Pocketful

Category: Investing

  • Detailed Guide on Bond Investing: Characteristics, Types, and Factors Explained

    Detailed Guide on Bond Investing: Characteristics, Types, and Factors Explained

    We all must save some money, but if our risk-taking capacity does not allow us to take exposure in equity, then the option of bonds seems viable. 

    Today, we’ll explain what bonds are, how they function, and their kinds.

    Introduction of bonds

    Bonds fall within the category of fixed-income securities. Bonds are debt securities offered by private institutions and federal and state governments to raise funds to cover their costs. An entity issues bonds to investors to raise funds and, in turn, pays “coupon” payments. The payments are based on fixed interest rates, decided at the start of the tenure.

    Investing in bonds

    Characteristics of Bonds

    1. Issuer – Bonds may be issued by both private and public institutions, including business houses, state and federal governments, and municipalities. 
    2. Face Value – Also referred to as the par value or redemption value. It represents the nominal value of security in the eyes of the issuer. This value, along with the interest component, is returned to the investor on the maturity date of the bond. 
    3. Coupon Rate – It is the interest (on face value) paid out periodically to the investor.
    4. Tenure – It relates to the duration of bond issuance; for example, if a bond is issued on January 1, 2020, for a tenure of five years, its maturity date will be January 1, 2025. 
    5. Issuance of Bonds – Bonds are initially issued on the primary market and subsequently traded on the secondary market. 
    6. Ratings – The task of rating the bond based on the company’s creditworthiness is carried out by several credit rating firms that perform a thorough analysis of both the issuer and the bond itself. 
    7. Yield to Maturity (YTM) – YTM is the bond’s internal rate of return (IRR) if the investor holds the bond till maturity.

    Bond issuance process

    1. The borrowing entity prepares a bond indenture that contains all the relevant details, such as the par value, coupon rate, maturity date, tenure, and credit rating.
    2. The bond indenture is then circulated in the primary market to accept applications from investors.
    3. The borrower then regularly pays the coupon amount to the bondholder, and the borrower can default only in case of financial turmoil.
    4. The unallocated applications are returned to the investors, and allocated investors are sent the bond confirmation that acts as proof of lending to the issuer.
    5. The borrower then regularly pays the coupon amount to the bondholder, and only in case of financial turmoil can the borrower default.
    6. At the end of the tenure, the borrower pays the face value of the bond and any accumulated interest.

    Types of Bonds

    Bonds are divided into various groups according to their characteristics. 

    Treasury Bonds

    The central government issues bonds of this kind, with maturities ranging from ten to thirty years. With little to no credit risk, it is considered the safest bond.

    Municipal Bonds

    The municipal or state governments issue these bonds to generate money for the state’s welfare projects. 

    Corporate Bonds

    Corporate entities issue these bonds to generate money for various operational needs. While they often offer greater yields than government bonds, these bonds also carry a higher risk. 

    Zero-Coupon Bonds

    As the name suggests, Zero-coupon bonds do not make periodic coupon payments but pay the entire interest component at the end of the tenure. These bonds are redeemed at face value and are issued at a discount. Thus turning the discount into the interest component of the bond.

    Junk Bonds

    The bonds allocated below BBB rating by credit rating agencies are called Junk bonds. These bonds often provide the highest yield but carry the highest risk. These are generally issued by organizations that are prone to default. 

    Convertible Bonds

    This bond has an option to convert the bonds into stocks. These bonds allow the investor to earn greater returns when the company’s shares increase.

    Callable Bond

    The bond allows the issuer to redeem the callable bonds at a predetermined date before maturity. These bonds protect the borrowers if the interest rate decreases as it allows for refinancing the borrowing at the decreased rates.

    Putable Bond

    This bond allows the bearer to redeem it at a predetermined date before its maturity. This bond protects the holder from an interest rate increase as it allows the holder to sell the bond back to the issuer at a predetermined price.

    Floating Rate Bonds

    These bonds’ interest rates fluctuate in line with the repo rates set by the Reserve Bank of India. 

    Inflation Linked Bonds

    The coupon rates on these bonds are typically higher than the overall economic inflation rates. The coupon payments of these bonds are adjusted to preserve their real worth after adjustment of the inflation rate.

    Perpetual Bonds

    These bonds don’t have a maturity date because the bond’s issuer is not required to pay the par value to the bondholder. As long as they own the bond, the bondholder will continue to receive interest.

    CAT Bonds

    Insurance companies issue CAT bonds, also known as catastrophe bonds, to investors to help them assume the risk of certain calamities like earthquakes and floods. These bonds typically have a high yield as they come with higher risk.

    Capital Gain Bonds

    A select few institutions issue these bonds, allowing them to benefit from capital gains made on selling real estate, including buildings and land, under section 54EC. 

    Advantages of investing in bonds

    1. Regular Income – Bond investments provide consistent income because the bond issuer is expected to make coupon payments regularly. 
    2. Less volatile – Bonds are well-liked by investors with low-risk tolerance since they are relatively less volatile than equity investments but offer greater returns than normal bank FDs.
    3. Diversification – Allocating a portion of the portfolio to fixed-income securities lowers the overall risk. Bonds will continue to yield returns even in an equity market decline.
    4. Capital Preservation – If the company becomes insolvent, bondholders have a higher probability of receiving their principal amount than equity shareholders.
    research on bond investing

    Disadvantages of investing in bonds

    1. Credit Risk – The bondholder must bear the risk of not receiving their payment obligations in the case of default.
    2. Lower Return – Historically, in comparison to equity investing, bonds offer a lower rate of return. 
    3. Reinvestment Risk – Reinvestment risk arises when an investor cannot reinvest the interest at the same YTM rate as when the bond was first issued. Failure to reinvest the coupon at YTM rate would result in a decreased rate of return over the tenure of the bond.
    4. Inflation Risk – Rising inflation over time may cause the purchasing power of bonds, other than inflation-linked bonds, to decline more than equity shares.

    Factors that affect bond prices

    1. Interest Rate – Interest rates and bond prices are inversely correlated. This implies that bond prices may decrease when interest rates rise, and vice versa. 
    2. Maturity Date – When investing in bonds, investors must consider their investment duration. Bonds with longer maturity dates are more sensitive to interest rates, whereas bonds with shorter maturity dates are less sensitive. 
    3. Credit Quality – The price of high credit-rated bonds will rise due to investor demand outpacing that of lower-rated bonds.
    4. Supply and Demand – Bond price will be impacted by supply and demand; if supply is high and demand is low, bond price will be lower, and vice versa.

    Additional factors to be considered

    1. Credit Risk – Risks of issuer not paying the instalments is called Credit Risk. It is advisable to opt for credit-worthy issuers when shortlisting borrowers in order to limit the risk of default. 
    2. Liquidity of Bonds – An investor should consider bonds that provide greater liquidity, which generally exists in credit worthy issues. 
    3. Investment Goal – When choosing which bond to invest in, you should consider your investment horizon, risk tolerance, and investing goal.
    4. Maturity of Bonds – Bonds with shorter maturities are less susceptible to fluctuations in interest rates; conversely, the prices of bonds with longer maturities are more unstable. 
    5. Taxation – Since the interest on bonds is taxable according to the income tax bracket, an investor should think about the tax consequences before investing.

    Conclusion 

    Bonds are typically a good option for risk-averse investors who prefer steady returns on their capital rather than portfolio volatility. It is advisable to do your research to find the right kind of bond to buy because each type has a different risk-reward profile.

    Frequently Asked Questions (FAQs)

    Q1. What is the primary risk affecting corporate bonds?

    Ans. The primary risk connected to corporate bonds is default risk, often known as credit risk.

    Q2. What kind of bond is the safest?

    Ans. Bonds issued by the Government of India are regarded as the safest kind of bonds available in the Indian market.

    Q3. What is the primary distinction between YTM and coupon rate?

    Ans. The Yield To Maturity (YTM) is a bond’s internal rate of return (IRR) if the investor holds the bond till maturity, and the coupon rate is the set interest paid by the bond’s issuer on its face value.

    Q4. Are bond interest payments taxable?
    Ans. Yes, bond interest receipts are taxable according to the investor’s income tax bracket.

    Q5. Is it possible to sell the bond before it matures?
    Ans. Yes, you can sell the bonds on the secondary market before they mature.

    Disclaimer: The securities, funds, and strategies mentioned in this blog are purely for informational purposes and are not recommendations.

  • Sectoral Funds Decoded: Riding the Investment Roller-Coaster

    Sectoral Funds Decoded: Riding the Investment Roller-Coaster

    Imagine sitting on a steep roller-coaster ride, coupled with the fear of a crash. That is the world of sectoral funds!

    If you do not want to end up stranded in the financial cosmos, read today’s blog, in which we will uncover the secrets of sectoral funds and whether they deserve a place in your investment portfolio.

    Overview of Sectoral Funds Decoded

    Sectoral Funds are a type of equity mutual fund that only invests in companies operating within a specific sector or industry of the economy.

    These funds allow the investor to gain concentrated exposure to a particular sector and amplify their returns if that sector outperforms the broader index. However, sectoral funds have increased risks due to a lack of diversification.

    These funds focus on various sectors and industries such as technology, healthcare, consumer staples, financial services, energy, and infrastructure.

    Benefits of Sectoral Funds Decoded

    Sectoral funds can offer tempting advantages to investors. Let us have a look at the benefits of sectoral funds:

    1. When a chosen sector experiences a boom, sectoral funds can outperform diversified funds. Imagine the tech boom of the late 90s; any technology-focused fund would have given incredible returns to investors.
    2. Investing in such a fund offers the investor an opportunity to gain exposure to the sector without analysing each stock within the industry. 
    3. Sectoral funds can be used for tactical portfolio diversification, allowing you to capitalise on short-term trends and sector rotation.

