module 2_cost of capital

8/18/2019 Module 2_cost of Capital

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FINANCIALMANAGEMENT 1

Prof. R Madhumathi

Department of ManagementStudies


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Modue !

C"ST "F CAPITAL


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SEC#RITIES

1. Corporate securities Equity Shares

Preference Shares

Debentures

Bonds

Warrants

2. Deposits in banks and non-banking copanies.

!. "#$ and other utua% fund schees.

&. Post o'ce deposits and certi(cates). *ife insurance po%icies

+. Pro,ident fund schees.

. o,ernent and sei-o,ernent securities.


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Corporate se$urities% Corporate securities are thesecurities issued by /oint stock copanies in the pri,atesector. #hese inc%ude equity shares0 preference shares and

debentures. Equity shares ha,e ,ariab%e di,idend and hencebe%ong to the high risk - high return category0 hi%epreference shares and debentures ha,e (ed returns ith%oer risk.Deposits% 3ong the non-corporate in,estents0 the ostpopu%ar are deposits ith banks such as sa,ings accounts and

(ed deposits. Sa,ings deposits ha,e %o interest rateshereas (ed deposits ha,e higher interest rates ,aryingith the period of aturity. $nterest is payab%e quarter%y orha%f-year%y. 4ied deposits ay a%so be recurring depositsherein sa,ings are deposited at regu%ar inter,a%s. Soe

banks ha,e rein,estent p%ans herein sa,ings aredeposited at regu%ar inter,a%s. Soe banks ha,erein,estent p%ans herein the interest is rein,ested as itgets accrued. #he principa% and accuu%ated interest are paidon aturity.


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Deposits% 5oint stock copanies a%so accept (eddeposits fro the pub%ic. #he aturity period ,aries frothree to (,e years. 4ied deposits in copanies ha,e high

risk since they are unsecured0 but they proise higherreturns than bank deposits.4ied deposit in non-banking (nancia% copanies67B4Cs8 isanother in,estent a,enue open to sa,ers. 7B4Cs inc%ude%easing copanies0 hire purchase copanies0 in,estent

copanies0 chit funds etc. Deposits in 7B4Cs carry higherreturns ith higher risk copared to bank deposits.#TI and other mutua fund s$hemes% "#$ is the o%destand the %argest 9utua% 4und in the country. $t has anyin,estent schees. "nit Schee 1:+&0 "nit *inked$nsurance P%an 1:10 9aster share0 9aster Equity P%ans0

9astergain etc. are soe of the popu%ar schees of "#$. 3nuber of coercia% banks and (nancia% institutions ha,eset up 9utua% 4unds. 9utua% 4unds ha,e been set up in thepri,ate sector a%so. #hese 9utua% 4unds o;er ,ariousin,estent schees to in,estors.


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Post o&$e deposits and $erti'$ates% #he in,estenta,enues pro,ided by post o'ces are genera%%y non-arketab%e. 9oreo,er0 the a/or in,estents in post o'ce

en/oy ta concessions a%so. Post o'ces accept sa,ingsdeposits as e%% as (ed deposits fro the pub%ic. #here isa%so a recurring deposit schee hich is an instruent ofregu%ar onth%y sa,ings.Si-year 7ationa% Sa,ings Certi(cates67SC8 are issued by post

o'ce to in,estors. #he interest on the aount in,ested iscopounded ha%f-year%y and is payab%e a%ong ith theprincipa% at the tie of aturity hich is si years fro thedate of issue.$ndira


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Pro(ident fund S$heme% Pro,ident fund schees arecopu%sory deposit schees app%icab%e to ep%oyees in thepub%ic and pri,ate sectors. #here are three kinds of pro,ident

funds app%icab%e to di;erent sectors of ep%oyent0 nae%y0Statutory Pro,ident 4und0 >ecogni?ed Pro,ident 4und and"nrecogni?ed Pro,ident 4und.$n addition to these0 there is a ,o%untary pro,ident fundschee hich is open to any in,estor hether ep%oyed or

not. #his is knon as the Pub%ic Pro,ident 4und 6PP48. 3nyeber of the pub%ic can /oin the schee hich is operatedby the post o'ce and the State Bank of $ndia.Go(ernment and semi)Go(ernment se$urities% #hego,ernent and sei-go,ernent bodies %ike the pub%icsector undertakings borro oney fro the pub%ic through

the issue of o,ernent securities and pub%ic sectorbonds. #hese are %ess risky a,enues of in,estent becauseof the credibi%ity of the o,ernent and o,ernentundertakings.


