Apr 252011
 

Ref: 2011-07 of 24 April, 2011

There is an adage “ The people peep into others home when troubles are in their own”

United States, United Kingdom and entire Europe, most of whom are NATO members follow the above adage literally. When United States intervened in World War II, the entire Europe that was decimated resurrected to become a super power. When US threw two atomic bombs on Hiroshima and Nagasaki in Japan, the Japanese re-livened from disaster to become a magical super economic power. US engineered Asian crisis to destroy rising economic powers. And Asian emerged as the super economic power larger than Japan and Europe combined.

However, these super power merged themselves in every action later on world stage with experience in military warfare. They tried Vietnam, failed; then Korean peninsula, failed; Cambodia and Laos, failed; Iraq, failed; Palestine, failed; Lebanon, failed; Bosnia, failed; Iraq, failed; Afghanistan, failed; and now Libya, failing; Iran, nearly failed or failing.

The above alliances or mergers are similar on financial battleground to Time Inc. merging with Warner Communication to become Time Warner in days of trouble and when it did not work, they merged with another uprising power AOL to become Time Warners AOL to hide enormous troubles within. It did not work either. Now they are separating. The western culture of “marry and divorce, marry and divorce” is not working as efficient model.

Since the days of Iraq war, the western powers have found new battleground in Middle East. However, their tactics are not working because of vast cultural difference between other nations where they intervened and current one. Middle East nations are mostly “Muslim” countries where the prime loyalty is to their “religion” or “Koran”. A person is a “Muslim” first and then only Kuwaiti, Iraqi, Irani, Pakistani etc. Such unilateralism unites them and any attack on any nation is viewed as an attack on Islam, their religion. These are the countries where mullahs, kajis, ayatollahs and other religious leaders have dominating influence over the political leaders or sheiks or sultans. Western political leaders therefore can not force the “democratic” values upon the national leaders of those countries only because their role is secondary.

As result, the Muslim community as whole has become extremely volatile. The real education has not percolated down enough through the masses. Even well educated Muslim scholars do not imbibe or publicly profess the democratic values for fear being “cast out” of their community. Their children have to pay the price. Their daughters or sons do not get suitable match only because other families may not want to associate with literate or reformist Muslim.

Unless and until the attacks are directed to eliminate the root causes, that is, Islamic religious leadership, nothing is going to work, and the common people are going to continue to lose lives of their dearest kin, parents, husbands, wives, children etc. for no fault of theirs. Removing a political leader like Saddam Hussein, Shah of Iranl, Gadaffi, Saleh or Assad will not bring in democracy. If intention was to remove only the offending leaders, why not Western powers concentrate bombing on the leaders and their place of dwellings to eliminate them, and instead bomb all around through war planes or drones which kill only innocent civilians who turn against the very western powers trying to help them?

 

Economic Sanctions and their effects

In the name of democracy, the western powers go on interfering into the internal affairs of those nations. They use “United Nations” to validate their military actions by allowing free passage of resolutions authorizing them to indulge into such actions. They also get to pass resolution authorizing “economic sanctions” on those countries. Why should the entire nation be penalized with economic sanctions for the single unacceptable act of a political leader of that nation?

Such economic sanctions under the authority of United Nations is no different similar sanctions imposed by Clerics, Mullahs or Ayatollahs on their Muslim community. They impose their brand of social sanctions which is also a form of economic sanctions. One does in the name of United Nations, other does in the name of clerics or mullahs or ayatollah. How many times the Western attack was aimed at removing the belligerent clerics or mullahs who were instrumentals in authorizing, conceiving, planning and executing terrorist attacks on western worlds? Almost none.

The western nations also take pride in launching attack from 20 miles above the ground with almost 2000 pounds of bombs on Islamic civilian targets alleged to be used by real terrorists as their hide out. When the affected people find themselves paralyzed to launch similar counter attacks, they resort to guerrilla warfare and become terrorists (in the language of western powers). In their own nations such people are recognized and applauded as “nationalist” or “real Muslim”. When your home is attacked with guns and arsenals, would not you traditional weapons like Iron bars or wooden sticks or even kitchen pots to stop the invader into your home?

