Convertible Debentures Final

Summer Internship Report
Exploring opportunities in Resource

Mobilization from
Domestic Markets by the means of
Convertible Bonds for PFCL
Submitted by:
Preeti gupta
(200709 Batch)
POWER FINANCE CORPORATION LTD.,

URJANIDHI, 1, Barakhamba Lane, Cannaught Place, NEW DELHI 110001
Under the guidance of
Mr. Milind M. Dafade

Manager (Finance)
Power Finance Corporation Ltd.
Jagan Institute Of Management Studies

New Delhi
Table of Contents
Summer Project Certificate......4
Acknowledgement..5
Executive Summary...6
1) Indian Power Sector: ....7
1.1 Introduction..7
1.2 Privatization...13
1.3 Highlights of Performance....14
1.4 Demand side Management: Recommendations..16
1.5 Supply side Management: Recommendations17
2) Power Finance Corporation: Overview.18
3) Resource Mobilization Unit29
3.1 Rupee Resources (Domestic).29
3.2 Foreign Currency Resources (International)..30
3.3 The 3 Main Decisions Taken by RMU.....31
3.4 Instruments Used By PFC to Raise Funds in Domestic Market...........34
4) Indian Debt Market.37
5.1 Overview.37
5.2 Market Micro Structure....41
5) Capital Market: Fixed Income Market.............46
4.1 Introduction....46
4.2 Classification of Bond Market......47
4.3 Bonds Market Instruments...49
4.4 Factors Influencing Bond Market....51
6) Corporate Bond.......52
6.1 Convertibles and Exchangeables..52
6.2 Adjustment Events.....56
6.3 Why Invest in Convertible Bonds: Investors perspective.60
7) Some General Underlying Legal Issues in Convertible...61
7.1 SEBI Guidelines.....62
7.2 Guidelines for Preferential Issues.................................67
Jagan Institute of Management Studies, New Delhi.
7.3 Guidelines for the OCTEI Issues..69

7.4 Guideline for Bonus Issues70
7.5 Some SEBI Circulars for Amendment of Guidelines.72
7.6 Private Placement of Securities79
7.7 The Indian Stamp Act...82
8) General Procedure Followed While Issuing Convertible Debenture.....84
9) Methodology.88
9.1 Essentials in case PFC goes for convertible debentures issue....88
9.2 Assumptions.......89
9.3 Analysis...90
9.4 Recommendations .92
10) References...93
Summer Project Certificate
Acknowledgement
This project would have been difficult to complete without the invaluable contributions
from some important persons. Let us take this opportunity to thank them.
First of all, we would like to thank Power Finance Corporation Ltd for giving us such
challenging projects to work upon. We hope this challenge has brought the best out of us.
We are indebted to our project guide Mr. Milind M. Dafade, Sr. Manager (Finance),
Resource Mobilization Unit, for the direction and purpose he gave to this project through
his invaluable insights, which constantly inspired us to think beyond the obvious. His
encouragement and co-operation helped us instill a great degree of self-confidence to
deliver a good work. We are also thankful to Mrs. Parminder Chopra (DGM) and Ms.
Tabassum for taking constructive interest in our project and providing us valuable support
at many points of time.
We are also thankful to all the employees of Power Finance Corporation who provided us
with an environment conducive for learning during the last two months.
We hope we can build upon the experience and knowledge that we have gained here and
make a valuable contribution towards this industry in the coming future.
Preeti Gupta
Executive Summary
As Indian economy has been growing at a rapid and impressive pace averaging over
8.5% and Electricity is one of the most vital infrastructure inputs for economic development of a
country; the country needs a commensurate growth in the Power Sector also. So, even
Power Finance Corporation (PFC) has to live up to its impeccable image of being a
leading Power Sector Financial Institution in the country. PFC is committed to act as a
catalyst for reforming Indias Power Sector to mobilize various types of resources at
competitive rates and further lend the funds to enable availability of required quality
power at minimum cost to consumers. Herein lays the justification of the project
undertaken.
Our project attempts at analyzing various present and prospective sources of finance that
can be used by PFC to maximize rate of return through efficient borrowing & lending and
introduction of innovative financial instruments for the power sector. With the blurring of
geographical boundaries after globalization, taking advantage of the global markets for
mobilizing resources at a cheaper rate has become a necessity to sustain and grow. Hence,
exploring the possibilities of mobilizing resources through innovative routes becomes a
natural extension for any Power Financing Corporation.
The following project aims at working out the possibility of issuing Convertible Bonds
and MIBOR-linked Bonds in the Domestic market as a means of resource mobilization.
As PFC is a Public Sector Undertaking, issuing Convertible Bonds will although lead to
dilution of Governments stake in the undertaking but it can turn out to be a good a
source of finance bringing in hordes of funds, the benefits of both Debt & Equity and at
the same time can help in containing the Debt-Equity Ratio of the corporation within the
financial covenants specified by the corporations lenders. At the same time, resorting to
another option of issuing MIBOR-linked Bonds can further expand the horizon of sources
of finance for the corporation. It can help the corporation in enjoying the advantage of
market-linked interest rates and avoiding a fixed rate of interest which has to be paid
irrespective of the market conditions prevailing in the economy.
Our project has thrown open two new ways of mobilizing funds in the Domestic market
which if implemented can definitely reduce the cost of borrowings for the corporation
and can facilitate in achievement of the Corporations long term goal of catapulting the
sustainable development of Indian Power Sector.
Indian Power Sector

Introduction to the Power Sector in India
Electricity is one of the most vital infrastructure inputs for economic development of a
country. The demand of electricity in India is enormous and is growing steadily. The vast
Indian electricity market, today offers one of the highest growth opportunities for private
developers.
Since independence, the Indian electricity sector has grown many folds in size and
capacity. The generating capacity has increased from a meager 1362 MW in 1947 to more
than 91000 MW by 2003, a gain of more than 60 times in capacity addition. India's per
capita energy consumption is projected to grow from 6.2 million Btu in 1980 to 18.2
million Btu in 2010 -- a rise of almost 300 percent. Although, India's energy consumption
per unit of output is still rising, but it is expected to level off and to decline in the future.
India consumes two-thirds more energy per dollar of gross domestic product (GDP) as
the world average. India consumes only about 18 percent of the energy per person as the
world average. Nearly 64.4 per cent of India's electricity is produced in thermal facilities
using coal or petroleum products. 25 per cent electricity is generated by hydroelectric
facilities.
In its quest for increasing availability of electricity, the country has adopted a blend of
thermal, hydro and nuclear sources. Out of these, coal based thermal power plants and in
some regions, hydro power plants have been the mainstay of electricity generation. Of
late, emphasis is also being laid on non-conventional energy sources i.e. solar, wind and
tidal.
India is one of the main manufacturers and users of energy. Globally, India is presently
positioned as the eleventh largest manufacturer of energy, representing roughly 2.4% of
the overall energy output per annum. It is also the worlds sixth largest energy user,
comprising about 3.3% of the overall global energy expenditure per year. In spite of its
extensive yearly energy output, Indian Power Sector is a regular importer of energy,
because of the huge disparity between oil production and utilization.
Indias power market is growing faster than most of the other countries. With an installed
generation capacity of 141.5 GW, generation of more than 600 billion kWh, and a
transmission & distribution network of more than 6.3 million circuit Kms, India has
today emerged as the fifth largest power market in the world compared to its previous
position of eighth in the last decade.
Usually energy, especially electricity, has a major contribution in speeding up the

economic development of the country. The existing production of per capita electricity in
India is around 600 kWh per annum. Ever since 1990s, Indias gross domestic product
(GDP) has been increasing very rapidly and it is estimated that it will maintain the pace
in the next couple of decades. The rise in GDP should be followed by an increase in the
expenditure of key energy other than electricity.
The gross electricity production capability of Indian Power Sector is placed at around
141.5 GW. A key portion of this generated electricity i.e. 64.4 per cent is thermal energy.
Though, this is still not sufficient.
Installed Generation Capacities
Total installed capacity is 141,500 MW

Electricity generation mix is heavily dependent on thermal at around 64.4% with
hydro contributing to 25%
The following graph shows a near doubling of per capita consumption of electricity from
about 350 units in 1998 to over 600 units in 2005.
Structural and regulatory reform conducive to PSP

In the past, the power sector growth has not kept pace with the economic expansion and
this has resulted in India experiencing a 13 per cent shortage in peak capacity and 8 per
cent in energy terms, on an overall basis. Driven by the requirement to enhance the
budgetary allocations to social sectors to meet the emerging requirements of sustainable
growth, the Government has envisaged a manifold increase in the role of the private
sector in the financing and operations of the power sector. Significant structural and
regulatory reforms have paved the way for increased private sector participation in all
aspects of the sector. Many of the legal and regulatory requirements to enable this are in
place, while the operational provisions are in different stages of implementation in
different states.
Opportunities of growth in the Indian power sector

The Government of Indias blueprint for the power sector envisages a capacity addition
of 100,000 MW between 2002 & 2012, and a required associated investment for the
transmission and distribution network. A similar substantial capital investment is required
to develop the national grid, for renovation and modernization of inefficient and ageing
generation plants and network, for electrification of rural areas, and to improve adequacy,
reliability and the quality of power supply.
Growth Blue-print of Ministry of Power:

An investment requirement of US$ 90 billion in generation of which US$ 19 billion is
expected from the private sector
An investment requirement of US$ 90 billion in transmission and distribution of which

nearly US$ 15 billion is needed for the National Grid
An investment of US$ 6 billion for the National Grid is expected to come from the
private sector, the rest from the Central sector
The rest of the investment in transmission and distribution will be financed through a
mix of the state and the private sector
Implies at least US$ 25 billion of investments from the private sector. The large capital
and knowledge requirements cannot be met by the Government alone. Further, given the
magnitude of actual and opportunity loss, these investments and efforts must be brought
in at the earliest. A partnership and private & foreign investment is necessary to meet the
rapidly growing demand and to achieve global standards in operating efficiency and
quality of supply.
In Generation, the development of the power market and deregulation of supply to
large consumers, presents options for the sale of power to distribution utilities and to
contestable consumers.
In Transmission, competitive bidding guidelines are being finalised, and the Central
Transmission Utility has identified specific elements of interstate transmission systems.
The JV or BOT model may be adopted in the intra-state transmission segment as well.
In Distribution, privatisation continues to remain on the agenda of states (e.g. Uttar
Pradesh), though the actual timing of initiation of any privatisation process remains
uncertain. The Act envisages the possibility of more than one distribution licensee in an
area. Some applications for such licenses have been made to the relevant SERCs, and the
guidelines for issue of such licenses (including minimum service obligations) are
expected to evolve.
Power trading has been recognized as a separate activity, and a number of private firms
have obtained trading licenses. The trading volumes have increased manifold over the last
few years, and are expected to increase further as the national grid is strengthened and
inter-regional flows increase. The trading business offers opportunities as a stand-alone
business, as well as a strategic adjunct to investments in other segments.
The investment required is not restricted to financial capital. The electricity sector
incurs a commercial loss of about Rs 20,000 crores (nearly US$ 4 billion) per annum; a
significant part of which is attributed to inefficient operation. To plug this, the power
sector, and specifically, the distribution companies must re-engineer their business
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processes, invest in modern IT systems for billing, MIS, tracking, energy audit etc., train
their operating staff to improve their management, commercial and technical skills, and
undertake other such performance improvement measures. All of this provides significant
business opportunities to various service providers.
Ultra Mega Power Projects by Government of India

Reorganizing the fact that economies of scale leading to cheaper power could be secured
through large size power projects and for introducing the efficient super critical
technology in a big way, a unique initiative has been launched for development of Ultra
Mega Power Projects (UMPPs) under tariff based international competitive bidding
route. 9 sites for development of 4000 MW project each have been identified so far.
Government of India (GoI) has launched Ultra Mega Power Projects initiatives to step
up power generation capacity at rapid speed

Seven projects of capacity 4000 MW each identified to be allocated to the developers
on tariff based competitive bidding
Each Project to cost around USD 3 bn
Tariff determined in this manner to be accepted by the regulator under the Electricity
Act
GoI to acquire land, secure environment clearance, arrange water linkage and secure
Captive Coal Mine (for pit head plants) before handing over the projects
Payment Security Mechanism in terms of Letter of Credit, Escrow Arrangement and
Third Party Sale
Transmission: Policy Initiatives

Guidelines for encouraging competition in development of transmission
projects
Policy was issued on 13th April, 2006.

Promote competitive procurement of transmission services.
Encourage private investment in transmission lines.
Facilitate transparency and fairness in procurement processes.
Facilitate reduction of information asymmetries for various bidders.
Protect consumer interests by facilitating competitive conditions in procurement
of transmission services of electricity.
Enhance standardization and reduce ambiguity and hence time for materialization
of projects.
Ensure compliance with standards, norms and codes for transmission lines while
allowing flexibility in operation to the transmission service providers.
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High Voltage Transmission Capacity:

Capacity
MVA
Circuit KM
1,500
439
6,170
7,390
7,863
4,927
3,000
5,872
765/800 KV
400 KV
220 KV
HVDC
Distribution
In principle approval accorded for 90 projects with an outlay for Rs.1588 crore to
strengthen the distribution system in urban areas
More than Rs.2030 crore utilized under APDRP for strengthening & up gradation
of electricity distribution network.
Incentive for cash loss reduction has been disbursed to Kerala, Punjab and West
Bengal.
Andhra Pradesh, Goa, Himachal Pradesh, Punjab, Gujarat, Meghalaya,
Chattisgarh and West Bengal have reported profits during 2005-06. Jharkhand,
Madhya Pradesh, Haryana, Rajasthan, Uttaranchal, Karnataka, Kerala and Assam
have reported reduction in losses during 2005-06.
Andhra Pradesh, Goa and Tamil Nadu have AT&C losses below 20% during
2005-06. Punjab and 2 DISCOMs of Gujarat (Madhya & Uttar) have AT&C
losses below 25% during 2005-06.
Action plan prepared for franchising in urban areas to reduce AT&C losses and
improve efficiency in distribution. Maharashtra, Rajasthan and Madhya Pradesh
have invited tenders for franchisee in urban areas. The first urban franchisee has
been awarded by Maharashtra in Bhiwandi town.
5304 engineers of State distribution utilities were trained under Distribution
Reforms capacity building programme.
Started the Advanced Certificate Programme in Distribution Management in
collaboration with IGNOU, about 1212 have registered so far.
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Privatization
Many countries facing high electricity demand growth favor privatizing their electric
power sectors and opening their markets to foreign firms. This approach can free up large
amounts of public capital, which can be used instead for social programs. In addition,
private ownership allows managerial accountability, market efficiency, and better
customer service while reducing government deficits and international debt. The reasons
for electric utility privatization are numerous and vary from country to country.
Some of the more evident reasons include the following:
Raising revenues for the state through asset sales
Acquiring investment capital
Improving managerial performance
Moving toward market-determined prices
Technology transfer
Reducing the frequency of power shortages
Reducing the cost of electricity to consumers through efficiency gain
Taking advantage of creating national and regional power grids, and
Re-thinking whether electric power generation in today's economy constitutes a
natural monopoly.
Privatization of formerly state-owned electric power assets in developing countries has
opened up enormous investment opportunities. For foreign investors, investment in
overseas electricity assets offers opportunities to achieve potentially higher returns and,
in many cases, helps to realize greater growth opportunities than are available at home.
In 1991, the Government began to encourage private sector participation in the power
industry. Since this date, a total capacity of approximately 7,400 MW from 37 private
power plants has been commissioned. As of March 31, 2006 an additional capacity of
around 4,500 MW from 12 projects is reported to be under construction. Orissa was the
first state in the country to privatize the state's electricity distribution. This was followed
by the privatization of Delhi Vidyut Board. Various other states including Uttar Pradesh,
Haryana, Karnataka, Andhra Pradesh, Madhya Pradesh, Delhi and Rajasthan have
restructured their boards into separate entities for generation, transmission and
distribution. Some states are also attempting to corporatize the former SEB entities.
Reliance Energy Limited and Tata Power Limited dominate the private sector.
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Tata Power, with a generation capacity of 2278 MW. Tata Power recently
bagged 4000 MW UMPP contract.
Reliance Energy has a 933 MW of generation capacity.
GMR Infrastructure Limited with a combined generation capacity of 420 MW
and an additional 389 MW plant to be commissioned in the near future is
another serious private sector participant.
Private investment in Power sector
Post Electricity Act 2003, private sector interest has revived.

