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Recent Trends in Financial Innovation towards Nurturing the Growth of Capital Markets in Indian Corporate

INTRODUCTION Financial innovation has been a continuous and integral part of growth of the capital markets. Greater freedom and flexibility have enabled companies to reinvent and innovate financial instruments. Many factors such as increased interest rate, volatility, frequency of tax and regulatory changes etc. have stimulated the process of financial innovation. The deregulation of financial service industry and increased competition within investment banking also led to increased activities to design new products, develop better processes, and implement more effective solution for increasingly complex financial problems. Financial instrument is a combination of characteristics such as promised yield liquidity, maturity, security and risk. The process of financial innovation involves creating new instruments and technique by unpackaging and rebinding the same characteristics in different fashion to suit the constantly changing needs of the issuers and the investors. t times it leads to introduction of revolutionary new products such as swap, mortgage, and !ero coupon bonds to finance leveraged buyouts. "ome times it involves the piecing together of existing products and process to fit in a particular set of circumstances. Many companies consider the types of securities #debt and equity$, and a handful of simple financial institutions #banks or exchanges$. %owever, there is a range of financial products, types of financial institutions and a variety of processes that these institutions employ to do business. &Financial innovation& is the act of creating and populari!ing new financial instruments as well as new financial technologies, institutions and markets. The 'innovations' are classified into (. )roduct innovation* The product innovations may be represented by new derivative contracts, new corporate securities or new forms of investment products. +. )rocess innovation* The process improvements can be represented by new means of distributing securities, processing transactions, or pricing transactions. ,n terms of financial innovations, securities innovations include instruments such as debt, preferred stock, convertible securities, and common equities. They help in reallocating risk, increasing liquidity, reducing agency costs, transactions costs, taxes and sometimes circumventing regulatory constraints. F-./T,0." 0F F,. ./, 1 ,..02 T,0." The financial innovations help in moving funds across time and space3 pooling of funds3 managing or reallocating risk3 extracting information to support decision*making3 addressing asymmetric information problems3

facilitating the sale or purchase of goods and services through a payment system3 reducing agency cost, and enhancing liquidity

,..02 T,0." ,. F,. ./, 1 )405-/T" fter the liberali!ation measures were announced in (66(, ,ndian /ompany under took issuance of new instruments seriously in order to attract large section of investors. 7ssar "teel used convertible debentures with warrants and loyalty coupons, Tata ,ron and "teel /ompany 1imited issued secured )remium .otes with warrants, Flex ,ndustries issued partly convertible debentures and non convertible debentures with warrant attached to each instrument 51F aments issued multiple option bonds, 7ssar oil issued optionally fully convertible debentures and 4eliance )etroleum issued triple option convertible with equity warrant and 7sab ,ndia issued partly convertible debenture. This burst of innovation has seen a typical shift in the design and development of new instrument. The classic conversion is that of debt in to equity. 0ffering the investor the option of conversion keeps the cost of his convertible debt lower than straight debt, thus minimi!ing the cash out flows during the gestation period. 0nce the pro8ect yields steady profits, the equity conversion results in a relatively* expensive dilution. The use of fectures like warrants makes the equity and convertible less expensive for the investor. ,t creates possibilities for their full subscription by the investors and also turns out to be cheaper for the issuing company. The worldwide financial industry is filled with innovative product design. .ew financial products become popular because people find them useful. .ew products like index funds, index futures, index options, etc., became internationally successful because they fulfil basic economic ob8ectives of people in the economy. The relationship between the underlying spot market, index funds, index futures and index options9 are explained as follows9 The prerequisites for an index fund are program trading facilities and an index where all components are liquid and convenient to trade. ,ndex funds fulfilling these conditions have now come to exist in ,ndia. ,ndex funds make it possible for people to sell options on the index while being covered this could happen on exchanges which trade index options or over the counter. ,ndex futures make the implementation of index funds easier. ,ndex funds generate an order flow for index futures markets, and help make them more liquid. ,ndex futures markets enable index options markets. ccess to index futures and index options make index funds more attractive, since users can couple their investments in index funds with risk management using the futures and options. ,ndex options make possible innovative new products like &guaranteed return funds&.

