RTA and issuer is entered before an issue.
Once signed agreement will; be valid for all the issues unless any change in Terms or change in the
party or any new regulations is made. Two agreements each with NSDL and CDSL are made. The RTA
(Registrar and Transfer Agent) is MCS services.

Letter to NSDL and CDSL

A letter is sent to the depository, here, National Securities Depository Limited (NSDL) and CDSL
(Central Depository Services Limited) with a request to allot ISIN (International Securities
Identification Number), an unique identification number, for the securities to be issued. The Details
of STRPPs are also communicated since each STRPP has different maturity period and thus will have
different ISIN code. The Pay-In date and also the deemed date of allotment is mentioned. This
communication is mailed before the closing of books. The MCF (Master file Creation Form) for the
purpose of allotment of ISIN code is also attached. Intimation that the Corporate Action file shall be
sent separately is also made. A true copy of extract of resolution approved by the Committee of
Directors for Bonds is also attached.

The ISIN code is a 12 digit Alpha-Numeric code. The first three characters are alphabets which
represent the Nation of Origin (for Indian securities it is INE), the next five characters are issuer
specific (like 752E0 for Power Grid and 002A0 for Reliance Industries) and the last four are specific to
characteristics of security like Equity, Secured Debentures, and Maturity etc...

The MCF file has details like Name of the Entity (issuer), contact details, security details, debenture
trustee details, type of placement, issue size, stock exchange details, registrar details etc…

Some of the attachments along with the letters are:

 Articles of Association of the firm
 Memorandum of Association
 Certificate of Incorporation and Certificate of Commencement
 Audited Accounts of last three years
 Trust deed
 Offer Document (Disclosure Document)
 In-Principal approval for Listing from NSE
 Copy of board resolution

68

Corporate Action

A request is made to execute the corporate action to the credit the following securities to the
accounts in NSDL. The details provided are ISIN of securities, Allotment date, Security description,
face value per security, and Distinctive number. Since no security is being issued in physical form
there will not be any distinctive number...

Also allotment details like number of securities and number of records with NSDL, CDSL and Physical
form are also shared.

Undertaking that all the necessary approvals have been obtained is also mentioned. The resolution
by the Committee and ISIN wise details of securities is enclosed along with the letter.

Letters from NSDL and CDSL

Reply letters from both the depositories are received. It communicates that as per the Corporate
Action executed, the details of Bonds credited/debited on the systems. The details like ISIN, ISIN
Description, Records, Quantity, and Execution date are communicated to the issuer. The records are
number of distinct entities holding the security.

Details of Demat Allotment

The allotment details of the issue are prepared by the issuer for the purpose of records. Details like:

 ISIN
 Name of the Investor
 Details of Security (STRPP wise)
 Date of allotment
 Date of Maturity
 DP name
 DP Id
 Client Id
 No. of STRPPs of that particular STRPP (A-L)
 Total amount for that particular STRPP (i.e...Rs. 12.5 lacs X No. of STRPPs)
 House/ Non House (House implies Investor and the DP are same)

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Listing Process

All the bonds issued by the company are listed with NSE under WDM segment. Since the bonds can
be listed only after they are issued and allotted to the investors, they are issued as proposed to be
listed to the investors.

The short summary of listing process is as follows:

 Approval for Listing Agreement with NSE from Board
 Listing Agreement with PGCIL and NSE
 Letter to NSE (Undertaking)
 Letter to NSE (Fees details)
 Letter from NSE (Intimation of Listing)
 Letter to NSE (Covering letter for Trust Deed)

The process of Listing starts with the In-Principle Approval from NSE taken before issuing the bonds.
The In-principle approval signifies that the bonds shall be listed after they are allotted on an
condition that, all the procedurals, policies and guidelines are followed.

After the shares are allotted, approval is taken from the Board for the [purpose of creating a listing
agreement with NSE. The Listing Agreement is signed on a stamp paper. It has all the clauses,
undertakings and policies with respect to the listing guidelines as mentioned by SEBI. This agreement
is to be signed by The Board and also by the company secretary.

After the listing agreement is signed, this agreement along with the application form, the company
contact details, the details of Bond structure and also the STRPP details are to be attached.

A checklist is provided by the NSE, to ensure that all the formalities have been furnished and also all
the required documents are attached with the application form.

Along with the Listing agreement and the application form, a separate letter is sent to NSE stating
that:

 Undertaking that all the guidelines as issued by SEBI (Issues and Listing of Debt Securities),
Regulations, 2008, provisions of Companies Act, 1956 have been followed.
 Undertaking that Trust deed has not yet been executed and shall submit the true copy as
soon as it is done.
 Also an undertaking that the Offer document has been prepared as per SEBI ( Issues and
Listing of Debt Securities), Regulations, 2008

Apart from the above documents, a separate letter is sent to NSE regarding the Fee details. The
letter has the details of the previous listings of PGCIL Bonds, details of present listing along with the
maturity value, date of allotment etc... And since the fees is paid at the maximum cap of Rs. 7.5 Lakh
in advance, no further fees is needed to be paid for the present listing. Also a request is made to list
the present issue of bonds at WDM segment.

70

After, all the documents are submitted to NSE and all the formalities are fulfilled; an Intimation
letter from NSE is received stating that, the securities as specified in the agreement are duly listed
on WDM segment with effect from a date as mentioned.

After this the bonds are listed on the WDM segment of NSE and the investors are allowed to trade.
And NSE provides the monthly statistics of for daily price and the volume.

But after the trust deed is executed, a covering letter along with the Trust deed is sent to the NSE.

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Debt Servicing

The bonds are issued with a specific payment structure pre defined at the time of issue and
mentioned in the offer document/ information memorandum. For instance a bond may be issued
with the structure as Intrest paid half yearly with 3 years moratorium and 10 equal instalments. In
this case the Bond is divided into 10 STRPPs (Separately Transferable Redeemable Principal parts)
redeemable each year after 3 years of the issue. And the interest is paid on every 6 months on the
amount outstanding.

Also the interest payment and redemption date are also pre determined. Usually both the dates are
kept as the date on which the bonds are issued. The issue date of the bond series becomes its Intrest
and principal payment date.

By and large, the company issues its bonds with following structure:

 3 year moratorium period + 10 equal instalments
 1 year moratorium + 5 equal instalment
 4 year moratorium + 12 equal instalments
 5 years moratorium + 10 equal instalment

As on 31st of March, 2010, the total number of Bonds outstanding was 26, from series No.VI to XXXI,
(excluding the series no. VII), which is redeemed.

Thus the company has regular interest payments and principal payments scheduled over the year
depending upon the issue date. (The details of each bond along with the coupon rate, payment
structure and payment date has been made available in online appendix)

Before understanding the process, some of the terms need to be mentioned

Record Date

The bonds of the company are listed on NSE- WDM (Wholesale Debt market) Segment and are
traded. Thus the holding changes after every trade. For the purpose of payment of interest and
redemption of STRPPs, the book of transfers is closed a month before the scheduled interest
payment date. And the BO position as on the record date is considered and the interest is paid to
the holder on or before the Record date.

BO Position

The Beneficiary Owner position is the list of beneficial owners to whom the interest is to be paid. It
may or may not be the list of actual owner. For instance a person holding the security on record date
will be included in the BO position statement though he sells it after the record date. This position is
provided by the registrar to the company on record date of each issue.

72

Registrar

Registrar and Transfer agent is the party who records all the transfers took place. He is expected to
maintain a register of holders of each Bond along with the STRPP details and should update the
register after every transfer taking place. He is also required to provide the BO Position statement
whenever company asks for it.

Demat and Physical Holding

SEBI has necessitated that, all the issues of fresh equity and debentures must be in Demat Form. The
Demat (Dematerialised) implies in digital form instead of physical form. In this case the bonds are
traded electronically through the route of depositories. But the initial issues of bonds till XII issue,
the bonds were issued in Physical form i.e... In form of Physical Bond certificates. In this case the
transfers take place at individual level and the information is provided to the Registrar by either of
the investor.

Depository

Depository as the name signifies, it acts as the depository of the physical certificates of the
dematerialised securities. It is reservoir of the physical securities and issues dematerialised securities
replacing the physical form. And also it acts as the central body for transferring the securities into
different accounts based on the trading takes place. In India the two central depositories are
National Securities Depository Limited (NSDL) and Central Depository Services (India) Limited (CDSL).

Depository Participant (DP)

Depository Participant is similar to a commercial bank, if the Depository is regarded as Central bank.
It acts as the middleman between the investor and the central depository. It facilitates the trades of
his clients and holds his securities in Demat form on his behalf and maintains an account. The DPs
can be commercial banks, private brokers, Broker institutes etc... Some of the DPs in India are ICICI
Bank, Religare Securities, Motilal Oswal Securities Ltd., and Anand Rathi etc...

DP ID

The DP ID is the unique identification of each Depository participant. As similar to Bank code
required for a banking transaction, DP ID is requisite for any transaction in securities in Demat form.

Client ID

As mentioned before, each DP has clients. These clients are normal investors including individuals,
corporations and associations etc... The client ID is unique account number for the Demat account of
each client. This number is required for transferring securities in the clients account.

IFSC Code

The IFSC code stands for Indian Financial System Code. It is a unique code for each financial
institution in India. It is an 11 digit code, of which the first 4 represents bank code; the fifth character
is at present ‘0’ for all, which may be changed for further codes. The next 6 characters represent the

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Branch code. This unique code is used for reference of each branch of a bank. It is used for purpose
of Fund transfers in case of RTGS payment.

RTGS and NEFT

RTGS stands for Real Time Gross Settlement. The funds between banks can be transferred by way of
NEFT (National Electronic Fund Transfer) or RTGS. In case of NEFT, there is limitation in way of
transfer of funds. NEFT settlement takes place 6 times a day during the week days (9.30 am, 10.30
am, 12.00 noon. 1.00 pm, 3.00 pm and 4.00 pm) and 3 times during Saturdays (9.30 am, 10.30 am
and 12.00 noon). Any transaction initiated after a designated settlement time would have to wait till
the next designated settlement time.

RTGS system is a funds transfer mechanism where transfer of money takes place from one bank to
another on a "real time" and on "gross" basis. This is the fastest possible money transfer system
through the banking channel. Settlement in "real time" means payment transaction is not subjected
to any waiting period. The transactions are settled as soon as they are processed. "Gross settlement"
means the transaction is settled on one to one basis without bunching with any other transaction.
Considering that money transfer takes place in the books of the Reserve Bank of India, the payment
is taken as final and irrevocable. But in case of RTGS, the funds are transferred on Gross basis, i.e...
Funds are transferred as soon as the fund is received. But RTGS can be used only in case if amount
exceeds Rs. 1 lakh.

PAN

PAN stands for Permanent Account Number. It is unique code allotted by Central Board of Direct
Taxes (CBDT) for each tax payer. According to CBDT, the PAN number should be disclosed for all the
transactions exceeding Rs. 50,000. PAN is a 10 digit code of which the first five are Alpha, the next
four are Numerical and the last is an alphabet. And of these, the fourth character represents the
type of assessee. According to Income Tax Act 1961 Assessee is a' as a person by whom any tax or
any other sum of money is payable under this Act, and includes - Company (C), Association of person
(A), Person (P), HUF (H), Trust (T), Government (G). And the fifth character can be the last name of
the surname in case of person or the first name of the entity in case of company or association or
rest.

UTR No.

UTR stands for Unique Transaction Reference number. It is generated in case of a RTGS Transaction.
It is a 16 digit unique code used for future reference of any NEFT/ RTGS Transaction.

After understanding the above discussed terms, the Debt Servicing process can be understood
easily. The process of debt servicing starts with:

Master RTGS File

A Master RTGS file is maintained by the company which has details of all the investors of all the
bonds. It includes the details of all the previous as well as current investors. And the data required

74

for payment of interest like IFSC code, Account No. etc are taken from this file. The file has details
like:

Index No. : Unique no. for each investor for easy reference
Name of the Investor or Beneficiary
Bank name
IFSC code of the Bank Branch
Branch Name
Account Number of the Investor
MICR code
Contact person and his email and phone number
PAN Number
DP ID and
Client ID

BO position from RTA

After the record date of each issue, the BO position of that issue is requested from RTA. For Instance
for the issue XXV, whose interest payment is due on 12th June, the BO Position is asked from the RTA
in month of May. The BO position for Demat is provided in a digital copy and for the physical holding
(Remat) the statement is provided in a physical format. The details like DP Id, Client ID, name of the
Investor and his holdings are provided in the BO Position.

Checking the Availability of Details if the Beneficiary

After receiving the names of beneficial owners to whom the interest is to be remitted, the required
details for remitting the amount like IFSC code, Account Number, Bank and its Branch etc... are to be
gathered. For this purpose, first the Master RTGS file is referred to collect the data.

Call for Details

In case if the details of the BO are not available in the Master RTGS file, then in that case, a letter or
email is sent to the BOs asking for the details like Bank Name, Branch name, IFSC Code, Client ID, DP
ID, Account Number, PAN, Contact person and his contact number and email, etc...

The received details in reply from the BOs are indexed and the Master RTGS file is updated. In some
cases even after the letter or email, the BO does not respond, thus calls are to be made to them to
get the details.

List of Beneficiaries is sent to Bank

The list of beneficiaries to whom the interest and principal repayment is given to the banker with the
details required for RTGS or payment through cheque. The amount to be paid is also mentioned and
a cheque for the lump sum amount is given to the banker. The banker takes the responsibility of
remitting the funds to individuals as per the list given to it. IDBI bank acts as the banker for remitting
the funds.

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The company directs the Bank to remit the funds mostly by RTGS because it is most economical
method and also the safest and quickest mode of transfer. And also since most of the cases the
payment exceeds rs.1 lakh making the RTGS possible. Sometimes even NEFT mode is also used.

In case if the Beneficiaries Branch does not have RTGS facility or if he is unable to provide IFSC
details and wishes to receive the amount by cheque, post dated cheques are sent to such investors.

Payment Details from Banker

After the payment is made, the Bank provides the payment details for each issue separately under
RTGS and through cheque. It provides details like UTR No., Amount, Instrument status as in whether
the schedule has been generated or not, and Beneficiary description, beneficiary’s Bank and branch,
IFSC code etc... in case of RTGS payment.And in case if payment is made through cheques, the
details like Beneficiary name, Instrument Number ( the cheque number), Instrument amount,
Instrument date, Instrument status and liquidation date. The status may be paid or Unpaid
depending upon the encashment of the cheque. The status remains unpaid till the cheque is
presented for payment by the beneficiary’s bank or till the cheque is expired.

Reconciliation

After the details of payment are received, the Bonds department reconciles the total payment
through RTGS route and by Cheques mode with the total amount of cheque given to the bank for
the purpose.

In case of deviation, the entries are reconciled with the BO list provided to the bank.

In case of Single Investor

The Power Grid Corporation of India Limited issues its bonds by route of Private Placement. Thus
sometimes, the whole issue size is mobilised by single investor and usually it is Life Insurance
Corporation of India Limited (LIC). In this case since the interest and principal of that specific issue is
to be paid to the single party, the payment is made by the company itself and this job is not done
through the IDBI bank. The payment is made to it by RTGS. For instance in case of XVIII, XX and XXIV
issue, the sole investor is LIC, thus the payment is made to it directly.

76


Chapter IV
Characteristics of
Bonds
 Yield
 Duration
 Convexity
 Yield of PSU and GSec Bonds
 Duration of PSU and GSec Bonds
 Convexity of PSU and GSec Bonds

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Yield or IRR

The yield on any investment is the interest rate that will make the present value of the cash flows
from the investment equal to the present value (i.e... the price an investor pays to buy the
investment). Mathematically the yield cab be computed as

1 2 3
= + 2
+ 3
+ ……..+
1 + (1 + ) (1 + ) (1 + )

Here P= Present value
CF= Cash Flows (Intrest as well as principal for each year)
y = IRR/ Yield to Maturity
N = Tenure

There are different measures for the yield commonly quoted by the dealers and used by the
portfolio managers. Some of the Conventional measures are

Current Yield
As the name signifies it is the yield for the current period. It relates the annual cash flow to the
current market price. But here only Intrest receipt is considered and the other gains which affects
the yield like capital gain, discount price etc are ignored. The time value of money is also ignored.
Thus

=

This measure is commonly used by short term investors and also more suitable for short tenure
bonds.

Yield to Maturity
Yield to maturity is also the IRR of the future Cash Inflows as discussed before. Unlike the Current
yield, here all the gains in form of Intrest as well as Capital redemption are considered. Also the Time
value of money is considered. The formula for the same is

= + 2
+ 3
+ ……..+
+
1 + (1 + ) (1 + ) (1 + ) (1 + )

Here P= Price the Investor paid to get the Investment
C= Coupon Payment (half yearly or annual)
M = Principal Payment (Maturity value)
N= Number of Periods (Tenure X frequency)

Annualised Yield
In the above formula the payments may be annual or half yearly or even monthly. Thus the yield
obtained using above formula needs to be annualised if the payments are not on annual basis. Thus
the formula for the same is

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= (1 + ) − 1

Here Y= Annualised Yield
m= Frequency of payments (2 for half yearly and 12 for Monthly)

Yield to Call / Put
The bonds may be issued with the option of Call or Put. In case of option with Call, the issuer has the
right to call back the bond and pre-pay the amount after a predetermined period. The issuer uses
this option in case of availability of alternative sources of cheaper funds. The investor is under
obligation to sell the bonds if the issuer exercises the option.

Similarly the Bonds can be issued with the Put Option where the Investor is given right to sell the
Bonds i.e... Put the bonds to the issuer at any time after a predetermined period. The investor uses
this option in case if he has more profitable avenues to invest when compared to the bonds.

Thus the Yield is computed for different options like Yield to First call (for the bonds which are not
presently callable), Yield to next call (for the bonds which are currently callable), Yield to Refunding,
etc.... Yield to Worst is the lowest yield rate of every possible call and put date.

Price- Yield Relationship

A Fundamental property of a bond is that the price changes in the opposite direction from the
change in yield. The reason or the justification for the same could be, the present price is discounted
future cash flow of the bond and the discount rate being used is the required yield. In case of
increase in the yield i.e... The discount rate increases and leads to the fall in the present value of the
future cash flows which leads o fall in the price and vice versa.

