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Vivek Shah* and Padma Srinivasan** In layman’s terms, financial engineering is an engineering discipline which deals with the creation of new and improved financial products through innovative design or repackaging of existing financial instruments. Financially, engineered products like American Depository Receipt (ADR) and Global Depository Receipt (GDR) have provided Indian companies access to international financial markets to raise funds. However, financial engineering is considered as being responsible for triggering the global financial crisis by increasing leverage and price risks. The regulatory framework is not the only solution to deal with the negative side of financial engineering, the informed market that responds sensibly to financial innovations (which is the current need) is also responsible. This paper looks into how fund raising by innovative financial instruments impacts the share price of the company using the cases of the Indian corporate houses.
Financial engineering involves the design, the development and the implementation of innovative financial instruments and processes, and the formulation of creative solutions to problems in finance. – John Finnerty Financial engineering is all pervasive. Its presence spans across areas like design of innovative financial instruments, financing Mergers & Acquisition (M&A) deals, corporate restructuring, derivative trading strategies, etc. Financial engineering and innovations are seen in bonds, equity, derivatives and in fields like mergers, acquisitions and corporate restructuring.1 Some of the innovations in the Indian financial market are debt-oriented schemes of mutual funds, interest rate futures, interest rate swaps, currency swaps, floating rate bonds, money market mutual funds, etc.
* Student, IBS, Bangalore, India. E-mail: firstname.lastname@example.org ** Faculty, IBS, Bangalore, India. E-mail: email@example.com
www.icwai.org/.../ICWAI%20Magazine%20Page%2036%20To%2040.pdf The IUP Journal of Risk & Insurance, Vol. VII, Nos. 1 & 2, 2010
© 2010 IUP. All Rights Reserved. 50
– Launch of debt oriented schemes of mutual funds to get tax advantage.000 cr from State Bank of India (SBI). The process included: • A classification of financially engineered products in terms of financially engineered equity. and • To study the role of financial engineering in global financial crisis.Some of the examples can give a glimpse of financial engineering and its application: • Product Level (Financial instruments) – Launch of stock index futures to protect against rising volatility of equity. – Vijay Mallya securitized “Kingfisher Airlines” brand to raise Rs. and – Tata’s Differential Voting Right (DVR) Issue—the first of its kind in India.. debt. mutual funds. • To find out the development in engineering part of different asset classes like equity. Objectives The main objectives of this paper are: • To identify the process of financial engineering. debt. Research Methodology The methodology is based on the empirical research using BSE 200 companies for two years during 2007-09. • To find out the rationale behind application of financial engineering. hybrid instruments and financially engineered mutual funds. where the Indian economy went through a multidimensional paradigm shift. and – Launch of Forward Rate Agreement (FRA) to hedge interest rate volatility. • To study developments in Indian Financial market like launch of interest rate futures. National Stock Exchange (NSE) and company websites have been used here. 2. • To find out the role played by investment banks and stock exchanges in financial engineering. – Tata-Tetley Leveraged Buyout. Only secondary data based on Bombay Stock Exchange (BSE). Financial Engineering is basically intended to split risk and return components of financial product/instruments and offering the combination which is best-suited to investor’s risk-return profile. • Company Level (Corporate finance) – Mahindra-Satyam merger deal and Tata-Corus deal financed by Special Purpose Vehicle (SPV). etc. The scope of the study is limited to financial engineering in asset classes and developments in Indian Financial market (in terms of innovation). Financial Engineering and Innovation as Risk Management Tools: The Case of Indian Companies During Global Financial Crisis 51 .
