Jaipuria Institute of management,Indore

Case Analysis
Of
“Mahindra and Mahindra”

Submitted to:- Submitted by:-

Prof. Neeraj Gupta Aaditya Richhariya
Aakanksha Joshi
Mahindra and Mahindra ZCD issue 1990
Convertible Bond
A convertible bond is a fixed-income debt security that yields interest
payments, but can be converted into a predetermined number of
common stock or equity shares. The conversion from the bond to stock
can be done at certain times during the bond's life and is usually at the
discretion of the bondholder.
Convertible bonds are a flexible financing option for companies. A
convertible bond offers investors a type of hybrid security, which has
features of a bond such as interest payments while also providing the
opportunity of owning the stock. This bond's conversion ratio determines
how many shares of stock you can get from converting one bond. For
example, a 5:1 ratio means that one bond would convert to five shares of
common stock.

Types of Convertible Bonds

1. A vanilla convertible bond

provides the investor with the choice to hold the bond until maturity or
convert it to stock. If the stock price has decreased since the bond's
issue date, the investor can hold the bond until maturity and get paid
the face value. If the stock price increases significantly, the investor
can convert the bond to stock and either hold or sell the stock at their
discretion. Ideally, an investor wants to convert the bond to stock
when the gain from the stock sale exceeds the face value of the bond
plus the total amount of remaining interest payments.

2. Mandatory convertibles
Mandatory convertibles provide investors with an obligation to convert
their bonds to shares at maturity. The bonds usually come with two
conversion prices. The first price would delimit the price at which an
investor will receive the equivalent of its par value in shares. The second
price sets a limit to the price that the investor can receive above the par
value.

3. Reverse convertibles
Reverse convertible bonds give the issuer an option to either buy back
the bond in cash or convert the bond to the equity at a predetermined
conversion price and rate at the maturity date.
 

Advantages of convertible bonds

Convertible bonds are a flexible option for financing that offers some
advantages over regular debt or equity financing. Some of the benefits
include:

1. Lower interest payments

Generally, investors are willing to accept lower interest payments on
convertible bonds than on regular bonds. Thus, issuing companies can
save money on their interest payments.

2. Tax advantages
Since interest payments are tax-deductible, convertible bonds allow the
issuing company to benefit from interest tax savings that are not possible
in equity financing.

3. Deferral of stock dilution

If a company is not willing to dilute its stock shares in the short or
medium term but is comfortable doing so in the long term, convertible
bond financing is more appropriate than equity financing. The current
company’s shareholders retain their voting power and they may benefit
from the capital appreciation of its stock price in the future.
Example

• (XOM) issued a convertible bond with a $1,000 face value that

pays 4% interest. The bond has a maturity of 10 years and a
convertible ratio of 100 shares for every convertible bond.

• If the bond is held until maturity, $1,000 in principal plus $40 in

interest for that year. Share price increase at $11 per share. As a
result, the 100 shares of stock are worth $1,100 (100 shares x $11
share price), which exceeds the value of the bond. The investor
can convert the bond into stock and receive 100 shares, which
could be sold in the market for $1,100 in total.

History of Zero coupon Bond

Zero coupon bonds were first introduced in the 1960s, but they did not
become popular until the 1980s. The use of these instruments was aided
by an anomaly in the US tax system, which allowed for deduction of the
discount on bonds relative to their par value.

A zero-coupon bond (also discount bond or deep discount bond) is

a bond where the face value is repaid at the time of maturity this
definition assumes a positive time value of money. It does not make
periodic interest payments, or have so-called coupons, hence the term
zero-coupon bond. When the bond reaches maturity, its investor
receives its par (or face) value. Examples of zero-coupon bonds
include U.S. Treasury bills, U.S. savings bonds, long-term zero-coupon
bonds,[1] and any type of coupon bond that has been stripped of its
coupons. Zero Coupon and Deep Discount Bonds are used
interchangeably
In contrast, an investor who has a regular bond receives income from
coupon payments, which are made semi-annually or annually. The
investor also receives the principal or face value of the investment when
the bond matures.
Some zero coupon bonds are inflation indexed, so the amount of money
that will be paid to the bond holder is calculated to have a set amount
of purchasing power rather than a set amount of money, but the majority
of zero coupon bonds pay a set amount of money known as the face
value of the bond.
Zero coupon bonds may be long or short term investments. Long-term
zero coupon maturity dates typically start at ten to fifteen years. The
bonds can be held until maturity or sold on secondary bond markets.
Short-term zero coupon bonds generally have maturities of less than one
year and are called bills. The U.S. Treasury bill market is the most active
and liquid debt market in the world.

