| The table tells the whole story. While the real interest rate on the US 10-year treasury note is 3.9 per cent, the real yield on the Indian 10-year government bond is a mere 0.2 per cent. It's not a surprise, therefore, that domestic bond yields are rising.
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| Moreover, the least the market expects is a 25 basis point rise in US Federal Reserve Funds rates every quarter, although most observers expect a 75 basis point rise by the end of the calendar year, and that rise is bound to be reflected to some extent in the local market.
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The cost of money | |
Real interest rates, % |
US |
India | |
Inflation rate |
0.8 |
5.5 | |
Fed funds/repo rate |
1.0 |
4.5 | |
Ten-year bond yield |
4.7 |
5.7 |
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| Interestingly, the yield on the US 10-year treasury note has gone up from 3.13 per cent in June last year to 4.72 per cent, a rise of 159 basis points, without there being any change in the Fed funds rate.
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| In contrast, the Indian 10-year bond yield has risen by only 81 basis points, from 4.94 per cent in October 2003 to 5.75 per cent. There's plenty of scope, therefore, for long-term yields to harden further, even if the Reserve Bank of India (RBI) doesn't raise the repo rate.
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| Running for forward cover
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| One fallout of the rise in yields in the bond market has been the sharp rise in forward premiums. The forward premium on the six-month dollar is well over 1 per cent.
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| It's double the six-month dollar premium a week ago. And it's a sea-change from the situation prevailing a month ago "" the six-month forward dollar was available at a discount of 0.65 per cent on May 21.
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Bond-struck
Premiums (discounts) on forward dollars, per cent | |
2004 |
Six-month |
One-year | |
21-May |
-0.65 |
-0.29 | |
15-Jun |
0.44 |
0.43 | |
23-Jun |
1.15 |
0.90 |
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| Forex dealers say that importers have come forward in large numbers to cover, and that has pushed up forward premiums. The uncertainty over the value of the rupee has been a strong motivating factor for importers, and the RBI's recent policy of allowing more volatility in the market has been a salutary influence, persuading importers to cover.
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| Also, forward premiums are supposed to reflect interest rate differentials, and the discounts prevailing a month ago were due to the very one-sided market.
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| That anomaly has now been corrected. The RBI had on several occasions pointed to the need for corporates to be prudent about their unhedged exposures, and it should be satisfied with the new trend.
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| Larsen & Toubro unshackled
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| The value of Larsen & Toubro's core engineering business has finally been unlocked. The L&T stock, without the baggage of the cement business, closed on its first trading day at Rs 638 per share.
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| This is pretty much in line with analysts' estimates of an 11-12 times forward PE. Bharat Heavy Electricals, a comparable company, gets a similar valuation. But despite the impressive listing, it turns out that investors holding on to L&T shares are in a losing proposition.
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| Prior to the split in shares between the cement and the non-cement companies, the L&T stock had closed at Rs 501.85 per share on the NSE. For an investor with 100 shares, the value of the holding amounted to Rs 50185.
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| According to the de-merger scheme, this investor would now hold 40 shares of Ultra Tech Cemco (the cement company) and 50 shares of L&T (non-cement). Based on Wednesday's close of Rs 638, the holding in L&T is valued at Rs 31900.
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| Even if Ultra Tech Cemco lists at Rs 342.6, which was what Grasim paid in its open offer, the value of the investor's 40 shares would be Rs 13704. This puts the total value of the holding at Rs 45604, 9 per cent lower than the Rs 50185 figure the investor began with.
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| In fact, Ultra Tech Cemco is expected to list at a much lower price as its FY05 PE based on the offer price works out to over 20 times, higher than even industry majors. So the loss in value would be even higher.
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| Meanwhile, L&T's core engineering and construction business, with an order backlog of over two times FY04 sales, is set to grow at over 20 per cent. Besides, with most of the these orders priced keeping in mind higher steel prices, margins are expected to be better than last year.
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| The only hitch could be a drop in other income, which stood at a high 52 per cent of PBT in FY04, since a big chunk of that was non-recurring in nature. This is one of the reasons some analysts prefer BHEL for a play on the infrastructure sector.
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| With contributions from Mobis Philipose |
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