Primary & Secondary Market
INVESTMENT AVENUES
CORPORATE BONDS
Bonds are senior securities in a firm. They represent
a promise by a company to the bondholder to pay a specified rate of interest
during a stated time period annually and the return of the principal sum on the
date of maturity. Date of maturity is also called the date of retirement of a
bond. Bonds are of many kinds. The difference in bonds is due to the terms,
conditions and features each bond bears. Bonds may be distinguished according
to their repayment provisions, type of security pledged, time of maturity and
technical factors.
Bonds are an important source of funds to the
corporate sector. They are usually an issue of long-term debt of a corporate
organization. Since no individual can fulfill the requirements of the firms,
the loan is parts of small denominations and sold to investors in the form of
bonds.
Types of Bonds
Serial Bonds: Serial bonds are issued by an organization with
different maturity dates. This is done to enable the company to retire the
bonds in installments rather than all together. It is less likely to disturb
the cash position of the firm than if all the bonds were retired together. From
the point of view of the bondholder, this gives him a chance to select a bond
of the maturity date which suits his portfolio. He may select a short- term
maturity bond, if it meets his need or take a bond with a long-term maturity if
he already has too many shorter-term investments. Serial bonds usually do not
have the call feature and the company retires the debt when it becomes payable
on the maturity date. Such bonds are useful to those companies that wish to
retire their bonds in series. Serial bonds resemble sinking fund bonds and have
an effect on the yields of bonds. Bonds with shorter-term maturity have lower
yields compared to those of long-term maturities.
Sinking Fund Bonds: Sometimes, an organization plans the issue of its
bonds in such a way that there is no burden on the company at the time of
retiring bonds. This has the advantage of using the funds are well as retiring
them without any excessive liquidity problems. The company sets apart an amount
annually for retirement of bonds. The annual installment is usually fixed and
put in a sinking fund through the trustees. The trustee uses his discretion in
investing these funds. He may use the fund to call the bonds every year or purchase
bonds from them at a discount. Sinking fund bonds are commonly used as a
measure of industrial financing.
Registered Bonds: Registered bonds offer an additional security by a
safety value, attached to them. A registered bond protects the owner from loss
of principal. The bondholder’s bond numbers, name address and type of bond are
entered in the register of the issuing company. The bondholder has to comply with
the firm’s formalities at the time of transfer of bonds. While receiving
interest, registered bondholders usually get their payment by cheque. The main
advantage of registering a bond is that if the bond is misplaced or lost the
bondholder does not suffer a loss unlike the unregistered bonds. However,
registered bonds do not offer security of principal at maturity.
Debenture Bonds: Debentures in the USA are considered to be slightly
different from bonds. Debenture bonds are issued by those companies who have an
excellent credit rating, but do not have security in the form of assets to
pledge to the bondholders. The debenture holders are creditors of the firm and
receive the full rate of interest whether the company makes a profit or not. In
India debentures can be issued with the specific permission of the Controller
of Capital Issues. Bearer debentures are not considered legal and permissible
documents in India. Convertible debentures have become popular in recent years.
Convertible debentures have lower rates of interest, but the convertible clause
makes it an attractive investment. While permission has to be sought for the
convertibility clause, it is not necessary if they are solely offered to
financial institutions. Debentures just like bonds can be of different kinds.
They may be registered, convertible, mortgage, guaranteed and may also combine
more than one feature in one issue.
Mortgage Bonds: A mortgage bond is a promise by the bond issuing
authority to mortgage real property as additional security. If the company does
not pay its bondholders the interest or the principal, when it falls due, the
bondholders have the right to sell the security and get back their dues. The
value of mortgage bonds depends on the quality of property mortgages and the
kind of charge on property. A first charge is the most suitable and highly
secure form of investment since its claims will be on priority of the asset. A
specific claim on a particular property is also an important consideration
compared to a general charge. A second and third charge on security of property
is considered to be a weak form of security and is less sound than a first charge.
A property of high value and immediately saleable
because of its strategic placement should be considered very valuable even if
it offers a second and third charge. Another property offering no saleable
features but giving a first charge may be worthless to the bondholders. The
quality of the mortgage is, therefore, an important consideration to the
mortgage bondholders. Mortgage bonds may be open end, close end and limited open
end. An open end mortgage bond permits the bond issuing company to issue
additional bonds if earnings and asset coverage make it permissible to do so.
In close end mortgage bonds, the company can make only one issue of bonds and
while those bonds exist, new bonds cannot be issued. If additional bonds are
issued they get the ranking of junior bonds and the prior issue gets the first
priority in receiving payments. The limited open end bonds permit the
organization to issue specified number of fresh bonds series distributed over a
number of years.
Collateral Trust Bonds: A collateral trust bond is issued generally when two
companies exist and are in the relationship of parent and subsidiary. The
collateral that is provided in these bonds is the personal property of the
company which issues the bonds. A typical example of such bonds is when a
parent company requires funds; it issues collateral bonds by pledging
securities of its own subsidiary company. The collaterals are generally in the
form of tangible securities like shares or bonds. These bonds have a priority
charge on the shares or bonds which are used as collaterals. The quality of the
collateral bonds is determined by the assets and earning position of both the
parent as well as the subsidiary company.
Equipment Trust Bonds: In the USA, a typical example of Equipment Trust
Bonds is the issue of bonds with equipment like machinery as security. The
property papers are submitted to trustees. These bonds are retired serially.
The usual method of using these bonds was to issue 20% equity and 80% bonds.
The equity issue is like a reverse to protect the lender in cases where the
value of the asset falls in the market. The trustee also has the right to sell
the equipment and pay the bondholders in case of default.
Supplemental Credit Bonds: When additional pledge is guaranteed to the
bondholders their
bonds are categorized as supplemental by an additional
non-specific guarantee. Such bonds are classified as: Guaranteed Bonds, Joint
Bonds and Assumed Bonds.
Guaranteed Bonds: Guaranteed Bonds are issued as bonds secured by the
issuing company and they are guaranteed by another company. Sometimes, a
company takes assets through a lease. The leasing company guarantees the bonds
of the bond issuing company regarding interest and principal amount due on bonds.
Joint Bonds: Joint bonds are guaranteed bonds secured jointly by
two or more companies. These bonds are issued when two or more companies are in
need of finance and decide to raise the funds together through bonds. It serves
the purpose of the company as well as the investor. The company raises funds at
reduced cost. Since funds are raised jointly, dual operations of advertising
and the formalities of capital issues control are avoided. The investor is in a
favourable position as he has security by pledge of two organizations.
Assumed Bonds: These bonds are the result of a decision between two
companies to amalgamate or merge together. For example, Company-X decides to
merge into Company-Y. X’s issue of bonds prior to merger then becomes the
obligation of Company-Y when merger is effected. These are called assumed bonds
as Company-Y did not originally issue them but as a result of merger the debt
was passed on to them. The bondholder receives an additional pledge from
Company-Y. He is more secured as his bonds due to merger get the security of
both Companies X and Y.
Income Bonds: Such bonds offer interest to the bondholders only when
the firm earns a profit. If profit is not declared in a particular year,
interest on bonds is cumulated for a future period when the company can
sufficiently earn and make a profit. Income bonds are frequently issued in case
of reorganization of companies. When income bonds arise out of reorganization
they are called adjustment bonds. They are also used to recapitalize the firm
and take the benefit of deduction of tax by changing preference shares with
income bonds.
Bonds with Warrants: Bonds with warrants are also called Warrant Bonds.
Each bond has one warrant attached to it and it gives the right to the
bondholder to pay a subscription price and exchange the bonds for equity
shares. This right is given, for a limited period of time. Usually a time
period is put up in a legal document with the trustee.
Foreign Bonds: Bonds raised in India by foreign companies but for
Indian investor will be called a ‘foreign bond’. A foreign bond, for example,
an American Bond or Japanese Bond in India may be very attractive to investors
because (a) the dollar yield is much higher than the rupee, (b) deposits in
dollars are considered a good investment and (c) risk on the portfolio is
diversified.
Convertible Bonds: Convertible bonds have a dual feature of getting fixed
interest till the redemption period and then the company offers the bond
holders to purchase equity shares of the company at a premium price. Due to the
nature of this bond and the feature it provides there are an investment value,
conversion value and market value of this bond. This particular bond is
explained theoretically, graphically and with example through table in a
separate section after describing the objectives of issuing bonds and
evaluating them.
PREFERENCE SHARES
Preference shares unlike bonds have an investment
value as it resembles both bonds as well as equity shares. It is a hybrid
between the bond and equity shares. It resembles a bond as it has a prior claim
on the assets of the firm at the time of liquidation. Like the equity shares
the preference shareholders receive dividend and have similar features as
equity shares and liabilities at the time of liquidation of a firm. The
preference share has the following characteristic features:
Features of Preference
Shares
(i) Dividends: A preference shareholder has priority over equity shareholders
in the payment of dividends but the rate is fixed unlike the equity share
holders. Preference shareholders usually get cumulative rate of dividend, so
that if, in one year the company does not pay a dividend, it pays in the next
year. These dividends also have a priority over equity shares. Equity share dividends
vary from year to year depending on the profits of the company.
(ii) Right to Vote: The preference shareholders in India do not have a
right to vote in the annual general meeting of a company and their dividends
are usually fixed, but in the event of non-payment of dividend for two years or
more the preference shareholder can vote. Voting may be, in the form of show of
hands or ballot.
(iii) Right on Assets: The preference shareholders have a similar right to
that of bondholders on the assets of the firm. At the time of liquidation, the
preference shares have a prior right to that of the equity shareholders, but
the payment and the face value of the preference shareholders are paid only after
the rights of the bondholders and other creditors are met. Their rights,
therefore, come last amongst the creditors, but before the equity shareholders.
(iv) Par Value: The preference share usually has a par value or face
value or denomination by which it is valued. This par value can also be changed
by the corporate shareholders. In India, the preference shares have only a par
value.
(v) Retirement of Debt
through Sinking Fund:
A company usually retires its preference shares with the help of a special fund
created for the purpose. This fund is called the sinking fund. A sum of money
is annually set apart in this fund and is used to retire the preference shares
when they become due. This is specially so in the case of redeemable preference
shares. If no right of redemption is given the preference shares are usually
redeemable.
(vi) Pre-emptive Right: The preference shareholders like the equity shareholders
have a right of receiving further issues from the company before it is advertised
or offered to the other members of the public. This right gives it a special
resemblance to the equity shareholders. It also gives an additional right above
the right of the bondholders. A right to further issues is a chance given to
shareholders to receive the benefits of growth of the firm. This makes the
value of preference shares higher than that of the bonds. In India, however,
the preference shares are not preferred and equity shares continue to be of
higher value than both preference share and bonds.
(vii) Convertibility: The preference shares are usually non-convertible
unless otherwise stated in a clause inserted at the time of issuing of these
shares. The clause should mention the rights, privileges, the convertibility
aspect, the rate of conversion, the number of shares offered at the time of
conversion and put in a special legal document with the trustees-in-charge. The
convertibility clause gives the preference shareholders a share in the growth
of the company. Also, it is rated at a higher value than non-convertible
preference shares.
(viii) Hybrid: The preference share is a hybrid between a bond and
equity shares. As already stated, it resembles both these types of share.
Valued as a bond it has a greater claim on the assets of the firm and is almost
in the position of creditors. As equity share holder is entitled to rights of
dividend. At the time of liquidation also it has the rights given only after
the bondholders are satisfied. These features of a preference share give it an
added value over bond and stability of income over equity shares.
Types of Preference Shares
Preference shares, if not, described in a legal
document are irredeemable non-participating but cumulative in nature. The
following varieties of preference shares are available depending on the clause
inserted in the agreement made at the time of issue of the shares:
(i) Cumulative or
Non-Cumulative: Cumulative
preference shares have the right of dividend of a company even in those years
in which it makes no profit. If the company does not make a profit in the year 2007,
2008 and 2009 but it makes a profit in 2010 it must satisfy its preference
shareholders in the year 2010 and make full payment for the years for which it
has not declared any dividend. This may be paid altogether in 2010 with
interest or in installments but before the rights of the equity shares holders
have been satisfied.