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E*#IT+ S,ARES• Equity shares are coon%y referred to as

coon stock or ordinary shares. E,en thoughthe ords shares and stocks areinterchangeab%y used0 there is a di;erencebeteen the. Share capita% of a copany is

di,ided into a nuber of sa%% units of equa%,a%ue ca%%ed shares. #he ter stock is theaggregate of a eber@s fu%%y paid up shares ofequa% ,a%ue erged into one fund. $t is a set of

shares put together in a bund%e. #he AstockA isepressed in ters of oney and not as anyshares. Stock can be di,ided into fractions ofany aount and such fractions ay be

transferred %ike shares.


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E*#IT+ S,ARES

• Share certi(cate eans a certi(cate under the

coon sea% of the copany specifying thenuber of shares he%d by any eber. Sharecerti(cate pro,ides the pria facie e,idence oftit%e of the ebers to such shares. #his gi,esthe shareho%der the faci%ity of dea%ing ore easi%yith the shares in the arket. $t enab%es the sa%eof shares by shoing arketab%e tit%e.


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E*#IT+ S,ARES

Equity shares ha,e the fo%%oing rights according tosection ) 628 of the Copanies 3ct 1:)+ in $ndia

1. >ight to ,ote at the genera% body eetings of the copany.

2. >ight to contro% the anageent of the copany.

! >ight to share in the pro(ts in the for of di,idends and bonusshares.

&. >ight to c%ai on the residua% ,a%ue after repayent of a%% thec%ais in the case of inding up of the copany.

). >ight of pre-eption in the atter of issue of ne capita%.

+. >ight to app%y to court if there is any discrepancy in the rights setaside.

. >ight to recei,e a copy of the statutory report0 copies of annua%

accounts a%ong ith audited report.. >ight to appea% to the centra% go,ernent to ca%% an annua%eeting hen a copany fai%s to ca%% such a eeting.

:. >ight to appea% to the Copany *a Board for ca%%ing anetraordinary genera% eeting.


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E*#IT+ S,ARES

•

$n a %iited copany the equityshareho%ders are %iab%e to pay thecopany@s debt on%y to the etent of theirshare in the paid up capita%. #he equity

shares ha,e certain ad,antages. #he ainad,antages are

• Capita% appreciation

•

*iited %iabi%ity• 4ree tradabi%ity

• #a ad,antages 6in certain cases8 and

• edge against inFation


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• #ypes of Equity Shares

– 7on-,oting Shares – >ights Shares

– Bonus shares

– Seat Equity

E*#IT+ S,ARES


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N"N)-"TING S,ARES• 7on-,oting shares carry no ,oting rights. #hey carry

additiona% di,idends instead of the ,oting rights. E,en

though the idea as ide%y discussed in 1:0 it as on%yin the year 1::& that the 4inance 9inistry announcedcertain broad guide%ines for the issue of non-,oting shares.

•

#hey ha,e right to participate in the bonus issue. #he non-,oting shares a%so can be %isted and traded in the stockechanges. $f non-,oting shares are not paid di,idend forto years0 the shares ou%d autoatica%%y get ,otingrights. #he copany can issue this to a aiu of 2)

per cent of the ,oting stock. #he di,idend on non-,otingshares ou%d ha,e to be 2G percent higher than thedi,idend on the ,oting shares. 3%% rights and bonus sharesfor the non-,oting shares ha,e to be issued in the for ofnon-,oting shares on%y.


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RIG,TS S,ARES

• Shares o;ered to the eisting shareho%ders at a price bythe copany are ca%%ed rights shares. #hey are o;ered

to the shareho%ders as a atter of %ega% right. $f a pub%iccopany ants to increase its subscribed capita% byay of issuing shares after to years fro its forationdate or one year fro the date of (rst a%%otent0hiche,er is ear%ier0 such shares shou%d be o;ered (rstto the eisting shareho%ders in proportion to the capita%paid up on the shares he%d by the at the date of sucho;er. #his pre-epti,e right can be forfeited by theshareho%ders through a specia% reso%ution. #he

shareho%der can renounce the rights shares in fa,our ofa noinee in part or fu%%y. #he rights shares ay bepart%y paid. 9iniu subscription %iit is prescribed forrights issues. $n the e,ent of copany fai%ing to recei,e:GH subscription0 the copany sha%% ha,e to return the

entire oney recei,ed. 3t present0 SEB$ has reo,edthis %iit. >i hts issues are re u%ated under the