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Duration

A bond's maturity measures the time to receipt of the final principal repayment and, therefore, the
length of time the bondholder is exposed to the risk that interest rates will increase and devalue the
remaining cash flows. Although it is typically the case that, the longer a bond's maturity, the more
sensitive its price is to changes in interest rates, this relationship does not always hold. Maturity is an
inadequate measure of the sensitivity of a bond's price to changes in interest rates, because it
ignores the effects of coupon payments and prepayment of principal.

Duration is the measure for the sensitivity of the Bonds. As discussed before there is a negative
relationship between yield and price. A change in yield would lead to a change in price. Thus the
duration measures the impact of change in yield on change in price.

Macaulay’s Duration
Dr. Fedrick Macaulay has coined this term and used this measure rather than a maturity as a proxy
for the average length of the time that a bond investment is outstanding. Macaulay recognized this
distinction and determined that the time to receipt of each cash flow should be weighted, not by the
relative magnitude of the cash flow, but by the present value of its relative magnitude. Macaulay's
duration, therefore, equals the average time to receipt of a bond's cash flows, in which each cash
flow's time to receipt is weighted by its present value as a percentage of the total present value of
all the cash flows. The sum of the present values of all the cash flows, of course, equals the price of
the bond. The formula for the same is

1 2
+ + …….+ + (1 + )
1 + (1 + )2 (1 + )
=

Here C= Coupon Inflows
y = IRR/ Yield
M= Maturity Amount (Redemption Amount)
n= Number of Periods
P= Price

Modified Duration
The ratio of Macaulay’s Duration to (1+yield) is commonly termed as Modified Duration. The
Modified duration is the approximate percentage change in price for a given change in yield.
Although Macaulay conceived of duration as a measure of the effective life of a bond, it can be
modified to measure the sensitivity of a bond's price to changes in the yield to maturity. The
modification simply requires dividing Macaulay's duration by the quantity one plus the yield to
maturity,
′
=
(1 + )

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Convexity

The duration is the measure of volatility. But it depicts a linear relationship between the Price and
yield. But in reality it is not a case. The relationship between Yield and the price may not be linear
and it could be collinear. Thus the Convexity is the second derivative measure of relationship
between [rice and the yield.

In finance, convexity is a measure of the sensitivity of the duration of a bond to changes in interest
rates. There is an inverse relationship between convexity and sensitivity - in general, the higher the
convexity, the less sensitive the bond price is to interest rate shifts, the lower the convexity, the
more sensitive it is.

As discussed before Duration is a linear measure or 1st derivative of how the price of a bond
changes in response to interest rate changes. As interest rates change, the price is not likely to
change linearly, but instead it would change over some curved function of interest rates. The more
curved the price function of the bond is, the more inaccurate duration is as a measure of the interest
rate sensitivity.

Convexity is a measure of the curvature or 2nd derivative of how the price of a bond varies with
interest rate, i.e. how the duration of a bond changes as the interest rate changes. Specifically, one
assumes that the interest rate is constant across the life of the bond and that changes in interest
rates occur evenly. Using these assumptions, duration can be formulated as the first derivative of
the price function of the bond with respect to the interest rate in question. Then the convexity
would be the second derivative of the price function with respect to the interest rate.

The formula for computing the convexity is

+ 1
1 + +2
= /2
100

Here t= Time period No.
CF= Cash Flow (Interest and Principal)
r = Yield
m= Frequency of Debt Servicing

In actual markets the assumption of constant interest rates and even changes is not correct, and
more complex models are needed to actually price bonds. However, these simplifying assumptions
allow one to quickly and easily calculate factors which describe the sensitivity of the bond prices to
interest rate changes.

81


Yield of PSU and GSec Bonds

Bonds have become a very important source of long term funds for Government of India (Both
Central and State Government) and also the corporations including private sector and also public
sector. Different issuers have different structure of their bond with different repayment structure,
differing interest rates and different terms. For Instance the GSec (acronym for the securities issued
by Government of India through Reserve Bank of India) is repaid at the end of tenure where as
bonds of Power Grid Corporation of India Limited are repaid in 12 equal instalments. Also the
frequency of Intrest payment would differ and they may be quarterly, half yearly or even annual.
Thus it is per se necessary to compute yields and other parameters of different bonds.

Selection of Bonds
For the purpose of study all the bonds which are issued by the Power Grid Corporation of India
Limited till date and are yet to be redeemed are considered. Apart from this two bonds of the Power
Finance Corporation which have similar issue and redemption date with that of two Power Grid
Corporation of India Limited’s bonds and also two GSec bonds having similar Maturity to that of the
two selected PFC Bonds are selected.

The summary of the bonds selected is

Bond Date of Issue Tenure Average Redemption Duration to Coupon Present
Description Tenure Date Maturity ( Rate Value ( Rs.
Yrs) Crores)
PGXIII 31.07.2002 15 9 31-7-2017 7.333333333 8.63% 1.133466
PGXIV 17.07.2003 12 7 17-7-2015 5.297222222 6.10% 0.705981
PGXV 23.02.2004 15 9 23-2-2019 8.897222222 6.68% 1.139539
PGXVI 18.02.2005 13 8 18-2-2018 7.883333333 7.10% 1.122116
PGXVII 22.09.2005 13 8 22-9-2018 8.477777778 7.39% 1.27544
PGXVIII 09.03.2006 15 9 09-3-2021 10.94166667 8.15% 1.375
PGXIX 24.07.2006 15 9 24-7-2021 11.31666667 9.25% 1.4997551
PGXX 07.09.2006 15 9 07-9-2021 11.43611111 8.93% 1.5
PGXXI 11.10.2006 15 9 11-10-2021 11.53055556 8.73% 1.5046713
PGXXII 07.12.2006 15 9 07-12-2021 11.68611111 8.68% 1.494723
PGXXIII 09.02.2007 15 9 09-2-2022 11.85833333 9.25% 1.5
PGXXIV 26.03.2007 15 9 26-3-2022 11.98888889 9.95% 1.5
PGXXV 12.06.2007 15 9 12-6-2022 12.2 10.10% 1.4917073
PGXXVI 07.03.2008 15 9 07-3-2023 12.93611111 9.30% 1.5
PGXXVII 31.03.2008 15 9 31-3-2023 13 9.47% 1.5065713
PGXXVIII 15.12.2008 15 9 15-12-2023 13.70833333 9.33% 1.568498
PGXXIX 12.03.2009 15 9 12-3-2024 13.95 9.20% 1.535168
PGXXX 29.09.2009 15 9 29-9-2024 14.49722222 8.80% 1.517222
PGXXXI 25.02.2010 15 9 25-2-2025 14.90277778 8.90% 1.507589
PGXXXII 29.03.2010 15 9 29-3-2025 14.99722222 8.84% 1.5

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PFC ( S-57) 07-08-2009 15 10 07-08-2024 14.35277778 8.60% 99.43469
PFC 8.85% 31-05-2006 15 10 31-05-2021 11.16666667 8.85% 100.089
2021(S-XXVIII)
GOI LOAN 30-05-2001 15 15 30-05-2021 11.16666667 10.25% 115.259
10.25% 2021
GOI LOAN 15-09-2009 15 15 15-09-2024 14.45833333 8.20% 999
8.20% 2024 OIL
BOND
Table 11 List of Bonds selected for Study

Bond Description: The PG implies bonds issued by Power Grid Corporation of India Limited and the
subsequent roman number implies the series number of the bond. Each bond issue is numbered and
given an identification nomenclature. For Power Grid Corporation of India Limited till date it has
issued 32 bond series. Similarly for Power Finance two bonds of 28th series and 57th series are
selected. And the last two entries are the bond issued by Central Government of India.

Date of Issue: This date is relevant to compute the tenure, average tenure and also all the payments
of interest and capital redemption are made with reference to the date of issue.

Tenure: The tenure is the absolute number of years between the issue date and the redemption
date. It is the period for which the bond will remain active and servicing of debt needs to be done.

Average Tenure: Bonds may be issued with a moratorium period followed by Instalment payment.
For example the Power Grid Corporation of India Limited issues bonds with the moratorium period
of 4 years and followed by 12 equal annual instalments. Thus in this case, for the initial 3 years only
interest will be paid and from the year 4 onwards along with the interest the 12 th part of loan
amount will be repaid. Thus the average tenure will be 3 years + 12/2 years i.e... 9 years. And in case
of Power Finance’s Bond Series 5710, the repayment is done in 3 equal 5 yearly instalments. Thus
though the tenure is 15 years, the average tenure will be 10 years And in case of G-Sec the amount
is repaid at end of tenure thus the tenure and average tenure will be same.

Redemption Date: As the name clearly signifies it is the date on which the whole principal
outstanding is to be redeemed. This date is useful in computing the Years to Maturity.

Duration to Maturity: Duration to maturity implies number of years remained for the bond to
mature. It is just a gap between Today’s date and the maturity date. This figure is relevant for the
investor as he can know the period for which the bond is to be held. Also the volatility and sensitivity
is the function of years remained for maturity.

Coupon Rate: The coupon rate is the rate of Intrest the issuer pays on the face value of the
outstanding bond. This coupon rate may be determine by the issuer or is determined by the Book
Building process. It is one of the important parameter in determining the yield, duration and
convexity.

9
The Present value is the Index value as published by NSE in its Monthly Trade history. In this case the face
value has been taken as 100.
10
Source: The Information memorandum published for before the specific issue of PFC,

83

Present Value: The present value is last traded price of the bond. Though the bond market is not
much developed in India, the trading of these bonds takes place in Wholesale Debt Market (WDM)
of NSE. And the bonds issued by Power Grid Corporation of India Limited are in form of 12 STRPPs
(Separately Tradable Redeemable Principal Parts) which have different maturity period since one
STRPP is redeemable every year after the moratorium period. Also the trading takes place differently
for each STRPP. And since the cost of each Bond is Rs. 1.5 Crores, the value of each STRPP will be Rs.
12.5 lakh. Similarly in case of Bonds of Power Finance, the Bond consists of 3 STRPPs redeemable
every 5 years. The assumptions and process of computation of present values is as follows:

 From the data available at NSE website11, the present value of each STRPP was taken
 Average of all the outstanding STRPPs of each bond was computed. For Instance the bond
PGXIV has 6 STRPPs outstanding, thus the average of the 6 is considered as the present
value
 In case if any STRPP is not traded, the present value is taken as 100. The NSE has the
practice of publishing Indexed present value. Since Bonds have different face values ranging
from Rs 10 lakh to Rs.2 Crores, the values is published with the base as 100. Thus the
Present value of 99 implies the value is down by 1% from its actual face value and vice versa
for the case of 101.
 In case of Power Grid Corporation of India Limited Bonds the index value is multiplied with
the face value of the partial bond i.e... (Sum of Face values of the outstanding STRPPs). For
Instance for PGXVI series the face value of Bonds was Rs. 1.5 Crores with 10 STRPPs thus the
face value of each STRPP is Rs 15 Lakh. As on 31st March 2010, the no. of STRPPs
outstanding is 8. Thus the Index value was multiplied by Rs. 1.2 Crores i.e... 8X15 Lakh.

Computation of Yield to Maturity
For computing the Yield to Maturity all the future cash flows need to be forecasted. Since the
coupon rate is predetermined and also the redemption schedule is predefined, the cash flows can be
determined easily. In case of Floating rate, since there is uncertainty on the rate of interest,
estimation of margin needs to be done.

Following is the computation of Yield for the bond PGXXXI, which has 4 years Moratorium period
with 12 equal instalments to be annually at a coupon rate of 8.90%. The table of future cash flows
and the present value as on 31st March 2010 is used to compute IRR (Yield to maturity).

Year Interest Principal Opening Total
Balance Payments

2010 0 0 0 -1.50759
2011 0.1335 0 1.5 0.1335
2012 0.1335 0 1.5 0.1335
2013 0.1335 0 1.5 0.1335
2014 0.1335 0.125 1.5 0.2585
2015 0.122375 0.125 1.375 0.247375
2016 0.11125 0.125 1.25 0.23625

11
The Monthly Trading report of WDM Segment for March 2010 available on www.nse-india.com

84

2017 0.100125 0.125 1.125 0.225125
2018 0.089 0.125 1 0.214
2019 0.077875 0.125 0.875 0.202875
2020 0.06675 0.125 0.75 0.19175
2021 0.055625 0.125 0.625 0.180625
2022 0.0445 0.125 0.5 0.1695
2023 0.033375 0.125 0.375 0.158375
2024 0.02225 0.125 0.25 0.14725
2025 0.011125 0.125 0.125 0.136125
Table 12 Yield to Maturity of PG XXXI

Using the IRR Function of the column ‘Total Payments’ Yield to Maturity is computed; in the year
2010 the negative value is the present value of the bond. The negative value implies it is outflow for
the Investor and for the subsequent years the amounts are inflows.

The Yield to Maturity of this Bond as on 31st March 2010 is 8.816%. The yield is less than the Coupon
rate because the present value is more than the face value. This implies that the investor is paying
more amount than the value of that bond.

Similarly in case of GSec Bonds whose redemption is on maturity after 20 years with years to
maturity being 12 years with the coupon rate of 10.25%.

Year Intrest Principal Opening Total Payments( C)
Balance
2010 0 0 0 -115.25
2010 10.25 0 100 10.25
2011 10.25 0 100 10.25
2012 10.25 0 100 10.25
2013 10.25 0 100 10.25
2014 10.25 0 100 10.25
2015 10.25 0 100 10.25
2016 10.25 0 100 10.25
2017 10.25 0 100 10.25
2018 10.25 0 100 10.25
2019 10.25 0 100 10.25
2020 10.25 0 100 10.25
2021 10.25 100 100 110.25
Table 13 Computation of Yield of GSec Bond

The Yield to Maturity of this Bond as on 31st March 2010 is 8.205%.

85

Computation of Current Yield
The Current Yield as defined before is the yield to the investor for one year. If holds the bonds or any
investment for the period of 1 year. It is just a ratio of Coupon rate and the face value. Thus say for
Bond PGXXXI the Current yield will be 8.86% for the coupon rate of 8.90% and present value of Rs.
1.5075 Crores. And for the GSec Bond with coupon rate of 10.25%, the Current Yield is 8.89%
because of its high market value.

Similarly Yield to Maturity and Current Yield of all the Bonds are as follows:

Bond Duration to Coupon Face Present YTM Current Yield
Maturity Rate Value Value
(Rs. Crs.) (Rs. Crs.)
XXXII 14.997222 8.84% 1.5 1.5 8.840% 8.84%
XXXI 14.902778 8.90% 1.5 1.507589 8.816% 8.86%
XXX 14.497222 8.80% 1.5 1.517222 8.612% 8.70%
XXVIII 13.708333 9.33% 1.5 1.568498 8.521% 8.92%
XXVII 13 9.47% 1.5 1.5065713 9.382% 9.43%
XXVI 12.936111 9.30% 1.5 1.5 9.300% 9.30%
XXV 12.2 10.10% 1.5 1.4917073 10.215% 10.16%
XXIX 13.95 9.20% 1.5 1.535168 8.780% 8.99%
XXIV 11.988889 9.95% 1.5 1.5 9.950% 9.95%
XXIII 11.858333 9.25% 1.5 1.5 9.250% 9.25%
XXII 11.686111 8.68% 1.5 1.494723 8.758% 8.71%
XXI 11.530556 8.73% 1.5 1.5046713 8.661% 8.70%
XX 11.436111 8.93% 1.5 1.5 8.930% 8.93%
XVIII 10.941667 8.15% 1.5 1.375 8.150% 8.89%
XVII 8.4777778 7.39% 1.375 1.27544 8.873% 7.97%
XVI 7.8833333 7.10% 1.35 1.122116 8.995% 8.54%
XV 8.8972222 6.68% 1.2 1.139539 6.359% 7.03%
XIX 11.316667 9.25% 1.125 1.4997551 9.254% 6.94%
XIV 5.2972222 6.10% 0.75 0.705981 8.153% 6.48%
XIII 7.3333333 8.63% 1 1.133466 5.141% 7.61%
PFC ( S-57) 14.352778 8.60% 100* 99.4346* 8.691% 8.65%
GOI LOAN 8.20% 2024 14.458333 8.20% 100* 99* 8.335% 8.28%
OIL BOND
GOI LOAN 10.25% 2021 11.166667 10.25% 100* 115.25* 8.205% 8.89%
Table 14 YTM and Current Yield of All Bonds

Some of the important analysis is:

 For all the Bonds, if market value is less than the present face value (i.e. Face Value less
redeemed value), the Yield to Maturity will be more than the coupon rate. The rationale
behind this is that the investor to own the security is paying more amount than its Face
value. Thus the overall yield will be less than the coupon rate. And the Yields will be more if
the face value is less than the face value.

86

 Similar is the case with the Current Yield. The coupon rate is calculated on the face value
whereas the investor will calculate his yield on his investment which is based on market
value, thus lower the market value, higher the Yield.

Yield- Coupon-Price
12.00%

10.00%

8.00%
Coupon/ Yield

6.00% Coupon Rate
YTM
4.00%
Current Yield
2.00%

0.00%
-2 0 2 4 6 8 10 12 14 16 18
Difference in PV and FV

 From the above chart it is clearly visible that both the yields are lower than the coupon rate
when the difference in Present market Value and the present face value is positive. In other
words when the present value is more than the face value.
 Also the current yield is less than the Yield to Maturity in case of a small difference, but The
current yield will be more than the YTM in case of a large difference, this is because, the
large difference will promise high returns in short term if the security is held for short
duration but in case of a long duration, the present high returns will be normalised and the
overall YTM will be reduced.

Maturity- Yields
12.000%

10.000%

8.000%
Yields

6.000%
YTM
4.000%
Current Yield
2.000%

0.000%
3 5 7 9 11 13 15 17
Years to Maturity ( Yrs.)