Technolog Driven Financial Innovations

dvancements in ,nformation Technology have facilitated a number of innovations, such as new methods of underwriting securities assembling portfolios of stocks new markets for securities new means of executing security transactions

.ew intellectual technologies, such as derivative pricing models, are credited with stimulating the growth and populari!ation of a variety of new contracts. Many new forms of derivatives have been made possible because business people could have some confidence in the methods of pricing and hedging the risks of these new contracts. 2arious forms of innovations such as new risk management systems and measures, on*line retirement planning services and new valuation techniques were clearly facilitated by both intellectual and information technology innovations. C!"##IFIC"TION OF FIN"NCI"! $RODUCT# The classification of the Financial )roducts is illustrated as below9 #l%No $roduct ( + ; )ayment products Trade finance /ommercial lending &le'ents 4etail, corporate and trade*related products, and financial:securities products. bills of exchange, collection bills, letters of credit, factoring, forfeiting, performance:bank guarantee, and export and import bills overdrafts, cash*credits, open loans, goods loans, hypothecation of stock*in*trade facilities, medium*term loans, syndicated loans, financial guarantees, acceptance instruments, etc commercial and real*estate finance, pro8ect and start*up finance or equity loans, buy*outs of management or leveraged buy*outs, subordinated debts, etc. pro8ect loans or long*term acceptance bills, leasing and hire purchases


"tructured finance

= > ? @

7quipment finance

Money market products certificate of deposits, commercial paper, treasury receipts:bills and repurchase agreements and also, money market mutual fund units /apital market products bonds and debentures, government bonds:gilt*edged securities, equities of all types, including preference and ordinary 5erivative 4isk products products Aforeign exchange forward covers, rate agreements, financial futures, Managementswap and options personal loans, housing loans, car loans, hire*purchase and lease arrangements, mutual and pension*related funds and /redit:debit cards: other types of cards both local and ethnic financial products such as chit funds and benefit funds .ational "aving schemes

/onsumer products

,ndigenous products )ostal products

"ome of the innovative financial instruments used by the companies in the ,ndian Financial Market are explained as follows9 ($ T4,)17 0)T,0. /0.274T,B17 57B7.T-47" #T0/5$9 First ,ssued by 4eliance )ower 1imited with an issue si!e of 4s. +,(?+ /r. There was no outflow of interest for first five years. 7quity increase was in phases. .o put option to investors and no takeover threat. 4educed dependence on the financial institutions. The expenses for floating the issue was 8ust +.>+C of the issue si!e which was very less when compared to the (D*(+C for a general public issue.


577) 5,"/0-.T B0.5"9 The investor got a tax advantage and could eliminate the re*investment risk. From the issuer&s point of view also, the issue cost was saved as it involved no immediate service cost and lower effective cost. The refinancing risk was also eliminated.


F10 T,.G 4 T7 .0T7"9 First issued by Tata "ons with a floor rate of (+.=C and a cap of (=.=C and a reference rate of ;>< T*Bill yield, which was 6.@=C at the time of issue. The investors would get a minimum return of the floor rate and the maximum return was the cap rate. They would get higher than floor rate depending upon the fluctuations in the reference rate.


E740 /0-)0. B0.5"9 ,t did not involve any annual interest on the bonds. But it had a higher maturity value on the initial investment for a particular time period. .5 E740 /0-)0. /0.274T,B17 B0.5"9



"imilar to the !ero coupon bonds except that the effective interest was lower because of the convertibility.


"7/-475 )47M,-M .0T7" #")."$9 First issued by T,"/0 in Fuly, (66+. These financial instruments were secured against the assets of the company but the investors had to pay a premium over the market price for these types of instruments.


7G-,TH I,T% 5,FF747.T, 1 20T,.G 4,G%T"9

,ssued by Tata Motors, in which the shares were classified as '0rdinary "hares' and ' 0rdinary "hares'. The ordinary shares were issued at 4s. ;<D per share, had a voting right of one vote per share.

0n the other hand, the ordinary shares were issued at 4s. ;D= per share but the voting rights were limited to one vote for every (D shares. ,n addition, they were paid extra dividend of five percentage points.