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"N#S S,ARES• Bonus share is the distribution of shares in addition to the

cash di,idends to the eisting shareho%ders. Bonus sharesare issued to the eisting shareho%ders ithout any

payent of cash. #he ai of bonus share is to capita%isethe free reser,es. #he bonus issue is ade out of freereser,es bui%t out of genuine pro(t or share preiuco%%ected in cash on%y. #he bonus issue cou%d be ade on%yhen a%% the part%y paid shares0 if any0 eisting are adefu%%y paid up.

• #he dec%aration of the bonus issue used to ha,efa,ourab%e ipact on the psycho%ogy of the shareho%ders.

#hey take it as an indication of higher future pro(ts. Bonusshares are dec%ared by the directors on%y hen theyepect a rise in the pro(tabi%ity of the concern. #he issueof bonus shares enab%es the shareho%ders to se%% theshares and get capita% gains hi%e retaining their origina%

shares.


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S/EAT E*#IT+• Seat equity is a ne equity instruent introduced in

the Copanies 63endent8 Irdinance0 1::. 7e%yinserted Section :3 of the Copanies 3ct0 1:)+a%%os issue of seat equity. oe,er0 it shou%d beissued out of a c%ass of equity shares a%ready issuedby the copany. $t cannot for a ne c%ass of equity

shares. Section :3 628 ep%ains that a%% %iitations0restrictions and pro,isions app%icab%e to equity sharesare app%icab%e to seat equity. #hus0 seat equityfors a part of equity share capita%.

• #he de(nition of seat equity has to di;erentdiensions

– Shares issued at a discount to ep%oyees and directors.

– Shares issued for consideration other than cash forpro,iding kno- ho or aking a,ai%ab%e rights in the

nature of inte%%ectua% property rights or ,a%ue additions.


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S/EAT E*#IT+

• $n its (rst for0 issue of seat equity ay bepriced at a discount to the preferentia% pricing orat a discount to face ,a%ue. $ssue of seat equityfa%%s in the category of preferentia% issue underSection 1 6%38 of the Copanies 3ct0 1:)+.3greed upon price of shares of the copany is

deri,ed in accordance ith preferentia% pricingnor0 hich ay be ca%%ed as nora% price.

• #he %e,e% of discount to nora% price ay bedecided on the basis of the ,a%uation of theintangib%es to be acquired. Discount is thedi;erence beteen the nora% price and price athich seat equity is issued.


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S/EAT E*#IT+

• Discount ay a%so ean any issue of seat equitybe%o the par ,a%ue. #his eases the restriction on

issue of shares at discount as stated in Section :. #his route can be used by a copany hose shareprice is 1G-2GH abo,e the par ,a%ue. $ssue of sharesat discount under Section : can be carried at 1GHdiscount. $n case of seat equity0 it becoesiperati,e to decide the aiu %e,e% of discount

that can be o;ered to the ep%oyees and directors.

• #he second type of seat equity can be issued at par

or abo,e par. $n other ords0 the seat equity can beissued against kno-ho0 inte%%ectua% property rightsor in recognition of ,a%ue additions. $ssue of seatequity for consideration other than cash shou%d be atthe nora% preferentia% price.


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Reasons for issuing s0eat e1uit2

• Directors and ep%oyees contribute inte%%ectua% propertyrights to the copany. #his ay be in the for of pro,iding

technica% kno-ho captured by ay of research0contributing to the copany in the for of strategy0 softarede,e%oped for the copany0 or adding pro(t.

• #raditiona% ay of recogni?ing the ep%oyees and directors in

the for of onetary and non-onetary bene(t isde(cient. E,en incenti,e bonus on the basis of perforancefai%s to reard the adequate%y. >ather in the atter ofinte%%ectua% property right0 the contributingep%oyeesJdirectors are not e%% protected.

• $n case a directorJep%oyee %ea,es the copany or is askedto %ea,e0 the generation of cash Fos to the copany foran unidenti(ed future period is not stopped and thedirectorJep%oyee a%so gets adequate return.


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S0eat e1uit2 is espe$ia2 for• DirectorsJep%oyees ho designed strategic a%%iance

• DirectorsJep%oyees ho orked for strategic arketpenetration and he%ped the copany attain sustainab%e arketshare.

