FINANCIAL INSTRUMENTS

VIKASH KUMAR GUPTA

YASH KHANDELWAL

CONTENT LAYOUT

• INTRODUCTION

• INTRUMENTS TRADED IN MONEY MARKET

• INTRUMENTS TRADED IN CAPITAL MARKET

INDIAN FINANCIAL SYSTEM

FINANCIAL MARKET

Financial Markets are the centers or arrangements that provide facilities for buying and selling of financial claims.

FINANCIAL MARKET

• Efficient transfer of resources from those having idle resources to others who have a pressing need for them is achieved through financial markets.

• Stated formally, financial markets provide channels for allocation of savings to investment.

• The financial markets have two major components:

• Money market

• Capital market.

MONEY MARKET

The Money market refers to the market where borrowers and lenders exchange short-term funds to solve their liquidity needs.

Money market instruments are generally financial claims that have low default risk, maturities under one year and high marketability.

INTRUMENTS TRADED IN MONEY MARKET

• TREASURY BILLS

• CALL/NOTICE MONEY

• COMMERCIAL PAPER

• CERTIFICATE OF DEPOSITS

• COMMERCIAL BILLS

TREASURY BILLS

• A treasury bill is a particular type of finance bill or a promissory note put out by the government of the country.

• Although state governments also issued treasury bills on occasions until 1950, since then it is only the central government that has been selling them.

• Treasury Bills are highly liquid because there cannot be a better guarantee of repayment than the one given by the government.

Important Qualities of Treasury Bills

a) The high liquidity

b) Absence of risk of default

c) Ready availability on tap

d) Assured yield

e) Low transactions cost

f) Eligibility of inclusion in Statutory Liquidity Ratio (SLR)

g) Negligible capital depreciation

CALL MONEY MARKET

• Call Money Market is that part of the national money market where the day-to-day surplus funds, mostly of banks are traded in.

• The loans made in this market are of a short-term nature, their maturity varying between one day to a fortnight.

• The nature of this market in different countries varies from each other. Differences in institutional structures account for the differences in the nature, participants, purposes or types of transactions in such markets.

• All, however, have one common feature: they deal in loans which have a very short maturity and are highly liquid.

COMMERCIAL PAPER

• A Commercial Paper is quite a new instrument in the money market in India and even in the advanced industrial nations, except in the U.S. where it has been in vogue since the early 19th century.

• However, in all other countries, it is only a post-1980 phenomenon.

• CPs are short-term promissory notes with fixed maturity issued mostly by the leading, nationally reputed, credit-worthy, and highly rated large corporations.

• Any person, bank, company, incorporated and unincorporated bodies, and NRIs can invest in CPs.

• Interest rates on CPs are market-determined. The cost of CP finance is lower than or comparable to that of bank credit.

CERTIFICATE OF DEPOSITS

• Certificate of Deposits (CDs) are marketable receipts in bearer or registered form of funds deposited in banks for a specified period at a specified rate of interest.

• They are transferable, negotiable, short-term, fixed-interest bearing, maturity dated, highly liquid and riskless money market instruments.

• Banks issue CDs to compete with other financial intermediaries and to counter the process of securitization.

• CDs can be issued to individuals, corporations, companies, trust, funds, associations and NRIs.

• The maturity period of CDs varies between three months to one year.

• The rate of interest on CDs is also market-determined and it is more attractive than that on bank deposits.

COMMERCIAL BILLS

• According to the Indian Negotiable Instruments Act, 1881, it is a written instrument containing an unconditional order, signed by the maker, directing a certain person to pay a credit sum of money only to, or to the order of, a certain person, or to the bearer of the instrument.

• A commercial bill or bill of exchange is a short-term, negotiable, and self-liquidating money market instrument.

• It is an asset with a high degree of liquidity and a low degree of risk.

CAPITAL MARKET

Market where long term funds are borrowed and lent, the primary purpose being directing the flow of savings into long-term investments.

Capital Markets deal in long-term claims (maturity period above 1 year).

INSTRUMENTS TRADED IN CAPITAL MARKET

• Equity/Ordinary Shares

• Preference Shares

• Debentures

• Bonds

PREFERNCE SHARE

• Preference shares allow an investor to own a stake at the issuing company with a condition that whenever the company decides to pay dividends, the holders of the preference shares will be the first to be paid.

• Dividend payment of the preference shareholders is fixed and if somehow company liquefies, the owners of the preference shares will be the first one to get their money back after the company has paid back its debt.

• Thus, preference shares are those shares which full-fill both the following two conditions:

(i) They carry preferential share right in respect of dividend at a fixed rate,

(ii) They also carry preferential right in regard to payment of capital on winding up of the company.

TYPES OF PREFERENCE SHARES

a) Cumulative and Non-cumulative

b) Convertible and Non-convertible

c) Redeemable and Non-redeemable

d) Participating and Non-participating

TYPES OF PREFERENCE SHARES

a) On cumulative preference shares, if in any year the profits are insufficient to pay the preference dividend then this dividend can be paid in the subsequent year before any other dividend is paid. In other words the right to receive the dividend goes on accumulating till it is paid. In case of Non – cumulative preference shares the dividend can be paid only in that year. If there are insufficient profits then such preference shareholders do not get any dividend for that year.

b) Convertible preference shares can be converted into ordinary shares on terms and conditions fixed at the time of issue of such shares.

c) A redeemable preference share matures in a fixed period of time and for all practical purposes it is regarded as a debt security like a debenture.

TYPES OF PREFERENCE SHARES

d) Participating preference shareholders can earn a higher dividend than the fixed one if the company makes good profits. Participating preference shares are entitled to participate in the surplus profits remaining after the payment of: (a) Fixed dividend to preference shareholders, and

(b) Dividend to the equity shareholders.

