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UNDER THE GUIDANCE OF PROF. Kamal Rohara
UNDER THE GUIDANCE OF PROF. Kamal Rohara
UNDER THE GUIDANCE OF PROF. Kamal Rohara
UNDER THE GUIDANCE OF PROF. Kamal Rohara
UNDER THE GUIDANCE OF PROF. Kamal Rohara
UNDER THE GUIDANCE OF PROF. Kamal Rohara
UNDER THE GUIDANCE OF PROF. Kamal Rohara
UNDER THE GUIDANCE OF PROF. Kamal Rohara

UNDER THE GUIDANCE OF PROF. Kamal Rohara

Royal College of Arts, Science and Commerce

SUBJECT: .5.5 (SECURITY ANALYSIS & PORTFOLIO MANAGEMENT) PROJECT ON : Various Instruments in Capital market

T.Y.BANKING & INSURANCE

SEMESTER 5

(2011-2012)

T.Y.BANKING & INSURANCE SEMESTER – 5 (2011-2012) AZIM (39) SHWETA (25) DHAVAL (40) KAVERI (03) GROUP

AZIM (39)

SHWETA

(25)

DHAVAL

(40)

KAVERI

(03)

GROUP NO: 02

5 (2011-2012) AZIM (39) SHWETA (25) DHAVAL (40) KAVERI (03) GROUP NO: 02 VINAYA (16) SUNITA

VINAYA

(16)

SUNITA

(05)

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We would like to express our profound gratitude to our project guide Prof. KAMAL ROHRA,
We would like to express our profound gratitude to our project guide Prof. KAMAL ROHRA,
We would like to express our profound gratitude to our project guide Prof. KAMAL ROHRA,
We would like to express our profound gratitude to our project guide Prof. KAMAL ROHRA,
We would like to express our profound gratitude to our project guide Prof. KAMAL ROHRA,
We would like to express our profound gratitude to our project guide Prof. KAMAL ROHRA,

We would like to express our profound gratitude to our project guide

Prof. KAMAL ROHRA, who has so ably guided our research project with his vast

fund of knowledge, advice and constant encouragement, which made us, think

past the difficulties and lead us to successful completion of the project.

We have tried to cover all the aspects of the project & every care has been taken

to make the project faultless. We have tried to write the project in our words as

far as possible and simplified all the concepts by presenting it in a different form.

We’ll be looking forward in future for such type of project. We are eagerly waiting

for fruitful comments & constructive suggestions.

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SR.NO TOPIC PAGE.NO 1 Meaning & Concept of Capital Market. 05 2 Significance, Role or
SR.NO TOPIC PAGE.NO 1 Meaning & Concept of Capital Market. 05 2 Significance, Role or

SR.NO

TOPIC

PAGE.NO

1

Meaning & Concept of Capital Market.

05

2

Significance, Role or Functions of Capital Market.

07

3

Regulation of the Market

09

4

How to issue New Securities in capital Market.

10

5

Trading Principles & System.

12

6

Capital Market Instruments.

15

7

Different Instruments in Capital Maket.

17

8

Conclusion

30

9

Webliography

31

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VARIOUS INSTRUMENT IN CAPITAL MARKET

MEANING AND CONCEPT

Capital Market is one of the significant aspect of every financial market. Hence it is necessary to study its correct meaning. Broadly speaking the capital market is a market for financial assets which have a long or indefinite maturity. Unlike money market instruments the capital market intruments become mature for the period above one year. It is an institutional arrangement to borrow and lend money for a longer period of time. It consists of financial institutions like IDBI, ICICI, UTI, LIC, etc. These institutions play the role of lenders in the capital market. Business units and corporate are the borrowers in the capital market. Capital market involves various instruments which can be used for financial transactions. Capital market provides long term debt and equity finance for the government and the corporate sector. Capital market can be classified into primary and secondary markets. The primary market is a market for new shares, where as in the secondary market the existing securities are traded. Capital market institutions provide rupee loans, foreign exchange loans, consultancy services and underwriting.

exchange loans, consultancy services and underwriting. The capital market is the market for the issue and

The capital market is the market for the issue and trading of long-term securities. The term in this instance is measured as the term to maturity of the security and in order to be classified as a capital market instrument, the term to maturity should be longer than 3 years. During the trading of these instruments, the securities traded are informally classified into short-term, medium-term and long-term securities depending on their term to maturity. Where the term to maturity of the instrument is up to five years, the security is classified as a short-term capital market instrument. Where the term to maturity is five to ten years, the security is classified as medium term, and

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where the term to maturity is more than 10 years, the security is known as long-term.

The primary market is the market for the first issue of securities. normally done by means of a public issue or by private placement.

secondary market is the market for trading securities once they have been issued. The secondary market has a big influence on the issues in the primary market, as the market rate is determined in the secondary market. Issues in the primary market at below market rate, determined in the secondary market, would be issued at a discount on the nominal value of the instrument. If the volumes traded in the secondary market are high it could be an indicator that an excess of long-term money is available in the market, and it

may thus be an opportune time to issue new securities into the market by means of the primary market. Therefore, if the liquidity in the secondary market is high, chances are that new issues would be more successful than in an illiquid market.

