Building a Junk-bond Market in India and its Impact on Overall Economy

- by Ankit Chetan & Sudhanshu Duggal *

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As expected, the higher the spread, the greater the advantage of bearing credit risk. If you're a small investor with modest portfolio exposure to junk, say 1% to 2%, you can afford to wait a few years for prices to recover.

Hence, keeping in mind the conservative nature of Indian Investors, with the investors preferring to save their incomes in banks
for returns over a long period; junk bond investment over a long period provides an ideal opportunity to bear the credit risk and provide better returns to the investors. Thus, in addition to the benefits to the companies having lower credit ratings to raise funds via junk bonds, the investors also benefit.

2) Junk bonds in a diversified portfolio

For junk bonds market to be established, improvement of creditor’s rights is a must, and creditor’s rights is about improving recovery rates. Credit spreads will be lower with better recovery rates. In fact junk bonds can be traded via "junk funds".

This will have less credit rationing, since the lender can find more comfort in lending to weaker borrowers. Thus, a junk bond market has a better probability of existence with better probability of recovery. Considering this model, a loan worth Rs. 100 earns Rs. 10 when the borrower defaults. A world with better recovery means: a loan worth Rs. 100 can earn Rs. 50 at default. The lender faces a better portfolio in the latter situation as shown: -

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* Contributed by -
Ankit Chetan & Sudhanshu Duggal,
National Institute of Industrial Engineering (NITIE),
Mumbai.

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