Innovations like technology are vulnerable to obsolescence. Besides. 52 The IUP Journal of Risk & Insurance.). Process of Financial Engineering and Creation of Innovative Financial Instruments This is the general procedure followed by financial engineers while developing new financial instruments. Review of Literature Financial innovations play an important role in increasing cost-efficiency by reducing transaction costs. mutual funds managers developed debtoriented mutual fund schemes by introducing variations in mutual fund schemes. individual investors wanted to reduce their tax liability. These factors also contributed to financial crisis. For example. 1 & 2. For example. credit default swaps and collateralized mortgage obligations with global financial crisis. VII. For this. Mauri and Conti (2007) have found that corporate financial risk management has been practiced by banks and companies alike by using financial engineering products like that of derivatives and the accounting and regulatory framework are also being redone. But does it hold true? Financial engineering alone is not responsible for whatever has happened.• To apply latest corporate fund raising issues to its source (like ADR. which cater to the requirements of institutional clients. derivative product pricing is a very complex process. There are some other reasons like ignorance among investors. Such financial engineers work at investment banks. Cole et al. This kind of model helps to price the complex financial products (Figure 1). Lo (2009) also feels that financial engineering may provide the appropriate expertise to handle all the regulatory reforms during the financial crisis of 2007-08. 2010 . Black. etc. some investor might want to increase his exposure to a particular sector like the real estate sector. Nos. GDR. Similarly. the by-products of financial engineering like securitization. counterparty credit risk. computer programs and mathematical algorithms are used to price some of the highly complex financial products. Identification of need involves the objective which the investor wants to achieve through financially engineered products. were blamed for the present economic turmoil and global financial crisis. liquidity risk and regulatory failings. and • To study the interrelations between securitization. This study is based on secondary data and financial engineering field is related to innovation. pricing of the product has assumed more importance. • To study patterns of corporate financing pre and post-liberalization. To help achieve this objective. he can invest in infrastructure funds introduced by mutual fund managers. However. Collateralized Debt Obligations (CDOs) and Collateralized Mortgage Obligations (CMOs). (2009) opine that financial engineering provides potential in reducing consumption fluctuations and lower adoption of risk management technology during select seasons. Among all these steps. Scholes and Merton have formulated option pricing model for which they were awarded Nobel Prize. Vol. So.
To earn low risk. preferred stock. high return pay off profile. However. equity offers high return at high risk. debt. it is applied to trading mechanism like screen-based trading. That is exactly what is done by financially engineered products.Figure 1: Financial Engineering and Innovation Processs Identification of Need Initial Sketch of Product Complex Model Building Exercise Pricing of the Product Perfect Product on the Basis of Simulation Exercise Testing of the Product Restructuring of the Product Test Marketing Launching of the Product Financial engineering is applied to asset classes like equity. but are offered compensation in terms of issue of shares at discount or higher dividend on share. Figure 2: Financially Engineered Products Equity Financially Engineered Products Debt Pay-Off: Low Risk Low Return Pay-Off: High Risk High Return Financial Engineering in Equity Non-Voting Shares The holders of such shares do not have any voting right in the company. This kind of issue is not allowed to Indian public companies. etc. Similarly. if such kind of equity securities issued in future. it is done by combining features of plain vanilla debt and equity. Besides. Figure 2 indicates that debt involves lower risk but it also offers lower return compared to equity. Basically. it would have the following benefits: Financial Engineering and Innovation as Risk Management Tools: The Case of Indian Companies During Global Financial Crisis 53 . electronic fund transfer. we need to combine features of equity and debt.