87

 From the relationship between the Yield and the Duration (years to maturity), it can be seen
that, less the duration to Maturity, more deviation in Current Yield and YTM. The Yield to
maturity is computed by calculating the future cash flows, in case if the present value is
higher and the years for which the cash flows are to be estimated are less, this would lead to
lower yields. And the reverse situation in a vice versa case.

Price-Yield Relationship
A fundamental principle of an option free bond (i.e... a bond without any call / put option embedded
with it) is that the price of the bond changes in a direction opposite to that of change in the required
yield for the bond. But the relationship may be linear, collinear or quadratic. Thus it is necessary to
determine the price-yield relationship. This relationship when plotted on a graph will give Yield-
Curve. The Yield Curve is used by the investors and also valuators of the bond to measure the
volatility and also the sensitivity.

The Price Yield curve for PGXXX bond which has a coupon rate of 8.80% and Maturity of 15 years is

Yield Curve -PGXXX
3
2.5
2
Price

1.5
1
PRICE
0.5
0
0.00% 5.00% 10.00% 15.00% 20.00% 25.00% 30.00% 35.00% 40.00%
Yield

Figure 33 Yield Curve of PGXXX

Similarly the Yield curve for GSec Bond of coupon rate 8.20% and Maturity of 14.5 years is

Yield Curve- GSec 8.20%
200

150
Price

100

50 Price

0
0.000% 5.000% 10.000% 15.000% 20.000% 25.000%
Yield

Figure 34 Yield Curve of GSec 8.20%

88

And the Yield Curve for PFC Bond 57 of Coupon rate of 8.60% and the Maturity of 14.5 Years
(approx.)

Yield Curve - PFC Bond 57
200

150
Price

100

50 Price

0
0% 3% 6% 9% 12% 15% 18% 21% 24% 27% 30% 33% 36% 39%
Yield

Figure 35 Yield Curve of PFC (S-57)

From the above three yield curves of different Bonds namely of Power Grid Corporation of India
Limited , Government of India and Power Finance Corporation, some of the observations that can be
made are:

 The Yield Curve of all the three Bonds is curvilinear and not exact linear.
 The Curve of PG Bond is curvilinear for the higher prices and is linear for the lower prices.
This implies, the yield would be less responsive to the rise in price but it will be high
responsive to the fall in price.
 The GSec Bond is perfectly curvilinear because of its redemption pattern. IT is redeemed as a
bullet payment after its tenure unlike the Power Grid Corporation of India Limited bonds
which are redeemed in instalments.
 The sensitivity and convexity of the bonds can be measured with more accuracy using tools
like Convexity, Modified Duration etc...

89


Duration of PSU and GSec Bonds

After computing and analysing the Yield of each bond and Yield curve, it is also necessary to analyse
the Duration of the selected bonds. As mentioned before the Macaulay’s Duration is effective
tenure of the bonds. In simple words it is time period after which the investor will receive back his
investment at a particular yield to maturity. Macaulay's duration, therefore, equals the average time
to receipt of a bond's cash flows, in which each cash flow's time to receipt is weighted by its present
value as a percentage of the total present value of all the cash flows.

As mentioned before, The Macaulay’s Duration is Time weighted, present values of the future cash
flows. Thus to compute the Macaulay’s Duration, The cash flows must be multiplied by the
respective time period, and its present value needs to be computed. The ratio of sum of the present
values of Time weighted future cash flows and the current price of that bond results in Macaulay’s
Duration. Thus the formula used is:

1 2
1 + + (1 + )2 + … … . + (1 + ) + (1 + )
=

Here C= Coupon Inflows
y = IRR/ Yield
M= Maturity Amount (Redemption Amount)
n= Number of Periods
P= Price

And Modified Duration which shows the sensitivity of the bond prices with respect to the yield. In
other words it shows the change in price with the change in Yield. It is computed by dividing the
Macaulay’s Duration by 1+Yield i.e... (1+y)

Following is the computation of Macaulay’s Duration and Modified Duration for the bond PGXXXI,
which has 4 years Moratorium period with 12 equal instalments to be annually at a coupon rate of
8.90%. The table of future cash flows and the present value as on 31st March 2010 was used to
compute IRR (Yield to maturity). And the same IRR is used to discount and get the present values of
time weighted Cash flows.

Period Year Total Payments (1+r)^n N*C N*C/(1+r)^n
(N) (C) r=8.816%
0 2010 -1.50759 1 0 0
1 2011 0.1335 1.088162 0.1335 0.122684
2 2012 0.1335 1.184098 0.267 0.225488
3 2013 0.1335 1.28849 0.4005 0.310829
4 2014 0.2585 1.402087 1.034 0.737472
5 2015 0.247375 1.525698 1.236875 0.810694
6 2016 0.23625 1.660208 1.4175 0.853809
7 2017 0.225125 1.806576 1.575875 0.872299

90

8 2018 0.214 1.965848 1.712 0.870871
9 2019 0.202875 2.139162 1.825875 0.853547
10 2020 0.19175 2.327756 1.9175 0.823755
11 2021 0.180625 2.532976 1.986875 0.784403
12 2022 0.1695 2.75629 2.034 0.737949
13 2023 0.158375 2.999291 2.058875 0.686454
14 2024 0.14725 3.263716 2.0615 0.631642
15 2025 0.136125 3.551453 2.041875 0.574941
Sum (1) 9.896837
Price(Present Value) (2) 1.507589
Macaulay’s Duration= (1)/ (2) 6.564678
Modified Duration 6.032811
Table 15 Modified and Macaulay's Duration of PGXXXI

The Macaulay’s Duration is sum of the discounted time weighted values of the future cash flows as
on 31st March 2010. In this case the present value being Rs. 1.507589 Crores, The Macaulay’s
Duration is 6.564678 years. This implies the investor at the present yield of 8.816%, can get back his
investment in 6.5 years, though the years to maturity are 15 years.

And the Modified Duration, which is ratio of Macaulay’s Duration and 1+Yield to maturity, is
6.032811. This implies for every 1 basis point change in the yield, the price will change in a reverse
direction by 6 basis points. Similarly in case of GSec Bonds whose redemption is on maturity after 20
years with years to maturity being 12 years with the coupon rate of 10.25%.

Period Year Total Payments (1+r)^n N*C N*C/(1+r)^n
(N) ( C) r=8.205%
0 2010 -115.25 1 0 0
1 2010 10.25 1.08204869 10.25 9.472771505
2 2011 10.25 1.17082937 20.5 17.50895609
3 2012 10.25 1.26689438 30.75 24.27195225
4 2013 10.25 1.37084141 41 29.90863839
5 2014 10.25 1.48331715 51.25 34.55093872
6 2015 10.25 1.60502138 61.5 38.31724657
7 2016 10.25 1.73671128 71.75 41.31371789
8 2017 10.25 1.87920617 82 43.63544636
9 2018 10.25 2.03339257 92.25 45.36753068
10 2019 10.25 2.20022977 102.5 46.58604357
11 2020 10.25 2.38075574 112.75 47.35891128
12 2021 110.25 2.57609363 1323 513.5682892
Sum (1) 891.8604425
Price(Present Value) (2) 115.25*
Macaulay’s Duration= (1)/ (2) 7.738485401
Modified Duration 7.151698
Table 16 Modified and Macaulay's Duration of GSec

91

Here the present value is in index points as published by NSE WDM Segment. This index implies for
the face value of 100 points, the present value in market is 115.25 points. For simplicity and accuracy
in calculation, 100 have been used as the face value for computing the coupon payments.

The Macaulay’s Duration turns up to 7.74 years (Approx) and Modified Duration is 7.15. Every one
basis point increase in the yield would lead to 7.74 basis point fall in the price.

Similarly the Macaulay’s Duration and Modified Duration of each of the Bonds is summarised in the
following table:

Bond Duration to Maturity Coupon YTM Macaulay's Modified
(Years) Rate Duration Duration
XIV 5.2972222 6.10% 8.153% 3.128941 2.89307
XVI 7.8833333 7.10% 8.995% 3.782077 3.469942
XIII 7.3333333 8.63% 5.141% 3.919007 3.72737
XVII 8.4777778 7.39% 8.873% 4.099708 3.765581
XV 8.8972222 6.68% 6.359% 4.269027 4.013794
XVIII 10.941667 8.15% 8.150% 4.720113 4.364413
XXIV 11.988889 9.95% 9.950% 4.760437 4.329638
XIX 11.316667 9.25% 9.254% 4.850537 4.439701
XXIII 11.858333 9.25% 9.250% 4.850878 4.440163
XX 11.436111 8.93% 8.930% 4.893468 4.492305
XXII 11.686111 8.68% 8.758% 4.919947 4.523764
XXI 11.530556 8.73% 8.661% 4.926986 4.534258
XXV 12.2 10.10% 10.215% 5.295218 4.804435
XXVII 13 9.47% 9.382% 5.413836 4.949495
XXVI 12.936111 9.30% 9.300% 5.432109 4.969907
XXIX 13.95 9.20% 8.780% 6.037437 5.550137
XXVIII 13.708333 9.33% 8.521% 6.057109 5.58152
XXXI 14.902778 8.90% 8.816% 6.564678 6.032811
XXXII 14.997222 8.84% 8.840% 6.567683 6.034255
XXX 14.497222 8.80% 8.612% 6.60183 6.07838
PFC ( S-57) 14.352778 8.60% 8.691% 6.761574 6.220913
GOI LOAN 10.25% 11.166667 10.25% 8.205% 7.738485 7.151698
2021
GOI LOAN 8.20% 14.458333 8.20% 8.335% 8.049266 7.429977
2024 OIL BOND
Table 17 Macaulay's and Modified Duration of All Bonds

From the above table of summary, some of the observations that can be made are:

 Modified and Macaulay’s duration are less than Maturity. This implies that, though the
security has a longer maturity, but the investor can get back his investment sooner than the
redemption date.
 And also, the Modified duration is always less than the Macaulay’s Duration.

92


Duration
9
8
7
6
Duration

5
Macaulay's Duration
4
3 Modified Duration
2
1
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23

Figure 36 Modified Vs Macaulay's Duration

 For same maturity bonds, Lower the coupon greater the duration
 With all factors constant, Longer the maturity, greater the modified duration

Duration- Maturity
7
6
5
Maturity

4
3 Macaulay's Duration
2 Modified Duration
1
0
0 5 10 15 20
Duration

Figure 37 Duration Vs Maturity

 With all factors constant, Lower the coupon rate, greater the modified duration
 With all factors constant, Lower the yield, greater the modified duration

93


Duration- Yield
8

7
Duration

6
Macaulay's Duration
5
Modified Duration
4
7.000% 8.000% 9.000% 10.000%
Yield

Figure 38 Duration Vs Yield

 Also, it can be seen that, among the Power grid bonds and PFC bonds and also GSec bonds,
the Power grid Bonds have less Duration, both the Macaulay’s and modified are less.
 Though the years to Maturity and coupon rate are almost same for PGXXX, PFC (S-57) and
GOI LOAN 8.20% 2024 OIL BOND, the Macaulay’s Duration and Modified Duration differ and
it is lowest for the PGXXX followed by PFC (S-57) and then GOI Loan 8.20%. The main reason
behind this is the repayment structure. In case of Power Grid, the repayment of principal is
done annually after 3 years, and in case of PFC the principal is repaid in each 5 years and in
case of GOI, it is paid only on maturity. Thus the repayment also affects the Bonds Duration.

94


Convexity of PSU and GSec Bonds

Convexity is the measure of sensitivity of duration of bond to the change in yield. As discussed
before, the Modified Duration also measures the sensitivity of bond price to the change in Yield. But
the modified duration predicts the relationship more accurately in case of small change in the yield.
There is a scope of error in case of larger change in the yield. Thus Convexity measures the
sensitivity of Duration, which further predicts the sensitivity of bonds.

Duration is a linear measure or 1st derivative of how the price of a bond changes in response to
interest rate changes. As interest rates change, the price is not likely to change linearly, but instead it
would change over some curved function of interest rates. The more curved the price function of the
bond is, the more inaccurate duration is as a measure of the interest rate sensitivity.

Convexity is a measure of the curvature or 2nd derivative of how the price of a bond varies with
interest rate, i.e. how the duration of a bond changes as the interest rate changes. Specifically, one
assumes that the interest rate is constant across the life of the bond and that changes in interest
rates occur evenly. Using these assumptions, duration can be formulated as the first derivative of
the price function of the bond with respect to the interest rate in question. Then the convexity
would be the second derivative of the price function with respect to the interest rate.

In actual markets the assumption of constant interest rates and even changes is not correct, and
more complex models are needed to actually price bonds. However, these simplifying assumptions
allow one to quickly and easily calculate factors which describe the sensitivity of the bond prices to
interest rate changes.

For computing the convexity following formula is used:

+ 1
1 + +2
= /2
100

Here:

t= corresponding period of the payment, (1 for first payment)
C= Coupon Flows
r= Yield to Maturity
m= frequency of Intrest payment in a year (2 for half yearly)

Following page has the computation of Convexity for the bond PGXXXI, which has 4 years
Moratorium period with 12 equal instalments to be annually at a coupon rate of 8.90%. The table of
future cash flows and the present value as on 31st March 2010 was used to compute IRR (Yield to
maturity). And the same IRR is used as discount rate (r).

95

Period Year Total 1/(1+r)^t+2 t(t+1)C t(t+1)C /
Payments (1+r)^t+2)
0 2010 -1.50759 0.843226 0 0
1 2011 0.1335 0.774313 0.267 0.206741481
2 2012 0.1335 0.711031 0.801 0.569535759
3 2013 0.1335 0.652921 1.602 1.045979356
4 2014 0.2585 0.59956 5.17 3.099725703
5 2015 0.247375 0.55056 7.42125 4.085845154
6 2016 0.23625 0.505565 9.9225 5.016468269
7 2017 0.225125 0.464247 12.607 5.852761609
8 2018 0.214 0.426306 15.408 6.568519178
9 2019 0.202875 0.391465 18.25875 7.147667886
10 2020 0.19175 0.359472 21.0925 7.582169706
11 2021 0.180625 0.330094 23.8425 7.870264977
12 2022 0.1695 0.303117 26.442 8.015008446
13 2023 0.158375 0.278344 28.82425 8.023055926
14 2024 0.14725 0.255596 30.9225 7.903664961
15 2025 0.136125 0.234707 32.67 7.667877721
Sum 80.65528613
2
(Sum/100)/m 0.806552861
Table 18 Convexity of PGXXXI

The convexity of the above bonds turns up to 0.806; this implies a one basis point change in yield
would lead to 0.806 basis points change in duration.

Similarly the Convexity of the other bonds is as summarised in the following table:

Bond Duration to Coupon Rate YTM Convexity
Maturity
XIV 5.2972222 6.10% 8.153% 0.10768
XVI 7.8833333 7.10% 8.995% 0.24911
XIII 7.3333333 8.63% 5.141% 0.19280
XVII 8.4777778 7.39% 8.873% 0.32667
XV 8.8972222 6.68% 6.359% 0.28267
XVIII 10.941667 8.15% 8.150% 0.42211
XXIV 11.988889 9.95% 9.950% 0.46356
XIX 11.316667 9.25% 9.254% 0.48399
XXIII 11.858333 9.25% 9.250% 0.48399
XX 11.436111 8.93% 8.930% 0.49372
XXII 11.686111 8.68% 8.758% 0.50151
XXI 11.530556 8.73% 8.661% 0.49994
XXV 12.2 10.10% 10.215% 0.54853
XXVII 13 9.47% 9.382% 0.57145
XXVI 12.936111 9.30% 9.300% 0.57785

96

XXIX 13.95 9.20% 8.780% 0.68333
XXVIII 13.708333 9.33% 8.521% 0.67719
XXXI 14.902778 8.90% 8.816% 0.80655
XXXII 14.997222 8.84% 8.840% 0.81014
XXX 14.497222 8.80% 8.612% 0.81255
PFC ( S-57) 14.352778 8.60% 8.691% 0.59129
GOI LOAN 10.25% 2021 11.166667 10.25% 8.205% 0.65486
GOI LOAN 8.20% 2024 OIL 14.458333 8.20% 8.335% 0.76856
BOND
Table 19 Convexity of All Bonds

From the above summary of convexity of different bonds, some of the analyses that can be made
are:

 Higher the convexity implies more sensitive the prices of the bonds are.
 For the bonds, whose present value is more than its face value (this can be verified by
looking at Coupon rate and YTM, if YTM is more than Coupon rate implies the Present value
is less than the face value and vice versa), the Convexity is low, this signifies that, since the
price is already high, the sensitivity of the same is decreased.
 Also in case if Present value is less than the face value (i.e... YTM is less than the coupon
rate), the Convexity is high implying that the sensitivity of the price is high.
 Also it can be seen that, there is a Direct relationship between the Years to Maturity and
Convexity. In other words Bonds with more years to mature are more sensitive when
compared to the bonds with shorter maturity. This is mainly because of uncertainty of the
yield to be remaining constant, and thus the change in yield would impact the prices highly.

Duration-Convexity
16
14
Years to Maturity

12
10
8
6
4
2
0
0.00000 0.20000 0.40000 0.60000 0.80000 1.00000
Convexity

Figure 39 Duration Vs Convexity

 Also among the bonds having same maturity, there is inverse relationship between the
Coupon rate and the convexity. The higher the coupon rate, lesser the convexity. This is

97

bacause, since all the bonds will be matured in the same year, the bonds with higher coupon
rate will be less sensitive to the changes in intrest rates ( Yield) and the oppostie trend in
case of bo0nds with lower coupon rate.

Coupon Rate- Convexity-Maturity
10.20%
10.00%
9.80%
Coupon Rate

9.60%
9.40%
9.20%
9.00%
8.80%
8.60%
0.46000 0.47000 0.48000 0.49000 0.50000 0.51000
Convexity

Figure 40 Coupon Rate Vs Convexity (Same Maturity)

 And for the Bonds having same Duration, there exist a positive relationship between Coupon
rate and the Convexity.

