Lesson-2

Various Avenues and Investments Alternative

Introduction: Different avenues and alternatives of investment include share
market, debentures or bonds, money market instruments, mutual funds, life
insurance, real estate, precious objects, derivatives, non-marketable securities.
All are differentiated based on their different features in terms of risk, return,
term etc.
In this chapter we will learn the following:
1 Investment Avenues
1.1 Equity Shares
1.2 Debentures or Bonds
1.3 Money Market Instruments
1.4 Mutual Funds
1.5 Life Insurance and General Insurance
1.6 Real Estate
1.7 Precious Objects
1.8 Derivatives
1.9 Non-Marketable Securities
2 Steps or Process of Selecting Investment Alternatives
2.1 Investment Alternatives with their Attributes
2.2 Analysis and Selection of Assets in a Portfolio
2.3 Allocation of Funds by Portfolio Theory of Diversification
2.4 Investment Monitoring
INVESTMENT AVENUES
1.1 EQUITY SHARES
WHAT ARE EQUITY INVESTMENTS?
Equity investments are nothing but buying into the stocks and shares of
companies. Retail, as well as institutional investors, invest into equity for a
number of reasons. The most common among them is to harness the sharp price
rise in a short period of time categorizing such investments. Equity represents
the own funds of the company. Therefore, the investor becomes a direct party to
all profits and losses of the company proportionately. Another reason, why
equity investments are so popular, is because of the magnitude of return it
provides.
The equity investments provide the necessary aggression required to fast-track
the process of income generation. The icing on the cake is also the fact that
equity investments can be tailored to suit the risk appetite of investors
individually.
TYPES OF EQUITY INVESTMENTS
INDIVIDUAL STOCKS
Investors can park their funds into one or more stocks depending on their
preference. This form of equity investment can be ventured into independently
and complete control over own funds is retained. No involvement from any
fund managers or analysts is required. The trade can be executed by the investor
himself. The decision regarding the stocks to pick may be at the investor’s own
discretion. Alternatively, guidance can also be sought from various sources such
as trade shows and expert recommendations.