    Risks

    1. Sectoral funds come with a high probability of losses. If the chosen sector underperforms, sectoral funds will suffer as fund managers will not have room for diversification and protecting the capital. 
    2. These funds are inherently more volatile than diversified funds. Therefore, sharp swings in prices/NAVs are more likely to occur.
    3. Understanding the sector dynamics and prospects is essential and complex at the same time before investing. Failure to interpret the sector’s trajectory during the investment horizon could lead to significant losses in the short term. 
    4. In the race to earn benchmark-beating returns, choosing the right sectoral fund, after considering the political, economic, and technological landscape, is highly crucial because making the wrong choice might lead to inadequate returns or even losses in the short and medium term.
    Different sectors

    Performance

    The Covid-19 pandemic sent shockwaves throughout the global economy, and many sectors were impacted differently. Sectoral funds felt the heat too.

    The Sunny Side

    Pharma Funds – As the pandemic raged, demand for healthcare products soared and pharma funds were riding the wave since they delivered consistent returns.

    Technology Funds – With the world shifting online, technology companies thrived. Tech-focused funds witnessed exponential growth because of increased dependence on remote work, communication and entertainment platforms.

    The Dark Side

    If you invested in these sectoral funds, you must have witnessed their consolidation in the past couple of years.

    Technology Funds – The initial sector boom, fuelled by the growth of online platforms and digital transformation, faded away when the economies reopened, and offline activities resumed.

    Compared to their respective benchmark, some top-performing sectoral funds that doubled their returns during the Covid-19 pandemic were not even at par post-Covid.

    As of 23rd February 2024, the broader Nifty 50 index has risen over 91% since November 2020, while the Nifty IT index has risen 82%.

    Pharma Funds – Something similar happened with pharma stocks. During the height of the pandemic, these stocks surged due to increased demand for vaccines, diagnostics, and other medical equipment, eventually leading to better pharma funds’ performance. The demand for medical products flattened once the initial panic subsided and vaccine rollouts progressed. This led to a massive correction in the stock prices of the pharma sector.

    As of 23 February 2024, the broader Nifty 50 index has risen 91% since November 2020, while Nifty Pharma has only given 64% returns.

    Read Also: Decoding Credit Risk Funds In India

    Returns Comparison

    The table below shows the performance of different sectoral funds in the past 4 years relative to their benchmark.

    Technology Sector

    Scheme2023202220212020
    ABSL Digital India Regular35.75-21.6470.4759.03
    SBI Technology Opportunities Regular24.82-15.4666.4347.45
    ICICI Prudential Technology Fund Regular27.45-23.2275.7470.59
    S&P BSE IT TRI28.28-22.7058.4560.05
    *(S&P BSE IT TRI is the benchmark index for technology funds)

    Pharma Sector

    Scheme2023202220212020
    Nippon India Pharma Fund Regular39.15-9.923.9366.44
    SBI HEALTHCARE Opportunities Regular38.24-6.0220.1565.83
    ABSL Pharma and Healthcare Regular37.67-12.6819.5453.84
    S&P BSE Healthcare TRI37.97-11.521.5462.61
    *(S&P BSE Healthcare TRI is the benchmark index for pharma funds) 

    Example

    Let us understand the cycle of sectoral funds with the help of the table.

    Suppose investor A invested in technology and pharma funds during Covid 19. Some of the top-performing funds gave massive returns and significantly outperformed their respective benchmark indices, affirming the beliefs of the investor. The table shows that S&P BSE IT TRI & S&P BSE Healthcare TRI gave a return of 58.45% and 21.54% respectively in the year 2021. 

    However, investor A stayed invested in these funds with the hope of getting more profits. But after the COVID wave subsided, the market witnessed a stark contrast in the performance of both the technology and pharma sector funds, and these funds gave returns of -22.7% & -11.5%, respectively. Thus leading to catastrophic losses.

    This example indicates that sectoral funds concentrate their investments in specific sectors. This concentration leads to their performance moving in tandem with the cyclical nature of the underlying sector. Therefore, the exposure of unsystematic (diversifiable) risk increases substantially.  

    *(The funds mentioned above are for educational purposes only and are not recommendations).

    Read Also: History of Mutual Funds in India

    Conclusion

    After analysing the pros and cons and the recent performance of sectoral funds, the million-dollar question remains: Should you invest? As with most investment decisions, the answer is not a simple ‘yes’ or ‘no’. It depends on your risk tolerance and investment goals. Consider sectoral funds if you are a long-term investor, have a high-risk tolerance, and have a firm conviction in a particular sector. Avoid sectoral funds if you are a short-term and risk-averse investor lacking sector expertise.

    Ultimately, the decision is yours. Sectoral funds can be a powerful tool to maximise wealth, but they also need a deep understanding of the sector-specific risks.

    Frequently Asked Questions (FAQs)

    1. Why should I invest in sectoral funds?

      Sectoral funds offer investors the potential for higher returns (with increased risk). Thus making them a lucrative investment vehicle for those who can take the risk. 

    2. Are sectoral funds right for me?

      The answer depends on your risk tolerance, investment goals, and knowledge of the chosen sector.

    3. Is there a magic formula for picking the right sectoral fund?

      No, there is no guaranteed recipe for success. So, one should evaluate all factors before investing.

    4. Can I time the market with sectoral funds?

      Predicting market trends can be tricky. Therefore, performing self analysis is of utmost importance. 

    5. Can sectoral funds help me get rich quickly?

      Sectoral funds do carry the potential to offer high returns but simultaneously come with amplified risks and volatility. Do not invest in these funds with a get-rich-quick objective!

  • The Art of Value Investing: Meaning and Strategies

    The Art of Value Investing: Meaning and Strategies

    In the hustling world of finance, where trends shift and fortunes change quicker than ever, one strategy stands the test of time and is known as value investing.

    This approach has guided investors to discover gems in the rough for decades. But is value investing still relevant in an age of instant satisfaction and flashy IPOs?

    In today’s blog, we will be analysing the concept of value investing and how to assess a company’s true worth.

    Concept 

    Value investing is an investment philosophy based on buying stocks that are trading below their intrinsic value. Intrinsic value represents the true worth of the company estimated by analysing its fundamentals, such as financial statements, business models, and industry trends.

    The concept of value investing functions on the following principles,

    Undervaluation: 

    Value investors generally look for stocks that are trading less than their intrinsic value and offering a discount.

    Margin of Safety: 

    MoS is when an investor buys below intrinsic value, providing a buffer against unforeseen events and protecting against overpaying.

    Contrarian Approach:

    Value Investors are predisposed to buy stocks out of favour with the market, betting the market will eventually recognise the true value.

    Long-term Investing:

    Focusing on holding stocks for an extended period and waiting for the market to catch up with their intrinsic value.

    Read Also: Intrinsic Value vs Book Value

    Benefits

    1. The core advantage of value investing lies in its ability to control market inefficiencies. Recognising and buying undervalued stocks with a margin of safety can help investors achieve returns that exceed the market average over the long term.
    2. Value investing inherently emphasizes on buying stocks trading below their intrinsic value. This helps create a buffer against downturns, which means that even if the market price falls, it is less likely to fall below the intrinsic value.
    3. Value investors generally prefer companies with strong financial health, stable business models and consistent cash flows. This focus on fundamental strength helps preserve capital by investing in companies with a higher chance of fighting market storms and keeping themselves financially sound.
    4. Value investing encourages a disciplined and research-driven approach to investment in the market. The focus is on fundamental analysis, and emotional decisions based on market sentiments are avoided, eventually preventing investors from getting into impulsive trades.
    5. Additionally, value investors often adopt a contrarian approach, which can lead to significant gains if markets correct their mispricing.
    6. Value investing also offers emotional benefits. Investors can avoid the anxiety and stress linked with reactive trading decisions and short-term market noise by focusing on research and analysis.

    Risks 

    1. The success of value investing hinges on finding market inefficiencies. If the market is truly efficient, recognising undervalued stocks might be difficult.
    2. Value investing demands patience and discipline from the investors. It might take a long time for the market to identify a company’s true value.
    3. Going against the market sentiment and buying unpopular stocks can be emotionally challenging, and investors need to stick to their convictions.
    4. Not every cheap stock is a good investment. Some companies appear undervalued but may have legitimate reasons for low prices, such as poor management, structural decline or hidden liabilities. These value traps can lead to losses and destroy the investor’s confidence if not identified correctly.
    5. Broader economic trends such as regulatory shifts, recession or any industry-specific changes can also impact even the fundamentally strong companies.

    Key Metrics

    Some of the key metrics that an investor needs to look for are as follows.

    Price-to-Earnings Ratio (P/E Ratio)

    This ratio tells us how much an investor would have to pay to own a piece of a company based on how much profit the company makes. A lower P/E ratio indicates that a stock is undervalued as we would have to pay less to gain the profit. However, it is essential to analyse and compare the P/E to the company’s industry average and historical P/E ratios.

    For example, Consider two companies

    Company A

    Stock price – INR 50

    EPS – 5

    PE Ratio – INR 50/5 = 10

    Company B

    Stock Price – INR 100

    EPS – 20

    PE Ratio – INR 100/20 = 5

    Company A is trading at a higher multiple of their earnings. Thus, Company B is undervalued when compared to A. 

    Debt-to-Equity Ratio

    This ratio compares the company’s total debt to its equity. A lower debt-to-equity ratio shows that a company is less risky in financial terms as they don’t have to worry much during reduced margins. 

    For example, consider two companies

    Company A

    Debt – INR 1 lakhs

    Equity – INR 2 lakhs

    Debt-to-Equity Ratio – INR 1 lakhs/ INR 2 lakhs = 0.5

    Company B

    Debt – INR 3 lakhs

    Equity – INR 1 lakhs

    Debt-to-Equity Ratio – INR 3 lakh/INR 1 lakh = 3

    With a Debt-to-Equity ratio of 0.5, Company A has less debt relative to its equity, indicating a more conservative financial structure and low financial risk.

    On the other hand, Company B has a debt-to-equity ratio of 3, reflecting more debt than its equity, indicating a higher financial risk.

    Price-to-Book Ratio (P/B Ratio)

    This ratio compares a company’s stock price to its book value per share. A low P/B ratio indicates that the stock is undervalued.

    For example, consider two companies

    Company A

    Stock Price – INR 20

    Book Value per share – INR 10

    P/B ratio – 20/10 = 2

    Company B

    Stock price – INR 40

    Book value per share – INR 20

    P/B Ratio – 40/20 = 2

    While Company A trades at INR 20, Company B trades at INR 40. B is expensive and overvalued at a superficial level, but after calculating the P/B ratios, they both seem equally valued in the market. 

