Definition of Security Market Instruments

Capital Market Instruments

Meaning

A real or virtual document representing a legal agreement involving some sort of monetary value. These financial instruments are tradable assets used 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 and enable channelizing funds from surplus units to deficit units.

It is an easily tradable package of capital. These instruments can be classified generally as equity based, representing ownership of the asset, or debt based, representing a loan made by an investor to the owner of the asset. Foreign exchange instruments comprise a third, unique type of instrument. Different subcategories of each instrument type exist, such as preferred share equity and common share equity

Classification of Capital Market Instruments

There are number of Capital market instruments used in the Capital market. Basically these instruments are classified into three categories. These are

Pure Instrument: Equity shares, Preference shares and debenture or bonds which are issued with the basic characteristics without mixing the instruments are called Pure Instrument.

Hybrid Instrument: Those instruments which are created by combining the features of equity with bond, preference or equity shares are called as Hybrid Instrument. This is created in order to fulfill the needs of investors. For example: Convertible Preference Shares, Partial convertible debentures etc.

Derivative: are those instruments whose value is determined from the reference of other financial instruments. For example: future and option.

Various Types Capital Market Instruments

Equity

A stock or any other security representing an ownership interest.

On a company’s balance sheet, the amount of the funds contributed by the owners (the stockholders) plus the retained earnings (or losses).

In the context of margin trading, the value of securities in a margin account minus what has been borrowed from the brokerage.

In the context of real estate, the difference between the current market value of the property and the amount the owner still owes on the mortgage. It is the amount that the owner would receive after selling a property and paying off the mortgage.

In terms of investment strategies, equity (stocks) is one of the principal asset classes. The other two are fixed-income (bonds) and cash/cash-equivalents. These are used in asset allocation planning to structure a desired risk and return profile for an investor’s portfolio.

Preference shares: Sec. 85(1) of the Companies Act defines preference shares as those shares which carry preferential rights as the payment of dividend at a fixed rate and as to repayment of capital in case of winding up of the company. Thus, both the preferential rights include (a) preference in payment of dividend and (b) preference in repayment of capital in case of winding up of the company, must attach to preference shares.

Cumulative Preference Shares: are those preference shares which gets dividend in first claim as and when dividends are declared. If the company is not earned profit, then the dividend get accumulated and whenever company earns profit the shareholder will get all the accumulated dividend.

Non – Cumulative Preference Shares: are those preference shares which do not accumulate the profit if the company has not earned the profit. As and when the company declare dividend then only it goes to non- cumulative preference shares.

Convertible Preference Shares: If the Preference Share holders have termed in issue of shares that they can convert the preference shares into equity shares. These type of convertible shares are called as Convertible Preference Shares. Preference shares are convertible because to get various rights like voting rights, bonus issue and higher dividend. So for these issues, companies issue these shares with premium.

Redeemable Preference Shares: When the preference shares are issued with the stipulation that these shares are to be redeemed after a certain period of time, then such preference shares are known as redeemable preference shares. If a company collects the money through redeemable preference shares, this money must be returned on its maturity whether company is liquidated or not. These shares are issued only to raise the capital for temporary period.

Irredeemable Preference Shares: are those shares which are issued with the terms that shares will be not redeemed for indefinite period except certain instances like winding up.

Participating Preference Shares: If a company earns profit then it gets distributed to preference shareholders, equity shareholders etc. But after that also profit is left, then such profit can again distribute as dividend to participating preference shareholder as well as company can also issue bonus shares.

Debentures: includes stocks, bonds etc which are issued by the company as a cer-tificate of indebtness. For the issue of debentures, date of the repayment of principle and interest is decided. It is created on the charge of undertaking of assets of the company. If the company is not able to make the payment on the time, so the inves-tors can redeem the debentures by undertaking the assets or from the sale of assets.

Unsecured debentures: are those debentures which are not secured from the asset for the repayment of principle and interest.

Secured debentures: are those debentures which are secured by registered asset of the company.

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 within the time limit notified by the company

Redeemable debentures: are those debentures which are redeemable after a certain period or on their expiry date.

Perpetual debentures: are those debentures which are issued for the redemption on any specific event like winding up which may happen for any indefinite period.

Bearer debentures: are the debentures payable to bearer and also transferrable and the name of the holder will not be registered in the books of the company. SO whoever is the holder can bear the principle and interest as on due.

Equity shares with detachable warrants: are those warrants whose holder apply for a specific numbers of shares on appointed date at a pre- determined price. These warrants are separately registered with stock exchange and also traded separately. In Indian Market, Reliance applies on such warrants.

Sweat Equity Shares: are shares allotted to employees o companies, as rewards, free of cost or at a price which is considerable below the ruling market price. It is given as a reward for performance to further encourage them to put in their best in the organization. Under the Companies act, 1956, sweat equity shares means equity shares issued by a company to its employees or directors at a discounts or for consideration other than cash for providing know how or making available rights in the nature of intellectual property rights. Such issue may be made only if it is authorized by a special resolution passed by the company in the general meeting specifying the number of shares to be issued, class of the employees or directors to whom such shares are to be issued, the consideration and the current market price of the equity shares. Sweat equity shares can be issued if more than one year has elapsed from the commencement of the business. All limitations, restriction and provisions relating to equity shares shall be applicable to such sweat equity shares.

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.

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.

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 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.

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. 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.

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.

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.

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.

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 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 financial market – since ADRs and GDRs are traded like any other stock, NRIs and foreigners can buy these using their regular equity trading accounts.

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 domesticcurrency. 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.

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 categorised 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 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. As the seller of the 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.

