DERIVED INSTRUMENTS

These instruments are not direct debt instruments. Instead they derive value from various debt instruments. Mortgage bonds, Pass through Certificates, Securitized Debt Instruments etc. fall under this category. 

Mortgage Bonds: 

▪Mortgage backed bonds is a collateralized term – debt offering. 

▪Every issue of such bonds is backed by pledged collateral. 

▪Property that can be pledged as security for mortgage bonds is called eligible collateral. 

▪The terms of these bonds are like the bonds floated in the capital market, semi – annual or quarterly payments of interest and final bullet payment of principal. 

Example: A bank offering home loan might round up Rs.20 crore worth of such loans. That pool is then sold to a Government Agency or a government sponsored – enterprise (GSE), or to others to be used as the collateral for the new Mortgaged Bonds.

▪When mortgages are pooled together and undivided interest in the pool is sold, pass – through securities are created. 

▪The pass – through securities promise that the cash flow from the underlying mortgages would be passed through to the holders of the securities in the form of monthly payments of interest and principal.

▪A pass – through certificate (PTC) is an instrument that evidences the ownership of two or more equipment trust certificates. 

▪In other words, equipment trust certificates may be bundled into a pass – through structure as a means of diversifying the asset pool and/or increasing the size of the offering.

Example: Banks provide mortgages to borrowers, and then Banks place a group of these mortgages in a large investment and sell it to another financial institution. The interest from all of these mortgages represents the pass – through certificate as the holder of the note receives the money. This process can be quite complex and creates some difficulty for the financial institutions involved. 

PARTICIPATION CERTIFICATES: 

▪These are strictly inter – bank instruments confined to the Scheduled Commercial Banks. 

▪This instrument is a money market instrument with a tenure not exceeding 90 days. 

▪The interests on such participation certificate are determined by the two contracting banks.

▪In other words, A Participation Certificate (PC) is a financial instrument, a form of financing, used by municipal or government entities which allows an individual to buy a share of the lease revenue of an agreement made by these entities. 

▪Participation certificate is a new form of credit instrument whereby banks can raise funds from other banks and other central bank approved financial institutions to ease liquidity. 

▪In this case banks have the option to share their credit asset(s) with other banks by issuing participation certificates. 

▪With this participation approach, banks and financial institutions come together either on risk sharing or non – risk sharing basis. While providing short – term funds, participation certificates can also be used to reduce risk. The rate at which these certificates can be issued will be negotiable depending on the interest rate scenario.