Coupon Rate-Convexity-Duration
9.00%

8.50%
Coupon Rate

8.00%

7.50%

7.00%

6.50%

6.00%
0.20000 0.25000 0.30000 0.35000 0.40000 0.45000 0.50000 0.55000
Convexity

Figure 41 Coupon Rate Vs Convexity (Same Duration)

98


Chapter V
Analysis of Fixed and
Floating Intrest Rates

 Introduction to Fixed and
Floating Rate
 Debt Servicing of PGCIL Bonds
 Floating Interest for PGCIL
Bonds
 Factors Effecting the Selection
of Each Method

99


Introduction

Bonds (Debentures) are the avenues of the investment for the investors. They are similar to
securities on which a regular income can be generated. And these are issued by the corporate, the
exchequer or by any Public undertaking or Municipal bodies etc... They act as source of funds for the
issuer. They are similar to loans but instead of taking from a sole institute or a consortium, the bonds
are raised from wide range of public. And the issuer pays regular interest on these bonds. This
interest is determined by either the Issuer or the investor or by both. The rate determined is termed
as Coupon rate. This coupon rate can be either fixed at the time or issue or it can be even floating.

In specific to India, the bonds are issued by The Central Government in form of Zero coupon
securities (Treasury Bills), bonds of tenure 1 year, 3 years, 5 years, 10 years, 15 years and even 20
years, by the state government, PSUs ( Public Sector Undertakings) and also private players. These
are of different maturity and also different repayment structure. For instance the GSec (central Govt
Securities) are redeemed only on their maturity and interest is paid half yearly, the corporate bonds
are repaid in equal annual or 3 year or even 5 year instalments with some moratorium period. And
the interest is paid either half yearly or yearly. But the bonds issued by them are usually of fixed
interest rate. But in a recent past, central Government and also some corporate have issued the
bonds at fixed rate. Now let us understand the meanings of fixed and floating rates.

Fixed Intrest Rate

As the name very clearly signifies that the interest rate in this case is fixed and will remain the same
for throughout the life of the bond say 15 years or so. In this case the coupon rate is attached to the
nomenclature of bonds and the coupon rate is paid annually or semi annually on the face value of
bond outstanding. For Instance a bond PGC 8.80% 2025 (S-XXX) implies the bond issued by Power
Grid Corporation of India Limited which will mature in the year 2025 and coupon rate of 8.8% will be
paid annually/ semi-annually as defined in the Information memorandum.

The Coupon rate is determined by the process of Book Building in case of Private Placement or it can
be even fixed by the issuer. However the rationale to set the fixed coupon rate and its process is as
follows:

I. Credit rating on the Security to be issued from 2 or more Credit Rating Agencies shall be
obtained as per the SEBI (Disclosure and Investors’ Protection) Guidelines, 2000 amended on
14th August 2003.
II. At the time of opening of the issue, the prevailing rate on Government securities of same
tenure that of the security to be issued, is considered. This can be the coupon rate of latest
issue of the similar bond by GoI or Average of last 5 or so issues.
III. Also the prevailing conditions of economy in general and in specific the condition of money
market is also considered. The high liquidity is considered as favourable and also any policies
of RBI or any announcements in the recent future or during the time of issue are also
considered.
IV. Also the Bank lending rate ( PLR) is considered

100

V. The coupon rate of other corporate bodies issues also impact the coupon rate determination
of the present issue.
VI. After the above factors are considered, the interest rate on GSec is taken as base rate and a
spread is added to it.
VII. Since the GSec issued by the government is considered as the safest and secured
investment, a spread is to be added to its coupon rate based on the security and the rating
of the bond.
VIII. The spread is widely influenced by the factors like security on the bond, the credibility of the
issuer, the market conditions, issues of other players etc.
IX. In India, The FIMMDA ( The Fixed Income and Money Market Derivatives Association), a
association to co-ordinate and also promote the Money market Instruments like Commercial
papers, Certificate of Credit, Bonds, etc..., provides the spread for each kind of security and
for each duration.
X. Thus based on the tenure of the bonds and the rating on that bond, a spread is obtained.
The spread published by the FIMMDA is already adjusted with all the factors affecting the
interest rate.
XI. Thus a range of interest rate is defined based on interest rate determined by adding spread
to GSec rate.
XII. The range may be defined by defining just the floor or ceiling rate and keeping the other end
open.
XIII. Usually the floor rate is kept open to take advantage of sudden change in economic
conditions, where the issuer could be in a position to get a rate lower than the defined rate.
And the ceiling rate is fixed to avoid more escalation of rate towards upper end.
XIV. After the range is defined, by the process of bidding the coupon rate is determine and this
rate is kept fixed for the whole tenure of the bond.

The fixed interest rate has many benefits attached to it. Some of them are:

 The payment towards interest rate is fixed and the issuer can prepare a budget well in
advance. And also repayment schedule can be prepared.
 It is preferred by the investors as a fixed income is promised every year and the risk of rates
falling down can be avoided.
 Also this kind of investments is preferred by the investors seeking for regular and non-
fluctuating. These include the provident Funds, Pension Funds and Gratuity Funds, which
form majority in the investors group.
 For the issuer, there is indemnity of hike in rates due to unfavourable circumstances.

Along with the aforesaid merits, there are some demerits attached to it like

 In case of down turn in economy, there will be fall in all the interest rates and also the fall in
performance of the business leading to unattractive cash flows. But even in this case the
interest to be paid on the bonds remains at the same level.
 The interest for the whole tenure is based on the conditions of money market and the
economy at the time of issue. The later conditions are not reflected.
 Even for the investor, there is scope of demerit if the security is issued at the time when the
condition of economy was poor and the interest rate fixed was very low. And this will not

101

increase even though the general interest rate is increased due to improvement in the
economic conditions.
 The issuer may end up paying high debt obligation in case of fixed interest rate and cannot
take the advantage of fluctuations and trends in other rates.

Thus to avoid the demerits of the Fixed Intrest rate, some issuer go for the FRBs (Floating rate
Bonds).

Floating Intrest Rate

It is clear from the term that, the interest rate is floating and not fixed. In this case the interest rate
will be adjusted periodically based on the benchmark rate. In this case for every interest payment
period the interest rate is determined based on the benchmark rates and a spread is added to it.
Unlike Fixed interest rates where the coupon rate was determined at the time of issue, in this case it
cannot be predetermined. The nomenclature in this kind will be GOI FLOATING RATE +0.14% 2014,
this implies the bond is issued by the Government of India, will be matured in the year 2014 and the
spread is +0.14%. This implies that 0.14% will be added to the benchmark rate for every reset period.
The Benchmark rate and the reset period are determined by the issuer and are shared in their
disclosure document. Usually the reset period is based on the frequency of interest payment. For
instance, in the above case the reset period was 6 months because the interest is paid semi-
annually. And the Benchmark rate was average yield of last 5 T-Bills (Treasury bills) issued by the
Government preceding the reset date.

As in case of fixed interest rate, the coupon rate was determined based on the bidding by the
investor, in the case of floating rate, the spread is determined by the bidding process.

A Benchmark or a Reference Rate is a rate that is an accurate measure of the market price. In the
fixed income market, it is an interest rate that the market respects and closely watches. A
benchmark rate should be from an unbiased source, be representative of the market, transparent,
reliable and continuously available and most importantly be widely acceptable to the market as the
benchmark rate

Such benchmark rates issued by unbiased sources are the Treasury Bill (T-Bill) rate issued by the
Government of India, the bank rate as decided by the Reserve Bank of India, the Mumbai Interbank
Offering Rate (MIBOR) released by the National Stock Exchange of India and GOI Securities. Thus
specifically for the Bonds the base rate can be any of the following:

 Coupon rate of similar tenure GSec Bond issued preceding the reset date.
 Average of Coupon rate of last 5 similar tenure GSec Bonds issued preceding the reset date.
 Average yield of last 5 Treasury Bills of maturity of 364 days issued preceding the reset date.
( for annual interest payment)
 Average yield of last 5 Treasury Bills of maturity of 180 days issued preceding the reset date.
( for semi annual interest payment)

102

 Average of Yields of similar tenure GSec bonds for the last 12 months preceding the reset
date.
 Average of Yields of similar tenure GSec bonds for the last 6 months preceding the reset
date. ( for semi annual interest payment)
 Average daily yield of similar tenure GSec bonds for a month preceding the reset date.
 Average Yield of 1 year GSec for the 3 days preceding the reset date.

The above stated base rates are not exclusive and exhaustive. Different issuers take different base
rates based on the structure of the repayment, the tenure of the bonds etc...

The Reset Date is the date on which the interest rate is reset based on the base rate and the spread
pre determined. The frequency of reset date could be quarterly, half yearly or even annually based
on the interest payment date. Sometimes the reset date may be annually where as the interest is
paid semi annually and vice versa. The determination of reset date depends on the issuers wish.

And the Spread can be either negative or positive i.e... The interest rate can be less than the base
rate or more than that. Usually it is positive signifying that the bonds must pay more interest than
the GSec yield as there is risk attached to it. The spread is predetermined at the time of issue and
remains same for the life of the bond. And the spread can be determined by the bidding by the
investors participating. But the base range is estimated with the help of average spread as published
by FIMMDA or the difference in base rate and the prevailing rate on similar bonds during the time of
issue.

Some of the benefits of Floating rate are:

 The issuer can take advantage of movement in general interest rates and condition of
market.
 No matter whatever is the condition of economy during the issue, the later on interest rates
are truly represented by the state of the economy.
 The investors risk is minimised as the returns are based on the market conditions and the
opportunity cost is negligible.
 Also the floating rate minimises the fluctuation in prices. Floating Rate funds are protective
funds and shield your investments from interest rate fluctuations.

In a declining interest rate scenario older securities issued at higher coupon rates (interest paid on
the face value of a debt instrument) appear much more attractive than the ones that are currently
issued. Consequently older higher interest bearing securities would go at a premium. Thus long term
income funds by virtue of their investments in longer maturing securities would see a rise in their
Net Asset Values.

However, when interest rates are on the rise newer securities appear more attractive than the ones
that were issued earlier, as they offer higher coupons than their predecessors. The lesser paying
older securities therefore will be sold at a discount. So the same income fund with a majority of
investment in longer maturing securities, now start earning you lesser as newer securities continues
to earn higher returns than the ones in the portfolio.

103

This bearish scenario lasts as long as interest rates continue to show an upward trend. It is during
these times that floating rate funds offer the best utility.

Some of the demerits are:

 The investor is exposed to fluctuations in interest rates.
 He cannot pre plan the expenses towards financial charges well in advance
 Since the interest rates fluctuates, the investor class looking for fixed and regular income (
including PF Funds and gratuity fund) may not be attracted.

Though both the methods have some merits and some demerits, it can be concluded on which
method is to be used. Suitability of each mechanism is based on the tenure of bond, amount of
interest to be paid, the market condition during the issue etc.....

Indian Issuers going for FRBs

Though most of the Indian issuers of Bonds go for the fixed coupon rate, there are few players who
also go for Floating rate like Government of India issued few of its bonds under floating rate and also
Power Finance Corporation of India, a NBFC to finance power project has also issued one of its bonds
with floating rate. But one must observe that both the above mentioned issuers do not issue only
floating rate but they also issue some of the bonds based on the tenure and condition of economy
with floating rate option. Also the structure of repayment, the benchmark and its determination
differ in each case.

Some of the prominent issuers of FRBs and their issue structure are as follows:

GOI Floating Rate Bonds
As mentioned before the Government of India issues the floating rate bonds along with the fixed
rate. It has issued its first FRB on 02nd of July, 2002 at a spread o =).34% (+3 basis points) over the
yield of last 5 T-Bills issued preceding the Intrest payment date. The tenure of these bonds was 15
years, maturing on 02nd of July, 2017.

As per NSE’s Monthly Trading history provided by its Wholesale Debt Segment, as on 31st March,
2010, there are 8 FRBs issued by Government active on the exchange. Each had different maturity
and different spreads. But the interest on these is paid half yearly with reset period of 6 months.
The benchmark for all the cases was Average yield on last 5- Treasury Bills of 364 Days maturity
issued immediately preceding the Reset date. The summary of all those issues is as follows:

Issue Description Spread Issue Dt. Mat Dt. Maturity Cpn Freq
( years)
GOI FLOATING RATE +0.13% 2011 +0.13% 08-Aug-03 08-Aug-11 8 Half-Yearly
GOI FLOATING RATE +0.09% 2012 +0.09% 10-Nov-03 10-Nov-12 9 Half-Yearly
GOI FRB +0.45% 2013 +0.45% 10-Sep-04 10-Sep-13 9 Half-Yearly
GOI FLOATING RATE +0.14% 2014 +0.14% 20-May-03 20-May-14 11 Half-Yearly
GOI FLOATING RATE +0.19% 2015 +0.19% 02-Jul-04 02-Jul-15 11 Half-Yearly
GOI FLOATING RATE +0.50% 2015 +0.50% 10-Aug-04 10-Aug-15 11 Half-Yearly

104

GOI FRB +0.04% 2016 +0.04% 07-May-04 07-May-16 12 Half-Yearly
GOI FLOATING RATE +0.34% 2017 +0.34% 02-Jul-02 02-Jul-17 15 Half-Yearly
12
Table 20 FRBs by GOI

Indian Railway Finance Corporation Limited (IRFCL)
The Indian Railway Finance Corporation is a separate unit established for the purpose of finance the
projects related to building and development and also maintenance of railway. The company is a
Government of India undertaking. Along with the fixed coupon rate bonds, it also issues the floating
rate bonds.

The maturity o the bonds issued is 5 years. And in one case the bond series issued was in form of
STRPP (Separately Transferable Redeemable, principal parts) which are redeemed in equal annual
instalments. And the benchmark rate for these bonds is INBMK rate for relevant GSec of relevant
maturity as published by The Reuters. Since the interest payment is semi-annual, the interest rate is
reset in a period of six months. The summary of issues by this company, as provided by NSE (WDM)
as on 31st march 2010 is:

Issue Description Spread Issue Dt. Mat Dt. Maturity Redemption Reference Rate
( years)
IRFC +0.37% 2010 +0.37% 22-Jun-05 22-Jun-10 5 Bullet INBMK of 5 Yr GSec
(S- 49)
IRFC -0.10% 2010 -0.10% 22-Jun-05 22-Jun-10 5 Bullet INBMK of 5 Yr GSec
(SER-49)
IRFC +5.60% 2010 +5.60% 25-Aug-5 25-Aug-10 5 Bullet (5 yr INBMK) – (1Yr
(SERIES-50) INBMK)
IRFC -0.10% 2020 -0.10% 22-Jun-05 22-Jun-20 15 STRPPs INBMK of GOI relevant
(SER-49) Maturity for each STRPP
12
Table 21 FRBs by IRFC

In the above table, for the series 50, the spread seems to be very high, but in this case the
benchmark is determined as the difference between INBMK of 5 year GSec and INBMK of 1 year
GSec. In other words the spread is added to the excess yield on 5 year GSec over the 1 year GSec. In
case if the Floating rate turns out to be negative, no interest is paid.

Also in case of Series 49 Option III (Maturity of 15 years); the redemption is in form of different
STRPPs having different maturity. Thus in that case the interest is determined separately for each
STRPP by taking Reference Rate as INBMK of similar maturity GSec for each STRPP.

Power Finance Corporation Limited,
PFC, a Government of India Undertaking, is a Non Banking Finance Company, established with the
object of financing Power projects in the country. It also issues the bonds regularly and till date it has
issued around 60 series of Bonds. Apart from issuing bonds under fixed coupon rate, it also issues its
bonds as FRBs.

The tenure of bonds range from 3 years to 10 years, and the reset period is six months for semi-
annual Intrest payment and 12 months for annual interest payments. The reference rate is different

12
Source: www.nse-india.com/Debt/WDM

105

for each series. It is MIBOR (Mumbai Inter Bank Offer Rate), or YINCMT or even difference between
1 yr INBMK and 5 yr INBMK. The summary of the past FRBs by PFCL is as follows:

Issue Description Spread Issue Dt. Mat Dt. Maturity Cpn Freq Reference Rate
( years)
PFC +5.70% 2010 +5.70% 01-Sep-05 01-Sep-10 5 Half- 5 yr INBMK - 1Yr
(S- XXIV) Yearly INBMK
PFC MIB +2.15% 2011 +2.15% 29-May-08 29-May-11 3 Yearly MIBOR
(S-XLVI)
PFC 1YINCMT+1.35% 12 +1.35% 20-Nov-09 20-Nov-12 3 Yearly 1 YINCMT
(S-60-A)
PFC 1YINCMT+1.79% 19 +1.79% 20-Nov-09 20-Nov-19 10 Yearly 1 YINCMT
(S-60-B)
13
Table 22 FRBs by PFC

ICICI Bank
ICICI Bank, the largest private sector bank in India, issues both the fixed and floating rate bonds. The
summary of its issues is:

Issue Description Spread Issue Dt. Mat Dt. Maturity Reference
( years) Rate
ICICI BK +0.60%2010(S-DFE05FRB +0.60% 28-Feb-05 31-May-10 5 1 Yr INBMK
ICICIBK+0.50% 2011(S-DJN05FRB) +0.50% 29-Jun-05 29-Apr-11 6 1 Yr INBMK
13
Table 23 FRBs by ICICI Bank

Others
Apart from the above mentioned, many other corporate issue the Floating rate Bonds. And the list
includes:

 UTI Bank,
 IDFC (Infrastructure Development Finance Company Limited),
 Kotak Mahindra Bank ,
 EXIM Bank ( Export Import Bank of India),
 IDBI ( Industrial Development Bank of India),
 CITI Bank,
 Sundaram Finance

The issue details of some of the above mentioned issuers are as follows:

Issue Description Spread Issue Dt. Mat Dt. Maturity Reference Rate
( years)
EXIM BK +0.33% 2010 (SER-I03) +0.33% 09-Aug-05 09-Aug-10 5 Avg Yield on 1 Yr GSec
for 3 days
IDFC +1.50% 2017 (S-PP6/2008) +1.50% 16-May-07 16-May-17 10 MIBOR
KOTAK MAH BK +0.55% 2012 (S- +0.55% 22-Aug-05 22-Aug-12 7 1 Yr INBMK
I)
13
Table 24 FRBs by Others

13
Source: www.nse-india.com/Debt/WDM

106


The Debt Servicing for PGCIL’s Bonds

The Power Grid Corporation of India Limited issues bonds with fixed coupon rate determined by the
book building procedure. The average maturity of most of the bonds is 15 years (4 years of
moratorium and then repayment of loan in 12 equal annual; instalments). Apart from this it has also
issued different structure bonds of 6 years Maturity ( 1 year moratorium and 6 annual equal
repayments), 12 years maturity ( 3 years moratorium and 10 equal annual repayments) etc... The
details of all the bonds issued by PGCIL till date along with its repayment structure are attached in
the appendix.