EQUITY FUNDS
Equity funds are a variation of mutual funds whereby the majority of the funds
are invested into stocks and shares of companies. These funds are basically a
pool of several equity stocks. They are aggregated and units of the fund are then
sold to the investors. Consequently, an investor is able to enjoy the benefits
of diversification and cover a wider base of equity investments. This would not
be possible in an individual capacity by the investor. An equity fund can further
be classified into numerous branches. Some of them are elaborated here below
ACTIVE & PASSIVE FUNDS
Passive funds seek to replicate the index while active funds are very aggressive.
The fund manager has to actively keep on altering the contents of the portfolio
to ensure a return higher than the benchmark.
GROWTH, INCOME & HYBRID FUNDS
Growth funds invest into stocks with high capital appreciation potential. Income
funds generally invest into large cap companies which are relatively stable and
pay dividends on a regular basis. However, investors who prefer the best of both
worlds can also opt for a hybrid fund. The fund managers here strive to provide
reasonable appreciation while maintaining a constant stream of income.
MARKET CAPITALIZATION
These equity funds segregate their holdings on the basis of sectors. However,
the market cap is carefully accounted for. They generally hold a couple of large-
cap stocks as their core holding. This provides a firm footing to the fund. The
balance is invested into small to mid-cap stocks promising attractive prospects.
Therefore the volatility of the latter is offset by the stability of former.
PRIVATE EQUITY INVESTMENTS
They represent investing in stocks of companies not listed on the exchange.
They are generally not liquid and involve a huge ticket size. For this reason,
only high net worth individuals and institutional investors can afford to invest in
them. Private equity investments are resorted to at the inception or expansionary
phase of a venture and entail high return on investment.
VENTURE CAPITAL
The investors step in at the cradle stage of the company. These private equity
investors charge a hefty premium and take away a considerable portion of
ownership. They expect to be compensated handsomely for the risk they take
with such baby companies. The risk involved is so huge that company may
skyrocket or even never take off.
GROWTH CAPITAL
Growth capital is similar to venture capital funds except that they invest in
mature companies. They provide funds to established companies seeking
expansion, diversification and exploring new avenues. They come to rescue
when the company is not in a position to raise more debt.
REAL ESTATE FUNDS
These are private equity funds with real estate and properties as the main
underlying. They are involved in acquisition, development, and maintenance of
real assets. Rental income constitutes the mainstream of cash flow. The property
is also sold away at opportune times to take the advantage of a bullish property
market. The main advantage of this fund is that it enables small investors to
reap the benefits of changes in property prices without actually buying one.
ADVANTAGES OF EQUITY INVESTMENTS
DIVERSIFICATION
The equity investments can be diversified across various sectors, cap,
geographies and even the phase of business cycles. The investor is thus
protected against the consequences of “putting all eggs in one basket”.
Turbulence in any specific stocks or sectors is unable to adversely impact the
value of the portfolio as a whole.
RISK ADJUSTED
A wide arena of mutual and equity funds have emerged lately. The sheer
abundance of these funds enables the investor to choose a fund which exactly
caters to his investment preferences. There is something for everyone in today’s
market. Conservative to aggressive equity investment funds are available
rampantly. Equity investments were earlier synonymous with risk and
uncertainty. With the advent of portfolio funds that is no longer the case. Funds
offset risky equity investments with cash and bond positions to offer a relatively
secure product to the investor.
LIQUIDITY
Though not always true for private equity investments, liquidity is a sure shot
benefit for listed and public stocks. There is a ready market available for shares
of listed companies. The volume and number of transactions are always large
enough to assure the investor of a ready sell whenever he intends to. Cashing
out and squaring position at any time is possible. Therefore, equity investments
serve as a lucrative means of investment for investors with a not so long
horizon.
DISADVANTAGES OF EQUITY INVESTMENTS
VOLATILITY
The prices of equity investments are determined by the forces of demand and
supply. The perception of investors also plays a key role. A negative sentiment
or false information about a stock can spread like wildfire. This inadvertently
impacts its prices. Investor perception is a highly random variable which cannot
be controlled. Moreover, the companies operate in an ecosystem and are subject
to business cycles, adverse government policies, and sector-specific
disturbances. Equity investments display movement than its counterpart index
or bonds. Risk-averse investors may, therefore, be uncomfortable parking their
funds into such investments.
MANAGER BIAS
The investors do not have direct control over the equity funds they invest in. It
is run by a fund manager who makes allocations into various stocks on their
behalf. It will not be wrong to say that the investors are left at the mercy of the
wisdom of their fund manager. Most managers are accustomed to a particular
type of investing and follow similar patterns. Also, to an extent, the allocations
are influenced by the manager’s personal preferences and beliefs. The investors
have no option but to rely on their manager. Therefore, one must invest in more
than one equity fund to do away with the impact of manager biases.
OVER DIVERSIFICATION
While diversification helps in eliminating unsystematic risks, there also exists
the possibility of over-diversification. Where on one hand diversification helps
in capping the downside, over-diversification may also limit one’s upside. A
fund which may be diversified to an extent that it no longer reaps additional
returns but only averages out the results. In such cases, the investor ends up
merely replicating the index. An efficient diversification strategy is one in
which stocks are carefully handpicked to harness its growth potential. Blindly
adding stocks to the basket defeats the purpose.
1.1 A PREFERENCE SHARE
Preference shares are a long-term source of finance for a company. They are
neither completely similar to equity nor equivalent to debt. The law treats them
as shares but they have elements of both equity shares and debt. For this reason,
they are also called ‘hybrid financing instruments’. These are also known as
preferred stock, preferred shares, or only preferred in a different part of the
world.
There are various types of preference shares used as a source of finance.
TYPES OF PREFERENCE SHARES
Some of the common types of preference shares are as follows:
CONVERTIBLE AND NON-CONVERTIBLE PREFERENCE SHARES
Convertible preference shares have a similar concept of convertible debentures.
These shares possess an option or right whereby they can be converted into an
ordinary equity share at some agreed terms and conditions. Non-convertible
simply does not have this option but has all other normal characteristics of
a preference share.
REDEEMABLE AND IRREDEEMABLE PREFERENCE SHARES
A redeemable preference share is very commonly seen preference share which
has a maturity date on which date the company will repay the capital amount to
the preference shareholders and discontinue the dividend payment thereon.
Irredeemable preference shares are little different from other types of preference
shares. It does not have any maturity date which makes this instrument very
similar to equity except that the dividend of these shares is fixed and they enjoy
priority in payment of both dividend and capital over the equity shares. Since
there is an absence of maturity, they are also known as perpetual preference
share capital.
PARTICIPATING AND NON-PARTICIPATING PREFERENCE
SHARES
Participating preference shares are a unique type of preference shares which has
an additional benefit of participating in profits of the company apart from the
fixed dividend. The distribution may depend on the terms and conditions
mentioned in the agreement which may vary to some extent from case to case.
Other preference shares who do not participate are called non-participating
preference shares. Unless it has been mentioned, that preference shares are
participating, it is assumed that it is non-participating.
CUMULATIVE AND NON-CUMULATIVE PREFERENCE SHARES
Non-payment of preference dividend does not amount to bankruptcy but this
does not mean that the liability of the company is lost. If the shares are
cumulative preference shares, the dividends are accumulated and therefore paid
before anything paid to equity shareholders. Even in the event of liquidation,
accumulated preference dividend and the preference share capital will be
redeemed prior to any payment to equity shareholders. Whereas, for non-
cumulative preference shares, if a company does not pay the dividend in the
current year, the claim of preference shareholder is lost to that extent. Unless it
is specified that preference shares are non-cumulative, it is assumed that it is of
cumulative in nature.