The Western forces are also cowards. They can not not take part on the ground and fight the opponents on one to one basis because of fear of loss of their lives. Only yesterday, an American drone (unmanned plane) attacked one place in Pakistan killing 26 civilians including few women and children. The attackers did not say “sorry” but tried to justify their attacks based on information of terrorists hide out there. Killing of 26 innocent civilians push them more into the fold of their religious leaders, against their political leaders for allowing or consenting Western powers to use their home land to attack their own people and creating 260 future terrorists to avenge the death of their parents, children or next to kin.

In other words, the western powers are attacking leaves, secondary branches and other branches of a tree rather than attacking the roots where the Clerics or Mullahs live. Even if they help the rebels, who are also Muslim, they will grab the power from one political leader and appoint their own, but follow the same principles, guides, directions and intentions of their religious leaders because they too are Muslim first and rebel later.

Freezing Islamic Nations Forex Reserve and Impact on Oil prices, Euro

In the name of economic sanctions, the countries like United States and United Kingdom are freezing the national Forex reserve of affected Islamic or Arabic countries. If US Dollar is to be used as “world’s reserve currency”, it should be respected as such by its own issuer – United States. Forex reserve of any country lying in United States is “sacred” and should not be touched even with remote hand or pole by the US administration. It is not their money. Such Forex reserve is held in United States in Trust, and US has to carry out the duties as “Trustee“. You can not freeze the Forex reserve held in trust with the United States. If you are keeping your valuable ornaments in any bank locker, would you accept if they refuse to allow you to access to your own private property held in trust at the bank? Certainly not.

Undesirable Effect of Freezing  “$ Reserve” on Oil prices and Inflation

If there are troubles in Greece, Portugal, Iceland or Spain, why the hell their currency “Euro” is rising? It may be noted that Euro has been rising with every increase in oil price in US$ terms? What is the correlationship?

Almost all Arab nations, who are involved in political turmoil, for fear of being their Forex reserve being frozen in United States and United Kingdom (America’s bedside partner), have started quoting oil prices in Euro rather than US dollars. As result, the buyer of the oil has to buy Euro first by selling dollar and then place buy order for oil with reasonable assurance from European nations that they would not freeze their reserve held in “Euro”. As result, the dollar has been plunging, oil prices are rising in dollar terms and Euro is surging.

Such “Forex Reserve Freezing exercise” has turned out to be “nightmare” for US financial officials like Fed, Treasury and even President Obama who launched massive investigations for extra ordinary rise in oil prices in United States by penalizing the “speculators”. Oh Mr. Obama, no one is manipulating oil prices at the pumps – it is only your economic sanctions freezing “Forex reserve” of Arab nations, is the main cause. Remove that cause, your dollar will start rising again. When you can see such truth with naked eye, why do you use “binoculars” and “microscope” to ferret out the truth. The culprit and speculator is nowhere else but only in White House – that is You, Bernanke, Geithner and rebellious senators in the House of Senate and House of Representative. Look in the mirror, Mr. President, you will find the criminal there itself.

In my book “Sub Prime Resolved” I have devoted entire chapter on oil price manipulation, its mechanism and also informed the readers that “US Should pass a legislation removing the authority of anyone, including President , to freeze any country’s Forex or Dollar reserve lying at FED/Treasury as untouchable sacred money belonging to other nations lying in trust with them.

Saddam Hussein was attacked by United States because his $1.6 billions were frozen in United States which forced him to quote the oil prices in Euro. US being extremely fearful of economic adverse effect attacked his country in the name his possessing WMD or Weapons of Mass Destructions which were never found.

Even India found difficult to buy oil from Iran. India buys 400,000 barrels of oil every day from Iran. Manmohan Singh in his policy of appeasement directed RBI to frame rules not to deal with Iran and carry out monetary transactions in dollar. Indian Oil Corporation was in such dire strait that it had to buy the oil from other sources paying 10% premium to market price. Iran recently agreed to supply crude oil without payment for time being and requested settlement in non dollar currency or gold, that is, Euro or Gold. This is one of the main reason why both Euro and Gold are rising neck to neck with oil prices in dollars.

