Pick your deep-ended option

Reshma Krishnan

THE corporate bond market has seen little or almost no liquidity in the past fortnight.

Bonds that witnessed some trading were the deep discount bonds (zero-coupon bonds) such as Sardar Sarovar, Tisco and IDBI.

Sardar Sarovar

Recommendation: Hold

Sardar Sarovar issued this bond in 1993 at a face value of Rs 5,000. It matures in 2013 at a face value of Rs 1.11 lakh. The bond has a put option structure that enables the investor to redeem the bond at the end of the 7, 11, and 15 years, when it can be redeemed at Rs 12,500, Rs 25,000 and Rs 50,000 respectively. It is now trading at Rs 16,170.

Exercising the put option in the seventh year, which is the current financial year, would be a wasted effort as the market price is higher than the redemption value of Rs 12,500. The next put option can be used in 2004 when the bond can be redeemed at Rs 25,000. The yield on this option is 12.04 per cent, while the yield of the 15th year, if the put option is exercised, is 15.50 per cent. The yield to maturity is 16.20 per cent per annum.

Taking into account risk and yield, exercising the put option at the end of the 11th or 15th year is not an attractive proposition. After accounting for transaction costs, the yields would not be attractive. Shareholders would be wise to hold on until maturity. The price of the bond has been steadily rallying since May 2000 and was traded at the Rs 15,500-16,500 range in the last fortnight.

IDBI

Recommendation: Buy

This bond was issued in January 1992 and is a deep discount bond. This means the bond was issued at a discount to its face value. In this case the bond was issued for Rs 2,700. It is now trading at Rs 10,150. It has a complex redemption scheme with a (layered call option by IDBI) and a put option for the investor at the end of every five years from March 1992.

The first option was in March 1997 when the bond was redeemed at Rs 5,700. The next date is March 2002, when it will be redeemed at Rs 12,000. The bonds will also be redeemed in March 2007, 2012 and 2017 at Rs 25,000, Rs 50,000 and Rs 1 lakh respectively.

If the bond is redeemed in 2002, the yield-to-maturity (YTM) would be 15.43 per cent. The 2007 option would realise a yield of 15.74 per cent. The 2012 option would realise a yield of 15.35 per cent and the 2017 option 15.20 per cent. There are a few things to take into consideration to see whether any of these options are viable. Apart from the YTM, there is credit risk and the maturity period.

The bond would prove to be most attractive even if the 2002 put option is used. After factoring in transaction costs and a short maturity period, this bond yields an attractive return of about 13-14 per cent under the present interest rate scenario. Compared to other bonds, it is fairly liquid and provides the investor with an exit option.

Tisco

Recommendation: Hold/Avoid fresh exposures

Tisco issued this bond in September 1996. It was issued as a deep discount bond and priced at a discount to the face value at Rs 5,100. It was issued as a set of three, with each bond priced at Rs 1,700. It is currently trading at Rs 10,500. The bond can be redeemed in three stages, beginning in November 2005 with Rs 7,500, followed by another Rs 7,500 in 2006 and Rs 10,000 in November 2007.

The yield-to-maturity of the bond at the present price levels stands at 15.89 per cent. However, there is the risk of early redemption, a call option that the issuer can exercise. The early redemption option will mean the redemption of Rs 11,250 in September 2001. At the present price, it will give a yield of 10.90 per cent. The likelihood of the company exercising this option next year is high, as this bond was issued at a high interest rate by current market standards, and the company will probably use this option to reduce the cost of the bonds. Thus, it would not be wise to invest in this bond at this point. Shareholders can however hold the bond till maturity.