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.

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 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.

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.

Equity

In accounting and finance, equity is the residual claim or interest of the most junior class of investors in assets, after all liabilities are paid. If liability exceeds assets, negative equity exists. In an accounting context, Shareholders’ equity (or stockholders’ equity, shareholders’ funds, shareholders’ capital or similar terms) represents the remaining interest in assets of a company, spread among individual shareholders of common or preferred stock.

In simple Words, a share or stock is a document issued by a company, which entitles its holder to be one of the owners of the company. A share is issued by a company or can be purchased from the stock market.

Equity Shares are those shares which refer to a part of ownership as a shareholde. These type of shareholder undertakes the maximum entrepreneurial risk associate with the business.

Equity Shareholders are called RESIDUAL OWNERS of the company. After all the obligations of the company are over, the Equity Share Holders get their share. Preference Share Holders get paid their dividends ahead of Equity Shareholders.

It is a COMMON STOCK and most frequently issued class of stock; usually it provides a voting right but is secondary to preferred stock in dividend and liquidation rights.

Shareholders Equity

A firm’s total assets minus its total liabilities. Equivalently, it is share capital plus retained earnings minus treasury shares. Shareholders’ equity represents the amount by which a company is financed through common and preferred shares.

Also known as “share capital”, “net worth” or “stockholders’ equity”

When you invest in a stock, you are essentially buying part ownership of a company, including its physical plant, output and everything it owns. As a shareholder, you are entitled to a proportionate share of the corporation’s profits and assets.

Businesses issue stock to raise capital. By issuing stock, a company generally can raise more capital than it could borrow. In addition, the company does not have to make periodic interest payments to creditors or make principal payments.

Conversely, by issuing stock, the principal owners have to share their ownership with other shareholders. And, shareholders have a voice in policies that affect the company’s operations.

Common Stock

People who own shares of common stock expect one or both of two things in return - dividends and/or capital appreciation. Dividends are taxable payments given to shareholders from the company’s current or retained earnings. The continuation of the dividend payments depends on the company’s ability to maintain or grow its current or retained earnings. Therefore, there is no assurance that dividends will continue to be paid. Dividends are generally paid quarterly and are usually distributed in cash, although stock or other property can also be given as dividends. Capital appreciation is the difference between the price you paid for a stock and its current value.

Owning shares of common stock entitles you to vote in the election of the corporation’s directors and other issues. Each share that you own represents one vote.

Features of Equity Capital

Limited Liability

Equity capital is issued with limited liability. This means, if the creditors to a business are not able to recover their dues, equity shareholders will not be asked to pay up. The liability of equity shareholders in a company is limited to their contribution made or on any amount unpaid which they have agreed to pay.

Face Value

The total equity capital required by a company is divided into smaller denomination called the face value or par value of the equity shares.

For example, if a company has an equity capital of ` 10,00,000, this can be divided into:

One lakh shares with a face value of ` 10; or

Two lakh shares with a face value of ` 5; or

Ten lakh shares with a face value of Re 1.

Equity shares were earlier issued as certificates; now they are invariably issued in electronic/dematerialised form.

The par value or face value of the shares can be changed subsequently, if the company so desires. This is called a split or a consolidation of shares. If a share with a face value of ` 10 is divided into two shares with par values of ` 5 each, it is called a split. If 5 shares of ` 2 face value each are clubbed into one share of ` 10, it is called a consolidation of shares.

Authorised Capital

The maximum amount of equity capital that a company will have is defined in the Memorandum of Association (MoA) of the company and is called its authorised capital. The authorised capital of a company can be raised or reduced subsequently by the company.

Issued Capital

The company may issue a portion of its authorised capital as and when it requires capital.

The capital may be issued to the promoters, public or to specified investors. The portion of authorised capital that has been issued to investors is called issued capital. Capital can be raised at various times as and when the company requires it, provided the sum of all capital issued is less than or equal to the authorised capital of the company.

The capital may be issued by the company either at its face value or at a premium (higher than the face value) or at a discount (lower than the face value). The issued capital will take into account only the face value of the shares issued. The remaining portion paid by the investor is accounted under the share premium account (liability side of the balance sheet) or share discount account (asset side of the balance sheet).

Paid-up capital

When investors subscribe to the capital issued by a company, they may be required to pay the entire price at the time of issue or in tranches (instalments) as application money, allotment money and call money. The portion of the issued capital that has been fully paidup by the allottees is the paid-up capital of the company.

A company decides that the maximum equity capital it needs is ` 20 cr. In the initial stages, the need is ` 10cr. It issues equity shares of ` 10 face value, at par. Investors are required to pay ` 5 per share with application, ` 2 on allotment, and balance ` 3 after it has been called. What is the authorised, issued and paid-up capital of the company, before the issue, after application, after allotment and after the call?

Thus it can be seen that the paid up capital is always less than or equal to issued capital; issued capital is always less than or equal to authorised capital. Authorised capital is the maximum amount that can be issued or paid up.

Ownership Rights

Equity represents ownership of the company. Equity share holders are part-owners of the company, the extent of their ownership is defined by their portion of the shares held in issued capital.

For example, if a company has an issued capital of ` 10cr made up of 1cr shares of ` 10 each, an investor who holds 10lakh equity shares is a part-owner with a 10% stake in the company.

Equity shareholders have the right to participate in the management of the company. They can do this through voting rights. Each equity share carries one vote. Major decisions of the company require resolutions to be passed, which have to be voted by a majority or more of the equity shareholders.

Equity capital entitles its contributors to participate in the residual profits of the company. After meeting all expenses and provisions, whatever is the profit that remains in the books belongs to equity share holders.

