Long Term Funds

LONG TERM FUNDS

GLOBAL COST AND AVAILABILITY OF CAPITAL • Global integration of capital markets has given many firms access to new and cheaper sources of funds beyond those available in their home markets. • These firms can accept more long-term projects and invest more in capital in improvements and expansion. • If a firm is located in a country with illiquid and / or segmented capital markets, it can achieve this lower global cost and greater availability of capital by properly designed and implemented strategy.

Dimensions of the Cost and Availability of Capital Strategy Local Market access

Global Market access

Firm-specific Characteristics Firm`s securities appeal only to domestic investors

Firm`s securities appeal to international portfolio investors

Market Liquidity for Firm`s Securities

Illiquid domestic securities market and limited international liquidity

Highly liquid domestic securities market and broad international participation

Effect of Market segmentation on Firm`s Securities and Cost of Capital Segmented domestic securities market that prices shares according to domestic standards

Access to global securities market that prices shares according to international standards

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A firm that must source its long-term debt and equity in a highly illiquid domestic securities market will probably have :

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a relatively high cost of capital and will face limited availability of such capital , which in turn will lower its competitiveness both internationally and vis a vis foreign firms entering its home market . This category of firms include both : firms resident in emerging countries , where the capital mkt remains undeveloped and firms too small to gain access to their own national securities market. Many family-owned firms find themselves in this category because they choose not to utilize securities market to source their long – term capital needs.

• Firms resident in industrial countries with small capital market often source their long-term debt and equity at home in these partially liquid domestic securities market. • The firm` cost and availability of capital is better than that of firms in countries with illiquid capital mkt. • However if these firms can tap the highly liquid global market , they can also strengthen their competitive advantage in sourcing capital.

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Firms resident in countries with segmented capital markets must devise a strategy to escape dependence on that market for their long-term debt and equity needs. A national capital mkt is segmented if the required rate of return on securities in that market differs from the required rate of return on securities of comparable expected return and risk traded on other securities market. Capital market become segmented because of factors such as: excessive regulatory control ; perceived political risk ; anticipated foreign exchange risk; lack of transparency; asymmetric availability of information , cronyism ; insider trading ; corporate governance differences and many other market imperfections.

Firms constrained by any of these conditions must develop a strategy to escape their own limited capital market and source some of their long-term capital abroad.

MNE s have a higher or Lower WACC than their Domestic Counterparts? • The cost of equity required by investors is higher for multinational firms than for domestic firms. Possible explanations are: higher level of political risk, foreign exchange risk and higher agency costs of doing business in a multinational managerial environment . • However, at relatively high levels of the optimal capital budget , the MNE would have a lower cost of capital.

SOURCING EQUITY GLOBALLY •

Indian companies are allowed to raise equity capital in the international mkt through the issue of GDR/ADR/Foreign Currency Convertible Bond [ FCCB].

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These are not subject to any ceilings on investment an applicant company seeking govt`s approval in this regard should have a consistent track record for good performance for a minimum period of 3 years.

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This condition can be relaxed for infrastructure projects such as power generation , telecommunication , petroleum exploration and refining , ports airports and roads.

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There is no restriction on the number of GDR/ADR/FCCB to be floated by a company or a group of companies in a financial year.

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There is no end-use of GDR/ADR issue proceeds include: financing capital goods import ; capital expenditure ; pre-payment or scheduled repayment of earlier ECB; approved investments abroad; equity investment in JVs ; 25% of the proceeds can be used for general corporate restructuring and working capital requirements and ban on investment in real estate and stock markets.

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The FCCB issue proceeds need to conform to external commercial borrowing end-use requirements.

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Two-way fungibility of ADR/GDR is allowed by RBI

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Allowed to invest 100% of the proceeds of ADR/GDR issues for the acquisitions of foreign companies and direct investment in joint ventures and wholly-owned subsidiaries overseas.

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Permission to retain ADR/GDR proceeds abroad for future foreign exchange requirements.

ADR’s Vs GDR’s • • • •

ADR Traded in American stock exchanges Mostly in NYSE, AMEX and NASDAQ Traded in US Dollars Issuance of ADR’s is relatively more difficult because of more stringent US GAAP disclosure norms. Thus issuing ADR’s is more expensive and time consuming than GDR’s

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GDR Traded in European stock exchanges London and Luxemburg Traded in Euros or US Dollars GDR’s follow European IAS ( International Accounting Standards) which have less stringent norms

Salient Characteristics of ADR’s and GDR’s • DR Ratio is the number of ordinary domestic shares underlying each DR • A company may list DR’s without listing its shares in the domestic market • DR’s too have a Face Value( in USD / Euro) • DR holders enjoy the same rights as the ordinary domestic shareholders.

Benefits To The Company Issuing DR’s • Adds considerable credibility to the company • Helps diversify investor base • Offers new avenues for raising capital at competitive rates • M&A currency: companies use ADR’s and GDR’s to swap stocks during mergers and acquisitions. Without them international mergers and acquisitions would be a much costlier affair

How ADR’s and GDR’s Work Indian Company Foreign Bank Indian Shareholders

Custodian Bank

Depository

Arbitrage

Foreign Shareholders or DR Holders

DEFINITION OF ECB External Commercial Borrowings (ECB) are defined to include : commercial bank loans, buyer’s credit, supplier’s credit, securitized instruments such as floating rate notes, fixed rate bonds etc., • credit from official export credit agencies, • commercial borrowings from the private sector window of multilateral financial institutions such as IFC, ADB, AFIC, CDC etc. and • Investment by Foreign Institutional Investors (FIIs) in dedicated debt funds • • • •

ECB

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The policy also seeks to give greater priority for projects in the infrastructure and core sectors such as : Power, Oil Exploration, Telecom, Railways, Roads & Bridges, Ports, Industrial Parks and Urban Infrastructure etc. and the export sector

TYPES OF EBC ECB can be accessed under two routes: (i) Automatic Route: ECB under Automatic Route do not require approval of Government of India / RBI. (ii) Approval Route: ECB under approval route requires approval by the government.

