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Financial Markets

A QUALITY E-LEARNING PROGRAM BY WWW.LEARNWITHFLIP.COM

Raising Money
A business can raise money through either borrowing (called debt) or through owners’ investments (called equity.)

Equity
The sources of equity (owners’) funds are: 1. Internal Reserves: Profits earned may be kept aside and used for short term or long term investment needs. This is part of the existing equity of the company. Fresh Equity: When investors buy shares of a company they increase the equity funds available to the company.

2.

Fresh Equity is raised using specific financial instruments, which can be bought and sold. Equity instruments are of two types: 1. Common Shares: Common shares or stock represent ownership in a company. They carry voting rights for the owners. They do not guarantee any return. They exist as long as the company exists.Key features are: • Face Value/Par Value: It is set when the share is first issued. It is an internally set value given to the share and has no relationship to the market price. Selling of Shares: A publicly traded company’s shares are listed and traded on various stock exchanges. Claim of Common Shareholders: Common shareholders have the last claim on profit. Only after everybody else is paid, they get their share. When the company goes into liquidation, common shareholders are the last to get their money back.

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2.

Preference Shares: Preference shareholders are a specific type of share. They carry a fixed rate of dividend, but have a claim only on profits .This means that the company will pay the dividends only in years of profit. They do not have any voting rights. Types of Preference Shares : • Perpetual: They exist as long as the company exists, and are not repayable or redeemable, similar to common shares. Redeemable: Redeemable preference shares have a fixed maturity. The face value is returned to the shareholder after maturity. Convertible: Convertible preference shares are convertible to common shares at a pre-defined ratio, at the option of the investor, after a certain period.

ADR or American Depository Receipt is a non-American stock that trades in American stock exchanges. It is valued in dollars, and each ADR represents a specific number of shares (one or more) in a non-American corporation. GDR or Global Depository Receipt, is used to offer Indian shares in any other country other than the US. The process for issuing an ADR/GDR:

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they are its creditors. (FLIP). • Holders of debt securities are not owners of the company. Ltd. The categorization is based on: 1.Financial Markets A QUALITY E-LEARNING PROGRAM BY WWW. Proprietary content. Authority Corporates Banks Government 2. • Maturity Period . 2. Features of debt securities: • Debt securities typically carry a fixed rate of interest committed by the issuer. The two ways to borrow money are: 1. b. ©Finitiatives Learning India Pvt. 2010. The Base Rate is the rate of interest at which banks lend to their most favored customers. They are listed on the stock exchanges and behave exactly like regular stocks. whether they make profits or not. each receipt representing a fixed number of shares. Issuance of debt securities: When a company decides to borrow from a large pool of lenders instead of banks. it does so by issuing debt securities. Please do not misuse! . This security carries the rate of interest. • Debt securities are tradable. An Indian company deposits a large number of its shares with a bank located in the US/Other Foreign Country b. The bank issues receipts against these shares.COM a. The receipts are sold to the people of this foreign country. This debt must be repaid along with interest. • Company has to pay interest. Issuing a. Maturity period a. c. and amount to be repaid.LEARNWITHFLIP. The issuer can be a corporation or the government (state or central). Money Market Securities: These are short term instruments and can be issued by corporates or the central Government. The lender evaluates both the repayment ability of the company as well as the purpose for which the funds are proposed to be used. Types of Debt Securities Debt securities are of various types. Bonds issued by the Central Government in India are called GOI Securities or just G-secs. date when the amount is to be repaid. Loan from institutions: by borrowing from financial institutions such as banks. called ‘Coupon’. b. • They have a ‘face value’ like common stock. Debt – Borrowing Money Borrowing is called ‘leveraging’ or ‘gearing’. Bonds & Debentures : A bond is a long-term debt security.Short term (<1yr) or long term (>1yr). c.

Hence the coupon can be.g.Commercial paper (CP) is an unsecured debt instrument issued by a corporation to raise money.A zero coupon bond is issued at a price which is at a discount to face value. Certificate of Deposits . • • Capital Structure The way the capital is split between debt & equity is called the capital structure of a company. It can be fixed or floating.Financial Markets A QUALITY E-LEARNING PROGRAM BY WWW. The Mandex company has capital of USD 100 bio. They need to track their average cost.LEARNWITHFLIP. The return is the difference between purchase price and redemption price. Repurchase Agreements – It refers to a lending transaction where the borrower uses debt securities as collateral for the borrowing. Factors Affecting the Capital Structure • • • • • Effect on Return on Equity (RoE): Raising debt helps ROE if the cost is lower than the return on the investment. Companies usually raise capital at different times using both means – debt and equity. called the ‘Weighted Average Cost of Capital’ or WACC. and is expressed as a percentage. raised through different means.The coupon is the original interest rate committed by the issuer at the time the security is first issued. through equity. Zero Coupon Bond/Discounted Bond .This is a debt security issued by the Govt. • • Treasury Bills . rate of return. by taking a loan from a bank. Ltd. Yield .Yield in financial terms means. it is redeemed at face value. LIBOR is a popular benchmark. It is Income / Investment. for example. Proprietary content. This remains constant over the life of the bond.COM Bonds – Key Terms Coupon . E.A Certificate of Deposit (CD) is an instrument issued by a bank or Financial Institution (FI) to raise money. 2010. Please do not misuse! . the Coupon changes. of India to raise money for shorter maturities. AS LIBOR changes. Money market securities These are securities used to raise money for a short duration i. similar to your fixed deposit.e. USD 21 bio by issuing debentures and USD 20 bio. resulting in a regular claim on cash of the company Financial structure: Raising debt limits the amount of debt which can be raised in the future. less than one year. The firm has raised USD 55 bio. Cost of raising funds: Raising equity is usually more expensive Tax Implications: Interest on debt is tax-deductible Cash flow: Debt has to be repaid. ©Finitiatives Learning India Pvt. Commercial Papers . which have different cost.5%. This is got by multiplying the Amount of each capital by the weight and the cost. Credit ratings define the bond issuer’s ability to repay the bond amount. The floating rate is pegged to a benchmark.USD 4 bio through preference capital. So it doesn’t specify a coupon. LIBOR+ 1. Raising equity has no such issues. (FLIP).

Ltd.COM Source of finance Equity capital Preference capital Debenture capital Term loan Cost (per cent) 15.65 14. That project must return more than the WACC to be feasible. 2010. Please do not misuse! .25 Weight 0.20 (20/100) Product of cost and weight 8.LEARNWITHFLIP.75 Weighted Average Cost of Capital (%) The WACC is used during evaluation of projects or investments.04 8.04 (4/100) 0.65 12.61 0.55 (55/100) 0. Proprietary content.Financial Markets A QUALITY E-LEARNING PROGRAM BY WWW. (FLIP).75 9.21 (21/100) 0.90 1. ------------------- ©Finitiatives Learning India Pvt. The capital raised is used to invest in a project.59 1.