Liquidity and Return

Equity shares are first issued by a company. They are then listed on the stock exchange, where they can be transferred from one investor to another. Such transactions are between existing shareholders, and therefore do not result in change in the capital structure of the company. Equity capital is for perpetuity.

It cannot be redeemed and the company does not have to repay it. The return from equity capital is in the form of dividends from the profits of the company and appreciation in the value of the holdings. There is no guarantee of dividends or capital appreciation on equity capital.

Characteristics of Equity Shares

Investors in Equity Shares

A company raises equity capital to meet its need for long-term funds for expansion or continuing operations of the company. Equity capital does not impose any liability on the company in terms of returns or repayment. However, when a company issues equity capital, the investors also get control and ownership. Their ownership rights depend on the proportion of issued capital that they hold.

A company can raise capital from different categories of investors. Different cat-egories of investors have different requirements in terms of returns, risk and management control.

Promoters

Promoters are the group of investors who set up the company and bring in the initial capital required to start the business. This is the risk capital that allows the business to leverage and to protect it from fluctuations in earnings. At this stage the entire control of the company is with the promoters. They bring in additional capital as and when required.

As the capital needs of the business grow, promoters find that they cannot meet the company’s need for funds. Equity is then issued to eligible investors such as institutions and retail public investors.

Promoters usually retain the majority shareholding in the company so that they can continue to control its affairs even after their stakes are diluted. The stage at which the promoters bring in the initial capital is the riskiest as the business is in the nascent stage and has a high risk of failure.

Institutional Investors

Institutional investors include financial institutions, venture capital companies, mutual funds and foreign financial institutions, banks among others. These are professional investors who have the ability to evaluate the business proposition, the risks associated with it and the expected returns.

The company may allot shares to such investors through a private placement of shares where the regulatory requirements are much less as compared to a public issue of shares. The risks and returns will depend upon the stage at which the institutional investors bring in capital.

Some like venture capital firms may be willing to bring in capital for companies in the startup stage or even later while others like financial institutions invest in more established firms. Institutional investors such as venture capital firms may be actively involved in the management of the company while others like mutual funds may be more passive investors who are more interested in the returns that their investment can generate rather than in the management of the company.

Apart from the attractiveness of the business proposition, institutional investors would also be interested in factors such as exit options, since many of them may hold a significant proportion of the equity capital. Many institutional investors like venture capitalists, encourage a company to offer its shares to the public investors as an exit option for themselves.

Public Investors

When the equity shares are held by promoters and a few investors, it is said to be closely held. Such companies are also private companies, which are not required to disclose too much of information about themselves to the public.

When a company offers its equity shares to the public at large, it moves from being a privately held company, to a publicly held company, which agrees to disclose periodic information about its operations and business to the public.

Investors, other than promoters, participate in the equity of a company when a company comes out with a public issue of shares. A public issue of shares requires regulatory compliance with SEBI’s guidelines and regulations governing listing of the shares on a stock exchange.

Public investors in shares may be retail investors, high net worth individuals (HNI), non institutional investors or institutional investors. Retail investors, and to a great extent HNIs, are more interested in the returns that they can generate from their investment from capital appreciation in the value of the shares and dividend rather than in the control and management of the company. They hardly exercise their voting rights.

Large stake holders and institutional shareholders actively participate in the affairs of the company. Some large institutional investors are also given a seat on the board of the company. Regulations require extensive and timely disclosures of all information that affects the interests of the public investors in a company.

Risks in Equity Investing

No Fixed Return

The return in the form of dividend from equity is not pre-defined either in terms of the percentage of dividend or the date on which the payment will be made. Dividend is paid If the company makes sufficient profits and the management of the company feels it is appropriate for some of the profits to be distributed among the shareholders.

In case the company makes losses or the profits made by the company is ploughed back for the expansion and other operations of the company, the shareholders may not get a dividend.

The other source of return for the holder of equity shares is the appreciation in the price of the share in the secondary market. This constitutes the major portion of the return for the equity investor.

If the company’s performance is bad or if the stock markets are going through a downturn, the value of the shares may actually depreciate leading to a loss for the investor. There is no guarantee that the principal amount invested in equity shares will remain intact.

No Fixed Tenor

Equity shares are issued for perpetuity. This means that there is no period of maturity after which the money will be returned to the shareholders. Investors who want to exit their investments may do so by selling the shares on the stock exchange to other investors.

The investor who is selling all his shares ceases to be a shareholder of the company. The shares are transferred to the buyer who now gets all the rights and obligations associated with it. Transactions between investors on the secondary market do not increase or decrease the share capital of the company. The risk to the shareholder arises if the shares are illiquid and not easily sold at its market value or if the shares are unlisted. The investor’s investment may get struck without an exit option.

No Collateral Security

Equity capital is not secured by the assets of the company. The cash and assets of the company are first applied to settle the claims of the lenders and creditors. The claims of the equity shareholders always rank last in order of preference. During the normal course of operations of the company, dividends are payable to the equity shareholders only after the expenses, interest and taxes are provided for. In the event of liquidation of the company, the equity shareholders are only entitled to a refund of capital after the claims of all the other creditors are satisfied from the sale of the company’s assets.

Preferred Stock

Preferred stock offers investors certain advantages over common stock. Preferred stock represents ownership units in a company, but, unlike common stock, most preferred stock does not carry voting rights. However, preferred shareholders have priority over owners of common shares regarding payment of dividends. This means that they get paid their dividends, even if the common stockholders get none. Also, if the company goes bankrupt, preferred stockholders have priority over common stockholders in the distribution of corporate assets. Bond investors, though, have priority over preferred stockholders.