Poor Obama! He has lost his mind. He knows the solution to higher oil prices is lying on his desk but he is not aware of it. He looks more at TV, tea parties, and daily change in gas prices at the pumps and increasingly ordering “drone” attacks on Libyans in the hope of reducing oil prices. Who will show him the “Kalidas Note” that solution lies in his pen by de-freezing Forex reserve of any nation even if they are under watch of economic sanctions, not in drone or manned attacked on rebels from several miles above in the sky. Hey Mr. President. The Arabs have money and you are preventing them from sending dollar remittances to your country!

GET DOWN TO EARTH, Mr. OBAMA. You are now welcome on this planet if you are carrying a pen to sign the defreezing order. Otherwise the oil prices will go so high that Americans will freeze to death in winter only due to your freezing actions of other nations dollar reserve lying in your country which are in fact financing your huge deficits otherwise. Do not drive them away – only you and American people will suffer.

If there are troubles in Middle East countries, Mind Your Own Business. If they do not want democracy, so be it. If they want to die, let them die, but while helping them to live, do not kill rest of the nations in the world. There are over 6 billion people on this planet. Existence or non existence of about 50 million people in Middle East is not going to make much difference!

 

Anil Selarka ( Kalidas )

2011-04-24 Ref: 2011-07

 

© Copyrights Reserved by Anil Selarka (also known as Kalidas) 2011

 

 

Jan 102011
 

Ref: 2011-01 of 1 January, 2011 (This is Abridged Web Edition) (eBook version – $9.95 – See sidebar)

 

You have heard about CB or FCCB which is nothing but Convertible Bonds or Foreign Currency Convertible Bonds. Dhirubhai Ambani of India made the CB very popular and made his Reliance empire only from Convertible Bonds. He almost destroyed Birla who promoted and owned MRPL or Mangalore Refinery and Petrochemicals Ltd. , sold it to ONGC for just Rs 2 per share against current market price of Rs 80 or nearly 40 times or 4000% return on investment to ONGC who owns over 80% of the company.

Individuals and Funds must know how to invest into this wonderful hybrid security – Convertible Bonds.The Corporate borrowers like Birla and Tata must learn how to borrow via CB or FCCB route profitably.The history shows that they failed in the past, Most equity investors world over do not know much about investing into CB or FCCB. It is a brilliant art, science and commerce.I made most money for my HNW (High Net Worth) investor clients by focusing on Convertible Bonds almost exclusively.

 

CB usually have following terms:

  1. Amount : Say, Rs 500 crores with Denomination of Rs 5000 each.(Denomination may vary from Rs 1000 to Rs 1 Lakh). In private placement, it is Rs 100,000 or above.
  2. Format: DMAT form or physical (in Printed form). Most are in DMAT forms or popularly known as Electronic format
  3. Taxation Status: Taxable or Tax Exempt
  4. Maturity: 5 years (to 7 years)
  5. Coupon: Also known as CPN which is interest payable in % terms during entire life of bond. There are three types of yields.
    1. Yield at the time of issue based on the Par value. This is same as the CPN value. If the CPN is 5%, then original yield is 5% unless there is redemption premium on maturity. If the CB is redeemable on maturity at say, 5% premium for 5 years maturity, then the effective yield is 6%.
    2. The market considers the Yield Till Maturity as effective guidance. Supposing the market price is 110, then the Yield Till Maturity is 25% (5 x 5%) + 5% (Redemption Premium) – 10% being premium paid to the market = 20% in 5 years, or 4% per year. The rise in bond price is ignored while working out YTM because on maturity, the company is obliged to pay only Redemption value regardless of the conversion price.
    3. Current Yield which is worked out = CPN/Current Bond Price. This is used by the short term investors.
  6. Interest Payment: Half Yearly or annually (mostly in Euro bonds). Domestically, the interest is based on 365 days but in Euro bonds (FCCB), the interest is worked out on 360 days basis. It is a dash higher compared to domestic bonds
  7. Conversion Price: The price at which the bonds would be converted into equity shares. For example, Rs 5000 face value (known as nominal value) worth of bonds would be eligible for conversion into equity shares @ Rs 130 per share (Current Market Price Rs 100). That is, it is issued at 30% premium.
  8. Conversion Terms: Optional or Mandatory.
  9. Optional: Most of the bonds are convertible into equity shares at the option of the holder (buyer). The holder would be encouraged to convert into equity shares if the share price is over Rs 130. Supposing the shares are trading at Rs 180 at the time of maturity, he would be at profit of Rs 50 per share if he converts. If he does not, he would get Rs 100 face value, same amount he invested before.