2 The First set of investors have 1 voting right for 1 share. Vol. 2 www. It is widely practiced in software companies. For example. but are more concerned about dividends and returns. Reliance Industries reclassified Rs.thehindubusinessline. 2009. Example: (1) Even though it is prohibited in India. they are allowed to exchange the same stock with less voting rights and high dividend provisions. in October 2008. This option is exercised by swapping the salary of the employee with equity.. investors have disproportionate voting rights. and • It can be bought by retail investors who do not bother about voting rights. it results into different voting rights for different set of investors. while another set of investors might have voting rights of 100 shares for 1 share. 1 & 2. Jain Irrigation. This plan is voluntary and employees opting for such plan gets an option to subscribe to the company’s shares at discounted price in future date. Differential Voting Rights (DVRs) In shares with DVR. Nos. These shares were pooled as treasury stock which was owned by eight corporate bodies. Thus.. Those having less voting rights are paid higher dividends because of less control over the company. In recent economic downturn. 9. which could protect company from hostile takeover. all investors are offered same stock with same terms. shares held by these eight subsidiaries were non-voting right shares. As per statutory requirements./2009090350210900. Example: Companies like Infosys. VII. Example: Mukesh Ambani had 12% sweat equity stake in Reliance Infocomm which became cause of dispute between the Ambani Brothers. and (2) BNP Paribas issued non-voting shares worth €5.com/.htm The IUP Journal of Risk & Insurance. Employee Stock Option Plan It is offered to employees and directors of the company to give them a sense of ownership of the company and to encourage them to participate actively in the management of the company. In the initial stage. Later on. Sweat Equity Shares In this case. 2010 54 . the manager is offered shares in lieu of salary and it is called ‘sweat equity’. Example: Tata Motors was the first company in India to commence the issue of DVR which carried 1/10 of the value of ordinary shares and offered 5% point higher dividend to shareholders. subsidiaries cannot own shares with voting rights in the parent company. Over time. ESOPs could be one way of motivating the employees (when pay cut measures are taken) and to increase their productivity.1 bn for the year ended March 31. So. Bajaj Electricals offers ESOP to their employees. which was subsequently converted to subsidiaries of Reliance. a similar kind of situation was created by corporate using treasury stock. Dish TV. the entrepreneur invests his capital and the manager brings his knowledge.• It would enable management to retain their control.41 cr worth of shares and moved them from Promoters and Person Acting in Concert category to public category.
It does not exist in India. Because of this. NRIs are free from the hassle of remitting money to relatives in India through banking channels. Financial Engineering in Debt Zero Coupon Bonds These bonds are issued at discount and redeemed at par.com/printer/news/82561 Financial Engineering and Innovation as Risk Management Tools: The Case of Indian Companies During Global Financial Crisis 55 . These bonds do not carry interest. Dual Currency Bonds In these kinds of bonds. This is one kind of buy-back offer by the company. There is no loss to the company because shareholders will not exercise option once the company performs well. The rate could be quoted as ‘LIBOR + 200 Basis Points’.500 cr by zero coupon bond and it was backed by put option with Vodafone Group. 11 bn via floating rate bonds. For example. principal is denominated in dollars while interest is denominated in Indian Rupees. in October 2009. The difference between face value and issue price is implied interest. The redemption is made in installments. The floating interest rate provides protection against inflation risk. Floating Rate Bonds In floating rate bonds. During lock-in period. which has good reputation in the market.3 This kind of bond can be issued to Non-Resident Indians (NRIs). For example. For example. Master Limited Partnership A business is given the legal form of a partnership but otherwise it is traded like public company on stock exchange. in April 2008.Puttable Common Stock Companies in the USA issue this kind of stock where investors are offered put option. Essar Group raised Rs. The company. They could designate beneficiary in India and the amount is remitted to designated beneficiary in India.financialexpress. 3 www. For example. An example of it could be issue of SPN by TISCO.113 bn to finance Mundra Power Project. charges higher premium for puttable common stock. in November 2009. Secured Promissory Notes (SPNs) SPNs is a secured debenture and it is redeemable at premium over face value. no interest is paid on SPN and redemption is also not allowed. SPN is tradable in market. 4. The company sold 3-year bond paying 135 basis points over one year government security and 10-year bond paying 179 basis points over one year government security. interest is not fixed but is linked to some reference rate like London Interbank Offer Rate (LIBOR) or Mumbai Interbank Offer Rate (MIBOR). Intel had issued puttable common stock. Adani Power issued dual currency bond amounting $1. that is they can sell shares at predetermined date at agreed price. Power Finance Corporation raised Rs.