This issue is The

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SIGNIFICANCE, ROLE OR FUNCTIONS OF CAPITAL MARKET

Like the money market capital market is also very important. It plays a significant role in the national economy. A developed, dynamic and vibrant capital market can immensely contribute for speedy economic growth and development.

Let us get acquainted with the important functions and role of the capital market.

with the important functions and role of the capital market. 1. Mobilization of Savings : Capital

1. Mobilization of Savings : Capital market is an important source for mobilizing idle savings from the economy. It mobilizes funds from people for further investments in the productive channels of an economy. In that sense it activate the ideal monetary resources and puts them in proper investments.

2. Capital Formation : Capital market helps in capital formation. Capital formation is net addition to the existing stock of capital in the economy. Through mobilization of ideal resources it generates savings; the mobilized savings are made available to various segments such as agriculture, industry, etc. This helps in increasing capital formation.

3. Provision of Investment Avenue : Capital market raises resources for longer periods of time. Thus it provides an investment avenue for people who wish to invest resources for a long period of time. It provides suitable interest rate returns also to investors. Instruments such as bonds, equities, units of mutual funds, insurance policies, etc. definitely provides diverse investment avenue for the public.

4. Speed up Economic Growth and Development : Capital market enhances production and productivity in the national economy. As it makes funds available for long period of time, the financial requirements of business houses are met by the capital market. It helps in research and development. This helps in, increasing production and productivity in economy by generation of employment and development of infrastructure.

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5. Proper Regulation of Funds : Capital markets not only helps in fund mobilization, but it also helps in proper allocation of these resources. It can have regulation over the resources so that it can direct funds in a qualitative manner.

6. Service Provision : As an important financial set up capital market provides various types of services. It includes long term and medium term loans to industry, underwriting services, consultancy services, export finance, etc. These services help the manufacturing sector in a large spectrum.

7. Continuous Availability of Funds : Capital market is place where the investment avenue is continuously available for long term investment. This is a liquid market as it makes fund available on continues basis. Both buyers and seller can easily buy and sell securities as they are continuously available. Basically capital market transactions are related to the stock exchanges. Thus marketability in the capital market becomes easy. These are the important functions of the capital market.

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Regulation of the market

The market was unregulated in terms of trading up to the 1980s. Trading took place on an OTC basis and the settlement system, which is still used in some cases, where physical settlements take place on the second Thursday after the transaction. With the new bond exchange, settlement will come in line with international standards, with settlement taking place three days after the transaction by electronic means.

place three days after the transaction by electronic means. In 1989 the Financial Markets Control Act

In 1989 the Financial Markets Control Act was promulgated which regulated the initiation and existence of financial markets. The Bond Market Association was formed to establish an exchange and from this the Bond Exchange of South Africa (BESA) was established as a formal financial exchange licensed under the act on 15 May 1996. BESA is responsible for the listing/delisting of instruments, its members and the surveillance of trading activities.

Members of BESA include resident banking groups, large issuers, stockbrokers and a number of major resident financial institutions and intermediaries meeting specific requirements. BESA members are allowed to act as agent and principal (dual trading capacity), or as principal only. A Guaranty Fund has been established in order to protect the investing public against the consequences of the insolvency of members.

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HOW TO ISSUES NEW SECURITIES

The major issuers of bonds in South Africa at present are the Republic of South Africa ("RSA") through the Treasury and semi- governmental bodies such as Eskom, Development Bank of Southern Africa, Telkom,

Transnet and Land Bank.

are commonly referred to as "gilts". Intermediaries such as brokers and banks (especially merchant banks) are often used by

borrowers to administer the issuing of new bonds.

Government bonds

to administer the issuing of new bonds. Government bonds Bonds can be issued in the primary

Bonds can be issued in the primary market using several different methods. As with equities, bonds can be issued by way of public subscription where a prospectus is issued which contains details of the company issuing the bond, and of the bond itself. The public can then subscribe to the bond, and the borrower or an intermediary on behalf of the borrower will allocate bonds to subscribers on issue date by means of a certain process.

Bonds can also be issued through private placing. This method is used when the borrower (or an intermediary on behalf of the borrower) places bonds with certain investors selected by the borrower. The selected investor would then receive a certain amount of bonds at issue date and pay the borrower the issue price for the bonds received.