If the preference shares are non-cumulative in nature
they do not have a share in the profits of the company in the year in which the
company does not make profit. The advantage of preference shares is that they
are usually issued as cumulative.
(ii) Participating and
Non-Participating Preference Shares: Participating preference shares get a share of
dividends over and above the share of dividends received at a fixed rate
yearly. This special feature arises when the company makes an extra profit and
declares a higher dividend for the equity shareholders. This gives a further
advantage to the preference shareholders to participate in the growth of the
firm. The preference shares are usually non-participating in nature and do not
receive a share higher than that fixed amount unless it is specifically stated
at the time of the issue of shares.
(iii) Redeemable and
Non-Redeemable Shares:
All preference shares are non-redeemable in nature. Non-redeemable means like
the equity shares its existence is permanent in nature and its shareholding is continuous
till the liquidation of the company. In this sense it resembles the equity
shares but non-redeemable preference shares do not have an investible value in
the market so far as the investments are concerned. To attract the investor, a
clause is inserted for redeeming the preference shares after a certain number
of years.
This redeemable quality integrates its rate in the
market because it is considered a stable form of return. Also hedge against
inflation and purchasing power risk is avoided because of the nature of return
of the preference shares. Usually these preference shares are redeemed between
10 and 15 years from the time of issue. This makes excellent investment for
those who wish to get a stable rate of return and also fight the risk of
purchasing power as in the case of deposits in banks or provident funds. The
small investor finds a redeemable preference share an attractive form of
investment. Redeemable preference shares are also callable at the option of the
issuing firm. The issuing firm may pay a higher rate to its shareholders than the
face value of the preference share and return the amount whenever it deems fit.
This ‘call’ option is very unfavorable and the investor must find optional
investment deals in case this call is exercised. However, call option sometimes
states the number of years before which the company will not call the issue.
This gives adequate protection to the investor and before taking a redeemable
preference share, he must value these optional facilities and deals. A
non-redeemable preference share would generally be avoided by an investor. The
equity form of investment is more profitable than a non-redeemable preference
share because it gives the chance of share in the growth of a firm as well as
increase and decrease of dividends depending upon the capital market. It is a
risky form of investment but there is a potential appreciation of share.
Preference shares do not receive this increase or appreciation in the future
whether redeemable or non-redeemable in nature.
(iv) Convertible and
Non-Convertible Preference Shares: A convertible preference share is to be evaluated both as a preference
share as well as an equity share. It has the advantage of receiving a stable income
in the beginning of few years and then the conversion into an equity share.
This gives it stability of income, appreciation, premium and constant rate of
growth. In the beginning it is a safe investment because the dividend will be
continuous and safe also. The investor receives a continuous stream of payments
and it will be evaluated with similar preference shares in the market but with
those which do not have a convertibility clause. In this sense the preference
share will have an advantage of being converted into an equity share at a later
date. The premium in the case of convertible bonds should be expected to be
about 20%. A higher premium than this should not be expected because it will
erode the value of preference shares. In the later years of its life the
convertible preference shares should be evaluated as equity share. For this it
is important to find out the conversion rate and the number of shares the
preference shareholders will get when it is converted into equity share. Once
it is converted, the preference shareholder will have the same rights as the
equity shareholder.
He will also have the right to vote and the right to
receive dividends in case of declaration of dividend. He will be evaluated as a
part owner of the company. A convertible share which also has cumulative and
participating rights maybe considered to be an excellent form of investment
from the point of view of a small investor. Non- convertible preference shares
do not enjoy the same status as a convertible share. It is an ordinary
preference share but such a share may be issued with features of participation
in the dividends and may also be cumulative in nature. Non-convertible
preference shares may also be redeemable.
While these preference shares have been evaluated and
described as different kinds of preference shares, each type of preference
share may be individually described or certain features may be added to it. It
is not necessary to add all the features of cumulative participating,
redeemable and convertibility but a preference share may also be issued with
all the features. A preference share with all the features would be a
favourable investment. It is important to note that an investor should not
purchase only preference shares because it suffers from the drawbacks of
purchasing power risk and there is less appreciation of price unless it is
converted into equity shares. In India, preference shares are not considered a
useful medium for investment. Equity shares have been a good form of saving for
an investor. With the introduction of convertible debentures, derivatives, new
policies of Life Insurance, Unit Trust, Mutual Funds, Post Office Savings and
new innovative financial engineered securities, the investor finds an array of
investment outlets. He may choose any investment from the point of view of
security, safety, price appreciation and share growth. As discussed earlier, an
investor has to make his investments on that point of incidence where his
return and risk feature may meet. He also must make an investment depending on
the income group to which he belongs. An investor in a higher income group must
be careful to invest in those outlets when the maximum tax benefits can be
taken care of. To a small investor stability of income is more important than
risky investments and tax benefits. Whoever be the investor a balanced
portfolio should be desired so that he should hedge against all possible
unfortunate circumstances and for an immediate and safe investment.
GOVERNMENT SECURITIES
Types of Securities
Government
securities are in the form of promissory notes, stock certificates.
(a) Promissory
Notes:
Promissory notes are the usual form of government securities. They are
purchased by banks and are highly liquid in nature. Promissory notes can be
transferred, by transfer or endorsement. Transfer can also be by delivery to
the transferee. Promissory notes are registered promises of the government and
are usually entered in a register specially made for entering promissory notes.
Government provides to the investors a half-yearly interest which is given only
on presentation of the promissory note at the office of purchase. This is the
most popular government security and finds favour with investors.
(b) Stock
Certificates: A
stock certificate is not a popular investment outlet for investors. It is not transferable
like the promissory note and the banks prefer promissory notes to stock
certificates. The stock certificate suffers from the defect of illiquidity and
non-marketability. The investors usually keep it till the time of maturity. The
Life Insurance Corporation of India and Provident Funds are the biggest
purchasers of stock certificates and hold it till maturity. They purchase it partly
because of legal restraints on them to invest in government securities out of
their investible surplus for the year and partly because they have large
resource available with them and after fulfilling the maximum limits
permissible for investment in private sector they invest their funds in
government securities. Also, this form of purchase helps the national economic
policies for further development of the country in consonance with planned
priorities of the government.
LIFE INSURANCE
Life Insurance is a contract
between a person and an insurance company for a number of years covering either
the life time period or a fixed number of years. In India, life is protected by
a monolithic institution called the Life Insurance Corporation of India. Life
insurance is called an investment because of a number of reasons: it provides
protection against risk of early death, it can be used as a collateral for
taking loans from banks, life of key men in an association can be protected, it
provides tax advantages, it is a measure of protection at the time of death
because it gives provision for estate duty and it is a sum of money received at
the end of a particular number of years, i.e., “the termination period of the
contract”.
Kinds of Life
Policies
The
kinds of policies are dependent on the amount of premium payable, the amount
promised by insurance company at the end of the termination period and the
circumstances in which the amount becomes payable. Basically, the Life
Insurance Corporation issues whole life policies, endowment policies and term
policies. These in turn may be with profits or without profits. All policies
make available certain attractive benefits and also have certain limitations.
There is no best policy and the attractiveness of the policy will depend on the
requirements of the investor.
(a) Whole Life
Policy: The
Whole Life Policy is for the full life of the insurer and the amount of insurance
will be paid only at the time of death. The insurer, therefore, gets no
benefit, but his family receives the amount after his death. The premium of
Whole Life Policy may be paid in three ways: Single Premium Plan, Limited
Premium Plan — where premium ceases at a stated age and Continuous Premium Plan
where premium are paid throughout the life time of the policy holder. The
advantage of a Whole Life Policy is that it provides:
·
The
lowest rate of premium when compared to other policies. If a person insures
himself at an early age, he can obtain a large amount of insurance for small
premium.
·
It
is useful for a person who would like to profit for payment of estate duty on
his property, if he dies.
·
It
provides protection to the family after the salary earner’s death. The policy
has many drawbacks.
·
He
does not enjoy the life policy as an investment for himself because the return
will come only after his death.
The Whole Life Policy continues
till the death of the insurer. The sum which is insured is payable only when
the policy holder dies. Since, it is payable after his death the insurer’s nominees
receive the policy money. The Whole Life Policy may be issued in the following
way: (i) Ordinary Whole Life Policy, (ii) Limited Payment Whole Life Policy,
(iii) Single Premium Whole Life Policy, (iv) Special Whole Life Policy, (v)
Convertible Whole Life Policy.
(b) Ordinary Whole
Life Policy:
Ordinary Whole Life Policy remains in force till the life of the assured and
the premium is paid till the lifetime of the assured. The premium charged under
this policy is the lowest and the minimum amount of this policy is ` 1,000. If
the policy has completed 35 years or the person attains 80 years of age,
whichever is earlier, further premium is waived by the Life Insurance
Corporation.
(c) Limited Payment
Whole Life Policy: Limited
Payment Whole Life Policy is a measure for payment of premium for a limited
period only. After the expiry of the contract period and further to the
retirement age, the Whole Life policies continue if all the premiums have been
paid, but after the expiry of a number of years, further premiums need not be
paid. The minimum amount for which this policy can be issued is ` 5,000.
(d) Single Payment
Whole Life Policy:
Single Payment Whole Life Policy is not very popular as large premiums have to
be paid and in one lump sum. This kind of insurance can be taken either by
people who have received income through windfall like a lottery or rich
industrialists. The Whole of the amount on such a policy is lost if the
investor dies at an early age. This policy is of greater element of investment
on the part of the investor and a lesser degree of protection.
(e) Special Whole
Life Policy:
This policy can be surrendered and converted into a paid-up policy under the
terms of the Special Whole Life Policy. The payment of premium ceases at death
if it takes place earlier or on completion of a particular age, for example 70
years. The sum which is insured is paid on the death of the life insured.
(f) Convertible
Whole Life Policy:
The Convertible Whole Life Policy gives the option of conversion into Endowment
Policy after the expiry of five years of the contract. This is useful as the
protection to a person is given at a lower rate and the benefit of conversion
after a particular time is also allowed. At the time when the option is
exercised, the policy changes into Endowment Policy and the premiums increases.
(g) Endowment
Policy: The
Endowment Insurance is the best form of investment to an investor who wish to
take life policy as a form of investment with the benefit of: (a) saving his
income, (b) protection to life and (c) receiving tax benefits. Under this plan,
the company promises to pay a stated amount of money to the beneficiary, if the
insured dies during the life of policy or to the insurer himself if he survives
the endowment period. For example, if an investor takes an endowment policy for
20 years for ` 1 lakh. In the event of death, at any time, during the period of
20 years this sum becomes payable to his dependents. If he survives this period
the policy matures and he receives the payment of the sum assured on the expiry
of 20 years. The premium of this policy is higher than Whole Life Policies. The
Endowment Policy is like a reservoir or a fund which the investor needs on a
particular date and will be payable to him or to his nominee. It combines both investment
and protection elements. Endowment Policies may be issued in different forms.
These are Ordinary Endowment Policy, Pure Endowment Policy, Optional Endowment
Policy, Double Endowment Policy, Anticipated Endowment Policy, Endowment
Combined with Whole Life, Fixed Term Marriage Endowment Policy, Educational Endowment
Policy, Joint Life Endowment. Endowment Policies can be issued for a minimum
sum of ` 5,000.
(h) Ordinary
Endowment Policy:
The Ordinary Endowment Policy is a promise by the Life Insurance Corporation to
pay the insured amount on death or attainment of a specified age of the insured
whichever is earlier. The premium is to be paid for a fixed number of years.
(i) Pure Endowment
Policy: Pure
Endowment Policy is issued for a specified period and the amount on the policy
is to be paid only if the insured person survives the endowment period. It is
an extreme form of Life Endowment Policy, because, if the insured died before
the completion of the contracted period his dependants do not receive the value
of the policy. Investors who do not have dependants may invest their surplus in
this kind of policy.
(j) Optional
Endowment Policy:
The Optional Endowment Policy is a method of converting the Whole Life Policy
at any time after the completion of the first five years of payment of premium
on the policy. This policy is beneficial from the point of view of the investor
as he can avail of the advantages of endowment policy, although he has
originally subscribed to the Whole Life Policy.