The market price of most preferred stock is not as volatile as common stock, which means prices of preferred stocks do not move up or down as quickly as common stock prices. Like bonds, preferred stock prices are interest-rate sensitive - when interest rates go up, the price of preferred stocks generally goes down; when interest rates go down, the price of the preferred stocks generally goes up.

There are a number of types of preferred stock, including:

Straight or Fixed Rate Perpetual

The dividend rate is fixed for the life of the issue, and it has no maturity date.

Convertible Preferred Stock

A preferred stock that can be converted to the company’s common stock at a conversion price that is determined at issuance.

Adjustable Rate Preferred Stock

It generally pays a quarterly dividend that is tied to a Treasury bill or other rate. The dividend is adjusted to changing interest rates according to a predetermined formula.

Participating Preferred Stock

Holders of this type of preferred stock receive dividend increases in years during which common stock dividends are greater than those of the preferred stock.

Stock Splits

A stock split is an increase in the number of shares of a company’s outstanding common stock. Since each shareholder’s equity cannot be affected by the split, the market price per share is adjusted. For example, if you own 100 shares of XYZ Company at ` 50 a share, your stock is worth ` 5,000. If XYZ declares a 2 for 1 split, you will then own 200 shares of stock. The price per share is adjusted to ` 25 per share, which leaves the total value unchanged (` 5,000).

Companies generally declare stock splits to reduce the price of their stock to make it more attractive to investors. For example, investors might be more apt to invest in a stock that is priced at $50 a share than one priced at ` 100 a share.

Stock Dividends

Stock dividends are paid in common shares, and can be used to pay shareholders instead of a cash dividend. For example, if you own 100 shares of a company that declared a 1% stock dividend, you will receive one more share of stock from the company’s reserve of shares.

If a company needs to tighten its fiscal belt, it may decide to declare a stock dividend rather than a cash dividend. A stock dividend will conserve cash while still allowing shareholders to benefit from the firm’s earnings.

Types of Stock

There are many different types of stocks available and in order to meet your financial goals, it’s important that you understand the differences between them.

Blue Chip Stocks

Blue chip stocks are well-established, nationally known, and generally financially sound companies. Blue chip companies have consistently demonstrated good earnings and industry leadership. Blue chips are typically less volatile than other stocks and have a record of paying dividends in both good and bad times.

Growth Stocks

Growth-stock companies have earnings and market share expansion that exceeds the industry average and the economy in general. Growth stock companies typically reinvest their profits to expand and strengthen their businesses, retaining most of their earnings to finance expansion and paying little, if any, dividends to shareholders. Investors are attracted to these stocks because they expect the stock price to go up as the company grows.

Penny Stocks

he term penny stock generally refers to low-priced (below $5) stock, which is traded over the counter (OTC). Penny stocks are generally considered a very high-risk investment.

Value Stocks

Value stocks are those that are considered undervalued by value investors. Value investors typically define undervalued stocks by their book/market and price/earnings ratios. Often value stocks represent companies with past financial difficulties, whose potential for growth has been underestimated, or that are part of an industry that is currently out of favor with investors.

Defensive Stocks

These are stocks of companies that provide necessary services, such as utilities that provide electric and gas, supermarkets that provide food, etc. Because the companies representing these stocks fulfill basic human needs, these stocks tend to provide a degree of stability for investors during recessions or economic slowdowns.

Income Stocks

Income stocks typically pay high dividends in relation to their market price, making them attractive to people who buy stocks for current income. Historically, these have been public utilities, but some blue chip stocks may fall into this category as well.

Cyclical Stocks

Cyclical stocks represent companies whose earnings are closely tied to the business cycle. When business conditions are good, a cyclical company generally prospers and its common stock price generally rises. When the economy slows or falls into recession, these companies’ earnings and stock prices typically fall. Airlines, automobiles, furniture manufacturers, steel and paper producers are examples of cyclical stocks.

Seasonal Stocks

The performance of these stocks fluctuates with the seasons. For example, retail companies’ sales and profits often increase at Christmas and the start of the school year.

International Stocks

Many investors use domestic (U.S.-based) equities as an integral part of their investment portfolios. However, the U.S. equity markets represent only about one-third of the total world markets. To be truly diversified, you should consider international equity investments.

In additional to the risks associated with equity investments, international stock investments have additional risks. Market volatility, reduced liquidity, a lack of public information, and social, political and currency risks are inherent to international investments.

Market Capitalization

Market capitalization refers to the total market value of a company. Investors find this information useful because companies that fall within the same market capitalization category (small, mid, or large) often have similar performance characteristics.

Market capitalization is calculated by multiplying the current market price of the stock by the total number of shares outstanding. For example, if XYZ Corporation has 100,000 shares outstanding at ` 10 a share, its market capitalization would be ` 10,00,000.

Generally, companies fall into one of the three categories of market capitalization:

Large Capitalization (large-cap) stocks

Mid Capitalization (mid-cap)

Small Capitalization (small-cap) stocks

When using market capitalization as an investment tool, it is important to remember that generally, no one class consistently outperforms the others. A diversified portfolio containing stocks of different sizes can be a practical means of seeking long-term investment success while managing risk.

Investing in Small-Cap Companies

Small-cap companies are usually young and unproven, without many products to sell and thin financial reserves. Because these companies are small and unknown, it may be difficult to find information on them. They may not be covered by analysts and may be inaccurately valued. Small-cap companies are vulnerable to economic slowdowns and recessions and their stocks tend to be volatile. While investing in small cap stocks carries substantial risk, they offer investors greater earnings potential than larger, more established companies.

