The Hindu Business Line : Corporate floaters not appealing enough to investors

WHAT do investors in corporate papers want? A fixed rate instrument or a floating rate mechanism? Or a finer priced instrument which reflects the market rates movement?

Finding takers for a fixed rate instrument is difficult in a rising interest rate scenario; this has induced corporates to come up with floating rate instruments with rates reset about every six months with the underlying as the one-year Indian benchmark (INBMK), popularly known as the 364-day g-sec.

These instruments known as floaters can range anywhere from two to seven years and even above. The pricing structure for such bonds is a spread over the one-year Indian benchmark rate or the MIBOR.

But these papers do have their disadvantage. According to analysts, re-setting the rates based on the one-year g-sec does not always reflect the actual movement in the interest rates.

"Widening of spread between the g-sec and the corporate paper will hit the investor hard, so will the perception of the corporate related risk increasing in future," said Mr Sameer Kulkarni, Senior Vice-President & Head, Fixed Income, Franklin Templeton Investments.

Having the one-year Indian benchmark as underlying for a two-year paper is reasonable but the risk increases if the same base is also employed for a seven to eight year paper, he said.

Investors' appetite for such papers may reduce with the tightening of liquidity in the system. The volume of money parked in repos came down from Rs 70,000 crore to Rs 58,000 crore as on July 31, 2004. The yield on 364 day T-bill also moved up by about 20 basis points since the beginning of the current fiscal.

Investors question the validity of the structures of these floating rates instruments. They say that the floaters should be benchmarked against the g-sec of the same maturity. For example, they question if a five-year paper should be benchmarked against a five-year g-sec.

Relevance of linking the longer tenor papers to one-year g-sec and MIBOR is questionable. Current benchmarks for floaters leave a lot to be desired, as the correlation between the volatility of such benchmarks and comparable bonds in the similar tenor is very low.

Validity of such structures is being increasingly questioned by end-investors in such papers, says Mr Kinshuk Sharma, Bond Trader, ICICI Bank.

Several investors also suggest a variable spread with the paper being embedded with a put and a call option which makes its recall possible by either party in case of unfavourable movements in interest rates for any one of them.

Preferred benchmark for pricing issues in the US is the three months LIBOR as hedging in the form of swap rates is available for papers up to a maturity of 10 years. Unavailability of such swap curve in India is a constraint for issuing longer tenor papers with a shorter tenor underlying.

Appetite of investors is bound to diminish for such papers, which do not link the maturity to the underlying, in the present market scenario, said a dealer with a leading investment bank.

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