    In such cases, the Interest Coupon is less or it is less costly to the issuer company. During the life of the bond, the equivalents of shares are treated as “future equity issues” which results into dilution of equity. EPS of such companies are shown as basic or diluted (additional shares issuable after conversion).

    The issuer company also does not treat the bonds strictly as debt because the chances are the bonds would be converted into equity shares if the share prices remain above conversion price at any time. There is always a clause forcing holders to convert into equity if the share price remains 20% or 30% above the conversion price for certain period, say 30 days.

    Mandatory: These bonds are mandatorily converted into shares regardless of the market price of the shares at the time of maturity. These are definitely future equity because no option is given to the holder. Reliance Industries Ltd. (RIL) used to follow this route whereas other companies were following option under (1). This is why RIL scored victory over other corporate borrowers in managing its overall debt.

  10. REDEMPTION: The bonds mature on certain fixed date at the end of set period, say 5 years in above case. Such redemption could be “At Par”, that is same price at which they were issued, or at some nominal premium of 5% at the maximum. It all depends on interest coupon and conversion price. Higher the coupon or lower the conversion price, there may not be redemption premium.
  11. Some companies issue 0% Convertible Bonds (IFCI issued such bonds to nationalized banks in the past) which are issued at deep discount and pay heavy redemption premium ranging from 30% to 35% to compensate the holders of interest if the share prices do not perform well and remain below the conversion price.
  12. These bonds track the equity shares in tandem and interest rates for similar maturity in the market, especially Treasury Bonds. Each 1 percent is known as 100 basis points. If the bonds are issued at say, 5% coupon, and Treasury Yield for similar maturity is 4%, then the bonds are considered issued at 100 basis points above equivalent 5 years Treasury.

Why invest in CB/FCCB and not in Equity shares instead?

  • A good question. Whatever said and done, the CB or Convertible Bonds are “Debt Instrument” until they are converted physically into equity. The issuing company is under obligation to retire this debt at maturity if they are optionally convertible as usually the case.
  • If the company goes into liquidation, the equity turns zero, but the CB being a debt has priority over other debts, preference and equity shares, including trade creditors.
  • Some good CB issues have redemption corpus (similar to sinking fund where the company deposits regular amount to fund its future liability). It is rare nowadays.
  • In a country like USA, where the companies easily file Chapter 11 or bankruptcy, the equity holders are biggest losers, whereas the bond investors benefit most. For instance, when United Airlines filed for bankruptcy, all investors, majority of them being employees, suffered 100% loss. The bond investors got the company in debt swap for a song, and the stock which at one time sank below $1, rose smartly when it came out of bankruptcy, giving fabulous return to the chagrin of the old equity investors, most of them employees. US capitalists and private equity firms never like employee owned companies. They play dirty games to destroy them with the cooperation of lawmakers and the courts. Another major failure, Lehman Brothers, was allowed to fail only because it was majority owned by the employees.
  • In India, the nationalized banks lost over Rs 1500 crores notionally in their “Zero Coupon Convertible Bonds” issued by IFCI. They did not earn the interest for 7 years, nor did they get the shares at cheaper price. They were finally obliged to swap their debt into equity at conversion price in excess of Rs 100 whereas the current share price hovers around Rs 72. At one time after conversion, it sank as low as Rs 18, causing investment loss on paper up to 80%. 

Difference between CB and FCCB

Rupee Payment Instructions for Convertible BondsNot much difference except that the investors in FCCB are foreign investors such as FII, Pension Funds, Mutual Funds and NRI (Non Resident Indians). The exchange rate is another factor that adds to volatility and a major factor for investment. FCCB are generally issued in US dollar, and therefore, $/Rupee exchange rate plays important part. They also behave more aggressively than their Rupee counterparts, because the Foreign Investors are more agile and susceptible to market risks in terms of currency, overseas equity markets and individual health of the issuer. They are also more guided by “rating” outlook of the issuer and the country.

If Rupee gets stronger, and equity prices also rise, FCCB holders have double engine for growth – one for absolute rise in rupee value as traded on BSE/NSE, and another exchange gain.