PREFERENCE SHARES WITH CALLABLE OPTIONS

Whenever a company is issuing long term fixed rate dividend preference shares,
at that time, the company is having a risk of decrease in the rate of preference
dividend rate in the market. Hence, it may issue preference share with a callable
feature. In that company has a right to redeem preference share in between.
Such preference shares will be redeemed at a premium if redeemed in between
because the investor will have a loss in that case. The company will exercise
such an option if the rate of preference dividend is falling in the market.
ADJUSTABLE-RATE PREFERENCE SHARES
These are some of the innovative types of instruments where the rate of
dividend is not fixed and is formulated based on some calculations relating to
the current interest rates etc.
FEATURES OF PREFERENCE SHARES SIMILAR TO DEBT

FIXED DIVIDENDS
Like debt carries a fixed interest rate, preference shares have fixed dividends
attached to them.
But the obligation of paying a dividend is not as rigid as debt. Non-payment of a
dividend would not amount to bankruptcy in case of preference share.
PREFERENCE OVER EQUITY
As the word preference suggests, these type of shares get preference over equity
shares in sharing the income as well as claims on assets. Alternatively,
preference share dividend has to be paid before any dividend payment to
ordinary equity shares. Similarly, at the time of liquidation also, these shares
would be paid before equity shares.
NO VOTING RIGHTS
Preference share capital is not allotted any voting rights normally. They are
similar to debenture holders and do not have any say in the management of the
company
NO SHARE IN EARNINGS
Preference shareholders can only claim two things. One agreed on percentage of
dividend and second the amount of capital invested. Equity shares are entitled to
share the residual earnings and residual assets in case of liquidation which
preference shares are not entitled to.
FIXED MATURITY
Just like debt, preference shares also have fixed maturity date. On the date of
maturity, the preference capital will have to be repaid to the preference
shareholders. A special type of shares i.e. irredeemable preference shares is an
exception to this. They do not have any fixed maturity.

