Fixed Investment Management

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Fixed Investment Management

Case Background

Fixed Investment Management(FIM), a Mumbai based financial consultancy firm has team of analysts under the supervision of Robert. They gathered together to decide upon issuing a recommendation to one of FIM’s best clients, the board of trustees of the endowment of the Amboli Golf Club (AGC), for whom they managed portfolio of Rs.50 crores.

The board of trustees had several professionals, all members of AGC but none a specialist in finance matters. They used to meet four times a year, at the beginning of each quarter, discussed and analysed the performance of the fund looking backwards and its perspectives looking forward. The trustees provided Robert with some medium term goals, FIM then would get back to AGC with a few bonds that met the criteria, and trustees would the convene to decide which bonds to buy. The trustees of AGC managed the endowment with great caution and their main emphasis was on preservation of principal.

 In 2017 Reserve Bank of India cut the interest rates from 7.783% to 6.549% and due to this AGC now wanted to change their stance from a more cautious one to a more aggressive one. They wanted bonds that are safe as well as high yield.

The analysts came up with four different bonds, out of which they need to select the one that met their criteria:

1. A 10.1% 5 year SBI bond with credit rating of AAA. It has yearly coupon payment and a maturity date as 12 Sept. 2022.
2. A 12.75% DS Kulkarni bond with quarterly payments. It has a credit rating of BBB+, and maturity date as 4 Aug’2022.
3. A 9.15% 5 and Half Year Andhra Pradesh State Financial Corporation Fund that had an aggressively high yield rate but a very low safety at only BB+ rating. It has Semi-annual coupon payments with a maturity date of 20 Mar 2023.
4. A GOI Treasury bond with a coupon rate of 8.08%, and a credit rating of AAA. It has maturity date as 2 Aug’2022.

Robert asked them to not only take decisions based on yield rate but also analyse the interest risk rates and comprehensively analyse the pros and cons of the different bonds and then come to a decision.

Critical Financial Problems

The problems identified are:

1. AGC demanded a bond with high yields with low risk

The demand of AGC was a bond having a high return with low risk factor. So, Fixed Investment Management need to analyse the yield and the risk profile of each of the bonds and decide the bond that best meets the criteria.

The financial markets work on a simple principle of high risk-high return logic. It is very difficult to choose the perfect fixed income instrument that has optimized yield and an acceptable risk factor at the same time. But since the interest rate is decreasing, it is highly likely that the price of the bonds will rise and thereby the new bonds will relatively have lower coupon rates.

1. The Bond suggested by Rishabh is very risky

The bond recommended by Rishabh was a 9.15% 5 and Half Year Andhra Pradesh State Financial Corporation Fund that had an aggressively high yield rate but a very low safety at only BB+ rating. It has Semi-annual coupon payments with a maturity date of 20 Mar 2023.

The risk associated with this bond is that it is a junk grade bond since it is rated as BB+ by CRISIL. Majorly aggressive investors such as Hedge Funds invest in these bonds. Thus, taking into account AGC being a safe player in terms of investments, it is highly unlikely that they would want to invest in this type of bond.

1. Low yield bond recommended by Ram

Ram shortlisted two investment grade bonds considering AGC’s constraints. The bonds suggested by him:

1. A 10.1% 5 year SBI bond with credit rating of AAA. It has yearly coupon payment and a maturity date as 12 Sept. 2022.
2. A 12.75% DS Kulkarni bond with quarterly payments. It has a credit rating of BBB+, and maturity date as 4 Aug’2022.

Though these two bonds are very safe and has an investment grade rating aligning with the strategy of the client but these bonds have a comparatively lower yield rate than what AGC were targeting to get.

1. Low yield bond suggested by Ryan

The bond recommended by Ryan is a Government of India Treasury bond with a coupon rate of 8.08%, and a credit rating of AAA. It has maturity date as 2 Aug’2022.

It is a very safe bond as it is issued by Government of India. Also, other advantage is that it can be easily traded in the secondary market unlike the other corporate bonds. But since it has a very low yield rate it does not align with the AGC’s requirement.

1. AGC’s Defensive Investment strategy

AGC’s total Asset under management is worth Rs.50 Crores with the main emphasis was on preservation of principal. Thus, it is very important to cautiously analyse the instruments before deciding the best investment out of the four options available. Also, AGC required the bond with a high yield and low risk. To make things worse and difficult, the analyst has very little time to come up with a suitable recommendation.

Case Analysis

The challenge ahead of the analysts of Fixed Income Management is to choose the most suitable bond that would meet the criteria laid out by AGC i.e. a bond with high yield, and low risk. So, the analysts need to look at the yield rates of each of these bonds and the risk associated with the bonds to decide upon the best investment for AGC.

The information available for each of the bonds is summarised in the table below:

Yield Rates

To analyse these bonds, the first step is to calculate the yield rate for each of these bonds.

The yield is the income return on an investment, such as the interest or dividends received from holding a particular security. The yield is usually expressed as an annual percentage rate based on the investment's cost, current market value or face value.