    Return on Equity (ROE)

    This metric measures a company’s ability to generate profit from the equity of shareholders. Higher ROE indicates a well-organized use of capital.

    Consider a company named ABC Technologies with an income of INR 10 Lakhs and shareholder equity of INR 50 Lakhs.

    ROE – Income/shareholder’s Equity = INR 10 lakhs/INR 50 lakhs = 0.2

    This shows that for every rupee provided by the shareholders, ABC Technologies generates 20% of profit.

    Discounted Cash Flow (DCF)

    This model helps estimate the present value of the company’s future cash flow, allowing investors to analyse the stock’s intrinsic value.

    For example, to estimate a company’s intrinsic value using a DCF model, an investor needs to forecast the future cash flows, which is the core part of the model, and to forecast the future cash flow, an investor first needs to.

    • Project financial statements by analysing historical track records.
    • Use applicable assumptions to predict Cash Flows for coming years and estimate the terminal value of the company using different methods.
    • Then, determine the appropriate discount rate to reflect the risk linked with the company and the projected cash flows.
    • Now, the investor can use the chosen discount rate to bring each year’s forecasted Cash Flows back to its present value (PV) and then add the PV of all the future cash flows to arrive at the present value of all future cash flows.
    • Add the present value of the terminal value to the present value of free cash flows to get the estimated intrinsic value.

    *(Remember that real-world DCF models involve complex adjustments and calculations).

    PEG Ratio

    This ratio compares the company’s P/E ratio to its expected earnings growth rate. A lower PEG ratio indicates that a stock is undervalued relative to its growth potential.

    For example, Consider 2 companies

    Company A

    P/E Ratio – 20

    Expected EPS growth rate – 10 %

    PEG Ratio – 20/10 = 2

    Company B

    P/E Ratio – 15

    Expected EPS growth rate – 5%

    PEG Ratio – 15/5 = 3

    A PEG ratio closer to 1 indicates undervaluation relative to the company’s growth potential (like company A).

    Additional Tips for Value Investing

    1. Do not choose cheap stocks, look for quality companies with strong financials that are trading at a discount.
    2. Understand and analyse the company’s business model and competitive landscape before investing.
    3. It may take time for the market to identify the worth of an undervalued company. So, patience and confidence in our choices are extremely important.

    Value Investing v.s. Growth Investing

    1. Value investing seeks stocks currently trading below their intrinsic value, whereas growth investing seeks stocks with high growth potential, irrespective of the current valuation.
    2. Value investing uses fundamental analysis, including metrics like P/E ratio, P/B ratio, etc., while growth investing uses growth metrics like revenue and sales growth, market share, etc.
    3. The former is used for longer time-frames and needs patience, while the latter can be used in medium timeframes.
    4. Features of value investing include reduced downside risk and capital preservation, whereas features of growth investing include the potential for significant returns with comparatively higher risk.

    Value Investing for Beginners

    1. Grasp the core principles and understand the philosophy of value investing along with the metrics used to identify them.
    2. Make financial statements a friend and analyse the industry trends carefully.
    3. Beginners should avoid making impulsive decisions and should stick to their investment goals.

    Read Also: Explainer on Cigar Butt Investing: Features, Advantages, Limitations, and Suitability Explained

    Conclusion

    To wrap it up, only invest money you can afford to lose because past returns do not guarantee future success, and not every cheap stock is a good investment. Value investing isn’t a get-rich-quick scheme fuelled by speculation. Instead, it is a research-driven approach built on patience and deep fundamental analysis.

    Frequently Asked Questions (FAQs)

    1. Why should I consider value investing?

      Value investing focuses on strong fundamentals and protects from market downtrends.

    2. Isn’t the concept of value investing outdated in the fast-paced market?

      No, because value investing helps you discover undervalued gems.

    3. Is value investing risky?

      Remember that every investment comes with a risk. Every investor needs to focus on thorough research and diversification of their portfolio.

    4. How do I get started with value investing?

      Practice fundamental analysis and gradually add individual stocks to your portfolio while analysing their trends.

    5. Is value investing right for me?

      It depends on your specific risk tolerance and investment goals.

  • From Private to Public: Decoding the IPO Journey

    From Private to Public: Decoding the IPO Journey

    Visualize this – your once close-knit company, fostered in privacy, is about to step into the arena of the stock exchange. But the path from privacy haven to public spectacle is filled with complex steps and informed decisions.

    In today’s blog, we will discover a company’s journey from private to public. This blog will serve as a roadmap to your guide to the IPO procedure.

    What is an IPO?

    IPO stands for Initial Public Offering. It refers to the process when a private company first sells its shares to the public on the stock exchange. This transforms the company from being privately owned to publicly owned.

    Going public through an IPO can be a transformative affair for the company. However, the journey is complex and demands careful planning and execution.

    Let’s delve into the key stages of the exciting voyage.

    When the company makes its first IPO to the public, the money flows to the company as its share capital and the new shareholders become owners of the company. However, these company shareholders are free to exit their investment anytime.

    But before investing in an IPO an investor should keep in mind that not all companies that go public are successful. Some IPOs flop and the company’s stock price might fall after listing.

    IPOs can be either SME or Mainboard. Let us have a brief overview.

    SME IPO

    An SME IPO is a process through which small and medium-sized enterprises (SMEs) can raise funds from the public by issuing shares. SME IPOs are listed on a stock exchange such as BSE, SME, or NSE Emerge.

    Eligibility Criteria for an SME IPO

    1. The company should be a Small and Medium Enterprise as defined by the Ministry of Micro, Small and Medium Enterprises (MSME).
    2. The company should have a minimum post-issue paid-up capital of INR 1 crore and a maximum of INR 25 crore.
    3. The company should have a good track record of profits for the last 3 years.
    4. All SME IPOs should be 100% underwritten* and merchant bankers must underwrite at least 15% of the shares of the SME IPO company.

    Note – An underwriter is a professional or institution who analyses and assumes another party’s risk for a fee. Underwriting is a process through which an individual or institution determines and evaluates the risk of a financial agreement.

    Mainboard IPO

    A mainboard IPO is also known as a mainline IPO. As the name suggests, it is the process by which a large and established company offers its shares to the public for the first time.

    Eligibility Criteria for Mainboard IPO

    1. The company should have a minimum post-issue-paid-up capital of INR 10 crore.
    2. The company should have a good financial track record with profitable business operations.
    3. Underwriting is not necessary for a mainboard IPO. However, at least 50% of shares must be subscribed by the qualified institutional buyers (QIB).

    Note – QIB or Qualified Institutional Investors are a class of investors with a higher level of financial resources and expertise that meet specific criteria decided by the Securities and Exchange Board of India.

    Read Also: Best Smallcap IT Stocks List in India

    Steps to take a company public

    1. The company evaluates its willingness to go public and considers factors like financial statements, growth potential, regulatory compliance and market conditions
    2. The company needs to partner with experienced advisors that include merchant/investment bankers, lawyers, chartered accountants and public relations specialists.
    3. The next step is filing the IPO with SEBI, the company drafts the prospectus, a detailed document that is subject to regulatory analysis and outlines the company’s financials, business model, risks, management and promoter details, objects of the issue, capital structure, and dispute, if any.
    4. The company starts a series of presentations for investors showing its value proposition and growth outlook which is also known as a roadshow.
    5. A method called Price discovery is used to find the stock’s price based on demand of the IPO. There are two modes of price discovery, which are explained later.
    6. Your company then officially hits the stock exchange.

    Price Discovery

    Fixed Price Issue 

    In the case of a fixed price, the issue price is already selected by the company along with the merchant banker and printed in the offer document before the IPO, and no price discovery mechanism is used.

    Note – A merchant banker is a financial institution or an individual who provides a range of services including advisory, capital raising etc. to corporations and governments.

    Stages of Fixed Price Issue

    • The issuer company collaborates with SEBI-registered intermediaries except for an underwriter.
    • The lead manager then files a draft red herring prospectus (DRHP) with the SEBI/Stock Exchange.
    • After the successful approval from the SEBI and stock exchange, the issue price and issue period are determined.
    • The prospectus is then filed with the Registrar of Companies (ROC).
    • Once the issue opens, the investor submits an application form to the intermediary for uploading on the stock exchange platform.
    • The issue closes and all the important compliances related to the issue are completed. Securities are finally allocated to the investors at the fixed offer price.

    Book-Building Issue 

    Book Building Process is the more common mode of IPO. Book-building is a process to determine the final price at which the securities will be offered to the public.

    Stages in Book-Building

    • Company planning to go public appoints the lead merchant bankers as Book Runners. These banks play an important role in the book-building and ensuring a successful offering.
    • Investors give their bids to underwriters specifying the quantity of shares.
    • Underwriters then input the orders in the electronic book through bidding. The book normally remains open for 5 days.
    • The book-running lead managers (BRLM) analyse the bids received and determine the demand at multiple price levels to find the price at which the maximum number of shares can be sold.

    Note – BRLM or book-running lead managers play a pivotal role in the IPO procedure. BRLMs conducts due diligence on behalf of the company which involves in-depth analysis of company financials, operations and legal compliance and also helps in setting the offer price.

    • The issuer company with the help of book-running lead managers decides on a price band in which investors can bid. The minimum price at which bids can be made is known as the floor price
    • Once the bidding period ends, the book is closed and no more bids are accepted.
    • Depending on the bids received and the price discovered the lead managers allocate shares after determining the final price.

    Benefits of IPO

    An IPO can offer various benefits to both the company and the investor.

    For Companies

    • Helps in raising capital to fund growth initiatives, capital expenditures, acquire other companies, loan repayment and brand awareness.
    • Going public allows the shareholders to trade shares on the stock exchange providing liquidity and gains.
    • A successful IPO listing can boost a company’s reputation and credibility which will eventually attract new customers.

    For Investors

    • Adding IPOs to an investment portfolio will help in diversification.
    • IPOs offer the opportunity to invest in companies with promising growth potential before they are widely available in the stock market.

