Looking at the jungle for some succour

By R A J R I S H I S I N G H A L
THE markets have always been fascinated by animals. Time and again, innovative market players have delved into the animal kingdom for inspiration on new products. Whenever, capital market players, especially those in the bond market, have come up with new products, and were faced with the prospect of naming the newer beast, they found inspiration from animal names. The time may have come again to look to the jungle for some respite. The fascination with quadrupeds began with investment banks venturing into the government securities market. These banks would buy US government treasury bonds, put them into an escrow account and re-create instruments derived from these bonds. The interest payout on the original bond would be used to create new bonds. Typically, these instruments would be issued at a deep discount to their face value and investors would receive the face value at maturity, the difference being the implied interest rate.

These bonds were issued mostly between 1982 and 1986. Merrill Lynch — recently taken over by Bank of America — floated TIGRs, or Treasury Investors Growth Receipts. Similarly, Lehman Brothers, which went bankrupt and had to be shut down floated LIONs, or Lehman Investment Opportunity Notes. Not to be outdone, Salomon Brothers invented CATS, or Certificates of Accrual on Treasury Receipts. Predictably, the market referred to these bonds collectively as “felines”. In the past, Indian MFs also took a stab at launching new fund offers with similar names. For example, DSP Merrill Lynch had floated a new scheme called the TIGER fund, which was an acronym for The Infrastructure Growth and Economic Reforms Fund. ING Bank’s local mutual fund arm floated LION Fund, which expanded into the slightly contrived and convoluted Large-cap, Intermediate-cap Opportunities New Offerings Fund. Recently, insurance companies, stung by the colossal damage claims arising out of storms, hurricanes, typhoons, earthquakes and other similar natural calamities, came up with CAT bonds, which are different from the ones floated by Salomon Brothers. These are a short form for “catastrophe bonds”. Insurance companies float these specialised bonds to transfer their risk to the broader capital market. Typical investors include hedge funds and dedicated catastrophe-oriented funds. Given the upheaval in the world markets — called by various people a calamity, catastrophe or a cataclysm — this might be the right time to launch some more “animal” bonds to revive investor interest. Here are some of the mythical beasts.

DOG: Expanded they stand for — pardon the expression — Dump On Government. These are bonds issued by all kinds of special investment vehicles which may or may not have any underlying assets. In case the issuer stops paying interest, the government will be obliged to buy them back.

GOAT: Government Offering for Actual Trading, instruments primarily designed for Indian markets. These are paper issued by the government in lieu of all its payments — subsidy, tax refunds, bank recapitalisation, et al — which can then be traded on the market. This one feature will be the big, big difference. The current lot of bonds — issued to oil companies to make up for the shortfall between cost and market prices, and banks for sterilising dollar purchases, fertiliser companies — cannot be traded on the market and has left treasury heads of all these companies and banks in a quandary.

VIPER: These will be a genre of paper in the manner of “catastrophe” bonds, but issued for insuring disaster in the financial sector, instead of natural mishaps. Called Voucher In Place Exceptions Regretted, these bonds will help insurance companies provide cover against the next generation of banks, which issue exotic derivatives, going kaput.

COBRA: These instruments — Collateral Based on Reducing Assets — will be designed for subscription by conglomerates, especially those which need tax breaks. Imagine a holding company with investments spread across a large number of companies. This portfolio could also include minority interest joint ventures. In such cases where the minority interest company is making a loss, the holding company is unable to take the benefit of a tax write-off. This bond allows the holding company to do that.

CHEETAH: You’ve heard of NINJA — No Income No Jobs or Asset — loans provided to sub-prime borrowers. When the next spell of easy money rolls around — and you can bet your shirt that it will, given the kind of liquidity being pumped in daily by the world’s central banks — the same kind of loan can be rolled off the assembly line, albeit with a different name: Childless, Earning-Exempted, Totally Assetless Homes.

LAMB paper: As soon as Lehman went bust, the impact was felt on all those holding paper issued by the investment bank. The current credit crisis was sparked off when one money market mutual fund woke up one Monday morning and found its asset value wiped out. But, there might be a contrarian — and intrepid — vulture investor, or even a former Lehman trader, who might find some residual value in some of that paper.

Source : Economic Times