AVERAGE MATURITIES FOR ECB Time in Years

ECB

Sectors Permitted

Min average maturity of 3 yrs

Equal to or less All Sectors than 20 million Except 100% USD EOU’s

Min average maturity of 5 yrs

Greater than All Sectors USD 20 million Except 100% EOU’s

Min average maturity of 3 yrs

Any amount

100% EOU’s

END-USE REQUIREMENTS (A)External commercial loans are to be utilised for import of capital goods and services and for project reletated expenditure in all sectors subject to following conditions : (a) ECB raised for project-related rupee expenditure must be brought into the country immediately. (b) ECB raised for import of capital goods and services should be utilised at the earliest and corporate should strictly comply with RBI's extant guidelines on parking ECBs outside till actual imports.

END-USE REQUIREMENTS (B) Corporate borrowers will be permitted to raise ECB to acquire ships / vessels from Indian shipyards. (C) Under no circumstances, ECB proceeds will be utilised for ( i) Investment in stock market; and (ii) Speculation in real estate.

INTERNATIONAL DEBT MARKET

INTERNATIONAL DEBT MARKET Bank Loans and Syndications (floating rate , short to medium term)

Euro note Market (floating rate , short to medium term)

International Bank Loans Eurocredits Syndicated Credits Euro notes Facilities Euro Commercial Paper [ECP] Euro Medium term Notes [EMTNs]

International Bond Market (fixed & floating rate , medium to long term)

Eurobond Foreign Bonds

Bank Loans and Syndications International Bank Loans • Traditionally sourced in the Eurocurrency market . • The key factor attracting both depositors and borrowers is the narrow interest rate spread within the market. • The difference between deposit and loan rates is often less than 1%. EuroCredits : • These are bank loans to MNEs , sovereign govt , international institutions and bank denominated in Eurocurrencies and • extended by banks in countries other than the country in whose currency the loan is denominated .

Syndicated Credits • The syndication of loans has enabled banks to spread the risk of very large loans among a number of banks. • Syndication is particularly important because many large MNEs need credit in excess of a single bank's loan limit. • Lead bank - participating banks - underwriters

Euro Note Market Euro Note facilities : • this includes issuance of short term , negotiable promissory notes and revolving underwriting facilities. • these are provided by international investment and commercial banks. • these are cheaper source of short term funds than syndicated loans , because the notes were placed directly with the investor public and the securitized and underwritten form allowed the ready establishment of liquid secondary markets. Euro Commercial Paper [ECP] : • short – term obligation of a corporation with maturity of 1, 3, 6 months.

• Euro Medium term Notes [EMTNs]: these bridge the gap between the ECP and long-term and less flexible international bonds. Similarity with Bonds: • Their basic characteristics are similar to that of bonds . maturity period from 9 months to a maximum of 10 years. • Coupons are paid semi-annually and the rate are comparable to the bond issues. Difference with Bonds: • Allows continuous issuance over a period of time , unlike bond issue , which essentially is sold all at once. • As EMTNs are sold continuously , in order to make debt service manageable , coupons are paid on set calendar dates regardless of the date of issuance. • EMTNs are issued in relatively small denominations from $2 million , making medium –term debt acquisition much more flexible than the large minimum customarily needed in the international bond market.

International Bond Market

II BOND MARKET A bond is a debt security issued by the borrower , purchased by the investor , usually through the intermediation of a group of underwriters.

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Straight Bond a fixed maturity period , a fixed coupon which has a fixed periodic payment usually expressed as percentage of the face or par value.

• Callable Bond This can be redeemed by the issuer , at the issuer’s choice , prior to maturity. Puttable Bond • It allows the investor to sell it back to the issuer prior to maturity, at investor’s discretion, after a certain number of years from the issue date . • The investor pays for this privilege in the form of the lower yield.

Sinking Fund Bond • It is a device , often used by small risky companies to assure the investors that they will get their money back. • Instead of redeeming the entire issue at maturity , the issuer would redeem a fraction of the issue each year so that only a small amount remains to be redeemed at maturity. Floating Rate Note • It is a bond with varying coupon . • Periodically the interest rate payable for the next six months is set with reference to a market index such as Libor. Zero coupon Bond • The bond is purchased at a substantial discount from the face value and redeemed at the face value on maturity. • There is no interim interest payment .

Convertible Bonds The bonds that can be exchanged for equity shares of the issuing company. Foreign Bonds Is issued by a foreign borrower to the investors in a national capital market and denominated in that nation’s currency. E.g. a German MNC issuing dollar denominated bonds to the US investors .

Global Bond A bond denominated in a particular currency but sold to investors in national capital market other than the country that issued the denominating currency. E.g. a Dutch company issuing dollar denominated bonds to investors in U.K. , Switzerland, Japan . Bearer Bond Possession is the evidence of ownership. Registered Bonds The owner’s name is on the bond and it is also recorded by the issuer.

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