$n the ser,ice industry0 seat equity has a specia% re%e,ance. #hea/or industries here the directors and ep%oyees can be

rearded through seat equity are

Coputer hardare and softare de,e%opent

9anageent consu%tancy here a standard strategy is issued toearn a fee0 %ike Enterprise >esource P%anning 6E>P8 so%ution

7B4Cs here product design is crucia% Ither non-traditiona% (nancia% ser,ice industries %ike custodians0

depositories and credit rating herein basic ser,ice design isiportant

$n the %ife insurance segent0 coission-based business can be

con,erted into seat equity ith de,e%opent o'cers and branchanagers 6sa%es8


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PREFERENCE S,ARES• #he characters of the preferred share are hybrid in

nature. Soe of its features reseb%e the bond andothers the equity shares. *ike the bonds0 their c%aison the copany@s incoe are %iited and they recei,e(ed di,idend. $n the e,ent of %iquidation of thecopany their c%ais on the assets of the (r are a%so

(ed. 3t the sae tie %ike the equity0 it is a perpetua%%iabi%ity of the corporate. #he decision to pay di,idendto the preferred stock is at the discretion of the Boardof Directors. $n the case of bonds0 payent of interestrate is andatory.

• #he di,idend recei,ed by the preferred share is treatedon par ith the di,idend recei,ed fro the equity sharefor ta purposes. #hese shareho%ders do not en/oy anyof the ,oting poers ecept hen any reso%ution a;ectstheir rights.


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T2pes of Preferen$e Shares

• Cuu%ati,e preference shares• 7on-cuu%ati,e preference shares

• Con,ertib%e preference shares

• 7on-Con,ertib%e preference shares

• >edeeab%e preference shares

• $rredeeab%e preference shares

• Cuu%ati,e Con,ertib%e Preferenceshares


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Cumuati(e preferen$e shares

• ere0 the cuu%ati,e tota% of a%% unpaid preferred

di,idends ust be paid before di,idends are paid onthe coon equity. #he unpaid di,idends are knonas arrears. #he arrears do not earn interest. #he nonpayent of the di,idend on%y continues to gro. #hearrears occur on%y for a %iited nuber of years and

not inde(nite%y. enera%%y three years of arrears accrueand the accuu%ati,e feature ceases after three years.But the di,idends in arrears continue if there is nopro,ision in the 3rtic%es of 3ssociation. $n the case of

%iquidation0 no arrears of di,idends are payab%e un%essthere is a pro,ision for the in the 3rtic%es of3ssociation.


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Non)$umuati(e shares

• 3s the nae suggests0 the di,idend does notaccuu%ate. $f there is no pro(t or inadequate pro(t in

the copany in a particu%ar year0 the copany doesnot pay it. When the copany is ound up if thepreference and equity shares are fu%%y paid they ha,eno further rights to ha,e c%ais in the surp%us. $f thereis a pro,ision in the 3rtic%es of 3ssociation for such

c%ais0 then they ha,e the rights to c%ai.Con(erti3e preferen$eshares

#he con,ertibi%ity feature akes the preference share aore attracti,e in,estent security. #he con,ersion

feature is a%ost identica% ith that of the bonds. #hesepreference shares are con,ertib%e as equity shares at theend of the speci(ed period and are quasi-equity shares.

#his gi,es the additiona% pri,i%ege of sharing thepotentia% increase in the equity ,a%ue0 a%ong ith the

security and stabi%ity of incoe.

i3 f h


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Non)Con(erti3e preferen$e shares

• #he non-con,ertibi%ity feature ip%ies that thepreference shares retain their characteristics of

a preference share docuent.Redeema3e preferen$eshares$f there is a pro,ision in the 3rtic%es of 3ssociation0

redeeab%e preference shares can be issued. But

redeption of the shares can be done on%y hena8 #he part%y paid up shares are ade fu%%y paid up.b8 #he fund for redeption is created fro the pro(ts0hich ou%d otherise be a,ai%ab%e for distribution ofdi,idends or out of the proceeds of a fresh issue of shares

for the purpose.c8 $f any preiu has to be paid on redeption0 it shou%dbe paid out of the pro(ts or out of the copany@s sharepreiu account.d8 When redeption is ade out of pro(ts0 a su equa% tothe noina% ,a%ue of the redeeed shares shou%d betransferred to the capita% redeption reser,e account.