Investing in Mid-Cap Companies

Mid-cap stocks have a large volume of shares to trade on major and regional exchanges. But the companies are smaller and less mature than large-cap stocks. Typically, they offer a greater potential for growth than larger companies, but the risk is also slightly greater.

Investing in Large-Cap Companies

Large-cap companies are typically well-known companies with a variety of products and services. Given their size and success, most have proved to be capable of surviving recessions and other temporary setbacks. But despite their market presence and strength, they are not immune to bad news and should not be considered risk-free investments.

Analysts carefully track these companies since they are large, established corporations. However, their earnings growth potential is not as great as that of a developing small-cap. Consequently, because large-caps are not compelled to reinvest all their profits into the growth of the company, a portion can be distributed to shareholders as dividends.

Secured Premium Notes (SPNs)

SPNs are bonds issued by corporations which are medium term in nature, maturing between 3 to 8 years. The advantage is the flexibility it offers in giving the returns as premium or interest payments depend upon the preferences of the holders.

The only issuer of SPNs in the Indian markets till now is TISCO Ltd. It issued SPNs of ` 300 each. The repayment started after three years, and there was no payment of interest in between. The repayment went on for four years starting from the fourth year to seventh year. Every year there will be a payment of ` 150 (totalling ` 150*4 = ` 600 in four years). ` 75 in this would be accounted for as principal repayment and the rest ` 75 could be taken as a mixture of interest and premium at the option of the investor. (` 25 as interest + ` 50 as premium; ` 37.50 interest + ` 37.50 premium; ` 50 interest + ` 25 premium).

The advantage of this was easier tax planning for the investor, but the tax authorities were not happy with this kind of an arrangement. TISCO also attached an equity warrant which was convertible into equity at a price which was at considerable discount to the market price prevailing at that time.

Secured Premium Notes is also issued along with a detachable warrant and is redeemable after a notified period of say 4 to 7 years. The conversion of detachable warrant into equity shares will have to be done within time period notified by the company.

Warrants

Warrants are usually attached to a debenture issue of the company to make the debenture more attractive. The number of shares that the warrant entitles the holder to subscribe to, the price at which such shares can be bought and the period during which the warrant can be exercised are specified at the time of the issue.

Warrants will be exercised if the share price at the time of exercise is higher than the price at which the investors have the option to buy the shares.

For example, assume a warrant enables an investor to buy an equity share of a company at ` 100. The warrant will be exercised if, when it is due to be exercised, the price of the share in the markets is more than ` 100. If the market price is less than ` 100, the investor can always buy from the market, rather than use the option to buy the same share at a higher price. When warrants are exercised they result in additional shares being issued by the company and a dilution in the stake of the existing shareholders.

Warrants may be traded on the stock exchange as a security separate from the debenture with which it was issued. Warrants usually have a longer lifetime (usually in years) as compared to option contracts which they closely resemble.

Warrants may be used by promoters to increase their stake in the company. SEBI requires that shares issued to promoters as a result of exercising the option on the warrant will have a lock-in of three years from the date the shares are allotted.

Sweat Equity Shares

Sweat equity shares are equity shares issued by a company to its employees or directors at a discount, or as a consideration for providing know-how or a similar value to the company.

A company may issue sweat equity shares of a class of shares already issued if these conditions are met:

The issue of sweat equity shares should be authorised by a special resolution passed by the company in a general meeting

The resolution should specify the number of shares, current market price, consideration, if any, and the section of directors /employees to whom they are to be issued As on the date of issue, a year should have elapsed since the company was entitled to commence business.

The sweat equity shares of a company whose equity shares are listed on a recognised stock exchange should be issued in accordance with the regulations made by the Securities and Exchange Board of India (SEBI).

In the case of a company whose equity shares are not listed on any recognised stock exchange, sweat equity shares can be issued in accordance with such guidelines as may be prescribed.

In the case of unlisted companies, sweat equity shares cannot be issued before one year of commencement of operations. Moreover, there is a cap of 15 percent on the number of sweat equity shares that can be issued without a specific central government approval.

Sweat equity shares are no different from employee stock options with one year vesting period. It is essential when a company is formed, to assure the financial investors that the knowhow providers will stay on, or for a start-up with limited resources to attract highly-qualified professionals to join the team as long-term stakeholders.

These shares are given to a company’s employees on favourable 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.

Section 79A of the Companies Act lays down conditions for the issue of sweat equity shares. For listed companies, there are regulations made by the SEBI. The SEBI also prescribes the accounting treatment of sweat equity shares. Thus, sweat equity is expensed, unless issued in consideration of a depreciable asset, in which case it is carried to the balance sheet.

Sweat equity is a device that companies use to retain their best talent. Usually, it is given as part of a remuneration package. However, start-ups sometimes use sweat equity to retain talent. If the company fails, its employees may end up with worthless paper in the form of sweat equity shares.

Unlisted companies cannot issue more than 15 percent of the paid-up capital in a year or shares with a value of more than ` 5 crores - whichever is higher - except with the prior approval of the central government. If the sweat equity is being issued for consideration other than cash, an independent valuer has to carry out an assessment and submit a valuation report.

The company should also give ‘justification for the issue of sweat equity shares for consideration other than cash, which should form a part of the notice sent for the general meeting’.

The board of directors’ decision to issue sweat equity has to be approved by passing a special resolution at a shareholders’ meeting later in the year. The special resolution must be passed by 75 percent of the members attending voting for it.

