In my earlier blog I had written about a derivative instrument called the credit default swap. The ET on 28th June 2007 carried an article about how banks are offering equity linked notes to woo rich investors. This is a clear indicator of how our markets are maturing in a big way.

Citibank and DSP Merrill Lynch have issued equity linked notes to raise resources. The equity linked notes are basically debt instruments issued at a discount with certain additional payoffs being made on the happening or non happening of certain events. To cite an example A Ltd can issue a debenture at Rs.100 which will be repayable on maturity at 100+3 = Rs.103. It can however contain a rider which says that if the Nifty falls / rises by more than say 30% any time between the date of allotment and the date of redemption the repayment will be say Principal + 20%.

This kind of a product provides capital safety plus the opportunity to participate in a equity rally by the investor, while for the borrower it may enable him to issue such paper at a lesser rate than what he would had to offer on a pure debt instrument. These bonds will be rated and traded on the NSE. However as of right now due to lack of depth and knowledge of the product it is likely to be a OTC product with limited liquidity. However if a number of company (say the index companies) start coming out with such an instrument then it will be quite possible to create a basket derivative of such instruments.

This also means that credit rating agencies in India which have so far been rating predominantly vanilla products will have to gear themselves up to deal with such sophisticated instruments. Like I keep saying – exciting times ahead!!!!!!!!

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