    IPO v.s. Private Funding

    Private funding refers to raising capital for a company from non-public sources, in exchange for equity in the company. It is completely in contrast to public funding which comes from selling shares of the company to the general public through an IPO.

    Sources of private funding include firms that invest in early-stage companies with the potential for high returns.

    1. Angel investors or wealthy investors who invest in companies at their nascent stage.
    2. Private equity firms, debt financing such as bank loans, crowdfunding i.e., raising smaller amounts of capital online from many individual investors.

    Private funding is a suitable option for companies seeking moderate capital for initial growth or specific projects or partnerships with investors who share their vision.

    However, the ideal option depends on the company’s goals and stage of development. If the company needs substantial capital for immediate expansion and is comfortable with public analysis, an IPO might be suitable and if a company emphasises flexibility and control, private funding can be a better fit.

    Key Considerations for IPO

    Launching an IPO is a thrilling journey and demands careful consideration of several factors.

    Some of the key considerations are listed below.

    1. Ensure that the company has a strong financial track record with audited statements. Investors will analyse the financial performance, revenue, and other financial metrics before investing.
    2. Analysis of ongoing market conditions such as the industry trends and the other upcoming IPOs. Favourable market conditions can increase the chances of a successful debut.
    3. Clearly express the company’s business model because the investor seeks companies with a compelling story and clear path to future growth.
    4. Ensure compliance with all relevant legal and regulatory requirements including corporate governance standards, working with legal advisors, etc.
    5. Investors evaluate the leadership team’s track record. Hence, the companies should have a capable and experienced management team.
    6. Develop a comprehensive investor relations strategy which includes communication plans, investor education and fostering positive relationships with the investment committee.
    7. Choose underwriters with good reputations and expertise. Underwriters play an important role in smoothing the IPO procedure.
    8. Conduct a thorough risk analysis and disclose the potential risks to the investors. Transparent communication about risks will validate a commitment.

    Read Also: What is Grey Market Premium (GMP) in IPOs?

    Conclusion

    The journey from a private company to a public company through an IPO is indeed fascinating, and filled with zeal and strategic decisions. By carefully considering the various aspects and seeking professional supervision, the IPO procedure can influence the power of public markets because an IPO is just the beginning, sustainable growth, and value creation are important for long-term success in the public eye.

    Frequently Asked Questions (FAQs)

    1. How long does an IPO generally take?

      The average timeline for an IPO is generally 6 to 12 months. Although it can vary depending on company size and complexity.

    2. What are the major costs involved in an IPO?

      Investment banking fees, legal fees, accounting and auditing fees, filing and exchange listing fees, and advertising expenses.

    3. How can I invest in an IPO?

      Participate in retail allotments by the company through your bank or buy shares on the open market listing.

    4. What happens to employees’ shares after an IPO?

      It depends upon agreements and company policies. Some employees may receive restricted stock units or employee stock options.

    5. What happens to the money raised in an IPO?

      The company may use the fund for debt repayment, capital expenditure, or research and development.  

  • IPO Alert: Entero Healthcare Solutions Limited (EHSL)

    IPO Alert: Entero Healthcare Solutions Limited (EHSL)

    The Indian healthcare industry is booming, and in this dynamic landscape, EHSL has emerged as a major player in healthcare product distribution. The ongoing IPO subscription has drawn significant attention from investors and has sparked questions about their growth potential in the highly competitive market.

    In today’s blog, we will explore the company and dive deep into the business model and the key IPO details. 

    Company Overview

    The company was incorporated on January 10, 2018, as Entero Healthcare Solutions Private Limited by Prabhat Agarwal and Prem Sethi to create an organised, technology-driven, pan-India distribution platform for integrated healthcare products.

    Entero is one of India’s largest and fastest-growing healthcare distribution platforms, with an operational presence across 495 districts through physical warehouses in 37 cities in 19 states and union territories.

    Over the Financial Years 2021 to 2023, the company saw consistent growth, initially serving 39,500 retail and 1,600 hospital customers. By 2022, these numbers rose to 64,200 and 2,500, respectively. Furthermore, in 2023, they expanded their reach to 81,400 retail and 3,400 hospital customers, illustrating a steady increase in customer engagement.

    Currently, the company operates in cities like Amritsar, Dehradun, Lucknow, Gurgaon, Jaipur, Guwahati, Hyderabad, Bombay etc. 

    IPO Details

    1. Entero Healthcare Solutions is a book-built issue of INR 1600 crore. 
    2. The issue is a combination of a fresh issue of 1000 crore shares and an Offer For Sale (OFS) of 600 crore.
    3. The bidding for the IPO opened for subscription on February 9, 2024, and will close on February 13, 2024.
    4. The allotment is expected to be finalised on Wednesday, February 14, 2024.
    5. The temporary listed date is fixed as Friday, February 16, 2024, with a price band of INR 1195 to INR 1258 per share.
    6. The minimum lot size for an application is 11 shares with a minimum investment amount for retail investors standing at INR 13,838.
    7. The issue includes a reservation of up to 70,625 shares for employees offered at a discount of Rs 119 to the issue price.
    8. The company will utilise the IPO proceeds from the fresh issue.
    • To partially or fully repay or prepay the borrowed amount.
    • Fulfill the working capital requirements.
    • General corporate purposes.
    1. ICICI Securities, JM Financial, and Jefferies India Private Limited are the book-running lead managers.
    IPO DateFebruary 9, 2024 to February 13, 2024
    Expected Listing Date16th February, 2024
    Price BandINR 1195 to INR 1258
    Total Issue Size1,27,18,600 shares
    Employee DiscountINR 119 per share
    Listing atBSE and NSE
    IPO TypeMainboard IPO
    Issue TypeBook-Built Issue
    Initiation of refundsThursday, February 15, 2024

    Business Model

    The company operates under the two lines of business. 

    1. Primary Business

    It involves distribution of healthcare products to retail pharmacies, hospitals, and healthcare clinics in India.

    The company periodically buys the products in bulk from product manufacturers and then curates and offers a diverse product portfolio to retail pharmacies, hospitals, and healthcare clinics based on their requirements through its distribution network.

    Healthcare Product Distribution – provide distribution and logistics services for healthcare products to retail pharmacies, hospitals and healthcare clinics in India. Such products are sourced from healthcare product manufacturers and sold to pharmacies, hospitals and clinics at margins over the cost of the products. The product range offered includes pharmaceutical products, medical devices, surgical consumables, OTC, nutraceuticals and vaccines.

    Furthermore, the healthcare products distribution channel consists of retail distribution and hospital distribution. 

    Retail Distribution – the company’s retail distribution channel involves distributing healthcare products to pharmacies, who then sell these products to end customers. Supply a wide range of healthcare products, including pharmaceutical, nutraceutical OTC products, and medical devices, to pharmacies through a distribution network. 

    Hospital Distribution – EHSL distributes healthcare products to hospitals and healthcare clinics across India through the hospital distribution channel . The prices of the products are pre-determined in the contract between the hospitals and the suppliers.

    Entero also supplies healthcare products to customers based on their orders, which are placed through the Entero Direct application or other order-taking applications or which have been communicated through salespeople or call centre representatives.

    2. Ancillary Business

    The segment can be broadly categorised into 2 further classifications.

    1. The provision of complete and integrated commercial solutions, including sales, marketing and supply chain solutions to pharmaceutical companies and healthcare product manufacturers.
    2. The sale of private label products and medical devices under their private label, Entero Surgicals.

    Private Label Products 

    Entero Surgical comprises brands such as Carent, Entros, Entair, Safent and Glovent. The product categories under the private label products business entail homecare medical devices, surgical consumables, and rehabilitation products and devices. Furthermore, key private-label products include nebulizers, hygiene and surgical consumable products, homecare medical devices, gloves and mobility equipment.

    Read Also: How to Cancel Mutual Fund SIP?

    Future Outlook

    The Indian healthcare market is expected to grow significantly in the coming years, driven by several factors like rising disposable income, increasing awareness about healthcare and an ageing population. Entero is well-positioned to capitalise on this growth with its strong business model, vast network and technology focus. 

    As of FY23, Entero Healthcare had a market share of 1.24% while making a revenue of 3,300.2 Crores. This indicates that the potential for growth is huge, and the company is poised for success if it continues to provide value to the end consumer.


    Financial Highlights

    ParticularsAs of March 31, 2023 (FY23)As of March 31, 2022 (FY22)As of March 31, 2021 (FY21)
    Total Assets1,308.731,125.98833.79 
    Total Liabilities711.07562.77346.73 
    Total Borrowings342.45247.90141.70 
    Revenue3,305.722,526.551,783.67
    Net Profit/(Loss)-11.10-29.44-15.35 
    Revenue from Operations3,300.212,522.071,779.74 
    Expenses3,309.412,546.361,794.51 
    EBITDA21.5524.4464.01 
    EBITDA Margin1.21%0.97%    1.94%
    ROCE1.88%1.49%6.05%
    Note – In Crores, unless stated otherwise

    EHSL has shown impressive revenue growth, which indicates a healthy financial track record, and its turnaround from losses, which have narrowed over the past three years, highlights improvement. The debt level might be a concern, but the company seems to be managing it effectively.

    Strengths

    1. Benefit of consolidation – The company operates in a large and highly fragmented Indian healthcare products distribution market. This could prove beneficial for EHSL if they can consolidate such a fragmented industry.
    2. Growth – Entero is one of India’s largest and fastest-growing healthcare product distribution platforms with a major focus on network expansion and cost efficiency, catering to the needs of a wide range of customers.
    3. Large reach – In a matter of just 4 years, EHSL has reached 37 cities and employs 3040+ people. This indicates that it is no longer a small player. 
    4. Industry growth – The healthcare market in India is expected to grow at 11% p.a. in the next 5 years. This opens up a long list of opportunities for EHSL to grow. 

    Risks

    1. High short-term borrowing – The majority of EHSL’s borrowing exists for the short term. This may not be a good sign, as failure to meet these payments could be catastrophic for the company. 
    2. Competition –  There are many players in the industry, and any of the behemoths can enter the industry and cause substantial damage to the bottom line figures. 
    3. Negative Cash Flows – Historically, the company has had negative cash flows, and this trend could continue for some more years. 