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Irredeema3e preferen$e shares• #his type of shares is not redeeab%e ecept on

occasion %ike inding up of the business. $n $ndia0 thistype of shares ere peritted ti%% 1)th 5une 1:. #heintroduction of section G3 in the Copanies 3ct 1:)+has put an end to it.

Cumuati(e Con(erti3e Preferen$e

Shares 4CCPS5 #his CCPS as introduced by the o,ernent in 1:& #his preference share gi,es a regu%ar return say 1GHduring the gestation period fro three years to (,eyears and then are con,erted into equity as per theagreeent. 3ccording to the guide%ines0 CCPS can be

issued for any of the fo%%oing purposes 6a8 setting up ofne pro/ects 6b8 epansion or di,ersi(cation of eistingpro/ects 6c8 nora% capita% ependiture for oderni?ationand 6d8 orking capita% requireents. CCP fai%ed toattract the interest of the in,estors because the rate ofinterest is ,ery %o and the gain that cou%d be recei,ed


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DEENT#RES

• 3ccording to the Copanies 3ct 1:)+0

ADebenture inc%udes debenture stock0 bonds andany other securities of copany0 hetherconstituting a charge on the assets of thecopany or notA. Debentures are genera%%y

issued by the pri,ate sector copanies as a %ong-ter proissory note for raising %oan capita%. #hecopany proises to pay interest and principa%as stipu%ated. Bond is an a%ternati,e for ofdebenture in $ndia. Pub%ic sector copanies and

(nancia% institutions issue bonds.


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Chara$teristi$ Features of De3entures

• Form $t is gi,en in the for of certi(cate of indebtedness by thecopany specifying the date of redeption and interest rate.

• Interest #he rate of interest is (ed at the tie of issue itse%fhich is knon as contractua% or coupon rate of interest. $nterestis paid as a percentage of the par ,a%ue of the debenture anday be paid annua%%y0 sei annua%%y or quarter%y. #he copanyhas the %ega% binding to pay the interest rate.

•Redemption 3s stated ear%ier the redeption date ou%d bespeci(ed in the issue itse%f. #he aturity period ay range fro) years to 1G years in $ndia. #hey ay be redeeed ininsta%%ent. >edeption is done through a creation of sinkingfund by the copany. 3 trustee incharge of the fund buys thedebentures either fro the arket or oners. Creation of thesinking fund e%iinates the risk of facing (nancia% di'cu%ty at thetie of redeption because redeption requires a huge su.

• Buy back pro,isions he%p the copany to redee the debenturesat a specia% price before the aturity date. "sua%%y the specia%price is higher than the par ,a%ue of the debenture.

Chara$teristi$ Features of


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Chara$teristi$ Features ofDe3entures

• Indenture% $ndenture is a trust deed beteen the

copany issuing debenture and the debenturetrustee ho represents the debenture ho%ders. #hetrustee takes the responsibi%ity of protecting theinterest of the debenture ho%ders and ensures that

the copany fu%(%%s the contractua% ob%igations.4inancia% institutions0 banks0 insurance copaniesor (r attornies act as trustees to the in,estors. $nthe indenture the ters of the agreeent0description of debentures0 rights of the debenture

ho%ders0 rights of the issuing copany and theresponsibi%ities of the copany are speci(ed c%ear%y.


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T2pes of De3entures

• Debentures are c%assi(ed on the basis of the

security and con,ertibi%ity • Secured or unsecured

• 4u%%y con,ertib%e debenture

• Part%y con,ertib%e debenture

• 7on-con,ertib%e debenture

S d d


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Se$ured or unse$ured

• 3 secured debenture is secured by a %ien on the copany@sspeci(c assets. $n the case of defau%t the trustee can take

ho%d of the speci(c asset on beha%f of the debenture ho%ders.$n the $ndian arket secured debentures ha,e a charge onthe present and future io,ab%e assets of the copany.

• When the debentures are not protected by any security they

are knon as unsecured or naked debentures. $n the3erican capita% arket debenture eans unsecured bondshi%e bonds cou%d be secured or unsecured in the $ndianarket. "nsecured debentures (nd it di'cu%t to attractin,estors because of the risk in,o%,ed in the. enera%%ydebentures are rated by the credit rating agencies.


