[DOCUMENT TITLE]

Financial Management 1
 RIL’s Super-Long Bonds
Case Background

During the years 1996-97, Reliance Industries Limited was responsible for manufacturing a
full 3% of India’s Gross Domestic Product and nearly 5% of the India’s exports. RIL was the
source of 10% of the indirect tax revenues of the Government of India, and commanded 15%
of the weightage of the Sensex. It made 30% of the total profits of all the private companies in
India put together.

Reliance Industries Limited went public in the year 1978. In the year 1997, RIL entered the US
debt markets with its five Yankee Bond issues for a total sum of US$ 614 Million. The maturity
periods for these debts were spread across the range of 10 to 100 years. RIL, post the issue of
these debts, became the first corporate issuer of long term bonds from Asia, it also became the
first issuer with a split rating to issue 100 year bonds.

Reliance Industries Limited until 1996-97 raised a total of $914 million in the international
fixed market which led to lowering of its average cost of capital and increase in the average
maturity. The average maturity of debt has more than doubled thereby bringing the maturity
profile closer to the economic life of the underlying productive assets. The interest rates were
around the lower end when RIL approached the market further lowering the costs.
During 1995, Standard & Poor, Moody’s Investor Services Inc. and National Association of
Insurance Commissioners rated RIL for the first time. IN 1996, Moody’s and NAIC retained
their ratings of “Baa3 Investment Grade” and “NAIC 2 Investment Grade” respectively
whereas S&P upgraded its rating from “BB+ Stable Outlook” to “BB+ Positive Outlook”.
Financial Aspects of the Case
Following are the key financial aspects associated with the case:

1.) Interest Rates

The interest rates as given in exhibit 2 have fallen over the last 30 years. The bonds
were apparently issued in a high interest rate environment, hence the bonds are expected
to appreciate as the interest rates fall. However, it needs to be understood that once the
interest rates hit the bottom end of the spectrum, a further fall in the interest rates and
therefore any appreciation of the bond prices would become highly unlikely. This
would also mean that there would be lesser demand for the bonds subsequently leading
to fall in prices.

2.) Volatility of Prices

Issuing super long bonds leads to high volatility of the bond prices. Any change in the
interest causes high variation in the present value of distant cash flows thereby having
more influence on the net value of the bond, unlike the short term bonds where short
term flows remain relatively stable.
Investors and financial managers routinely track the duration because it measures how
the bond prices change when interest rates vary. Also, the modified duration or
volatility is monitored and is given as:
Modified duration = volatility (%) = duration / (1+ yield)

In the forthcoming section we will analyse the volatility of the bonds issued by RIL.

3.) Foreign Currency Rates

As the bonds have been issued in the international market it will have an added currency
risk owing to fluctuations in the currency values. Any slump in the currency in which
the bond has been issued will lead to lower returns, conversely appreciation of the
currency will lead to higher returns.
Further a strong currency control inflation, hence increasing the returns of the
bondholders whereas weaker currency causes higher inflation thereby reducing thereby
decreasing the net returns that the bond holders receive.
Analysis and Interpretations
Below is an account of the discussion questions pertaining to the case.

1.) How are the RIL Super Bonds expected to react to the interest changes that are expected
in the market?
A change in the interest rates has only a modest impact on the value of short term cash
flows, but much greater impact on the distance cash flows. Thus the price of long term
bonds are vary way more than the short term bonds on changes in the interest rates.
Therefore a 100 year bond will have much higher fluctuations as compared to a 20 year
bond. RIL’s super bonds will have higher variation as compared to the bonds issued by
RIL with lower maturity periods.
 Refer Exhibit 1 for price versus interest rate calculations of the 20 year Bond

2.) Does the 100 year bond issue indicate a trend and evidence of confidence in the
economy or issuer or merely a novelty item?
The demand for such long bonds are indeed seen as a sentiment for a specific company.
A buyer would not take a 100 year long bond if he knows that the company under no
circumstance would survive for such a long time. In this case, post the liberalisation in
1991, the economy was looking up with Reliance Industries Ltd. Being the flagbearer
of the Indian private firms.
The growing positive sentiment is reflected in the fact that Reliance did manage to raise
considerable amount through such super long bonds.