    Awards & Recognitions

    • ‘Best Healthcare Brand of 2021’ – Economic Times
    • ‘Outstanding Performance’ Award for FY 2022-23 – Mankind Ltd.
    • ‘Outstanding Performance’ – JB Chemicals Ltd.
    • Recognised as ‘Maximiser 2022’ by Pfizer for improving access to quality medicine.
    • Received ‘Outstanding Contribution’ Award – Alkem Laboratories Ltd.

    Read Also: Rashi Peripherals Limited: IPO Analysis

    Conclusion

    Entero Healthcare Solutions boasts rapid growth, a sizable customer base and a well-established distribution network. The company’s turnaround from losses to profitability (11.6 Crores in 2Q24) highlights financial improvement over the years. 

    It is important to consider the risks and uncertainties before drawing any definite conclusions. The performance of the stock after listing will depend on various factors, including the overall market conditions and Entero’s competitive landscape. It is important to conduct your research and analysis before investing in any IPO.

    Frequently Answered Questions (FAQs)

    1. What is the expected use of proceeds from the IPO?

      The proceeds from the IPO will be used to repay the borrowings and fulfill the working capital requirements.

    2. Who are the major competitors of the EHSL?

      The company faces tough competition from Mankind Pharma, Max Healthcare, and Apollo Pharmacy.

    3. What is the minimum investment amount for the IPO?

      The minimum lot size is 11 shares, with an investment amount of INR 13,838.

    4. What are the risks of investing in EHSL?

      Some analysts consider the pricing aggressive, and the company has a relatively short track record compared to other established players.

    5. Should I invest in EHSL?

      This depends on your individual risk tolerance and investment goals, and do your research before investing.

  • IPO Alert – Capital Small Finance Bank

    IPO Alert – Capital Small Finance Bank

    India’s investor community has come a long way from investing in bank fixed deposits to participating in initial public offerings (IPOs), a relatively riskier alternative. Initially, people hesitated to invest even in a renowned company, but nowadays, they are actively interested in initial public offerings (IPOs).

    You would be surprised to hear that in 2022, the Indian stock market reported the third-highest number of initial public offerings (IPOs) globally. Additionally, India saw several fantastic initial public offerings (IPOs) in 2023, some of which allowed investors to earn over 90% in listing gains!

    In today’s blog, we will explore another IPO, Capital Small Finance Bank.

    If you haven’t read our blog on Jana Small Finance IPO, click here to check it out. 

    Overview of the company

    Initially founded as Capital Local Area Bank(CLAB), Capital Small Finance Bank mostly operated in Punjab. With RBI’s approval on April 24, 2016, it became India’s first small finance.

    In February 2017, it received the designation of a ‘scheduled bank’ (these banks get access to low-interest loans from RBI), which allowed it to increase its lending and borrowing capabilities.

    Capital Small Finance Bank started its business operations with 39 branches but currently operate around 1000 branches in the country. 

    Promoters

    The Samara Family is in charge of the Capital Small Finance Bank, and Mr Sarvjit Singh Samra serves as both the institution’s managing director and CEO. In the year 2000, he was instrumental in the founding of Capital Local Area Bank.

    Dinesh Gupta, Amarjit Singh Samara, Navneet Kaur Samara, and Surinder Singh Samara are other family members who are regarded as promoters.

    The promoters group holds approximately 24% of Capital Small Finance Bank Shares.

    Details of the issue

    Capital Small Finance Bank is proposing an IPO of Rs. 523.07 crore. The IPO consists of an offer for sale of 73.07 crore and a fresh issue of Rs. 450 crore.

    The Capital Small Finance Bank IPO is open to the public from February 7 to February 9, 2024. The shares will be allotted in full on February 12th, 2024, with a listing date of February 14th on the NSE and BSE.

    Timeline of the IPO

    IPO Open Date7th Feb 2024
    IPO Close Date9th Feb 2024
    Finalization of Allotment12th Feb 2024
    Initiation of Refund13th Feb 2024
    Credit of Shares into a Demat Account13th Feb 2024
    Listing Date on NSE & BSE14th Feb 2024

    Details of the IPO

    Face Value of ShareRs. 10
    Price BandRs. 445 – 468 per share
    Market Lot32 Shares
    Total Issue SizeRs. 523.07 Crores
    Total Number of Shares1,11,76,713 shares
    Fresh Issue SizeRs. 450 Crore
    Offer for SaleRs. 73.07 Crore
    Listing ExchangeNSE & BSE

    Objective of the Issue

    The main objective of Capital Small Finance Bank is to use the funds from the offering to meet the bank’s projected future capital needs, and the issue costs may also be covered using the money that was raised.

    IPO Allotment Size

    The table below displays the minimum and maximum number of shares that an investor is eligible to apply for.

    ApplicantMarket LotShareAmount
    Retailer (Min)13214,976
    Retailer (Max)134161,94,668
    Small High Net Worth Individual (Min)14448209,664
    Small High Net Worth Individual (Max)662,1129,88,416
    Ultra High Net Worth Individual (Min)672,14410,03,392

    The aforementioned figures showcase that a retail investor can invest a minimum of INR 14,976 rupees and a maximum of INR 1,94,668. 

    Lead Managers

    Equirus Capital Private Limited, DAM Capital Advisors Limited, and Navuma Wealth Management Limited are the firms in charge of managing the Capital Small Finance Bank IPO procedure.

    Read Also: IPO Alert: Jana Small Finance Bank

    Financial Highlights of Capital Small Finance Bank (In crores, unless stated otherwise)

    Particulars31 Mar 202331 Mar 202231 Mar 2021
    Assets7,990.777,153.926,371.24
    Revenue725.48632.40557.27
    Profit After Tax93.6062.5740.78
    Reserve & Surplus576.36481.74416.88
    Total Borrowings721.38498.43616.72
    Capital Adequacy Ratio – Total Capital (CRAR) (%)18.87%18.63%19.8%
    Net NPA (NNPA) (%)1.36%1.36&1.13%
    Net Interest Margin (NIM) (%)4.19%3.74%3.36%
    CASA Ratio (%)41.88%42.16%40.08%

    Both the revenue and the assets have significantly improved which suggests that the bank is operating profitably. Additionally, not only did the bank’s clients increase, but the profit after tax also rose by almost 50% y-o-y in FY23.

    The CASA ratio indicates that the bank has access to a stable and consistent source of cheap money as interest rates on Savings and Current account holdings are much lower than traditional borrowings. 

    The Net NPA ratio showcases the bank’s efficiency in providing loans only to credit-worthy individuals and institutions. A consistent rate of 1.3% is much lower than the industry average of 3-4%.

    A healthy NIM of around 4% indicates stability even in an environment where all major banks saw a decrease in NIM.

    Additional Key Performance Indicators (KPIs) 

    ROE – Capital Small Finance Bank’s return on equity ratio rose to 16.62% in FY23 from 12.95% in FY22.

    RoE is the ratio of profit after tax to average net worth.

    EPS – Capital Small Finance Bank’s earnings per share rose to 27.35 in FY23 and 18.41 in FY22. 

    This crucial financial ratio establishes the company’s profitability. It is computed by dividing net income by the total number of outstanding shares of the corporation.

    P/E Ratio – Currently, the price-to-earnings ratio stands in the range of 16.27 to 17.11, based on the lower and upper end of the price band. 

    The amount an investor is willing to pay for a single share of a company for one rupee of its earnings is referred to as the PE ratio.

    Risks

    1. Competition – The small finance banking industry is extremely competitive, with many players entering the market and even getting into the public domain via launching IPOs. This may cause some serious issues as fierce competition leads to decreased margins and market share.
    2. Negative Cash Flow – The bank has a history of having negative cash flow from operating activities. In FY23, CFO stood at -107.44 Crores, and in FY22, CFO was -210.74 Crores. The bank’s inability to generate positive cash flow from a money-making business like banking could be indicative of deeper inefficiencies that are more qualitative than quantitative. 
    3. High attrition rate – In FY23, the bank faced an attrition rate of 19.82%. This is extremely high and showcases the dissatisfaction among the workforce. This could translate into decreased margins in the coming years. 
    4. RBI Crackdown impending – As of now, the small finance banking industry has been allowed many relaxed requirements that other banks have to face. If RBI decides to take some of those relaxations away, then it could dramatically affect the margins of these banks. 
    5. Geographical concentration – As of FY23, 87% of the branches were in Punjab and 96.44% of deposits came from the region. This could be indicative of the bank’s unwillingness to expand beyond Punjab, to other regions of the country. 

    Read Also: Small Finance Bank Share List in India 2025

    Conclusion

    Investors have a fantastic opportunity to access a bank with a strong and profitable track record in the market through the initial public offering (IPO). Currently, the bank offers a varied loan portfolio with robust growth in both revenue and margin over the years.

    Investing in initial public offerings (IPOs) involves conducting extensive research on the regularities that the companies must meet. 

    The suitability of investment in an IPO depends on an individual’s risk horizon and financial objective. So, you must do your research before investing! 

    Frequently Asked Questions (FAQs)

    1. How can I participate in the Capital Small Finance Bank IPO?

      You can participate in Capital Small Finance Bank IPO through your demat account via ASBA (Application Supported by Blocked Amount) or UPI (through the broker).

    2. What will happen after I subscribe for the IPO?

      Shares are listed on the exchange after you subscribe for the initial public offering (IPO), at which point you can purchase and/or sell shares.

    3. Does the bank have enough capital to support its deposits/liabilities in case of emergency?

      The Capital Adequacy ratio, as prescribed by RBI, has to be above 15% for Small finance banks, and the Capital Small finance bank has consistently beaten this requirement by at least 3%. 

    4. What is the issue price of the Capital Small Finance Bank IPO?

      The price band of Capital Small Finance Bank IPO is 445 to 468 INR.

    5. Why is Capital Small Finance Bank going public?

      Capital Small Finance is going public to meet capital requirements.

  • IPO Alert: Jana Small Finance Bank

    IPO Alert: Jana Small Finance Bank

    If you are someone who is curious about investing in IPOs, fasten your seat belt because we are back again with another IPO study!