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Fu2 $on(erti3e de3enture

• #his type of debenture is con,erted into equityshares of the copany on the epiry of speci(cperiod. #he con,ersion is carried out according tothe guide%ines issued by SEB%. #he 4CD carries %oerinterest rate than other types of debenturesbecause of the attracti,e feature of con,ertibi%ity

into equity shares.Part2 $on(erti3e de3enture #his debenture consists of to parts nae%ycon,ertib%e and non-con,ertib%e. #he con,ertib%eportion can be con,erted into shares after a speci(cperiod. ere0 the in,estor has the ad,antage ofcon,ertibe and non-con,ertib%e debentures b%endedinto one debenture. Eap%e Procter and ab%ehad issued PCD of >s 2GG each to its eistingshareho%ders. #he in,estor can get a share for >s +)

ith the face ,a%ue of >s 1G after 1 onths fro


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Non)$on(erti3e de3enture

7on-con,ertib%e debentures do not conferany option on the ho%der to con,ert thedebentures into equity shares and areredeeed at the epiry of the speci(edperiod.


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"NDS

• Bond is a %ong ter debt instruent that proises to

pay a (ed annua% su as interest for speci(ed periodof tie. #he basic features of the bonds are gi,en be%o

18 Bonds ha,e face ,a%ue. #he face ,a%ue is ca%%ed par,a%ue. #he bonds ay be issued at par or at discount.28 #he interest rate is (ed. Soeties it ay be ,ariab%e

as in the case of Foating rate bond. $nterest is paid sei-annua%%y or annua%%y. #he interest rate is knon as couponrate. #he interest rate is speci(ed in the certi(cate.!8 #he aturity date of the bond is usua%%y speci(ed at theissue tie ecept in the case of perpetua% bonds.

&8 #he redeption ,a%ue is a%so stated in the bonds. #heredeption ,a%ue ay be at par ,a%ue or at preiu.)8 Bonds are traded in the stock arket. When they aretraded the arket ,a%ue ay be at par or at preiu or atdiscount. #he arket ,a%ue and redeption ,a%ue need not

be the sae.


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T2pes of onds

• Secured bonds and unsecured bonds

• Perpetua% bonds and redeeab%ebonds

• 4ied interest rate bonds and Foating

interest rate bonds

• Kero coupon bonds

• Deep discount bonds

• Capita% indeed bonds


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Se$ured 3onds and unse$ured 3onds #hesecured bond is secured by the rea% assets of theissuer. $n the case of the unsecured bond the nae

of issuer ay be the on%y security.Perpetua 3onds and redeema3e 3onds Bondsthat do not ature or ne,er ature are ca%%edperpetua% bonds. #he interest a%one ou%d be paid. $nthe redeeab%e bond the bond is redeeed after a

speci(c period of tie. #he redeption ,a%ue isspeci(ed by the issuer.

Fi6ed interest rate 3onds and 7oating interestrate 3onds $n the (ed interest rate bonds theinterest rate is (ed at the tie of the issue. Whereas

in the Foating interest rate bonds the interest rateschange according to the pre(ed nors. 4or eap%ein Dec 1::! State Bank of $ndia issued Foating interestrate bonds orth >s )GG Cr. pegging the interest rateith its on three and (,e years (ed deposit rates to

pro,ide bui%t in yie%d Feibi%ity to the in,estors


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8ero $oupon 3onds% #hese bonds se%% at a discount andthe face ,a%ue is repaid at aturity. #he origin of this typeof bond can be traced in the ".S. Security 9arket. #he high,a%ue of the ".S.o,ernent security pre,ented thein,estors fro in,esting their oney in the o,ernentsecurity. Big brokerage copanies %ike 9erri% *ynch0 Pierceand others purchased the o,ernent securities in %argequantu and reso%d the in sa%%er denoination at adiscounted rate. #he di;erence beteen the purchase costand face ,a%ue of the bond is the gain for the in,estor. Sincethe in,estor does not recei,e any interest on the bond0 thecon,ersion price is suitab%y arranged to protect the interest%oss to the in,estor.


