Floating Rate Bond Attracts Mfs

Mutual funds are showing greater interest in floating rate instruments as their cash outflows are dependent on the prevailing interest rates.

The recently launched Rs 17.5 crore rating-linked floating rate bonds of Dewan Housing Finance Ltd was totally mopped up by the country's largest mutual fund, Unit Trust of India.

"As dividend pay-out in debt-based mutual fund schemes are not fixed and varies in line with the interest rate scenario, such debt instruments find fancy with mutual funds as opposed to banks," said Sandeep Bhattacharya, dealer with Darashaw Broking and Investment Banking Company, which structured the instrument for the housing finance company.

Floating rate bonds have failed to enthuse investors as the industry perception points to a decreasing interest rate regime.

Investors have shown preference for fixed rate instruments, as gauged from the floating-cum-fixed bond issues of Maharashtra State Road Development Corporation (MSRDC) and Bharat Petroleum Corporation Ltd (BPCL) in 1999.

In the case of MSRDC, most of the funds went into the fixed portion of the corporation's close to Rs 1,000 crore bond issue.

Similarly, BPCL's Rs 500 crore issue saw the fixed portion being oversubscribed in around two hours, while there were few takers for the floating rate component.

Corporates with higher ratings, however, are increasingly opting to raise funds through floating rate securities. MSRDC opted for a provident fund-linked floating rate instrument. "It makes sense for corporates to get fair rates based on the market conditions," said Bhattacharya.

The coupon on the floating rate bonds of Dewan Housing Finance was linked to government security yields as also to the rating of the instrument. The investor receives a spread over the yield on the benchmark government security, which varies with any change in the ratings of the instrument.

For each change in the rating, the spread over the benchmark changes 25 basis points. "The investor thus benefits with a payout that conforms to market conditions as well as the credit quality of the instrument," he added.

Dewan Housing can thus take advantage of a long-term decreasing interest rate scenario, and need not lock into today's borrowing cost. Moreover, the corporate is rewarded for improvements in its performance and rating with a decrease in its cost of funds.

The tenure of the instrument is 4 years and 11 months. The coupon is pegged at 160 basis points above a benchmark rate, which in this case would be the daily volume weighted simple average of secondary market government yields for government securities with residual maturities between 4.75 years to 5.25 years.