Payment in Kind (PIK) Bonds
These are bonds in which the coupon is not reimbursed in cash but by way of more bonds.
Companies with cash flow problems issue such securities, and consequently, by nature, these instruments are unsafe.
Moreover, while temporary cash flow stress is kept away, more loans get added to the company's balance sheet, which is already in trouble. Hence, these products are typically for high-risk investors.
Principal – Protected Note (PPN):
PPN is a fairly composite debt product that aims to protect the principal amount invested by investors if the investment is held to maturity. Characteristically, a portion of the amount is invested in debt to mature to the principal amount on the expiry of the note's term.
The balance portion of the original investment is invested in equity, derivatives, commodities, and other products which have the potential of generating high returns.
Even though this is marketed as a debt paper, as it has a description similar to fixed-income securities, it is a synthetic product constructed by financial engineering – a mixture of debt and derivative structures.
Risk-averse investors get an occasion to invest in products with a likelihood of high returns, while at the same time, their downside is protected in PPNs. It must be implicit that principal protection does not mean a lack of credit risk. Investors in PPNs are exposed to the credit risk of issuers.
Several Non-Banking Finance Companies (NBFCs) have issued PPNs titled Equity Linked Bonds (ELBs) or Commodity Linked Bonds (CLBs) in the past to raise capital. Some of these structured instruments are listed on Stock Exchanges.
Inflation-Protected Securities
As they are fixed-income products, debt instruments risk conveying actual negative returns during high inflation periods. Sometimes, the investors of debt papers are retired aged persons who do not have another source of income. In such cases, it becomes enormously significant to have returns beating inflation. Inflation-Indexed Bonds (IIB) are a group of government securities issued by the RBI which provide inflation-protected returns to the investors.
In India, Inflation-indexed bonds have been launched in which both principal and interest are in tune for inflation. These bonds have a fixed real coupon rate which is functional to the inflation-adjusted principal on each interest payment date. The higher the face value or inflation-adjusted principal is paid out to the investors on maturity. Consequently, the coupon income and the principal are adjusted for inflation.
The inflation adjustment to the principal is made by multiplying it with the index ratio. The index ratio is calculated by dividing the reference index on the settlement date by the reference index on the date of the security issue. The Wholesale Price Index (WPI) is the inflation measurement observed to calculate the index ratio for these bonds.
An additional class of inflation-indexed instrument issued by the RBI for retail investors is the Inflation-Indexed National Saving Securities-Cumulative 2013. These bonds of 10 years were available to retail resident individuals, minors, HUFs, and charities, among others. The bond holds a fixed interest of 1.5% and an inflation rate calculated based on the Consumer Price Index (CPI). The interest is compounded every six months and cumulated, and the same is payable with the principal on maturity. The fixed rate of interest is the floor and is payable even if there is devaluation. The interest is taxable in part to the tax status of the investors.