FEATURES OF PREFERENCE SHARES SIMILAR TO EQUITY SHARES

DIVIDEND FROM PAT
Equity share dividend is paid out of the profits left after all expenses and even
taxes and same is the case with preference shares. The preference dividend is
paid out of the divisible profits of the company. Out of the divisible profits, the
preference dividend would be paid first and the remaining profits can be utilized
for paying any dividend to equity shareholders.
MANAGEMENT DISCRETION OVER DIVIDEND PAYMENT
The payment of preference dividend is not compulsory and is a decision of the
management. Equity shareholders also do not have any right to ask for
dividends, the dividends are paid at the discretion of the management of the
company. Unlike debt, the non-payment of a dividend of preference shares
does not amount to bankruptcy.
NO FIXED MATURITY
The maturity of a special variant of preference share is not fixed just like equity
shares. This variant is popularly known as irredeemable preference shares.
There are some advantages and disadvantages of preference shares like no legal
obligation for dividend payment, improves borrowing capacity, no dilution on
control, costly source of finance etc.

1.2 DEBENTURES OR BONDS

Debentures or bonds are long-term investment options with a fixed stream of
cash flows depending on the quoted rate of interest. They are considered
relatively less risky. An amount of risk involved in debentures or bonds is
dependent upon who the issuer is. For example, if the issue is made by a
government, the risk is assumed to be zero. However, investment in long term
debentures or bonds, there are risk in terms of interest rate risk and price risk.
Suppose, a person requires an amount to fund his child’s education after 5
years. He is investing in a debenture having maturity period of 8 years, with
coupon payment annually. In that case there is a risk of reinvesting coupon at a
lower interest rate from end of year 1 to end of year 5 and there is a price risk
for increase in rate of interest at the end of fifth year, in which price of security
falls. In order to immunize risk, investment can be made as per duration
concept.
Following alternatives are available under debentures or bonds:
Government securities
Savings bonds
Public Sector Units bonds
Debentures of private sector companies

Benefits and Disadvantages of Debentures

Long-term debt financing is majorly categorized into a term loan and
debentures. Debentures are one of the common long-term sources of finance.
They normally carry a fixed interest rate and a certain date of maturity. One has
to pay interest every year and the principal on the date of maturity. Term loan
carries a fixed interest rate and the payment is done in instalments which
consists of both principal and interest.
The term loan is lent by a financial institution or a bank so the financier is the
bank / financial institution. Whereas the debentures are issued to the general
public and therefore the financier is the general public. This is the basic
difference between these two types of long-term source of debt finance. The
difference between the terms – Debentures, Bank loan, equity shares, and bond.
Since both debenture and term loan is a type of debt financing, they share basic
characteristics of debt and hence their advantages and disadvantages are also
similar.
ADVANTAGES OF DEBT FINANCING – DEBENTURES AND TERM
LOANS
BENEFIT OF TAX
‘Debt Financing’ or ‘Issuing of Debenture’ results in interest expense for the
borrower which is a tax-deductible expense. A company can claim an interest as
an expense against its profits. Whereas dividends paid to equity or
preference shareholders are paid out of net profits after taxes. In short, debt
financing such as debentures, term loans etc avails tax benefit to the borrower
which is not there in case of equity.
CHEAPER SOURCE OF FINANCE
As discussed above, the interest cost incurred on debt financings such as
debentures or term loans enjoys a tax shield which indirectly lowers the cost.
Effective interest cost of a 12% debenture with current tax rate of 30% is 8.4%
{12% * (1-30%)}. The underlying assumption behind the calculation is that the
entity is making the profit at least to the tune of total interest payment. Even the
rate of interest is lower than the cost of equity. It is because of the reason that
debt financiers have comparatively lower risk, so they are offered less return.
Following are the reasons due to which investors of debenture have a
comparatively lower risk.
NO DILUTION OF CONTROL
Issuing of debentures or accepting bank loan does not dilute the control of the
existing shareholders or the owners of the company over their business. If there
is a rise in the same fund using equity finance, there are chances of losing
control of existing shareholders.
NO DILUTION IN SHARE OF PROFITS
Opting for debentures over the equity as a source of finance keeps intact the
profit-sharing percentage of existing shareholders. Debenture holders or
financial institutions do not share profits with the company. They are liable to
receive the agreed amount of interest only. Therefore, the same number of
hands share the profits before and after the new project. However, in the case
of convertible debentures (debentures who convert into equity shares after a
certain point of time), this may no more remain an advantage. As the debenture
holders would then become equity shareholders receiving all the rights as of the
equity shareholder’s.
THE BENEFIT OF FINANCIAL LEVERAGE
By involving debt in a profit-making company, the management can always
maximize the wealth of the shareholders. For example, the internal rate of
return of a company is 15% against a 12% rate of interest on debt funds. The
shareholders share the extra 3% of earning out of the money of say debenture
holders. Since there is a definite interest cost on the debt. Therefore the returns
over and above the cost of interest spill over into the hands of shareholders
only. This is how financial leverage converts into wealth maximization. All this
is true under the condition that the rate of return on investment on debt funds is
at least greater than the percentage of interest.
DISCIPLINARY EFFECT
There is a burden of interest despite business profit or loss, operational
situations, etc. This makes the entrepreneur all the more cautious and committed
to managing the business and maintaining the cash flows effectively. It is
because a severe punishment i.e. ‘bankruptcy’ is enclosed for nonpayment of
debenture interest on time. It is similar to the situation of a car seat belt. One
uses it more because of the penalties, the government authority imposes rather
than for the safety reason. Similarly, a fixed instalments of debt repayment
brings in a discipline in the management for better management of cash flows
and other operations.
LOW ISSUE COST
In the case of a term loan, there is a comparatively lower cost of the issuance.
Whereas in the case of equity financing, there is a huge cost of issuance.
FIXED INSTALMENTSS
Debt financing by term loan or debentures has fixed instalments/coupon
payments until the maturity of the loan. In a rising economy with increasing
inflation, the effective cost of future instalments decreases due to a decline in
the value of the currency.
NO HARM IN COMMUNICATING CRITICAL BUSINESS SECRETS
In the case of a term loan, the company may have to reveal a lot of information
about the company to the financial institutions. By entering into NDA (non-
disclosure agreement), the company can ensure its secrets remaining hidden
from its competitors.
CALLABLE DEBENTURES / BONDS
There can a debenture or Bond issuance with a callable feature. If in case there
is a decrease in the rate of interest in the market, the company can redeem
existing debenture. It can do so by offering premium and can issue new debt
financing at a lower interest rate.