100% FDI allowed in generation, transmission & distribution, 100% FDI also
allowed in power trading (License given to British Gas).
Inter Institutional Group (IIG) and Green Channel constituted to facilitate
financial closure of Independent Power Projects (IPPs).
11 IPPs of more than 4000 MW capacity have achieved financial closure.
Another 3 IPPs have been agreed in principle by FIs for financial closure.
Another 8 IPPs of about 9500 MW capacity are under active consideration.
Highlights of performance of Power sector in 2007

(i) Capacity Addition:
(ii) Placement of Award (generation projects):
(iii) Growth in Power Generation:
(iv) Plant Load Factor:
(v) Villages Electrified:
(vi) Ultra Mega Power Projects:
(vii) Important policies notified:
9050 MW (5093 MW)

9354MW (9701 MW)
6.9% (7.2%)
76.7% (75.77%)
39,383 villages
LOI issued in case
of Sasan and Mundra
- Tariff Policy
- Rural Electrification Policy
- Policy for development of
Merchant Plants
- Guidelines for encouraging
competition in development of
Transmission projects.
Note: Figures in brackets pertain to year 2006
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Highlights of the XIth Five Year Plan

Capacity Addition Projections (as on 28 Feb. 2008)
Figures in MW
Total Installed Capacity:

Sector
MW
%age
74,453.76
52.5
47,520.99
34.0
19,525.09
13.5
State Sector
Central Sector
Private Sector
15
Total
1,41,499.84
Fuel
MW
%age
91,145.84
64.6
Coal
75,252.38
53.3
Gas
14,691.71
10.5
Oil
1,201.75
0.9
35,378.76
24.7
4,120.00
2.9
10,855.24
7.7
Total Thermal
Hydro (Renewable)
Nuclear
RES** (MNRE)
Total
1,41,499.84
Power Situation: (April 2007-February 2008) (Provisional)
Demand
Met
Surplus/
Deficit
671,915 MU
608,053 MU
-9.5 %
Energy
16
Demand side Management

Recommendations
Encourage Non-conventional energy usage,

Raising energy efficiency awareness
Turning the Computer Monitors off when not in use
There is a need to boost:

Energy audits reports by energy managers consumption of >1MVA
Commercial buildings to use only energy efficient lighting and equipment.
Energy efficient equipment manufacturing incentives.
TOD tariff
Buildings with natural ventilation and lighting Passive Houses
Penalty for power factor
Evaluate the major facilities for interruptible load opportunities.
Supply side Management

Recommendations
There is a need to boost:
Upgrading existing Supply
Load Aggregation
On-Site Generation
Use of Captive Power Plants
17
Peak Power development through Hydro

Encourage capacity addition through various fuels
Distributed Generation
Setting up Big size High efficiency plants
Setting up Merchant Power Plants-
Required investment in the Indian Power Sector (Next 3 to 5 years)
99
9
95
0
126
0
Generation
Distribution
550
0
Transmission
Areas for investment

Additional generation capacity
Transmission system to envisaged
additional generation capacity
Renovation and Modernisation
Cross Country Grid
Efficiency improvement in generation
Reduction of T&D losses: Energy
Audit /metering
Energy Conservation & Demand Side
Management
Rural Electrification
Source: Ministry of Power All figures in billion INR
Power Finance Corporation

Background
PFC was established in July 1986 as a Development Public Financial Institution (PFI)
under Section 4A of the Companies Act, 1956. It is dedicated to the Power Sector. It is a
wholly owned by Government of India. A Nav-Ratna public Sector Undertaking. It has
highest safety ratings from domestic and international credit rating agencies and also ISO
9001-2000 Certification for the Project Appraisal System.
PFC provides financial assistance to all types of power projects like Generation, R&M,
Transmission, Distribution, system improvement, etc. PFC encourages optimal growth
and balance development of all segments of power sector through assigning priorities for
financing different categories of projects. The state sector utilities are the main
18
beneficiary of PFCs financial assistance. PFC has also been funding private sector
projects for last 5-6 years.
Mission
PFC's mission is to excel as a pivotal developmental financial institution in the power
sector committed to the integrated development of the power and associated sectors by
channeling the resources and providing financial, technological and managerial services
for ensuring the development of economic, reliable and efficient systems and institutions.
Received awards from Hon'ble President, Hon'ble Vice President & Hon'ble Prime
Minister for being in the top ten Public Sector Undertakings of Government of India
Credit Ratings
Placed at Sovereign Rating by International Rating Agencies - Moodys and

Standard & Poors for long term foreign currency debt.
Placed at the highest safety ratings by accredited rating agencies in India CRISIL and ICRA
Domestic borrowings include term loans and bonds; External borrowings take the
form of Syndicated Loans, Fixed & Floating Notes.
Consistently rated Excellent by the Government of India (GOI) for overall
performance against the targets set in Memorandum of Understanding (MoU)
between GOI and PFC.
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Performance Highlights
*Consistently rated Excellent for its overall performance against the targets set in
Memorandum of Understanding (MoU) by the Government of India (GoI) since 1993-94.
*Nav-Ratna Public Sector Undertaking.
*Ranked among the top 10 PSUs for the last four years.
*Employee profit stands at Rs.3.9 crores per head.
A Development Financial Institution - has consistently maintained profitability in its
operations provides finances for projects/ schemes, has expertise in reform linked
studies/consultancy.
PFC has an authorized capital of Rs.20000 Million and paid-up capital of Rs.11477.70
Million (presently the entire equity is in owned by Government of India). PFC in its
present role has the following main objectives:
To rise the resources from international and domestic sources at the competitive rates
and terms and conditions and on-ward lend these funds on optimum basis to the
power projects in India.
To act as catalyst to bring institutional, managerial, operational and financial

improvement in the functioning of the state power utilities
To assist state power sector in carrying out reforms and to support the state power
sector during transitional period of reforms
Range of Services
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Fund Based
Rupee Term Loan

Foreign Currency Term Loan
Buyers Line of Credit
Working Capital Loan
Loan to Equipment manufacturers
Debt Restructuring/ Refinancing
Take out Financing
Bridge Loan
Bill Discounting
Lease Financing
21
Non-Fund Based
Guarantees
Exchange Risk Management
Consultancy Services
Clients of PFC:
State Electricity Boards

State Power Utilities
State Electricity/Power Departments
Other State Departments (like irrigation Department) engaged in the development
of power projects
Central Power Utilities
Joint Sector Power Utilities
Co-operative Societies
Municipal Bodies
Private Sector Power Utilities
22
Institutional Development
Institutional Development of Power Utilities
Formulation and Implementation of Operational and Financial Action Plan (OFAP) for its
borrowers - to achieve qualitative improvement in the functioning of the State Power
Utilities in managerial, technical and financial areas through: Participative approach in formulation of OFAPs - prepared in consultation and
agreement with the Utility and State Government concerned.
Organizing seminars, workshops and training for Power Sector personnel - in
India and abroad.
Studies and Consultancy Services
Reforms & Restructuring Initiatives

PFC has been actively persuading State Govts. to initiate reform and restructuring of
their power sector in order to make them commercially viable. In this regard following
initiatives have been taken:
PFC is providing financial assistance to reform-minded States under relaxed

lending criteria/exposure limit norms
PFC has decided to provide technical/financial assistance to State Govts. / Power

Utilities for structural reforms of the State Power Sector.
Reform Group constituted in PFC to advice and assists the State Govt. /Power
Utilities to formulate suitable restructuring programmes.
23
Major Projects Funded by PFC:

Name of the Project
Capacity (MW)
Cost (Crs)
Malwa TPS
Yamuna Nagar TPS
Tenughat
Extn.
Stage II
Khaperkheda TPS
Extn.
Kameng HEP
Birsinghpur TPS
Mejia Extn. Unit
Sagardighi TPS PH1
Chandrapura Extn.
Unit 7&8
Panipat TPS Stage
V
Parichha TPS Units
3&4
Revival of PP&
LNG
work
of
Dhabol Power Co.
Tehri Dam HEP
Stage1
Nathpa Jhakri HEP
2x500
2x300
3x210
4054
2400
2366
Amount Funded by
PFC (Crs)
2730
1920
1892
1x500
2191
1753
4x150
1x500
2x250
2x300
2x250
2485
1950
280
2754
2053
1740
2x250
1785
1428
2x210
1755
1404
2150
10038
1400
4x250
8000
2560
6x250
8328
1438
1456
1925
1435
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Financial Position
Financial Highlights for the year 2007-08 (Audited)
Profit After Tax
Sanctions
Disbursements
Net Interest Margin
Resource Mobilization
Net Worth
Realization
Rs. 1,206.76 Crores

Rs. 69,498 Crores
Rs. 16,211 Crores
3.75 %
Rs. 52,421 Crores
Rs. 8824 Crores
99%
25
Resources as on 31 March, 2008
Recent Initiatives:
Exploring possibilities of faster capacity addition through Special Purpose

Vehicles.
Made a foray into renewable energy sector.
Extended tenor of loans up to 20 years for Hydro and 15 years for other schemes.
Policy for short term financial assistance for import of coal introduced
26
Expense limit increased for reforming GENCOS.

Short-term loan extended to TRANSCOS against receivable from DISCOMS.
Aims to capture a share of 20-25% of the total investment to be made in the
Power Sector during the Xth and XIth Plan period.
Accomplishments:
First Developmental Financial Institution to introduce Operational and Financial

Action Plans to improve efficiency in the State Power Sector.
Long term financial resources to the power sector from multilateral agencies
channeled through PFC.
Tapped international financial markets to raise ECBs, setting benchmark rates for
Indian corporates.
Complementing the efforts of Govt. of India, for its sponsored programmes
Accelerated Generation & Supply Programme and Accelerated Power
Development & Reform Programme.
Introduced new tailor-made products and services like debt re-financing, interest
restructuring, funding to equipment manufacturers, short term loans, buyers' line
of credit and loans for asset acquisition.
Future Plans:
Aims to capture a share of 20-25% of the total investment to be made in the

Power Sector during the 10th and 11th Plan period.
To consolidate and expand present business.
To introduce new financial initiatives such as Universal Banking Services,
Insurance, Equity Participation and Merchant Banking.
To spread into allied sectors.
To make a foray into global markets.
Diversification in terms of forward or backward integration in the power sector
(financing for fuel tie ups and laying down of gas pipelines).
27
SWOT Analysis:
Strengths
Govt. of India undertaking.

Good quality management
Well established, Long standing relations in the power industry
Implementing agency for Mops schemes including AG &SP and APDRP
Highest credit rating (due to government ownership)
Weaknesses
Poor asset quality with most of the lending to SEBs, whose loan repayment
capabilities in the long run is doubtful.
Concentration risk attributed to lending in single sector.
Opportunities
Power sector presents significant investment opportunities.

Sector expertise for consultancy and providing investment gateways for domestic
and external financial agencies.
New business opportunities to cover the entire range of activities in the Power
sector.
Threats
PFC has significant exposures entities which are loss making, financially weak
and are defaulting to most of their creditors. Delinquencies by these entities to
PFC could impair the currently sound Balance Sheet of PFC.
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Under the Tenth Five-year Plan, REC has been allowed to disburse funds through
AG & SP. Since this scheme gave a price advantage to PFC, its competitive edge
is diluted.
With increasing exposure to SEBs, their weak balance sheet may affect PFCs
creditworthiness.
Currently, borrowers of PFC are unable to attract other sources of funding. If the
reform programme is successful, and these entities become creditworthy, PFCs
ability to lend against quality assets would be weakened.
29
30
Resource Mobilization Unit

Resource Mobilization Unit (RMU) is responsible for raising fund resources both in
domestic for further disbursement as financial assistance to its customers. RMU also
undertakes various activities like appointment for various agencies like RTA, Trustees,
IPA, Collecting and Paying Banker for coordinating the resource mobilizing process. It is
also responsible for listing for various debt instruments on NSE.
The main objective of the RM department is to mobilize resources/raise funds at the
minimum cost and the easiest terms and conditions keeping in mind the requirements,
objectives and the financial position of the company.
The fund requirement for carrying out disbursement varies from year to year. In 20002001, the disbursement was amounting to Rs. 3230 crores. In the year 2005-2006 PFC
achieved a disbursement level of as high as 9870crores, a three-fold increase. Thus, in
order to keep pace with the increasing level of disbursement needs, the RMU has to keep
itself occupied and vigilant to tap the markets for smooth operations of the company.
The company segments the market into two:
Domestic (under the RM dept.)

International
Rupee resources (Domestic)

In terms of domestic resources, a significant proportion of our Rupee funds are raised
through privately placed bond issues in the domestic market and term loans. We have a
diverse investor base of banks, financial institutions, mutual funds, insurance companies,
provident fund trusts, gratuity fund trusts and superannuation trusts. The bonds we issue
are unsecured, redeemable, non-convertible, non-cumulative and taxable and are listed on
the wholesale debt market segment of the NSE. Our bonds are rated LAAA by ICRA and
AAA by CRISIL, the highest safety domestic ratings. In fiscal 1988, the Ministry of
Finance authorized public sector issuers that were infrastructure oriented to issue taxexempt bonds. We were historically given a large share of this annual allocation and a
large portion of our funds were raised through tax exempt bonds. From fiscal 2001
onwards, it became part of the governments overall policy to reduce funding support to
companies that had become financially independent and that could raise resources at
competitive rates on their own. After this time, our direct support from the GoI for raising
debt reduced.
The following table gives details of our Rupee funds as on March 31 in FY 2007-08:
31
Foreign currency resources (International)

Multilateral, Bilateral and Export Credit Agencies
We began accessing foreign currency loans from multilateral, bilateral and export credit
agencies in fiscal 1991 when we obtained funds from the French government, which were
guaranteed by the GoI. Subsequently, we obtained a complementary financing loan from
the Asian Development Bank in fiscal 1991, which was denominated in US Dollars and
Japanese Yen. Traditionally, our major foreign currency borrowings have been from
multilateral institutions such as the World Bank and the ADB. These funds were routed
through GoI, where the foreign exchange risk was borne by GoI. These sources enabled
us to raise long term funds at competitive costs, which supplemented the funds available
from commercial sources. Presently, we are borrowing directly from these agencies, and
the foreign exchange risk is borne by us. We have a US$ 50 million line of credit facility
with the ADB that has 20 year tenure. This line of credit facility is guaranteed by the GoI.
We also have foreign currency loans from two other external credit agencies namely KfW
and Export Development Canada (EDC).
Commercial borrowings in foreign currency

We first accessed commercial foreign currency borrowings that were not guaranteed by
the GoI in January 1997 with the establishment of a syndicated loan facility. Since then,
we have borrowed funds in the international commercial markets in the form of
syndicated loans as well as fixed and floating rate note/bonds issues. This has enabled us
to diversify our investor base.
32
The 3 main decisions taken by Resource Mobilization department are:

1. When to raise Funds and for what tenure.
2. Instruments to be used for raising these funds.
3. Pricing of the debt raised.
1. When to raise funds

The RM Unit has to decide when it will be most conducive to raise funds for the
company so as to ensure there is:
a. Timely availability of funds.
b. Lowest Cost at which funds can be raised.
c. Least pressure for obligations.
The amount of funds to be raised is normally decided by the Treasury Management Unit.
The RM Unit prepares a Liquidity Statement to find out the time for raising funds when
there is least pressure for obligations for the company. Liquidity Statement shows the
funds inflows and outflows of the company. The following factors are taken into
consideration while preparing it:
Amount of Disbursement that has to be made.
Interest Payments.
Repayment of loan taken by the company.
Taxes, Dividends, etc.
Funding Sources:
PFC generally fund their assets, comprising loans to the power sector, with borrowings of
various maturities in the international and domestic markets. Their market borrowings
include bonds, short term loans, medium term loans, long term loans, and commercial
papers.
33
Sources of Funds
Debt
International
Domestic
Long Term to
Medium Term
Taxable & Non
Taxable Bonds
Equity
Short Term
Commercial
Paper
FCNR (B)
FCNR (B) (Fixed

& LIBOR
Linked)
Loan
Loans
ICD
Fixed
Rate
ECB
Multilateral
Loans
ECAs
MIBOR
Linked
2. Instruments to be used for raising funds:

Debt instruments are obligations undertaken by the issuer of the instrument as regards
certain future cash flows representing interest and principal, which the issuer would pay
to the legal owner of the instrument. Debt instruments are of various types. They are:
a. Money Market Instruments: The term money market refers to the market
for short-term requirements and deployment of funds. Money market instruments
are those instruments, which have a maturity period of less than one year. The
most active part of the money market is the market for overnight and term money
between banks and institution (called call money) and the market for repo
transactions. The main traded instruments are commercial papers (CPs),
certificate of deposits (CDs) and treasury bills (T-Bills). All of these are
discounted instruments i.e. they are issued at a discount to their maturity value
and the difference between the issuing price and the maturity/face value is the
implicit interest. These are also completely unsecured instruments. One of the
most important features of money market instruments is their high liquidity and
tradability. A key reason for this is that these instruments are transferred by
endorsement and delivery and there is no stamp duty or any other fee levied when
the instrument changes hands. Also there is no tax deducted at source from the
interest component.
34
b. Long term Debt Instruments: These are the instruments having a maturity
exceeding one year. The main instruments are Government of India securities
(GOISEC), State Government securities (state loans), Public Sector bonds (PSU
bonds), corporate debentures, etc.
Most of these are coupon bearing instruments i.e. interest payments (called
coupon) are payable at pre specified dates called coupon dates. At any given
point of time, any such instrument has a certain amount of accrued with it i.e.
interest which has accrued (but is not yet due) calculated at the coupon rate
from the date of the last coupon payment. E.g. if 30 days have elapsed from the
last coupon payment of a 14% coupon debenture with a face value of Rs.100, the
accrued interest will be
100*0.14*30/365 =1.15
Whenever coupon-bearing securities are traded, by convention, they are traded at
a base price with the accrued interest separate. In other words, the total price
would be equal to the summation of the base price and the accrued interest.
3. Pricing of the Issue:

The unit has to keep a number of factors into consideration to decide upon the price of
the instruments and loan facilities it wish to avail.
The factors considered by the company normally are:
Liquidity Position of the company
Present Benchmark Rates
Primary / Secondary Market Conditions
Timing of issue or raising
Quantum of funds to be raised
Liquidity in the debt market
Other Economic and market considerations
35
Types of Instruments used for raising funds by PFC in the Domestic Market
I. Bonds - Bonds are a form of indebtedness that is sold in set increments. In return for
loaning the debtor the money, the lender gets a piece of paper that stipulates how much
was lent, the agreed-upon interest rate, how often interest will be paid, and the term of
the loan.
Features of bonds
1. Nominal, principal or face amount: The amount over which the issuer pays
interest, and which has to be repaid at the end.
2. Issue price: The price at which investors buy the bonds when they are first
issued, typically Rs.1 million (specifically for PFC). The net proceeds that the
issuer receives are calculated as the issue price, less issuance fees, times the
nominal amount.
3. Maturity date: The date on which the issuer has to repay the nominal amount. As
long as all payments have been made, the issuer has no more obligations to the
bond holders after the maturity date. The length of time until the maturity date is
often referred to as the term or maturity of a bond.
i. short term (bills): maturities up to one year;
ii. medium term (notes): maturities between one and ten years;
iii.
Long term (bonds): maturities greater than ten years.
4. Coupon: The interest rate that the issuer pays to the bond holders. Usually this
rate is fixed throughout the life of the bond. It can also vary with a money market
index, such as MIBOR or LIBOR, or it can be even more exotic.
5. Optionality: A bond may contain an embedded option; that is, it grants option
like features to the buyer or issuer:
i. Callability: Some bonds give the issuer the right to repay the bond before
the maturity date on the call dates. These bonds are referred to as callable
bonds.
ii. Puttability: Some bonds give the bond holder the right to force the issuer
to repay the bond before the maturity date on the put dates.
6. Liquidity: A bond is a highly liquid instrument which is freely tradable in the
market. A large number of investor categories such as bank treasuries, mutual
funds, insurance companies and funds like pension fund and provident funds
prefer this instrument because of its assured returns and suitable maturities for
each investor category.
36
Procedure followed by PFC for issue of bonds:

1. Board approval.
2. Borrowing limit of the corporation as laid down as u/s 293 (1) (d) of the
Companies Act, 1956.
3. Determining nature of bonds to be issued.
4. Credit rating.
5. Appointment of registrar and transfer agent.
6. Appointment of trustees.
7. Debt/Equity ratio.
8. AL&RM position of the corporation.
9. Collection banker.
10. Interest rate determination.
11. Shelf Information memorandum.
12. Merchant banker.
13. One to one deal with banks, institutions, body corporates etc.
14. Receipt of application money and application forms.
15. Allotment of bonds.
16. Conversion of application money into bonds.
17. Issuance of letter of allotment/ bonds in Dematerialized form.
18. Remittance of interest on application money along with excess application money
if any.
19. Issuance of letter of allotment in physical form.
20. Payment of stamp duty.
21. Listing with NSE.
22. Execution of documents with the trustees.
23. Appointment of printers.
24. Appointment of payee bankers.
II. Commercial Paper

Commercial paper is a money market security issued by large banks and corporations. It
is generally not used to finance long-term investments but rather to manage working
capital. It is commonly bought by money funds (the issuing amounts are often too high
for individual investors), and is generally regarded as a very safe investment. As a
relatively low risk option, commercial paper returns are not large.
The stamp duty on Commercial paper is between 5 to 7 basis points which is very less in
comparison to bonds. It is a short term instrument, highly liquid resulting in free
tradability among the market participants. It is mainly preferred by mutual funds and it
proves to be an efficient instrument in raising money in emergency situation.
37
III. Loans
A bank loan to a company, with a fixed maturity and often featuring amortization of
principal. If this loan is in the form of a line of credit, the funds are drawn down shortly
after the agreement is signed. Otherwise, the borrower usually uses the funds from the
loan soon after they become available.
A fixed-rate term loan offers an unchanging interest rate for the life of the loan, making it
easy to budget, with the same predictable payments over the life of the loan.
Secure, fixed interest for the life of the loan borrowed what you need with a predictable
monthly payment. Fixed-rate loans offer an unchanging interest rate for the life the loan,
making it easy to budget with the same, predictable payments over the entire term.
i. Simplify budgeting with predictable payments
ii. Lock in interest rates with fixed interest over the life of the loan
iii.
Stabilize your business finances
Short-term
Short-term loans can have maturations of as little as 90-120 days or as long as one to
three years, depending on the purpose of the loan. In general, banks require very
specific repayment plans for their short-term loans. For instance, if you took out a
loan to even out your cash flow until your customers paid you, the lender would
expect you to repay the loan as soon as you receive your money. In the case of shortterm loans for inventory purposes, you would pay off your debt when you sell your
inventory. Before a lender will grant a short-term loan, it will review your cash-flow
history and payment track record. Most short-term loans are unsecured, meaning they
do not require collateral. Rather, the bank relies on your personal credit history and
credit score for approval.
Medium-term
Medium term loans have maturity of less than three years; these loans are generally
repaid in monthly installments (sometimes with balloon payments) from a business's
cash flow. There repayment is often tied directly to the useful life of the asset being
financed.
Long Term
Long term loans are commonly set for more than three years. Most are between three
and 10 years, and some run for as long as 20 years. Long-term loans are collateralized
by a business's assets and typically require quarterly or monthly payments derived
from profits or cash flow. These loans usually carry wording that limits the amount of
additional financial commitments the business may take on (including other debts but
also dividends or principals' salaries), and they sometimes require that a certain
amount of profit be set-aside to repay the loan.
38
The Indian Debt Market

The Debt Markets play a very critical role in any modern economy. And more so in the
case of developing countries like India which need to employ a large amount of capital
and resources for achieving the desired degree of industrial and financial growth. The
Indian Debt Markets are today one of the largest in Asia and includes securities issued by
the Government (Central & State Governments), public sector undertakings, other
government bodies, financial institutions, banks and Corporates.
There is no single location or exchange where debt market participants interact for
common business. Participants talk to each other, conclude deals, send confirmations, etc
on the telephone, with clerical staff doing the running around for settling trades. In that
sense the wholesale debt market is a virtual market. The daily transaction volume of all
the traded instruments would be about Rs.5 bn per day excluding call money and repos.
The debt market is much more popular than the equity markets in most parts of the world.
In India the reverse has been true. This has been due to the dominance of the government
securities in the debt market and that too, a market where government was borrowing at
pre-announced coupon rates from basically a captive group of investors, such as banks.
Thus there existed a passive internal debt management policy. This, coupled with
automatic monetization of fiscal deficit prevented a deep and vibrant government
securities market.
The debt market in India comprises broadly two segments, viz., Government Securities
Market and Corporate Debt Market. The latter is further classified as Market for PSU
Bonds and Private Sector Bonds.
The market for government securities is the oldest and has the most outstanding
securities, trading volume and number of participants. Over the years, there have been
new products introduced by the RBI like zero coupon bonds, floating rate bonds, inflation
indexed bonds, etc. The trading platforms for government securities are the Negotiated
Dealing System and the Wholesale Debt Market (WDM) segment of National Stock
Exchange (NSE) and Bombay Stock Exchange (BSE).
The PSU bonds were generally treated as surrogates of sovereign paper, sometimes due
to explicit guarantee of government, and often due to the comfort of government
ownership. The perception and reality are two different aspects. The listed PSU bonds are
traded on the Wholesale Debt Market of NSE.
The corporate bond market, in the sense of private corporate sector raising debt through
public issuance in capital market, is only an insignificant part of the Indian Debt Market.
A large part of the issuance in the non-Government debt market is currently on private
placement basis. Tables 1, 2 and 3 provide details of amount raised by financial
institutions and non-financial institutions by way of public issue and private placement.
39
Private placement accounts for little over one third of the debt issuance. Unofficial
estimates indicate that about 90 per cent of the private corporate sector debt has been
raised through private placement in the recent past. The amount raised through private
placement has been continuously rising for the past five years which increased by more
than 300 per cent over the five year period. The growth rate in the public issue processes
is only about 80 per cent over the period, increasing from Rs. 20896 crore to Rs. 36466
crore. The listed corporate bonds also trade on the Wholesale Debt Segment of NSE. But
the percentage of the bonds trading on the exchange is small. The secondary market for
corporate bonds till now has been over the counter market. With the recent guidelines
issued by SEBI the scenario is expected to change.
The development of a corporate bond market in India has lagged behind in comparison
with other financial market segments owing to many structural factors. While primary
issuances have been significant, most of these were accounted for by public sector
financial institutions and were issued on a private placement basis to institutional
investors. The secondary market, therefore, has not developed commensurately and
market liquidity has been an issue. The Government had constituted a High Level
Committee on Corporate Bonds and Securitization (Patil Committee) to identify the
factors inhibiting the development of an active corporate debt market in India and
recommend necessary policy actions. The Committee made a number of
recommendations relating to rationalizing the primary issuance procedure, facilitating
exchange trading, increasing the disclosure and transparency standards and strengthening
the clearing and settlement mechanism in secondary market. The recommendations have
been accepted in principle by the Government, the Reserve Bank and SEBI and are under
various stages of implementation. The two stock exchanges, namely, the Bombay Stock
Exchange (BSE) and the National Stock Exchange (NSE), as well as the industry body
FIMMDA have since operationalized respective trade reporting platforms. While all the
exchange trades in corporate bonds get captured by concerned exchanges reporting
platform, OTC transactions can be reported on any of these platforms. The aggregated
trade information across the platforms is being disseminated by FIMMDA on its website.
BSE and NSE have also started order driven trading platforms in July 2007. In practice,
however, trading still continues to be largely OTC. SEBI has also implemented measures
to streamline the activity in corporate bond markets by reducing the shut period in line
with that of G-sec, reducing the size of standard lots to Rs. one lakh and standardizing the
day count convention. Further, to streamline the process of interest and redemption
payments, Electronic Clearing Services (ECS), Real Time Gross Settlements (RTGS) or
National Electronic Funds Transfer (NEFT) are required to be used by the issuers. Further
progress is anticipated in regard to rationalizing the primary issuance procedures, which
is a critical step for moving away from the pre-dominance of private placements. To
reduce the settlement risk and enhance efficiency, the Patil Committee has also proposed
setting up of a robust clearing mechanism. The settlement was proposed to be initially on
delivery versus payment (DvP) I basis (i.e., trade by trade basis) to address the
counterparty settlement risk and gradually migrate to DvP III (net settlement of funds as
well as securities) to impart enhanced settlement efficiency. (The DvP modules can be
broadly classified into three broad categories, viz., DvP I, DvP II and DvP III. Under DvP
I, the funds leg as well as the securities leg is settled simultaneously on a contract-bycontract basis. Under DvP II, while the securities leg is settled on a contract-by-contract
40
basis, the funds leg is settled for the net amount. Under DvP III, both the funds and the
securities legs are settled for the net amounts.)
Igniting the Dormant Corporate Debt Market (CDM)

The relatively young private bond segment in India presently stands at US$100bn and is
predicted to grow to US$ 575bn by 2016. The primary market for corporate debt paper
issuance is dominated mainly by domestic non-banking finance companies (NBFCs). For
other corporate borrowers, bank finance has traditionally been the favored funding
source.
Significant developments in the CDM space since the 1990s include abolition of
controlling function by government and the controller of capital issues (CCI) on the
interest rates that Corporates had to pay whenever they raised capital through debentures.
Reserve Bank of India (RBI) also gradually annulled all the conditions in regard to the
level of interest rates that the banks could charge on their loans to corporate clients. Over
time, the role of the development financial institutions, which were the major source for
funding long term corporate projects, also declined.
In 2004, SEBI mandated secondary market trading through an automated order matching
screen-based trading system. However, this, did not find favor with the institutional
participants, thus leaving the OTC deals still the preferred way of dealing in corporate
bonds for operational and liquidity concerns. The government has accepted the
recommendations of the report submitted by the High Level Committee on Corporate
Bonds and Securitization (RH Patil Committee) and have re-iterated that necessary steps
would be taken to create a single, unified, exchange-traded market for corporate bonds.
The leading exchanges, Bombay Stock Exchange (BSE) and National Stock Exchange
(NSE), as well as the industry body Fixed Income, Money Market and Derivatives
Association (FIMMDA) have already commenced services of the trade reporting
platforms for deals done in the CDM segment.
On the whole though, the CDM hasn't picked up in India. One can sense that this market
was left on its own, hence it has become more lethargic, inefficient and less vibrant. The
reform process in the CDM faces multiple challenges. Attracting the retail investors is not
going to be an easy task given the current state of CDM microstructure. There is not a
single trade reported in the Retail Debt Market Segment (RDM) of the NSE in the second
half of year 2007. There is a disincentive for a retail investor to invest/trade in corporate
bonds as the total cost of trade (including stamp duty, brokerage, and cost of settlement)
impacts the returns to the investor. The same money can be deployed in debt schemes of
mutual funds without hassle and worry about costs. Efforts should be directed towards
educating the retail investors about the pricing of bond and peculiar bond market
concepts like yield to maturity etc, in the same way as was done when derivatives were
first introduced in India. This will help them to better understand and embrace the debt
market.
From the issuer's point of view, reaching retail investors adds to the cost of distribution,
plus there is a continuous cost of servicing the retail bond holders and the time to market
41
is longer. Hence Corporates prefer private placement as it is much cheaper and quicker.
Also, private placement of bonds bypasses the already loosely tied regulations and gives
Corporates one more reason not to buy public bonds.
There is an urgent need to introduce market makers as this will improve the liquidity and
bring in more variety of investors with different risk profiles. Another way forward could
be to allow the banks to distribute the debt products to the retail investors for a fee-based
income.
The way forward is to establish screen-based trading and a well defined and structured
clearing and settlement mechanism. The procedure for issuance of bonds in the primary
market needs to be rationalized in order to widen the investor base and move away from
the dominance of private placement deals. There is also a need to re-examine the stamp
duty structure for consistent application across the country.
42
Market Micro Structure
It is necessary to understand microstructure of any market to identify processes, products

and issues governing its structure and development. In this section a schematic
presentation is attempted on the micro-structure of Indian corporate debt market so that
the issues are placed in a proper perspective. Figure 1 gives a birds eye view of the
Indian debt market structure.
The microstructure of the Indian Debt Market can be explained under two broad sub
sections:
43
a) Primary Corporate Debt Market

1) Market structure consists of issuers, instruments, processes, investors, rating agencies
and regulatory environment.
i) Issuers
Indian Debt Market has almost all possible variety of issuers as is the case in many
developed markets. It has large private sector corporate, public sector undertakings
(union as well as state), financial institutions, banks and medium and small companies:
Thus the spectrum appears to be complete. Above figure delineates details on various
classes of issuers. Two main classes include private sector corporates and banks.
ii) Instruments
Figure provides names of some of the more popular instruments that have been issued.
Till recently Indian debt market was predominantly dominated by plain vanilla bonds.
Over a period of time, many other instruments have been issued. They include partly
convertible debentures (PCDs), fully convertible debentures (FCDs), deep discount bonds
(DDBs), zero coupon bonds (ZCBs), bonds with warrants, floating rate notes (FRNs) /
bonds and secured premium notes (SPNs).
The coupon rates mostly depend on tenure and credit rating. However, these may not be
strictly correlated in all cases. The maturities of bonds generally vary in between one year
to ten years. However, the median could be around four to five years. The maturity period
by and large depends on outlook on interest rates. In expectation of falling interest rates
environment, corporate, it is observed, mostly go to shorter term instruments while the
opposite is true in case of possible hike in interest rates. For the past few years interest
rates have been falling and short end issues are on the rise. This is one of the reasons that
many corporate are reluctant to go for public issue route and listing of their securities.
iii) Processes
There are several processes that are in vogue in India as well as in other markets. The
more popular ones are public issue and private placement routes. Both these have their
own pros and cons. In a mature and developed market where large number of institutional
investor /sophisticated investors is available and a highly developed mutual fund industry
is in operation, the private placement route may be acceptable to issuers, investors and
regulators. In a less developed market / small market it is a catch 22 position. Private
placement is not suitable because this market do not have adequate number of informed
investors and the public issue route may create regulatory arbitrage, higher compliance
costs resulting sometimes in migration of markets. In India private placement route is
highly popular owing to various reasons.
44
iv) Intermediaries
Two classes of intermediaries required for the proper development of debt market are
broker and investment banker/ merchant banker. Most of the brokers as well as merchant
bankers in India are inadequately capitalized and their professional knowledge also needs
further improvement. In some markets, it is observed that there are dedicated Debt
Managers who facilitate subscription or sometimes subscribe to the issue and later on
even facilitate trading in bonds. India needs a dedicated Bond Manager concept.
v) Investors
For the development of Corporate Debt Market / Fixed Income Securities Market, it is
necessary and sufficient to have a large as well as diverse number of sophisticated /
institutional investors. Figure lists some of the classes of investors that have been
investing in the debt market. Institutional Investors in India are few in number and the
variety also is limited. We have only 37 mutual funds, hardly five insurance companies
till recently and there are no pension funds. Banks and financial institutions, by and large,
do not take active interest in Corporate Debt Market. Investors with diverse expectations
are a precondition for the development of corporate debt market. Diversity could be in
terms of maturity needs as well as expectations on interest rates. The most important
structural weakness in India is lack of large and diverse institutional investors.
India has large number of retail investors; however, their expectations are quite contrary
to market principles - risk and return. Most investors think and perceive that investments
in bonds should provide them guarantee, repayment of principal and regular payment of
coupons. Any delay/default causes worries in their minds. And sometimes these investors
complain to regulators or to the government for non receipt of coupons or non-repayment
of principal. This type of behavior implies lack of understanding of the principles of the
capital market on the part of the investors.
vi) Rating agencies
India has a well developed Credit Rating Agency system and rating agencies are well
experienced and regarded. By and large, their ratings do carry confidence in the market.
2) Some of the Structural Weaknesses identified in the Primary Market are:
(i) Lack of large and diverse investors
(ii) Lack of dedicated intermediaries (Bond Manager)
(iii) Heavy tilt towards private placement
45
b) Secondary Corporate Debt Market

1) Appropriate micro-structure of secondary market is vital for trading, clearing and
settlement. The present infrastructure has its own merits and demerits. Some of the micro
structure features are discussed below:
i) Trading Platform
Corporate debt instruments are traded either as bilateral agreements between two
counterparties or on a stock exchange through brokers. Worldwide, the majority of
transactions in corporate bonds is conducted in the over-the-counter (OTC) market by
bilateral agreements. In India corporate bonds are traded, mostly, on WDM segment of
NSE.
The National Stock Exchange (NSE) introduced a transparent screen- based trading
system in the whole sale debt market, including government securities in June 1994. The
wholesale debt market (WDM) segment of NSE has been providing a platform for
trading / reporting of a wide range of debt securities.
The WDM trading system, known as NEAT (National Exchange for Automated
Trading), is a fully automated screen based trading system, which enables members
across the country to trade simultaneously with enormous ease and efficiency. The
trading system is an order driven system, which matches best buy and sell orders on a
price/time priority.
Trading system provides two market sub-types:
Continuous Automated Market:

In continuous market, the buyer and seller do not know each other and they put their best
buy/ sell orders, which are stored in order book with price/time priority. If orders match,
it results into a trade. The trades in WDM segment are settled directly between the
participants, who take an exposure to the settlement risk attached to any unknown
counter-party. In the NEAT-WDM system, all participants can set up their counter-party
exposure limits against all probable counter-parties. This enables the trading
member/participant to reduce/minimize the counter-party risk associated with the
counter-party to trade. A trade does not take place if both the buy/sell participants do not
invoke the counter-party exposure limit in the trading system.
Negotiated Market:
In the negotiated market, the trades are normally decided by the seller and the buyer, and
reported to the exchange through the broker. Thus, deals negotiated or structured outside
the exchange are disclosed to the market through NEAT-WDM system. In negotiated
market, as buyers and sellers know each other and have agreed to trade, no counter-party
exposure limit needs to be invoked.
46
ii) Clearing and Settlement Mechanism:

Primary responsibility of settling trades concluded in the WDM segment rests directly
with the participants and the exchange monitors the settlement. Mostly these trades are
settled in Mumbai. Trades are settled gross, i.e. on trade for trade basis directly between
the constituents / participants to the trade and not through any clearing house mechanism.
Thus, each transaction is settled individually and netting of transactions is not allowed.
Settlement is on a rolling basis, i.e. there is no account period settlement. Each order has
a unique settlement date specified upfront at the time of order entry and used as a
matching parameter. It is mandatory for trades to be settled on the predefined settlement
date. The Exchange currently allows settlement periods ranging from same day (T+0)
settlement to a maximum of two business days from the date of trade (T+2).
iii) Instruments traded on WDM:

The WDM provides trading facilities for a variety of debt instruments including
government securities, Treasury Bills and bonds issued by Public Sector Undertakings
(PSU)/ corporate/ banks like Floating Rate Bonds, Zero Coupon Bonds, Commercial
Paper, Certificate of Deposit, corporate debentures, State Government loans, SLR and
Non-SLR bonds issued by financial institutions, units of mutual Funds and securitized
debt by banks, financial institutions, corporate bodies, trusts and others.
From Table 4, a highly skewed pattern can be observed in trading of debt instruments. In
1994-95 government securities used to account for less than 50 per cent of the total trades
reported, in 2002-03 the same went up to about 94 percent which is more than double. All
other segments account for a little over 6%.
iv) Investors in WDM:
Large investors and a high average trade value characterize this segment. Till recently, the
market was purely an informal market with most of the trades directly negotiated and
struck between various participants. The commencement of this segment by NSE has
brought about transparency and efficiency to the debt market, along with effective
monitoring and surveillance to the market.
v) Regulatory Environment:
The listed corporate debt is under the regulations of SEBI. SEBI is involved whenever
there is any entity raising money from Indian individual investors through public issues/
private placement. It regulates the manner in which such moneys are raised and tries to
ensure a fair play for the retail investor. It forces the issuer to make the retail investor
aware of the risks inherent in the investment. SEBI has in fact laid down guidelines
known as Disclosure and Investor Protection (DIP) Guidelines, 2000 guidelines to
maintain transparency in the market and make it efficient.
Some of the Structural Weaknesses identified in Secondary Market
(i) Absence of Clearing Corporation and CCPS.
(ii) Dedicated trading platform.
(iii) Exclusive, well capitalized and professional intermediaries.
(iv) Lack of reliable and up to date information.
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Capital Markets: Fixed Income Market

Introduction
Capital Markets comprise of the Equities Market and the Debt Markets. Worldwide
equity market attracts a lot of attention. Debt is considered boring. But it is surprising to
know that in any country in the world, the debt market is several times bigger than the
equity market. So much bigger, that most of the market is beyond the reach of ordinary
investors. Institutional investors are the major players in the market. These institutions
buy bonds worth tens of millions and not thousands. Debt Markets are markets for the
issuance, trading and settlement in fixed income securities of various types and features.
Fixed income securities can be issued by almost any legal entity like Central and State
Governments, Public Bodies, Statutory corporations, Banks and Institutions and
corporate bodies.
Fixed income securities

Fixed Income securities are one of the most innovative and dynamic instruments evolved
in the financial system ever since the inception of money. Based as they are on the
concept of interest and time-value of money, Fixed Income securities personify the
essence of innovation and transformation, which have fueled the explosive growth of the
financial markets over the past few centuries.
Fixed Income securities offer one of the most attractive investment opportunities with
regard to safety of investments, adequate liquidity, and flexibility in structuring a
portfolio, easier monitoring, long term reliability and decent returns. They are an essential
component of any portfolio of financial and real assets, whether in form of pure interest
bearing bonds, innovative and varied type of debt instruments or asset-backed mortgages
and securitised instruments.
Market
Segment
Government
Securities
Issuer
Instruments
Central Government
Zero Coupon Bonds, Coupon Bearing Bonds,

Treasury Bills, STRIPS
Coupon Bearing Bonds.
State Governments
Public
Bonds
Sector Government Agencies / Govt. Guaranteed Bonds, Debentures

Statutory Bodies
Public Sector Units
PSU Bonds, Debentures, Commercial Paper
Private
Bonds
Sector Corporates
Banks
Financial Institutions
Debentures, Bonds, Commercial Paper,

Floating Rate Bonds, Zero Coupon Bonds,
Inter-Corporate Deposits
Certificates of Deposits, Debentures, Bonds
Certificates of Deposits, Bonds
Fixed Income Markets

48
The Fixed Income securities market was the earliest of all the securities markets in the
world and has been the forerunner in the emergence of the financial markets as the engine
of economic growth across the globe. The Fixed Income Securities Market, also known
as the Debt Market or Bond Market, is easily the largest of all the financial markets in the
world today. The Debt Markets have a very prominent role to play in the efficient
functioning of the world financial system and in catalyzing the economic growth of
nations across the globe.
Classification of Bond Markets

Bond markets can be categorized into different classes based on the nature of the market,
nature of the issuer, and nature of issuance. They can be classified as primary bond
market and secondary bond markets based on the nature of the market; government and
corporate bond market based on the nature of the issuer; and domestic, foreign, and
Eurobond market based on the nature of bond issuance.
Primary and Secondary Bond Markets

Bonds are first issued in a primary bond market. In this marketplace, a borrower issues or
sells bonds to the investor or buyer. As the name suggests, it is a first-sale market, where
the issuer places his bonds with the investor for the first time. Until 1970s, only primary
bond markets existed and bonds were issued in the form of plain vanilla products.
Investors used to purchase bonds and hold them until maturity. The predictable nature of
the future cash flows associated with bonds made them more attractive. Investors enjoyed
the risk-free returns.
A secondary market for bonds came into existence in the late 1970s. Since then, investors
started taking advantage of price differences. Unlike primary market, secondary market is
a re-sale market, where the buying and selling of already existing bonds take place. There
is no fresh issue of bonds; instead, the already existing bonds are exchanged among
investors.
Bond dealers and banks are the major participants in a bond market. They act as
intermediaries, by buying bonds from issuers and selling the same to investors in a
primary bond market. Bond dealers also maintain active secondary bond markets. Bond
trading is largely done over-the-counter, where bond dealers bid for bonds that
investors are willing to sell and offer them to investors willing to buy. Secondary bond
markets are equipped with highly sophisticated networked counters.
Bond markets can be segregated into government bond markets and corporate bond
markets based on the issuers of bonds.
Government Bond Markets

49
According to many studies, governments are the largest issuer of bonds worldwide.
Government bonds, also known as 'sovereign debts', play an important role in enhancing
the liquidity of a bond market. These are the backbones of healthy domestic debt markets.
From a macroeconomic perspective, government bonds enhance stability in an economy
by acting as one of the sources for funding budget deficit. Market-oriented funding of
budget deficit reduces debt-service costs. A government bond market also facilitates the
implementation of monetary policy. Development of a deep and liquid government bond
market helps in ironing out the friction caused by financial shocks. Such a market,
coupled with sound debt management, can help governments reduce exposure to
currency, interest rate and other financial risks
Corporate Bond Markets

Private and public corporations issue corporate bonds in order to fund their business
purposes, ranging from building facilities to purchasing equipment for expansion.
Investors generally go for corporate bonds due to their advantages of attractive yields,
marketability, dependable income, safety and diversity. Moreover, credit ratings of the
corporate bonds enhance the safety factor associated with them. Investors in this market
include individuals, and large financial institutions e.g., pension funds, endowments,
mutual funds, insurance companies and banks.
Corporate bonds serve as a readily available source of financing for companies hunting
for long-term funds. These reduce companies' over dependence on banks for short-term
borrowing and instead facilitate long-term financial planning. In order to issue corporate
bonds, companies approach investment bankers with their proposal to issue bonds, who
in turn send recommendations to exchanges after a due diligence analysis.
Domestic Bond Markets

Bonds in domestic/local markets are issued by a domestic borrower usually in the local
currency. There has been a rapid growth in the local bond markets over the past few
years. This growth is the immediate upshot of the financial crises. The blows dealt by the
financial crises made countries realize the need for an efficient domestic debt market that
could act as a substitute for external sources of funding. These markets could shield
against the on-and-off nature of international capital markets during the crises period. It
could also help in creating a wider list of home-grown instruments to overcome inherent
currency and maturity mismatches. Countries are poised to develop a strong domestic
bond market to reduce dependence on international markets. To what extent the domestic
bond market can prove to be a substitute of international sources of funding in crisis still
remains a point to ponder.
Domestic bond markets were full of lacunae, such as, restricted demand for fixed income
products, limited supply of quality bond issuances, and last but not the least, inefficient
market infrastructure. These loopholes were overlooked till the Asian crisis, but as an
aftermath, many governments are making consistent and determined efforts to plug them.
Nevertheless, there have been differences in the rate of growth and factors driving the
50
growth in different countries. Financing expansionary fiscal policies, the need for recapitalizing the banking system and a lack of bank credit have been the major drivers to
the growth of domestic bond markets in the Asian region. Whereas, the increased
participation of domestic institutional investors and corporate sector's refinancing needs
have been the main drivers to bond market growth in the Latin American region. In the
EU region, the harmonization of regulations for the accession to the EU, has been the
primary driver for growth.
Foreign Bond Markets

Foreign bonds are issued by a foreign borrower in a local market in the local currency.
Foreign bonds have interesting nomenclatures indicating the local markets where they are
issued. Bonds issued in US dollar by a borrower located outside US are called Yankee
bonds, bonds issued in sterling by a borrower residing outside UK are known as Bulldog
bonds. Similarly, bonds issued in yen by a borrower residing outside Japan are called
Samurai bonds.
Ninety years ago, international bond markets were confined to foreign bonds. Erstwhile
international bond markets were not very different from today's markets in terms of types
of issuers and subscribers, and underwriting and syndication practices. In the post-World
War I era the US economy witnessed a tremendous growth and so did its currency. The
US foreign bond market, also called the Yankee bond market, continued dominating the
world's capital markets. It grew more rapidly after World War II. The Yankee bond
market remained the most dominant and largest foreign bond market for many years. But
of late, it is being overtaken by CHF (Swiss franc) foreign bond markets. Table 1 gives
the history of foreign bond markets in major countries.
Eurobond Markets
Loans arranged through a syndicate of banks of international repute and placed in the
countries not corresponding to the currency of issue are called Eurobonds. The history of
Eurobonds dates back to the early 1960s, when Eurodollar bonds (USD bonds issued
outside US) dominated the Eurobond market. The first Eurobond was issued in 1957.
Presently, Eurobonds are denominated in almost all the major currencies. Today, the
Eurobond markets are well developed and more sophisticated than they were at their
inception.
Bond Market Instruments:

A wide variety of bonds are available in the marketplace. Issuers can issue bonds
according to the specifications of an investor, such bonds are not publicly traded and are
privately placed. The most popular instruments of bond markets are:
Straight bonds: These are the fixed income bonds with specific interest
payments on specified dates over a specified period of years. Straight bonds are
also known as debentures. These are the basic fixed income bonds, where the
owner receives a predetermined interest amount from the issuer at regular
51
intervals, either annually or semi-annually. The issuer doesn't have an option to

redeem the loan prior to maturity. The issuer has to redeem the bond at its face
value, also known as par value at a predetermined date.
Perpetual bonds: These bonds have no maturity date. A steady stream of
interest on these bonds is paid forever and these cannot be redeemed.
Callable bonds: The issuer has an option to call back or buy back all or a part
of their bonds under specified conditions before the maturity date. Corporations
and municipal corporations issue these bonds in order to capitalize on the fall in
interest rates. When the issuer calls back his bonds, then the owner is obligated to
sell them back to the issuer at a price specified when they were issued, which
usually exceeds the market price. The difference between current market price
and the call price is the call premium.
Zero-coupon bonds: These are the straight bonds with no periodic interest
payments. These bonds are issued at less than par value and redeemed at par
value. They serve to eliminate investment risk to the investor. The investor does
not receive any interest payments on these bonds. Hence the investor bears no
reinvestment risk till the maturity of the bond. Greater certainty of the returns is
the major attraction to the investors of these bonds.
Strips: A Separately Registered Interest and Principal of Securities is an
innovation to zero-coupon bonds. This is issued by the borrowers and deposited
with a trustee, who in turn, divides the bond into separate individual payment
components that allow the components to be registered and traded as separate
securities. Then the trustee directs the appropriate amount of interest or maturity
payments to investors.
Floating rate notes: These notes are issued by banks and building societies.
FRNs are similar in structure to the straight bonds except for their interest
calculations. Coupon rates of FRNs are linked to the London Interbank Offered
Rate (LIBOR). The coupon rates are reset at regular specified intervals, normally
3 months, 6 months, or one year. Investors benefit from lower pricing of bank
loans and larger maturities of straight bonds.
Convertible bonds: Convertible bond, as the name suggests, can be converted
to or exchanged for another security at the bondholder's option under specified
conditions. Convertible bonds are generally exchanged for an issuer's common
shares. Issuers can have an advantage of lower funding costs and possibility of
non-repayment of the principal amount.
Junk bonds: Junk bonds are high-yield bonds issued by companies and are
considered highly speculative because of high risk of default. The credit rating for
these bonds are either 'speculative' grade or below 'investment' grade. Although
these bonds have higher default risks than others, the returns associated with these
are relatively higher than those of other bonds. Hence the risk of default is more
than compensated by high yields.
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Catastrophe bonds: These are insurance linked debt instruments used to raise
money in case of a catastrophe. The catastrophe could be an earthquake or
hurricane of sufficient magnitude and within a particular region. Usually,
insurance or a reinsurance company is the issuer of a catastrophe bond. The
special condition linked with such a bond is that, if the issuer suffers a loss from a
catastrophe, then the investor is obligated to either defer or completely forgo the
principal and/or interest payable by the issuer.
Factors Influencing Bond Markets

The fluctuations in bond markets are caused by several economic factors, the most
significant factor being a change in interest rates. Interest rates have an inverse relation
with the bond price: as interest rates rise, the bond price falls and vice versa. Changes in
interest rates could be due to changes in demand and supply of credit, fiscal and monetary
policies, exchange rates, market psychology and inflation expectations.
Inflation is considered to be yet another major factor affecting bond markets. Bond
investors always have an aversion towards inflation. They fear inflation, as it lowers the
value of bonds by reducing the future purchasing power of fixed interest payments they
receive. Hence, any economic development that is likely to result in inflation causes
panic in the bond markets.
International bond markets are exposed to exchange-rate risk. Cash flows associated with
foreign bonds are dependent on the exchange rate at the time the payments are received.
Hence, fluctuations in the exchange rates cause changes in the value of bonds.
Policy actions can also impact bond markets significantly. A conscious policy move or
increase in the forex reserves makes the bond markets more volatile. Liquidity created by
such policy actions drives investors to trade more frequently and actively. In an uncertain
interest rate scenario, created by conflicting signals from different policy makers, bond
investors tend to become increasingly risk-averse.
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Corporate Bond
A debt security issued by a corporation and sold to investors. The backing for the bond is
usually the payment ability of the company, which is typically money to be earned from
future operations. In some cases, the company's physical assets may be used as collateral
for bonds.
Corporate bonds are issued by private and public corporations. Companies issue
corporate bonds to raise money for a variety of purposes, such as building a new plant,
purchasing equipment, or growing the business. When one buys a corporate bond, one
lends money to the "issuer," the company that issued the bond. In exchange, the company
promises to return the money, also known as "principal," on a specified maturity date.
Until that date, the company usually pays you a stated rate of interest, generally
semiannually. While a corporate bond gives an IOU from the company, it does not have
an ownership interest in the issuing company, unlike when one purchases the company's
equity stock.
Corporate bonds are considered higher risk than government bonds. As a result, interest
rates are almost always higher, even for top-flight credit quality companies.
Corporate bonds are issued in blocks of $1,000 in par value, and almost all have a
standard coupon payment structure. Corporate bonds may also have call provisions to
allow for early prepayment if prevailing rates change.
Corporate bonds, i.e. debt financing, are a major source of capital for many businesses
along with equity and bank loans/lines of credit. Generally speaking, a company needs to
have some consistent earnings potential to be able to offer debt securities to the public at
a favorable coupon rate. The higher a company's perceived credit quality, the easier it
becomes to issue debt at low rates and issue higher amounts of debt.
Convertibles and exchangeables

Convertible bonds are corporate bonds with an embedded equity option and often with
embedded (issuer) calls and/or (holder) puts. Convertibles have characteristics of both
bonds and equities (or equity derivatives if held on a hedged basis), i.e. they are hybrids.
A convertible bond is a bond which can be converted into shares of the bond issuing
company at the option of the bondholder. The bonds can be converted into equity at a prespecified ratio, the conversion ratio; or alternatively, at a pre-specified price, the
conversion price, which is at a premium to the underlying equity spot price at issuance.
54
An exchangeable bond differs only in that the bond is exchangeable for shares in a
company other than the issuing company. Invariably the issuer is committed to paying a
periodic coupon on the bond and repaying the principal at maturity, as for any other bond.
However, the holder may elect to have the bond converted/exchanged into a fixed
number of shares. Convertibles and exchangeables combine the characteristics of straight
bonds and equity derivatives. Holders will accept the lower coupon rate paid on
convertibles and exchangeables because of the potential profit if the stock price increases,
whilst issuers potentially give up some equity in exchange for a lower funding cost.
Alternatively, they may be viewed as stock substitutes. The bond allows the holder to
acquire the stock for a set amount, but provides the protection of a fixed income
instrument should the stock price perform poorly. Also, the holder receives the coupon
instead of the stock dividend prior to conversion. Since the coupon is typically higher
than the dividend (although, as noted above, usually lower than the coupon on a straight
bond) this makes the convertible attractive to investors. If the stock price increases
quickly and the bonds are converted, the issuer will receive more for the shares than if
they had issued shares directly since the conversion price is invariably set at a premium
to the stock price at the time of issue. The conversion price is the amount of face value of
the bond which must be surrendered for each share received on conversion. For example,
if a 1,000 face value bond is convertible into 20 shares, the "conversion price" is 50 per
share.
Most convertible bonds have several additional features, a common one being a call
option permitting the issuer to redeem the bonds at a fixed price at some future, fixed
date if the shares reach a certain price, typically 130 or 140 per cent. of the initial
conversion price this option will effectively force all bondholders to effect their
conversion/ exchange (i.e. so as to receive the benefit of the stock price increase).
Equally common is a put feature, which allows the holder to choose to have the bonds
redeemed at a pre-determined price and time in the future the put price usually being at
a premium so that, on exercising this put, the bond will have paid a yield equivalent to a
straight bond by that issuer.
Busted Convertible Security