(k) Double
Endowment Policy:
The Double Endowment Policy is a promise by the insurer to pay double the
amount of the sum which has been insured, if the insured lives beyond the date
of maturity. If the insured dies before the expiry of the period the sum under
the contract is given if he survives he gets double the assured amount. The
minimum amount under which this policy can be issued is ` 1,000. This policy
can be issued up to the age of 65 years.
(l) Anticipated
Endowment Policy:
The Anticipated Endowment Policy gained popularity recently. Under this plan,
if the insured survives the contract period, he receives certain advantages in
terms of benefits of holding this policy. These benefits, may be given at
intervals of 5 years, 10 years, 15 years but if the investor dies within the
contracted period the full insured sum is paid by the Life Insurance
Corporation without any deductions for the amount paid on any benefit which the
insured had already received. This kind of policy can be issued for a minimum
amount of ` 1,000, the term period of these policies ranges from 15 years to 25
years. If the investor has taken a policy of 15 years term and if he survives
he gets benefit as follows: (a) 1/5th of the sum insured after 5 years, (b)
Next 1/5th after 10 years and the balance 3/5th after he survives the 15 year
period. An investor may find it beneficial to plan his investment by receiving
payments in lump sum at periodic intervals in addition to providing for his own
old age.
(m) Endowment
Combined with Whole Life Policy:
This policy is a combination or a hybrid between the Endowment and the Whole
Life Policies. The sum which has been insured is payable at death whenever the
death occurs but an equal amount is provided to the insured if he lives till
the expiry of the term. The person insured under this scheme benefits by
survival on the selected age pattern but if he dies before the particular date
his beneficiaries get the insured sum.
(n) Fixed Term
Marriage Endowment Policy:
This policy is provided by parents and guardians for the marriage of their
children. Premium ceases at the time of death of the parent but the policy matures
at the end of a specified period. The insured sum is payable either to the
person who look the policy or his nominee, if he dies during the time of the
insurance contract. The policy can be taken by a parent from the age of 18
years to 55 years and the maturity period of these contracts may be from 5
years to 25 years term. This policy is taken without profit basis and the
minimum amount that can be assured under this plan is ` 1,000. If the child dies
before the policy becomes matured then the parent is given the option to name
any other child as beneficiary or to take part of the premium with the
exception of the first year’s premium.
(o) Education
Endowment Policy:
Under this plan the benefits are not payable in a lump sum but at selected
periods over a period of 5 years in ten equal half-yearly installments
beginning at a specified date. These installments provide finance for the
education of a child whether the parent is alive or dies during the period.
This policy also extends from 5 years to 25 years and is a provision by the
parent for the adequate provision of education for his children.
(p) Joint Life
Endowment Policy:
This policy is taken usually by the husband and wife jointly. The insured sum
is payable at the end of specified period to either the husband or the wife or
to them jointly if both survive the contract period. In this policy the medical
examination of both the husband and wife is taken. The premium which is fixed
on this policy depends on the ages of both the parties. This is useful to an
investor if he wishes to provide either for himself or for one survivor
specifically.
(q) Term Insurance
Policy: Term
Insurance Policy is a method or contract for payment of amount insured only if
the insured dies during the term of the policy or a specified period stated
within the contract. If the insured does not die during the specified period
the contract expires and is treated as cancelled. This policy may be a Straight
Term Policy, Convertible Policy, Decreasing Term Insurance, Renewable Term
Insurance and Yearly Renewable Policy.
(r) Straight Term
Policy: Straight
Term Policy is taken usually either for a year or a specified number of years
stated in the contract. This policy terminates automatically at the end of the
contracted period of time. This contract period may vary from 10 years to 50
years. Such a policy does not combine risk element because the assured receives
the amount only if he dies within the period. The premium to be payable on such
a policy, is required to be made either on the maturity of the policy or death
of the insured person. These policies are taken usually by people who travel
from one country to another.
(s) Convertible
Policy: This
policy gives a right to change into Whole Life Policy or Endowment Policy. When
the insured opts for a change he pays the premium applicable to the kind of
policy in which he requires to be converted. The minimum amount for this policy
is ` 5,000.
(t) Decreasing Term
Policy: This
insurance policy offers decreasing risk with each installment. Premiums may be
paid in a lump sum or periodically installment. This is useful for loan
transaction where installments are continued and paid every year.
(u) Renewable Term
Policy: This policy
can be renewed after the period of termination of the contract. The rates of
premium will be fixed only for the contracted period when the insurance is
renewed, no medical examination is required but premium will be paid afresh for
the new contract.
(v) Yearly
Renewable Policy:
This type of term policy expires at the end of every year. The person wishing
to insure himself can request for renewing his policy every year but he does
not have to go through the formalities of filling in the proposal form and medical
examination every year. Most of the insurance policies fall under three
categories — Whole Life, Endowment and Term Policies Each policy carries
different terms and conditions such as Regular premium policy, Limited premium
paymen policy, Single premium policy, Non-medical policy, Modified life payment
increasing rate policy, policies withprofit and without profit policy, Group
insurance policy, Grih Laxmi Policy, Guaranteed Triple Benefit Policy and
Contingent Assurance Policy.
COMMERCIAL BANKS /
BANK DEPOSITS
Commercial
banks provide to the investor both deposits which are liquid in nature, which
have stability and which also give an element of security. Commercial bank
fixed deposits also qualify as collateral for loans. While other forms of
investments may be avoided by an investor, commercial bank deposits cannot be
eliminated from his portfolio nor can its use be underestimated from the point
of view of liquidity and stability of income. The following kinds of deposits
are provided by the banks.
(a) Saving Bank
Account: The
most liquid form of investments are the deposits in savings banks account. The
deposits may be made at any time through the introduction of a person already
having a bank account or through the Manager of the bank on completion of the
formalities of filling a form and having it certified, the investor can begin
to operate his account. He is supplied with a pass book and a cheque book.
Withdrawals can be made at any time during the year upto a limit of the saving in
the account. The advantages of savings bank account are to receive an element
of investment as it provides to the investor some return in the form of rate of
interest after every six months. It also offers to the investor the right to
withdraw any amount at will.
(b) Current
Account: An
investor is also given the option of having a current account in the bank for maintaining
liquidity. A current account is usually opened by a business house. Of this
current account, the account holder is permitted to draw according to a fixed
limit provided by the banker in agreement with the account opening association.
In India, it is not only prestigious but also convenient to ope a current
account. This does not carry the benefit of any interest.
(c) Recurring
Deposits:
Recurring deposit is a method by which an investor may at regular interval deposit
a fixed sum of money in a bank. This amount is to be paid for a stated number
of years atthe termination of which the investor receives the principal sum
with interest. The recurring depositsare usually for a period ranging from 12
months to 120 months
(d) Fixed Deposit
Scheme: Each
bank has certain special schemes. These schemes vary from bank to bank, but the
maturity value is normally the same and the interest at a fixed deposit is
specified from time to time by the Reserve Bank of India.
(e) Mutual Fund
Schemes:
Commercial banks in India have also started mutual fund schemes. The first bank
to take this step was State Bank of India in 1987. It first launched Magnum
Regular Income Scheme 1987 which was opened for public subscription on 30th
November 1987. This scheme was introduced to collect resources from rural and
semi-urban areas. Magnum certificates carry a buy back facility and thus, it
has easy liquidity. Magnum regular income scheme series were further issued in 1989.
SBI capital funds have also launched Magnum Capital Venture Fund and Magnum
Equity Support fund for institutional investor like banks, financial
institutions and companies.
PROVIDENT FUND
There
are mainly four types of provident funds —
Statutory
Provident Fund, Recognized Provident Fund, Unrecognized Provident Fund and
Public Provident Fund.
(a) Statutory
Provident Fund:
Statutory Provident Fund was set-up in 1925. This fund is maintained by
government, semi-government organization, local authorities, railways,
universities and educational institutions. In statutory provident fund
contribution from the employer is exempt from tax. Relief under Section 80C of
employee’s contribution is available to the interest credited to the provident
fund which is exempted from tax and the lump sum amount which is paid at the
time of retirement is also exempted from tax.
(b) Recognized
Provident Fund:
Recognized Provident Fund is given this name because it is recognized by the
Commissioner of Income Tax according to the rules which are contained in
Part-A, Schedule- IV of the Income Tax Act. When the Commissioner of Income Tax
recognizes this fund it becomes recognized also by the Provident Fund
Commissioner. Recognized Provident Fund is also contributed in the same way as
Statutory Provident Fund, i.e., both by the employer and the employee. The employer’s
contribution is exempt upto 10% of the salary of the individual in excess of
employer’s contribution over 10% of salary makes it taxable. The recognized
Provident Fund and statutory provident funds have another advantage. Loans may
be taken from this account without payment of any interest. This, therefore,
forms a very cheap means of taking loans for the purposes of making a house,
making additions to a house, house repairs, and wedding in the family or
illness.
(c) Unrecognized
Provident Fund:
Unrecognized Provident Fund is exempted from tax when the employer contributes
to it but relief under Section 80C is not available to the investor. The
interest which is credited to this account is, however, exempted from tax and
the payment which is received in respect of employee’s own contribution at the
time of retirement is also exempt from tax. the amount so accumulated will be
paid only at the end of maturity. In this fund employer does not contribute,
but relief Under Section 80C is available and the interest credited to this
fund is exempted from tax. The amount received at the time of termination of
this contract is also exempt from tax.
(d) Public
Provident Fund:
In Public Provident Fund the employer does not contribute any amount. It is a
fund provided for non-salaries people to mobilize personal savings. Any person
from the public, whether salaried or self-employed, can open a Public Provident
Fund Account at any branch of State Bank of India. Any amount up to a maximum
of ` 1,00,000 can be deposited under this account but the amount so accumulated
will be paid only at the end of maturity. In this fund employer does not contribute,
but relief Under Section 80C is available and the interest credited to this
fund is exempted from tax. The amount received at the time of termination of
this contract is also exempt from tax.
POST OFFICE SCHEMES
Post Office schemes are generally
like the commercial bank schemes. They have different kinds of accounts. These
are savings account, recurring accounts, ten years cumulative time deposit
accounts. The savings accounts operate in the same way as commercial banks
through cheques and there is no restriction on withdrawals. Those accounts
which have a minimum balance of ` 200 in the months of April, September,
October and March have an additional benefit. They qualify for a prize on draw
scheme which operates in the next June and July.
(a) National Saving
Schemes:
National Saving Schemes have been started by the Government of India mainly to
finance its economic development plans through the mobilization of savings of
smaller income group. This scheme is operated mainly through the post offices.
Because of the tax free nature of the scheme, its main purpose is to attract
higher income group of people also. These schemes resemble that of the
commercial banks. The mode of arrangement is basically the payment of a lump sum
amount to be received at the end of a certain period, the interest being paid
annually or to be paid altogether with the principal at the time of termination
of the contract period. The National Saving Schemes are uniform throughout the
country. The investor has an exact picture of the amount that he will receive
at the time of encashment of security. The rate of interest on National Saving Scheme
is usually higher than the commercial banks. These schemes can also be
transferred from one post office to another if the investor so desires. The
certificates have another advantage. They can be used as collateral at the time
of taking a loan from the bank.
(b) Saving
Deposits: The
public is encouraged to open accounts in the post office. They can also invest their
money in post office schemes. The post office saving deposits is popular
amongst low income group of people. Its schemes specially designed for the
senior citizens are also attractive and since, it gives a high rate of return,
the retired people deposit in these deposits. Their certificates are readily liquid
and preferred by people of all income groups. Saving deposits offer interest as
high as commercial banks. They were very popular but now banks offer many
benefits and higher rates of interest. Therefore, banks are being preferred to
post office saving deposits except in deposits of special nature like those for
pensioners.
(c) Fixed Deposit: Fixed deposit can be made for a
fixed period between 1 to 5 years. The interest given by Post Office on this
fixed deposit is deductible as per the norms of Section 88 of the Income Tax Act
applicable in India.
(d) Recurring
Deposits: The
Post Office allows an individual to open an account up to 60 months. It provides
an interest that is compounded quarterly and paid at maturity. The individual
pays a fixed amount every month till maturity.