DISADVANTAGES OF DEBT FINANCING – DEBENTURES AND TERM

LOANS
RIGID OBLIGATION
‘Interest paid to the debenture holders’ or ‘instalments and interest of term loan’
is a legal obligation and the business has to honor the same come what may.
This feature of debt financing, in general, creates a problem for the business in
bad times. Economic and other environmental ups and down are certain to
come. Under those situations, a new business which is just about to take off
cannot have such disciplined cash flows to pay the interest or instalments
timely.
Therefore, debenture and term loans are not the right kinds of financing option
for them, especially in their nascent stage. This fixed expense may create a big
mismatch with their cash flows and the company may have to go into
bankruptcy. A term loan can still be viable because banks provide moratorium
or gestation period or at times adjust the obligation with the pattern of cash
inflows of the company. Such modifications are not possible in debentures.
ENLARGE LEVERAGE RATIOS
Debt financing raises the leverage of the business. High leverage means a high
risk of bankruptcy. Bankruptcy is not the only risk but if the rate of return of the
company declines below the debenture interest rate at a later stage after issuing
the debentures, it can bring the whole project on a toss. The costs of projects
may increase due to market conditions but interest payment would not change to
compensate such increase in costs.
RESTRICTIVE COVENANTS
In the trust deed formed between the company and the trustee bank or financial
institution, there are certain restrictive covenants which restrict the hands of the
management from doing business with liberty. There are various restrictions
with respect to usage of assets, the creation of liabilities, cash flows, control,
etc. They may stumble upon every business decision and affect the effectiveness
of the overall decision-making process.
BAD FOR LOW INFLATIONARY CONDITIONS
Although fixed interest has certain benefits like it is beneficial to high inflation
environment, it also accompanies disadvantages. Under low inflationary
conditions, the cash outflow remains constant but the value of the money
increases. To compare it with business situations, the market price of the
products of the company will decline in low inflationary conditions but the
interest payment will remain the same and hence that will create a loss-making
mismatch.
ADVANTAGES AND DISADVANTAGES OF DEBENTURES FROM
INVESTOR’S POINT OF VIEW
From an investor’s viewpoint, the prime advantage of investing in debenture is
the fixed and stable return. They not only get that benefit but also a preferential
right of payment at the time of liquidation. Whereas that is not in case of equity
or preference shares. The main disadvantage of preferring debenture over
equities is that the debenture holder does not get the right to vote and there is no
profit sharing. The returns are finite to the extent of interest irrespective of the
higher earnings of the company. Also, there is another benefit besides this. In
case of an increase in the market interest rate, the debenture holder will get their
fixed interest income. Even though the rate of interest has increased in the
market.
Bonds and their Types
Bond is a financial instrument whereby the issuer of the bond raises (borrows)
capital or funds at a certain cost for certain time period and pays back the
principal amount on maturity of the bond. Interest paid on bonds is usually
referred to as coupon. In simple words, a bond is a loan taken at a certain rate of
interest for a definite time period and repaid on maturity.
From a company’s point of view, the bond or debenture falls under the
liabilities section of the balance sheet under the heading of Debt. A bond is
similar to the loan in many aspects however it differs mainly with respect to its
tradability. A bond is usually tradable and can change many hands before it
matures; while a loan usually is not traded or transferred freely.
FEATURES OF A BOND
Let us have a look at the common features of bonds and the financial terms
related to bonds.

