SBI Bond Issue 2011 – The Coal India of Bond Markets?

The recent SBI bond issue has seen an overwhelming response from the retail investors who have applied for around Rs 54 bn worth of bonds. Rumours are that the grey market is already quoting a 3% premium over the price of the bond. The retail brokers are betting that this could be the Coal India of the bond market.

So what is so exciting about this bond issue? Here we try and decode the same for you. But before rushing ahead, we need to understand the key terms of the SBI bond.

Background

India’s largest bank, SBI launched the second tranche of its long term bond issue on 21^st Feb, 2011 which will get listed on the NSE within next one week. The main features of the SBI bond issue are as below.

Particulars	Retail Applicant		Options	Series 4 Lower Tier II Bonds
Issue Size	Maximum Rs 100 bn
Maximum Application size	Rs 500,000		Price of the Bond / Par Value	Rs 10,000
			Coupon
Duration	15 Years		1. For Retail Applicants	9.95% per annum
Call Option	10 years		2. For Non Retail Applicants	9.45% per annum

Here ‘Call Option’ means that SBI has an option return the money and take back the bond from the bond holder at the end of 10^th Year. But this is an option with SBI and not a compulsion.

Why so much excitement among investors?

The excitement in the SBI Bond IPO is because of possible listing gains. The 10 year fixed deposit rates for banks are varying from 8.25% to 9.25%, while the 10 year government bonds (G-Sec) is around 8%. But the SBI bond’s 9.95% coupon rate is much higher than the expected interest rate. And for this reason, these bonds are more valuable than any other fixed deposits.

Two other advantages this bond has are:

1.     9.95% coupon rate is for retail applicants only and not for the HNIs and Institutions.

2.     It will get listed in the NSE and will be available for trading.

Thus, it is pretty clear that the value of bond will be more than its issue price of Rs 10,000. But can we find what that number is, as on date? Yes we can. We just need the expected market interest rate. As mentioned before that the maximum interest rate on a bank FD is 9.25%, we assume the following scenarios of assumed market interest rates.

Assumed Market Interest Rate	Est. Bond Price (Rs)
9.20%	10477
9.30%	10412
9.40%	10347
9.50%	10283
To understand Bond Pricing, please refer below

As shown in the table, even if we assume the market interest rate of 9.5%, the fair value of the bond comes to around Rs. 10300. That is a gain of 3% and with zero risk on the day of listing. In October 2010, there was a similar SBI N2 series bond issue which got listed and on the listing day it gained by 4.5%. The coupon rate on that bond was just 9.5%.

Now one may question that a 3%-5% return is not a great thing. But if you have extra money in your bank account or in a liquid fund which are not supposed to be used for buying stocks, then this 3%-5% return in a month’s time is by all means excellent. To re-iterate the same, if you had invested Rs 500,000/- in the bond as a retail investor, you can earn a fixed return of around Rs. 15,000+.

How are bond prices calculated?

The formula for the same as below:

In the case of SBI Series N4 bonds

C =       Rs 995            

n =       10 years  (bonds are callable after 10 Years)

M =      Rs 10,000

Now assuming different value of the market interest rate, we get the bond prices as shown in the table above.