2. Investment Avenues

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Module 2

Investment avenues


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Investment avenues

There are two basic investment avenues

Financial assets eg. Equity shares, corporate

debentures, government securities, deposits with

banks, mutual funds, insurance policies, derivatives

Real assets eg. Residential houses, commercialproperty, agricultural farm, gold, precious stones, art

objects.

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Financial assets Investments in financial assets include1. Securitised investments

2. Non-securitised investments

Securities are those instruments which arequoted and are transferable. Eg. Shares, bonds

Non-securitised investments are those which arenot quoted and not freely marketable Eg. Bank deposits, national savings, insurance

policies

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Investment attributes

Risk and return Risk can be defined as the variability of rates of

returns from an investment.

Rate of return is the yield and capital appreciation

expected by the investor from his investment

Liquidity

An investment is highly marketable if it can be

bought and sold quickly with a minimum loss.

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Investment attributes

Tax advantages Initial, ongoing or terminal tax shelters.

Convenience Convenience is the procedural ease when the

investment is made and also the ease with which

the day to day management of the investment can

be done

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Non-marketable financial assets

Bank deposits

Post office savings account

Post office time deposits

Monthly income scheme of post office Kisan Vikas Patra

National savings certificate

Company deposits

Employee provident fund scheme

Public provident fund scheme

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Money market instruments

These are debt instruments which have a maturityof less than one year.

They are highly liquid and have low risks

Eg. Treasury bills, certificates of deposit,commercial papers and repos.

The participants of the money market are the

government, financial institutions, banks and

corporates. The securities traded are in large denominations

and hence out of reach of individual investors

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Treasury bills These represent the obligations of the Government

of India.

They are usually issued for 91 days and 364 days.

They are sold by auction every week by RBI

They are sold at a discount and redeemed at par.

They are heavily traded in the secondary market

They have no credit risk and have negligible price

risk

Interest rates are not very attractive.

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Certificates of deposit Banks and financial institutes are the major issuers

of CDs.

Issued for amounts of Rs 1 lakh and above

Issued at a discount and redeemed at par.

The principal investors are banks, FIs, corporates

and mutual funds

Short term and easily transferable

Have a maturity of 3 months to 1 year

Generally risk free

Offer a higher rate of interest as compared to

treasury bills9


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Commercial paper Short term promissory unsecured notes

Sold for large amounts

Maturity of 90 to 180 days

Sold at a discount and redeemed at par

Attract stamp duty in the primary market

Issued by companies that are financially strong and

highly rated

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Repos and Reverse Repos (repurchaseagreement)

Involves simultaneous sale and purchase

agreement.

Government securities are transferred to aninvestor with an agreement to buy back those

securities after the repo period at a slightly higher

price

Can be used to finance short term requirements Reverse repo is the mirror image of a repo.

Reverse repo involves an initial purchase and a

subsequent sale

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Call money market Call money market is a money market where day to

day surplus funds are traded mostly by banks.

The loans in this market are of short term naturematurities ranging from 1 day to a 14 days.

Loans are highly liquid and are repayable on demand. Banks and primary dealers are allowed to borrow and

lend in this market.

Other corporates and investment companies areallowed to only lend in these markets. They are

encouraged to participate in the repo market

RBI wants to convert the call money market into apure interbank money market

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Bonds or debentures

Bonds are long term, fixed income, debtinstruments.

The issuer promises to pay its investors a certain

rate of interest and to repay the principal amount

on the maturity date.

Includes government securities, bonds issued by

state governments, corporate bonds, public

sector bonds, and bonds by financial institutions

They are redeemed on the maturity date.

An indenture a trust deed is drawn between the

bond holders and the company.

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Government securities

Government securities are also called as giltedged securities or treasury bonds

Issued by central government, state government

and quasi-government bodies

Carry a fixed coupon rate, have a fixed maturityperiod, issued at face value

Interest is paid at half-yearly rests and varies from

7% to 10%

Maturity ranges from 3 to 20 years Have tax benefits

Low interest rates, long maturity periods,

somewhat illiquid.

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Government securities

Government securities Banks, FIs, insurance companies, corporates,

FIIs, primary dealers, mutual funds invest in these

securities

RBI maintains a special account called SubsidiaryGeneral Ledger (SGL) for holding and trading the

securities in Demat form. Banks and primary

dealers open SGL accounts with RBI. PDs can

open constituent SGL accounts to other clients tohold securities in demat form.

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Bonds or debentures

Corporate bonds or debentures Debentures are secured by a charge on the

immovable properties of the company by way of

mortgage

Carry a maturity period of more than 18 months. Must be credit rated.

Debentures have a convertible clause wherein the

investor can convert it into equity shares after a

specified period.

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Bonds or debentures

Public sector bonds Issued by public sector

Both taxable and tax free bonds

They are transferable by endorsement and

delivery

They are traded in exchanges

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Types of bonds Bearer bonds

the holder of the bond is paid the interest.

They are unregistered and transferred by simply handing over

Deep discount bonds long duration instruments and are

issued at a discount to their face value

Non-convertible bonds issued by corporates for periods

between 5 to 8 years. They are credit rated. They cannot beconverted to shares

Secured premium notes (SPNs) issued for 3 to 8 years.

They offer yield in the form of interest payments or premium

Zero coupon bonds are issued at a discount to the face value

and are redeemed at par.

Floating rate bonds have a variable interest rate

Capital indexed bonds interest rates vary as per the WPI

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Types of bonds

Puttable bonds

provide the investor the

right to seek redemption before the maturity

date

Callable bonds

gives the right to the issuer

to repurchase the bonds at a lower rate.