ISSUER
The entities that borrow money by issuing bonds are called as issuers. In the
US, there are mainly 4 major issuers of bonds which include the government,
government agencies, municipal bodies, and corporates.
FACE VALUE
Every bond that is issued has a face value; which is usually the principal amount
that is borrowed and returned on maturity. In layman’s term, it is the value of
the bond on its maturity.

COUPON
The rate of interest paid on the bond is called as a coupon.
RATING
Every bond is usually rated by credit rating agencies; higher the credit rating
lower will be the coupon required to pay by the issuer and vice versa.

COUPON PAYMENT FREQUENCY

The coupon payments on the bond usually have a payment frequency. The
coupons are usually paid annually or semi-annually; however, they may be paid
quarterly or monthly as well.

YIELD
The effective return that the investor makes on the bond is called a return.
Assuming a bond was issued for a face value of $ 1000 and a coupon rate of
10% on initiation. The Price at a later date may rise or fall and hence the
investor who invests at a rate other than $ 1000 will still receive a coupon
payment of $100 (1000 * 10%) but the effective earning shall be different since
investment amount is not $1000. That effective return in layman’s term is called
as the yield. If the holding period is considered for a year this is referred to as
current yield and if it is held to maturity it is referred to as yield to maturity
(YTM).
There are many types of bonds issued that differentiate each other in respect of
their features. These features vary depending upon the requirement of the issuer.
Let us have a look at some of the major types of bonds issued.