3.) Why there is no put option or call option attached to RIL’s 100 year super long bond?
The idea behind issuing a super long bond as RIL did is to pull bondholders who are
looking forward to long and stable return on the bond. The understanding being that the
company would be doing well in the long run and would continue to be in business until
the maturity time. Putting a call or put option basically undermines the long term trust
that the firm is seeking from the investors. As it would allow the bondholders to pull
out their money or for the firm to call back the bond issue thereby undoing the whole
idea of issuing a super long bond.
4.) What will be the income component and capital gain or loss component of the bonds?
How this can affect the decision to subscribe or not to subscribe the bonds?
Income component for a bond is the amount received in the form of interest received
whereas the capital gain or loss is the change in the bond price at the time of maturity.
For the given super bond of coupon value at 10.25%, the total PV of the cash flow
stands at $96.7 Million, hence the bonds will have a total price of $96.7 Million which
will increase to $100 Million on maturity. Hence there is a net capital gain for the given
bond unless the interest rates fall enough.
Capital Loss = (P1 – P0 / P0)*100
= 100 – 96.7 / 96.7 = 3.41%
Income component = Interest received over the course of the bond
= $96694040.29
5.) Based on the issue price of the bonds, what is the market acceptable interest rate for a
100 year borrowing? How this bond is expected to be in demand on varying interest
rate and inflation rate regimes?
The market acceptable interest rate for a 100 year borrowing would be anywhere below
the coupon rate for the bond which is 10.25%.
Fall in the interest appreciates the value of the bond, hence in case of interest rates
falling, there will be higher demand for the bond. However, an all time low interest rate
would also mean that the bond prices would be at their highest points, hence the prices
are expected to only fall beyond one point as the interest rates can only go up from the
all-time low value.
6.) How these bond values are going to get affected by volatile FOREX rates? How
investors will protect themselves from this?
International bonds are usually issued to gain from lower interest rates. For a volatile
forex rates, the currency fluctuations can bring added instability to the bond values.
Currency risk arises when an investor holds a bond denominated in a currency other
than the domestic currency of the investor.
For example, a slide in the currency in which your bond is denominated will lead to
lower total returns, similarly a rise in the currency will boost the total returns. Investors
protect themselves from these fluctuations by hedging the currency risk by currency
forwards or current options. Currency forwards is basically a binding contract the locks
the exchange rate for the purchase or sale of a currency on a future date. Currency
options provide the buyer an option to buy or sell a specified currency at a specified
exchange rate on or before a specified date.
7.) Why RIL launched these bond in the international market denominating in USD? Is it
that Indian market was not matured enough or large enough to accommodate these
bonds?
The Indian market would have very few or no takers for such long bonds, leaving the
option to issue the bonds in the international market. Now while issuing bonds in the
international market US dollar is considered to the safest bet, as it is highly unlikely to
slide in value as against other currencies thereby providing protection from the currency
risk, at the same time bonds issued in USD would also ensure a higher number of
potential buyers.
8.) What if the 100 year RIL bonds were designed as ZCB?
The idea behind buying a 100 year bond is to ensure a steady return of money for a long
time. For a zero coupon bond, interest and the principal amount is paid only at the time
of maturity. Therefore a 100 year bond designed as ZCB would mean that the
bondholders would not receive any money for a period of 100 years. Such an investment
is essentially meaningless from point of view of the investors as they would have to
wait too long to receive any return from the bond.
Therefore, we can say that there would be no takers for a zero coupon bond if they have
such a long maturity period.
9.) How the price yield curve of RIL bonds are stated in exhibit 1 differ from each other?
The price yield curves for a long term bonds display a much higher sensitivity when
compared to the bonds with shorter maturity periods. Below are the yield curves plotted
for two of the bonds with maturity period of 20 years and one with 100 year.
 20 Year Bond at 10.375% coupon rate
180000000
160000000
140000000
120000000
Axis Title