Foreign currency bonds bonds issued in

foreign currency to raise funds in foreign

currency

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Types of debentures

Secured or unsecured

Fully convertible

Partly convertible

Non-convertible

Registered / Unregistered

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Equity shares

Equity shares represent ownership capital

Equity shareholders bear the risk and enjoy the

rewards of the ownership.

They have a residuary claim on the profits and

assets of the company. They possess an

unlimited potential for share in profits.

They control the company through the board of

directors. The liability of the equity share holders is

limited to the value of the shares they have

purchased

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Classification of equity shares

Blue chip

shares of large, well establishedcompanies

Growth shares enjoy above average growth

and profitability

Income shares have stable operations, limited

growth opportunities and high dividend payout

ratios

Cyclical shares

shares of companies whoseoperations are of a cyclical nature.

Defensive shares shares of companies

unaffected by ups and downs in the market

Speculative shares

shares tend to fluctuate22


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Types of equity shares Sweat equity are shares issued to employees and

directors at a discount for considerations other thancash for services rendered like providing know-how,making available intellectual property right

Non-voting shares are shares issued with no votingrights or with minimum voting rights. Preferenceshares are a form of non-voting shares. These sharesget a slightly higher dividend to compensate for non-voting rights.

Rights shares are shares offered to existingshareholders at a price by the company in proportionto the shares held by them.

Bonus shares are issued in addition to the cashdividends paid to the existing shareholders. The aim

of bonus shares is to capitalise free reserves. Bonus23


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Advantages of equity shares

Do not create an obligation to pay a fixed rate ofdividend

Can be issued without creating any charge on the

assets

Permanent source of capital

In case of profits, the equity share holders are the

real gainers as they get increased dividends and

appreciation in the value of the shares


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Preference shares

Preference shares are hybrid in nature i.e. theycarry the features of both debt and equity.

Carry a fixed rate of dividend

Dividend is paid out of distributable profits

Preference shares are cumulative. Dividendskipped in a particular year can be paid in the next

year

Redeemable in 7 to 12 years

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Preference shares

Preference share holders enjoy preferences intwo situations

Payment of dividend they are paid before the

equity holders

Repayment of capital at the time of liquidation

they are paid after outside liabilities are repaid and

before equity shareholders are repaid

Do not have voting rights


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Types of preference shares

Cumulative preference shares These shares have a right to claim dividends for those

years also for which there have been no profits

Non-Cumulative preference shares

They have no claim on dividend which are in arrears Redeemable preference shares

These shares can be returned after a certain period

Irredeemable preference shares Cannot be redeemed till the company is liquidated

Participating preference shares

Have a share in the surplus profits after fixed dividendhas been paid


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Types of preference shares

Non-participating preference shares Earn only fixed dividends

Convertible preference shares

Shares can be converted into equity shares after a

certain period

Non-convertible preference shares

Cannot be converted into equity shares


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Hybrid security

Preference share is a hybrid form of security as ithas both features of debt and equity

Features of equity

Payment of dividend is not obligatory

Preference dividend is paid out of distributable

profits

Not deductible as an expense for the purpose of tax

calculation

Features of debt

Carries a fixed rate of dividend

Entitles the owner a claim prior to the equity holders

Does not give voting rights


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Warrants

Warrant is a document of title to buy specifiednumber of equity shares at a specified price.

Warrants are generally issued to make the bonds

more attractive. They can be exercised over a

number of years.

Warrants are detachable instruments and can be

traded in stock exchanges.

Warrants can be converted into equity shares at aprice called exercise price.

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Bank deposits

Demand deposit Saving deposit

Term deposit

Recurring deposit Current account

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Insurance Insurance is a form ofrisk management primarily used to hedge

against the risk of a contingent, uncertain loss.

Insurance is defined as the equitable transfer of the risk of a loss,

from one entity to another, in exchange for payment.

An insurer, or insurance carrier, is a company selling the

insurance; the insured, or policyholder, is the person or entity

buying the insurance policy .

The amount to be charged for a certain amount of insurance

coverage is called the premium.

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http://en.wikipedia.org/wiki/Risk_managementhttp://en.wikipedia.org/wiki/Hedge_%28finance%29http://en.wikipedia.org/wiki/Riskhttp://en.wikipedia.org/wiki/Uncertaintyhttp://en.wikipedia.org/wiki/Uncertaintyhttp://en.wikipedia.org/wiki/Riskhttp://en.wikipedia.org/wiki/Hedge_%28finance%29http://en.wikipedia.org/wiki/Risk_management


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Mutual fund schemes

A mutual fund is a vehicle for collectiveinvestment.

Mutual fund is an investment vehicle that pools

together funds from investors to purchase stocks

, bonds or other securities.

An investor can participate in the mutual fund by

buying the units of the fund.

The gain or loss made by the mutual fund ispassed on to the investors after deducting the

deducting the administrative expenses and

investment management fees.

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The gains are distributed to the unit holder in the

form of dividend or reinvested by the fund to

generate further gains. Portfolio manager evaluates his portfolio

performance and identifies the sources of

strength and weakness.

The evaluation of the portfolio provides a feedback about the performance to evolve better

management strategy.

Even though evaluation of portfolio is considered

to be the last stage of investment process, it is

continuous process.

The managed portfolios are commonly known as

mutual funds.


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Important questions

What are different types of bonds? What are the features of shares?

What are the different types of preference

shares?

What are the different types of bank deposits?

Why is insurance an investment?

What are derivatives? How are they classified?

What are the advantages of trading inderivatives?

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Documents

2. Investment Avenues