A third method used to issue bonds is known as the "tender" method. The borrower or intermediary will issue a media statement that bonds will be issued in the market on a certain date. The details of the bonds and the capitalisation of the issue (total nominal amount to be issued) will also be communicated. Interested parties are then invited to tender before a certain date for these bonds. Tenders from interested parties would normally consist of the nominal amount plus the percentage of the nominal amount that the interested party is willing to pay for the bonds at issue, for example, a tender for R5 million worth of bonds at 97% of the nominal amount. If this tender succeeds, the tendering party will take up R5 million worth of bonds at issue date and pay the borrower (R5 000 000 x 97%) = R4 850 000. The borrower

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usually allots the bonds in order of highest tenders first, but it is in his power to decide who will receive bonds at issue date.

Another method that is used to issue new instruments is known as the "tap" method, whereby not all the bonds are allocated at the first issue (which can be done by any of the above three methods). If, for instance, a borrower wants to issue R100 million worth of bonds he can choose to issue only R60 million at the first issue. The borrower or intermediary then starts creating a secondary market for these instruments by buying and selling the issued

instruments in the secondary market.

and sells the same instrument in the market, is known as market making. The market maker thus has a bid (to buy) and an offer (to sell) in the market for

the same instrument, trying to create an active and liquid market in this instrument. The "tap" method is then used by the borrower or intermediary,

whereby more instruments are sold in the market than that bought back.

using this method, the amount of the loan is increased, often without the market realising it. This method can also be used in inverse form to decrease the total outstanding loan. The ultimate borrower in the capital market can use the tap method, because he is allowed to trade in his own securities. This

is however not possible in the equities market because a company is not allowed to buy its own shares according to the Companies Act.

This process, where one party buys

By

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Trading principles and systems

Capital market instruments or bonds

are instruments that represent future cash flow streams. In the case of an interest-paying bond, the cash flow will be made up of periodic interest payments and the nominal amount at

redemption date.

zero-rated coupon bonds, the cash flow is a single payment of the nominal or redemption amount at the redemption date.

In the case of nil or

amount at the redemption date. In the case of nil or As can be seen from

As can be seen from the value determination in 4.6, the values of these instruments are determined by discounting the cash flows back to the current date at an applicable rate (the yield or market rate). If the rate used to discount the cash flows back to a present value is high, the present value is low. If the rate used to discount the cash flows is low, the current value is high. This rate used for discounting the cash flows will be the yield that the investor would receive (known as the yield-to-maturity or YTM) on his original investment (the physical investment being the present value) if he keeps the bond up to maturity.

Bonds are thus traded in terms of yields-to-maturity expressed as interest rates. The rate at which the bond traded for a specific day or period would be known as the market rate for that specific day or period.

South African bonds can be screen traded, or by open outcry, through a BESA member. Screen trading takes place through intermediaries such as FCB or

IMB.

quoted on a screen. This screen is available to traders in the market. If a trader wants to trade on one of the bids or offers quoted, he phones the intermediary (FCB or IMB) who then lets the other party to the transaction know that the deal is closed and the detail thereof. Both parties have to book the deal with BESA who matches the deal and sends a report of deals done to every member at the end of the day. Trading hours on BESA are from Monday

Bids and offers received telephonically from players in the market are

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through to Friday from 07h00 to 17h00. Bonds are exempt from marketable securities tax and stamp duty.

A dealer's note or a capital market transaction note is normally completed by the dealer, mostly on screen, who then hands it to the administrative section for confirmation, settlement and accounting purposes. The dealer or capital market transaction note normally has at least the following information indicated

the name of the bond traded, e.g. E168

the nominal amount traded

the rate or yield at which traded (from which the settlement amount or value will be calculated)

the counter party

whether the transaction is a buy or a sell

the date and time of the transaction

the settlement date (which differs from the transaction date)

the dealer's name and signature.

Dealers do different kinds of transactions. If a dealer acts only as an agent, transactions are done in such a manner that the dealer's company has no open position. A back-to-back deal, for instance, is a transaction where the instrument involved is bought and sold, resulting in no open position for the trader.

Small participators in the market often do not have the funds to settle the transaction on the settlement date. If such a trader in the market is of the opinion that rate will decrease, resulting in an increase in value of the security, he could do the following deal:

He could buy the instrument for settlement in three days time (for this example, assume that the first settlement date is 1 March). If the rates have not moved down on 1 March, he will want to keep the instrument, but does not have the cash to settle the transaction. He can then do a transaction with a large institution where he sells the instrument to them for settlement on 1 March, and buys the instrument back from them for settlement on 4 March. This transaction, where an instrument is simultaneously bought and sold to the same party for different settlement dates, is called a carry transaction. The trader's position for 1 March is a net nil position because he has bought and sold the

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instrument. He must, however, settle on 4 March, or do a similar carry transaction for that date. Since the implementation of the T+3 settlement period on the bond exchange (settlement within three working days of the transaction), these transactions have mainly been replaced by scrip lending (see below) or future swaps transactions.

