basic knowledge about debt

Copyright Aditya Birla Nuvo Limited 2008 1

Birla Sunlife AMC Welcomes you…

August 2008

Confidential Copyright © Aditya Birla Group

What is Debt ?


Debt is Borrowing…..

An amount of money borrowed and owed by one party to another.

Features Coupon Principal Tenure


Fixed Income Security

Example of Dated Security

9.81% GOI 2013

issuerMaturity date

coupon


Example – Coupon & Yield

Issue Price – 100 Market Price - 102 Coupon – 9 %, Rs.9 Tenure – 10 years Yield – Coupon/Market Price

- 9/102 = 8.82%


Quiz Time

Example – If a 12.5% bond sells in the market for Rs. 104.50. What is the yield?


Price and Yield Increase in rates reduces value of existing bonds.

Decrease in rates increases value of existing bonds

Price and yield are inversely related

The relationship between yield and tenor can be plotted as

the yield curve.


Interest Rates & Debt Fund NAV


Discuss: What is the present Scenario?


Debt - Some Perceptions


Risk in Debt

Why banks have different interest rates on FD’s of 1 year, 3 years & 5 years……

What difference it makes if you lend a person for 1 year, 3 year or 5 years……………


Risk in Debt

• Default Risk

If you lend a person a sum of 1cr. for 1 year and to another person for 5 years,in which case default risk is higher ?

Would you charge same interest rate in both the cases or different rate…………


There are two 5 year Corporate Debentures available in the market one of HLL & Second of XYZ Ltd.

Which one you will buy & Why?

Do you think both company’s will have the same coupon rate? If not than Why ?


Risk in Debt

Reinvestment Risk

If you lend a person at a rate of 8 % for 5 years and in second year of the tenure market rate is 10%………………..

So tenure in an instrument and credibility of the borrower makesa lot of difference to the return on investment in a debt instrument.


• Interest Rate Risk (Price Risk) For Example: If you have purchased a bond for Rs. 100 with coupon

rate of 8%. In case interest rate in the market goes up to 9% and you have to sell this bond at same time, at what price you will be able to sell………..

• Downgrade Risk Effect on the price of a bond in case of downgrade in the rating of the

company………….


Duration:

To maximize returns fund managers constantly adjust the duration of the bond portfolio

• If our outlook on interest rates is “bullish” ( we expect interest rates to fall ) duration is extended i.e buy long bonds

• If the outlook is “bearish” (we expect the interest rates to rise ) the duration is reduced i.e sell long bonds and buy short bonds or come into cash.


The Market …The debt market in India comprises basically three segments, viz.,

1. Government Securities Market, which is oldest and most dominant; 2. PSU Bonds Market, which is basically a development since late eighties;

and 3. Corporate Securities Market, which is growing fast after liberalisation,

especially in the last two years. 4. CDs

Government Securities Market is the most important …1. …the principal segment of our debt market2. … it has a role in setting benchmarks in the financial markets as a

whole. 3. … critical in bringing about an effective and reliable transmission

channel for the use of indirect instruments of monetary control.


Importance of Money and Debt markets..

Money & Debt Markets fulfill the basic needs of borrowing and lending of the market participants

Borrowers… who are in need of cash Lenders… who have surplus cash

The objective is to lend liquidity into the markets and help in smooth functioning of the markets and the overall financial system of the country


Borrowers …

Who are the major borrowers? The Government of India is the largest borrower in

the market Corporates

Why does the Central Government Borrow? Financing of gross fiscal deficit Capital expenditure Repayment of external borrowing Servicing of outstanding borrowings


Who are the Investors?

Banks,

Mutual funds and

Insurance Companies

Why do they invest ?

Surplus money for a certain period/s

Investors…


Debt Market

Long Term DebtShort Term Debt(One Year or Less)

Dated Government Securities (1 – 30 years) Corporate Bonds/debentures – floating /fixed rate (1 month to 20 years)

(More than one year) Call/Notice Money (1-14 days)

Term Money – FDs (upto 1 year)

Repo (1-14 days)

CBLO (Collateralized Borrowing and Lending Obligations) This is parallel to Call Money Market (1 day to 3 months)

Treasury Bills (91 day and 365 day)

Certificates of Deposits (upto 1 year)

Commercial Paper (upto 1 year)


Money Market Instruments

Money Market is the financial market where short-term (one year or less)

debt securities are issued and traded.

Typical Money Market instruments available to the investor include treasury

bills (TB's), certificates of deposit (CD's), Commercial Papers,

These debt obligations are much like cash because they are highly liquid.

The Money Market provides financial institutions and large corporations with

quick cash for short-term needs.


Call Money, Notice Money Dealers Call Money is essentially a money market instrument

wherein funds are borrowed / lent for a tenor of one

day/overnight (excluding Sundays/holidays).

Notice Money is an instrument where the tenor is more than 3

days and less than 15 days.

Interest is calculated on a actual / 365 - day basis.

Participants are banks and Primary (PDs)


Central Government Securities-Treasury Bills

Short Term Debt Instruments Issued on behalf of Government by RBI. 2 Types 91-day and 364 day. Sold thorough an Auction process according to a Fixed

Auction Calendar.Auctions every Wednesday. Banks and Primary Dealers are major bidders. Non-Competitive bids allowed, allotted at weighted

average yield.