Strip bonds
Zero coupon bonds have a duration equal to the bond's time to maturity,
which makes them sensitive to any changes in the interest rates.
Investment banks or dealers may separate coupons from the principal of
coupon bonds, which is known as the residue, so that different investors
may receive the principal and each of the coupon payments. This
creates a supply of new zero coupon bonds.
The coupons and residue are sold separately to investors. Each of these
investments then pays a single lump sum. This method of creating zero
coupon bonds is known as stripping and the contracts are known as strip
bonds. "STRIPS" stands for Separate Trading of Registered Interest
and Principal Securities.
Dealers normally purchase a block of high-quality and non-callable
bonds—often government issues—to create strip bonds. A strip bond
has no reinvestment risk because the payment to the investor occurs
only at maturity.
The impact of interest rate fluctuations on strip bonds, known as
the bond duration, is higher than for a coupon bond. A zero coupon bond
always has a duration equal to its maturity; a coupon bond always has a
lower duration. Strip bonds are normally available from investment
dealers maturing at terms up to 30 years. For some Canadian bonds the
maturity may be over 90 years.
In Canada, investors may purchase packages of strip bonds, so that the
cash flows are tailored to meet their needs in a single security. These
packages may consist of a combination of interest (coupon) and/or
principal strips.
In New Zealand, bonds are stripped first into two pieces—the coupons
and the principal. The coupons may be traded as a unit or further
subdivided into the individual payment dates.
In most countries, strip bonds are primarily administered by a central
bank or central securities depository. An alternative form is to use
a custodian bank or trust company to hold the underlying security and a
transfer agent/registrar to track ownership in the strip bonds and to
administer the program. Physically created strip bonds (where the
coupons are physically clipped and then traded separately) were created
in the early days of stripping in Canada and the U.S., but have virtually
disappeared due to the high costs and risks associated with them.

Uses
Pension funds and insurance companies like to own long maturity zero-
coupon bonds because of the bonds' high duration. This high duration
means that these bonds' prices are particularly sensitive to changes in
the interest rate, and therefore offset, or immunize the interest rate risk
of these firms' long-term liabilities.

Taxes
In the United States, a zero-coupon bond would have original issue
discount (OID) for tax purposes. Instruments issued with OID generally
impute the receipt of interest (sometimes called phantom income), even
though these bonds do not pay periodic interest. Because of this, zero
coupon bonds subject to U.S. taxation should generally be held in tax-
deferred retirement accounts, to avoid paying taxes on future income.
Alternatively, when purchasing a zero coupon bond issued by a U.S.
state or local government entity, the imputed interest is free of U.S.
federal taxes, and in most cases, state and local taxes, too.
Example of Zero coupon bond

• Face value of the share – 1000

• Issue price –800

• Interest- 0%

• After 5 year converted into 5 equity share

• 1000/5 -200 Rs per share

• Current market price of a share is 300 Rs. Per share

• Expected market price at the end is – 500 Rs.

Calculation of Interest Part

For first 1 year Interest Calculation

=110*12.5/100

=13.75

Interest For next Half year

=55*12.5%/100

=6.875
Zero coupon bond does not carry any interest benefit ,

so company issue it in discount.

First part comparison between both alternative

• At what rate outflow of zcb equal to Conversion price of FCD

• So for calculation of that we use formula

• =amount invested= Conversion price /(1+r ¿ n

• So here we get 17.5% yield return

• This is intrinsic yield of Zcb.