An instrument can be sold short in the capital market (a bear sale).

instrument is sold on 1 April for settlement on 4 April, without the seller physically owning the instrument, it can be bought back before 4 April for settlement on 4 April. Alternatively, the certificates needed to settle the transaction could be borrowed from a large institution owning some of these instruments and not trading in them. Security will have to be given, and credit

risk checks will be done on the borrower. This is known as scrip lending. Scrip lending typically costs the borrower between 2% and 3% per year of the value of the scrip for the period that the scrip is being borrowed.

If an

Some institutions that have scrip on hand also offer physical/future swap transactions. This means that the person or institution that is short of scrip because of a bear sale, can swap the physical scrip and a future to sell the same stock, with the institution that has the scrip on hand physically. The difference between the buying price of the physical stock and the selling price of the future contract will be the profit that the facilitator would make.

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CAPITAL MARKET INSTRUMENTS

Capital market instruments are those instruments which are not facilitate the transfer of capital in the financial markets (!).Let's start with a basic definition of capital markets. A capital market is where people (individuals, corporations, governments)lend or borrow money. To facilitate an example, we ask: how do lenders decide who should borrow from them? The markets have evolved uniform instruments to help lenders in the capital markets make investment decisions. One example of these uniform instruments is a fixed rate bond. A fixed rate bond allows a company/government to borrow money for a fixed period of time while paying a fixed interest rate on that borrowed money. In the capital markets, the uniformity of fixed rate bonds facilitate the transfer of capital from lender to borrower. Other examples of capital market instruments include equity, floating rate bonds, convertible bonds, asset backed securities, mortgage backed securities, and interest rate swaps.

mortgage backed securities, and interest rate swaps. A capital market is a market for securities (debt

A capital market is a market for securities (debt or equity), where business enterprises and government can raise long-term funds. It is defined as a market in which money is provided for periods longer than a year, as the raising of short-term funds takes place on other markets (e.g., the money market). The capital market is characterized by a large variety of financial instruments: equity and preference shares, fully convertible debentures (FCDs), non-convertible debentures (NCDs) and partly convertible debentures (PCDs) currently dominate the capital market, however new instruments are being introduced such as debentures bundled with warrants, participating preference shares, zero-coupon bonds, secured premium notes, etc.

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Capital market instruments are responsible for generating funds for companies, corporations, and sometimes national governments. These are used by the investors to make a profit out of their respective markets. There are a number of capital market instruments used for market trade, including Stocks Bonds Debentures Treasury-bills Foreign Exchange Fixed deposits, and others Capital market is also known as securities market because long term funds are raised through trade on debtand equity securities. These activities may be conducted by both companies and governments. This market is divided into primary capital market. and secondary capital market. The primary market is designed for the new issues and the secondary market is meant for the trade of existing issues. Stocks and bonds are the two basic capital market instruments used in both the primary and secondary markets. There are three different markets in which stocks are used as the capital market instrument:

the physical, virtual, and auction markets.

Bonds, however, are traded in a separate bond market. This market is also known as a debt, credit, or fixed income market. Trade in debt securities are done in this market. There are also the T-bills and Debentures which are used as capital market instruments by the investors. These instruments are more secured than the others, but they also provide less return than the other capital market instruments. While all capital market instruments are designed to provide a return on investment, the risk factors are different for each and the selection of the instrument depends on the choice of the investor. The risk tolerance factor and the expected returns from the investment play a decisive role in the selection by an investor of a capital market instrument. Capital market instruments should be selected only after doing proper research in order to increase one.

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DIFFERENT INSTRUMENTS IN CAPITAL MARKET

A capital market is a market for securities (debt or equity), where business enterprises and government can raise long-term funds. It is defined as a market in which money is provided for periods longer than a year, as the raising of short-term funds takes place on other markets (e.g., the money market). The capital market is characterized by a large variety of financial instruments:

equity and preference shares, fully convertible debentures (FCDs), non- convertible debentures (NCDs) and partly convertible debentures (PCDs) currently dominate the capital market, however new instruments are being introduced such as debentures bundled with warrants, participating preference shares, zero-coupon bonds, secured premium notes, etc.

shares, zero-coupon bonds, secured premium notes, etc. 1. SECURED PREMIUM NOTES SPN is a secured debenture

1. SECURED PREMIUM NOTES

SPN is a secured debenture redeemable at premium issued along with a detachable warrant, redeemable after a notice period, say four to seven years. The warrants attached to SPN gives the holder the right to apply and get allotted equity shares; provided the SPN is fully paid. There is a lock-in period for SPN during which no interest will be paid for an invested amount. The SPN holder has an option to sell back the SPN to the company at par value after the lock in period. If the holder exercises this option, no interest/ premium will be paid on redemption. In case the SPN holder holds it further, the holder will be repaid the principal amount along with the additional amount of interest/ premium on redemption in installments as decided by the company. The conversion of detachable warrants into equity shares will have to be done

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within the time limit notified by the company. Ex-TISCO issued warrants for the first time in India in the year 1992 to raise 1212 crore.