It is a convertible security that is trading well below its conversion value. The result is
that the security is valued as regular debt because there is very little chance that it will
ever reach the convertible price before maturity.
This is a convertible that is now a non-convertible because the convertible price is 50%
or more above the current share price. Some investors have found success in trading
busted convertibles. While the possibility of converting into stock is usually remote,
busted converts usually trade at prices and yields very close to other nonconvertible debt
(so you don't compromise returns). Meanwhile, if by chance the stock rebounds, the bond
could become extremely valuable.
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Conversion Price
It is the price per share at which a convertible security, such as corporate bonds or
preferred shares, can be converted into common stock.
The conversion price is determined when the convertible security is issued and can be
found in the bond indenture (in the case of convertible bonds) or in the security
prospectus (in the case of convertible preferred shares). The conversion price is essential
in determining the number of shares to be received, by computing the quotient of the
principal value of the convertible security divided by the conversion price. Usually, the
conversion price is set at a significant amount higher than the current price of the
common stock, so as to make conversion desirable only if a company's common shares
experience a significant increase in value.
Structure of a typical convertible Bond

There are many options available to issuers when structuring their convertible bond issue
to suit their financing needs best, including:
Plain vanilla convertible (e.g., five-year convertible, around 2-3% coupon, 2040% conversion premium callable after two years and puttable after three).
Exchangeable, issued by a different company to the underlying stock, very
common in Europe for divestment/privatisation.
Floating rate coupons.
Perpetual/deeply subordinated structures.
Mandatory convertibles/exchangeables.
Features
The features embedded in a convertible can greatly affect its valuation; some are
advantageous to the issuer while others are beneficial to the bondholders. Prospectuses
should be read carefully to fully understand all the bonds features.
Calls give the issuer the opportunity to redeem the bond, over a pre-specified
period and under pre-specified conditions.
Puts permit the bondholder to redeem the bond on pre-specified dates, usually at
issue price or accreted value.
Dividend protection: compensates bondholders for foregone stock dividends in
excess of set thresholds.
Takeover protection: compensates bondholders for loss of optionality/credit
deterioration in a change of control event.
Yields
56
Yield is a critical concept in bond investing, because it is the tool used to measure the
return of one bond against another. It enables one to make informed decisions about
which bond to buy. In essence, yield is the rate of return on bond investment. However, it
is not fixed, like a bonds stated interest rate. It changes to reflect the price movements in
a bond caused by fluctuating interest rates. The following example illustrates how yield
works.
You buy a bond, hold it for a year while interest rates are rising and then sell it.
You receive a lower price for the bond than you paid for it because, no one would
otherwise accept your bonds now lower-than-market interest rate.
Although the buyer will receive the same amount of interest as you did and will
also have the same amount of principal returned at maturity, the buyers yield, or
rate of return, will be higher than yours, because the buyer paid less for the bond.
Yield is commonly measured in two ways, current yield and yield to maturity.
Current yield
The current yield is the annual return on the amount paid for a bond, regardless of
its maturity. If you buy a bond at par, the current yield equals its stated interest
rate. Thus, the current yield on a par-value bond paying 6% is 6%.
However, if the market price of the bond is more or less than par, the current yield
will be different. For example, if you buy a Rs. 1,000 bond with a 6% stated
interest rate at Rs. 900, your current yield would be 6.67% (Rs. 1,000 x .
06/Rs.900).
Yield to maturity
It tells the total return you will receive if you hold a bond until maturity. It also enables
you to compare bonds with different maturities and coupons. Yield to maturity includes
all your interest plus any capital gain you will realize (if you purchase the bond below
par) or minus any capital loss you will suffer (if you purchase the bond above par).
Valuation of Corporate Bonds

Corporate bonds tend to rise in value when interest rates fall, and they fall in value when
interest rates rise. Usually, the longer the maturity, the greater is the degree of price
volatility. By holding a bond until maturity, one may be less concerned about these price
fluctuations (which are known as interest-rate risk, or market risk), because one will
receive the par, or face, value of the bond at maturity. The inverse relationship between
57
bonds and interest ratesthat is, the fact that bonds are worth less when interest rates rise
and vice versa can be explained as follows:
When interest rates rise, new issues come to market with higher yields than older
securities, making those older ones worth less. Hence, their prices go down.
When interest rates decline, new bond issues come to market with lower yields
than older securities, making those older, higher-yielding ones worth more.
Hence, their prices go up.
As a result, if one sells a bond before maturity, it may be worth more or less than
it was paid for.
Why issue Convertible Bonds

Companies choose to issue convertible/exchangeable bonds instead of straight bonds or
equity, or at a certain time, for a variety of reasons, including:
Reduced cost of capital versus straight equity or straight debt: Convertible bonds,
however, enable the company to either sell (deferred) equity at a considerable
premium if the holders convert or issue straight debt with a significantly reduced
coupon/yield if the bonds are redeemed. Whether the bonds are converted or
redeemed depends largely on the realized stock growth rate.
Valuation/pricing: The market forces of supply and demand both from investors
and from banks that are competing for the deals mean that convertible bonds
may be priced on very favorable terms to the company.
Market opportunity/timing: Companies may take advantage of a sharp rise in their
equity to opportunistically issue a convertible on favorable terms to the issuer
when their stock is attracting positive sentiment.
New/broader investor groups: Convertible bonds attract additional investor
groups, such as hedge funds, outright convertible funds and institutional trading
desks.
Capital structure/reporting benefits: As hybrid products, convertibles may be
accounted for in various ways depending on accounting rules and on its terms and
features.
Tax advantages: Depending upon the jurisdiction of the holder and issuer,
Convertibles may have the effect of reducing or deferring tax liabilities
Adjustment events
Where the issuer of the bonds makes adjustments that may affect the right to convert or
exchange into the underlying shares, typically as a result of some kind of dilution event
(rights issue, capital distribution etc), it is imperative to the investor that the value of the
conversion/exchange right is properly preserved. This is dealt with in different ways
under convertible bonds and exchangeable bonds, primarily because an issuer of
58
convertible bonds is also the issuer of the underlying shares (and therefore controls those
shares) whereas an issuer of exchangeable bonds will typically have little or (more likely)
no control over the issuer of the underlying shares.
Convertibles: dilution and key adjustment provisions

Dilution
As discussed above, the bondholder, when purchasing the bonds, knows the price at
which conversion may take place and hence the number of shares that the bondholder
will receive on conversion. However, it may be that the value of the shares is diluted as a
result of capitalisation issues. Consequently, provisions are included in the terms and
conditions of the bonds to protect the bondholder in such circumstances.
Dilution events
These may be split into distributions to shareholders (subdivisions, consolidations, rights
issues and distributions of assets other than shares) and distributions to others (issues of
securities convertible into or exchanged for shares, other issues of shares and issues of
warrants to obtain shares/ securities convertible into or exchangeable for shares).
1. Subdivision or consolidation
If an issuer decides to carry out a one for five share split then each share will represent a
smaller proportion of the aggregate assets of the issuer and accordingly its value will
decrease. In such circumstances the number of shares the bondholder receives must be
adjusted in order to cater for this decrease proportionately. For example, if the conversion
price is 10 per share and the market value of each share is 15, the conversion right is
"in the money". However, if the issuer carries out the one for five split then the market
price of each share will fall to 3 and the value of the conversion right would be
eliminated. In such circumstances, the terms of the issue will provide for an increase in
the proportionate number of shares the bondholder receives on conversion
proportionately (i.e. the conversion price becomes 2 (the original 10 conversion price
divided by 5).
The date on which the necessary adjustment takes place will be the date giving rise to the
adjustment or, if earlier, the record date for determining which shares and shareholders
are to participate in the event. This is to protect bondholders who have converted before
the event. For example, if an issuer resolves to carry out a share split on 1 July of each
share held by each person on the Register of Members on 1 June; the bondholder
exercises its right to convert on 2 June. Since the record date (1 June) is the date for
adjustment, the bondholder, despite converting on 2 June, will receive the benefit from
the adjustment to the conversion price.
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2. Rights issue
Dilution will only occur if the subscription price is below the then market price. If the
market value or indeed a premium is paid for the new shares then the increased number
of shares is matched by an increase in net asset value and as such there is no dilution.
However, if the subscription price is below the market value, the bondholders will seek
protection from the dilution. It is not unusual for there to be a 95 per cent of market value
threshold if the rights issue subscription price is below 95 per cent of the market value
of the shares (market value usually being a 5 day average of the share price immediately
prior to the announcement of the rights issue) then the conversion price is adjusted
(otherwise, not).
For example, a company has 100,000 shares in issue and the net asset value of the
company is 1,000,000. Each share is therefore worth (1,000,000 divided by 100,000) =
10. Following a rights issue a further 100,000 shares are subscribed for at 5.00. Each
share is now worth (1,500,000 divided by 200,000) = 7.50.
As a result an adjustment to the conversion price (in the shape of an adjustment formula)
will be built in to the terms and conditions of the bonds to compensate the bondholders.
3. Other distributions to shareholders

This is relevant if the issuer reduces its net assets by way of an issue of loan stock to
existing shareholders since this will decrease the value of the shares. To compensate
bondholders, the conversion price is reduced pro rata to the decrease in the value of each
share as a result of the dissipation of the issuer's assets.
4. Issue of securities convertible into or exchangeable for shares

In such circumstances there is a dilution in the value of the shares to the extent that the
issuer will not receive the full market value for the shares (assessed at the time the
conversion or exchange price for the new convertible or exchangeable securities is fixed).
5. Other issues of shares

If the issuer issues shares below their market value in any circumstances not described
above the conversion price will be reduced in proportion to the under valuation in
accordance with the adjustment formula referred to above.
The key provision in connection with the adjustment of the conversion price is the
definition of capital distribution. This is because, although it is easy to spot a diluting
rights issue, typically what constitutes an "ordinary" (non-diluting) dividend and a
"diluting" dividend can be hard to identify. Practice has evolved whereby a "diluting"
dividend is identified as a "capital distribution" and thereby affects the conversion price
of the bond. Essentially, a capital distribution usually encapsulates any dividend which is
something other than an ordinary dividend and therefore which ought to accrue to the
benefit of the bondholder.
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The definition is cast in differing ways but will typically include any dividend which is
declared to be a capital distribution or extraordinary or special dividend or distribution or
similar whether of cash, shares or property. It also includes any cash dividend subject to
certain thresholds, under which such dividend could not be considered to be of a capital
value. In a recent deal, these thresholds were set at (i) an amount equal to cumulative net
profits less cumulative net losses attributable to members of the company, taking into
account distributions already paid that financial year, or (ii) if the relevant distribution
exceeds the amount calculated under (i), an amount equal to the higher of (a) twice the
cash or other dividend for the relevant shares in the previous financial period and (b) 5
per cent of the market value of the shares.
Payoff and Valuation Profile

Similar to a call option, the value of a convertible bond resembles a convex profile,
bounded by the bond floor and parity (the value of the underlying shares).
Payoff at maturity is the greater of parity and the redemption price.

At any time prior to maturity, the convertible bond value is bounded below by
parity and by the equivalent straight bond value, i.e. the bond floor.
The convertible bond value approaches parity as the stock price rises because, in
the limit, there is no time value, i.e. no optionality.
The value of a corporate bond typically falls as the equity decreases towards zero
due to the increased risk of default. In this event, bondholders compete with other
creditors (on the basis of their relative ranking and subordination) to extract as
much value as possible from the restructuring or liquidation: this is the recovery
value.
Sensitivities
Being a hybrid structure (i.e. a combination of bond and equity features) a convertible
bond is sensitive to a range of variables:
Delta: equity sensitivity = change in value of the convertible bond per unit change
in parity.
Gamma: equity sensitivity of delta = change in value of the convertible bond delta
per unit change in parity.
Vega: volatility sensitivity = change in value of the convertible bond per unit
change in volatility.
Rho: interest rate sensitivity = change in value of the convertible bond per unit
change in the risk-free yield curve.
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Why invest in Convertible Bonds: (Investors perspective)

A wide range of investors buys convertible securities for various reasons, as they have
become an increasingly popular and better-understood asset class.
Equity funds: downside protection and/or yield advantage.

Fixed income and high yield investors: upside participation, credit exposure.
Convertible funds: valuation and security-specific strategies.
Hedge funds: leveraged option trading and hedging-based strategies.
Risk-arbitrage/specialist funds: corporate activity and special situations.
Convertible Bonds: A Good Investment? (Investors perspective)

Some financial products straddle the fence between two worlds. Convertible bonds are
such products, offering benefits for the investor from the world of bonds and the world of
stocks.
Not all products that attempt this multiple personality existence work. However,
convertible bonds can be an attractive investment under right circumstances, but you
should be very careful of several potential problems.
Corporations issue convertible bonds and carry the right to convert the bond into a
specified number of shares of common stock.
Convertible bonds usually earn a lower interest rate than regular bonds because the price
of the bond will rise as the value of the underlying stock rises.
The bonds benefit in a rising stock market, but still pay interest if the underlying stock
doesnt rise.
Proponents of Convertible Bonds

Proponents point out that investors potentially get the best of both worlds: interest
payments and higher bond prices if the underlying stock rises.
However, there are some serious flaws in the convertible bond picture. Here are some
things you should consider before buying convertible bonds:
Almost all convertible bonds are callable, meaning the corporation can redeem the
bonds at its discretion. You get the face value back, but may have to reinvest the
money in a less attractive investment.
The stock price has to hit a certain number before you can convert. This number
may be quite high. This is the conversion premium. If you want to own the stock,
you are better off buying it at the lower current price rather than waiting for it to
hit this premium.
You receive a lower interest rate on the bond and if the stock declines, the bond
price drops. In the worst of all worlds, interest rates rise and the stock falls.
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Some General Underlying legal issues in Convertibles
There are a number of legal issues which need to be considered in relation to the
underlying shares in convertibles. The main concerns relate to the fact that the issuer will
need to allot and issue shares on exercise of the conversion right by the bondholder.
There are four main issues to consider:
1. Does the issuer have sufficient authorized share capital so that on conversion of the
bonds into shares there are sufficient shares available for issue? If this is not the case, the
authorized share capital will need to be increased and this would be done by ordinary
resolution under Section 94 of the Companies Act 1956 prior to the issue of the bonds,
assuming the articles do not prohibit an increase in share capital.
2. The issuer's directors will need authority to allot the shares under the Articles of
Association. Under Section 80 of the Companies Act, a company may not allot "relevant
securities" unless authorized to do so by its Articles of Association or by the company in
general meeting. The definition of relevant securities includes any rights to convert any
security into shares of the company. Accordingly if the issuer does not have the power
under its Articles of Association for the directors to allot the shares, an ordinary
resolution will need to be passed in general meeting to enable them to do so.
3. It will be necessary to check whether there are any pre-emption rights for existing
shareholders. Section 89 of the Companies Act requires that where a company proposes
to issue "equity securities" for cash, the securities must be offered first to its equity
shareholders on a pre-emptive basis. The definition of equity securities includes securities
that have the right to convert into a company's ordinary shares. Section 89 may have been
disapplied in the Articles of Association. However, if the pre-emption rights have not
been disapplied prior to the bonds being offered for subscription, the company will need
to pass a special resolution at its general meeting. Alternatively, it may opt to offer the
bonds first to its existing shareholders.
4. There is the question of valuation of the consideration for the shares. A company is
prohibited from allotting shares otherwise than for cash except where the consideration
has been independently valued. In relation to a convertible bond, new shares are issued in
consideration for the cancellation of the debt represented by the bond. The Companies
Act specifically provides that a company will be deemed to have allotted shares for cash
where the consideration for allotment is a release of a liability for a liquidated sum.
Therefore no independent valuation is required.
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Securities and Exchange Board of India

(Disclosure and Investor Protection) Guidelines
Issue of debentures including bonds
Credit rating of debentures or bonds shall be compulsory, if conversion or

redemption falls after 18 months.
Premium amount on conversion, time of conversion, in stages, if any, shall be predetermined and stated in the offer document.
Redemption amount, period of maturity, yield on redemption for the PCDs /

NCDs shall be indicated in the offer document.
The interest rate for debentures can be freely determined by the issuer company.
Issue of debentures / bonds with maturity of 18 months or less are exempt from
the requirement of appointment of Trustee.
In case of debenture / bonds with maturity beyond 18 months, a trustee or an

agent, by whatever name called shall be appointed to take care of the interest of
debenture / bond holders irrespective of whether or not the debentures / bonds are
secured.
Where the debentures / bonds are unsecured, the issuing DFI (Designated
Financial Institution), incorporated as companies, shall ensure compliance with
the provisions of the Companies (Acceptance of Deposits) Rules, 1975, as
unsecured debentures / bonds are treated as "deposits" for purposes of these rules.
The names of the debenture trustees shall be stated in the Offer Documents and
also in all the subsequent periodical communications sent to the debenture
holders.
A trust deed shall be executed by the issuer company in favor of the debenture
trustees within three months of the closure of the issue.
Trustees to the debenture issue shall be vested with the requisite powers for
protecting the interest of debenture holders including a right to appoint a nominee
director on the Board of the company in consultation with institutional debenture
holders.
The debenture trustee shall ensure compliance of the following:

a) It shall obtain reports from the lead bank, regarding monitoring progress of the project.
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b) It shall monitor utilization of funds raised in the debenture issue.

c) Trustees shall obtain a certificate from the company's auditors:
(i) In respect of utilization of funds during the implementation period of projects.
(ii) In the case of debentures for working capital, certificate shall be obtained at the end
of each accounting year.
(d) Debenture issues by companies belonging to the groups for financing replenishing
funds or acquiring share holding in other companies shall not be permitted.
Explanation:
The expression `replenishing of funds or acquiring shares in other companies'
shall mean replenishment of funds or acquiring share holdings of other companies in the
same group. In other words, the company shall not issue debentures for acquisition of
shares / providing loan to any company belonging to the same group. This shall not apply
to the issue of fully convertible debentures providing conversion within a period of
eighteen months. However, the company may issue equity shares for purposes of
repayment of loan to or investment in companies belonging to the same group.
Any conversion in part or whole of the debentures shall be optional at the hands
of the debenture holder, if the conversion takes place after 18 months from the
date of allotment.
In case of debentures with conversion period beyond 36 months, the issuer

designated DFI may exercise call option provided disclosure to this effect has
been made in the offer document
The interest rate for the debentures shall be freely determinable by the issuer DFI.
Rollover of debentures / bonds
The letter of option regarding roll over shall be filed containing disclosure with
regard to the credit rating, bond / debenture holder resolution, option for
conversion and such other terms which the Board may stipulate from time to time.
Undertaking by the issuer company shall be incorporated in the offer document

that the issuer company shall apply in advance for the listing of equities on the
conversion of Debentures / Bonds.
Where credit ratings are obtained from more than two credit rating agencies, all
the credit rating/s, including the unaccepted credit ratings, shall be disclosed.
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Computation of Promoters Contribution in Case of Issue of Convertible