(e) Monthly Income
with Fixed Investment:
An individual can invest between ` 5,001 and ` 1 lakh fixed amount for 741
months. Interest is paid at 13% monthly. It also provides a bonus of 10% at the
time of maturity. This scheme is now closed as interest rates were very high.
(f) National Saving
Certificates:
The investor of National Savings Certificates receives an interest of 12%
compounded half yearly. The principal plus interest is payable at maturity.
(g) Savings
Certificate: The
rate of interest in this instrument is compounded half yearly, but it is payable
only at maturity. The interest accrued is reinvested but has the eligibility of
receiving a rebate in tax u/s 88. (Now Section 80C)
(h) Indira Vikas
Patra (IVP): Post
Offices also sell Indira Vikas Patra. These securities are freely transferable
and are like bearer bonds. They are sold at the face value of ` 100, 200, 500,
1,000, 5,000. In India these are very popular. They carry compound interest and
have a maturity value of 5.5 years.
(i) Kisan Vikas
Patra (KVP):
Post Offices are also popularizing Kisan Vikas Patra. They have a face value of
` 1,000, 5,000, 10,000 and give a compound interest. This investment doubles in
5.5 years. The encashment of these certificates are possible after the holding period
of 2.5 years. These instruments cannot be transferred easily from one person to
another. The investor can nominate any person who can avail of this scheme in
the event of the death of investor.
(j) National Saving
Scheme (NSS):
Section 80CCA of the Income Tax Act provide exemption from tax to investor if
they deposit a sum of money in NSS scheme. The rate of interest was 11% per annum.
The maximum amount to be deposited every year was ` 40,000. However, this
scheme is taxable at the time of withdrawal. This scheme was closed in 1992-93
and new NSS 1992 was introduced with some changes in old program.
UNIT
II
FINANCIAL
MARKETS
Financial
markets are the centre that facilitates buying and selling of financial
instruments, claims or services. It caters the credit needs of the individuals,
firms and institutions. It deals with the financial assets of different types
such as currency deposits, cheques, bills, bonds etc. it is defined as a
transmission mechanism between investors and the borrowers through which
transfer of funds is facilitated. It consists of individual investors,
financial institutions and other intermediaries who are linked by a formal
trading rules and communication network for trading the various financial
assets and credit instruments.
FUNCTION OF FINANCIAL MARKETS
Financial
markets serve six basic functions. They are briefly listed below.
1. Borrowing and Lending:
Financial markets permit the transfer of funds from one agent to another for
either investment or consumption purposes.
2. Price Determination:
It provides means by which prices are set both for newly issued financial
assets and for the existing stock of financial assets.
3. Information Aggregation and
Coordination: It acts as collectors and aggregators
of information about financial asset values and the flow of funds from lenders
to borrowers.
4. Risk Sharing:
It allows a transfer of risk from those who undertake investments to those who
provide funds for those investments.
5. Liquidity:
It provides the holders of financial assets with a chance to resell or liquidate
these assets.
6. Efficiency:
It reduces transaction costs and information costs.
ROLE OF FINANCIAL MARKET
The
financial market plays a crucial role in the functioning of an economy. Some of
the key roles of financial markets are highlighted below.
Allocating Capital
Raising
capital is one of the primary functions of the financial markets. Financial
markets provide a platform for investors to allocate their capital to various
financial instruments such as stocks, bonds, and mutual funds. This helps
companies and governments to raise adequate funds for their operations.
Facilitating Investment
Financial
markets make it easier for individuals and institutions to invest their money.
This provides them with an opportunity for diversifying their portfolios and
managing their financial assets.
Providing Liquidity
Financial
markets ensure adequate liquidity in the market for investors for easy entry
and exit opportunities. This enables them to quickly buy or sell assets as
their financial needs change.
Price Discovery
Financial
markets help determine the price of financial instruments by bringing together
buyers and sellers. This provides an opportunity for fair price discovery
through the basic functions of demand and supply thus providing a fair and
transparent price for each asset.
Risk Management
Financial
markets provide risk management opportunities for investors through the use of
derivatives such as options and futures.
Promoting Economic Growth
Financial
markets facilitate the flow of capital and ensure that is put to its most
productive use. This is crucial for promoting overall economic growth and the
development of the economy.
CONSTITUENTS OF FINANCIAL MARKETS
1. Money Market: it
is a market for short-term funds normally up to one year. It refers to the
institutional arrangement which deals with the short term borrowing and lending
of funds. It is a short-term credit market.
2. Capital Markets:
it is a market for issue and trading of long-term securities. The term to
maturity should be longer than 3 years. The securities traded in capital market
are informally classified into short-term, medium-term, and long-term securities
depending on their term to maturity. It is market for long term borrowing and
lending of funds.
3. Financial Mortgages Market:
It is a market through which mortgage loans are granted to individual
customers. Mortgage loans are granted against immovable property like real
estate. Mortgage is the transfer of an interest in the specific immovable
property for the purpose of securing loans. The transferor is called mortgager
and transferee is called mortgagee. The common type of mortgage loan, which are
seen in India is residential mortgages, housing Development Corporation,
National Housing Bank, Housing Finance Companies and Life Insurance Corporation
are prominent players in financing residential projects.
4. Financial Guarantees Market:
The financial guarantee market is an independent market. It is a financial
service market. It is the centre where finance is provided against the
guarantee of a reputed person in the financial circle.
5. Foreign Exchange Market:
Foreign exchange refers to the process of conversion of home currencies into
foreign currencies and vice versa. According to Kindle Berger: Foreign exchange
market is a place where foreign moneys are bought and sold. This market deals
with exchange of foreign currency, notes , coins and bank deposits denominated
in foreign currency units and liquid claims like drafts, traveler’s cheques,
letters of credit and bills of exchange expressed in Indian rupee but payable
in foreign currency. In india foreign exchange market is the privilege of the
Reserve Bank of India. Foreign Exchange Regulation Act (FERA) was passed by the
Government of India in 1947, which was later modified in 1973 to regulate
foreign exchange market.
MONEY MARKET
The
money market deals with near substitutions for money or near money like trade
bills, promissory notes and government papers drawn for a short period not exceeding
one year. It is a mechanism which makes it possible for borrowers and lenders
who meet together to deal in short term funds. It does not refer a particular place
where short term funds are dealt with. It includes all individuals,
institutions and intermediaries dealing with short term funds. It meets the
short term requirements of the borrowers and provides liquidity or cash to
lenders.
DEFINITIONS
According
to Madden and Nadler, “ a money market is a mechanism through which short term
funds are loaned and borrowed and through which a large part of the financial
transaction of a particular country or of the world are cleared.”
The
Reserve Bank of India defines money market as, The centre for dealing, mainly
of short term character, in monetary assests, it meets the short term
requirements of borrowers and provides liquidity or cash the lenders.”
FEATURES OF A MONEY MARKET
The
following are the important features of money market
·
It is a market for short-term funds or
financial assets called near money.
·
It deals with financial assets having a
maturity period of one year.
·
The borrowers will get fund for period
varying from a day, a week. a month, three to six months.
·
It is a collection of market for
following instruments- call money, notice money, repos, term money, treasury
bills, commercial bills, certificate of deposits, commercial papers inter-bank
participation certificates, inter-corporate deposits, swaps, bills of exchange,
treasury bills, etc.
·
Money market consists of several sub
markets such as call money market, trade bills market etc, these sub markets
have close inter –relationship and free movement of movements of funds from one
sub-market to another.
·
The borrowers in the money market are
traders, manufacturers, speculators and even government institutions.
·
It does not refer a particular place
where borrowers and lenders meet each other.
·
Transactions can be carried through oral
or telephonic communications. The relevant documents and written communication
can be exchanged subsequently.
·
The important components of money
markets are the central bank, commercial banks, non-banking financial
institutions, discount houses and acceptance houses.
·
It does not deal in money but in short
term financial instruments or near money assets.
·
It is a need based market wherein the
demand and supply of money shape the market.
FUNCTIONS OF MONEY MARKET
It
facilitates economic development through provision of short term funds to
industrial and other sectors.
·
It provides a mechanism to achieve
equilibrium between demand and supply of short-term funds.
·
It facilitates effective implementation
of RBIs monetary policy.
·
It provides ample avenues for short-term
funds with fair returns to investors.
·
It instills financial discipline in
commercial banks.
·
It provides funds to meet short-term
needs.
·
It enhances capital formation through
savings and investment.
·
Short-term allocation of funds is made
possible through inter-banking transactions and money market instruments.
·
It helps employment generation.
·
It provides funds to government to meet
its deficits.
·
It helps to control inflation.
·
It provides a stable source of funds to
banks in addition to deposits, allowing alternative financing structures and
competition.
·
It encourages the development of non
bank intermediaries thus increasing the competition for funds.
·
Savers get a wide range of savings
instruments to select from and invest their savings.
COMPONENTS OF INDIAN MONEY MARKET
The
money market provides a mechanism for evening out short-term liquidity imbalances
within an economy. The development of the money market is thus, a prerequisite
for the growth and development of the economy of a country. The main components
of Indian money market are:
Organized money market :
these markets have standardized and systematic rules, regulations and
procedures to govern the financial dealings .Organized money market are
governed and regulated by Government and Reserve Bank of India. It consists of
Reserve Bank of India and other banks, financial institutions, specialized
financial institutions, non-banking financial institutions, quasi government
bodies and government bodies who supply funds through money market.
Unorganized money market:
unorganized market consists of indigenous bankers and money lenders. They
collect deposits and lend money. A part from them there are certain private
finance companies or non-banking companies, chit funds etc. Reserve Bank of
India has taken a number of steps to regulate such type of institutions and
bring them in the organized sector. One of such step is issuing of non-banking
Financial Companies Act, 1998.
Sub market:
it consists of call money market and bill market. Bill market consists of
commercial bill market and Treasury bills market, certificates of deposits, and
commercial papers.
MONEY MARKET ORGANIZATION
Money
market is a Heterogeneous Market which consist of sub markets. It consists of:
CALL MONEY MARKET:
it is sometimes referred as “ loans or money at call and short notice’’. The
rate at which funds are borrowed and lend in this market is called the call
money rate.
LOAN MARKET: The period of this type
of loans is over 14 days and generally up to 90 days without any collateral
securities. The lenders cannot recall these loans back before maturity. DFHI is
the important institution which plays an important role in the call and inters bank
loan market by arranging, lending and borrowing short- term funds.
COMMERCIAL BILL MARKET OR DISCOUNT
MARKET: Commercial
bill or the bills of exchange popularly known as bill is a written instrument
containing an unconditional order. The bill is signed by the drawer directing a
certain person to pay a certain sum of money only to or order of a certain
person or to bearer of the instrument at a fixed time in future or on demand.
A
well organized bill market or discount market for short term bill is essential
for establishing an effective link between credit agencies and Reserve Bank of
India.
TREASURY BILLS: Treasury bill is a
short term government securities usually of the duration of 91 days sold by the
central bank on behalf of the government. There is no fixed rate of interest payable
on the treasury bills. These are sold by the central bank on the basis of competitive
bidding. Treasury bills are highly secured and liquid because of guarantee of
repayment assured by the RBI who is always willing to purchase or discount
them.
CALL AND SHORT NOTICE MONEY: Call
money refers to a money given for a very short period. It may be taken for a
day or overnight but not exceeding seven days in any circumstances. Surplus
funds of the commercial banks and other institutions are usually given as call
money.
CERTIFICATE OF DEPOSITS: As
per the Reserve Bank of India Certificate of Deposit is a negotiable money market
instrument and issued in dematerialized form or as a Usance Promissory Note against
funds deposited at a bank or other eligible financial institutions for a
specified time period.
Certificate of Deposits are
marketable receipts in bearer or registered form of funds deposited in a bank
or other eligible financial institution for a specified period at a specified
rate of interest. They are different from the fixed deposits in the sense that they
are freely transferable can be sold to someone else and can be traded on the secondary
market. Reserve Bank of India launched a scheme in June 1989 permitting banks
to issue CDs. The Reserve Bank of India has modified its guidelines from time to
time. At present the minimum amount of a CD should be Rs.1 lakh and in
multiples of Rs. 1 lakh thereafter. The maturity period of certificate of
deposit at present should not be less than 7 days and not more than one year
from the date of issue in case of CD issued by a bank. The financial
institutions can issue CDs for a period not less than one year
and not exceeding three years from the date of issue.