2. DEEP DISCOUNT BONDS

A bond that sells at a significant discount from par value and has no coupon

rate or lower coupon rate than the prevailing rates of fixed-income securities

with a similar risk profile. They are designed to meet the long term funds requirements of the issuer and investors who are not looking for immediate return and can be sold with a long maturity of 25-30 years at a deep discount on the face value of debentures.

3. EQUITY SHARES WITH DETACHABLE WARRANTS

A warrant is a security issued by company entitling the holder to buy a given

number of shares of stock at a stipulated price during a specified period. These warrants are separately registered with the stock exchanges and traded separately. Warrants are frequently attached to bonds or preferred stock as a sweetener, allowing the issuer to pay lower interest rates or dividends.

4. FULLY CONVERTIBLE DEBENTURES WITH INTEREST

This is a debt instrument that is fully converted over a specified period into equity shares. The conversion can be in one or several phases. When the instrument is a pure debt instrument, interest is paid to the investor. After conversion, interest payments cease on the portion that is Oral Tution Classes- EIRC of ICSI Securities Laws and Compliances by Neha Singhi converted. If project finance is raised through an FCD issue, the investor can earn interest even when the project is under implementation. Once the project is operational, the investor can participate in the profits through share price appreciation and dividend payments

5. EQUIPREF

They are fully convertible cumulative preference shares. This instrument is divided into 2 parts namely Part A & Part B.

Part A is convertible into equity shares automatically /compulsorily on date of allotment without any application by the allottee.

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Part B is redeemed at par or converted into equity after a lock in period at the option of the investor, at a price 30% lower than the average market price.

6. SWEAT EQUITY SHARES

The phrase `sweat equity' refers to equity shares given to the company's employees on favorable terms, in recognition of their work. Sweat equity usually takes the form of giving options to employees to buy shares of the company, so they become part owners and participate in the profits, apart from earning salary. This gives a boost to the sentiments of employees and motivates them to work harder towards the goals of the company. The Companies Act defines `sweat equity shares' as equity shares issued by the company to employees or directors at a discount or for consideration other than cash for providing knowhow or making available rights in the nature of intellectual property rights or value additions, by whatever name called.

7. TRACKING STOCKS

A tracking stock is a security issued by a parent company to track the results of one of its subsidiaries or lines of business; without having claim on the assets of the division or the parent company. It is also known as "designer stock". When a parent company issues a tracking stock, all revenues and expenses of the applicable division are separated from the parent company's financial statements and bound to the tracking stock. Oftentimes, this is done to separate a subsidiary's high-growth division from a larger parent company that is presenting losses. The parent company and its shareholders, however, still control the operations of the subsidiary.

8. DISASTER BONDS

Also known as Catastrophe or CAT Bonds, Disaster Bond is a high-yield debt instrument that is usually insurance linked and meant to raise money in case of a catastrophe. It has a special condition that states that if the issuer (insurance or Reinsurance Company) suffers a loss from a particular pre- defined catastrophe, then the issuer's obligation to pay interest and/or repay the principal is either deferred or completely forgiven.

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9. MORTGAGE BACKED SECURITIES(MBS)

MBS is a type of asset-backed security, basically a debt obligation that represents a claim on the cash flows from mortgage loans, most commonly on residential property. Mortgage backed securities represent claims and derive their ultimate values from the principal and payments on the loans in the pool. These payments can be further broken down into different classes of securities, depending on the riskiness of different mortgages as they are classified under the MBS.

Mortgage originators to refill their investments

New instruments to collect funds from the market, very economic and more effective

Conversion of assets into funds

Financial companies save on the costs of maintenance of the assets and other costs related to assets, reducing overheads and increasing profit ratio.

Kinds of Mortgage Backed Securities:

Commercial mortgage backed securities: backed by mortgages on commercial property

Collateralized mortgage obligation: a more complex MBS in which the mortgages are ordered into tranches by some quality (such as repayment time), with each tranche sold as a separate security Stripped mortgage backed securities: Each mortgage payment is partly used to pay down the loan's principal and partly used to pay the interest on it.

10. GLOBAL DEPOSITORY RECEIPTS/ AMERICAN DEPOSITORY RECEIPTS

A negotiable certificate held in the bank of one country (depository) representing a specific number of shares of a stock traded on an exchange of another country. GDR facilitate trade of shares, and are commonly used to invest in companies from developing or emerging markets. GDR prices are often close to values of related shares, but they are traded and settled independently of the underlying share. Listing on a foreign stock exchange requires compliance with the policies of those stock exchanges. Many times, the policies of the foreign exchanges are much more stringent than the

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policies of domestic stock exchange. However a company may get listed on these stock exchanges indirectly using ADRs and GDRs. If the depository receipt is traded in the United States of America (USA), it is called an American Depository Receipt, or an ADR. If the depository receipt is traded in a country other than USA, it is called a Global Depository Receipt, or a GDR. But the ADRs and GDRs are an excellent means of investment for NRIs and foreign nationals wanting to invest in India. By buying these, they can invest directly in Indian companies without going through the hassle of understanding the rules and working of the Indian Oral Tution Classes-EIRC of ICSI Securities Laws and Compliances.