They are also entitled to participate in the surplus funds remaining at the time of winding of the company after payment of (a) Preference share capital & (b) Equity Share Capital.

Non – participating preference share are not entitled to participate in the surplus profits or surplus funds left over at the time of winding off.

EQUITY/ORDINARY SHARES

• According to Section 85 of The Companies Act, 1956, an Equity Share is a share which is not a preference share. In other words, shares which do not enjoy any preferential right in the payment of dividend or repayment of capital, are termed as equity/ordinary shares.

• The equity shareholders are entitled to share the distributable profits of the company after satisfying the dividend rights of the preference shareholders.

• The dividend on equity shares is not fixed and it may vary from year to year depending upon the amount of profits available for distribution.

• The equity share capital may be (i) with voting rights; or (ii) with differential rights as to voting, dividend or otherwise in accordance with such rules and subject to such conditions as may be prescribed.

DIFFERENCE

PREFERENCE SHARE

I. Preference shareholders are paid dividend before the equity shareholders.

II. Rate of dividend is fixed.

III. Preference share may be converted to equity shares, if the terms of issue provide so.

EQUITY SHARE

I. Equity shareholders are paid dividend out of the balance of profit available after the dividend paid to preference shareholders.

II. Rate of dividend is decided by Board of Directors, year to year depending on profits.

III. Equity shares are not convertible.

Right of Dividend

Rate of Dividend

BASIS OF DIFFERENCE

Convertibility

DIFFERENCEPREFERENCE SHARE

IV. Preference shareholders do not have the right to participate in the management of the company.

V. Preference shareholders do not carry the voting right. They can only vote in special circumstances.

VI. At the time of winding up of the company, preference share capital is paid before the payment of equity share capital.

EQUITY SHARE

IV. Equity shareholders have the right to participate in the management of the company.

V. Equity shareholders have voting rights in all circumstances.

VI. On winding up, equity share capital is paid after preference share capital is paid.

Participation in

Management

BASIS OF DIFFERENCE

Voting Right

Refund of

Capital

DEBENTURE

• The word ‘debenture’ has been derived from a Latin word ‘debere’ which means to borrow.

• Debenture is a written instrument acknowledging a debt under the common seal of the company.

• It contains a contract for repayment of principal after a specified period or at intervals or at the option of the company and for payment of interest at a fixed rate payable usually either half-yearly or yearly on fixed dates.

• According, to Section 2(12) of The Companies Act,1956 ‘Debenture’ includes Debenture Inventory, Bonds and any other securities of a company whether constituting a charge on the assets of the company or not.

TYPES OF DEBENTURES

• Convertible Debentures: Debentures which are convertible into equity shares or in any other security either at the option of the company or the debenture holders are called convertible debentures. These debentures are either fully convertible or partly convertible.

• Non-Convertible Debentures: The debentures which cannot be converted into shares or in any other securities are called nonconvertible debentures. Most debentures issued by companies fell in this category.

On the basis of CONVERTIBILITY

TYPES OF DEBENTURES

• Redeemable Debentures: Redeemable debentures are those which are payable on the expiry of the specific period either in lump sum or in Instalments during the life time of the company. Debentures can be redeemed either at par or at premium.

• Irredeemable Debentures: Irredeemable debentures are also known as Perpetual Debentures because the company does not given any undertaking for the repayment of money borrowed by issuing such debentures. These debentures are repayable on the on winding-up of a company or on the expiry of a long period.

On the basis of TENURE

BONDA debt investment in which an investor loans money to an entity (corporate or governmental) that borrows the funds for a defined period of time at a fixed interest rate.

Bonds are used by companies, municipalities, states and federal governments to finance a variety of projects and activities.

TYPES OF BONDS

• Corporate Bonds

• Municipal Bonds

• Zero Coupon Bonds

CORPORATE BONDS

• Corporate bonds are debt securities issued by private and public corporations.

• Companies issue corporate bonds to raise money for a variety of purposes, such as building a new plant, purchasing equipment, or growing the business.

• When one buys a corporate bond, one lends money to the "issuer," the company that issued the bond.

• In exchange, the company promises to return the money, also known as "principal," on a specified maturity date. Until that date, the company usually pays you a stated rate of interest, generally semi-annually.

MUNICIPAL BOND

• Municipal Bond is a bond issued by a state, U.S. territory, city, local government, or their agencies.

• Interest income received by holders of municipal bonds is often exempt from the federal income tax and from the income tax of the state in which they are issued, although municipal bonds issued for certain purposes may not be tax exempt.

• This concept is new in India.

• The first municipal bonds in India were issued in 1995, while the first state-guaranteed bonds were launched by the Bangalore Municipal Corporation (Bruhat Bengaluru Mahanagara Palike) in 1997.

• In 2010, the Greater Visakhapatnam Municipal Corporation issued bonds worth Rs. 30 lakhs.

MUNICIPAL BOND

• In November 2013, the Associated Chambers of Commerce and Industry had written to the Reserve Bank of India to allow municipal bonds to be traded.

• In December, SEBI had set up a 20-member committee to develop a market for such bonds.

• Experts say India’s municipal bond market faces various hurdles, including low ratings, reluctant investors and unclear regulation.

• Municipalities in metros and other large cities are reluctant to turn to the debt market, as these are flush with cash.

• Municipalities in tier-III and tier–IV cities, which need capital, don’t have access to bond markets and rely on Housing and Urban Development Corporation for funding.

ZERO COUPON BOND

• Zero coupon bonds are bonds with no coupon payments.

• Like Treasury Bills, they are issued at a discount to the face value.

• The Government of India issued such securities in the nineties, it has not issued zero coupon bond after that.

• Examples of Zero-Coupon bond includes U.S. Treasury Bills, U.S. Savings bonds, etc.