Special Zero Coupon

Recapitalization Bonds

www.prepshiksha.com
Context:

• Recently, the government has used financial innovation

to recapitalize Punjab & Sind Bank by issuing the bank
Rs. 5,500 crore worth Special Zero Coupon
Recapitalization Bonds.
• Punjab & Sind Bank is a Government of India
undertaking.

Reason for Recapitalization:

• In compliance with Reserve Bank of India (RBI)

guidelines which are based on Basel norms requiring
banks to maintain certain amounts of capital reserves.
 Basics

• In order to expand, it's necessary for business owners to tap financial

resources.

• Business owners can utilize a variety of financing resources, initially

broken into two categories, debt and equity.

• "Debt" involves borrowing money to be repaid, plus interest, while

"equity" involves raising money by selling interests in the company.

• Essentially you will have to decide whether you want to pay back a
loan or give shareholders stock in your company.
 Some of the common types of the debt instrument are:

1. Debentures
Debentures are not backed by any security.
They are issued by the company to raise medium and long term funds.
They form the part of the capital structure of the company, reflect on the balance
sheet but are not clubbed with the share capital.

2. Treasury Bills
Treasury bills are short-term debt instruments that mature within a year.
They can be redeemed only at maturity.
They are sold at a discount if sold before maturity.
 3. Mortgage
A mortgage is a loan against a residential property. It is secured by an
associated property.
In a case of failure of payment, the property can be seized and sold to
recover the loaned amount.

4. Bonds
Bonds on the other hands are issued generally by the government,
central bank or large companies are backed by a security.
Bonds also ensure payment of fixed interest rates to the lenders of the
money.
On maturity of the bond, the principal amount is paid back. Bonds
essentially work the way loans do.
Bonds
• A bond is a debt instrument that represents a loan made by an
investor to a borrower.

• In simpler words, a bond acts as a contract between the investor

and the borrower.

• Mostly Companies and Government issue bonds and Investors buy

those bonds as a savings and security option.

• These bonds have a maturity date and when once that is attained,
the issuing company needs to pay back the amount to the investor
along with a part of the profit.
Bonds
• When you purchase a stock, you're buying a microscopic stake in the
company. It's yours and you get to share in the growth and also in
the loss.

• On the other hand, a bond is a type of loan.

• When a company needs funds for any number of reasons, they may
issue a bond to finance that loan.

• Much like a home mortgage, they ask for a certain amount of money
for a fixed period of time.
Bonds
• When that time is up, the company repays the bond in full. During
that time the company pays the investor a set amount of interest,
called the coupon, on set dates (often quarterly).

• For investors, the biggest risks are credit risk and interest rate risk.
Since bonds are debts, if the issuer fails to pay back their debt, the
bond can default.

• As a result, the riskier the issuer, the higher the interest rate will be
demanded on the bond (and the greater the cost to the borrower).

• Also, since bonds vary in price opposite interest rates, if rates rise
bond values fall.
 Types of Bonds

Govt. bonds Corporate Bonds Convertible bonds

Issued by a Issued by a Gives the right to
government to corporation in order convert or exchange
support government to raise financing for the par amount of
spending a variety of reasons the bond
low-risk investments such as to ongoing
since the issuing operations, M&A, or
government backs to expand business.
them.
 Junk Bonds Extendable Inflation-Linked
Considered to Bonds Bonds
be high credit Gives the holder Provides
risk the right to protection
extend the initial against inflation
maturity or
advance the
principle
Zero-Coupon Asset Backed Mortgage-
Bonds Securities Backed
Based on an Securities
underlying pool Based on a pool
of assets of underlying
mortgages
guaranteed by a
govt. agency
Key Points

Bank Recapitalization:

• It means infusing more capital in state-run banks so that they meet the capital
adequacy norms.
• Indian public sector banks are emphasized to maintain a Capital Adequacy Ratio
(CAR) of 12%.
• CAR is the ratio of a bank’s capital in relation to its risk weighted assets and current
liabilities.
• The government, using different instruments, infuses capital into banks facing shortage
of capital.
• As the government is the biggest shareholder in public sector banks, the responsibility
of bolstering banks' capital reserves lies with the government.
• The government infuses capital in banks by either buying new shares or by issuing
bonds.
How Banks earn money?
Recapitalization Bonds:

• The government issues bonds which are subscribed by banks.

• The money collected by the government goes to banks in the form of equity capital as the
government increases its share of equity holding, thereby shoring up banks' capital reserves.

• The money invested by banks in recapitalization bonds is classified as an investment which

earns them an interest.

• This helps the government in maintaining its fiscal deficit target as no money directly goes
out from its coffers.
Special Zero Coupon Recapitalization Bonds :

• These are special types of bonds issued by the Central government specifically to a
particular institution.

• Only those banks, whosoever is specified, can invest in them, nobody else.

• It is not tradable, it is not transferable. It is limited only to a specific bank, and it is for a
specified period.

• There is no coupon, it is zero coupon, it is issued at par and will be paid at the end of the
specified period.

• Coupon is the Interest which the Investor gets on a bond.

• It is held at the Held-To-Maturity (HTM) category of the bank as per the RBI guidelines.

• HTM securities are purchased to be owned until maturity.

• These are instruments which are a variation of the recapitalization bonds but effectively meet
the same purpose, and these are issued in conformity with the RBI guidelines.

• Financial Innovation: As the issuance of these special bonds will not affect the fiscal deficit
while at the same time provide much needed equity capital to the bank.
Difference Between Normal Zero Coupon Bonds and Special Zero Coupon Bonds:

Zero Coupon Bonds:

• Zero-Coupon Bond, also known as the pure discount bond or deep discount bond, is
purchased at a discounted price and does not pay any coupons or periodic interests to the
fund holders.
• The difference between the purchase price of a zero coupon bond and the par value at the
time of maturity, indicates the investor's return.
• The Zero Coupon bonds generally come with a time horizon of 10 to 15 years.

Difference:
• Special Zero Coupon Bonds are being issued at par,
• there is no interest however Normal Zero Coupon Bonds are issued at discount
• therefore they technically are interest bearing.
To The Point:
• "Debt" involves borrowing money to be repaid, plus interest, while "equity" involves raising
money by selling interests in the company.
• A bond is a debt instrument that represents a loan made by an investor to a borrower.
• These bonds have a maturity date and when once that is attained, the issuing company needs
to pay back the amount to the investor along with a part of the profit.
• Types of Bonds: There are many types of bonds, including government, corporate, municipal
and mortgage bonds.
• Risk factor: For investors, the biggest risks are credit risk and interest rate risk.
• Government bonds are generally the safest, while some corporate bonds are considered
the most risky of the commonly known bond types.
To The Point:
Bank Recapitalization:

• It means infusing more capital in state-run banks so that they meet the capital
adequacy norms.
• Indian public sector banks are emphasized to maintain a Capital Adequacy Ratio
(CAR) of 12%.
• CAR is the ratio of a bank’s capital in relation to its risk weighted assets and current
liabilities.
• The money invested by banks in recapitalization bonds is classified as an investment which
earns them an interest.

• This helps the government in maintaining its fiscal deficit target as no money directly goes
out from its coffers.
To The Point:
Special Zero Coupon Recapitalization Bonds :

• These are special types of bonds issued by the Central government specifically to a
particular institution.

• Only those banks, whosoever is specified, can invest in them, nobody else.

• It is not tradable, it is not transferable. It is limited only to a specific bank, and it is for a
specified period.

• There is no coupon, it is zero coupon, it is issued at par and will be paid at the end of the
specified period.

• Coupon is the Interest which the Investor gets on a bond.