How do Bond Issuances work?

Corporations seek new financing for a variety of reasons, including the need to increase working capital, repay debts, purchase fixed assets or other companies, or repurchase the firm’s own shares. Companies considering a new issue must also consider the following decisions:
» The types of securities to be issued

» The timing in bringing the issue to market

» The issue price, coupon rate, and underwriting fee

» The proportion of the issue that will be offered to institutional and retail investors


AdvantagesDisadvantages
Bonds• Bonds have a lower interest rate than comparable debentures.
• They are marketable to institutions that require debt issues secured by assets.
• Bonds are less flexible than equities because the assets are pledged to a trustee.
• They can be problematic in mergers and amalgamations because of pledges against specific assets.
• They require regular interest payments, the omission of which can lead to default.
Debentures• Debentures are flexible because here are no specific pledges or liens.
• The cost at issue is lower than for bonds because there is no registration of assets.
• The coupon rate can be higher than that of a comparable bond because of the lack of pledge on specific assets.
• They require regular interest payments, the omission of which can lead to default.
Preferred Shares• Technically, preferred shares are considered equity; therefore, if the issue is successful, the company can increase debt outstanding and still maintain a stable debt-to-equity ratio.
• Omission of a dividend payment does not trigger default, as non-payment of interest on the bond or debenture would.
• They provide greater flexibility in financing because no assets are pledged.
• They have a limited lifespan because they can be redeemed through the open market, a lottery, or a purchase fund.
• The cost of issuing preferred shares is high because the dividends are paid with after-tax income. The high cost can increase risk to the corporation.
• Occasionally, non-payment of dividends on preferred issues can trigger the implementation of voting privileges for preferred shareholders.
• A purchase fund can be a drain on company assets during recessionary times.

The Method of Offering

Public Offerings

In a public offering, the corporation and the dealer come to a preliminary agreement to determine whether the dealer will act as an agent or as the underwriter and principal of the securities. In the early stages of negotiation, the two parties establish the dealer’s commission (if acting as agent) or the spread between the proposed offering price and the dealer’s cost price (if acting as principal). The offering price and various other details are not normally finalised until just before the public offering date. The pricing of the issue and the actual volume of securities issued are dependent on the market environment at the issue date.

Private Placement
In a private placement, the entire issue is sold to one or several large institutional investors. The issuer solicits one or more large investors such as banks, mutual fund companies, insurance companies, or pension funds. Placements are generally offered to sophisticated investors and institutional clients. In many cases, private placements are announced after they have occurred, usually through advertisements in the financial press.

Essential details are enclosed in the Prospectus

» Details of the offering (e.g., offering price to the public, plan of distribution, and characteristics of the security)

» What the company plans to do with the proceeds from the issue

» Information on the business and affairs of the issuer (e.g., history, operation details, directors and their history, and legal proceedings)

» Factors affecting an investment decision (e.g., risk factors and income tax considerations)

» Information on promoters, principal security holders, and interest of management in material transactions

» Financial information (e.g., the company’s share and loan capital structure, operating results, and debt)

SECONDARY FIXED INCOME TRADING IN INDIA

India has a centralised clearing platform for fixed-income trading. The Clearing Corporation of India (CCIL) was set up in 2001 to provide exclusive clearing and settlement for transactions in money, government securities and foreign exchange. CCIL was set up with the objective of improving efficiency in the transaction settlement process and insulate the financial system from shocks emanating from operations related issues. The organisation also undertakes related activities that help to broaden and deepen the money, debt, and foreign exchange markets in the country.

  • CCIL maintains the Negotiated Dealing System (NDS), which is developed and owned by Reserve Bank of India and operated by CCIL, which is where government securities are traded on the secondary market.
  • CCIL has also developed and currently manages the NDS-CALL electronic trading platform for trading in call money. Furthermore, it has developed the NDS-Auction module for T-bills auction by the RBI.
  • CCIL guarantees settlements of all trades, thus eliminating counterparty risk. As the counterparty to both buyer and seller, it maintains a settlement guarantee fund (SGF) made up of margin contributions from each participant with the CCIL. 

The major participants in Secondary market in India are primary dealers, banks (public, private, and foreign), insurance companies, pension funds, mutual funds, foreign portfolio investments, and to a lesser extent retail investor. The Employees Provident Fund Organisation (EPFO) is also a major buyer of G-Secs both in primary and secondary markets. The settlement for trades done on the NDS-OM platform is on a trade-date-plus-one-business-day (T+1) basis. However, the bulk of the trading activity is intra-day. 

A note on Accrued Interest 

Accrued interest is the amount of interest built up during the previous holding period. 

The amount of accrued interest is found by using three numbers:

» Par value (the principal amount)

» Coupon rate

» Time period (the number of days since the last coupon payment) 

The accrued interest amount is found by using the following formula:
Accrued Interest= (Par Value) * (Coupon Rate/100)* (Time Period/365)
In the financial market, a bond price that does not take account of accrued coupon is called the clean price, whereas a bond price that does take account of accrued coupon is known as the dirty price.



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