. Gold-Linked Debentures Gold-linked debenture is a structured product with underlying being gold and is linked to gold price. Sensex falls below. If it is linked to Sensex at participation ratio of 100%. Reliance Industries issued triple option convertible debentures which can be converted into three equity shares. then. Nos. It is offered by Edelweiss Capital.com/loans/. In October 2008. interest on ELDs rise by 10%. The interest on ELDs depends on the performance of underlying stock or index. It is a recent development in financial market.25% up to March 2012 and then a floating rate that’s 500 points below the Prime Lending Rate (PLR).4 Currently. ELDs can be linked to stocks and indices by participation ratio. it is not fixed. In 2002. fixed interest rate is charged to the borrower up to prefixed period and thereafter loan is linked to benchmark rate. then investors will get back principal amount without return. Recently. a borrower will be required to pay 8. 1 & 2. the investor gets principal plus extent to which there has been rise in gold prices. 4 www. Principal is linked to market.75%. It is targeted to High Networth Individuals (HNIs) and the minimum investment requirement is 5 lakhs. In a 20-year loan of Rs. HDFC recently announced dual rate loan. VII. ELDs are of two types: 1.loan/8-25-fixed-rate-for-new-home-loans-hdfc/ The IUP Journal of Risk & Insurance. For example. and hence. In case the price of gold falls. Non-Convertible Debentures (NCDs) NCDs are straight debentures on which interest is paid on regular basis. Equity-Linked Debentures (ELDs) ELDs are introduced by asset management companies to meet retail investors requirements.Dual Rate Loans In dual rate loans. Vol. then investors get their principal back without return. Principal protected where principal is protected while interest is linked to market. JP Morgan Chase issued its first ELD which was referenced to Nifty Index. 2010 56 . and 2. Tata Capital and Shriram Transport Finance has issued NCDs. 30 lakh. In case.. if Sensex rises by 10%.deal4loans. Financial Engineering in Hybrid Instruments Convertible Debentures (CDs) CDs are converted into equity share on predetermined date at predetermined rate. If the price of gold rises. Convertible debentures best suit companies which have long gestation period and are not able to raise fund through equity. Kotak and Citi Group. PLR is 13.
Interest Rate Caps.6 5 6 www.5 The yield to maturity on semiannual basis is 3.5% and has also been listed in Singapore Stock Exchange. In August 2009. www.springerlink. Indexed Currency Options Issuer pays reduced principal at maturity if specified foreign currency appreciates relative to the US dollar. Exercise of warrant by the shareholder leads to dilution of control and issue of more equity. transfer of shares take place among existing shareholders. Stripped Mortgage Backed Securities Mortgage payment stream is divided into two classes: (1) One with below market coupon and another with above market coupon. HDFC raised Rs.com/index/G2217845282846J8. Here.com › Home › Companies & Industry. The interest on FCCBs is lower by 30-40% and it could translate into 2-3% cost saving of issue. Another differentiating feature of FCCB is that one can detach equity portion and sell debt portion.Foreign Currency Convertible Bonds (FCCBs) FCCBs are convertible bonds issued in foreign currency.301 cr via QIP issue of NCD + Warrants. Tata Power launched and allotted FCCBs convertible at the 10% premium over closing price on NSE on November 5. 4. These securities have unique option characteristics and hence are useful for hedging purpose. HDFC closed corporate India’s first Qualified Institutional Placement (QIP) issue of this instrument.pdf Financial Engineering and Innovation as Risk Management Tools: The Case of Indian Companies During Global Financial Crisis 57 . it seems an attractive option for the corporates to raise money from abroad at cheaper rate. Therefore. Stripped Treasury or Municipal Securities This is also known as ‘STRIPS’.business-standard. This means that it is risky proposition for investors who assume foreign currency risk by selling call option denominated in foreign currency. In November 2009. floors and collars agrees to make payment to the purchaser of contract when specified interest rate exceeds the specified cap or falls below the floor. It is issued by Government National Mortgage Association of USA. NCD + Warrants allow detaching both and trading them as separate units. and (2) One receiving interest and the other receiving principal from mortgage pool. Floors and Collars Investors who write interest rate caps. Non Convertible Debentures + Warrants (NCD + Warrants) NCD + Warrants are the new financial instruments proposed by SEBI which has two parts containing a debt portion (NCD) and an equity portion (Warrant). coupons are separated from principal to create a series of zero coupon bonds that can be sold separately. While in case of options. 2009. The issue corporation might issue it combined in order to reduce cost of issue.