The interest rate is determined based on the prevailing interest rate on 10 year GSec ( for a 15 year
PG bond, since the average tenure turns up to be 9 years because of equally annual repayments) and
a spread defined by FIMMDA for a AAA rated bond for 10 years is added to define a range for
bidding by investors. Then the rate obtained by the book building process is taken as the coupon
rate.

Following chart depicts the relationship between the prevailing interest rates on GSec Securities and
the Coupon rate of PGCIL Bonds.

The blue line depicts the coupon rates of each issue of bonds and the green line depicts the coupon
rate of GSec bonds issued immediately before the PGCIL bonds were issued and having same
redemption year and also same maturity. The data is taken from the NSE website’s WDM segment
and also from the Data published by RBI on the outstanding GSec.

From the below chart we can see that for most of the issues the coupon rate on bonds of the
company was more than the coupon rate of GSec of similar tenure issued before the issue of
PGCIL’s bonds. Some of the points to be noticed are:

 In case of XIV issue the Coupon Rate is very much close to the Coupon rate of GSec. The
coupon rate of bond is 6.10% whereas the rate of GSec is 6.07%. This is mainly because of
gap of one month. The GSec was issued on June 6th 2003 and was of Maturity of 15 years
whereas the PGCIL bond was issued on 17th July, 2003 and was with maturity of 12 years.
Since no GSec of 12 years was issued in the immediate past, this GSec is considered. Also
the Coupon rate is set lower because of its lesser maturity than the GSec.
 In case of X issue of PGCIL Bonds, the Coupon rate is lower than the GSec rate (highlighted
by the circle). This is unusual in normal scenario. This was mainly because of excess
borrowing by the government.
 The gap between the blue and green line is spread. Over the years the spread is more or less
constant and the average spread is 0.75%. In other words the Coupon rate on an average is
set 75 basis points above the GSec rate.

107


Coupon Rate Vs Gsec Rate
14.00%
13.00%
12.00%
11.00%
10.00%
9.00%
8.00%
7.00%
6.00%
5.00%
4.00%
3.00%
2.00%
1.00%
0.00%

Coupon Rate- PG Bonds Interest on Govt Securtiy

14
Figure 42 Coupon Rate of PG Vs GSec Rate

From the following chart we study the behaviour of Coupon rates of each bond with the average
yield on GSec. Here the Yield on GSec is the data published by RBI and is yield on all the GSec of all
the maturities. The blue line which depicts the Coupon rate of each bond series is always more than
the red line which represents the Average GSec yield for the year. Also the gap between them,
termed as spread, is more or less constant and the movement is in tandem.

Coupon Rate Vs Avg Gsec Yield
13.00%
12.00%
11.00%
10.00%
9.00%
8.00%
7.00%
6.00%
5.00%

Rate P.A. Avg Yield of GS

15
Figure 43 Coupon Rate of PG Vs Avg GSec Yield

14
Source: http://www.rbi.org.in/scripts/PublicationsView.aspx?id=9483 ; www.nse-India.com (WDM
Segment)
15
Source: www.Indiastat.com and www.nse-india.com

108


Floating Intrest for PGCIL’s Bonds
As mentioned before the Power Grid Corporation of India Limited has issued till date 32 series of
bonds and all at fixed coupon rate. Thus a study is being made to analyse the interest cost if the
company has gone for the floating rate.

Assumptions
Some of the assumptions taken for the purpose of computation and analysis of Floating rate costs
are as follows:

 Though the Floating rate deemed to have some additional costs for the company in terms of
arrangers’ fees, internal records maintenance, database for computing reference rate, etc...
But after speaking to the concerned persons in the company, it has been found that there
will not be any substantial additional expenses in case of floating rate.
 It is assumed that the Arrangers, as usual will quote a 0% fees because of Ratings (highest
rating) and also good credibility of the company.
 The company already has the Reuters database and subscribed to the FIMMDA access, thus
it need not incur additional expenses for determination of reference rate and spread.
 For determining the spread in case of floating rate, as mentioned before usually the spread
is determined by way of bidding or is determined by the merchant bankers and the issuer
based on the market conditions. Since the calculations are made backward, thus the spread
is computed based on the discussion with the Merchant banker16 on the actual industry
practices of determining the spread.
 For computing the floating rate for each period, three different reference rates are taken
based on other company’s practices.

Selection of Bonds
For the purpose of comparison under fixed and floating rates, the bonds on which the interest has
been made for 8 or more periods have been selected, so that a good study can be done. Also bonds
of different tenure, different repayment structure and different coupon rates have been taken so
that a comprehensive study for each kind of bond can be done. The details of Bonds selected are as
follows:

Bond Date of Loan Coupon Redemption Maturity Intrest Loan Repayment
Description Drawn Rate Date (Yrs.) Payment Amount Structure
(Rs. Crs)
Bonds VIII 27-04-2000 10.35% 4/2014 14 Half-Yrly 20.00 5 Yr.Moratorium
Issue + 10 Eq Ann.Inst
Bonds IX 22-08-2000 12.25% 8/2012 12 Half-Yrly 576.50 3 Yr.Moratorium
Bonds X 21-06-2001 10.90% 6/2015 14 Annual 761.52 3 Yr.Moratorium
Bonds XIII- 31-07-2002 7.85% 07/2008 6 Annual 250.50 1 Yr.Moratorium
Bonds XIV- 17-07-2003 6.10% 07/2015 12 Annual 699.00 1 Yr.Moratorium
Table 25 List of Bonds selected for Analysis

16
Mr. Venkat Krishna, VP, ICICI Securities Primary Dealership Limited

109

The above list has each kind of bond:

 Meagre loan Amount
 Half Yearly Intrest Payment
 Longer Maturity of 14 years
 Shorter Maturity of 6 years
 Low coupon rate

Based on the above selection suitability of Fixed or Floating rate for each kind of bond can be
studied. And as mentioned before, the bonds that are issued in the year 2000, 2001, 2002 and 2003
are selected because the interest is already paid on them under fixed rate and now study can be
made under floating rate for the bonds.

Selection of Reference Rate

As mentioned before in case of a floating rate there is a Reference or Benchmark rate, based on
which the floating interest rate is determined. For computation of floating rate following reference
rates were considered.

I. Average Monthly yield of 10 Year GSec preceding the reset month
II. Average Yield of 10 year GSec for 12 months preceding the reset month.
Average Yield of 10 year GSec for 6 months preceding the reset month ( for Semi Annual
Intrest Payment)
III. Average of 1 Year GSec for the past 3 days preceding the reset date.

From the above three options, the option I, which is average of GSec yield for the month preceding
reset month, will depict the market condition of only the month immediately preceding the reset
month. But since the interest is paid for the 6 months or the 12 months, the base rate should truly
reflect the conditions of those 6 or 12 months.

In the Option II, this is Average Yield of 10 years GSec for the 12 months preceding the reset month
for the Annual Intrest payment and 6 months for semi-annual interest payment. On an assumption
that, the investor is a long term investor and has invested in the bonds for purpose of income and
not trade, 10 years GSec is considered. Also all the above selected bonds except one have an
average tenure of 9 years or 10 years, thus Yield on 10 years GSec is comparable.

Following Graph will depict the annualised yields of 10 years GSec monthly and also the moving
average from the period April 1998 to April 2010.

110


10 Year Gsec Yield
14.00
12.00
10.00
8.00
6.00
4.00
2.00
0.00
Sep-1998
Feb-1999
Jul-1999

Sep-2003
Feb-2004
Jul-2004

Sep-2008
Feb-2009
Jul-2009
Dec-1999

Dec-2004

Dec-2009
Apr-1998

May-2000

Aug-2001

Apr-2003

May-2005

Aug-2006

Apr-2008
Nov-2002

Nov-2007
Oct-2000
Mar-2001

Jan-2002
Jun-2002

Oct-2005
Mar-2006

Jan-2007
Jun-2007
CLOSE Moving Average ( 12 months)

17
Figure 44 Trend of 10 Yr GSec Yield

From the above graph, it can be clearly seen that, if we take monthly data as base rate, there are lots
of fluctuations and also the interest will get widely affected by the state of economy and market
conditions of a particular month. But in the other case, if average of the 12 or 6 months is taken, the
condition of market for the whole 12 or 6 months is taken care of. Thus Option I is not considered.

And In the option III, which is yield on one year GSec for the preceding 3 days of reset date. Here the
assumptions are

 The investor is not a long term investor and is holding the security for a short term period.
Thus for him the interest must be based on the one year GSec.
 Also since the interest is paid for annual or semi-annual period, the base rate must also
reflect the representation of the movements in Sort term Securities ( 1 year GSec)

The following graph portrays the movement of Annualised yield of 1 year GSec on daily basis for the
period between 01-01-1998 to 30-04-2010

IN1YT=RR
14.00
12.00
10.00
8.00
6.00
4.00
2.00
0.00
Jan-2007
Jan-1998

Jan-1999

Jan-2000

Jan-2001

Jan-2002

Jan-2003

Jan-2004

Jan-2005

Jan-2006

Jan-2008

Jan-2009

Jan-2010
Jul-2008
Jul-1998

Jul-1999

Jul-2000

Jul-2001

Jul-2002

Jul-2003

Jul-2004

Jul-2005

Jul-2006

Jul-2007

Jul-2009

Figure 45 Trend of 1Yr GSec Yield

17
Source: Reuters Database

111


From both the graphs showing trend of each 10 year and 1 year GSec Yield, it can be seen that, the
yield is fluctuating over the period and the benefits of fluctuation can be taken.

And if we analyse the Coupon rate of PGCIL Bonds Movement of the issues till date, the trend is as
follows,

PGBonds
12.00%
10.00%
8.00%
6.00%
4.00%
2.00%
0.00%

Figure 46 Trend of Coupon Rates of PG Bonds

The curve if compared with the GSec yield it can be seen that the movement in the line is in tandem
with the movement of yield. Thus if the company goes for the floating instead of fixed, this can be
justified by the following graph.

14.000%
1 Yr Gsec Yield Vs PG Bonds
12.000%
10.000%
8.000%
6.000%
4.000%
2.000%
0.000%

IN1YT=RR PG Rate

Figure 47 Rates of PG Bonds Vs 1 Yr GSec Yield

112

Some of the points to be mentioned are:

 The Blue Circles and Rhombus represent the Coupon rate on the PGCIL Bonds and the red
line depicts the daily yield on 1 year GSec Yield.
 The Blue Circles represent the Coupon rate of Bonds selected for the study.
 The blue circles are selected in such a case that they represent both at a low yield and also
at a high yield.
 From the period Jan 2009 onwards the yield has been very low when compared to the
coupon rate.
 And the gap between the Blue Dots and the red line is considered as the spread. The spread
has been increasing by the fall in Yield from Jan-2008 onwards.
 Also for first four issues, the corporate payment was half yearly. Thus the interest rate was
annualised to have a better comparison with the annualised yield.

Reset Period and Reference Period

One of the three main parameters to be determined is the Reset period. It is the period at which the
Intrest rate is reset as per the reference rate. In case of Floating rate, though it is termed as floating,
but the Intrest rate does not change daily, it is reset and calculated at a predetermined period. In
our case the reset date is 12 months in case of Annual interest payment and is 6 months for Semi-
Annual Intrest payment.

Though the interest rate is reset every 12/6 months, but the reference period is also to be
determined. In simple words, the reference period implies, for the purpose of computation of base
rate the data pertaining to which period shall be taken.

In this case, following two situations are considered:

1. Data pertaining to the period preceding the coupon period. For Instance, in case of Semi
annual interest payment falling due on 22nd August 2003, then the coupon period starts
from 22nd February 2003. Thus Average yield of 6 months preceding the 22nd February 2003
will be considered. i.e... August 2002 to January 2003 will be considered.
2. The second option is, data pertaining to the period preceding the Intrest payment date. For
Instance, in case of Semi annual interest payment falling due on 22nd August 2003, then the
average yield of 6 months preceding the 22nd August 2003 will be considered. i.e... February
2003 to July 2003 will be considered.

For the present study both the reference periods have been considered.

Spread

The last parameter to be determined in case of Floating rate is the spread. Depending upon the
reference rate selected, the spreads will be different. And as mentioned before, the spread will
remain constant for the whole tenure of the Bond. Thus it is very crucial thing to determine the
spread. Usually in actual cases a range is to be determined, and the exact spread is determined
based on the bidding process. But for the purpose of study, based on discussion with the

113

experienced persons and merchant bankers on the actual practice in the industry is understood and
in consultation with them the spread is determined using relevant past data.

For purpose of Option II ( 12/ 6 months average yield of 10 years GSec), the spread is taken as
average spread for AAA Bonds for the tenure of 10 years for last 5 days preceding the date of issue.

For the purpose of Option III (3 days average of yield on 1 year GSec), the spread is taken as
difference between base rate as on date of issue and the coupon rate. The rationale behind this is,
since the coupon rate is determined by adding the Spread to the prevailing interest rate on 10 years
GSec, just the gap between the 1 year GSec and the Coupon rate can be taken as spread.

Floating Rate under Reference Rate of Average yield of 1 Year GSec
Bond VIII

Date of Issue: 27th April, 2000

Intrest Payment: Semi Annually

Coupon Rate: 10.35%

Loan Amount: Rs. 20 Crores

Repayment: 5 years Moratorium and 10 equal Instalments

Maturity: 27th April, 2014

Determination of Spread
Since the date of issue is 27th April, 2000, the average yields of 3 days preceding i.e... 24th, 25th and
26th April, 2000 is computed and the difference between the average and coupon rate is calculated
and the difference turned up to be 1.036% or 103.6 basis points. The computation is as follows:

Date Yield-1yr GSec Average yield Coupon Rate Spread
26-04-2000 9.291
25-04-2000 9.306 9.3140% 10.35% 1.03600%
24-04-2000 9.345 931.40%
Table 26 Determination of Spread for PGVIII for 1 year GSec as Reference Rate

Computation of Floating Rate
Average Yield of 1 years GSec ( 3 days preceding Intrest rate)
Intrest Floating Fixed
Payment Reference Period Average Govt yield Spread rate rate
27-Oct-00 Oct- 23, 24, 25 10.39233% 1.036% 11.428% 10.35%
Apr-01 Apr- 23, 24, 26 8.88833% 1.036% 9.924% 10.35%
Oct-01 Oct- 23, 24, 25 6.89533% 1.036% 7.931% 10.35%
Apr-02 Apr- 23, 24, 26 6.17367% 1.036% 7.210% 10.35%
Oct-02 Oct- 23, 24, 25 5.64967% 1.036% 6.686% 10.35%
Apr-03 Apr- 23, 24, 25 5.12000% 1.036% 6.156% 10.35%
Oct-03 Oct- 22, 23, 24 4.71800% 1.036% 5.754% 10.35%
Apr-04 Apr- 21, 22, 23 4.48700% 1.036% 5.523% 10.35%

114

Oct-04 Oct- 21, 25, 26 5.52533% 1.036% 6.561% 10.35%
Apr-05 Apr- 21, 25, 26 5.68333% 1.036% 6.719% 10.35%
Oct-05 Oct- 24, 25, 26 5.82767% 1.036% 6.864% 10.35%
Apr-06 Apr- 24, 25, 26 6.22600% 1.036% 7.262% 10.35%
Oct-06 Oct- 20, 23, 26 6.99133% 1.036% 8.027% 10.35%
Apr-07 Apr- 24, 25, 26 7.86667% 1.036% 8.903% 10.35%
Oct-07 Oct- 24, 25, 26 6.85867% 1.036% 7.895% 10.35%
Apr-08 Apr- 23, 24, 25 7.85000% 1.036% 8.886% 10.35%
Oct-08 Oct- 22, 23, 24 7.37800% 1.036% 8.414% 10.35%
Apr-09 Apr- 22, 23, 24 4.07600% 1.036% 5.112% 10.35%
Oct-09 Oct- 22, 23, 26 4.47700% 1.036% 5.513% 10.35%
Apr-10 Apr- 22, 23, 26 4.92367% 1.036% 5.960% 10.35%
Table 27 Floating rates for PGVIII for 1 year GSec as Reference Rate

Notes:

 Though the bond will mature in the year 2014, the interest payment till 27 th April 2010 can
be compared because of unavailability of data.
 In case of reference period, the three days preceding the interest payment date is
considered. Thus in this case, since the interest is to be paid on 27th of August and April, the
reference period should be 24th, 25th and 26th. But in case, if wither of 3 days is a holiday,
and no trade has been taken place the working days preceding to the holiday is considered.

Comparison of Intrest on Fixed and Floating Rate
(Rs Crs.)