100000000
80000000
60000000
40000000
20000000
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Interest Rate

Series1 Series2

100 year bond at 10.25% coupon rate

350000000
300000000
250000000
200000000
Price

150000000
100000000
50000000
0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Interest Rate

Series1 Series2

As can be observed the variability of the bond price is much higher for the long term
bond.
Refer Exhibit 1 for Price and Cash Flow Calculations

10.) Given historical interest rates (in exhibit 2) which of the RIL bonds would have given
better income and capital gain?
The interest rates have fallen gradually for the last 30 years from more than 15 percent
to less than 3 percent. The bonds having been issued in 1996-97 were apparently issued
in a higher interest environment. Therefore, if we assume that the interest rates would
remain stable on the lower side of the spectrum, we can say that the bond prices would
have appreciated maximum for the long term bonds. Therefore the 100 year bond would
 give a better income and capital gain unless the interest rates get back up by the time
maturity approaches.
11.) What will be the change in price of the bonds shown in exhibit 1 if the interest rates
change up or down by 1 percent?
We can determine the change in the price of the bonds for a given interest rate level.
Below are the figures for each of the bonds issued for the interest rate of 5%.

Time Coupon Maturity Amount Price at 4% Price at 5% Price at 6%

Jun-96 9.375% 20 100000000 127.41% 116.83% 107.53%
Jun-96 10.375% 30 100000000 210.24% 182.63% 160.22%
Aug-96 10.50% 50 100000000 225.56% 191.69% 165.50%
Jan-97 8.25% 30 214000000 173.49% 149.96% 130.97%
Jan-97 10.25% 100 100000000 253.16% 204.20% 170.62%

12.) Which of the bonds in exhibit 1 will have the greatest price volatility, assuming that
each bond is trading to offer the YTM?
The long term bonds have higher volatility as any change in the interest rate has more
impact on distance cash flows than short term cash flows. Therefore out of the bonds
mentioned in exhibit 1, the 100 year bond will have maximum volatility. This can also
be observed for the changes in the price of the bond for 5% interest levels where the
maximum change can be observed for the 100 year bond.
Exhibit 1
Yield Curve Data for 20 year Bond (in $ Millions)

Cash
Year Flow 3% 4% 5% 6% 7% 8% 9%
1 10.38 10.07 9.98 9.88 9.79 9.70 9.61 9.52
2 10.38 9.78 9.59 9.41 9.23 9.06 8.89 8.73
3 10.38 9.49 9.22 8.96 8.71 8.47 8.24 8.01
4 10.38 9.22 8.87 8.54 8.22 7.92 7.63 7.35
5 10.38 8.95 8.53 8.13 7.75 7.40 7.06 6.74
6 10.38 8.69 8.20 7.74 7.31 6.91 6.54 6.19
7 10.38 8.44 7.88 7.37 6.90 6.46 6.05 5.68
8 10.38 8.19 7.58 7.02 6.51 6.04 5.61 5.21
9 10.38 7.95 7.29 6.69 6.14 5.64 5.19 4.78
10 10.38 7.72 7.01 6.37 5.79 5.27 4.81 4.38
11 10.38 7.50 6.74 6.07 5.47 4.93 4.45 4.02
12 10.38 7.28 6.48 5.78 5.16 4.61 4.12 3.69
13 10.38 7.06 6.23 5.50 4.86 4.31 3.81 3.38
14 10.38 6.86 5.99 5.24 4.59 4.02 3.53 3.10
15 10.38 6.66 5.76 4.99 4.33 3.76 3.27 2.85
16 10.38 6.47 5.54 4.75 4.08 3.51 3.03 2.61
17 10.38 6.28 5.33 4.53 3.85 3.28 2.80 2.40
18 10.38 6.09 5.12 4.31 3.63 3.07 2.60 2.20
19 10.38 5.92 4.92 4.11 3.43 2.87 2.40 2.02
20 10.38 5.74 4.74 3.91 3.23 2.68 2.23 1.85
Price 154.35% 141.00% 129.30% 119.00% 109.91% 101.86% 94.71%