COMMERCIAL PAPERS : CPs are short term promissory notes issued by reputed companies with good credit standing and having sufficient tangible assests. CPs are unsecured and are negotiable by endorsement and delivery. CPs are normally issued by banks, public utilities, insurance and non banking financial institutions. CPs in India were launched by the RBI’s notification in January 1990. With a view to enable highly reputed companies to diversify their sources of short term borrowings and also to provide an additional instrument to investors. The issuing company is required to meet the stamp duty, credit rating agency fees, stand by facility charges etc. the maturity period of CPs was 30 days.
CAPITAL
MARKETS
The
term capital market refers to the institutional arrangements for facilitating
the borrowing and lending of long-term funds. It is concerned with those
private savings, individuals as well as corporate, that are turned into
investments through new capital issues and also new public loans floated by
government and semi-government bodies.
A
capital market may be defined as an organised mechanism for effective and efficient
transfer of money capital or financial resources from investing parties, i.e, individuals
or institutional savers to the entrepreneurs engaged in industry or commerce in
the business either be in the private or public sectors of an economy.
CHARACTERISTICS OF
CAPITAL MARKET
· The
following are the important features of a developed capital market
- · Market
for long term funds.
- · Important
component of financial system.
- · Facilitates
borrowing and lending of funds.
- · Helps
in raising capital.
- · Involves
both individual and institutional investors.
- · Meets
demand and supply of long term capital.
FUNCTIONS OF CAPITAL
MARKET
1.
Helps in capital formation.
2.
Act as a link between savers and investors.
3.
Helps in increasing national income.
4.
Facilitates buying and selling.
5.
Channelizes funds from unproductive to productive resources.
6.
Minimises speculative activities.
7.
Brings stability in value of stocks.
8.
Promotes econmic growth.
9.
Play important role in underdeveloped country.
A capital market
constitutes the following;
1. Fund Raisers:
Companies that raise funds from domestic and foreign sources, both public and
private.
2. Fund Providers:
The entities that invest in the capital markets .these includes subscribers to
primary market issues, investors who buy in the secondary market, traders,
speculators, foreign institutional investors, mutual funds, venture capital
funds, NRIs, ADR/GDR investors, etc.
3. Intermediaries:
Are service providers in the market, including stock brokers, sub-brokers,
financiers, merchant bankers, underwriters, depository participants, registrar
and transfer agents, portfolio managers, custodians, etc.
4. Organizations:
Include various entities such as MCX-SX, BSE, NSE, other regional stock
exchanges and the two depositories National Securities Depository Limited(NSDL)
and Central Securities Depository Limited (CSDL).
5. Market Regulators:
Includes the securities and Exchange Board of India (SEBI), the Reserve Bank of
India (RBI) and the Department of Company affaires (DCA).
COMPONENTS OF CAPITAL
MARKET
The
Indian Capital Market is broadly divided into Gilt-Edged Market and the Industrial
Securities Market.
1. Gilt-Edged Market:
Refers to the market for government and semi-government securities backed by
Reserve Bank of India (RBI). Government securities are tradable debt
instruments issued by the Government for meeting its financial requriments. It
is also called gilt edged securities market. The term gilt-edged means “ of the
best quality”.
2. Industrial
Securities Market: Refers to the market whic h deals
in equities and debentures of the corporate. It comprises of the most popular
instruments ie, equitity shares, preference shares, bonds and debentures. It is
further divided into three types.
` i) New issue market or primary
market.
ii)
Stock market or secondary market.
iii)
Financial institutions. DEBT MARKET Debt
market refers to the financial market where investors buy and sell debt securities,
mostly in the form of bonds. These markets are important source of funds,
especially in a developing economy like India. India debt market is one of the
largest in Asia. Like all other countries, debt market in India is also
considered a useful substitute to banking channels for finance. The
most distinguishing feature of the debt instruments of Indian debt market is
that the return is fixed. This means, returns are almost risk-free. This fixed
return on the bond is often termed as the 'coupon rate' or the 'interest rate'.
Therefore, the buyer (of bond) is giving the seller a loan at a fixed interest
rate, which equals to the coupon rate. CLASSIFICATION OF
INDIAN DEBT MARKET Indian
debt market can be classified into two categories: Government Securities
Market (G-Sec Market): It consists of central
and state government securities. It means that, loans are being taken by the
central and state government. It is also the most dominant category in the
India debt market. Bond Market: It
consists of Financial Institutions bonds, Corporate bonds and debentures and
Public Sector Units bonds. These bonds are issued to meet financial
requirements at a fixed cost and hence remove uncertainty in financial costs. DEBT INSTRUMENTS There
are various types of debt instruments available that one can find in Indian
debt market. GOVERNMENT SECURITIES: It is the Reserve Bank of India that issues Government
Securities or G-Secs on behalf of the Government of India. These securities
have a maturity period of 1 to 30 years. G-Secs offer fixed interest rate,
where interests are payable semi-annually. For shorter term, there are Treasury
Bills or T-Bills, which are issued by the RBI for 91 days, 182 days and 364
days. CORPORATE BONDS: These bonds come from PSUs and private corporations and are
offered for an extensive range of tenures up to 15 years. There are also some
perpetual bonds. Comparing to G-Secs, corporate bonds carry higher risks, which
depend upon the corporation, the industry where the corporation is currently
operating, the current market conditions, and the rating of the corporation.
However, these bonds also give higher returns than the G-Secs. CERTIFICATE OF DEPOSIT:
These are negotiable money market instruments. Certificate of
Deposits (CDs), which usually offer higher returns than Bank term deposits, are
issued in demat form and also as a Usance Promissory Notes. There are several
institutions that can issue CDs. Banks can offer CDs which have maturity
between 7 days and 1 year. CDs from financial institutions have maturity
between 1 and 3 years. There are some agencies like ICRA, FITCH, CARE, CRISIL
etc. that offer ratings of CDs. CDs are available in the denominations of ` 1 Lac and in multiple of that. COMMERCIAL PAPERS: There are short term securities with maturity of 7 to 365 days.
CPs are issued by corporate entities at a discount to face value. EUROBOND MARKET The
Eurobond market is made up of investors, banks, borrowers, and trading agents
that buy, sell, and transfer Eurobonds. Eurobonds are a special kind of bond
issued by European governments and companies, but often denominated in
non-European currencies such as dollars and yen. They are also issued by
international bodies such as the World Bank. The creation of the unified
European currency, the euro, has stimulated strong interest in euro-denominated
bonds as well; however, some observers warn that new European Union tax
harmonization policies may lessen the bonds' appeal. Eurobonds
are unique and complex instruments of relatively recent origin. They debuted in
1963, but didn't gain international significance until the early 1980s. Since
then, they have become a large and active component of international finance.
Similar to foreign bonds, but with important differences, Eurobonds became
popular with issuers and investors because they could offer certain tax
shelters and anonymity to their buyers. They could also offer borrowers
favorable interest rates and international exchange rates. NEW ISSUE/PRIMARY
MARKET This
market consists of all people, institutions, methods, mechanisms, services and
practices involved in raising fresh capital for both new and existing
companies. It deals in only new securities which are not issued earlier. The
task for marketing and selling of securities to public is performed by merchant
bankers, investment bankers' underwriters and brokers etc. Features of Primary
Market New Issues:
The fundamental feature of the primary market is that it is associated with new
issues. That is why the primary market is called as the (NIM) new issue market. Place:
Primary market is not a particular place but an activity of issuing, buying,
and selling. Floating Capital: Primary
market issues capital through public issue, offering for sale, private
placement, and right issue. It comes before the
Secondary Market: All the transactions are primarily
made in the primary market. Secondary market comes much later. Functions of Primary
Market: Main functions of New Issue Market are:
1.
Facilitates transfer of funds from saving public to needy entrepreneurs for
productive activities for setting up new companies or
expansion/modification/diversification of existing enterprises. 2.
Facilitate to sell existing firms to the public as going concerns by converting
privately held ownership concerns into public limited companies. Primary
Market performs above functions by providing under mentioned three services: 1. Origination Origination
means deep examination/ scrutiny, analyzing, reviewing, validating and
processing of new issue proposals by sponsors of issue. Before forming an
opinion to give clearance to the new issue the originator scrutinize the
current and proposed activities of the issuing company in terms of legal, environmental,
technical, economic and financial aspects. Further they render advisory
relating to type of securities be issued, price fixation, timing and size of
issue, selling strategies etc. 2. Underwriting When
new issue is not welcomed by public, promoters get shock and all expenses paid
to originators prove worthless. To
avoid such negative outcome the company appoints underwriter who guarantee that they will buy part of issue not
subscribed by market. This type of assurance provider is known as underwriter. Underwriting service is
provided on commission basis and guarantees success of the issue. 3. Distribution Distribution
service is provided by dealers, brokers and sub brokers who are constantly
direct in touch with present and prospective investors. Sale of securities by
distributors to ultimate investors is called distribution. TYPES OF ISSUE A) Public Issue: It
is a method by which companies raise finance by selling shares to investing
public in the
primary market. Public issue is of three types: 1. Initial Public
Offerings (IPO): An issue made by a new company in
the capital market is called an initial public offering. These issues are
listed and traded on stock exchanges as specified in the offer document. IPO Grading:
The basic objective of IPO grading is to provide additional fundamentals
information to the investors to assess the company offering equity shares or
any other security that is convertible into equity shares at later date. IPO
grading is given by a Credit Rating Agency like ICRA CRISIL etc. Grades are
given on a five point scale. These grades reflect a comparative measurement of
fundamentals of issuing company in relation to the other listed companies. The
following grades are assigned based on fundamentals of issuing company: IPO
grade 1 ‐ Poor fundamentals IPO
grade 2 ‐ Below‐Average fundamentals IPO
grade 3 ‐ Average fundamentals IPO
grade 4 ‐ Above‐average fundamentals IPO
grade 5 ‐ Strong fundamentals 2. Follow on Public
Offering (FPO): Shares issued by a company already
listed on a stock exchange are called a follow on public offer. These are also
called follow on public issue. 3. Fast Track Issue
(FTI): This facility is available only in BSE
and NSE to a well established and compliant listed company in their follow on
public offer and right issues. These companies have to provide only rationalize
disclosures not comprehensive one for issue of securities. B) Preferential Issue:
When listed companies issue securities to a selected group of persons
(financial institutions, mutual funds, high net worth individuals) under
section Section 62(1)(c) of Companies Act 2013 it is called preferential issue. C) Right Issue:
If a listed company issues fresh securities to the existing shareholders in the
specified ratio to the number of securities already held by them in compliance
of the provision of Section 62(1)(a) of Companies Act 2013 it is called right
issue of shares. METHODS OF NEW ISSUE IN
PRIMARY MARKET 1. Public Issue through
Prospectus: It is the most common method under
which the issuing company through a document named as Abridged Prospects invite
the public to subscribe its shares at a predetermined price. A prospectus
provides all essential information about Issuer Company and purpose of issue,
to decide the public to subscribe securities. 2. Offer for Sale:
Under this method, the company places its securities at an agreed fixed price
with some investment banker (firm of brokers/sponsor) who resale these
securities to ultimate investors at a higher price. The margin of investment
banker/sponsor is called spread which is the difference between selling and
buying price. 3. Private Placement of
Securities: This method is similar to offer for sale
except the investment banker/sponsor under this method resale the securities at high prices to
selected group of individual or institutional investors. The spread is their remuneration for this deal. No need to
appoint underwriters as sponsor guarantees hundred percent placement. 4. Book Building: “Book
Building may be defined as a process used by companies raising capital through
Public Offerings-both Initial Public Offers (IPOs) and Follow-on Public Offers
(FPOs) to aid price and demand discovery. It is a mechanism where, during the
period for which the book for the offer is open, the bids are collected from
investors at various prices, which are within the price band specified by the
issuer. The process is directed towards both the institutional investors as
well as the retail investors. The issue price is determined after the bid
closure based on the demand generated in the process”. 5. Employee Stock
Option Plan: Employee Stock Option Plan (ESOP)
enables employees of a company to buy a fixed number of shares at a
predetermined price called exercise price which is lower than existing market
price during a specified time period. Sometime a certain part of employee’s monthly
salary or remuneration is paid in the form of company’s securities. This scheme
create a sense of belongingness in employees towards company and useful to
companies whose business is purely based on the talent of their employees, as
in case of IT industry. Statutory compliance is strictly followed while
implementing ESOP. SECONDARY MARKET The secondary market is a common platform where
securities are traded between investors. It is a figurative place where
investors buy and sell securities they already own. Securities that anchor
investors purchase from the primary market are further bought and sold between
retail investors in the secondary market. The issuing company has no
participation in these transactions. Usually, the stock exchanges of a country
are referred to as the secondary markets; however, there can be other types of
security markets as well. FEATURES
OF SECONDARY MARKET Liquidity:
The secondary market provides liquidity to all
the traders. Any investors/ sellers who are in need of money can sell their
securities to any number of buyers. Adjustable
Price: Any development in the
securities leads to price fluctuation in the market. The market adjusts itself
to the price of the new securities. Transaction
Cost: The transaction cost in the
secondary market is very low due to the high amount of transactions. Rules: The investors in the secondary market have to
follow all the rules given by the stock exchange and the government. Higher
rules and regulations ensure the safety of securities of the investors. FUNCTIONS
OF THE SECONDARY MARKET 1. Trading
Securities Trading various types of securities can be a profitable
strategy to improve the financial health; however, these transactions can be
risky if not done properly. Secondary market depositories, such as the
National Stock Exchange (NSE) and Bombay Stock Exchange (BSE), monitor all
listings and trades as per the guidelines of the Securities and Exchange Board
of India (SEBI). 2.