    In this blog, we will explore the details of Jana Small Finance Bank IPO, which is all set to hit the Indian stock exchange on 14th February 2024.

    Jana Small Finance Bank Overview

    Before its establishment in 2006, Jana Small Finance Bank Limited was known as Janalakshmi Financial Services. It offered Micro, Small and Medium Enterprises (MSME) loans, affordable housing loans, term loans, fixed deposit loans, two-wheeler loans, and gold loans.

    In 2017, the Reserve Bank of India (RBI) granted Janalakshmi Financial Services a license to become a Small Finance Bank (SFB), enabling it to provide a broader range of financial products.

    SFBs are a new entrant into the banking system established to provide essential banking services to MSMEs, Shopkeepers, Farmers, etc. Recently, SFBs have witnessed a rapid growth in terms of deposits and branches.

    In terms of AUM and deposit size, Jana Small Finance Bank ranks as the fourth-largest small finance bank. Additionally, it has 771 banking outlets including 278 in unbanked rural centers. Thus serving more than 4.87 million active clients. The company is run by 18,184 permanent employees.

    Promoters

    The promoters of Jana Small Finance Bank are Jana Holdings Limited, Jana Capital Limited, and Jana Urban Foundation (which was previously known as Jana Social Services).

    Details of the IPO

    Jana Small Finance Bank IPO’s issue size is INR 570 crore, through a book-building issue. The IPO is a combination of a fresh issue and an offer for sale; the fresh issue consists of about INR 462 crores whereas, the offer for sale consists of INR 108 crores.

    The IPO’s subscription period will begin on February 7th, 2024, and will end on February 9th, 2024.

    Timeline of the IPO

    IPO Open Date7th Feb 2024
    IPO Close Date9th Feb 2024
    Finalisation of Allotment12th Feb 2024
    Initiation of Refund (in case of no allotment)13th Feb 2024
    The credit of shares into Demat Account (in case of allotment)13th Feb 2024
    Listing Date on NSE & BSE (tentative)14th Feb 2024

    The objective of the Issue

    The goal of Jana Small Finance Bank’s IPO is to use the proceeds to cover the bank’s anticipated future capital needs. The raised capital can also be used to cover the cost of the issue.

    Key details of the IPO

    Face Value of ShareRs. 10
    Price BandRs. 393 – Rs. 414 per share
    Market Lot36 Shares
    Total Issue SizeRs. 570 Crores
    Total Number of Shares13,768,049 shares
    Fresh Issue SizeRs. 462 Crore
    Offer for SaleRs. 108 Crore
    Listing ExchangeNSE & BSE

    Allotment Size

    The market lot of Jana Small Finance Bank IPO is 36 Shares. The minimum and maximum number of shares that an investor can apply for are shown in the table below.

    ApplicantMarket Lot(s)SharesAmount (Rs.)
    Retailer (Min)13614,904
    Retailer (Max)134681,93,752
    Small High Net Worth Individual (Min)145042,08,656
    Small High Net Worth Individual (Max)6724129,98,568
    Ultra-High Net Worth Individual (Min)68244810,13,172

    The figures above showcase that a retail investor can invest as little as INR 14,904 rupees and as much as INR 1,93,752 at maximum.

    Read Also: Small Finance Bank Share List in India 2025

    Financial Highlights of Jana Small Finance Bank

    Have a look at the key Financial metrics of the company (in Crores, unless stated otherwise).

    ParticularsFY 2023FY 2022FY 2021
    Total Assets25,64420,18919,079
    Revenue3,7003,0622,721
    Profit After Tax (PAT)25617.4772
    Net Worth1,7771,1851,101
    Reserves & Surplus1,472999914
    Total Borrowings6,2774,5094,815
    Total Capital Ratio (CRAR) (%)15.57%15.26%15.51%
    Tier 1 Capital Ratio (%)13.02%11.83%11.75%
    Net Non-Performing Assets (NPA) (%)2.64%3.95%5.33%
    Net Interest Margin (NIM) (%)7.73%7.32%8.36%
    CASA Ratio# (%)20.21%22.52%16.29%
    Source – Prospectus

    # – CASA Ratio is the ratio of current and savings account deposits to total deposits. It tells us the percentage of deposits that are low-cost access to banks as interest in these accounts is lower than in other deposits such as Fixed Deposits.

    The financial data makes it evident that profit after taxes has improved over the years, and NPAs have reduced substantially. Both assets and borrowings have increased with a significant increase in revenue. It is indicative of sound fundamentals.

    But, the NIM and CASA ratios tell a different story. The NIM of small finance banks are generally higher than other banks, and Jana SFB’s competitor, Ujjivan SFB, is averaging 9% NIM in these markets. The CASA ratio also does not paint a rosy picture of the bank’s operations. The industry standard ranges at north of 25%, but Jana SFB is unable to achieve these ratios. Also, the CRAR has a trend of barely meeting the guideline of 15% for small finance banks.

    Additional Ratios

    ROAE – ROAE or Return on Average Equity is calculated as the net profit for the relevant period to Average Net Worth for the relevant period, expressed as a percentage.

    Jana SFB’s ROAE as now is 16.78%.

    P/BV – Price to book value represents the price divided by book value or how much an investor is willing to pay for the company over book value.

    Price to book value or P/BV ratio is 1.28 for Jana Small Finance Bank.

    EPS – Earnings per share, or EPS, is the total earnings a shareholder has earned. It is computed by dividing the business’s profit after tax by the number of outstanding shares.

    Jana Small Finance Bank’s Basic EPS stands at 47.47.

    P/E Ratio – The relationship between the stock price and earnings per share is known as the company’s price-to-earnings ratio.

    According to the price range of IPO, Jana Small Finance Bank would have a PE Ratio of 8.28 – 8.72.

    Read Also: IPO Alert – Capital Small Finance Bank

    Conclusion

    The growing network of Jana Small Finance Bank may pose a threat to the current small financing banks. The Jana Small Finance Bank’s primary goal is to empower individuals and small businesses.

    Before taking into consideration the above-mentioned IPO of Jana Small Finance Bank, remember to consult your financial advisor. Keep in mind that the suitability of investment in IPOs completely depends on your investment horizon and risk profile.

    Frequently Asked Questions (FAQs)

    1. What is the issue price of Jana Small Finance Bank IPO?

      The price band of Jana Small Finance Bank IPO is INR 393 to 414.

    2. What will be the issue size of the Jana Small Finance Bank IPO?

      The issue size of Jana Small Finance Bank IPO is 570 crore.

    3. What is the minimum investment amount for retail investors?

      The minimum investment amount for a retail investor to invest in Jana Small Finance Bank IPO is INR 14,148 (at the lower end of the price range).

    4. Can Jana Small Finance Bank successfully expand its operations?

      With rural areas exhibiting lower financial inclusion rates than urban areas and facing less competition in banking services, it seems Jana Small Finance Bank has promising growth prospects ahead.

    5. Does Jana Small Finance Bank have any regulatory penalties?

      No, the management has remained clear of any major regulatory penalties as of Feb 2024.

  • Apeejay Surendra Park Hotels Limited: IPO Analysis

    Apeejay Surendra Park Hotels Limited: IPO Analysis

    Imagine a hotel experience that perfectly blends modern luxury with timeless heritage! Apeejay Surrendra Park Hotels (ASPHL), an Indian hospitality player, is ready to debut on the Indian Stock Exchanges with its upcoming IPO. But is it an investment opportunity worth exploring?

    Buckle up! In today’s blog, we will examine the company’s financials, business model, and key IPO details along with the risks and opportunities that await investors.

    Key Details

    1. Apeejay Surrendra Park Hotels IPO is a main-board IPO, which means that the post-issue paid-up capital will be a minimum of 10 crores.
    2. The IPO is a book-built issue of INR 920 crore. It is a combination of a fresh issue of INR 600 crore and an Offer For Sale (OFS) of INR 320 crore.
    3. The IPO will open for subscription on February 5, 2024, and close on February 7, 2024.
    4. The company has set the price band for shares at INR 147 to INR 155, and the minimum lot size is 96 shares.
    5. JM Financial, ICICI Securities and Axis Capital Limited are the book-running lead managers of the IPO and Link Intime India Private Limited is the registrar for the issue.
    6. The minimum amount of investment required by retail investors is INR 14,880.
    7. The initiation process for the IPO is scheduled for February 9, 2024.
    8. The IPO will be listed on Stock Exchanges, NSE and BSE on February 12, 2024.
    9. The promoters of the company are Karan Paul, Priya Paul, Apeejay Surrendra Trust, and Great Eastern Stores Private Limited.
    10. The company has allocated the IPO proceeds to repay the loan amount and address general corporate purposes.

    Opportunities linked with the IPO

    1. Apeejay Surrendra boasts a strong record of consistently growing brand portfolios that fulfil the needs of various segments.
    2. The company enjoys healthy financials with an almost 96% growth in Total income and also turned profitable in FY23 with a strong net profit of 48 Crores while exceeding 90% occupancy rates in owned hotels.
    3. Established brands of the hotel, which include ‘The Park’ and the ‘Zone by The Park’, have gained recognition and loyalty and significant competitive advantage over the years.
    4. An uptrend in Debt Service Coverage Ratio (DSCR) and Interest Service Coverage Ratio (ISCR) is visible with the DSCR reaching 1.63 in FY23 from 0.4 in FY22 and ISCR reaching 2.05 in FY23 from 0.3 in FY22.     

    Risks Linked with the IPO

    Risk in IPO
    1. The Indian hospitality sector is fiercely competitive, with strong and established players like ITC Hotels and Marriott Hotels competing for the market share. This could lead to big changes in topline figures if Apeejay Surrendra Park loses its market share.
    2. Economic uncertainties and fluctuations in tourism can expose the hotel industry to seasonality, impacting both occupancy rates and profitability.
    3. Almost 75% of the total income is realised from top 5 owned hotels, with the PARK Kolkata contributing a staggering 21.75% to the total income alone. This exposes Apeejay Surrendra Park hotels to the risk of Revenue concentration.
    4. Almost 49% of total bookings come from Online Travel Agents. While this is a growing industry, in an effort to increase their profits, these online travel agents could increase their convenience fees and other charges. This could substantially affect Park Hotels’ topline figures.
    5. A significant portion of the IPO involves selling existing shares (OFS), which means the company is not raising fresh capital. This might not directly fuel growth.