Security
In case of any issue of convertible security by a company, the promoters shall
have an option to bring in their subscription by way of equity or by way of subscription
to the convertible security being offered through the proposed issue
Provided that, if the conversion price of emerging equity is not pre-determined and the
same has not been specified in the offer document (instead a formula for conversion price
is indicated), the promoters shall not have the said option and shall contribute by
subscribing to the same instrument.
In case of any issue of security convertible in stages either at par or premium (conversion
price being predetermined), the promoters contribution in terms of equity share capital
shall not be at a price lower than the weighted average price of the share capital arising
out of conversion.
Explanation: For the purposes of above clause,
(a) Weights means the number of equity shares arising out of conversion of security
into equity at various stages.
(b) Price means the price of equity shares on conversion arrived at after taking into
account predetermined conversion price at various stages.
The promoters contribution shall be computed on the basis of post-issue capital
assuming full proposed conversion of such convertible security into equity.
Provided that where the promoter is contributing through the same optional convertible
security as is being offered to the public, such contribution shall be eligible as promoters
contribution only if the promoter(s) undertakes in writing to accept full conversion.
No company shall, pending conversion of Fully Convertible Debentures (FCDs)

or Partly Convertible Debentures (PCDs), issue any shares by way of bonus or
rights unless similar benefit is extended to the holders of such FCDs or PCDs,
through reservation of shares in proportion to such convertible part of FCDs/
PCDs falling due for conversion within a period of 12 months from the date of
rights / bonus issue.
The share so reserved may be issued at the time of conversion(s) of such

debentures on the same terms on which the bonus or rights issue was made.
Issue proceeds shall be kept in an escrow account until the documents for
creation of security as stated in the offer document, are executed.
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If the issuing company proposes to create a charge for debentures of maturity of

less than 18 months, it shall file with Registrar of Companies particulars of
charge under the Companies Act.
Provided that, where no charge is to be created on such debentures, the issuer company
shall ensure compliance with the provisions of the Companies (Acceptance of Deposits)
Rules, 1975, as unsecured debentures / bonds are treated as "deposits" for purposes of
these rules.
Requirement of letter of option

Where the company desires to rollover the debentures issued by it, it shall file with SEBI
a copy of the notice of the resolution to be sent to the debenture-holders for the purpose,
through a merchant banker prior to dispatching the same to the debenture-holders. The
notice shall contain disclosures with regard to credit rating, necessity for debentureholders resolution and such other terms which SEBI may specify. Where the company
desires to convert the debentures into equity shares, it shall file with SEBI a copy of the
letter of option to be sent to debenture-holders with the Board, through a merchant
banker, prior to dispatching the same to the debenture-holders. The letter of option shall
contain disclosures with regard to option for conversion, justification for conversion price
and such other terms which SEBI may specify.
In case of conversion of instruments (PCDs/FCDs, etc.) into equity capital:
i) In case, the convertible portion of any instrument such as PCDs, FCDs etc. issued by
a listed company, value of which exceeds Rs.50 Lacs and whose conversion price was
not fixed at the time of issue, holders of such instruments shall be given a compulsory
option of not converting into equity capital.
ii) Conversion shall be done only in cases where instrument holders have sent their
positive consent and not on the basis of the non-receipt of their negative reply.
Provided that where issues are made and cap price with justification thereon, is fixed
beforehand in respect of any instruments by the issuer and disclosed to the investors
before issue, it will not be necessary to give option to the instrument holder for
converting the instruments into equity capital within the cap price.
(iii) In cases where an option is to be given to such instrument holders and if any
instrument holder does not exercise the option to convert the debentures into equity at a
price determined in the general meeting of the shareholders, the company shall redeem
that part of debenture at a price which shall not be less than its face value, within one
month from the last date by which option is to be exercised.
(iv) Provision of sub-clause (iii) above shall not apply if such redemption is to be made
in accordance with the terms of the issue originally stated.
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The debenture trustee shall submit a certificate of compliance to the merchant banker
which shall be filed with the Board within 15 days of the closure of the rollover or
conversion.
Companies may issue unsecured/ subordinated debt instruments/ obligations (which are
not 'public deposits' as per the provisions of Section 58 A of the Companies Act, 1956 or
such other notifications, guidelines, Circular etc. issued by RBI, DCA or other
authorities).
Provided that such issue shall be subscribed by Qualified Institutional Buyers or other
investor who has given positive consent for subscribing to such unsecured / sub-ordinated
debt instruments/ obligation.
Additional Disclosures in respect of debentures:

The offer document shall contain:
(a) In case of PCDs/ NCDs, redemption amount, period of maturity, yield on redemption
of the PCDs/ NCDs.
(b) Full information relating to the terms of offer or purchase including the name(s) of the
party offering to purchase the khokhas (non-convertible portion of PCDs).
(c) The discount at which such offer is made and the effective price for the investor as a
result of such discount.
(d) The existing and future equity and long term debt ratio.
(e) Servicing behavior on existing debentures, payment of due interest on due dates on
term loans and debentures.
(f) That the certificate from a financial institution or bankers about their no objection for
a second or pari passu charge being created in favor of the trustees to the proposed
debenture issues has been obtained.
The offer document of the DFI shall contain specific disclosures in respect of the
following:
In the case of PCDs/FCDs convertible beyond 18 months and optional at the hands of
debenture holders, at least 50% of the debenture value shall be reckoned as probable
redeemable debt and apportioned accordingly.
The provisions of the Companies Act, 1956 and other applicable laws / listing
requirements of the stock exchange, etc., wherever applicable, shall be complied with by
the DFIs in connection with issue of shares, debentures and bonds etc.
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Guidelines for Preferential Issues

The preferential issue of equity shares/ Fully Convertible Debentures (FCDs)/ Partly
Convertible Debentures (PCDs) or any other financial instruments which would be
converted into or exchanged with equity shares at a later date, by listed companies whose
equity share capital is listed on any stock exchange, to any select group of persons under
Section 81(1A) of the Companies Act 1956 on private placement basis shall be governed
by these guidelines.
Such preferential issues by listed companies by way of equity shares/ Fully Convertible
Debentures (FCDs)/ Partly Convertible Debentures (PCDs) or any other financial
instruments which would be converted into / exchanged with equity shares at a later date,
shall be made in accordance with the pricing provisions mentioned below:
Pricing of the issue
The issue of shares on a preferential basis can be made at a price not less than the
higher of the following:
i) The average of the weekly high and low of the closing prices of the related shares
quoted on the stock exchange during the six months preceding the relevant date;
OR
ii) The average of the weekly high and low of the closing prices of the related shares
quoted on a stock exchange during the two weeks preceding the relevant date.
Explanation:
a) "relevant date" for the purpose of this clause means the date thirty days prior to the
date on which the meeting of general body of shareholders is held, in terms of Section
81(1A) of the Companies Act, 1956 to consider the proposed issue.
b) "Stock exchange" for the purpose of this clause means any of the recognized stock
exchanges in which the shares are listed and in which the highest trading volume in
respect of the shares of the company has been recorded during the preceding six months
prior to the relevant date.
(a) Where warrants are issued on a preferential basis with an option to apply for and be
allotted shares, the issuer company shall determine the price of the resultant shares in
accordance with Clause above.
(b) The relevant date for the above purpose may, at the option of the issuer be either the
one referred in explanation (a) to Clause above or a date 30 days prior to the date on
which the holder of the warrants becomes entitled to apply for the said shares.
The resolution to be passed in terms of Section 81(1A) shall clearly specify the
relevant date on the basis of which price of the resultant shares shall be
calculated.
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Pricing of shares on conversion

Where PCDs/ FCDs/ other convertible instruments, are issued on a preferential basis,
providing for the issuer to allot shares at a future date, the issuer shall determine the price
at which the shares could be allotted in the same manner as specified for pricing of shares
allotted in lieu of warrants.
A listed company shall not make any preferential issue of equity shares, Fully
Convertible Debentures, Partly Convertible Debentures or any other instrument
which may be converted into or exchanged with equity shares at a latter date if the
same is not in compliance with the conditions for continuous listing.
No listed company shall make preferential issue of equity shares / warrants /

convertible instruments to any person unless the entire shareholding of such
persons in the company, if any, is held by him in dematerialized form.
Where the shares / warrants/ convertible instruments are issued on preferential

basis, the entire pre preferential allotment shareholding of such allottees shall be
under lock in from the relevant date up to a period of six months from the date
of preferential allotment.
Where the shares / warrants / convertible instruments are issued on preferential

basis, the shareholders who have sold their shares during the six months period
prior to the relevant date shall not be eligible for allotment of shares on
preferential basis.
Explanation:
(a) For the purpose of this clause total capital of the company shall mean (i) Equity share capital issued by way of public/ rights issue including equity shares
emerging at a later date out of any convertible securities/ exercise of warrants and
(ii) Equity shares or any other security convertible at a later date into equity issued on a
preferential basis in favor of promoter/ promoter groups.
(b) (i) For computation of 20% of the total capital of the company, the amount of
minimum promoters contribution held and locked-in, in the past as per guidelines shall
be taken into account.
(ii) The minimum promoters contribution shall not again be put under fresh lock-in,
even though it is considered for computing the requirement of 20% of the total capital of
the company, in case the said minimum promoters contribution is free of lock-in at the
time of the preferential issue.
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Guidelines for the OTCEI Issues

Any company making an initial public offer of equity share or any other security
convertible at a later date into equity shares and proposing to list them on the Over The
Counter Exchange of India (OTCEI) shall comply with all the requirements specified in
these guidelines:
Eligibility norms
Any company making an initial public offer of equity share or any other security
convertible at a later date into equity shares and proposing to list them on the OTCEI, is
exempted from the eligibility norms specified in Clause 2.2 of Chapter II of these
guidelines subject to its fulfilling the following besides the listing criteria laid down by
the OTCEI:
i. It is sponsored by a member of the OTCEI and;
ii. Has appointed at least two market makers (one compulsory and one additional market
maker).
Any offer for sale of equity share or any other security convertible at a later date into
equity shares resulting out of a Bought out Deal (BOD) registered with the OTCEI is
exempted from the eligibility norms specified in Clause 2.2 of Chapter II of these
guidelines subject to the fulfillment of the listing criteria laid down by the OTCEI.
Provided that the issuer company which has made issue of capital under Clause above,
shall not delist its securities from OTCEI for a minimum period of three years from the
date of admission to dealing of such securities on OTCEI..
Pricing Norms
Any offer for sale of equity share or any other security convertible at a later date into
equity shares resulting out of a Bought out Deal (BOD) registered with OTCEI is
exempted from the pricing norms specified in Clause 3.2 of Chapter III of these
guidelines subject to the following conditions:
i) The promoters after such issue shall retain at least 20% of the total issued capital with
the lock-in of three years from the date of the allotment of securities in the proposed
issue; and
ii) At least two market makers (One Compulsory and one additional market maker) are
appointed in accordance with the Market Making guidelines stipulated by the OTCEI.
Projections
In case of securities proposed to be listed on OTCEI projections based on the appraisal
done by the sponsor who undertakes to do market making activity in the securities
offered in the proposed issue can be included in the offer document subject to compliance
with other conditions contained in the said clause.
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Guidelines for Bonus Issues

A listed company proposing to issue bonus shares shall comply with the following:
In the case of issue of debt instruments by infrastructure companies fully or partly
convertible into equity, while the PCD/FCD shall be listed directly, the equity held prior
to the public issue of the PCD/FCD shall be listed only at the time when the equity
arising on conversion of the PCD/FCD are listed."
In case of Conversion of Debentures Issued under Consent of Controller of Capital
Issues (CCI)
A) In case, the value of convertible portion of any instrument such as PCDs, FCDs, etc.
issued by a listed company exceeds Rs 50 Lacs and;
i) where in terms of the consent issued by the Controller of Capital Issues, the price of
conversion of PCDs / FCDs is to be determined at a later date by the Controller, such
price and the timing of conversion shall be determined at a general meeting of the
shareholders subject to a) The consent of the holders of PCDs / FCDs for the conversion terms shall be obtained
individually and conversion will be given effect to only if the concerned debenture
holders send their positive consent and not on the basis of non- receipt of their negative
reply; and
b) Such holders of debentures, who do not give such consent, shall be given an option to
get the convertible portion of debentures redeemed or repurchased by the company at a
price, which shall not be less than face value of the debentures.
c) Where the consent from the Controller of Capital Issues stipulates cap price for
conversion of FCDs / PCDs, the board of the Company may determine the price at which
the debentures may be converted.
Provided that options to debentures / other instrument holders for conversion into equity
not required where the consent from the Controller of Capital Issues stipulates cap price
for conversion of FCDs and PCDs and the cap price has been disclosed to the investors
before subscription is made.
ii) In case of issue of debentures fully or partly convertible made in the past, where the
conversion was to be made at a price to be determined by the CCI at a later date, the price
of conversion and time of conversion shall be determined by the issuer company in a
meeting of the debenture holders, subject to the following:
The decision in the said meeting of debenture holders may be ratified by the shareholders
in their meeting.
Such conversions shall be optional for acceptance on the part of individual debenture
holders.
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The dissenting debenture holders shall have the right to continue as debenture holders if
the terms of conversions are not acceptable to them.
iii) Where issue of PCDs and FCDs is made pursuant to the consent given by the
Controller of Capital Issues and the consent specifies the timing of conversion but the
price of conversion of PCDs / FCDs is to be determined at a later date, the following shall
be complied with:a) The consent of the shareholders is to be obtained only for the purposes of fixing the
price of conversion and not for the preponing and postponing the timing of the
conversion approved by CCI.
b) The conversion price shall be reasonable (in comparison with previous conversion
price where the terms of the issue provide for more than one conversion) and the
conversion price shall not exceed the face value of that part of the convertible debenture
which is sought to be converted.
c) In cases where an option is to be given to the debenture holders and, if any debenture
holder does not exercise the option to convert the debentures into equity at a price
determined in the general meeting of the shareholders, the company shall redeem that
part of debenture at a price which shall not be less than its face value within one month
from the last date by which option is to be exercised.
d) The provision in sub-clause (c) above shall not be applicable in case such redemption
is to be made in accordance with the original terms of the offer.
In cases of issues of debentures fully or partly convertible, irrespective of value made in
the past, where conversion was to be made at a price to be determined by CCI and the
consent order does not provide for a specific premium or a cap price for conversion, the
draft letter of option to the debenture holders filed with the Board shall contain
justification for the conversion price.
In case of a debenture issue, the issuer company shall also give undertakings to the
following effect in the prospectus:
(i) That the issuer company shall forward the details of utilization of the funds raised
through the debentures duly certified by the statutory auditors of the issuer company, to
the debenture trustees at the end of each half-year.
(ii) That the issuer company shall disclose the complete name and address of the
debenture trustee in the annual report.
(iii) That the issuer company shall provide a compliance certificate to the debenture
holders (on yearly basis) in respect of compliance with the terms and conditions of issue
of debentures as contained in the prospectus, duly certified by the debenture trustee.
(iv) That the issuer company shall furnish a confirmation certificate that the security
created by the company in favor of the debenture holders is properly maintained and is
73
adequate enough to meet the payment obligations towards the debenture holders in the
event of default.
(v) That necessary cooperation with the credit rating agency (ies) shall be extended in
providing true and adequate information till the debt obligations in respect of the
instrument are outstanding.
Some SEBI Circulars for Amendment of Guidelines

SEBI amends DIP Guidelines: Rating requirements for Corporate Bonds
simplified (Structural Restrictions on Corporate Bond issuances removed)
The provisions pertaining to issuances of Corporate Bonds under the SEBI (Disclosure
and Investor Protection) (DIP) Guidelines, 2000 vide circular dated December 03, 2007.
1. In order to facilitate issuance of below investment grade bonds to suit the risk/ return
appetite of investors, the stipulation that debt instruments issued through public/ rights
issues shall be of at least investment grade has been removed.
2. Further, in order to afford issuers with desired flexibility in structuring of debt
instruments, it has been decided that structural restrictions such as those on maturity,
put/call option, on conversion, etc currently in place have been done away with.
SEBI/MRD/SE/AT/36/2003/30/09
Any listed company making issue of debt securities on a Private Placement basis and
listed on a stock exchange shall be required to comply with the following:1.1.
The company shall make full disclosures (initial and continuing) in the
manner prescribed in Schedule II of the Companies Act, 1956, SEBI
(Disclosure and Investor Protection) Guidelines, 2000 and the Listing
Agreement with the exchanges. However, if the privately placed debt
securities are in standard denomination of Rs.10 Lakhs, such disclosures
may be made only through web sites of the stock exchange where the debt
securities are sought to be listed.
1.2.
The debt securities shall carry a credit rating of not less than investment
grade from a Credit Rating Agency registered with the Board.
1.3.
The company shall appoint a debenture trustee registered with SEBI in

respect of the issue of the debt securities.
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1.4.
The debt securities shall be issued and traded in demat form.
1.5.
The company shall sign a separate listing agreement with the exchange in
respect of debt securities and comply with the conditions of listing.
1.6.
All trades with the exception of spot transactions, in a listed debt security,
shall be executed only on the trading platform of a stock exchange.
1.7.
The trading in privately placed debts shall only take place between Qualified
Institutional Investors (QIBs) and High Net worth Individuals (HNIs), in
standard denomination of Rs.10 Lakhs.
1.8.
The requirement of Rule 19(2)(b) of the Securities Contract (Regulation)