Non-Voting Shares

Non-voting shares carry no rights to vote and usually no right to attend general meetings either What voting rights do shares have?. Such shares are widely used to issue to employees so that some of their remuneration can be paid as dividends, which can be more tax-efficient for the company and the employee.

The same is also sometimes done for members of the main shareholders’ families. Preference shares are often non-voting.

Tracking Stocks

A tracking stock is a special type of stock issued by a company to represent a particular division of segment of the business. It allows management to retain control of the operation without having to sell it or spin it off to shareholders as a legally separate entity while providing investors the opportunity to value various aspects of an enterprise on different terms and price to earnings multiples.

Many companies issue “tracking” stocks—also known as “targeted” stocks—in addition to their traditional common stock. A tracking stock is a type of common stock that “tracks” or depends on the financial performance of a specific business unit or operating division of a company—rather than the operations of the company as a whole. Tracking stocks trade as separate securities.

As a result, if the unit or division does well, the value of the tracking stock may increase—even if the company as a whole performs poorly. The opposite may also be true.

Shareholders of tracking stocks have a financial interest only in that unit or division of the company. Unlike the common stock of the company itself, a tracking stock usually has limited or no voting rights. In the event of a company’s liquidation, tracking stock shareholders typically do not have a legal claim on the company’s assets. If a tracking stock pays dividends, the amounts paid will depend on the performance of the business unit or division. But not all tracking stocks pay dividends.

Preference Shares

When we talk of shares of a company we usually refer to the ordinary shares of a company. A company may also raise capital with varying rights and entitlements. These are called preference shares because they may offer certain special features or benefits to the investor.

Some benefits that investors in ordinary equity capital have, such as, voting rights, may instead not be available to preference share holders. Preference shares are usually given preference over equity shares in the payment of dividends and the repayment of capital if the company is wound up.

Dividend is paid to the preference share holder at a fixed rate mentioned at the time of the issue of the shares. The terms of issue may allow the preference share holders to participate in the residual profits too in some defined ratio. These are called participating preference shares.

Preference shareholders are paid dividend only if the company has sufficient profits. The unpaid dividend may be carried forward to the following year(s) and paid if there are profits to pay the dividends, if the terms of issue of the shares so allow. Such shares are called cumulative preference shares.

The returns for the preference shares are only from the dividend the company pays. These shares are usually not listed and there is not much scope for capital appreciation. This is because these shares do not participate in the profits of the company. Their value is not affected by the over-performance or under-performance of the company.

Though preference shares are similar to debentures, they differ on the following points: - A preference share holder is a shareholder of the company. A debenture holder is a creditor of the company. - A debenture is usually secured on the assets of the company. A preference share is not secured since it is not a borrowing. –

The coupon interest on the debenture is an expense to be paid by the company before calculating the profits on which tax has to be paid. Dividends on preference shares are paid from the residual profits of the company after all external liabilities, including tax, have been paid.

Types of Preference Shares

Following are the major types of preference shares:

Cumulative Preference Shares

When unpaid dividends on preference shares are treated as arrears and are carried forward to subsequent years, then such preference shares are known as cumulative preference shares. It means unpaid dividend on such shares is accumulated till it is paid off in full.

Non-cumulative Preference Shares

Non-cumulative preference shares are those type of preference shares, which have right to get fixed rate of dividend out of the profits of current year only. They do not carry the right to receive arrears of dividend. If a company fails to pay dividend in a particular year then that need not to be paid out of future profits.

Redeemable Preference Shares

Those preference shares, which can be redeemed or repaid after the expiry of a fixed period or after giving the prescribed notice as desired by the company, are known as redeemable preference shares. Terms of redemption are announced at the time of issue of such shares.

Non-redeemable Preference Shares

Those preference shares, which cannot be redeemed during the life time of the company, are known as non-redeemable preference shares. The amount of such shares is paid at the time of liquidation of the company.

Participating Preference Shares

Those preference shares, which have right to participate in any surplus profit of the company after paying the equity shareholders, in addition to the fixed rate of their dividend, are called participating preference shares.

Non-participating Preference Shares

Preference shares, which have no right to participate on the surplus profit or in any surplus on liquidation of the company, are called non-participating preference shares.

Convertible Preference Shares

Those preference shares, which can be converted into equity shares at the option of the holders after a fixed period according to the terms and conditions of their issue, are known as convertible preference shares.

Non-Convertible Preference Shares

Preference shares, which are not convertible into equity shares, are called non-convertible preference shares.

Debentures

A debt security denotes a contract between the issuer (company) and the lender (investor) which allows the issuer to borrow a sum of money at pre-determined terms.

These terms are referred to as the features of a bond and include the principal, coupon and the maturity of the bond. In Indian securities markets, a debt instrument denoting the borrowing of a government or public sector organizations is called a bond and the borrowings by the private corporate sector is called debenture. The terms bonds and debentures are usually used interchangeably these days. The principal is the amount which is being borrowed by the issuer. Each debenture represents a portion of this principal amount borrowed. The face value or par value of the debenture is the amount of the principal that is due on each debenture. The face value of a debenture is usually ` 100.

The coupon is the rate of interest to be paid by the borrower to the lender. This is a percentage that is applied to the face value or par value of the bond. The periodicity (annual, semi-annual, or quarterly.) with which the interest will be paid is also agreed upon.

The maturity of a bond refers to the date on which the contract requires the borrower to repay the principal amount. Once the bond is redeemed or repaid, it is extinguished and ceases to exist.

Each of these features of a bond can be modified to create instruments that meet the specific requirements of the borrower or the lender. A plain vanilla bond will have a fixed term to maturity with coupon being paid at pre-defined periods and the principal amount is repaid on maturity. The bond is usually issued at its face value, say ` 100 and redeemed at par, the same ` 100.