Commercial Paper

Commercial Papers are unsecured short-term borrowings by

Corporates, FIs etc. having a maturity of 15 days to one year.

They are issued subject to minimum of Rs 5 lakhs and in multiples of Rs.

5 lakh thereafter.

Commercial paper is not usually backed by any form of collateral, so only

firms with high-quality debt ratings will easily find buyers without having to

offer a substantial discount (higher cost) for the debt issue.

Interest is calculated on actual number of days / 365 day year basis.


Certificate of Deposits

Involve Creation of Paper Predominantly issued by Banks Maturity Minimum Amount Loan Yield driven by Demand and Supply conditions.


Repo & Reverse Repo

Repo is used by Central Banks with the objective of injecting/withdrawing liquidity into and from the market and also to reduce volatility in short term in particular in call money rates.

For institutions and corporate entities, repos provide a source of inexpensive finance

An active repo market would lead to an increase in

turnover in the money market, thereby improving liquidity and depth of the market.


PTCs

Pass through certificates (PTCs) pre-dominantly issued by NBFCs at high yields

Underlying loan assets usually represent vehicle loans and home loans

Better cash and yield flow structure Credit enhancement and rating to make the product

attractive Low level of secondary market liquidity


CBLO

Secured paper created by CCIL based on SGL balances

Available only to NDS participants Overnight to 14 day tenor Rates close to call rates, though participant profile is

different

Mutual funds are large lenders Used by mutual funds for purposes of short term

parking, not for yield Yield driven by liquidity conditions


How does the government / corporate borrow..

The government /Corporate borrows by issuing Fixed income securities


Fixed Income Security

Example of Dated Security

9.81% GOI 2013

issuerMaturity date

coupon


Birla Sun Life Debt Products


ProductsTime Horizon Short Term(Less than one year) Long Term(More than one year)

Definition Investment is into money market instruments.

Investment is into Govt. Securities, Corporate Bonds etc.

Liquid Short Term Income Gilt

Products Cash Manager

Cash Plus

Liquid Plus

Short Term Fund

FMP’s, FRF’s

Income Plus

Income Fund

Dynamic Bond Fund

Gilt Plus

Objective Short Term Parking of Funds

Short Term Parking of Funds

To generate income and capital appreciation

To generate income and capital appreciation

Time Horizon Very High Liquidity(1-15days)

15 days – 1 year 1Year + 1year +

Taxation DDT – 28.325% DDT – 14.163% DDT – 14.163%, Short Term & Long Term

DDT – 14.163%, Short Term & Long Term

NAV Previous Day Same Day on realization of funds

Same Day Same Day


Liquid funds

Liquid Plus

Short Term Debt

Gilt Funds

Focused Debt Fund

Diversified Debt Funds

Risk

Return

Risk and Return


Taxation Taxation Individual Corporate

Dividend Tax Free Tax Free

DDT(Debt)

DDT(Liquid)

12.5%+10%(sur)+ 3% cess = 14.163

25% + 10% + 3% = 28.325%

20% + 10%(sur) + 3% cess = 22.66%

25% + 10% + 3% = 28.325%

Short Term

Capital Gain

30% + 10% + 3%

=33.99%

30% + 10% + 3%

=33.99%

Long Term

Capital Gain

10% without indexation

Or 20% with indexation

Whichever is lower

10% without indexation

Or 20% with indexation

Whichever is lower


Calculating Capital Gain Tax - An Example

Mr. H Invests Rs.2 lacs in MF units during FY 97-98

• After 2 years, he sells units and gets Rs.2.4 lacs

• His tax liability will be:

CII 99-00 : 389, CII 97-98 : 331 , Ratio : 389/331=1.18

• Indexed Cost (2,00,000 x 1.18) = Rs.2,36,000

• Capital Gains – Rs.4,000

• Long Term Capital Gain tax of Mr. H:

Rs.4,000* 20%=Rs.800 or 10% of Rs. 40,000/- i.e. Rs. 4,000/-

Obviously he will select the option of paying Rs. 800/-


With Single Indexation

Without Indexation

Individuals Corporates

A Purchase Price 100,000 100,000 100,000 100,000 100,000 B Post Expense Indicative Yield 10.20% 10.20% 10.20% 10.20% 11.00%C Repurchase Price 110,347 110,347 110,347 110,347 111,159D Gain = C-A 10,347 10,347 10,347 10,347 11,159 E Indexed Cost @ 105,709 0 - - -

FLong Term Capital Gain/(Loss) = C-E 4,637 10,347 - - 11,159

G Tax Rate 22.66% 11.33% 14.16% 22.66% 33.99%H Tax 1,051 1,172 1,283 1,911 3,793 I Post Tax Gains = D-H 9,296 9,174 9,063 8,435 7,366

JPost Tax Annualised Returns = (I/A) * no. of years 9.16% 9.05% 8.94% 8.32% 7.26%

BSLFTP Series BI - Growth Option

Illustrative Calculation and Comparison of returns generated by Birla Sun Life Fixed Term Plan Series BI (370 days)

BSLFTP Series BI - Dividend Option

Fixed Deposit

@ Indexation rate has been assumed to be 5.63% based on the cost inflation index numbers for the last 1 FY

basic knowledge about debt

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