Intrest Payment-Fixed Intrest Payment-Floating
Opening Opening
Year Balance Redemption Interest Year Balance Redemption Interest
Oct-00 20 0 1.035 Oct-00 20 0 1.142833
Apr-01 20 0 1.035 Apr-01 20 0 0.992433
Oct-01 20 0 1.035 Oct-01 20 0 0.793133
Apr-02 20 0 1.035 Apr-02 20 0 0.720967
Oct-02 20 0 1.035 Oct-02 20 0 0.668567
Apr-03 20 0 1.035 Apr-03 20 0 0.6156
Oct-03 20 0 1.035 Oct-03 20 0 0.5754
Apr-04 20 0 1.035 Apr-04 20 0 0.5523
Oct-04 20 0 1.035 Oct-04 20 0 0.656133
Apr-05 20 2 1.035 Apr-05 20 2 0.671933
Oct-05 18 0 0.9315 Oct-05 18 0 0.61773
Apr-06 18 2 0.9315 Apr-06 18 2 0.65358
Oct-06 16 0 0.828 Oct-06 16 0 0.642187
Apr-07 16 2 0.828 Apr-07 16 2 0.712213
Oct-07 14 0 0.7245 Oct-07 14 0 0.552627
Apr-08 14 2 0.7245 Apr-08 14 2 0.62202
Oct-08 12 0 0.621 Oct-08 12 0 0.50484
Apr-09 12 2 0.621 Apr-09 12 2 0.30672
Oct-09 10 0 0.5175 Oct-09 10 0 0.27565
Apr-10 10 2 0.5175 Apr-10 10 2 0.297983
17.595 12.57485
Table 28 Intrest under Fixed and Floating rates for PGVIII for 1 year GSec as Reference Rate

115


VIII ( 1 Yr Gsec)
1.2
1
0.8
0.6 Intrest Payment-Fixed
0.4
0.2 Intrest Payment-
0 Floating
Aug-01

Apr-03

Aug-06

Apr-08
Feb-04

Feb-09
Jun-02

Dec-04

Jun-07

Dec-09
Oct-00

Oct-05

Figure 48 Intrest Payments under Fixed and Floating Rate for PGVIII for 1 year GSec as Reference Rate

From the above table and chart, it is clearly visible that, the company would have been able to save
Rs. 5, 02,015,000 (Rs.50.2 Million) if it had issued the bond at floating rate. Also from the we can see
that, during the moratorium period, during which the project is not yet operational, the interest
payment in case of Floating rate ( as depicted by red line) is very less when compared to the same
under fixed rate ( represented by the line blue). And the payment towards interest (if the principal
payment is ignored) the amount towards debt obligation is always less in case of floating rate except
the initial interest payment.

Bond IX

Date of Issue: 22nd August, 2000

Intrest Payment: Semi Annually

Coupon Rate: 12.25%

Loan Amount: Rs. 576.50 Crores


Maturity: 22nd August, 2012

Since the date of issue 22nd August, 2000, the average yield of 3 working days preceding i.e... 16 th,
17th and 18th August, 2000 is computed and the difference between the average and coupon rate is
calculated and the difference turned up to be 1.52% or 152 basis points. The computation is as
follows:

Date Yield-1yr GSec Average yield Coupon rate Spread
18-08-2000 10.751
17-08-2000 10.839 10.730% 12.25% 1.5203300%
16-08-2000 10.599 10.72967
Table 29 Calculation of Spread for PGIX for 1 year GSec as Reference Rate

116

Intrest
Payment Reference Period Average Govt yield Spread Floating rate Fixed rate
22-Feb-01 Feb- 15, 16, 20 9.32% 1.520% 10.8393% 12.25%
22-Aug-01 Aug- 16, 17, 20 7.18% 1.520% 8.7040% 12.25%
Feb-02 Feb- 19, 20, 21 6.37% 1.520% 7.8920% 12.25%
Aug-02 Aug- 19, 20, 21 6.02% 1.520% 7.5433% 12.25%
Feb-03 Feb- 19, 20, 21 5.92% 1.520% 7.4447% 12.25%
Aug-03 Aug- 19, 20, 21 4.97% 1.520% 6.4947% 12.25%
Feb-04 Feb- 17, 19, 20 4.56% 1.520% 6.0797% 12.25%
Aug-04 Aug- 17, 18, 19 5.33% 1.520% 6.8503% 12.25%
Feb-05 Feb- 17, 18, 20 5.74% 1.520% 7.2627% 12.25%
Aug-05 Aug- 17, 18, 19 5.70% 1.520% 7.2180% 12.25%
Feb-06 Feb- 17, 20, 21 6.89% 1.520% 8.4110% 12.25%
Aug-06 Aug- 17, 18, 21 6.86% 1.520% 8.3820% 12.25%
Feb-07 Feb- 19, 20, 21 7.62% 1.520% 9.1403% 12.25%
Aug-07 Aug- 16, 17, 21 7.15% 1.520% 8.6723% 12.25%
Feb-08 Feb- 19, 20, 21 7.55% 1.520% 9.0713% 12.25%
Aug-08 Aug- 18, 20, 21 9.30% 1.520% 10.8230% 12.25%
Feb-09 Feb- 17, 18, 19 4.80% 1.520% 6.3250% 12.25%
Aug-09 Aug- 18, 20, 21 4.64% 1.520% 6.1567% 12.25%
Feb-10 Feb- 17, 18, 19 5.04% 1.520% 6.5573% 12.25%
Table 30 Floating Rates for PGIX for 1 year GSec as Reference Rate

Comparison of Interest on Fixed and Floating Rate
(Rs Crs.)

Opening Opening
Feb-01 576.5 0 35.3106 Feb-01 576.5 0 31.24437
Aug-01 576.5 0 35.3106 Aug-01 576.5 0 25.08927
Feb-02 576.5 0 35.3106 Feb-02 576.5 0 22.74868
Aug-02 576.5 0 35.3106 Aug-02 576.5 0 21.74365
Feb-03 576.5 0 35.3106 Feb-03 576.5 0 21.45924
Aug-03 576.5 57.65 35.3106 Aug-03 576.5 57.65 18.72087
Feb-04 518.85 0 31.7796 Feb-04 518.85 0 15.77217
Aug-04 518.85 57.65 31.7796 Aug-04 518.85 57.65 17.77147
Feb-05 461.2 0 28.2485 Feb-05 461.2 0 16.7477
Aug-05 461.2 57.65 28.2485 Aug-05 461.2 57.65 16.6447
Feb-06 403.55 0 24.7174 Feb-06 403.55 0 16.97129
Aug-06 403.55 57.65 24.7174 Aug-06 403.55 57.65 16.91277
Feb-07 345.9 0 21.1864 Feb-07 345.9 0 15.8082
Aug-07 345.9 57.65 21.1864 Aug-07 345.9 57.65 14.99879
Feb-08 288.25 0 17.6553 Feb-08 288.25 0 13.07405
Aug-08 288.25 57.65 17.6553 Aug-08 288.25 57.65 15.59864
Feb-09 230.6 0 14.1243 Feb-09 230.6 0 7.292721
Aug-09 230.6 57.65 14.1243 Aug-09 230.6 57.65 7.098633
Feb-10 172.95 0 10.5932 Feb-10 172.95 0 5.670451
497.8798 321.3677
Table 31 Interest under Fixed and Floating Rates for PGIX for 1 year GSec as Reference Rate

117


IX ( 1 Yr Gsec)
40.0000
35.0000
30.0000
25.0000
20.0000 Intrest Payment-Fixed
15.0000
Floating
5.0000
0.0000
Aug-03

Apr-05

Aug-08
Feb-01
Dec-01

Feb-06
Dec-06
Oct-02

Jun-04

Oct-07

Jun-09

Figure 49 Interest Payment under Fixed and Floating rates for PGIX for 1 year GSec as Reference Rate

In this case the Intrest under floating rate is much lower than the fixed rate. The main reasons are

 When this series was issued the market conditions were not favourable.
 Due to hike in CRR, the Bank rates and GSec rates hiked up,
 Most of the nationalised banks increased their PLR
 60% of Annual borrowings by GoI during the current year amounting to approx. Rs.1,20,000
Crores is yet to be raised
 All the above mentioned points may bring an upward pressure in GSec rates thus the coupon
rate was fixed with the spread of 75 basis points over the prevailing rate of 10 years GSec.

The company would have been able to save up to Rs.176, 51, 21,000 (Rs. 1.765 Billion) if it had
issued the bond at floating rate. Also the amount towards debt obligation both in case of fixed and
floating rate is falling over the period because of equal redemption towards principal.

Bond X

Date of Issue: 21st June, 2001

Intrest Payment: Annual

Coupon Rate: 10.90%



Maturity: 21st June, 2015

118

Since the date of issue 21st June, 2001, the average yield of 3 working days preceding i.e... 18th, 19th
and 20th June, 2001 is computed and the difference between the average and coupon rate is
calculated and the difference turned up to be 2.69% or 269 basis points. The computation is as
follows:

20-06-2001 8.151
19-06-2001 8.20 8.21% 10.90% 2.69%
18-06-2001 8.276 8.209
Table 32 Calculation of Spread for PGX for 1 year GSec as Reference Rate

Average Yield of 1 years GSec ( 3 days preceding Interest rate)
Interest
21-Jun-02 June 20, 19, 18 6.756% 2.69% 9.447% 10.90%
Jun-03 June 20, 19, 18 5.070% 2.69% 7.761% 10.90%
18
Jun-04 June 18, 17, 16 3.994% 2.69% 6.685% 10.90%
1
Jun-05 June 20, 17, 16 5.738% 2.69% 8.429% 10.90%
1
Jun-06 June 20, 19, 16 6.988% 2.69% 9.679% 10.90%
Jun-07 June 20, 19, 18 7.863% 2.69% 10.554% 10.90%
Jun-08 June 20, 19, 18 8.421% 2.69% 11.112% 10.90%
1
Jun-09 June 19, 18, 17 4.124% 2.69% 6.815% 10.90%
Table 33 Floating rates for PGX for 1 year GSec as Reference Rate

(Rs Crs.)

Interest Payment-Fixed Interest Payment-Floating
Opening Opening
Jun-02 761.52 0 83.00568 Jun-02 761.52 0 71.93826
Jun-03 761.52 0 83.00568 Jun-03 761.52 0 59.10157
Jun-04 761.52 63.46 83.00568 Jun-04 761.52 63.46 50.90761
Jun-05 698.06 63.46 76.08854 Jun-05 698.06 63.46 58.8418
Jun-06 634.6 63.46 69.1714 Jun-06 634.6 63.46 61.42293
Jun-07 571.14 63.46 62.25426 Jun-07 571.14 63.46 60.27812
Jun-08 507.68 63.46 55.33712 Jun-08 507.68 63.46 56.4134
Jun-09 444.22 63.46 48.41998 Jun-09 444.22 63.46 30.27359
560.2883 449.1773
Table 34 Interest under fixed and floating Rate for PGX for 1 year GSec as Reference Rate

18
Since one of the 3 days preceding the interest payment day was a holiday, the days preceding the holiday
has been considered.

119


X ( 1 Yr Gsec)
90
80
70
60
50 Interest Payment-
40 Fixed
30
Interest Payment-
20 Floating
10
0

Figure 50 Interest Payment under Fixed and Floating Rates for PGX for 1 year GSec as Reference Rate

The Bond series was issued during June 2001, which was characterised by favourable market
condition. The coupon rate was fixed after considering the spread of 65 to 90 basis points above the
GSec of similar maturity. Thus the company was able to issue its bonds at a coupon rate of 10.90%.
But if the interest payment is compared with that of Floating rate there is a scope of savings of
Rs.111,11,111,000 ( Approx Rs.1.1 Billion)

Also if we see the interest rates, there has been a dip in the interest rate under floating rate in the
year 2003, 2004 and 2009, leading to a huge gap between both the methods.

Bond XIII- Opt II

Date of Issue: 31st July, 2002

Intrest Payment: Annually

Coupon Rate: 7.85%


Repayment: 1 year Moratorium and 6 equal Instalments

Maturity: 31st July, 2008

Since the date of issue 31st July, 2002, the average yield of 3 working days preceding i.e... 26th, 29th
and 30th July, 2000 is computed and the difference between the average and coupon rate is
calculated and the difference turned up to be 1.794% or approx 180 basis points. The computation is
as follows:

120

30-07-2002 6.087
29-07-2002 6.091 6.056% 7.85% 1.79400%
26-07-2002 5.99 6.05600
Table 35 Calculation of Spread for PGXIII for 1 year GSec as Reference Rate

Interest
31-Jul-03 Jul- 25, 28, 29 4.8430% 1.7940% 6.6370% 7.85%
Jul-04 Jul- 28, 29, 30 4.8477% 1.7940% 6.6417% 7.85%
Jul-05 Jul- 25, 26, 29 5.8010% 1.7940% 7.5950% 7.85%
Jul-06 Jul- 26, 27, 28 6.9283% 1.7940% 8.7223% 7.85%
Jul-07 Jul- 26, 27, 30 6.7923% 1.7940% 8.5863% 7.85%
Jul-08 Jul- 28, 29, 30 9.4020% 1.7940% 11.1960% 7.85%
Table 36 Floating Rates for PGXIII for 1 year GSec as Reference Rate

(Rs Crs.)

Opening Opening
Jul-03 250.5 41.75 19.66425 Jul-03 250.5 41.75 16.62569
Jul-04 208.75 41.75 16.38688 Jul-04 208.75 41.75 13.86448
Jul-05 167 41.75 13.1095 Jul-05 167 41.75 12.68365
Jul-06 125.25 41.75 9.832125 Jul-06 125.25 41.75 10.92472
Jul-07 83.5 41.75 6.55475 Jul-07 83.5 41.75 7.169588
Jul-08 41.75 41.75 3.277375 Jul-08 41.75 41.75 4.67433
68.82488 65.94246
Table 37 Interest Under Fixed and Floating rates for PGXIII for 1 year GSec as Reference Rate

XIII- Opt-II ( 1 Yr Gsec)
25
20
15
Interest Payment-
10 Fixed
5 Interest Payment-
Floating
0

Figure 51 Interest Payments under Fixed and Floating Rates for PGXIII for 1 year GSec as
Reference Rate

121


The bond was issued at the coupon rate of 7.85% and is one the lower rates among the all PGCIL
Bonds. This is mainly because of its short tenure and also favourable market conditions.

Since the bond is issued for a short duration of 6 years and also due to low coupon rate there is a
nominal saving of Rs. 2,88,242,000 (Approx Rs. 28 Million). Also since the floating rate is pertaining
to a small period, there have been not many fluctuations. Thus the pattern of outflows with respect
to interest payment under both the methods viz fixed and floating is almost same.

Bond XIV

Date of Issue: 17th July, 2003

Intrest Payment: Annually

Coupon Rate: 6.10%

Loan Amount: Rs. 699 Crores

Repayment: 1 year Moratorium and 12 equal Instalments

Maturity: 17th July, 2015

Since the date of issue 17th July, 2003, the average yield of 3 working days preceding i.e... 14th, 15th
and 16th July, 2003 is computed and the difference between the average and coupon rate is
calculated and the difference turned up to be 5.87% or approx 587 basis points. The computation is
as follows:

16-07-2003 5.028
15-07-2003 5.027 5.0273% 6.10% 1.072700%
14-07-2003 5.027 5.0273
Table 38 Calculation of Spread for PGXIV for 1 year GSec as Reference Rate

Interest
17-Jul-04 Jul- 14, 15, 16 4.800% 1.073% 5.8724% 6.10%
Jul-05 Jul- 13, 14, 15 5.844% 1.073% 6.9170% 6.10%
Jul-06 Jul- 14, 13, 12 7.006% 1.073% 8.0790% 6.10%
Jul-07 Jul- 16, 13, 12 6.972% 1.073% 8.0450% 6.10%
Jul-08 Jul- 14, 15, 16 9.459% 1.073% 10.5317% 6.10%
Jul-09 Jul- 14, 15, 16 3.948% 1.073% 5.0210% 6.10%
Table 39 Floating Rates for PGXIV for 1 year GSec as Reference Rate

122

(Rs Crs.)

Opening Opening
Jul-04 761.52 0 46.45272 Jul-04 761.52 0 44.71925
Jul-05 761.52 0 46.45272 Jul-05 761.52 0 52.67459
Jul-06 761.52 63.46 46.45272 Jul-06 761.52 63.46 61.52345
Jul-07 698.06 63.46 42.58166 Jul-07 698.06 63.46 56.15916
Jul-08 634.6 63.46 38.7106 Jul-08 634.6 63.46 66.83417
Jul-09 571.14 63.46 34.83954 Jul-09 571.14 63.46 28.67713
255.49 310.5878
Table 40 Interests under Fixed and Floating rates for PGXIV for 1 year GSec as Reference Rate

XIV (1 yr Gsec)
120
100
80
Floating
40
Interest Payment-
20 Fixed
0

Figure 52 Interest Payments under Fixed and Floating Rate for PGXIV for 1 year GSec as Reference Rate

At the time of the issue the yield in Govt Bonds dipped to lows. The interest rates on GSec also fell
by around 115 basis points. The yield on the govt Bonds of 10 year maturity fell 5.75% indicating a 45
basis points fall. Thus the company was able to issue the bonds at a very low coupon rate of just
6.10% which is the lowest rate among all the series of bonds issued till date by the Power Grid
Corporation of India Limited.

Thus in this case it is highly beneficial for the firm to go for fixed rate. The company would have
ended up paying excess of amount Rs. 55, 09, 77,000 (Approx 550 million) towards interest rate if it
had gone for floating rate.

123

Floating Rate under Reference Rate of Average yield of 10 year GSec
After analysing the costs under the floating rate with reference rate as INBMK 1 Year GSec Yield, the
study has been done by taking reference rate as average yield of 10 year GSec for the 12 months.
Most of the bonds has the repayment structure of 4 years of Moratorium Period and then followed
by 12 annual equal repayment of the principle parts. Thus the average tenure turns up to 9 years.
Since there is no GSec of tenure 9 years, 10 years GSec can be taken as benchmark.

Intrest payment, floating rate and the total payment under both the cases Fixed and floating for
each bond is explained in the following part. Also the reference period is yield of GSec for the 6
months preceding the coupon period for the semi-annual interest payments ( and 12 months for
annual interest payments), and the rate will be determined at the beginning of coupon period.

Bond VIII

In this case, since the spread was not available for the preceding 6 months of the month of issue,
the spread of AAA Bonds over 10 year GSec Bond as published by FIMMDA ( Fixed Income and
Monet Market Association) , for the days preceding the opening of offer has been taken as the
spread. Though this spread is for the purpose of Fixed Coupon rate, the same spread is considered
for the floating rate despite the fact that there is less risk for the investors in case of floating rate as
the rate determined is truly reflected by the prevailing market conditions.

During the issue of this series, Market expected a cut in CRR and a fall in GSec ate due to the cut in
CRR. But the situation reversed and though the CR fell, but the rate on GSec 10 years papers
increased. Of the total issue size just 10% was proclaimed. And though the Intrest rates on GSec
increased to 10.70%, the coupon rate was fixed at 10.35%

Though the spread was negative, the spread of 100 basis point (1%) has been taken as the principle
of conservatism.