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8ero $oupon 3onds% #he erit of this bond is that thecopany does not ha,e the burden of ser,icing the debtduring the eecution period of the pro/ect. #he repayent

cou%d be ad/usted to fa%% after the cop%etion of the pro/ect. #his cou%d resu%t in considerab%e cost sa,ings for thecopany.Deep dis$ount 3onds Deep discount bond is another forof ?ero coupon bond. #he bonds are so%d at %arge discount ontheir noina% ,a%ueL interest is not paid for the and they

ature at par ,a%ue. #he di;erence beteen the aturity,a%ue0 and the issue price ser,es as an interest return. #hedeep discount bonds@ aturity period ay range fro ! yearsto 2) years or ore. $DB$ as the (rst to issue deep discountbonds in $ndia in 1::2 ith ,arying aturity period options.$C$C$ a%so issued deep discount bonds ith four optiona%aturity periods in 1::. Ear%y redeption option is pro,idedat the end of the +th012th and 1th year.

C i i d d 3 d C i % i d d b d


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Capita inde6ed 3onds% Capita% indeed bonds ereintroduced in 1::. $n the capita% indeed bond0 the principa%aount of the bond is ad/usted for inFation for e,ery year. 4oreap%e0 an in,estent of >s.%GGG in the inFation indeed

bonds earn the in,estor a sei annua% interest incoe for the(,e years@ period. #he rese%%ing of the principa% aount isdone sei annua%%y based on the Who%esa%e Price $nde 6WP$8o,eents. #he principa% aount of the bond is ad/usted forinFation for each of the years. In the inFation-ad/usted

principa%0 the coupon rate of + per cent is orked. #he bene(t of the bond is that it gi,es the in,estor an increasein return by taking inFation into account. #he in,estor en/oysthe bene(t of a return on his principa%0 hich is equa% to thea,erage inFation beteen the issue 6purchase8 and aturityperiod of the instruent. #o a,ai% the bene(t of inFated

principa%0 the in,estor needs to ho%d the instruent for theentire ) year period.$f the in,estor ants to eit ear%y0 he can do it throughthe secondary arket. #he ,a%ue of the principa%repayent i%% be ad/usted by the $nde >ate 6$>80 hichi%% be announced by the >B$ to eeks prior to therepayent of the principa%. #he $> is orked out as

fo%%os


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Inde6 ratio 4IR5 9 Referen$e /PI date:ase /PI

issue date

$n the $ndian situation indeed bonds o;er ore scope

since the econoy is high%y sensiti,e to inFation.3ccording to the study conducted by the De,e%opent>esearch roup 6D>8 of the >B$0 during the period 1:2-:!0 the rea% rate of interest as negati,e for ost of theyears. 3,erage ,a%ue o,er the period is inus 1.& percent.

#his situation arrants an inFation hedge. #he inFationprotection pro,ided by the bond guarantees rea% rate of

return hich eans that ith the rise in inFation0 thereturn fro the inFation protected bond i%% rise.

Where Date = Interest payment date

Reference WPI Date : Reference WPI applicable for aspecic day, i.e., interest payment date,Reference WPI Issue date : Applicable for the original issue

date.

/ARRANTS


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/ARRANTS

• 3 arrant is a bearer docuent of tit%e to buy speci(ed nuber ofequity shares at a speci(ed price. "sua%%y arrants can be eercised

o,er a nuber of years. #he %ife periods of arrants are %ong.Warrants are genera%%y o;ered to ake the bond or preferred stocko;ering ore attracti,e. Bonds ay bear %o interest rate but thearrants o;ered a%ong ith the he%ps the in,estor to en/oy theequity appreciation ,a%ue. Warrants are detachab%e. #he in,estor canse%% the arrants separate%y and they are traded in the arket.

• #he person ho is ho%ding the arrant cannot en/oy the bene(ts ofthe equity ho%der before the con,ersion of the arrant. #he price athich the arrants are con,erted is ca%%ed eercise price. #heeercise price is a%ays greater than the current arket price of the

respecti,e equity at the tie of issue of arrant. When arrants areissued a%ong ith host securities and are detachab%e0 they are knonas detachab%e arrants. $n soe cases the arrants can be so%d backto the copany before the epiry date and is knon as puttab%earrants. 7aked arrants are issued separate%y and not ith any hostsecurities. #he in,estor has the option to con,ert it into equity or

bond.

Ad(antages of /arrants


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Ad(antages of /arrants18 Warrants ake the non-con,ertib%e debentures and other

debentures ore attracti,e and acceptab%e.

28 #he debentures a%ong ith the arrants are ab%e to create theiron arket and reduce the copany@s dependence on (nancia%institutions and utua% funds.