Economic Boost Businesses and individuals invest capital in
secondary markets in the hopes of turning a profit. Investing and reinvesting
the returns results in a repetitive cycle. This boosts the economic growth of a
nation and also ensures proper utilisation of the capital of a nation. 3. Pricing
Parameter Secondary capital markets set a margin for the
right value of securities based on market demands. This helps to ensure the
balanced trading of securities in the economy. 4. Credit
Quality The value of investment portfolios in the
secondary market helps the Government and lenders understand the
creditworthiness of the nation’s population. 5. Easy
Access to Securities Primary and secondary capital markets provide
retail investors access to various types of securities that are associated with
high liquidity. Most retail investors fail to tap into the
primary market for various reasons. Hence, the secondary market gives retail
investors the chance to invest in liquid securities with minimum capital. 6. Easy
Liquidity Gateway Secondary markets have various investment
instruments with different features. Most instruments in secondary capital
markets offer high liquidity to investors. This allows investors an easy
gateway during a financial crunch. TYPES OF SECONDARY
MARKETS In
India, there are primarily two types of secondary markets. Additionally, with
investment options expanding every day, there are several growing secondary
markets. 1. Over the Counter
(OTC) Market Over
the Counter or OTC market is a decentralised form of a secondary market.
Investors trade among themselves in high volume without any immediate
supervision of centralised authorities. OTC
markets have a higher chance of fraud and defaults than stock markets. This is
because sellers and buyers trade directly without any intermediate participant,
like a broker. Stocks,
bonds and other instruments can be traded in OTC markets. Foreign currency
trading markets, known as FOREX markets, are prime examples of an OTC market. 2. Exchanges This
is the most popular type of secondary market among investors. Exchanges are
platforms to trade equities, bonds and other securities via the Demat accounts
of investors. The NSE and BSE are two stock exchanges in India that list and
regulate all company shares in India. ADVANTAGES OF SECONDARY
MARKETS 1. Source of Income:
Investors can utilise secondary market investments for capital gains. 2. Safety:
Secondary markets are regulated and offer security to investors over their
capital and income. 3. Economic Growth: Investing
in secondary markets offers investors the opportunity to contribute to the
growth of their nation’s economy. 4. Market Value: Securities
trading in secondary stock markets provides the fair price of different stocks
listed on two exchanges. 5. Access to Cash: Investors
get access to cash as liquidity is high for secondary market investments. 6. Creditworthiness: Investments
in securities are good indicators of a healthy credit score for individuals. DISADVANTAGES OF
SECONDARY MARKETS 1. High Risk: Investing
in stocks and other secondary market instruments is subject to high risk due to
the involvement of multiple market participants and investors. 2. Effects of Inflation:
Inflation negatively affects the performance of
secondary market securities and increases the risk of loss for investors. 3. Lack of Control: Individual
investors do not have direct control over their investments as several factors
influence market trends. DIFFERENCES BETWEEN
PRIMARY AND SECONDARY MARKETS Basis Primary
Market Secondary
Market Meaning A
marketplace for new shares A
marketplace where formerly issued securities are traded Another
Name New Issue Market (NIM) After Market Products IPO
and FPO Shares,
debentures, warrants, derivatives, etc. Type of
Purchasing Direct Indirect Parties
of buying and selling Buying
and selling takes place between the company and investors Buying
and selling takes place between the investors Intermediaries
involved Underwriters Brokers Price
Levels Remains
Fixed Fluctuates
with variations in demand and supply Financing
provided to It provides financing to the existing companies
for facilitating growth and expansion. No Financing is provided Purchase
Process The
purchase process happens directly in the primary market. The
company issuing the shares is not involved in the purchasing process. Beneficiary The beneficiary is the company The beneficiary is the investor Government
involvement A
company issues shares and the government interferes in the process There
is no involvement of the government in the process. EQUITY MARKET Equity
market is a place where stocks and shares of companies are traded. The equities
that are traded in an equity market are either over the counter or at stock
exchanges. Often called as stock market or share market, an equity market
allows sellers and buyers to deal in equity or shares in the same platform. BENEFITS OF INVESTING
IN EQUITIES Investment
in stocks provides the highest returns, especially over a long-term investment
horizon. Investment
in equities can also provide you income through dividend issuance. Issuing
dividends is a corporate action, where listed companies share their profits
with existing shareholders. Equities
have greater exposure to market volatility. Hence, conducting market research
is important before investing. One
can minimize the associated risks by choosing to invest in equity instruments,
like Futures and Options (F&O). TYPES OF EQUITY MARKETS Primary Equity Market:
These are the shares offered to general investors through IPOs. Once the IPO is
closed, the shares of a company are listed on the stock exchange. The two major
stock exchanges facilitating trading in stocks are the NSE and BSE. Secondary Equity
Market: If one does not purchase stocks of a company
at the time of an IPO, He/she can purchase and sell the shares in the secondary
market. Here, the investor plans their investment by deciding on an entry and
exit point. Equity Market
Procedures 1.Trading: Here,
the stock exchanges provide an open trade platform for buying and selling of
stocks and securities. This is completely automatic and computerized, and
traders can see the trades on a screen before placing orders. 2.Settlement and
clearing: Stock exchanges settle the trade during
a day’s session in a process known as a settlement cycle. In India, stock
exchanges have adopted the T+2 settlement cycle. This means that after
completion of a day’s trading session, traders receive the credits or sale
proceeds within two working days. 3.Risk management: To
prevent fraudulent activities and mitigate risk to investors, stock exchanges
have a sound risk management system in place. Some of them include: Margin
requirements Liquid
assets Pay-ins Voluntary
close-out DEPOSITORIES The
word depository means ‘a centralized place where securities are kept and
recorded in the books on behalf of the investors either in paper or in electric
form. Depository can be defined as “An institution which transfers the
ownership of securities in electronic mode on behalf of its members” As a consequences
of implementation of capital market reforms GOI enacted the Depositories Act in
1996. At
present National Securities Depository Limited (NSDL) and Central Depository
Services (India) Limited are providers of depository services in India. Objectives of Depository:
A depository enables the capital market to achieve the following objectives: i)
By creating a system for the central handling of securities to reduce time in
their transfer, ii)
Avoid the risk of settlement of securities, iii)
Reduce cost of transaction for the investor, iv)
Enhance liquidity and efficiency, v)
Promote the country’s competitiveness by complying with global standard. Constituents of
Depository System: There are four players in the
depository system namely depository participant, investor, issuer and
depository. Depository Participant:
A DP, generally a bank is an agent of depository. An investor who buys or sells
securities and wants to avail depository services he has to open D Mat. Account
with DP. It is just like to open any other account in a bank. A D Mat. Account
keeps the record of securities of investor. A DP must be registered with SEBI
and it could be a bank financial institution clearing corporation etc. List of
DPs can be seen on specified depository portal. Investor/Beneficial
owner: Investor/ beneficial owner is the real owner
of the securities who has lodged his scrip with the depository in the form of
book entry. Issuer:
An issuer is a company that issues securities and maintains record of
registered owners of scrip with depositories. As per SEBI rule every issuer
whose scrip have been declared as eligible to be held in dematerialization form
in a depository, shall enter into an agreement with depository and shall
maintain a record of certificates of securities which have been dematerialized. Depository:
A depository (NSDL, CDSL) is a firm wherein the scrips of an investor are held
in electronic form in the same way a bank holds money of its depositor. It
carries out the transactions of securities by means of book entry without
physical movement of securities. Depository acts as a defect owner of scrips
lodged with it for the limited purpose of transfer of ownership. All capital
market and money market securities, units of mutual funds and collective investment
schemes are eligible to be kept in demat form with depositories. Clearing and Settlement
Corporation: “It is a center to do trade matching
and settle the funds and exchange securities/ settles the transfer of funds
between the buyer and seller of securities”. NON-DEPOSITORY MARKET: As
the name suggests, non-depository intermediaries don't take deposits. Instead,
they perform other financial services and collect fees for them as their
primary means of business. 1. Insurance Companies:
Insurance
companies specialize in writing contracts to protect their policyholders from
the risk of financial losses associated with particular events, such as
automobile accidents or fires. Insurance companies make money on the policies
they sell, which protect against financial loss and/or build income for later
use. The policies are not tangible and the protection they offer is financial,
so the companies are performing a financial service. Insurance
companies collect premiums from policyholders, which the companies then invest
to obtain the funds necessary to pay claims to policyholders and to cover their
other costs. Although
insurance companies do not typically make loans, in some cases the paid value
of a policy may be used to secure a loan from the insurance company or other
banks who take the policy as security against the loan. Insurance premiums
(costs) are not deposits. Private insurance companies try to earn a profit from
the premiums beyond the cost of insurance payouts. 2. Trust
Companies/Pension Funds: Companies
that administer pension or retirement funds also perform financial services.
For many people, saving for retirement is the most important form of saving.
These companies take contributions from people and promise in return to provide
future income. Pension funds invest contributions from workers and firms in
stocks, bonds, and mortgages to earn the money necessary to pay pension
payments when contributors retire. Growth for the contributor comes not from
interest on deposits, but investments made by the administrator of these
pension funds. Some
pension funds are closely regulated, but others may not be. These investments
may yield a profit, but there is a risk of loss as well. Private and state and
local government pension funds are an important source of demand for financial
securities. 3. Brokerage Houses: A
brokerage firm, or simply brokerage, is a financial institution that
facilitates the buying and selling of financial securities between a buyer and
a seller. Brokers are people who execute orders to buy and sell stocks and
other securities. They are paid commissions. A
traditional, or "full service", brokerage firm usually undertakes
more than simply carrying out a stock or bond trade. Their staff is entrusted
with the responsibility of researching the markets to provide appropriate
recommendations. They provide service to help investors do as well as possible
with their investments. Brokerage houses may offer advice or guidance to
individual investors as well as pension fund managers and portfolio managers
alike. They are private companies who make a profit on the transactions. 4. Loan Companies: Loan
companies, sometimes called finance companies, are not banks. They do not
receive deposits, and they should not be confused with banks, savings and loan
associations, or credit unions. They are private companies that lend money and
make a profit on the interest. They have relaxed norms of documentation when
compared to other financial institutions and will sometimes offer loans to
customers when other institutions will not. To offset the risk these companies
charge a higher rate of interest but provide quick access to funds to their
customers. 5. Currency Exchanges: Currency
exchanges do not make loans or receive deposits. Currency exchanges are private
companies that cash checks, sell money orders, or perform other exchange
services. They charge a fee, usually, a percentage of the amount exchanged.