Some issuer companies benefit due to poor market internationally even if the company by itself was doing magnificently. For instance, Hotel Leela saw FCCB prices below 50% of issue price due to crash in overseas market. It wisely bought back the FCCB issues part by part making over 50% profit.

Following are the general rules of investment into Convertible Bond and Foreign Currency Convertible Market (FCCB) which should be observed by domestic and international investors:

Investment in CB/FCCB – General Principles:
Ideal conditions exist when the following variables are in your favor:
  1. Interest rates in domestic market have peaked, are consolidating and are showing signs of going down. Inflation is now under control.
  2. The stock and bond markets are showing signs of revival.
  3. Short term interest rates such as overnight call money rates are going down or stable with downward bias.
  4. Look out for the CB available in the local market which has at least 3 to 4 years of maturity left. Also consider investing into CB IPO of established companies with at least 5 years of maturity.
  5. If you are an overseas investor, then FCCB will be the choice.
    1. In addition to above 4 factors, look at the potential of local currency, in the present example Indian Rupees vs. US dollar.
    2. If the currency of issue of FCCB is US Dollar, explore Rupee potential. If the Rupee is at lowest point with upward bias, this is the ideal situation. In this case, there could be double engine growth – one from appreciation of stock prices + exchange gains.
    3. These bonds are best bought during market crisis or crisis engulfing the nations on negative credit watch, such as Ireland, Greece, Portugal and Spain in current environment. When the government credit goes down, the corporate borrowers also suffer, even if they are better off financially.
  6. If the CB is rated or about to be rated, watch for that report.
  7. This is not a must condition for individuals because rating agencies always lag behind reality. The FII and Fund investors give high regard to rating of the bond by S&P, Moody and Fitch in Europe. Moody casts paramount influence on rating.

    Most mutual and Pension funds have limitation set by their charter to invest only in Investment grade bonds. For instance, Pension Funds in USA are not authorized to invest into any security which is less than AAA or at least AA rating. They were not buyers of India debt because Indian rating was then below investment grade (junk grade) and even now, BB minus rated, almost 5 notches lower than the desirable grade for investment.

Watch the following events:

  1. Monitor the quarterly numbers closely and see their effects on stock prices. If the stock goes higher, the CB or FCCB will also go higher. Often, FCCB moves faster than domestic CB. If the premium develops too much, better be a seller. Normally, if the premium goes above 30%, it becomes a good sell. It may be noted that premium goes down when the maturity comes nearer and nearer. In other words, the time premium will be at the highest level in first two years.
  2. Similarly, the FCCB trades at considerable discount in the event of bad news for the stock, country or just international market for equity severely correcting. (Buy opportunity)
  3. If the discount exceeds 20% to local stock price, one may do arbitrage. It is meant for seasoned investors only. There is a time lag between conversions of CB into domestic equities. (Arbitrage opportunities)
  4. If the Company performs better and better on financial front, as evident from Quarterly numbers, stay with FCCB or buy even local shares. Rely more on “sequential growth” rather than YOY number (Year on Year). The sequential growth compares the performance of last quarter to previous quarter, not previous year. You are therefore with the latest trend in the company by following sequential growth.
Anil Selarka 

Hong Kong, 1st January, 2011

 

Copyrights

© Anil Selarka, 2011

Quiz …on how much you learnt from above article: (Enclosed with full version)

QUIZ

Let me now test the practical knowledge you have gained from above article. Where would you invest $ 1 Million today? A short Quiz is enclosed for your exercise.(with full version). Finish it within 30 minutes and send your comments to this article. Make it as pointed as possible.

ANSWER KEY (with full version)

Check your answers with the enclosed Answer Sheet after 30 minutes from the Test began.

If the score is > 40; Excellent; >30<40 = Very Good ; >25<30 = Good

and if it is <25 = Poor. You have or do not have enough knowledge to invest into Convertible Bonds. Read the article again if your score is poor. You are your own teacher.

READ ONLY AFTER having attended the Quiz in previous section (enclosed with the full version)

Simple Quiz on Convertible Bonds – Test Result

This is the Answer Sheet on self testing QUIZ on Convertible bonds. The answers are posted under each question with full explanation. Enjoy your result and improve your Investment skill.

 

Anil Selarka, Author – Camp: San Diego, USA

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