DIFFERENT TYPES OF BONDS

PLAIN VANILLA BONDS
A plain vanilla bond is a bond without any unusual features; it is one of the
simplest forms of bond with a fixed coupon and a defined maturity and is
usually issued and redeemed at the face value. It is also known as a straight
bond or a bullet bond.
ZERO COUPON BONDS
A zero coupon bond is a type of bond where there are no coupon payments
made. It is not that there is no yield; the zero coupon bonds are issued at a price
lower than the face value (say 950$) and then pay the face value on maturity
($1000). The difference will be the yield for the investor. These are also called
as discount bonds or deep discount bonds if they are for longer tenor.
DEFERRED COUPON BONDS
This type of bond is a blend of a coupon-bearing bond and a zero coupon bond.
These bonds do not pay any coupon in the initial years and thereafter pay a
higher coupon to compensate for no coupon in the initial years. Such bonds are
issued by corporates whose business model has a gestation period before the
actual revenues start. Examples of a company which may issue such type of
bonds include construction companies.
STEP-UP BONDS
These are bonds where the coupon usually steps up after a certain period. They
may also be designed to step up not once but in a series too. Such bonds are
usually issued by companies where revenues/ profits are expected to grow in a
phased manner. These are also called as a dual coupon or multiple coupon
bonds.
STEP DOWN BONDS
These are just the opposite of Step-Up Bonds. These are bonds where the
coupon usually steps down after a certain period. They may also be designed to
step down not once but in a series too. Such bonds are usually issued by
companies where revenues/ profits are expected to decline in a phased manner;
this may be due to wear and tear of the assets or machinery as in the case of
leasing.
FLOATING RATE BONDS
Floating rate bonds are so called because they have a coupon which is not fixed
but rather linked to a benchmark. For example, a company may issue a floating-
rate bond as Treasury bond rate + 50 bps (100 bps = 1%), In such cases on
every interest payment date, the payment will be made 0.50% more than the
treasury bill rate prevailing on the fixing date.
INVERSE FLOATERS
These types of bonds are similar to the floating rate bond in that the coupon is
not fixed and is linked to a benchmark; however, the differentiating thing is that
the rate is inversely related to the benchmark. In simple words, if the benchmark
rate goes up; the coupon rate comes down and vice versa.
PARTICIPATORY BONDS
A participatory bond is a bond whereby the issuer promises a fixed rate but the
coupon cash flow may increase if the profit/ income levels of the company rise
to a pre-specified level and may reduce when income falls below a pre-specified
level; thereby the investor participates in the return enjoyed based on company
revenues/ income.
INCOME BONDS
Income bonds are similar to participatory bonds however these type of bonds do
not have a reduction in interest payments if income/ revenue reduces.
PERPETUAL BONDS
These types of bonds pay a coupon rate on the face value till the life of the
company. Though Perpetuity means forever, bonds with maturity above 100
years are also considered to be perpetual bonds.
CONVERTIBLE BONDS
Convertible bonds are a special variety of bonds which have an inbuilt feature
of being converted to equity shares at a specified time at a pre-set conversion
price.
FOREIGN CURRENCY CONVERTIBLE BONDS
Foreign currency convertible bond is a special type of bond issued in the
currency other than the home currency. In other words, companies issue foreign
currency convertible bonds to raise money in foreign currency.
EXCHANGEABLE BONDS
These bonds are similar to the convertible bonds but differ in one aspect that
they can be exchanged for equity shares but not of the issuer. These can be
exchanged for equity shares of another company which the issuer may have
stakeholding.
CALLABLE BONDS
Bonds that are issued with a specific feature where the issuer has the right to
call back the bonds at a pre-agreed price and a pre-fixed date are called
as callable bonds. Since these bonds allow a benefit to the issuer to repay off the
liability before maturity, these bonds usually offer a coupon rate higher than a
normal straight coupon-bearing bond.
PUTTABLE BONDS
Bonds that are issued with a specific feature where the bondholder has the right
to return back the bonds at a pre-fixed date before maturity are called
as puttable bonds. Since these bonds allow a benefit to the bondholders to ask
for the principal repayment before maturity, these bonds usually offer a coupon
rate lower than a normal straight coupon-bearing bond.

MONEY MARKET INSTRUMENTS

Money market instruments are just like the debentures but the time period is
very less. It is generally less than 1 year. Corporate entities can utilize their
idle working capital by investing in money market instruments. Some of the
money market instruments are
Commercial Paper
Certificate of Deposits
Treasury Bills
Introduction
When the government goes to the financial market to raise money, it does so by
issuing two types of debt instruments — treasury bills and government bonds.
Treasury bills are issued when the government needs money for a short period.
These bills are issued only by the central government, and the interest on them
is determined by market forces.

WHAT ARE TREASURY BILLS?

 Treasury Bills or T-Bills are short-term government bonds that are issued
by the Central Bank on behalf of the government.
 They are risk- free because of the backing of the government. In the US,
the Department of Treasury issues such Bills on behalf of the US
Government.
 Their main purpose is to meet the temporary liquidity shortfalls of the
government.
 They have a maximum maturity period of 364 days from the issue date.
Therefore they are money market instruments and offer liquidity to the
investors. There are majorly five types of Treasury Bills, categorized on
the basis of their maturity periods.
 