Currency exchanges often located in areas where no other financial
intermediaries exist, and they offer the only financial services available to
people in those areas. 6. Mutual Funds: Mutual
Funds (MFs) are regulated entities, which collect money from many investors and
invest the aggregate amount in the markets in a professional and transparent
manner. A
mutual fund is a type of professionally managed collective investment vehicle
that pools money from many investors to purchase securities. A mutual fund
obtains money by selling shares to investors and then invests the money in
various equities and bonds, typically charging a small management fee for its
services and sharing the returns with the investors. They are sometimes
referred to as "investment companies" or "registered investment
companies." Most mutual funds are "open-ended," meaning
investors can buy or sell shares of the fund at any time. MFs offer various
schemes, like those investing only in equity or debt, index funds, gold funds,
etc. to cater to the risk appetite of various investors. Even with very small
amounts, one can invest in MF schemes through monthly systematic investment
plans (SIP). Mutual
funds have both advantages and disadvantages compared to direct investing in
individual securities. By
buying shares in a mutual fund, investors can take the benefit of increased
diversification and liquidity along with the ability to participate in
investments that may be available only to larger investors. They also reduce
the costs they would incur if they were to buy many individual stocks and bonds
along with professional investment management, service, and convenience.
Because mutual funds are willing to buy back their shares at any time, they
also provide savers with easy access to their money. Mutual
funds have disadvantages as well, which include additional fees, less control
over the timing of recognition of gains, less predictable income, and no
opportunity to exercise individual judgment or to customize the invested
portfolio. 7. Hedge Funds: Hedge
funds are not considered a type of mutual fund but are similar to mutual funds
in that they accept money from investors and use the funds to buy a portfolio
of assets. They are private, actively managed investment funds, which invest,
in a diverse range of markets, investment instruments, and strategies. Hedge
funds are often open-ended, and allow additions or withdrawals by their
investors. However,
a hedge fund typically has no more than 99 investors, all of whom are wealthy
individuals or institutions such as pension funds. Hedge funds typically make
riskier investments than do mutual funds, and they charge investors much higher
fees. As
these hedge funds are sold to a small number of investors, they have been
historically exempt from some of the regulation that governs other funds. They
are subject to the regulatory restrictions of their country and generally,
regulations limit hedge fund participation to certain classes of accredited
investors. 8. Investment Banks: An
investment bank is a financial institution that assists individuals,
corporations, and governments in raising capital by underwriting and/or acting
as the client's agent in the issuance of securities. They differ from
commercial banks in that they do not take in deposits and rarely lend directly
to households. Investment
Banks concentrate on providing advice to firms issuing stocks and bonds or
considering mergers with other firms. They also engage in underwriting, in
which they guarantee a price to a firm issuing stocks or bonds and then make a
profit by selling the stocks or bonds at a higher price. They may provide
ancillary services such as market making, trading of derivatives and equity
securities, and FICC services (fixed income instruments, currencies, and
commodities). FOREX MARKET The
forex market allows participants, such as banks and individuals, to buy, sell
or exchange currencies for both hedging and speculative purposes. The foreign
exchange (forex) market is the largest financial market in the world and is
made up of banks, commercial companies, central banks, investment management
firms, hedge funds, retail forex brokers, and investors. TYPE OF FOREX MARKETS Spot Forex Market : The
spot market is the immediate exchange of currency between buyers and sellers at
the current exchange rate. The spot market makes up much of the currency
trading. The
key participants in the spot market include commercial, investment, and central
banks, as well as dealers, brokers, and speculators. Large commercial and
investment banks make up a major portion of spot trades, trading not only for
themselves but also for their customers. Forward Forex Market:
In the forward markets, two parties agree to trade a currency for a set price
and quantity at some future date. No currency is exchanged when the trade is
initiated. The two parties can be companies, individuals, governments, or the
like. Forward markets are useful for hedging. On
the downside, forward markets lack centralized trading and are relatively
illiquid (since there are just the two parties). As well, there is counterparty
risk, which is that the other part will default. Futures Forex Market: Future markets
are similar to forward markets in terms of basic function. However, the big
difference is that future markets use centralized exchanges. Thanks to
centralized exchanges, there are no counterparty risks for either party. This
helps ensure future markets are highly liquid, especially compared to forward
markets. FINANCIAL INSTRUMENTS: Financial
instruments are contracts for monetary assets that can be purchased, traded,
created, modified, or settled for. In terms of contracts, there is a
contractual obligation between involved parties during a financial instrument
transaction. For
example, if a company were to pay cash for a bond, another party is obligated
to deliver a financial instrument for the transaction to be fully completed.
One company is obligated to provide cash, while the other is obligated to
provide the bond. Basic examples of financial instruments are cheques, bonds,
securities. TYPES OF FINANCIAL
INSTRUMENTS There
are typically three types of financial instruments: cash instruments,
derivative instruments, and foreign exchange instruments. 1. Cash Instruments: Cash instruments
are financial instruments with values directly influenced by the condition of
the markets. Within cash instruments, there are two types; securities and
deposits, and loans. Securities:
A security is a financial instrument that has monetary value and is traded on
the stock market. When purchased or traded, a security represents ownership of
a part of a publicly-traded company on the stock exchange. Deposits and Loans:
Both deposits and loans are considered cash instruments because they represent
monetary assets that have some sort of contractual agreement between parties. 2. Derivative
Instruments: Derivative
instruments are financial instruments that have values determined from
underlying assets, such as resources, currency, bonds, stocks, and stock
indexes. The
five most common examples of derivatives instruments are synthetic agreements,
forwards, futures, options, and swaps. This is discussed in more detail below. Synthetic Agreement for
Foreign Exchange (SAFE): A SAFE occurs in the
over-the-counter (OTC) market and is an agreement that guarantees a specified
exchange rate during an agreed period of time. Forward:
A forward is a contract between two parties that involves customizable
derivatives in which the exchange occurs at the end of the contract at a specific
price. Future:
A future is a derivative transaction that provides the exchange of derivatives
on a determined future date at a predetermined exchange rate. Options:
An option is an agreement between two parties in which the seller grants the
buyer the right to purchase or sell a certain number of derivatives at a
predetermined price for a specific period of time. Interest Rate Swap:
An interest rate swap is a derivative agreement between two parties that
involves the swapping of interest rates where each party agrees to pay other
interest rates on their loans in different currencies. 3. Foreign Exchange
Instruments : Foreign exchange instruments are
financial instruments that are represented on the foreign market and primarily
consist of currency agreements and derivatives. In
terms of currency agreements, they can be broken into three categories. Spot:
A currency agreement in which the actual exchange of currency is no later than
the second working day after the original date of the agreement. It is termed
“spot” because the currency exchange is done “on the spot” (limited timeframe). Outright Forwards: A
currency agreement in which the actual exchange of currency is done “forwardly”
and before the actual date of the agreed requirement. It is beneficial in cases
of fluctuating exchange rates that change often. Currency Swap:
A currency swap refers to the act of simultaneously buying and selling
currencies with different specified value dates. DIFFERENT INSTRUMENTS
OF THE CAPITAL MARKET Equity Shares: These
shares are the prime source of finance for a public limited or joint-stock
company. When individuals or institutions purchase them, shareholders have the
right to vote and also benefit from dividends when such an organization makes
profits. Shareholders, in such cases, are regarded as the owners of a company
since they hold its shares. Preference Shares: These
are the secondary sources of finance for a public limited company. As the name
suggests, holders of such shares enjoy exclusive rights or preferential
treatment by that company in specific aspects. They are likely to receive their
dividend before equity shareholders. However, they do not typically have any
voting rights. Debt Security: It
is a fixed income instrument, primarily issued by sovereign and state
governments, municipalities, and even companies to finance infrastructural
development and other types of projects. It can be viewed as a loaning
instrument, where a bond’s issuer is the borrower. Bonds: Bondholders
are considered as creditors concerning such an entity and are entitled to
periodic interest payment. Furthermore, bonds carry a fixed lock-in period.
Therefore, issuers of bonds are mandated to repay the principal amount on the
maturity date to bondholders. Debentures: Unlike
bonds, debentures are unsecured investment options. Consequently, they are not
backed by any asset or collateral. Here, lending is entirely based on mutual
trust, and, herein, investors act as potential creditors of an issuing
institution or company. MUTUAL FUNDS In
India, there are a large number of mutual funds. All mutual funds are under the
regulatory framework of the Securities Exchange Board of India with the
exception of Unit Trust of India (UTI). All mutual funds should have a net
worth of ` 5 crores each, they have to set-up a board of trustees and appoint
directors. The mutual fund concept is based on sharing of risks and rewards.
The income and capital appreciation arising out of investments are shared among
the investors. Their securities are subject to market risk. Share prices can move
up or down. The investor should be aware of these risks while making an
investment decision. Even with risks the mutual funds are able to perform
better than an individual because a careful selection of securities over a
diversified portfolio covering large number of companies and industries is made
and the portfolio is constantly reviewed. Mutual funds select a large share of
equities in the case of growth schemes. Although this has a greater risk and
potential for capital appreciation is higher in growth schemes. Besides
growth schemes mutual funds also have income schemes. When they have income
schemes they invest in securities of a guaranteed return. They generally select
a large share of fixed income securities like debentures and bonds. All growth
schemes are closed/ended and income schemes are either closed/ended or open
ended. In India, a large number of mutual funds have been floated. TYPES OF MUTUAL FUNDS: Mutual
fund types can be classified based on various characteristics. Learn more about
different mutual fund types below: Equity
Funds Debt
Funds Money
Market Funds Hybrid
Funds Growth
Funds Income
Funds Liquid
Funds Tax-Saving
Funds Aggressive
Growth Funds Capital
Protection Funds Fixed
Maturity Funds Pension
Funds Based
on Asset Class Based on asset class Equity Funds: Equity
funds primarily invest in stocks, and hence go by the name of stock funds as
well. They invest the money pooled in from various investors from diverse
backgrounds into shares/stocks of different companies. The gains and losses
associated with these funds depend solely on how the invested shares perform
(price-hikes or price-drops) in the stock market. Also, equity funds have the
potential to generate significant returns over a period. Hence, the risk
associated with these funds also tends to be comparatively higher. Debt Funds: Debt
funds invest primarily in fixed-income securities such as bonds, securities and
treasury bills. They invest in various fixed income instruments such as Fixed
Maturity Plans (FMPs), Gilt Funds, Liquid Funds, Short-Term Plans, Long-Term
Bonds and Monthly Income Plans, among others. Since the investments come with a
fixed interest rate and maturity date, it can be a great option for passive
investors looking for regular income (interest and capital appreciation) with
minimal risks. Money Market Funds: Investors
trade stocks in the stock market. In the same way, investors also invest in the
money market, also known as capital market or cash market. The government runs
it in association with banks, financial institutions and other corporations by
issuing money market securities like bonds, T-bills, dated securities and
certificates of deposits, among others. The fund manager invests your money and
disburses regular dividends in return. Opting for a short-term plan (not more
than 13 months) can lower the risk of investment considerably on such funds. Hybrid Funds:
As the name suggests, hybrid funds (Balanced Funds) is an optimum mix of bonds
and stocks, thereby bridging the gap between equity funds and debt funds. The
ratio can either be variable or fixed. In short, it takes the best of two
mutual funds by distributing, say, 60% of assets in stocks and the rest in
bonds or vice versa. Hybrid funds are suitable for investors looking to take
more risks for ‘debt plus returns’ benefit rather than sticking to lower but
steady income schemes. Based on Investment
Goals Growth Funds: Growth
funds usually allocate a considerable portion in shares and growth sectors,
suitable for investors (mostly Millennials) who have a surplus of idle money to
be distributed in riskier plans (albeit with possibly high returns) or are
positive about the scheme. Income Funds: Income
funds belong to the family of debt mutual funds that distribute their money in
a mix of bonds, certificate of deposits and securities among others. Helmed by
skilled fund managers who keep the portfolio in tandem with the rate
fluctuations without compromising on the portfolio’s creditworthiness, income
funds have historically earned investors better returns than deposits. They are
best suited for risk-averse investors with a 2-3 years perspective. Liquid Funds: Like
income funds, liquid funds also belong to the debt fund category as they invest
in debt instruments and money market with a tenure of up to 91 days. The
maximum sum allowed to invest is Rs 10 lakh. A highlighting feature that
differentiates liquid funds from other debt funds is the way the Net Asset
Value is calculated. The NAV of liquid funds is calculated for 365 days
(including Sundays) while for others, only business days are considered. Tax-Saving Funds: ELSS or Equity
Linked Saving Scheme, over the years, have climbed up the ranks among all
categories of investors. Not only do they offer the benefit of wealth
maximisation while allowing you to save on taxes, but they also come with the
lowest lock-in period of only three years. Investing predominantly in equity
(and related products), they are known to generate non-taxed returns in the
range 14-16%. These funds are best-suited for salaried investors with a
long-term investment horizon. Aggressive Growth Funds:
Slightly on the riskier side when choosing where to
invest in, the Aggressive Growth Fund is designed to make steep monetary gains.