Average Yield for 10Yrs GSec( 6 Months preceding Coupon period)
Intrest
Oct-00 Oct 99 to Mar 00 11.03% 1.00% 12.026% 10.35%
Apr-01 Apr 00 to Sep 00 11.11% 1.00% 12.108% 10.35%
Oct-01 Oct 00 to Mar 01 10.78% 1.00% 11.777% 10.35%
Apr-02 Apr 01 to Sep 01 9.49% 1.00% 10.493% 10.35%
Oct-02 Oct 01 to Mar 02 7.86% 1.00% 8.863% 10.35%
Apr-03 Apr 02 to Sep 02 7.37% 1.00% 8.369% 10.35%
Oct-03 Oct 02 to Mar 03 6.28% 1.00% 7.280% 10.35%
Apr-04 Apr 03 to Sep 03 5.57% 1.00% 6.574% 10.35%
Oct-04 Oct 03 to Mar 04 5.17% 1.00% 6.174% 10.35%
Apr-05 Apr 04 to Sep 04 5.79% 1.00% 6.793% 10.35%
Oct-05 Oct 04 to Mar 05 6.77% 1.00% 7.772% 10.35%
Apr-06 Apr 05 to Sep 05 7.07% 1.00% 8.075% 10.35%
Oct-06 Oct 05 to Mar 06 7.27% 1.00% 8.268% 10.35%
Apr-07 Apr 06 to Sep 06 7.82% 1.00% 8.824% 10.35%
Oct-07 Oct 06 to Mar 07 7.73% 1.00% 8.732% 10.35%

124

Apr-08 Apr 07 to Sep 07 8.03% 1.00% 9.029% 10.35%
Oct-08 Oct 07 to Mar 08 7.75% 1.00% 8.746% 10.35%
Apr-09 Apr 08 to Sep 08 8.57% 1.00% 9.574% 10.35%
Oct-09 Oct 08 to Mar 09 6.57% 1.00% 7.567% 10.35%
Apr-10 Apr 09 to Sep 09 6.90% 1.00% 7.901% 10.35%
Oct-10 Oct 09 to Mar 10 7.57% 1.00% 8.571% 10.35%
Table 41 Floating Rates for PGVIII for 10 Year GSec

(Rs Crs.)

Opening Opening
Oct-00 20 0 1.035 Oct-00 20 0 1.2026
Apr-01 20 0 1.035 Apr-01 20 0 1.210817
Oct-01 20 0 1.035 Oct-01 20 0 1.177733
Apr-02 20 0 1.035 Apr-02 20 0 1.049267
Oct-02 20 0 1.035 Oct-02 20 0 0.886317
Apr-03 20 0 1.035 Apr-03 20 0 0.83685
Oct-03 20 0 1.035 Oct-03 20 0 0.728
Apr-04 20 0 1.035 Apr-04 20 0 0.6574
Oct-04 20 0 1.035 Oct-04 20 0 0.617417
Apr-05 20 2 1.035 Apr-05 20 2 0.679317
Oct-05 18 0 0.9315 Oct-05 18 0 0.69948
Apr-06 18 2 0.9315 Apr-06 18 2 0.726705
Oct-06 16 0 0.828 Oct-06 16 0 0.661467
Apr-07 16 2 0.828 Apr-07 16 2 0.70588
Oct-07 14 0 0.7245 Oct-07 14 0 0.611205
Apr-08 14 2 0.7245 Apr-08 14 2 0.631995
Oct-08 12 0 0.621 Oct-08 12 0 0.52477
Apr-09 12 2 0.621 Apr-09 12 2 0.57446
Oct-09 10 0 0.5175 Oct-09 10 0 0.378325
Apr-10 10 2 0.5175 Apr-10 10 2 0.395067
Oct-10 8 0 0.414 Oct-10 8 0 0.34282
18.009 15.29789
Table 42 Interests under Fixed and Floating for PGVIII for 10 Year GSec

Bond IX

In this case, the spread is calculated as the average spread for the 6 months preceding the issue
month for AAA Bonds for 10 years Duration as published by FIMMDA. The Spread turns up at 0.75%
or 75 basis points. The computation is as follows:

Avg Spread for AAA
Bonds for 10 Years
Jul-00 74
Jun-00 77
May-00 72
Apr-00 80

125

Mar-00 70
Feb-00 75

Avg. 74.66667
19
Table 43 Calculation of Spread for PGX for 10 year GSec as Reference Rate

Intrest
Feb-01 Feb-00 to Jul-00 10.79% 0.75% 11.5442% 12.25%
Aug-01 Aug-00 to Jan-01 11.22% 0.75% 11.9663% 12.25%
Feb-02 Feb-01 to Jul-01 9.86% 0.75% 10.6057% 12.25%
Aug-02 Aug-01 to Jan-02 8.41% 0.75% 9.1612% 12.25%
Feb-03 Feb-02 to Jul-02 7.47% 0.75% 8.2233% 12.25%
Aug-03 Aug-02 to Jan-03 6.66% 0.75% 7.4127% 12.25%
Feb-04 Feb-03 to Jul-03 5.84% 0.75% 6.5890% 12.25%
Aug-04 Aug-03 to Jan-04 5.18% 0.75% 5.9262% 12.25%
Feb-05 Feb-04 to Jul-04 5.47% 0.75% 6.2200% 12.25%
Aug-05 Aug-04 to Jan-05 6.63% 0.75% 7.3803% 12.25%
Feb-06 Feb-05 to Jul-05 6.91% 0.75% 7.6580% 12.25%
Aug-06 Aug-05 to Jan-06 7.15% 0.75% 7.8960% 12.25%
Feb-07 Feb-06 to Jul-06 7.73% 0.75% 8.4753% 12.25%
Aug-07 Aug-06 to Jan-07 7.66% 0.75% 8.4125% 12.25%
Feb-08 Feb-07 to Jul-07 8.04% 0.75% 8.7875% 12.25%
Aug-08 Aug-07 to Jan-08 7.83% 0.75% 8.5817% 12.25%
Feb-09 Feb-08 to Jul-08 8.24% 0.75% 8.9945% 12.25%
Aug-09 Aug-08 to Jan-09 7.23% 0.75% 7.9823% 12.25%
Feb-10 Feb-09 to Jul-09 6.72% 0.75% 7.4667% 12.25%
Aug-10 Aug-09 to Jan-10 7.37% 0.75% 8.1248% 12.25%
Table 44 Floating Rates for PGIX for 10 year GSec as Reference Rate

Since the spread is very low because of Heavy borrowing by Government, the floating rate is very
low and is always less than the fixed interest rate.

(Rs Crs.)

Opening Opening
Feb-01 576.5 0 35.31063 Feb-01 576.5 0 33.27606
Aug-01 576.5 0 35.31063 Aug-01 576.5 0 34.49296
Feb-02 576.5 0 35.31063 Feb-02 576.5 0 30.57083
Aug-02 576.5 0 35.31063 Aug-02 576.5 0 26.40706
Feb-03 576.5 0 35.31063 Feb-03 576.5 0 23.70376
Aug-03 576.5 57.65 35.31063 Aug-03 576.5 57.65 21.36701
Feb-04 518.85 0 31.77956 Feb-04 518.85 0 17.09351

19
Source: www.fimmda.org

126

Aug-04 518.85 57.65 31.77956 Aug-04 518.85 57.65 15.37396
Feb-05 461.2 0 28.2485 Feb-05 461.2 0 14.34332
Aug-05 461.2 57.65 28.2485 Aug-05 461.2 57.65 17.01905
Feb-06 403.55 0 24.71744 Feb-06 403.55 0 15.45193
Aug-06 403.55 57.65 24.71744 Aug-06 403.55 57.65 15.93215
Feb-07 345.9 0 21.18638 Feb-07 345.9 0 14.65809
Aug-07 345.9 57.65 21.18638 Aug-07 345.9 57.65 14.54942
Feb-08 288.25 0 17.65531 Feb-08 288.25 0 12.66498
Aug-08 288.25 57.65 17.65531 Aug-08 288.25 57.65 12.36833
Feb-09 230.6 0 14.12425 Feb-09 230.6 0 10.37066
Aug-09 230.6 57.65 14.12425 Aug-09 230.6 57.65 9.20363
Feb-10 172.95 0 10.59319 Feb-10 172.95 0 6.4568
Aug-10 172.95 57.65 10.59319 Aug-10 172.95 57.65 7.02595
508.473 352.3295
Table 45 Interests under Fixed and Floating for PGIX for 10 Year GSec

IX ( 10 Yrs Gsec)
40
35
30
25
20 Intrest Payment-Fixed
15
10 Intrest Payment-
5 Floating
0
May-03

May-06

May-09
Feb-01
Nov-01
Aug-02

Feb-04
Nov-04
Aug-05

Feb-07
Nov-07
Aug-08

Feb-10

Figure 53 Interest Payments under Fixed and Floating Rate for PGIX for 10 year GSec as Reference Rate

Bond X

Computation of Spread
Avg Spread for AAA
Bonds for 10 Years
May-01 110
Apr-01 100
Mar-01 78
Feb-01 106
Jan-01 111
Dec-00 104

Avg. 101.5

127

Interest
Jun-02 Jun 00 - May 01 7.82% 1.015% 8.84% 10.90%
Jun-03 Jun 01 - May 02 7.13% 1.015% 8.15% 10.90%
Jun-04 Jun 02 - May 03 6.61% 1.015% 7.62% 10.90%
Jun-05 Jun 03 - May 04 5.37% 1.015% 6.38% 10.90%
Jun-06 Jun 04 - May 05 6.59% 1.015% 7.61% 10.90%
Jun-07 Jun 05 - May 06 8.17% 1.015% 9.19% 10.90%
Jun-08 Jun 06 - May 07 10.63% 1.015% 11.65% 10.90%
Jun-09 Jun 07 - May 08 10.77% 1.015% 11.79% 10.90%
Jun-10 Jun 08 - May 09 12.13% 1.015% 13.15% 10.90%

(Rs Crs.)

Opening Opening
Jun-02 761.52 0 83.00568 Jun-02 761.52 0 67.30631
Jun-03 761.52 0 83.00568 Jun-03 761.52 0 62.0569
Jun-04 761.52 63.46 83.00568 Jun-04 761.52 63.46 58.05955
Jun-05 698.06 63.46 76.08854 Jun-05 698.06 63.46 44.54903
Jun-06 634.6 63.46 69.1714 Jun-06 634.6 63.46 48.27085
Jun-07 571.14 63.46 62.25426 Jun-07 571.14 63.46 52.46397
Jun-08 507.68 63.46 55.33712 Jun-08 507.68 63.46 59.12484
Jun-09 444.22 63.46 48.41998 Jun-09 444.22 63.46 52.35725
Jun-10 380.76 63.46 41.50284 Jun-10 380.76 63.46 50.05883
601.7912 494.2475

X ( 10 yr Gsec )
90
80
70
60
40 Fixed
30
Interest Payment-
20 Floating
10
0

128


Bond XIII- Opt-II

Avg Spread for AAA
Bonds for 10 Years
Jun-02 138

May-02 127
Apr-02 173
Mar-02 200
Feb-02 198
Jan-02 159

Avg. 165.8333

Interest Reference
Payment Period Average Govt yield Spread Floating rate Fixed rate
Jul-03 Jul 01 - Jun 02 8.11% 1.658% 9.77% 7.85%
Jul-04 Jul 02 - Jun 03 6.39% 1.658% 8.05% 7.85%
Jul-05 Jul 03 - Jun 04 5.28% 1.658% 6.94% 7.85%
Jul-06 Jul 04 - Jun 05 6.70% 1.658% 8.36% 7.85%
Jul-07 Jul 05 - Jun 06 7.33% 1.658% 8.99% 7.85%
Jul-08 Jul 06 - Jun 07 7.88% 1.658% 9.54% 7.85%

(Rs Crs.)

Opening Opening
Jul-03 250.5 41.75 19.66425 Jul-03 250.5 41.75 24.47293
Jul-04 208.75 41.75 16.38688 Jul-04 208.75 41.75 16.80431
Jul-05 167 41.75 13.1095 Jul-05 167 41.75 11.5839
Jul-06 125.25 41.75 9.832125 Jul-06 125.25 41.75 10.46606
Jul-07 83.5 41.75 6.55475 Jul-07 83.5 41.75 7.508501
Jul-08 41.75 41.75 3.277375 Jul-08 41.75 41.75 3.983458
68.82488 74.81915

129


XIII-Opt II ( 10 Yr Gsec)
30

25

20
Interest Payment-
15 Fixed

Floating
5

0
Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08

Bond XIV

Avg Spread for AAA
Bonds for 10 Years
Jun-03 50

May-03 50
Apr-03 50
Mar-03 76
Feb-03 86
Jan-03 77

Avg. 64.83333

Interest Reference Floating Fixed
Payment Period Average Govt yield Spread rate rate
Jul-04 Jul 02 - Jun 03 6.39% 0.648% 7.04% 6.10%
Jul-05 Jul 03 - Jun 04 5.28% 0.648% 5.93% 6.10%
Jul-06 Jul 04 - Jun 05 6.70% 0.648% 7.35% 6.10%
Jul-07 Jul 05 - Jun 06 7.33% 0.648% 7.98% 6.10%
Jul-08 Jul 06 - Jun 07 7.88% 0.648% 8.53% 6.10%
Jul-09 Jul 07 - Jun 08 7.91% 0.648% 8.56% 6.10%
Jul-10 Jul 08 - Jun 09 7.17% 0.648% 7.82% 6.10%

130

(Rs Crs.)

Opening Opening
Jul-04 761.52 0 46.45272 Jul-04 761.52 0 53.61075
Jul-05 761.52 0 46.45272 Jul-05 761.52 0 45.13123
Jul-06 761.52 63.46 46.45272 Jul-06 761.52 63.46 55.94227
Jul-07 698.06 63.46 42.58166 Jul-07 698.06 63.46 55.72066
Jul-08 634.6 63.46 38.7106 Jul-08 634.6 63.46 54.1391
Jul-09 571.14 63.46 34.83954 Jul-09 571.14 63.46 48.90415
Jul-10 507.68 63.46 30.96848 Jul-10 507.68 63.46 39.69068
286.4584 353.1388

XIV (10 Yr Gsec)
60

50

40

Fixed
20
Interest Payment-
10 Floating

0

131

Floating Rate under Reference Rate of Average yield of 10 year GSec
In the previous section, the reference period was taken a 6/12 months preceding the coupon period.
But the interest payment in case of reference period of 6/12 months preceding the interest payment
has also been calculated and analysed.

The spread has determined by the same method as used in the previous section ( i.e. average spread
of 6 months preceding the month of issue) as published by FIMMDA. The computation has been
added to the online appendix. And the summary of total interest in each method is as follows:

Average Yield for 10Yrs GSec( Preceding Interest Payment)
(Rs. Crs)
Bond Maturity Interest paid till Spread Under Under
Fixed Floating
VIII 14 Apr-10 1.000% 17.595 14.59242333
IX 12 Feb-10 0.750% 497.8798 334.674
X 14 Jun-09 1.015% 560.2883 464.861
XIII-Opt-II 6 Jul-08 1.658% 68.8249 71.826
XIV 12 Jul-09 0.648% 255.49 320.4026
Table 46 Total Intrest Under Fixed and Floating Rates for All Bonds under 10 Year GSec as Base Rate

And the Intrest trends of each Bond are as follows:

VIII ( 10 Yrs Gsec)*
1.4
1.2
1
0.8
Intrest Payment-Fixed
0.6
0.2 Floating

0
Aug-01

Apr-03

Aug-06

Apr-08
Feb-04

Feb-09
Dec-04

Dec-09
Oct-00

Jun-02

Oct-05

Jun-07

132


IX ( 10 Yrs Gsec)*
40
35
30
25
20 Intrest Payment-Fixed
15
10 Intrest Payment-
5 Floating
0

May-09
May-03

Nov-04

May-06
Nov-01
Aug-02

Aug-05

Nov-07
Aug-08
Feb-01

Feb-04

Feb-07

Feb-10

X ( 10 Yr Gsec)*
90
80
70
60
40 Fixed
30
Interest Payment-
20 Floating
10
0

XIII- Opt II (10 yr Gsec)*
25

20

Fixed
10
Interest Payment-
Floating
5

0

133


XIV (10Yrs Gsec)*
70

60

50

Fixed
30
Interest Payment-
20 Floating
10

0

Figure 54 Intrest Payments Under Fixed and Floating Rates for All Bonds for 10 year GSec as Base Rate

134

Floating Rate under Reference Rate of Average yield of 10 year GSec-
Average Spread of last 12 months

Alternate study of interest cost by taking different spread has also been done. In the previous case,
where average spread of previous 6 months preceding the issue month was considered. But since
the reference rate is calculated by taking the average yield of 10 yr GSec for preceding 12 months,
the spread also need to be taken for the period of 12 months.

Among the 5 issues selected namely, VIII, IX, X, XIII-Opt-II and XIV, the Intrest on the Issue Series VIII
is paid half yearly, thus spread for 12 months need not be calculated. And for Series IX and X, due to
unavailability of data, the spread has not been computed for 12 months preceding the issue month.
Thus for issue Series XIII-Opt II and XIV, the spread as published by FIMMDA for AAA rated PSU
Bonds with reference to 10 year GSec paper for the 12 months preceding the issue month has been
considered. The costs under each case (fixed and floating) is summarised in the table.

Summary of Each Base Rate
The total interest payment till date under both fixed and floating rate for the selected 5 issues has
been summarised in the following table.