The simple variations to this structure could be a slightly varied issue price, higher or lower than par and a slightly altered redemption price, higher or lower than par. In some cases, the frequency of the interest payment could vary, from monthly, to quarterly and annual. All these variations still come under the plain vanilla definition of a bond, where the interest is paid at a fixed rate periodically, and principal returned when the bond is retired. There are however many ways in which bonds are differently structured, by tweaking their features.

Varying Coupon Structures

Zero Coupon Bond

In such a bond, no coupons are paid. The bond is instead issued at a discount to its face value, at which it will be redeemed. There are no intermittent payments of interest. When such a bond is issued for a very long tenor, the issue price is at a steep discount to the redemption value. Such a zero coupon bond is also called a deep discount bond. The effective interest earned by the buyer is the difference between the face value and the discounted price at which the bond is bought. There are also instances of zero coupon bonds being issued at par, and redeemed with interest at a premium. The essential feature of this type of bonds is the absence of periodic interest payments.
Floating Rate Bonds

Instead of a pre-determined rate at which coupons are paid, it is possible to structure bonds, where the rate of interest is re-set periodically, based on a benchmark rate. Such bonds whose coupon rate is not fixed, but reset with reference to a benchmark rate, are called floating rate bonds.

For example, a company can issue a 5 year floating rate bond, with the rates being re-set semi-annually with reference to the 1- year yield on central government securities and a 50 basis point mark-up. In this bond, every six months, the 1-year benchmark rate on government securities is ascertained.

The coupon rate the company would pay for the next six months is this benchmark rate, plus 50 basis points. The coupon on a floating rate bond thus varies along with the benchmark rate, and is reset periodically.

The other names, by which floating rate bonds are known, are variable rate bonds and adjustable rate bonds. These terms are generally used in the case of bonds whose coupon rates are reset at longer time intervals of a year and above. These bonds are common in the housing loan markets.

Other Variations

Some of other structures are: (a) deferred interest bonds, where the borrower could defer the payment of coupons in the initial 1 to 3 year period; (b) Step-up bonds, where the coupon is stepped up periodically, so that the interest burden in the initial years is lower, and increases over time.

Other Types of Bonds

Callable Bonds

Bonds that allow the issuer to alter the tenor of a bond, by redeeming it prior to the original maturity date, are called callable bonds. The call option provides the issuer the option to redeem a bond, if interest rates decline, and re-issue the bonds at a lower rate. The investor, however, loses the opportunity to stay invested in a high coupon bond, when interest rates have dropped.

Puttable Bonds

Bonds that provide the investor with the right to seek redemption from the issuer, prior to the maturity date, are called puttable bonds. A put option provides the investor the right to sell a low coupon-paying bond to the issuer, and invest in higher coupon paying bonds, if interest rates move up. The issuer will have to re-issue the put bonds at higher coupons.

Amortising Bonds

The structure of some bonds may be such that the principal is not repaid at the end/ maturity, but over the life of the bond. A bond in which payments that are made by the borrower includes both interest and principal, is called an amortising bond. Auto loans, consumer loans and home loans are examples of amortising bonds. The maturity of the amortising bond refers only to the last payment in the amortising schedule, because the principal is repaid over time i.e. redemption in more than one instalment.

Asset-Backed Securities

Asset backed securities represent a class of fixed income products, created out of pooling together assets, and creating bonds that represent participation in the cash flows from the asset pool. For example, select housing loans of a loan originator (say, a housing finance company) can be pooled, and bonds can be created, which represent a claim on the repayments made by home loan borrowers. Such bonds are called mortgage–backed securities.

In some markets like India, these bonds are known as structured obligations (SO). Assets with regular streams of cash flows are ideally suited for creating asset-backed securities.

Classification of Debt Instruments

Issuers in Bond Markets

There are two broad ways in which bond markets can be segmented. - Based on the type of borrower, we can segment the market between the bonds issued by governments, and those issued by non-government agencies like banks, corporations and other such entities.

Based on the tenor of the instrument, we can segment the bond markets as short-term, medium term and long term. These are not mutually exclusive segments. The government issues bonds to meet its requirements for various periods as does the private sector. Each issued bond has an issuer and a tenor.

Government Securities comprises the central government bonds, and quasi-government bonds issued by local governments, state governments and municipal bodies. Government securities do not have credit or default risk.

Corporate bond markets comprise pre-dominantly of short-term commercial papers and long-term bonds. Another segment comprises of short term paper issued by banks, in the form of certificates of deposit. The rate at which this segment borrows depends upon the credit quality of the borrower. The credit or default risk of the borrower is defined by the credit rating of the bond. Higher the credit rating lower is the risk of default.

Companies also raise fixed deposits from the retail investors to meet their borrowing requirements. Such deposits are for a fixed term and carry a pre-defined interest rate. The interest can either be paid periodically, such as annual, semi-annual, or quarterly or it is paid cumulatively at the end of the term along with the repayment of the principal.

Company deposits are credit rated but unsecured borrowings of companies and as such pay a higher interest rate on the deposit. Since these are deposits and not a security, there is no liquidity in such fixed deposits. The investors hold the deposits to maturity.

Treasury Bills

The government borrows for periods such as 91 days, 182 days and 364 days using these instruments. Treasury bills are issued through an auction process which is managed by the RBI. Banks, mutual funds, insurance companies, provident funds, primary dealers and FIs bid in these auctions. The treasury bills are usually issued as zero-coupon bonds.