!8 Since the eercise of the arrants takes p%ace at a future date0 thecash Fo and the capita% structure of the copany can be p%annedaccording%y.

&8 #he cost of debt is reduced if arrants are attached to it. $n,estorsare i%%ing to accept %oer interest rate in the anticipation ofen/oying the capita% appreciation of equity ,a%ue at a %ater date.

)8 Warrants pro,ide high degree of %e,erage to the in,estors. #heycan se%% the arrant in the arket or con,ert it into stocks or a%%o it

to %apse. But if the con,ersion is copu%sory0 e,en if there is a fa%% inthe price of the shares0 the in,estors ha,e to she%% out oney frohis pocket.

+8 Warrants are %iquid and they are traded in the stock echanges.ence0 the in,estor can se%% the arrants before eercising the.


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Di;eren$e et0een Share /arrantsand Share Certi'$ate

/arrants Share Certi'$ate1. $ssued by pub%ic %iitedcopany

$ssued by pub%ic and pri,atecopanies

2. 7eed for pro,ision in the3rtic%es of 3ssociation

7o need for pro,ision in the3rtic%es of 3ssociation

!. Shou%d be appro,ed by thecentra% o,ernent

Centra% o,ernent appro,a% isnot needed

&. #ransfer of share arrantrequires no registration

#ransfer of share ou%d becop%ete on%y if it registration iscop%ete

). Share arrants are issued tofu%%y paid up shares

Share certi(cates are issued tofu%%y and part%y paid shares

+. $t is considered as a negotiab%einstruent

Share certi(cate is not considered%ike that


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Cost of De3t

Present -aue of onds3 bond or debenture is a %ong-ter debt instruent. Bondsissued by the go,ernent or the pub%ic sector copanies in$ndia are genera%%y secured. #he pri,ate sector copanies issuesecured or unsecured debentures. $n the case of a bond ordebenture0 the rate of interest is (ed and knon to in,estors.3 bond is redeeab%e after a speci(ed period. $t is re%ati,e%yeasy to deterine the present ,a%ue of a bond since its cashFos and the discount rate can be deterined ithout uchdi'cu%ty. $f there is no risk of defau%t0 then there is no di'cu%tyin estiating the cash Fos associated ith a bond. #he

epected cash Fos consist of annua% interest payents p%usrepayent of principa%. #he appropriate capita%i?ation ordiscount rate to be app%ied i%% depend upon riskiness of thebond. #he risk in ho%ding a go,ernent bond is %ess than therisk associated ith a debenture issued by a copany.

Consequent%y0 a %oer discount rate ou%d be app%ied to thecash Fos of the o,ernent bond and a hi her rate to the


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Fa$e (aue% 4ace ,a%ue is ca%%ed par ,a%ue. 3 bondJdebenture isgenera%%y issued at a par ,a%ue of >s.1GG or >s.1GGG0 and interestis paid on face ,a%ue.

Interest rate% $nterest rate is (ed and knon tobondho%dersJdebenture ho%ders0 interest paid on abondJdebenture is ta deductib%e. #he interest rate is a%so ca%%edcoupon rate. $t is a rate entioned on the certi(cate 6coupon8

Maturit2% 3 bondJdebenture is issued for a speci(ed period oftie. $t is repaid on aturity.

Redemption (aue% #he ,a%ue hich a bondho%derJdebentureho%der i%% get on aturity is ca%%ed redeption ,a%ue. 3

bondJdebenture ay be redeeed at par or at preiu 6orethan par ,a%ue8 or at discount 6%ess than par ,a%ue8.

Mar


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ond 0ith a Maturit2 Period

• #he fo%%oing foru%a can be used to deterine the ,a%ubond

WhereP M Present ,a%ue of bondJdebentureC M aount of $nterest in period t

i M required rate of return on bond6H8 a%so ca%%ed cost ofdebt9 M terina%0 or aturity0 ,a%ue in period n7 M nuber of years to aturity3 bond or debenture ay be aorti?ed e,ery year. $n thatcase0 the principa% i%% dec%ine ith annua% payents andinterest i%% be ca%cu%ated on the outstanding aount.


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+ied to Maturit2%

• We ay be required to ca%cu%ate the required

rate of return hen the bond@s price and cashFo are knon. #his rate is a%so knon as yie%dto aturity 6N#98 or bond@s interna% rate ofreturn.

ere i M Nie%d to aturity 6N#98

module 2_cost of capital

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