Rules, 1957 will not be applicable to listing of privately placed debt
securities on exchanges, provided all the above requirements are complied
with.
1.9.
If the intermediaries registered with SEBI associate themselves with the

issuance of private placement of unlisted debt securities, they will be held
accountable for such issues. They will also be required to furnish periodical
reports to SEBI in such format as may be decided by SEBI.
SEBI/MRD/SE/AT/46/2003
The SEBI circular is applicable to all debt securities that have been and would be issued
on a private placement basis on or after the date of the circular, i.e., September 30, 2003.
The SEBI circular would not be applicable for private placement of debt securities having
a maturity of less than 365 days.
Issuer companies shall make full disclosures (initial and continuing) in the manner
prescribed in Schedule II of the Companies Act, 1956, Chapter VI of the SEBI (DIP)
Guidelines, 2000 and the listing agreement with the stock exchanges.
Such disclosures may be made through the web site of the stock exchanges where the
debt securities are sought to be listed if the privately placed debt securities are issued in
the standard denomination of Rs. 10 Lakhs.
As regards financial disclosures, issuer companies which are not in a position, for
genuine reasons, to disclose audited accounts up to a date not earlier than six months of
the date of the offer document, may disclose the audited accounts for the last financial
year and un-audited accounts for the subsequent quarters with a limited review by a
practicing Chartered Accountant.
It is also being clarified that the provisions other than Chapter VI of SEBI (DIP)
Guidelines, 2000 will not be applicable for privately placed debt securities.
75
Since engaging the services of an intermediary (other than debenture trustee) is not
mandatory, the appointment of such an intermediary would be left to the discretion of the
issuer company, as it deems fit.
Vetting of offer document
There is no requirement of vetting of the offer document by SEBI.
Whether the requirement of 1% deposit with the stock exchange/s is mandatory
There is no requirement to deposit 1% of the issue size of the privately placed debt
securities with the stock exchanges.
Applicability of minimum subscription clause as per DIP guidelines
This clause will not be applicable for privately placed debt securities.
Denomination for issuance and market lot for trading
The privately placed debt securities need not necessarily be issued in denomination of Rs.
10 Lakhs.
The securities shall be issued in demat form.
However, if an investor is allotted securities of Rs.1 Lakh or less, such securities may be
issued in physical form at the option of the investor. It shall be disclosed by the issuer
companies that such investors would not be able to trade in such securities through the
stock exchange mechanism.
SEBI/CFD/DIL/CIR- 39 /2004/11/01
Model Listing Agreement for listing of Debt Securities
SEBI, vide its circulars dated 30th September 2003 and 22nd December 2003,
stipulated the conditions to be complied with, in respect of privately placed debt
securities. One of the conditions specified therein requires that an entity desirous
of listing privately placed debt securities shall enter into a separate Listing
Agreement with the Stock Exchanges.
It has now been decided that listing of all debt securities irrespective of the mode
of issuance i.e. whether issued on private placement basis or through public/rights
issue, shall be done through a separate Listing Agreement. In this regard, the
Stock Exchanges are advised to henceforth list all debt securities through an
Agreement prepared in line with the Model Listing Agreement.
The Model Agreement has three parts. Part (I) contains clauses which shall be
complied by all issuers irrespective of mode of issuance, Part (II) contains clauses
which shall be complied with only if the debentures are issued either through
public or rights issue and part (III) contains clauses which are required to be
complied with only if the debentures are issued on private placement basis.
76
SEBI/CFD/DIL/LA/1/2007/20/03
i. Submission of unaudited half-yearly results subject to a limited review (instead of halfyearly audited results) has been permitted. The results shall be submitted to the exchange
within one month from the end of the half-year and a copy of the limited review report
shall be submitted within two months from the end of the half yearly period.
ii. The limited review shall be done by the statutory auditors of the company (or in case
of public sector undertakings, by any practicing Chartered Accountant) and report of the
limited review shall be prepared on the lines of the format now being included in the
Model Listing Agreement.
Amendments to the Model Listing Agreement for debentures

i. For clause 3.3, the following clause shall be substituted:
3.3 The issuer agrees to furnish unaudited financial results on a half-yearly basis
preferably in the format given in clause 2.14 of part 2 of this agreement within one month
from the end of the half-year to the stock exchange and publish the same in the manner
prescribed in clause 2.14.A.(5). The financial results shall be prepared as per the
accounting standards laid down by ICAI or as applicable to the issuer under relevant
statutes. The same shall be subjected to limited review by the statutory auditors of the
company (or in case of public sector undertakings, by any practicing Chartered
Accountant) and a copy of the limited review report prepared on the lines of the format
given in clause 2.14 shall be furnished to the stock exchange within two months from the
end of the half-year.
ii. In clause 2.14,(a) in Section A for item (1), the following items shall be substituted,
namely:
(1) The issuer agrees to furnish unaudited financial results on a quarterly basis in the pro
-forma given in Section B within one month from the end of quarter (quarter means 3
months only) to the Stock Exchange.
(1A) The same shall be subjected to limited review by the statutory auditors of the
company (or in case of public sector undertakings, by any practicing Chartered
Accountant) and a copy of the limited review report prepared on the lines of the format
given in Section BB shall be furnished to the stock exchange within two months from the
end of the quarter.
MRD/DoP/SE/Dep/Cir-36/04
Mandatory admission of debt instruments on both the Depositories
Please refer to SEBI circular No.D&CC/FITTC/CIR-13/2002 dated November 1,
2002 requiring, inter alia, that the issuer companies mandatorily admit their debt
instruments on both the depositories.
77
SEBI/CBM/BOND/2/2007/13/04
Amendments to the listing agreement for debentures
In order to facilitate development of a vibrant market in corporate debt instruments,
it has been decided to further amend the listing agreement for debentures issued by
circular No. SEBI/ CFD/ DIL/ CIR- 39 /2004/ 11/ 01 dated November 1, 2004 and
further amended by circular No. SEBI/ CFD/ DIL/ LA/ 1/ 2007/20/03 dated March
20, 2007, as follows:
1. In clause 1.4, for sub-clause (c), the following sub-clause shall be substituted, namely:
The issuer agrees to ensure that services of ECS (Electronic Clearing Service),
Direct Credit, RTGS (Real Time Gross Settlement) or NEFT (National
Electronic Funds Transfer) are used for payment of interest and redemption
amounts as per applicable norms of the Reserve Bank of India. In cases where
such facilities are not available, the issuer agrees to issue all interest warrants
and cheques for redemption money simultaneously, which shall be payable at
par at such centers as may be agreed between the exchange and the issuer. Such
centers will be disclosed to the debenture-holders. The amounts shall be
collectible at par, with collection charges, if any, being borne by the issuer, in
any bank within India even in centers other than the agreed centers. The
warrants or cheques shall be dispatched so as to reach the debenture-holders on
or before the date fixed for payment of interest on debentures or redemption
money, as the case may be.
2 In clause 1.6, after sub-clause (g), the following sub-clause shall be inserted,
namely:
The issuer agrees that no material modification shall be made to the structure
of the debenture in terms of coupon, conversion, redemption, or otherwise
without prior approval of the stock exchanges where the bond is listed.
The stock exchange shall also ensure that such information relating to
modification or proposed modification is disseminated on the exchange
website.
Applicability
The trading platforms may be used for executing all trades in listed debt securities issued
by all institutions such as Banks, Public Sector Undertakings, Municipal Corporations,
bodies corporate and companies.
Some Other Clauses
The prospectus for issue of debenture must contain the same particulars as are applicable
to a prospectus for issue of shares (Sec. 56 of the Companies Act). Where the prospectus
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states that an application has been made for permission for the debentures to be dealt in
any stock exchange, the company should secure such permission; otherwise the
provisions of Section 73 of the Companies Act would apply, as in the case of shares.
Allotment of shares/debentures without compliance of Section 73 would make the
allotment void.
Power to issue: Section 292 of the Companies Act vests in the Board the power to issue
debentures and the same can not be delegated. It has to be exercised by the Board by the
resolution passed at the meeting; the restrictions provided under Section 293 must be
noted while exercising the power provided under Section 292. Briefly stated, u/s 293
consent of the share holders by an ordinary resolution is required if it is proposed to sell,
lease or otherwise dispose of the whole or substantially the whole of the undertaking of
the company and also where the borrowings would exceed the aggregate of the paid up
capital of the company and its free reserves. Also, a general meeting is called to pass
necessary resolutions; if the issue would result in borrowings in excess of the limits fixed
by the Section 293(1)(d) of the Companies Act 1956, an ordinary resolution should be
passed; where the occasion demands issue to persons other than the existing members,
provisions of Section 81 should be complied and special resolution in terms of provisions
of the said section should be passed.
s
Prospectus: The provisions of Companies Act equally apply to issue of debentures and
therefore Public companies intending to issue debentures to the public must comply with
the various provisions of the Act, particularly Section 55 to 76; Section 2(36) of the Act
defines Prospectus to include debentures of a body corporate.
"Prospectus" means [any document described or issued as a prospectus and includes any]
notice, circular, advertisement or other document [inviting deposits from the public or]
inviting offers from the public for the subscription or purchase of any shares in, or
debentures of, a body corporate;
Allotment and issue of certificate of debentures: In this connection the requirements and
provisions of Section 75,132 and133 may be noted and complied with. The debenture
certificates are required to be sent within 3 months after the allotment; further the
certificate of charge given by the ROC must be endorsed on every certificate.
SEBI guidelines, Clarification iv, clarifies that FCDs/PCDs convertible within 18 months
are considered quasi-equity( Long term conversion after 18 months to raising deferred
equity) and therefore, they should be treated on par with equity. The promoters are
required to contribute to the equity to the extent of minimum specified percentage by way
of participation in FCDs/PCDs with the same conversion price as applicable to public. In
other words, the issue price for equity to be paid by the promoters shall be same as paid
by the debenture holders for equity on conversion.
If the debentures are to be issued with the option to convert them into shares, it should be
in accordance with Rule 3 of Public Companies(Terms of issue of debentures and raising
of loans with an option to convert such debentures or loans into shares) Rules, 1977.
79
Guidelines regarding floatation of bonds by public sector undertakings in the

telecommunication and Power sector issued vide Department of Economic Affairs,
Ministry Of Finance, and dated 06.09.1985
The scheme which applies to Government corporate bodies as may be specified in areas
of telecommunication and power and any other sector that government may notify is for
setting up of new projects, expansion, diversification of existing projects, normal capital
expenditure or for augmenting long term resources of the company for working capital
requirements. Till further notice, the maximum interest rate was fixed at 14% per annum,
period of redemption to be within 7 years but not later than 10 years. The bonds were
required to be listed and can be transferred by endorsement and delivery. There would be
no deduction of tax at source from the interest and the scheme carried other benefits like
exemption u/s 80L of the Income Tax Act, 1961, exemption from Wealth tax without any
limit. The bonds can be privately placed with the investment institutions with the
approval of the Ministry of Finance.
Guidelines for floatation of Public Sector Bonds vide Press Release dated 06.01.1992
issued by Ministry of Finance, Department of Economic Affairs, erstwhile office of
the CCI
The scheme is applicable to all Public Sector Enterprises (PSEs) whose equity share
capital is fully owned by the Central Government subject to the approval of DEA, bonds
can be issued by existing as well as new corporate undertakings including Finance
Corporations that may be set up in the specified sectors like Railways etc. Further for
approval of tax exemption, CBDT approval would be required and this should be
complied with before approaching the public for subscription. The objects of the issue
may be for setting up of new projects etc. as in the case if bonds for Telecommunication
and Power sector, quantum to be decided on a case by case basis, debt-equity ratio not
normally exceeding @ 4:1 and buy back arrangements up to Rs. 40,000 of the face value
of the bonds at the option of PSE after a lock-in period of 3 years from the date of
allotment of 9% bonds and one year in the case of taxable bonds. The bonds are to be
listed on the Stock Exchange. Tax free bonds are to carry interest at the rate of 9% per
annum. Tax benefits like exemption u/s 80L of the Income Tax Act, 1961, exemption
from Wealth Tax etc., would be available. PSEs may offer either a combination of both
types of bonds (taxable and tax-free bonds) with the approval of Ministry of Finance.
80
Private Placement of Securities

In Private Placement Market Financing, there will be no Prospectus but direct sale of
securities to a limited/selected number of investors.
While in the case of public issue, the minimum amount to be raised is Rs. 1.80 crore,
through private placement even small amounts say Rs. 50 lakh can be secured. The
private placement method also provides quick access to the capital market, while the
procedures involved in the case of a public issue usually takes 3-5 months time to
mobilize the funds.
Advantages
1. The company may be able to secure reduction of floatation costs. The placement fees are
generally considerably lower than the underwriters spread in a public issue.
2. Since there are no registration formalities with SEBI/ROC, etc. the decision to issue the
securities and receipt of funds is quicker, thus risk may be reduced.
3. In some cases, the companies making private placement do not wish to make public
certain key information.
4. While the issued terms may have to be standardized to be acceptable to a large number of
investors in the case of public issue, it is not so in the case of private placement.
Disadvantages
1. The cost of interest may be higher.
2. There will not be an established secondary market for it.
3. The financing institutions accommodating the private placement may drive a harder
bargain in terms of restrictions and protective covenants than the broader public market
may require.
4. It is always most difficult to go to the public market, the first time. The ground is not
cultivated to tap the public market.
5. The possibility of buying back the firms debt instrument at a discount in the open market
is foregone.
SEBI Guidelines regarding Private Placement

Private Placement may be divided into two categories as follows:
(i) One is in respect of friends, relatives and associates who are counted in the Promoters
quota; the minimum subscription by each of such person is rupees one lakh only. The
lock-in period of 5 years (from commencement of production or date of allotment,
whichever is later) is applicable.
(ii) In the second category, the subscription by collaborators and shareholders of promoters
companies are taken into account. In that case, the lock-in period is 3 years from the date
of commencement of the production or date of allotment whichever is later; no minimum
amount, however, is stipulated for this second category. The subscription made by them
would also not form part of the promoters quota, but would be in Preferential Allotment
Category.
To ensure substantial stake of promoters group, it has been prescribed that their
contribution should not be less than 25% of the total issued equity capital up to Rs. 100
81
crore. The promoters must bring their capital contribution in full, one day before opening
of the issue.
1.
2.
3.
4.
In the case of following types of companies private placement of promoters issue is not
allowed with unrelated investors (there is those who have sufficient intimate connection
between promoters/company and the investors in the categories of friends, relatives,
associated).
Issue by new companies.
Issue by new companies set up by existing companies with 5 years track record of
profitability.
Issue by existing private/closely held companies with 3 years track record of profitability.
Issue by existing listed companies.
Private Placement of Securities and Norms
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
The Institutional investors while sanctioning private placement, examine the following
norms/criteria:
Debt-Equity ratio: It relates all external debts to owners recorded claims. It is determined
to measure the firms obligations to creditors in relation to funds invested by owners.
Current ratio: It indicates working capital (the surplus of current assets over current
liabilities).
Interest Cover: This should be two times based on the latest balance sheet.
Profit before tax.
Net worth: The minimum should be Rs. 1 crore; if it is a listed company the stock price
should be above par for previous six months prior to the issue.
Percentage of unsecured deposits/borrowings.
Dividend record: The Company should have paid dividend for 3 or minimum 2 preceding
years.
No carry forward loss.
Asset cover or security cover: Minimum 1.25 times asset cover is preferred to be
maintained.
Clause applicable for private placement

3.1 The Issuer agrees unless the exchange otherwise agrees and the parties concerned
desire, to credit the demat account in such units of trading as may be specified by the
exchange subject to the same being in compliance with the instructions, if any issued by
SEBI in this regard
3.2 The issuer agrees:
That credit to demat account will be given within two working days from the date of
allotment
To pay interest as disclosed in the offer document and the application form
3.3 The issuer shall prepare its financial statements as per the accounting standards laid
down by ICAI or as applicable to the issuer under relevant statutes; and publish its half
82
yearly audited results preferably in the format mandated. The issuer further agrees to file
the same with the exchange.
3.4 The Issuer agrees to send the following to its debenture holders:
(a) Notice of all meetings of the relevant debenture holders specifically stating that the
provisions for appointment of proxy as mentioned in section 176 of the Companies Act,
1956 shall be applicable for such meeting.
(b) A half-yearly communication, counter signed by debenture trustees containing inter
alia following information:
i) Credit rating,
ii) Asset-cover available,
iii) Status of security
iv) Debt-Equity ratio
v) Previous due date for the payment of interest/principal and whether the same has been
paid or not
vi) Next due date for the payment of interest/principal and whether the same would be
paid or not
In addition to that, the aforesaid information of this sub-clause shall be made available to
public through any one of the following ways:
i) Hosting in the website of the issuer, if it has any
ii) Filing in SEBI EDIFAR, as and when mandated by SEBI
3.5 The issuer notes that Corporate Governance requirements of this agreement are
recommendatory and may be implemented as per discretion of the issuer. It agrees to
disclose adoption of the same, if any, in the Annual Report or such other document.
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The Indian Stamp Act, 1899 As Amended By the Finance Act, 2006
Bonds, debentures or other securities issued on loans under Act 11 of 1879:(1) Notwithstanding anything contained in this Act, any local authority raising a loan
under the provisions of the Local Authorities Loan Act, 1879, or of any other law for the
time being in force, by the issue of bonds, debentures or other securities, shall, in respect
of such loan, be chargeable with a duty of 2[one per centum] on the total amount of the
bonds, debentures or other securities issued by it, and such bonds, debentures or other
securities need not be stamped and shall not be chargeable with any further duty on
renewal, consolidation, subdivision or otherwise.
(2) The provisions of sub-section (1) exempting certain bonds, debentures or other
securities from being stamped and from being chargeable with certain further duty shall
apply to the bonds, debentures or other securities of all outstanding loans of the kind
mentioned therein, and all such bonds, debentures or other securities shall be valid,
whether the same are stamped or not.
Provided that nothing herein contained shall exempt the local authority which has issued
such bonds, debentures or other securities from the duty chargeable in respect thereof
prior to the twenty-sixth day of March, 1897, when such duty has not already been paid
or remitted by order issued by the 3[Central Government].
(3) In the case of willful neglect to pay the duty required by this section, the local
authority shall be liable to forfeit to the Government a sum equal to ten per centum upon
the amount of duty payable, and a like penalty for every month after the first month
during which the neglect continues.
Duties by whom payable.-In the absence of an agreement to the contrary, the expense of
providing the proper stamp shall be borne in the case of Bonds (No. 15 in Articles of
Schedule I) by the person drawing, making or executing this instrument.
Description of the instrument
(As specified in Schedule 1 to the Indian Stamp
Act,1899)
Debenture (whether a mortgage debenture or not), being a
marketable security transferable-
Proper Stamp-Duty
(a) by endorsement or by a separate instrument of transferWhere

Where
Where
Where
Where
Where
the amount or value does not exceed Rs. 10

it exceeds Rs. 10 and does not exceed Rs. 50
Ten paise
Twenty paise
Thirty five paise
Seventy five paise
One rupee ten paise
One rupee fifty paise
84
Where it exceeds Rs. 400 and does not exceed Rs. 500
And for every Rs. 500 or part thereof in excess of Rs. 1000
One rupee eighty five paise