Though susceptible to market volatility, one can decide on the fund as per the
beta (the tool to gauge the fund’s movement in comparison with the market).
Example, if the market shows a beta of 1, an aggressive growth fund will
reflect a higher beta, say, 1.10 or above. Capital Protection
Funds: If protecting the principal is the
priority, Capital Protection Funds serves the purpose while earning relatively
smaller returns (12% at best). The fund manager invests a portion of the money
in bonds or Certificates of Deposits and the rest towards equities. Though the
probability of incurring any loss is quite low, it is advised to stay invested
for at least three years (closed-ended) to safeguard your money, and also the
returns are taxable. Fixed Maturity Funds: Many
investors choose to invest towards the of the FY ends to take advantage of
triple indexation, thereby bringing down tax burden. If uncomfortable with the
debt market trends and related risks, Fixed Maturity Plans (FMP) – which invest
in bonds, securities, money market etc. – present a great opportunity. As a
close-ended plan, FMP functions on a fixed maturity period, which could range
from one month to five years (like FDs). The fund manager ensures that the
money is allocated to an investment with the same tenure, to reap accrual
interest at the time of FMP maturity. Pension Funds: Putting
away a portion of income in a chosen pension fund to accrue over a long period
to secure financial future after retiring from regular employment can take care
of most contingencies (like a medical emergency or children’s wedding). Relying
solely on savings to get through golden years is not recommended as savings (no
matter how big) get used up. EPF is an example, but there are many lucrative
schemes offered by banks, insurance firms etc. Based on Structure: Mutual
funds are also categorised based on different attributes (like risk profile,
asset class, etc.). The structural classification – open-ended funds,
close-ended funds, and interval funds – is quite broad, and the differentiation
primarily depends on the flexibility to purchase and sell the individual mutual
fund units. Open-Ended Funds: Open-ended
funds do not have any particular constraint such as a specific period or the
number of units which can be traded. These funds allow investors to trade funds
at their convenience and exit when required at the prevailing NAV (Net Asset
Value). This is the sole reason why the unit capital continually changes with
new entries and exits. An open-ended fund can also decide to stop taking in new
investors if they do not want to (or cannot manage significant funds). Closed-Ended Funds: In
closed-ended funds, the unit capital to invest is pre-defined. Meaning the fund
company cannot sell more than the pre-agreed number of units. Some funds also
come with a New Fund Offer (NFO) period; wherein there is a deadline to buy
units. NFOs comes with a pre-defined maturity tenure with fund managers open to
any fund size. Hence, SEBI has mandated that investors be given the option to
either repurchase option or list the funds on stock exchanges to exit the
schemes. Interval Funds: Interval
funds have traits of both open-ended and closed-ended funds. These funds are
open for purchase or redemption only during specific intervals (decided by the
fund house) and closed the rest of the time. Also, no transactions will be
permitted for at least two years. These funds are suitable for investors
looking to save a lump sum amount for a short-term financial goal, say, in 3-12
months. Based on Risk Very Low-Risk Funds: Liquid
funds and ultra-short-term funds (one month to one year) are known for its low
risk, and understandably their returns are also low (6% at best). Investors
choose this to fulfil their short-term financial goals and to keep their money
safe through these funds. Low-Risk Funds: In
the event of rupee depreciation or unexpected national crisis, investors are
unsure about investing in riskier funds. In such cases, fund managers recommend
putting money in either one or a combination of liquid, ultra short-term or
arbitrage funds. Returns could be 6-8%, but the investors are free to switch
when valuations become more stable. Medium-risk Funds: Here,
the risk factor is of medium level as the fund manager invests a portion in
debt and the rest in equity funds. The NAV is not that volatile, and the
average returns could be 9-12%. High-Risk Funds: Suitable
for investors with no risk aversion and aiming for huge returns in the form of
interest and dividends, high-risk mutual funds need active fund management.
Regular performance reviews are mandatory as they are susceptible to market
volatility. You can expect 15% returns, though most high-risk funds generally
provide up to 20% returns. Specialized Mutual
Funds Sector Funds: Sector
funds invest solely in one specific sector, theme-based mutual funds. As these
funds invest only in specific sectors with only a few stocks, the risk factor
is on the higher side. Investors are advised to keep track of the various
sector-related trends. Sector funds also deliver great returns. Some areas of
banking, IT and pharma have witnessed huge and consistent growth in the recent
past and are predicted to be promising in future as well. Index Funds: Suited best for
passive investors, index funds put money in an index. A fund manager does not
manage it. An index fund identifies stocks and their corresponding ratio in the
market index and put the money in similar proportion in similar stocks. Even if
they cannot outdo the market (which is the reason why they are not popular in
India), they play it safe by mimicking the index performance. Funds of Funds: A diversified
mutual fund investment portfolio offers a slew of benefits, and ‘Funds of
Funds’ also known as multi-manager mutual funds are made to exploit this to the
tilt – by putting their money in diverse fund categories. In short, buying one
fund that invests in many funds rather than investing in several achieves
diversification while keeping the cost down at the same time. Emerging market Funds: To
invest in developing markets is considered a risky bet, and it has undergone
negative returns too. India, in itself, is a dynamic and emerging market where
investors earn high returns from the domestic stock market. Like all markets,
they are also prone to market fluctuations. Also, from a longer-term
perspective, emerging economies are expected to contribute to the majority of
global growth in the following decades. International/ Foreign
Funds: Favoured by investors looking to spread
their investment to other countries, foreign mutual funds can get investors
good returns even when the Indian Stock Markets perform well. An investor can
employ a hybrid approach (say, 60% in domestic equities and the rest in
overseas funds) or a feeder approach (getting local funds to place them in
foreign stocks) or a theme-based allocation (e.g., gold mining). Global Funds: Aside
from the same lexical meaning, global funds are quite different from
International Funds. While a global fund chiefly invests in markets worldwide,
it also includes investment in your home country. The International Funds
concentrate solely on foreign markets. Diverse and universal in approach,
global funds can be quite risky to owing to different policies, market and
currency variations, though it does work as a break against inflation and
long-term returns have been historically high. Real Estate Funds: Despite
the real estate boom in India, many investors are still hesitant to invest in
such projects due to its multiple risks. Real estate fund can be a perfect
alternative as the investor will be an indirect participant by putting their
money in established real estate companies/trusts rather than projects. A
long-term investment negates risks and legal hassles when it comes to
purchasing a property as well as provide liquidity to some extent. Commodity-focused Stock
Funds: These funds are ideal for investors with
sufficient risk-appetite and looking to diversify their portfolio.
Commodity-focused stock funds give a chance to dabble in multiple and diverse
trades. Returns, however, may not be periodic and are either based on the
performance of the stock company or the commodity itself. Gold is the only
commodity in which mutual funds can invest directly in India. The rest purchase
fund units or shares from commodity businesses. Market Neutral Funds: For
investors seeking protection from unfavourable market tendencies while
sustaining good returns, market-neutral funds meet the purpose (like a hedge
fund). With better risk-adaptability, these funds give high returns where even
small investors can outstrip the market without stretching the portfolio
limits. Inverse/Leveraged Funds:
While a regular index fund moves in tandem with the
benchmark index, the returns of an inverse index fund shift in the opposite
direction. It is nothing but selling your shares when the stock goes down, only
to repurchase them at an even lesser cost (to hold until the price goes up
again). Asset Allocation Funds:
Combining debt, equity and even gold in an optimum
ratio, this is a greatly flexible fund. Based on a pre-set formula or fund
manager’s inferences based on the current market trends, asset allocation funds
can regulate the equity-debt distribution. It is almost like hybrid funds but
requires great expertise in choosing and allocation of the bonds and stocks
from the fund manager. Gift Funds: One
can also gift a mutual fund or a SIP to their loved ones to secure their
financial future. Exchange-traded Funds: It
belongs to the index funds family and is bought and sold on exchanges.
Exchange-traded Funds have unlocked a new world of investment prospects,
enabling investors to gain extensive exposure to stock markets abroad as well
as specialised sectors. An ETF is like a mutual fund that can be traded in
real-time at a price that may rise or fall many times in a day. LAND AND HOUSE PROPERTY
/ REAL ESTATE Land
and house property is also called real estate. This investment is taken by a
large number of people for hedging the interest rates. Who are the people who
should invest in real estate depends on some of the following questions: (a)
Does the investor have a large sum of money which he would like to invest for a
minimum of five years? Also, if he wishes to sell his property he will not be
able to receive an amount at a very short notice. The holding period of the
property is, therefore, important for an investor. (b)
The second question is: Is the investor likely to stay in one place or expect
transfer of geographical area as a settlement place for himself? Property
cannot be left without supervision. A person who does not have enough time to
supervise his property should not invest in it. (c)
Property requires care. If it is rented out, there is a requirement of repair
and maintenance. Tenants also are not permanent and keep on moving. Can the
investor accustom himself to the requirements of changes in tenants? Can he
find proper tenants to his liking to replace those who have left? Is it possible
for him to be able to enhance the rent as they increase? If the investor finds
that he can take care of these matters relating to property, only then he must
involve himself in this situation. (d)
Investment in real estate is also very risky. Although the average rate of
return is high a cautious investor should not think of property, because it
involves the exercising of a lot of pressures such as tax payments, capital
gains tax, annual property tax and so on. PRINCIPLES OF INVESTING
IN PROPERTY (a) Price:
The price of property is most valuable for determination of real estate. The
property must be evaluated with regard to its price in relation to its position
and its use. Regarding position, it should be situated in a place where higher
rent is available. For example, property situated in Connaught Place in Delhi
will be useful for departmental stores and hotels. A property situated in
Greater Kailash will be useful for residence, apartments or shops in the
shopping area. Property in Delhi situated in Brijwasan will be useful for
farms. After the property for farms is being considered it must be found out
whether the land is given for growing crops or is the climate suitable for
rearing fowls or poultry farms. So, the productivity will determine the price.
If the land is acquired for a price which gives a less profitable return the
price at which the investor purchases it will not be suitable for him.
Therefore, when an investor buys and sells property he should evaluate it
according to its most productive use. (b) Supply of Land:
Land as an asset is fixed but its demand keeps on increasing every time. In
areas in Mumbai, land is being recaptured by reclamation methods but these are
rare incidences. Therefore, the land should be evaluated only in terms of what
it actually is in terms of supply. The increasing population and affluence will
increase the rate and value of land. Land from the point of view of long- term
investment can be expected to be a good proposal because it is expected to
cover purchasing power risk with the prices of land which keep on increasing.
On short-term basis, property cannot be called as a good investment. (c) Land as Collateral:
Land is accepted as collateral by banks and other financial institutions. In
India it is found that almost all banks consider land as good collateral, but
lending on property is restricted by the banks to the market price as a
collateral value. If an investor can purchase land and borrow money on such an
investment at a lower rate of interest it is a good form of investment. (d) Tax:
The purchase of land must always be determined after carefully examining the
payment of tax on property. Tax must be paid on house property as well as after
property is sold under Capital Gains Tax.
No comments