11. FOREIGN CURRENCY CONVERTIBLE BONDS(FCCBs)

A convertible bond is a mix between a debt and equity instrument. It is a bond having regular coupon and principal payments, but these bonds also give the bondholder the option to convert the bond into stock. FCCB is issued in a currency different than the issuer's domestic currency. The investors receive the safety of guaranteed payments on the bond and are also able to take advantage of any large price appreciation in the company's stock. Due to the equity side of the bond, which adds value, the coupon payments on the bond are lower for the company, thereby reducing its debt-financing costs.

Advantages

• Some companies, banks, governments, and other sovereign entities may

decide to issue bonds in foreign currencies because, as it may appear to be more stable and predictable than their domestic currency.

• Gives issuers the ability to access investment capital available in foreign markets.

• Companies can use the process to break into foreign markets.

• The bond acts like both a debt and equity instrument. Like bonds it makes regular coupon and principal payments, but these bonds also give the bondholder the option to convert the bond into stock.

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• It is a low cost debt as the interest rates given to FCC Bonds are normally 30- 50 percent lower than the market rate because of its equity component.

• Conversion of bonds into stocks takes place at a premium price to market

price. Conversion price is fixed when the bond is issued. So, lower dilution of the company stocks.

Advantages to investors

• Safety of guaranteed payments on the bond.

• Can take advantage of any large price appreciation in the company’s stock.

• Redeemable at maturity if not converted.

• Easily marketable as investors enjoys option of conversion in to equity if resulting to capital appreciation.

Disadvantages

• Exchange risk is more in FCCBs as interest on bond would be payable in

foreign currency. Thus companies with low debt equity ratios, large forex earnings potential only opted for FCCBs.

• FCCBs means creation of more debt and a FOREX outgo in terms of interest which is in foreign exchange.

• In case of convertible bond the interest rate is low (around 3 to 4%) but

there is exchange risk on interest as well as principal if the bonds are not converted in to equity.

• If the stock price plummets, investors will not go for conversion but

redemption. So,

which can hit earnings.

companies have to refinance to fulfill the redemption romise

• It remains a debt in the balance sheet until conversion.

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13. DERIVATIVES

A derivative is a financial instrument whose characteristics and value depend

upon the characteristics and value of some underlying asset typically commodity, bond, equity, currency, index, event etc. Advanced investors sometimes purchase or sell derivatives to manage the risk associated with the underlying security, to protect against fluctuations in value, or to profit from periods of inactivity or decline. Derivatives are often leveraged, such that a small movement in the underlying value can cause a large difference in the value of the derivative.

Derivatives are usually broadly categorized by:

• The relationship between the underlying and the derivative (e.g. forward, option, swap)

• The type of underlying (e.g. equity derivatives, foreign exchange derivatives and credit derivatives)

• The market in which they trade (e.g., exchange traded or over-the-counter)

Futures

A financial contract obligating the buyer to purchase an asset, (or the seller to

sell an asset), such as a physical commodity or a financial instrument, at a predetermined future date and price. Futures contracts detail the quality and quantity of the underlying asset; they are standardized to facilitate trading on

a futures exchange. Some futures contracts may call for physical delivery of the asset, while others are settled in cash. The futures markets are characterized by the ability to use very high leverage relative to stock markets. Some of the most popular assets on which futures contracts are available are equity stocks, indices, commodities and currency.

Options

A financial derivative that represents a contract sold by one party (option

writer) to another party (option holder). The contract offers the buyer the right, but not the obligation, to buy (call) or sell (put) a security or other financial asset at an agreed-upon price (the strike price) during a certain

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period of time or on a specific date (excercise date). A call option gives the buyer, the right to buy the asset at a given price. This 'given price' is called 'strike price'. It should be noted that while the holder of the call option has a right to demand sale of asset from the seller, the seller has only the obligation and not the right. For eg: if the buyer wants to buy the asset, the seller has to sell it. He does not have a right.

Similarly a 'put' option gives the buyer a right to sell the asset at the 'strike price' to the buyer. Here the buyer has the right to sell and the seller has the obligation to buy. So in any options contract, the right to exercise the option is vested with the buyer of the contract. The seller of the contract has only the obligation and no right contract bears the obligation, he is paid a price called as 'premium'. Therefore the price that is paid for buying an option contract is called as premium.

The primary difference between options and futures is that options give the holder the right to buy or sell the underlying asset at expiration, while the holder of a futures contract is obligated to fulfill the terms of his/her contract.