Two rupees twenty five paise
Two rupees sixty paise
Three rupees
Three rupees forty paise
Three rupees seventy five paise
One rupee eighty five paise
(b) by deliveryWhere the amount or the value of the consideration for

such debenture as set forth therein does not exceed Rs. 50
Where it exceeds Rs. 50 but does not exceed Rs. 100
And for every Rs. 500 or part thereof in excess of Rs.1000
Thirty five paise

Seventy five paise
One rupee fifty paise
Two rupees twenty five paise
Three rupees
Four rupees fifty paise
Five rupees twenty five paise
Six rupees
Six rupees seventy five paise
Seven rupees fifty paise
ExplanationThe term Debenture includes any interest coupons attached thereto but the
amount of such coupons shall not be included in estimating the duty.
ExemptionA debenture issued by an incorporated company or other body corporate in terms of

a registered mortgage-deed, duly stamped in respect of the full amount of
debentures to be issued there under, whereby the company or body borrowings
makes over, in whole or in part, their property to trustees for the benefit of the
debenture holders, provided that the debentures so issued are expressed to be
issued in terms of the said mortgage-deed.
85
General Procedure Followed While Issuing Convertible Debenture

1. Purpose of issue
(a) Companies can issue debentures for any purpose.
(b) However, issue of debentures by a company for financing acquisition of shares or for
providing loan to any company belonging to the same group is not permitted.
(c) Issue of fully convertible debentures providing conversion within a period of 18 months
can be made for repayment of loan to or investment, in companies belonging to the same
group.
2. Issue of Fully Convertible debentures with a conversion period of more than

36 months
If the FCDs are proposed to be issued having a conversion period of more than 36
months, check that the conversion is made optional with put and call option.
3. Compulsory Credit Rating

(a) Check that the company has obtained credit rating from CRISIL or any other recognized
credit rating agency if conversion of FCDs is after 12 months or the maturity period of
NCDs/PCDs exceeds 12 months.
(b) Fresh credit rating would be required when debentures are sought to be rolled over.
4. Pre-determination of premium on conversion and time of conversion

Check that the premium on conversion of FCDs and PCDs and time of conversion, in
stages, if any, have been predetermined and stated in the prospectus.
5. Interest Rate
The interest rate on debentures is freely determinable.
6. Appointment of Debenture Trustees

(a) Check that the names of debenture trustees have been stated in the prospectus and the
Trust Deed has been executed within 6 months of the closure of the issue.
(b) The Trustees must be vested with the requisite powers of protecting the interest of
debenture holders including a right to appoint a nominee director in consultation with
institutional debenture holders.
(c) In the case of debentures with maturity period of 18 months or less, the appointment of
debenture trustees is not required.
86
7. Debenture Redemption Reserve
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
Creation of Debenture Redemption Reserve (DRR) is compulsory except for Debentures

with maturity period of 18 months or less. Creation of DRR is required to be done on the
following basis:
A moratorium up to the date of commercial production can be provided for creation of
DRR in respect of debentures raised for project finance.
The DRR may be created either in equal installments for the remaining period or higher
amounts if profits permit.
In the case of PCDs, DRR should be created in respect of non-convertible portion of
debenture issue on the same lines as applicable for fully non-convertible debenture issue.
In respect of Convertible issues by new companies, the creation of DRR should
commence from the year the company earns profits for the remaining life of the
debentures.
Companies may distribute dividends out of General Reserves in certain years if residual
profits after transfer to DRR are inadequate to distribute reasonable dividends.
DRR will be considered as part of General Reserve for consideration of bonus issue
proposals and for price fixation related to post tax returns.
In case of new companies, distribution of dividends shall require approval of debenture
trustee and the lead institution, if any.
Company must create DRR equivalent to 50% of debenture issue before debenture
redemption commences. Drawl from DRR is permissible only after 10% of debenture
liability has been actually redeemed by the company.
In the case of existing companies, prior permission of the lead institution for declaring
dividend exceeding 20% or as per the loan covenants is necessary if the company does
not comply with institutional condition regarding interest and debt service coverage ratio.
Company may redeem debentures in greater number of installments. The first installment
may start from 5th instead of 7th year.
8. Conversion Optional
Where the conversion of debentures (in part or whole) is to take place at or after 18
months from the date of allotment but before 36 months, check that such conversion has
been made optional at the hands of the debenture holder.
9. Disclosure of redemption amount, Period of maturity, Yield

Check that redemption amount, period of maturity, yield on redemption for the
PCDs/NCDs are indicated in the prospectus.
10. Discount on Non-convertible portion of PCD

Check that the discount on the non-convertible portions of PCDs in case they are traded
and procedure for their purchase on spot trading basis has been disclosed in the
prospectus.
87
11. Roll over of PCD/NCD

If the non-convertible portions of PCD/NCD are to be rolled over with or without change
in the interest rate, check that a compulsory option has been given to those debenture
holders who want to withdraw from and encash the debenture program. Roll over must be
done only in cases where the debenture holders have sent their positive consent and not
on the basis of non receipt of their negative reply.
Before roll over of any NCDs or non-convertible portion of the PCDs, fresh credit rating
must be obtained within a period of 6 months before roll over and fresh trust deed should
be made. There is, however, no need to create fresh security in the event of roll over of
the debentures, if the existing trust deed or the securities documents provide for
continuation of the security till redemption of the debentures.
Letter of information regarding roll over is required to be vetted by SEBI with regard to
credit rating, debenture holders resolution, option for conversion and such other items
which SEBI may describe from time to time.
The letter of option for roll over or conversion of debentures, value of which exceeds Rs.
50 Lakhs issued by a listed company, must be forwarded to SEBI for vetting through lead
manager or a merchant banker.
12. Other disclosures

The disclosures must include the existing and future equity and long term debt ratio,
servicing behavior on existing debentures, payment of due interest on due dates on term
loans and debentures and a certificate from a financial institution or bankers about their
no objection for a second or pari-passu charge being created in favor of the trustees to the
proposed debentures issue.
13. Creation of charge

Where the debentures have been issued having a maturity period not exceeding 18
months, it is not necessary to appoint a trustee. If the company proposes to create a
charge for such debentures, it must be filed with ROC. Where no charge is to be created,
the compliance of the provisions of Deposit Rules must be checked.
The proposal to create a charge or otherwise must be disclosed in the prospectus along
with its implications.
14. Monitoring
The lead institution/investment institution is required to monitor the progress in respect of
debentures for project finance/modernization/expansion/diversification/normal capital
expenditure. If debentures are for working capital funds, the lead bank should monitor.
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15. Certificate from Auditors

Institutional debenture holders and trustees should obtain from the auditors, a certificate
in respect of utilization of funds during the implementation period of the projects. In the
case of debentures for working capital, certificate should be obtained at the end of each
accounting year.
16. Pricing of conversion of FCDs/PCDs in respect of debentures issued in terms

of CCI (Controller of Capital Issues) consents
(a)
(b)
(c)
(d)
(e)
(f)
In case of FCDs/PCDs issued in the past, pursuant to CCI consent, where the conversion
was to be made at a price to be determined by the CCI at a later stage, the price and the
timing of conversion should be determined at the general meeting of the share holders
subject to:
the consent of the FCDs/PCDs holders for the conversion terms being obtained
individually;
conversion is given effect to, only if the concerned debenture holders send their positive
consent and not on the basis of non-receipt of their negative reply;
such holders of debentures, who do not give such consent, are invariable given the option
to get the debentures redeemed or repurchased by the company at a price, which shall not
be less than the face value of the debentures;
the draft of letter of option should contain justification for the conversion price and be
sent to SEBI for vetting;
where the consent from the CCI stipulates cap price of conversion of FCDs/PCDs, the
BODs may determine the price at which the debentures may be converted;
Where the consent from the CCI stipulates cap price of conversion of FCDs/PCDs and
the cap price has been disclosed to the investors before subscription is made, there is no
need to give option to debenture holders.
89
Essentials in case PFC goes for convertible debentures issue

1. Purpose of issue:- To augment long term resources of the Corporation
2. Credit ratings:- Placed at the highest safety ratings (AAA & LAAA
respectively) by accredited rating agencies in India - CRISIL and ICRA
3. Conversion Optional: - As the FCDs are proposed to be issued having a

conversion period of more than 36 months, it is compulsory that the conversion is
made optional with put and call option.
4. Appointment of Debenture Trustees: - As the issue is having maturity of

more than 18 months so the appointment of trustee is mandatory. PFC will need to
invite quotes for the same.
5. Debenture Redemption Reserve: - Company must create DRR equivalent to

50% of debenture issue before debenture redemption commences. Drawl from
DRR is permissible only after 10% of debenture liability has been actually
redeemed by the company.
6. Disclosure of redemption amount, Period of maturity, Yield: - These are

to be mentioned in the information memorandum.
7. Determination of Discount or premium and interest rate: - This will be

freely decided by the company at the time of issue.
8. Roll over: - Letter of information regarding roll over is required to be vetted by

SEBI with regard to credit rating, debenture holders resolution, option for
conversion and such other items which SEBI may describe from time to time.
9. Other disclosures: - All the disclosures and compliances that need to be

followed in the case of issue of shares are to be adhered to in the case of issue of
fully convertible debentures also.
10. Creation of charge: - As the debentures are proposed to be unsecured, there is

no need of creation of charges.
11. Monitoring: - Since the funds are raised to be invested in on-going/under

construction power project and its allied sector activities so the lead
institution/investment institution is required to monitor the progress.
12. Certificate from Auditors: - Institutional debenture holders and trustees

should obtain from the auditors, a certificate in respect of utilization of funds
during the implementation period of the projects.
90
Assumptions
1.
Modified data of PFC is used for the purpose of calculation and analysis.
2.
Bonds are taken as Zero Coupon Fully Convertible with a conversion period of
3
years.
3.
All the bond holders will opt to get their investment in FCDs converted into the
Equity shares of the company after 3 years.
4.
Entire cash inflows have been assumed to be reinvested in Power Projects.
5.
Keeping into account the CAGR of the past 5 years
Disbursements have been increased by 18%

Borrowings have been increased by 22%
Profit After Tax has been increased by 20% assuming that power sector will
grow at a rate higher than 20% (Based on annual report of MoP 2007-08 )
Funds required to be raised is 115% of the Shortfall to include a buffer of 15%
Recovery Rate is taken as 95% (Based on the realization rate)
Average recovery period is taken as 5 years.
6.
It is assumed that the issue is privately placed and after the conversion, the
equity shares will be held by private investors.
7.
To discount the cash flows from investment of the raised amount in power
projects, discounting factor is taken as 11.1%.
8.
Dividend rate is taken as 35% of Profit after Tax (based on current dividend
distribution trend) and for long term it is averaged at 37%.
9.
Various possibilities have been taken with different
Issue amounts as Rs. 1000 crs, Rs. 1500 crs and Rs. 2000 crs
Conversion Price as Rs. 200, Rs. 250 and Rs. 400
Rate of Discount given at the time of issue of FCDs as 6.5%, 7%, 7.5% and
8%
Rate of Return from investing in Power Projects as 10%, 10.5% and 11.0%
10. The amount of repayment by PFC to its lenders has been taken from the audited
balance sheet of the company for the year 2007-08.
91
Analysis
1. If the bonds are issued in the year 2008-09, then their maturity will fall in the year
2011-12 which will increase the amount of Issued Share Capital by the Issue Amount
which would still be safely less than the Authorized Share Capital of the company.
2. Analyzing the actual percentage increase in the amount of Borrowings &
Disbursements for the past five years, further percentage increase in the amount of
borrowings & disbursements has been extrapolated as 22% and 18% respectively.
3. As the Realization Rate for the company is around 99% for the past 5 years, the
amount that is recovered from its borrowers (Recovery) has been taken at a more
conservative rate of 95%.
4. The company can not afford to raise only the amount of Shortfall. It has to take into
account certain amount for any emergent contingency. So to guard against any
eventuality, the amount of Funds to be raised has been taken as 115% of the amount
of Shortfall to keep a cushion of 15% over and above the amount of Shortfall.
5. As the country needs various infrastructural inputs for its economic development and
the vast Indian Power Sector today offers one of the highest growth opportunities for power
financing companies, hence the increase in the Profit after Tax of the company has been
projected at 20%. This is also supported by the estimation of the Ministry of Power.
6. Debt-Equity Ratio: If the company does not issue Convertible bonds then the Debt-Equity
ratio of the company will violate the limits of the financial covenants (which is 6:1 as
agreed to by PFC and lenders of PFC) in the year 2011-12 but if these Convertible
bonds are issued then Debt-Equity Ratio will safely be in limits even if an amount of
mere Rs. 1000 crs is issued as FCDs. It should also be noted that with an increase in
Issue Size, say from Rs. 1000 crs to Rs. 2000 crs, the Debt-Equity ratio comes in
safer limits with Debt-Equity ratio being 5.91 when the issue size is Rs. 1000 crs;
5.72 when the issue size is Rs. 1500 crs; and 5.54 when the issue size is Rs.2000 crs.
7. Dilution of ownership: The government is generally reluctant to forgo its control over
Public Sector Undertakings by even a small percentage. But it should also be seen
that with a dilution of mere 2-7% a huge amount of Rs. 1000-2000 crs can be easily
mobilized. For example, if the company wants to mobilize Rs. 1000 crs and three
possibilities of Conversion Price as Rs. 200, Rs. 250 and Rs. 400(considering
Pessimistic, Most Likely and Optimistic conditions of the market) are taken then just
by diluting only 1.9% to 3.7% of the Govt. ownership, the company can obtain Rs.
1000 crs; and if it wants to mobilize Rs. 2000 crs taking Conversion Price as Rs. 200,
Rs. 250 and Rs.400 then by diluting only 3.7% to 7.1% of the govt. ownership, the
company can mobilize Rs. 2000 crs easily.
92
8. If the company wants to enjoy Positive NPV by investing the issue amount in power
projects for 3 years then the rate of return on the power projects should be at least 1010.5% to make the investment worth it.
9. It can also be observed that keeping the Rate of dividend distribution constant, with
an increase in the Conversion Price from Rs. 200 to Rs. 400, the amount of Dividend
paid goes on decreasing.
10. By issuing Convertible bonds the company can reap the benefits of tax deduction
available on the interest payment on these bonds for the initial 3 years. Also at the
time of conversion it can balance its Debt-Equity ratio by shifting its debt into equity
and can avoid breaching the limits of financial covenants.
93
Recommendations
1. The corporation may go for issue of Fully Convertible Bonds to contain its DebtEquity ratio within the specified financial covenants. Moreover, issuing bonds with a
conversion option becomes a cheaper source of finance as the interest rate offered is
quite below the normal rates in markets. Also, the company can take the tax
advantage on interest paid for the years before conversion and can opt not to
distribute dividends, if needed after conversion.
2. If the company opts for issuing FCDs in present scenario where the stock markets
have taken a downturn then the company is obliged to fix a lower Conversion price
which would decrease the amount of Share Premium and increase the number of
shares required to be issued per bond, hence the company may go for the issue at a
time when markets are at boom to get a higher premium per share.
3. If the company wants to avoid a situation in which it has to convert these bonds into
shares at a time when the market price of its shares is very high than the conversion
price then it may incorporate an option of Forced conversion by fixing a Strike Price.
Strike price is a price, which when breached by certain percentage, gives the right of
conversion forcefully to the issuing organization even before the conversion period.
4. The corporation may opt for leaving the decision of fixing of conversion price for a
later date like 6 months prior the conversion period. This will give a fair idea of
market price of equity shares, to the management, at the time of conversion.
5. If the Government does not want to dilute its ownership in PFC then a major portion
of the bond issue may be subscribed by the Government in the name of President of
India.
94
References
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Summer Internship Report

Exploring opportunities in Resource

POWER FINANCE CORPORATION LTD.,

Mr. Milind M. Dafade

Jagan Institute Of Management Studies

7.3 Guidelines for the OCTEI Issues..69

Jagan Institute of Management Studies, New Delhi.

Summer Project Certificate

Jagan Institute of Management Studies, New Delhi.

Jagan Institute of Management Studies, New Delhi.

Jagan Institute of Management Studies, New Delhi.

Indian Power Sector

Jagan Institute of Management Studies, New Delhi.

Usually energy, especially electricity, has a major contribution in speeding up the

Installed Generation Capacities

Jagan Institute of Management Studies, New Delhi.

Total installed capacity is 141,500 MW

Structural and regulatory reform conducive to PSP

Opportunities of growth in the Indian power sector

Jagan Institute of Management Studies, New Delhi.

Growth Blue-print of Ministry of Power:

An investment requirement of US$ 90 billion in transmission and distribution of which

Ultra Mega Power Projects by Government of India

up power generation capacity at rapid speed

Transmission: Policy Initiatives

Policy was issued on 13th April, 2006.

Jagan Institute of Management Studies, New Delhi.

High Voltage Transmission Capacity:

Jagan Institute of Management Studies, New Delhi.

Private investment in Power sector

Post Electricity Act 2003, private sector interest has revived.

Highlights of performance of Power sector in 2007

9050 MW (5093 MW)

Note: Figures in brackets pertain to year 2006

Jagan Institute of Management Studies, New Delhi.

Highlights of the XIth Five Year Plan

Total Installed Capacity:

Jagan Institute of Management Studies, New Delhi.

Power Situation: (April 2007-February 2008) (Provisional)

Jagan Institute of Management Studies, New Delhi.

Demand side Management

Encourage Non-conventional energy usage,

There is a need to boost:

Supply side Management

Peak Power development through Hydro

Required investment in the Indian Power Sector (Next 3 to 5 years)

Areas for investment

Power Finance Corporation

Jagan Institute of Management Studies, New Delhi.

Placed at Sovereign Rating by International Rating Agencies - Moodys and

Jagan Institute of Management Studies, New Delhi.

To act as catalyst to bring institutional, managerial, operational and financial

Jagan Institute of Management Studies, New Delhi.

Rupee Term Loan

Jagan Institute of Management Studies, New Delhi.

State Electricity Boards

Jagan Institute of Management Studies, New Delhi.

Reforms & Restructuring Initiatives

PFC is providing financial assistance to reform-minded States under relaxed

PFC has decided to provide technical/financial assistance to State Govts. / Power

Jagan Institute of Management Studies, New Delhi.

Major Projects Funded by PFC:

Jagan Institute of Management Studies, New Delhi.

Rs. 1,206.76 Crores