An example of it could be stock options and index options. 2010 . currency futures which are traded on National Stock Exchange. The example of futures could be stock futures. it is exchange traded. Put option entitles its holder with right but not an obligation to sell underlying at predetermined price on future date. there are two parties: One taking positive side and another taking negative side. Nos. VII. Mortgage Pass Through Certificates It is an undivided interest in mortgage pool which is insured by Government National Mortgage Association of USA. the corporate has constant cash flow coming from debt issue. An example of it could be currency forward contracts. 1 & 2. In option contract. In this. Vol. SBI raised $750 mn via medium-term notes. as it is customized. Those having bullish outlook about the market buy call option while those having bearish outlook go long on put option. There are two types of options: Call options and Put options. However. Futures Futures are just an extension of forward contracts. In October 2009. It is marked-to-market to avoid loss to clearing corporation as it acts as counterparty in futures transactions. The most popular are currency swaps. This is used when a company has taken loan in one currency and its cash inflows come from some other country. For example. As it is standardized contract. 3-month (on stock exchange). index futures. an Indian manufacturer has taken 58 The IUP Journal of Risk & Insurance. Swap is a series of futures. Call options give its holder right but not an obligation to buy underlying at future date at predetermined price. there are three contracts trading near month.Medium-Term Notes A corporate note is issued by the corporate to the investors for medium-term or maturity period ranging from 1 year to 10 year. Swaps Swaps are similar to futures but there is a small difference. Options Options give its holder right but not an obligation to buy/sell contract. Both parties to contract have to pay upfront margin. 2-month. At the same time. Financial Engineering in Derivatives (Risk Management Tools) Forwards Forward is a customized contract between two parties where one party agrees to sell/buy predetermined quantity of underlying on future date. The holder of call option gains when stock price goes above strike price. It is a standardized contract between two parties wherein one party agrees to buy/sell predetermined quantity at predetermined future price on future date. homeowner’s payments pass from original bank through investment bank to investors in mortgage pool. Through medium-term notes. it is too expensive and issues arise in settling the transactions.
It best suits the investor who wants reasonable rate of return with modest risk. ICICI Prudential Very Cautious Plan. Performance funds: It invests in stock with high price-earnings ratio and high price volatility. This is speculative in nature and it involves trading strategies like short sale to take advantage of declining market. Growth funds: The fund is invested in growth stock which has above average growth potential. for example. The classification of mutual funds is as follows: Classification According to Maturity Open-ended funds: The holder of unit of these funds can redeem them at any time to issuing company. Leveraged funds: In this fund. It best suits risk averse investors. for example. This best suits the investor who is willing to take high risk for high return. So. Such mutual fund companies invest in secondary market. Balanced funds: These funds invest 25% to 40% of the funds in conservative assets and the rest in the equity. ICICI Prudential Income Mutual Fund. Principal Emerging Blue chip Fund. This generates high capital gain component of return. for example. Its shares are issued like any other company’s new issues and are quoted at the stock exchange. Financial Engineering and Innovation as Risk Management Tools: The Case of Indian Companies During Global Financial Crisis 59 . for example. Kotak Dynamic Asset Allocation Scheme. The savings of retail investors are invested in conservative instruments with modest capital gains. There is no fixed maturity for these funds. Specialized funds: Specialized mutual funds invest in specialized securities or specialized industry. for example. Money market funds: The corpus is invested in short-term liquid assets like commercial papers and certificate of deposits. he should enter into swap transaction wherein he can swap dollar currency loan with euro denominated loan.loan in US$ but his major revenues are denominated in Euro. HDFC Prudence fund. Financial Engineering in Mutual Funds There are various types of mutual funds offered to investors depending on their risk appetite and time horizon for investment. borrowed amount is used to increase the size of the value of the portfolio. Classification According to Portfolio Bond funds: Bond funds provide fixed returns to investors and it is for risk averse investors. Stock funds: The retail investors’ funds are invested in diversified portfolio of common stock. Income funds: Income funds invest in equity and debt to maximize the income of the investors with modest risk. for example. Close-ended funds: Close-Ended Fund Asset Management Company has a definite target amount for the funds and cannot sell more shares after its initial offering. HDFC MIP.