14. PARTICIPATORY NOTES

Also referred to as "P-Notes" Financial instruments used by investors or hedge funds that are not registered with the Securities and Exchange Board of India to invest in Indian securities. Indian-based brokerages buy India-based securities and then issue participatory notes to foreign investors. Any dividends or capital gains collected from the underlying securities go back to the investors. These are issued by FIIs to entities that want to invest in the Indian stock market but do not want to register themselves with the SEBI. RBI, which had sought a ban on PNs, believes that it is tough to establish the beneficial ownership or the identity of ultimate investors.

15. HEDGE FUND

A hedge fund is an investment fund open to a limited range of investors that undertakes a wider range of investment and trading activities in both domestic and international markets, and that, in general, pays a performance fee to its investment manager. Every hedge fund has its own investment

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strategy that determines the type of investments and the methods of investment it undertakes. Hedge funds, as a class, invest in a broad range of investments including shares, debt and commodities. As the name implies, hedge funds often seek to hedge some of the risks inherent in their investments using a variety of methods, with a goal to generate high returns through aggressive investment strategies, most notably short selling, leverage, program trading, swaps, arbitrage and derivatives. Legally, hedge funds are most often set up as private investment partnerships that are open to a limited number of investors and require a very large initial minimum investment. Investments in hedge funds are illiquid as they often require investors keep their money in the fund for at least one year.

16. FUND OF FUNDS

A "fund of funds" (FoF) is an investment strategy of holding a portfolio of

other investment funds rather than investing directly in shares, bonds or other securities. This type of investing is often referred to as multi-manager investment. A fund of funds allows investors to achieve a broad diversification and an appropriate asset allocation with investments in a variety of fund categories that are all wrapped up into one fund.

17. EXCHANGE TRADED FUNDS

An exchange-traded fund (or ETF) is an investment vehicle traded on stock exchanges, much like stocks. An ETF holds assets such as stocks or bonds and trades at approximately the same price as the net asset value of its underlying assets over the course of the trading day. Most ETFs track an index, such as the S&P 500 or MSCI EAFE. ETFs may be attractive as investments because of their low costs, tax efficiency, and stock-like features, and single security can track the performance of a growing number of different index funds currently

the NSE Nifty.

18. GOLD ETF

A gold Exchange Traded Fund (ETF) is a financial instrument like a mutual

fund whose value depends on the price of gold. In most cases, the price of one

unit of a gold ETF approximately reflects the price of 1 gram of gold. As the

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price of gold rises, the price of the ETF is also expected to rise by the same amount. Gold exchange-traded funds are traded on the major stock exchanges including Zurich, Mumbai, London, Paris and New York There are also closed- end funds (CEF's) and exchange-traded notes (ETN's) that aim to track the gold price.

19.DEBT INSTRUMENTS

To meet the long term and short term needs of finance, firms issue various kinds of Securities to the public. Securities represent claims on a stream of income and /or particular assets.Debentures are debt securities, and there is a wide range of them. Market loans are raised by the government and public sector institutions through debt securities. Equity shares issued by cooperates are ownership securities. Preference shares are a hybrid security. It is a mixture of an ownership security and debt security.

DEBENTURES A debenture is a document which either creates a debt or acknowledges it. Debenture issued by a company is in the form of a certificate acknowledging indebtedness. The debentures are issued under the Company's Common Seal. Debentures are one of a series issued to a number of lenders. The date of repayment is specified in the debentures. Debentures are issued against a charge on the assets of the Company. Debentures holders have no right to vote at the meetings of the companies.

KINDS OF DEBENTURES

(a) Bearer Debentures:

They are registered and are payable to the bearer. They are negotiable

instruments and are transferable by delivery.

(b) Registered Debentures:

They are payable to the registered holder whose name appears both on the debentures and in the Register of Debenture Holders maintained by the company. Registered Debentures can be transferred but have to be registered again. Registered Debentures are not negotiable instruments. A registered debenture contains a commitment to pay the principal sum and interest. It also has a description of the charge and a statement that it is Issued subject to the conditions endorsed therein.

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(c) Secured Debentures:

Debentures which create a change on the assets of the company which may be

fixed or floating are known as secured Debentures. The term "bonds" and "debentures"(secured) are used interchangeably in common parlance. In USA, BOND is a long term contract which is secured, whereas a debentures is an unsecured one.

(d) Unsecured or Naked Debentures:

Debentures which are issued without any charge on assets are insecured or naked debentures. The holders are like unsecured creditors and may see the company for the recovery of debt.

(e) Redeemable Debentures:

Normally debentures are issued on the condition that they shall be redeemed

after a certain period. They can however, be reissued after redemption.

(f) Perpetual Debentures:

When debentures are irredeemable they are called perpetual. Perpetual

Debentures cannot be issued in India at present.

(g) Convertible Debentures:

If an option is given to convert debentures into equity shares at the stated rate

of exchange after a specified period, they are called convertible debentures. Convertible Debentures have become very popular in India. On conversion the holders cease to be lenders and become owners.

Debentures are usually issued in a series with a pari passu (at the same rate) clause which entitles them to be discharged rateably though issued at different times. New series of debentures cannot rank pari passu with the old series unless the old series provides so.