    Read Also: Rashi Peripherals Limited: IPO Analysis

    Apeejay Surendra Company Overview

    Apeejay Surrendra Park Hotels Limited is an India-based hospitality company. It holds the position of the eighth-largest hotel chain in India in terms of chain-affiliated hotel rooms with asset ownership. It is also renowned for its distinctive and personalized approach to hospitality, providing modern and stylish hotels tailored to both business and leisure travellers. ASPHL operates under 5 brands, namely:

    1. The Park is positioned as an upscale brand with luxury offerings with a philosophy that focuses on design, style and service.
    2. The Park Collection encompasses small luxury properties located at the selected travel destinations.
    3. Zone by the Park brand is positioned at the upper midscale level and is designed for price-conscious and design-conscious customers.
    4. Zone Connect by the Park is an upper midscale brand that networks its essence and design philosophy from Zone by The Park.
    5. Stop by the Zone is an economy motel brand that aims to provide convenient accommodation with easy access to parking, free Wi-Fi, and food services.

    All the brands are located in the prime locations of Bangalore, Chennai, Goa, Hyderabad, Indore, Kolkata, Mumbai, Navi Mumbai, New Delhi, and Vizag. The group will soon open hotels in other areas such as Chettinad, Patiala, Pune, and Kolkata.

    The hotels built by the group carry contemporary designs with luxurious interiors, furniture, paintings and accessories. Apart from this, the company focuses on relevant social issues and promotes art and culture in each region.

    Apeejay operates 27 hotels across luxury boutiques, upscale, and upper-midscale categories, with a pan-India presence in metro cities and aims to build upon existing brands, create an expanded group of upscale and upper-mid-scale hotels in strategic locations in India and abroad, leverage the cooperation between hospitality, food and beverage business while achieving strong profitability.

    Did you Know?

    The Park opened its first hotel in Kolkata in 1967, featuring 149 rooms on Park Street, which led to the company’s name.

    Apeejay Surendra Business Model

    Business Model of Apeejay

    Apeejay operates hotels by directly owning hotel properties, securing long-term leases for land and buildings, and entering into operation and management agreements on a contractual basis. The brand names are used on hotels constructed by third parties.

    Hotels operated under the ownership model are located on freehold and leasehold land that belongs to the company.

    Government authorities or private institutions lease some of the hotels, with lease terms ranging from five to fifty years, and renewals are possible upon expiration.

    Apeejay brand operates some hotels through operating and management contracts. Typically, the term of such contracts ranges from 8 to 25 years, with termination options available to either party.

    The fundamental hotel operations departments are front office, housekeeping, food and beverage service, food production and spa services while focusing on customer experience and comfort through quality service offerings.

    The Apeejay Park Hotel’s business model includes three different store formats:

    • A kiosk format comprising a store size of about 80 to 100 square feet.
    • A cafe format comprising a store size of about 350 to 400 square feet.
    • A restaurant format comprising a store size of about 800 to 1000 square feet.

    Awards & Recognitions

    Below mentioned are some of the accolades for ASPHL:

    • TripAdvisor Travelers Choice Awards in the year 2022-23
    • World Luxury Hotel Awards in the year 2023.
    • EEF Excellence Awards in the year 2022 for excellence in sustainable tourism.
    • CNBC TV18 Hotelier Awards in the year 2021

    Financial Statements – A Snapshot

    ParticularsFY 2021 (in millions)FY 2022 (in millions)FY 2023 (in millions)
    Revenue/Total Income1,902.902,678.305,244.30
    EBITDA228.46582.931,770.95
    Profit(758.84)*(282.02) *480.62
    Profit Margin(39.88%)*(10.53%)*9.16%
    Debt5,834.005,500.106,137.59
    Total assets12,803.3913,617.9012,751.76
    Debt-to-Equity Ratio1.091.210.99
    *(The figures in bracket shows the company incurred net loss for the particular FY)

    Read Also: Strategies To Boost Your IPO Allotment Chances

    Conclusion

    ASPHL’s IPO and planned expansion projects show its ambitious growth plans. Apeejay’s diverse brand portfolio and emphasis on innovation have helped them well to capture the opportunities in the Indian hospitality market.

    However, navigating industry competition and economic uncertainties will be important for Apeejay’s success. Do not forget to conduct proper research and analyse your risk tolerance before investing in the ASPHL IPO.

    Frequently Asked Questions (FAQs)

    1. What is the price band for the ASPHL IPO?

      The IPO price band for ASPHL is set at INR 147 to INR 155 per share.

    2. What will the IPO proceeds be used for?

      The IPO proceeds will be used for debt repayment and general corporate purposes.

    3. What makes ASPHL unique?

      ASPHL offers a set of diverse services that cater to different segments, from budget-friendly options to luxury stays.

    4. Who are the major competitors of ASPHL?

      ASPHL competes with major hotel chains like ITC Hotels and Marriott etc.

    5. Is investment in ASPHL IPO a good option for investment?

      Investing in ASPHL IPO should only be done after careful consideration of your financial objectives and risk tolerance. However, you should perform your own analysis before investing.

    Disclaimer: The securities, funds, and strategies mentioned in this blog are purely for informational purposes and are not recommendations.

  • Rashi Peripherals Limited: IPO Analysis

    Rashi Peripherals Limited: IPO Analysis

    The Indian tech giant Rashi Peripherals Limited (RPL) is all set to tap the public market with its much-anticipated INR 600 crore IPO! Are you excited to own a piece of this company in the Information and Communication Technology (ICT) distribution landscape?

    In today’s blog, we will share the key details about the IPO and a brief overview of the company. 

    Key details of the IPO

    1. Rashi Peripherals IPO is a book-built issue of INR 600 crores. The issue is completely fresh and will be opening for subscription from February 7, 2024, to February 9, 2024.
    2. Rashi Peripherals IPO is a main-board IPO, which means the post-issue capital is more than 10 crores.
    3. The price band of IPO is INR 295 to INR 311 per share.
    4. The listing date for Rashi Peripherals IPO is fixed at February 14, 2024.
    5. JM Financial Limited and ICICI Securities Limited are the book-running lead managers of the Rashi Peripherals IPO, whereas Link Intime India Private Ltd is the registrar for the issue.
    6. The fund’s return process is scheduled for Tuesday, February 13, 2024.
    7. The company will be listed on both the exchanges, i.e., NSE & BSE.
    8. The company promoters are as follows – Krishna Kumar Choudhary, Sureshkumar Pansari, Kapal Suresh Pansari, Keshav Krishna Kumar Choudhary, Chaman Pansari, Krishna Kumar Choudhary (HUF), and Suresh M Pansari HUF.
    9. Rashi Peripherals IPO’s objective is to raise capital from the market is to fund working capital requirements and prepayments and repayments of borrowings.
    Category of InvestorsAllocation of shares
    EmployeesNo employee quota
    Anchor AllocationCarved out of the QIB Portion
    QIB Shares Offered96,46,302 shares (50% of the net IPO offer size)
    NII (HNI) Shares Offered28,93,891 shares (15% of the net IPO offer size)
    Retail Shares Offered67,52,411 shares (35% of the net IPO offer size)
    Total Shares Offered1,92,92,604 shares (100.00% of IPO size)
    Source – RHP

    Read Also: IPO Alert – Capital Small Finance Bank

    Company Overview

    Company Overview

    Rashi Peripherals was incorporated in the year 1989 and carries experience of more than 33 years. The company took its time in rising to glory, and now it is one of the leading national distributors of global technology brands in India for Information and Communications Technology (ICT) products. It also offers end-to-end value-added services such as pre-sale activities, solutions design, technical support, marketing services, credit solutions, and warranty management services.

    The company also operates in Singapore. It has two subsidiaries – Znet Technologies Private Limited in India and Rashi Peripherals Pte Limited in Singapore.

    Business Model

    Rashi Peripherals operates in the following two business verticals:

    • PES (Personal Computing, Enterprise, and Cloud Solutions) – Under this vertical, the company distributes personal computing devices, enterprise solutions, embedded designs/ products, and cloud computing. These include Laptops, Desktops, Routers, and Switches.
    • LIT (Lifestyle and IT essentials)– LIT includes the distribution of products such as graphic cards, CPUs, motherboards, storage and memory devices, lifestyle peripherals, and accessories that include keyboards, mouse, web cameras, monitors, wearables, casting devices, fitness trackers and gaming accessories, power equipment such as UPS and inverters, and networking and mobility devices.

    Rashi Peripherals holds 50 branches that operate for sales and service centres, and 63 warehouses as of September 30, 2022. The company has a direct presence in 680 locations in India and 53 global technology brands, with 9,996 customers in FY23.

    Distribution Channel

    Rashi Peripherals has a vision of being a multi-channel pan-India distributor and leader with an emphasis on general trade, modern trade and e-commerce channels.

    • General trade includes hybrid resellers who sell to online marketplaces and retail channels, regional distributors, retailers, brand stores, original equipment manufacturers, etc., which are collectively known as ‘Channel Partners’.
    • Modern trade includes large-format retail, multi-format retail, and small-format retail chains.
    • E-commerce includes some of India’s leading online marketplaces.

    Over the years, Rashi Peripherals has consistently added new global technology brands to its portfolio and worked with them to distribute products across categories. Some of the top brands distributed by the company are: Asus, Fitbit, HP, Intel, Lenovo, LG, Philips, Samsung, Logitech, and Luminous.

    Key Strengths

    Strengths of Rashi Tech
    1. RPL ranks among the fastest-growing distribution partners in India’s ICT distribution market and offers a well-established channel across India.
    2. The Indian tech sector is expected to witness growth, which will eventually benefit the Rashi Peripherals distribution business.
    3. Return on Equity (RoE) stands at a comfortable 19.33%.  
    4. The industry is low capital-intensive, thus RPL does not manufacture any of its products, which indicates that the requirement to take further debt is substantially low.
    5. Repeat customers bring in almost 92% of revenue while maintaining a 6.3% growth in total customers. This indicates the company’s strong ability to retain and satisfy customers.
    6. The company has a high trade receivable turnover ratio, indicating that it is very efficient in collecting receivables from its clients.