Nos. H0: Fund raising by innovative financial instruments impact the share price of the company. VII. 2010 . the investor reacts by creating buying or selling pressure which subsequently impacts the stock price. they dump the shares and stock price subsequently drops. This is part of ‘behavioral finance’. Based on perception about the situation. who are the ultimate owners of the company. to the fund raising drive by Indian corporates using financially engineered products? So the following hypotheses were set and tested using a few Indian company cases. But what was the reaction of company shareholders. When investors react positively. Fund Raising and Innovative Instruments: Hypothesis Testing During the period of post-liberalization. use of innovative financial instruments to lower the cost of financing huge expansion plans increased. H1: Fund raising by innovative financial instruments does not impact the share price of the company. Tax saving funds: It offers tax benefits to investors. When investors react negatively. for example. for example. Real estate funds: These funds invest in real estate ventures. It is achieved by offering half of the amount of funds to those investors who wish regular income and half to those who wish growth. 1 & 2. 60 The IUP Journal of Risk & Insurance. Reliance Infrastructure Fund. Debt focused or Hybrid? • What is the impact of it on capital structure? Will it increase leverage and financial risk? • What is the cost of financing associated with the instrument? • What is the gestation period of the project for which raised fund will be allocated? • How will the cost of financing impact shareholders’ return in the long-term? • Do financially engineered products or traditional method of financing serve the purpose better? • Will the innovative financial instrument dilute their voting rights? These are some questions which come to investors’ mind while reacting to the news of fund-raising drives by corporates.Dual purpose funds: Income and growth are the two objectives of investment in mutual funds. There are many factors which should be taken into consideration while studying the reaction of shareholders: • What is the type of instrument used to raise fund? Is it Equity focused. they buy shares and stock price subsequently rises. Vol. Bajaj Capital Tax Saving Fund.