New debt instruments issued by public limited companies are participating debentures, convertible debentures with options, third party convertible debentures convertible debentures redeemable at premiums, debt equity swaps and zero coupon convertible notes. These are discussed below:

(h) Participating Debentures:

They are unsecured corporate debt securities which participate in the profits

of the company. They might find investors if issued by existing dividend paying companies.

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(i) Convertible Debentures with options:

They are a derivative of convertible debentures with an embedded option, providing flexibility to the issuer as well as the investor to exit from the terms of the issue. The coupon rate is specified at the time of issue.

(j) Third Party Convertible Debentures:

They are debt with a warrant allowing the investor to subscribe to the equity of third firm at a preferential price visa vis the market price. Interest rate on

third party convertible debentures is lower than pure debt on account of the conversion option.

(k) Convertible-Debentures Redeemable at a Premium:

Convertible Debentures are issued at face value with 'a put option entitling investors to sell the bond to the issuer at a premium. They are basically similar to convertible debentures but embody less risk.

(I) Debt-Equity Swaps:

Debt-Equity Swaps are an offer from an issuer of debt to swap it for equity. The instrument is quite risky for the investor because the anticipated capital appreciation may not materialize.

(m) Deep discount Bonds:

They are designed to meet the long term funds requirements of the issuer and investors who are not looking for immediate return and can be sold with a long maturity of 25-30 years at a deep discount on the face value of debentures. IDBI deep discount bonds for Rs 1 lakh repayable after 25 years were sold at a discount price of Rs. 2,700.

(n) Zero-Coupon Convertible Note:

A zero-coupon convertible note can be converted into shares. If choice is exercised investors forego all accrued and unpaid interest. The zero-coupon convertible notes are quite sensitive to changes in interest rates.

(o) Secured Premium Notes (SPN) with Detachable Warrants:

SPN which is issued along with a detachable warrant, is redeemable after a notice period, say four to seven years. The warrant attached to it ensures the holder the right to apply and get allotted equity shares; provided the SPN is fully paid.

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There is a lock-in period for SPN during which no interest will be paid for an invested amount. The SPN holder has an option to sell back the SPN to the company at par value after the lock in period. If the holder exercises this option, no interest/ premium will be paid on redemption. In case the SPN holder holds its further, the holder wili be repaid the principal amount along with the additional amount of interest/ premium on redemption in instalments as decided by the company. The conversion of detachable warrants into equity shares will have to be done within the time limit notified by the company.

(p) Floating Rate Bonds:

The rate on the floating Rate Bond is linked to a benchmark interest rate like the prime rate in USA or LIBOR in Eurocurrency market. The State Bank of India's floating rate bond was linked to maximum interest on term deposits which was 10 percent. Floating rate is quoted in terms of a margin above or below the bench mark rate. The-floor rate in the State Bank of India case was 12 per cent. Interest rates linked to the bench mark ensure that neither the borrower nor the lender suffer from the changes in interest rates. When rates are fixed, they are likely to be inequitable to the borrower when interest rates fall subsequently, and the same bonds are likely to be inequitable to the lender when interest rates rise subsequently.

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Conclusion

Conclusion The capital market provides financing to meet the denomination, liquidity, maturity, risk (with respect to
Conclusion The capital market provides financing to meet the denomination, liquidity, maturity, risk (with respect to
Conclusion The capital market provides financing to meet the denomination, liquidity, maturity, risk (with respect to
Conclusion The capital market provides financing to meet the denomination, liquidity, maturity, risk (with respect to
Conclusion The capital market provides financing to meet the denomination, liquidity, maturity, risk (with respect to
Conclusion The capital market provides financing to meet the denomination, liquidity, maturity, risk (with respect to

The capital market provides financing to meet the denomination, liquidity, maturity, risk (with respect to credit, interest rate, and market), and other characteristics desired by those who have a surplus of funds and those who have a deficit of funds. The capital market as a whole consists of overnight to long-term funding. The short to medium end of the maturity spectrum is called the money market proper, and the long end is identified as the capital market. The financial instruments range from money market instruments to thirty-year or longer bonds in credit markets, equity instruments, insurance instruments, foreign-exchange instruments, hybrid instruments, and derivative instruments. There has been an explosion of innovation in the creation and development of instruments in the money and capital markets since about 1960 in both debt and equity instruments.

Some of the important (by volume) money market instruments are Treasury bills, federal agency securities, federal funds, negotiable certificates of deposits, commercial paper, bankers' acceptances, repurchase agreements, Eurocurrency deposits, Eurocurrency loans, futures instruments and options instruments. Similarly, some of the key capital market instruments are U.S. securities; U.S. agency securities; corporate bonds; state and local government bonds; mortgage instruments; financial guarantees; securitized instruments; broker- dealer loans; foreign, international, and global bonds; and Eurobonds

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