    Weak Points

    1. The Information and Communication Technology (ICT) industry in India is highly competitive (Indian competitors include Savex Technologies Private Limited, Ingram Micro India Private Limited, and Redington (India) Limited). Both domestic and foreign players can significantly affect the top-line figures of the company.
    2. The company’s net profit margin stands at 1.3%, but the industry generates profit from volume rather than margins.
    3. The top 8 suppliers account for almost 83% of the total purchases. Any changes in the contracts with these suppliers could cause significant damage to the company’s financials as RPL does not manufacture any of its products.
    4. RPL’s Inventory turnover ratio decreased significantly in FY23, this may indicate the company’s inability to manage inventory well.

    Awards & Recognitions

    • Digital Terminal Most Preferred National Distributor 2023
    • VAR India VAD Award 2022
    • Samsung MSP Solutions Champion 2023
    • Digital Terminal Best ICT National Distributor in India 2023
    • LG Most Dynamic National Distributor in 2022
    • Intel Partner of the Year Award 2022,
    • HP Most Trusted and Preferred Distributor Award 2022
    • Samsung Top Distributor Partner in B2B Business in 2022

    Highlights of Financial Statements

    ParticularsFY 2023FY 2022
    Revenue/Total IncomeINR 9,469 croreINR 9,322 crore
    Profit-after-TaxINR 123.34 croreINR 182.51 crore
    Return on Equity Ratio19.33%37.56%
    Debt to Equity Ratio1.531.52
    Inventory Turnover Ratio6.629.93
    Trade Receivables Turnover Ratio9.349.58
    Trade Payables Turnover Ratio8.8310.52
    Debt Service Coverage Ratio (DSCR)0.20.26
    Source – RHP

    Read Also: IPO Alert: Entero Healthcare Solutions Limited (EHSL)

    We can say that the company experienced a minor growth in its revenue in FY 2023 as compared to the previous financial year. However, profit margins were decreased due to a larger decrease in profits.

    Conclusion

    To wrap it up, Rashi Peripherals Limited IPO is a mainboard and medium-risk investment. Although the company holds a strong track record and a wide network of distributors and operates in a competitive industry. It is suggested that investors carefully assess the risks and other factors before investing in the IPO.

    S.NO.Check Out These Interesting Posts You Might Enjoy!
    1IPO Alert: Vibhor Steel Tubes Limited
    2Platinum Industries IPO: Business Model, Key Details, KPIs, and SWOT Analysis
    3Mukka Protein IPO: Business Model, Key Details, Financial Statements, and SWOT Analysis
    4Bharat Highways InvIT IPO: Business Model, Financials, Key Details, and SWOT Analysis
    5Pune E-Stock Broking Limited IPO: Key Details, Business Model, Financials, Strengths, and Weaknesses

    Frequently Asked Questions (FAQs)

    1. What is the minimum investment amount in Rashi Peripherals IPO?

      The minimum lot size for the IPO is 48 shares, with an estimated cost of INR 14,928 at the lower end of the price band.

    2. What does Rashi Peripherals do?

      Rashi Peripherals is a large distributor of ICT products and offers several IT hardware and software solutions.

    3. Who are the book running lead managers for the IPO?

      J.M. Financials and ICICI Securities.

    4. What is the listing date?

      14th February, 2024.

    5. How can I apply for the IPO?

      You can apply for the IPO either through your broker or the ASBA facility available with the banks.

  • CAT Bonds: An Easy Explainer

    CAT Bonds: An Easy Explainer

    CAT is an animal right or Common Admission Test; this is what you have heard till now. Now, there is some twist in the plot. We also have bonds that are known as CAT Bond, financial instrument offering investors high returns and helping society prepare for the worst.

    Don’t be shocked, in our today’s blog, we will explain what CAT bonds are. 

    History of CAT Bonds

    History of CAT Bonds

    Have you ever wondered how do insurers manage their risks? Suppose, a natural disaster came which caused massive destruction. To compensate the claimants for the damage, insurance companies have to shell out a lot of funds; by this, insurance companies can even go bankrupt. So, to manage this risk they have their risk management in place, right?

    Before the invention of CAT Bonds, the insurers used the traditional method of re-insurance to manage such catastrophic risks. Re-insurance involves transferring a part of the risk to another insurance company. This process is also known as “Risk Transfer”. However, as the frequency of natural disasters increased, reinsurance became insufficient.

    In the year 1992, Hurricane Andrew, a category 5 hurricane, struck Florida and caused widespread destruction. The insurance industry faced severe and staggering losses, which eventually highlighted the need to re-evaluate risk management practices.

    In the aftermath of Hurricane Andrew, the first catastrophe bond was issued in the year 1997 named “Tempest Re”.

    The year 2005 Hurricane Katrina marked a turning point and was one of the costliest disasters in the history of the United States and the CAT Bonds came to the rescue since these bonds performed the way they were meant to. The event spurred the growth and significance of CAT Bonds in the market and insurers started seeking CAT Bonds as alternative risk-transfer solutions.

    The CAT Bonds market has consistently evolved since Hurricane Katrina, and today these bonds cover diverse risks.

    CAT Bonds – An Overview

    The word ‘CAT’ is derived from the word Catastrophe, which refers to an event that causes great suffering or damage.

    CAT Bonds or Catastrophe bonds are a type of insurance-linked security (ILS) that transfers specific risks from an insurance company to investors. They are a debt financial instrument that allows the insurers to manage their exposure to natural disasters such as earthquakes, floods, wildfires, etc. These bonds provide a way for these companies to obtain additional financial protection against large-scale and unexpected losses.

    Read Also: Electoral Bonds Explained: What Are They and Why Did Supreme Court Ban It?

    How do CAT Bonds work?

    When an insurance company issues CAT Bonds, they promise to pay interest to investors. If, in any case, a predefined disaster occurs and meets certain criteria, the insurance company does not have to pay back the principal to the investors. Instead, the money is used to cover the losses caused by catastrophes. It is a way for insurance companies to manage their risk and for investors to earn a higher return. Pretty cool! Isn’t it?

    The proceeds from issuing CAT Bonds are placed in a collateral account and sometimes may be invested in low-risk instruments such as T-Bills.

    The criteria for a catastrophe bond are generally defined in the bond’s terms and conditions (known as ‘Indenture’ in the bonds’ world). These criteria can differ depending on the specific conditions. In the case of a hurricane catastrophe bond, the criteria might include factors like the intensity of the hurricane, the damage caused, etc.

    Investors can benefit from the bonds through the interest payments they receive. When investors buy CAT Bonds, they lend money to the issuing insurance company. In return, they receive regular interest payments over the bond’s term, and if no qualifying catastrophe occurs during that period, the investors get back the principal amount at the end of the term. So, investors can generate a return through the interest payments while supporting disaster relief efforts. CAT bonds are a unique way to combine financial investment and social impact.

    Did you know?

    The World Bank has a cat bond market access facility for member countries.

    Risks Involved in CAT Bonds

    Investors in CAT bonds face certain risks. One of the major risks is that if a qualifying catastrophe occurs, the investors may not get back their principal amount and the funds would be used to cover the losses caused by the catastrophe. Additionally, the interest payment received may be lower than expected if there are no qualifying catastrophes during the bond’s term. It is always a good idea for investors to carefully evaluate the risks before making any investment.

    How are the returns on CAT Bonds calculated?

    The returns on CAT Bonds are calculated depending on the interest mentioned in the terms and conditions. Suppose, you invest INR 10,000 in a CAT Bond with a coupon of 5% (read it as interest rate). If no qualifying catastrophe occurs during the bond’s term, you will receive an annual interest of INR 500. (5% of INR 10,000). At the end of the tenure, you would get back your initial investment of INR 10,000.

    Benefits of CAT Bonds

    1. For Insurers, CAT Bonds offer a way for insurers to transfer risk to the capital markets, freeing up their capital to write more insurance. This can help them to improve their risk management and financial stability.
    2. For Investors, CAT Bonds carry the potential for high returns because they are not so liquid and have a higher risk of default than traditional bonds.
    3. Further, they also help you to diversify your portfolio because they are not in any way linked with other asset classes.

    CAT Bonds in India

    While catastrophe bonds are more commonly seen in international markets, including the United States and Europe, they have not gained much traction in India just yet and are still in their nascent stage.

    However, there is growing interest in exploring CAT Bonds as a risk-minimising source for the insurance sector in India. It can be an interesting development to keep an eye on in the coming future!

    Read Also: Detailed Guide on Bond Investing: Characteristics, Types, and Factors Explained

    Conclusion

    To wrap it up, CAT Bonds is a complex financial instrument that can be a valuable tool for both investors and insurers since it bridges the gap between risk management in the insurance industry and capital market opportunities.

    Challenges like climate change and other  natural uncertainties exist, but consistent innovation, interest of the investor and supportive frameworks hold promise for future growth.

    Considering the high-risk profile of CAT Bonds, it is suggested that you do thorough research and seek professional advice before investing in it.

    Frequently Asked Questions (FAQs)

    1. Why do CAT Bonds exist?

      CAT Bonds exist because they help insurers manage risk and avoid financial instability caused by natural disasters. And for investors, they get higher returns.

    2. Are CAT Bonds risky?

      Yes! Cat bonds are riskier than traditional bonds, and investors can lose their capital if a trigger event happens.

    3. Are there any ‘exotic’ CAT Bonds covering unusual risks?

      CAT Bonds generally focus on natural disasters; some bonds have covered volcanic eruptions and political instability.

    4. Do CAT Bonds always offer high returns?

      Not necessarily! Returns of CAT Bonds depend on specific risk profiles and market conditions. Although CAT Bonds returns are fascinating, they can also carry higher risk as compared to traditional bonds.

    5. How liquid are CAT Bonds?

      CAT Bonds are comparatively less liquid than Corporate or Government bonds. However, their unique risk profile can attract long-term investors.

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