On July 23. After FCCB issue. So. Treasury Stock Sale (September 2009) Suzlon offloaded 7 crores treasury stocks to raise Rs. Suzlon (2009-10) GDR Issue (July 2009) Suzlon raised $200 mn on July 21. 412. So. GDR instrument was used to raise fund. 2009. stock price of Tata Power went up by Rs. On July 21. 2009. treasury stock sale got negative response from shareholders. the issue got positive response from shareholders. 21 to Rs. Tata Power went up to touch Rs. stock was trading at Rs. JM Financial.20. Before FCCB issue. 7 www. had interest coverage ratio of 1. underwriter to the DVR issue.319..3% of DVR shares.livemint. 689 cr which was 4. stock price increased by Rs.20. November 23.7 This headline hit the newspaper on the next day of DVR issue by Tata Motors. On the next trading day.5% stake of promoters. 1.. On July 21. On November 6. DVR shares had one voting right for every 10 shares held. REPower.Cases of Indian Corporates to Test the Hypotheses Tata Group (2008-10) DVR Issue (November 2008) ‘Tata Motor’s DVR issue backfires on promoters’. FCCB Issue (November 2009) Tata Power raised $300 mn on November 20.9% post treasury stock sale. Tata Motors closed at 182. stock price fell to 157. So.15. The reason for poor response from shareholders was that they feared losing voting rights. Tata Steel’s GDR Issue (July 2009) Tata Steel raised $500 mn via GDR route to finance overseas mining and Jamshedpur plant expansion. Promoters ended up subscribing 84.com/. Tata Power was trading at Rs. Suzlon shares went down by 3. FCCB issue of Tata Power received positive response from shareholders.5.68 and it was facing pressure to service debt. 3 and by Rs. it clearly shows negative reaction of shareholders to DVR issue. So. 2009. So. Suzlon gave negative return of 15% in July 2009. 391. capital structure coupled with fund raising drive impacted stock price negatively as $90 mn was raised through zero coupon convertible debentures. $100 mn through GDR issue and $90 mn through zero coupon convertible debentures issue. approximately 16% fall. 17 on November 24. Suzlon’s debt post acquisition of German Wind Power Company. renegotiated deal with Tata Motors due to poor response from minority shareholders. On November 5./Tata-Motors8217-DVR-issue-b.339. 1.html Financial Engineering and Innovation as Risk Management Tools: The Case of Indian Companies During Global Financial Crisis 61 .
62 The IUP Journal of Risk & Insurance. So. Tata Motors’ right issue combined shares with full voting rights and less voting rights. Opto Circuits Limited Qualified Institutional Placement (QIP) (September 2009) Opto Circuits hit upper circuit on news of its fund-raising of Rs. On September 10.Reliance Industries Limited (RIL) Treasury Stock Sale (September 2009) RIL sold 15 million treasury stock at an average price of Rs. the share carries different voting rights for different class of shareholders. 2009. The fund raised is intended to be utilized for overseas acquisition and expansion of organized retail. stock closed at Rs. On September 9. 2. Vol. Tata Motors came out in 2008 with this DVR and the utility of DVRs share is as follows: Shares with DVRs act as a boon for management when another company is trying to takeover it (hostile). Class A of investors might have one voting right for one share while Class B of shareholders has 10 voting rights for one share. and here. 305. 188. exploration and production business. 2009.e. i. Out of seven instances. Nos. shareholders reacted positively to three instances and reacted negatively to four instances. VII. many innovative financial instruments have stormed into the Indian financial market. 35. H0 and H1 are relevant depending on the situation. stock went up to Rs. we can conclude that situation and other factors matter a lot when triggering shareholders’ response. Stock of RIL went down by 4.4 post treasury stock sale. 340 while shares with less voting rights were offered at Rs. It depends on condition and purpose for which funds raised are to be utilized. discount of Rs.. The fund raised was intended to pay back loans and to finance expansion. Normal shares were offered at Rs. 2.5% to Rs.086. DVRs can be cited. For example. Tata Motors’ DVR=> Dilution of Voting Right => Negative Price Change Tata Power’s FCCB Issue => Financing Expansion => Positive Price Change Tata Steel’s GDR Issue => Overseas Expansion => Positive Price Change Suzlon GDR Issue => Existing Debt Burden => Negative Price Change Suzlon’s Treasury Stock Sale => Negative Price Change RIL Treasury Stock Sale => Negative Price Change Opto Circuits Limited => Financing Expansion => Positive Price Change So.125. 2010 . These were the few samples to study the reaction of shareholders which can be measured by direction of change: positive or negative. The right issue was proposed to repay bridge loans taken to acquire Jaguar Land Rover. 400 cr by QIP. For instance. 206. approximately 10% increase. 1 & 2. Findings Based on the Above Case Analysis As discussed earlier.