Average Yield for 10Yrs GSec( Preceding Interest Payment)
(Rs. Crs)
Interest paid Under Under
Bond Maturity till Spread Fixed Floating Savings
VIII 14 Apr-10 1.00% 18.009 15.29789 2.71111
IX 12 Feb-10 0.75% 497.8798 334.674 163.2059
X 14 Jun-09 1.015% 560.2883 464.8609 95.42745
1.658% 68.82488 71.82599 -3.00112
XIII-Opt-II 6 Jul-08 20
1.507% 68.82488 73.49 -4.66512
0.648% 255.49 320.3901 -64.9001
XIV 12 Jul-09 2
0.711% 255.49 323.0287 -67.5387
Table 47 Summary of Costs under 1 Year GSec as Base Rate

Average Yield for 10Yrs GSec( Preceding Coupon period)
(Rs. Crs)
VIII 14 Apr-10 1.00% 17.59500 14.59242 3.002577
IX 12 Aug-10 0.75% 508.473 352.3925 156.0805
X 14 Jun-10 1.015% 601.7912 494.247 107.5442
1.658% 68.82488 74.81652 -5.99164
XIII-Opt-II 6 Jul-08 2
1.507% 68.82488 70.4959 -1.67103
0.648% 286.4584 353.1248 -66.6663
XIV 12 Jul-10 2
0.711% 286.4584 356.0833 -69.6249
Table 48 Summary of Costs under 10 Year GSec as Base Rate ( Coupon Period)

20
Spread is determined taking previous 12 months’ average of Spread as published by FIMMDA

135

(Rs. Crs)
VIII 14 Apr-10 1.04% 17.585 12.57485 5.01015
IX 12 Feb-10 1.52% 497.8798 321.3677 176.5121
X 14 Jun-09 2.690% 560.2883 449.1773 111.111
XIII-
Opt-II 6 Jul-08 1.794% 68.82488 65.9424 2.882475
XIV 12 Jul-09 1.073% 255.49 310.5878 -55.0978
Table 49 Summary of Costs under 10 Year GSec as Base Rate ( Interest Payment Period)

136

Factors Effecting the Selection of Each Method

From the above computation and comparison of Intrest payments under all the three benchmarks
rates with different spreads for different kinds of bonds differing with each other on the basis of
coupon rate, the quantum of loan and also the duration (Maturity). Some of the analysis that can be
made is:

The selection of different mechanism of paying interest Viz Fixed or Floating rate is influenced by
some of the following factors.

Term
Term implies the tenure of the bond. It is the maturity of the bond, after which the whole principal is
redeemed. For the bonds having short term maturity, the fixed coupon rate is suitable. This can be
validated from the above summary of results, where Bond XII-Opt II, which has the tenure of 6 years,
has interest payments under fixed coupon rate lower than that of payment under floating rate.

The rationale behind the floating rate is, the fluctuations, both short terms as well as long term are
normalised over the life of the bond. Thus in case of longer maturities, the fluctuations, both ups
and downs, are covered, thus on an average the payments under floating rate is normalised. But in
case of short duration bonds the floating rate may be either very low or very high based on the
period it belongs to.

PG XIII- 1Year Gsec PG XIII- 10Year Gsec
12.00% 12.00%
10.00% 10.00%
8.00% 8.00%
6.00% 6.00%
4.00% 4.00%
2.00% 2.00%
0.00% 0.00%

1 Year Gsec + Spread PGXIII 10 Year Gsec + Spread PGXIII

In the above chart, depicting the floating and fixed rate for the Bond Series XIII which has the tenure
of 6 Years, it can be seen that though the interest rate in case of floating rate was less than that of
fixed in the initial years, . In this case, since the tenure of short term, the fluctuations of both Ups
and downs are not covered within the period.

Coupon Rate
Coupon rate is the interest rate attached to the bond. The coupon rate exists only in case of fixed
Intrest rate. Under floating rate, since the interest rate is reset after every period, thus a fixed

137

coupon rate cannot be determined. The coupon rate is one of the important factors that affect the
decision of selecting fixed under floating rate.

In case, if the company is able to issue at a lower coupon rate, it will be beneficial for the company
to go for fixed rate. This is because, no matter whatever are the market conditions, in the future, the
company will be needed to pay the low pre-determined rate.

To explain, if we consider the Series XIV, which is issued at a coupon rate of 6.10%, the Floating rate
turns up to be unfavourable. From the following chart, it can be seen that the security is issued when
the Bond is issued just before the GSec rate was at its lowest. Thus the floating rate exceeds the
fixed rate for the subsequent years. Thus when the GSec yield is at its lowest, it is preferable to go
for fixed coupon rate.

XIV- 1 Yr Gsec XIV- 10 Year Gsec
12.000% 12.00%
10.000% 10.00%
8.000% 8.00%
6.000% 6.00%
4.000% 4.00%
2.000% 2.00%
0.000% 0.00%

1Yr Gsec + Spread XIV 10 Yr Gsec + Spread XIV

Market Condition
But since the coupon rate is determined based on the market conditions at the time of the issue, the
prevailing GSec rate and the spread, thus the market conditions during the time of issue is also an
important factor to consider.

If the market conditions are favourable, characterised, with adequate liquidity, low interest rates
etc... The prevailing GSec rats will be low and also the spread will be low resulting in low coupon
rate. And the benefit of this favourable condition can be enjoyed throughout the tenure of the bond.

But in case if the market conditions are not favourable, downturn in the economy, high borrowings
by the government, unfavourable policies by the RBI, would lead to high coupon rate. And though
this unfavourable condition lasts just for a month or a year, but the effect of the same shall be beard
over the long term.

Also the spread is determined based on the prevailing market conditions, and under both the cases
i.e... Fixed and floating the spread is kept fixed. But under floating rate, the reference rate keeps on
adjusting and thus there shall be benefits of savings.

138

For instance, in case of IX issue, when this series was issued the market conditions were not
favourable. Some of the events affecting the interest rates were

 Due to hike in CRR, the Bank rates and GSec rates hiked up,
 Most of the nationalised banks increased their PLR
 60% of Annual borrowings by GoI during the current year amounting to approx. Rs.1,20,000
Crores is yet to be raised
 All the above mentioned points may bring an upward pressure in GSec rates thus the coupon
rate was fixed with the spread of 75 basis points over the prevailing rate of 10 years GSec.

Thus, the rate determined was at 12.25%. And in this case, if the company had issued floating rate,
the effect of unfavourable conditions had to be suffered only for a year or so, and there would have
been savings under the floating rate.

XII Issue
14.0000%
12.0000%
10.0000%
8.0000%
6.0000% Gsec+Spread

4.0000% XII

2.0000%
0.0000%
2001

2004
2000

2002

2003

2005

2006

2007

2008

2009

Figure 55 Comparison of Fixed and Floating in case of Adverse Market conditions

From the graph, it can be commented that, floating rate is beneficial in case when market conditions
are not favourable. From the date of issue to the last interest payment date, the floating rate is
lower than the fixed coupon rate.

Quantum of Loan
The quantum of loan is also a component to be considered. For a loan of small amount, no matter
whatever be the coupon rate and whatever be the tenure, there will be very less losses or gains in
case of going to floating rate. Thus the company can be indifferent between fixed or floating rate.

Thus, in case of Bond series VIII, the loan amount of Rs20 Crores at the coupon rate of 10.35%, very
low saving of Rs.2 crores or Rs.5 crores depending upon different base rates can be seen, under the
floating rate.

Repayment Structure

Repayment structure determines the schedule of repayment of the principal and payment of
interest. Almost all the bonds of Power Grid Corporation of India Limited has initial moratorium

139

period followed by equal annual instalments for the principal payment. Thus the interest is paid for
the whole amount initially and then the payment is done on the outstanding balance which keeps on
reducing over the years.

Thus in case of floating rate, if the market conditions are favourable at the time of issue and
becomes adverse at the end, the company will get benefitted, as a low interest is paid on whole
amount and a higher interest is paid on the less amount. But in case of a reverse condition, i.e...
Market conditions being unfavourable at the initial years and then followed by the favourable
scenario, the fixed coupon rate is advisable.

Time of Issue
The timing of issue is very crucial for deciding the method of interest rate. The scenario of market
widely differs within a period of a month or so. If a month has scheduled government borrowings,
any awaited policy announcements, liquidity conditions etc..., the interest rates on GSec will be high
leading to the high coupon rate.

140


Chapter VI
Findings and
Recommendations

 Critical Analysis of Alternatives
 Recommendations

141


Critical Analysis of Alternatives
Based on the above discussed calculations and their analysis, some of the alternatives for the
purpose of issuing bonds are as follows:

Fixed Coupon Interest Rate
The company can go for the fixed coupon rate for some of its bonds based on the market conditions
and the suitability of the rate. In this case the coupon rate fixed by the process of book-bidding will
remain constant for throughout the life of the bond. The company can take benefits of the
favourable market conditions at the time of the issue for the whole life of the bond. But there is also
a risk attached to it, as it is highly skewed towards the market condition and the prevailing interest
rates at the time of the issue, and the company may need to suffer if the market conditions are not
favourable.

Some of the merits of this mechanism are:

 Since the interest rate is fixed at the time of issue, the company can easily forecast the
interest obligations for the future and budget the same.
 The zero variation in the income in way of interest attracts the client base belonging to Fixed
Income group. In India majority of investors is comprised of Retirement funds like Provident
Fund, Pension Plan, Superannuation funds etc. Thus this kind of plan can assure maximum
acceptance.
 This kind of mechanism is very beneficial, if the conditions of the market are favourable and
are characterised with low interest rates. Thus the coupon rate fixed at the time of issue
which remain fixed shall lead to lot of savings.
 This is suitable for a company which is very conservative.

Some of the Cons attached to this type of method are:

 The company cannot take the advantage of fluctuations in the interest rates due to the shift
in economic conditions and other favourable events.
 The coupon rate determined at the time of issue does not reflect the market conditions of
the subsequent years.
 If the issue comes out at a period when the market conditions are adverse, the coupon rate
determined will be very high because of high interest rates as well as high spreads. And the
rate determined will remain constant for the whole tenure leading to heavy costs.

Floating Rate

As against the case of fixed Coupon rate where the interest rate is determined at the time of issue
and is kept fixed, in case of Floating Interest Rate, the interest rate does not remain constant and is
reset after every predetermined reset period. In this case the interest paid for the period is truly
represented by the market conditions and the prevailing interest rates for that period. But there is
risk of fluctuation of interest rates and these may be very low or very high. Thus this method can be
used for few bonds based on the market situation, tenure of the bond and also the quantum of the
loan.

142

The rate is determined based on the reference rate. And this reference rate can be yield on a
Treasury bill, Yield on 1 year GSec paper, or 10 year GSec paper, or even Bank rates like MIBOR. The
selection of either of the reference rates depend on the kind of security, its maturity, its features in
terms of risk, raying etc. And also the decision is on the discretion of the issuer and the advice of
merchant bankers.

Some of the points in support of Floating rate are:

 The company can take advantage of Intrest rate fluctuations, and pay the interest as per the
prevailing interest rates in the economy.
 In case if the market conditions are not favourable at the time of issue, the interest paid on
the security for the subsequent years will not be much influenced by the market conditions
of the issue period.
 For the investor, this kind of securities are attractive and preferable by them, since the
returns on the security are truly represented by the market conditions and are similar to the
opportunity cost21 of the investment.
 Since the interest paid for any period is truly represented by that period’s condition and also
since the trading is allowed in the bonds, an investor can hold the security for short term
and need not hold it till the maturity.

Some of the points against this method are:

 This method is characterised with fluctuations in Income for the investors, thus it may be
less attractive for the Fixed and Regular Income class of the investors (Viz Retirement benefit
Funds).
 Also, since the interest payments for the future cannot be forecasted, the budgeting of
funds cannot be done effectively.

But this can be solved by maintain a provision account for some fixed coupon rate or as
some margin added to the past floating rate on the outstanding balance.

 For the companies which are very conservative and least prefers the variations in the
expenses, this method is least attractive.
 The benefit of favourable conditions at the time of issue vanishes in this method.
 Though the interest rates are truly represented by the prevailing market conditions, but the
spread is determined based on the prevailing spread at the time of issue. Thus there is some
influence of market conditions at the time of issue.

21
The returns which he would have received in case of investing in any alternate avenues.

143

Fixed Coupon Rate with Option
As mentioned before, one of the demerits of fixed coupon rate is, in case of high interest rates at the
time of issue, the same coupon rate is paid for throughout the tenure even though the market has
become favourable. This can be avoided if the bonds are issued with an option attached to it.

The option is the Option for the option holder to execute his option of Buy or sell, and the other
party is under obligation to fulfil the option. In this case the option holder has the option but he is
not under obligation to exercise his option. The Option can be compared with the person holding the
Ticket to a cinema. In this case the ticket holder has the right to watch the movie if he wishes to and
the Theatre management cannot deny him from his right and is under obligation to show him the
cinema. But also the Ticket holder is not at all under the obligation of watching the movie and the
management cannot force him to watch the movie.

The company can issue the Bonds with the Call Option with the company or Put option with the
investor. The Call option implies that the Option holder has the right to buy the security in a
predetermined period and at a predetermined price. And the other party is under obligation to sell
them whenever the Call option is exercised.

And the Put option implies that the Option holder has the right to sell the security at a
predetermined price after a predetermined period. But he is not under obligation to exercise the
right. But the other party is under obligation to buy the security in case if the holder exercises the
Option.

The Company can also attach the Option with the Bonds. If the company is expecting a fall in interest
rates after a period of five years, or in case if the current interest rates are very high but the raising
of loan cannot be postponed, in this case the Bonds can be issued with a Call Option with the
company to buy the Bonds after a predetermined period.

In case if the interest rates fall after the predetermined Hold-In period, the Company can call for the
bonds and repay the bondholders and then can raise the fresh bonds at a low coupon rate.

Some of the Merits attached to it are:

 Apart from the merits in case of fixed coupon rate, the coupon rate if is set at a very high
rate due to unfavourable market conditions, the company can redeem the bonds of high
coupon rate and can swap the amount with a low coupon rate bonds by issuing the fresh
bonds.
 Also, since the Investors do not have the Put Option the uncertainty of Disbursements in
case of sudden selling of bonds by investors is avoided.

But since the put option is not provided to the investors, in case of rise in the interest rates than the
coupon rate, the investor do not has the option of selling these bonds to the company and re-invest
the funds in a better avenue. This makes the instrument less attractive.

144


Recommendation

After comparing the interest costs under Fixed and Floating Rates for a array of bonds having
different characteristics like

 Meagre loan Amount
 Half Yearly Intrest Payment
 Longer Maturity of 14 years
 Shorter Maturity of 6 years
 Low coupon rate

Though the behaviour and pattern of the yields of GSec papers are very fluctuation and do not
follow a fixed pattern, very accurate recommendations could not be given. But based on the trend of
last 10 years GSec yield trend, some of the recommendations that can be made on the suitability of
each kind bond are:

 The company can go for Fixed Intrest rate if the market conditions are favourable at the time
of issue.
 Also for the meagre loan amount, the company can be indifferent between the Fixed and
the Floating rate.
 If the bonds are issued for a very short term period, the behaviour of the GSec yield will
influence the decision. If the issue is made at the period when the yield is high, the floating
rate will be suitable because the yield curve would fall for the subsequent years and only the
fall will be covered within the tenure because of short term maturity bond.
 But in case if the curve is already at its low, fixed rate must be preferred for the short tenure
bonds, because in case of floating rate, only the rise will be covered.
 For a longer maturity bond, Fixed interest is to be preferred if the yield curve of the GSec is
at its low, and the floating is to be preferred if the yield curve is at its high.
 The method of interest determination is not affected by the frequency of interest payment.
Be it half yearly or annually.
 In case of recession, the yield of GSec, the interest rates are low; the investors become
prudent and prioritise the security to the returns. Thus at such conditions, fixed coupon rate
can be issued as the company will be able to attract investment at low coupon rate.
 Also since as per CERC Guidelines, for the purpose of Tariff determination, the company shall
provide the interest expenses, if the company goes for the floating rate, the interest
payments will vary every year, thus a provision account can be maintained.
 The company can also issue the Call Option Embedded Bonds if the market conditions are
not favourable at the time of issue.
 The Intrest rates on GSec paper and the Yield curve is affected by some of the economic
events like announcement of budget, announcement of monetary policy by RBI etc... Thus in
case of fixed coupon rates, the timing of the issue must be planned and thus the advantage
of favourable market condition can be taken.

145


References

Bond & Money Markets: Strategy, Trading, Analysis, First South Asian Edition, Moorad Choudhry
Bond Markets, Analysis, and Strategies, Fifth Edition, Frank J. Fabozzi
CORPORATE CREDIT RATINGS A Note on Methodology- by ICRA
Financial Data from Company’s Annual report- 2008-09
http://en.wikipedia.org/wiki/Reverse_Greenshoe Visited on 11th April
http://www.equitymaster.com/detail.asp?date=9/6/2003&story=2 Visited on 3rd April
http://www.equitymaster.com/research-it/sector-info/power/ Visited on 3rd April
http://www.investopedia.com/terms/g/greenshoe.asp Visited on 11th April
http://www.jagoinvestor.com/2010/03/floating-rate-mutual-funds-%E2%80%93-how-when-and-
why.html visited on 26th April, 2010
http://www.linkedin.com/answers/finance-accounting/corporate-debt/FIN_CDT/327845-24854458
Visited on 7th April
http://www.powermin.nic.in/indian_electricity_scenario/introduction.htm Visited on 3rd April
http://www.sundarandco.com/sebi03.htm Visited on 11th April
http://www.youtube.com/watch?v=NV0S8pKvje8&feature=related Visited on 14th April
http://www.youtube.com/watch?v=tJLR3se4Pa4 Visited on 14th April
Offer Document of Power Grid Corporation of India Limited’s Bond series XII, IX, XXIX and XXXI.
Offer Documents of FRBs of ICICI Limited, Power Finance Corporation of India Limited, Kotak
Mahindra Limited, Indian Railway Finance Corporation of India Limited.
Red Herring Prospectus of Power Grid Corporation of India Limited’s IPO of September, 2007.
Securities and Exchange Board Of India (Disclosure And Investor Protection) Guidelines, 2000
Power Sector in India -White paper on Implementation Challenges and Opportunities” – KPMG
Repos in corporate bonds under consideration, says Sebi”- Newswire18 / Mumbai September 11, 2009,

Some of the data bases used are:

Capitaline
http://nse-india.com/
Reuters
www.FIMMDA.org
www.indiastat.com

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Analysis of fixed and floating interest rates

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