10% 11% 12% 13% 14% 15% 16% 17% 18% 19% 20%
9.43 9.35 9.26 9.18 9.10 9.02 8.94 8.87 8.79 8.72 8.65
8.57 8.42 8.27 8.13 7.98 7.84 7.71 7.58 7.45 7.33 7.20
7.79 7.59 7.38 7.19 7.00 6.82 6.65 6.48 6.31 6.16 6.00
7.09 6.83 6.59 6.36 6.14 5.93 5.73 5.54 5.35 5.17 5.00
6.44 6.16 5.89 5.63 5.39 5.16 4.94 4.73 4.54 4.35 4.17
5.86 5.55 5.26 4.98 4.73 4.49 4.26 4.04 3.84 3.65 3.47
5.32 5.00 4.69 4.41 4.15 3.90 3.67 3.46 3.26 3.07 2.90
4.84 4.50 4.19 3.90 3.64 3.39 3.16 2.95 2.76 2.58 2.41
4.40 4.06 3.74 3.45 3.19 2.95 2.73 2.53 2.34 2.17 2.01
4.00 3.65 3.34 3.06 2.80 2.56 2.35 2.16 1.98 1.82 1.68
3.64 3.29 2.98 2.70 2.45 2.23 2.03 1.84 1.68 1.53 1.40
3.31 2.97 2.66 2.39 2.15 1.94 1.75 1.58 1.42 1.29 1.16
3.01 2.67 2.38 2.12 1.89 1.69 1.51 1.35 1.21 1.08 0.97
2.73 2.41 2.12 1.87 1.66 1.47 1.30 1.15 1.02 0.91 0.81
2.48 2.17 1.90 1.66 1.45 1.28 1.12 0.98 0.87 0.76 0.67
 2.26 1.95 1.69 1.47 1.28 1.11 0.97 0.84 0.73 0.64 0.56
2.05 1.76 1.51 1.30 1.12 0.96 0.83 0.72 0.62 0.54 0.47
1.87 1.59 1.35 1.15 0.98 0.84 0.72 0.61 0.53 0.45 0.39
1.70 1.43 1.20 1.02 0.86 0.73 0.62 0.53 0.45 0.38 0.32
1.54 1.29 1.08 0.90 0.75 0.63 0.53 0.45 0.38 0.32 0.27
88.33% 82.62% 77.50% 72.88% 68.71% 64.94% 61.51% 58.39% 55.53% 52.92% 50.52%

Exhibit 2: Interest Rate Sensitivity

Issued in June 1996; Coupon Rate = 9.375%; Maturity = 20 Years

Year Cash Flow 4% 5% 6%

1 9375000 9014423.1 8928571.4 8844339.6
2 9375000 8667714.5 8503401.4 8343716.6
3 9375000 8334340.9 8098477.5 7871430.8
4 9375000 8013789.3 7712835.7 7425878.1
5 9375000 7705566.6 7345557.8 7005545.4
6 9375000 7409198.7 6995769.3 6609005.1
7 9375000 7124229.5 6662637.5 6234910.4
8 9375000 6850220.7 6345369.0 5881991.0
9 9375000 6586750.6 6043208.6 5549048.1
10 9375000 6333414.1 5755436.8 5234951.0
11 9375000 6089821.2 5481368.3 4938633.1
12 9375000 5855597.3 5220350.8 4659087.8
13 9375000 5630382.1 4971762.7 4395365.8
14 9375000 5413828.9 4735012.1 4146571.5
15 9375000 5205604.7 4509535.3 3911859.9
16 9375000 5005389.1 4294795.5 3690433.9
17 9375000 4812874.2 4090281.4 3481541.4
18 9375000 4627763.6 3895506.1 3284473.0
19 9375000 4449772.7 3710005.8 3098559.5
20 9375000 4278627.6 3533338.9 2923169.3
Total 127409309.5 116833222.0 107530511.4