CBLO

A Collateralised Borrowing and Lending Obligation (CBLO) is created using government securities as collateral and held with the Clearing Corporation of India Ltd. (CCIL) to enable borrowing. It is a discounted instrument available for maturities from one day to up to one year. Banks use the CBLO to borrow from mutual funds and insurance companies.

Certificates of Deposit (CD)

Banks use CDs to meet their short-term needs for funds. CDs are different from deposits because they involve creation of paper. This makes the CD transferable before maturity. Secondary market activity in CDs are however low.

Commercial Paper (CP)

CPs are short-term papers issued by companies or financial institutions to meet their working capital requirements. They can be issued for various maturities between a minimum of 7 days and maximum of up to one year from the date of issue. A company is eligible to issue a CP if the tangible net worth is not less than ` 4 crore, the company has a sanctioned working capital limit by banks or FIs and the borrowal account of the company is classified as a Standard Asset by the bank/FI. The popular CP is the 90-day CP. CPs are unsecured credit-rated borrowings with a limited secondary market.

Government Securities

Government securities, also called treasury bonds, are predominantly issued to fund the fiscal deficit of the government. Treasury bonds also set benchmark for pricing corporate paper of varying maturities. All other borrowers in the system borrow at a spread over this benchmark rate on government securities.

The instruments used in this segment are many, including fixed coupon bonds, commonly referred to as dated securities, treasury bills, floating rate bonds, zero coupon bonds and inflation index bonds.

Treasury Bonds may have tenors ranging from a year to 30 years.

Corporate Bonds

The market for corporate debt securities is dominated by private placements with large institutional investors. Public issue of corporate debt securities are regulated by SEBI’s regulations for the same.

The regulations require the issue to be credit-rated, appointment of a debenture trustee, creation of debenture redemption reserve and creation of a charge on the assets of the company.

The secondary market for long-term bonds is concentrated in the government securities segment. In this segment too, trading primarily happens in the benchmark securities. Trades in the government securities segment as well as the corporate bond segment are reported to the exchanges.

Yield from Debt Instruments

The returns to an investor in bonds, is primarily made up of the coupon payments. However, if the investor acquires or sells the bond at a price that is different from the par value the returns can vary from the coupon.

Therefore, the coupon rate of the bond is not an indicator of the returns on the bond, but merely helps in computing what cash flows would accrue periodically, to the investor.

We use the term ‘yield’, rather than ‘coupon rate’, to denote the returns to the investor.

Current Yield

Current yield simply compares the coupon of a bond with its market price. For example, if a bond paying an annual coupon of 12% is trading in the markets for ` 109.50, we compute the current yield as: 12/109.5 =10.95%

Yield to Maturity (YTM)

Yield to maturity (YTM) is a popular and extensively used method for computing the return on a bond investment. Every bond is made up of a set of cash flows that accrue at various points in time, from the time the bond is acquired, until it is sold or redeemed. We can then use the very well known principle in finance, to value the bond: the price at which a series of future cash flows should sell is the sum of the discounted value of these cash flows. The rate which equates the discounted value of the cash flows with the price of the bond is the yield to maturity of the bond.

New Instruments

Deep Discount Bonds

Secured premiums notes.

Zero interest fully convertible debentures.

Zero coupon bonds

Double option Bonds.

Option Bonds

Inflation Bonds.

Floating Rate Bonds.

Deep Discount Bonds:

Deep Discount Bonds is a form of Zero-interest bonds. These bonds are sold at a discounted value and on maturity face value is paid to the investors. In such bonds, there is no interest payout during lock in period.

Secured Premium Notes

Secured Premium Notes is issued along with a detachable warrant and is redeemable after a notified period of say 4 to 7 years. The conversion of detachable warrant into equity shares will have to be done within time period notified by the company.

Zero Interest Fully Convertible Debentures

These are fully convertible debentures which do not carry any interest. The debentures are compulsory and automatically converted a after specified period of time and holders thereof are entitled to new equity shares of the company at predetermined price.

From the point of view of company this kind of instrument is beneficial in the sense that no interest is to be paid on it, if the share price of the company in the market is very high then the investors tines to get equity shares of the company at the lower rate.

Zero Coupon Bonds

A Zero Coupon Bonds does not carry any interest buy it is sole by the issuing company at a discount. The difference between the discounted value and maturing or face value represents the interest to be earned by the investor on such bonds.

Double Option Bonds

These have also been recently issued by the IDBI. The face value of each bond is ` 5000. The bond carries interest at 15% per annum compounded half yearly from the date of allotment. The bond has maturity period of 10 years. Each bond has two parts in the form of two separate certificates, one for principal of ` 5000 and other for interest (including redemption premium) of ` 16,500. Both these certificates are listed on all major stock exchanges. The investor has the facility of selling either one or both parts anytime he likes.

Option Bonds

These are cumulative and non-cumulative bonds where interest is payable on maturity or periodically. Redemption premium is also offered to attract investors. These were recently issued by IDBI, ICCI etc.

Inflation Bonds

Inflation bonds are the bonds in which interest rate is adjusted for inflation. Thus, the investor gets interest which is free from the effect of inflation. For example, if the interest rate is 11 per cent and the inflation is 5 per cent, the investor will earn 16 per cent meaning thereby that the investor is protected against inflation.

Floating Rate Bonds

This as the name suggests is bond where the interest rate is not fixed and is allowed to float depending upon the market conditions. This is an ideal instrument which can be resorted to by the issuer to hedge themselves against the volatility in the interest rates. This has become more popular as money market instrument and has been successfully issued by financial institutions like IDBI, ICICI etc.