• Company’s debt burden leads to lower valuation of company.The other findings based on the hypotheses are: • As interest rates were low during the second half of 2009. Indian Financial Market started developing and new financial instruments were designed to cater to the varied requirements of clients and investors. the Indian Financial Market did not see enough development. • As liquidity in market dried up due to recession. It was only after the 1991 economic reforms. Table 1: Financial Innovations in Indian Financial Market and the Motivating Factors Innovations Debt-Oriented Scheme of Mutual Fund Partially Convertible Debentures and Fully Convertible Debentures Zero Coupon Bonds Puttable and Callable Bonds Stock Index Futures Badla Transactions Ready Forwards Havala Transactions Interest Rate Floors/Caps/Collars Interest Rate Swaps Currency Swaps Forward Rate Agreements Automated Teller Machines Motivating Factor Tax Advantage Pricing and Interest Rate Regulation Under Capital Control Act Tax Benefit Volatility of Interest Rates Volatility of Equity Prices Restrictions Under Forward Trading Restrictions Under Portfolio Management Scheme RBI Restrictions Volatility of Interest Rates Volatility of Interest Rates Volatility of Exchange Rates Volatility of Interest Rates Technology 63 Financial Engineering and Innovation as Risk Management Tools: The Case of Indian Companies During Global Financial Crisis . • Tata Group has been the most active during the year 2009 in fund-raising activities. • QIPs led to positive price change. corporate went for treasury stock sale to repay due debt and finance expansion plans. • “Signaling” hypothesis becomes relevant as information about fund-raising plans even impacted stock price as they are fed into market by speculators. Some of the financial innovations in Indian Financial Market and the motivating factors are summarized in Table 1. Financial Engineering and Innovations as Risk Diversion Tools: Strategies in Indian Financial Market Till the 1980s. • Treasury Stock Sale led to negative price change. corporates adopted cheaper route of debentures and FCCBs.
So. Conclusion The field of financial engineering needs much more development to ensure that investors have wider choice of investing and corporates have wider choice of financing. QIPs. 1 & 2. etc. financial innovations have played an important role in expanding source of finance and meeting investor and issuer requirements. The new instruments should be created to ensure financial efficiency and solve the problem of financing the corporations. there was healthy development in capital markets. Thus. different kinds of financial instruments are used. Besides. and (2) By 64 The IUP Journal of Risk & Insurance. It was during this time debt financing was started. During recession. investors’ outlook is pessimistic and IPO markets dry up. To conclude. Nos. interest rate futures come as rescue instrument in such scenario. and hence. So bond price falls and as a result interest rate risk arises. 2010 . financial instruments took place during this period. Vol. 1990 onwards: Post liberalization. there is less use of derivatives because market is stable and there is less volatility. So.) Innovations Screen Based Trading Floating Rate Bonds Electronic Funds Transfer Money Market Mutual Funds Specialized Mutual Funds Exchange Traded Options Project Finance Motivating Factor Technology Volatility of Interest Rates Technology Volatility of Interest Rates Investor Preference Volatility of Stock Prices Risk Sharing Economic Cycle. bank loans and debentures are used to raise funds. inflation rises. VII. the stress was more on public finance and the economy was highly regulated. the performance of capital market improved and economic scenario changed. GDR. depending on the stage of economic cycle. Equity was increasingly used as a source of financing. This can be done by two ways: (1) By unbundling existing products. Economic recession: During recession. Economic boom: Most of the companies go for IPO. Derivative contracts are widely used to hedge interest rate volatility and price volatility because market turns out to be more volatile. Post 1980s. Companies try to find innovative ways to finance like ADR. Corporates use different kind of financial instruments to raise funds depending on the stage of economic cycle.Table 1 (Cont. interest rate rises. The corporate started tapping offshore market for fund raising and innovations in trading mechanism. as investors have confidence in the market and the market sentiment is overall good. Financial Instruments and Corporate Financing Pattern The pattern of corporate financing in India since Independence has been as follows: 1960-1990: During this period.
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