Issued in June 1996; Coupon Rate = 10.375%; Maturity = 30 Years

Year Cash Flow 4% 5% 6%

1 10375000 9975961.538 9880952.381 9787735.849
2 10375000 9592270.71 9410430.839 9233713.065
3 10375000 9223337.221 8962315.085 8711050.061
4 10375000 8868593.482 8535538.176 8217971.756
5 10375000 8527493.733 8129083.977 7752803.543
6 10375000 8199513.204 7741984.74 7313965.607
7 10375000 7884147.312 7373318.8 6899967.554
8 10375000 7580910.877 7022208.381 6509403.353
 9 10375000 7289337.382 6687817.506 6140946.559
10 10375000 7008978.252 6369350.005 5793345.81
11 10375000 6739402.165 6066047.624 5465420.576
12 10375000 6480194.389 5777188.214 5156057.147
13 10375000 6230956.144 5502084.013 4864204.856
14 10375000 5991303.984 5240080.012 4588872.505
15 10375000 5760869.216 4990552.393 4329125.005
16 10375000 5539297.323 4752907.041 4084080.194
17 10375000 5326247.426 4526578.134 3852905.843
18 10375000 5121391.755 4311026.794 3634816.833
19 10375000 4924415.15 4105739.804 3429072.484
20 10375000 4735014.567 3910228.385 3234974.041
21 10375000 4552898.622 3724027.033 3051862.303
22 10375000 4377787.137 3546692.413 2879115.38
23 10375000 4209410.708 3377802.298 2716146.585
24 10375000 4047510.296 3216954.569 2562402.439
25 10375000 3891836.823 3063766.256 2417360.791
26 10375000 3742150.792 2917872.625 2280529.049
27 10375000 3598221.915 2778926.31 2151442.499
28 10375000 3459828.765 2646596.485 2029662.735
29 10375000 3326758.427 2520568.081 1914776.165
30 10375000 3198806.18 2400541.03 1806392.608
30 100000000 30831866.8 23137744.87 17411013.09
Total 210236712.3 182626924.3 160221136.3

Issued in January 1997; Coupon Rate = 8.25%; Maturity = 30 Years

Year Cash Flow 4% 5% 6%

1 17655000 9975961.538 9880952.381 9787735.849
2 17655000 9592270.71 9410430.839 9233713.065
3 17655000 9223337.221 8962315.085 8711050.061
4 17655000 8868593.482 8535538.176 8217971.756
5 17655000 8527493.733 8129083.977 7752803.543
6 17655000 8199513.204 7741984.74 7313965.607
7 17655000 7884147.312 7373318.8 6899967.554
8 17655000 7580910.877 7022208.381 6509403.353
9 17655000 7289337.382 6687817.506 6140946.559
10 17655000 7008978.252 6369350.005 5793345.81
11 17655000 6739402.165 6066047.624 5465420.576
12 17655000 6480194.389 5777188.214 5156057.147
13 17655000 6230956.144 5502084.013 4864204.856
14 17655000 5991303.984 5240080.012 4588872.505
15 17655000 5760869.216 4990552.393 4329125.005
16 17655000 5539297.323 4752907.041 4084080.194
17 17655000 5326247.426 4526578.134 3852905.843
18 17655000 5121391.755 4311026.794 3634816.833
19 17655000 4924415.15 4105739.804 3429072.484
20 17655000 4735014.567 3910228.385 3234974.041
21 17655000 4552898.622 3724027.033 3051862.303
22 17655000 4377787.137 3546692.413 2879115.38
23 17655000 4209410.708 3377802.298 2716146.585
24 17655000 4047510.296 3216954.569 2562402.439
25 17655000 3891836.823 3063766.256 2417360.791
26 17655000 3742150.792 2917872.625 2280529.049
27 17655000 3598221.915 2778926.31 2151442.499
28 17655000 3459828.765 2646596.485 2029662.735
29 17655000 3326758.427 2520568.081 1914776.165
30 17655000 3198806.18 2400541.03 1806392.608
30 214000000 30831866.8 23137744.87 17411013.09
Total 210236712.3 182626924.3 160221136.3