What are maturity period of treasury bills?
 
Treasury bills, or T-bills, have a maximum maturity period of 364 days. So,
they are categorised as money market instruments (money market deals with
funds with a maturity of less than one year). At present, treasury bills are issued
in three maturities — 91-day, 182-day and 364-day. In 1997 the government
also issued 14-day immediate treasury bills.
 
When were treasury bills introduced? Who issues treasury bills and who
can buy?
 
Treasury bills were first issued in India in 1917. They are issued via auctions
conducted by the Reserve Bank of India (RBI) at regular intervals. Individuals,
trusts, institutions and banks can purchase T-Bills. But they are usually held by
financial institutions. They have a very important role in the financial market
beyond investment instruments. Banks give treasury bills to the RBI to get
money under repo. Similarly, they can also keep it to fulfil their Statutory
Liquid Ratio (SLR) requirements.
 
How do T-bills work?
 
Treasury bills are issued at a discount to original value and the buyer gets the
original value upon maturity. For example, a Rs 100 treasury bill can be availed
of at Rs 95, but the buyer is paid Rs 100 on the maturity date. The return on
treasury bill depends on liquidity position in the economy. When there is a
liquidity crisis, the returns are higher, and vice versa.
 
Are T-bills a safe investment instrument?
 
Treasury bills have an advantage over other market instruments because of the
zero-risk weightage associated with them. The secondary market of T-Bills is
very active and they have a higher degree of tradability.

MUTUAL FUNDS
Mutual funds are an easy and tension free way of investment and it
automatically diversifies the investments. A mutual fund is an investment only
in debt or only in equity or mix of debts and equity and ratio depending on the
scheme. They provide with benefits such as professional approach, benefits of
scale and convenience. Further investing in mutual fund will have advantage of
getting professional management services, at a lower cost, which otherwise was
not possible at all. In case of open ended mutual fund scheme, mutual fund is
giving an assurance to investor that mutual fund will give support of secondary
market. There is an absolute transparency about investment performance to
investors. On real time basis, investors are informed about performance of
investment. In mutual funds also, we can select among the following types
of portfolios:
Equity Schemes
Debt Schemes
Balanced Schemes
Sector Specific Schemes etc.

LIFE INSURANCE AND GENERAL INSURANCE

They are one of the important parts of good investment portfolios. Life
insurance is an investment for the security of life. The main objective of other
investment avenues is to earn a return but the primary objective of life insurance
is to secure our families against unfortunate event of our death. It is popular in
individuals. Other kinds of general insurances are useful for corporates. There
are different types of insurances which are as follows:
Endowment Insurance Policy
Money Back Policy
Whole Life Policy
Term Insurance Policy
General Insurance for any kind of assets.
REAL ESTATE
Every investor has some part of their portfolio invested in real assets. Almost
every individual and corporate investor invest in residential and office buildings
respectively. Apart from these, others include:
Agricultural Land
Semi-Urban Land
Commercial Property
Raw House
Farm House etc
PRECIOUS OBJECTS
Precious objects include gold, silver and other precious stones like the diamond.
Some artistic people invest in art objects like paintings, ancient coins etc.
DERIVATIVES
Derivatives means indirect investments in the assets. The derivatives market is
growing at a tremendous speed. The important benefit of investing in
derivatives is that it leverages the investment, manages the risk and helps in
doing speculation. Derivatives include:
Forwards
Futures
Options
Swaps etc
NON-MARKETABLE SECURITIES
Non-marketable securities are those securities which cannot be liquidated in the
financial markets. Such securities include:
Bank Deposits
Post Office Deposits
Company Deposits
Provident Fund Deposits Here is a look at the interest rates on various small
savings schemes for the second quarter of FY 2020-21:

Post Office Deposits

Features of Post Office Fixed Deposit Account

Particulars Details
Tenure 1, 2, 3 and 5 years
Minimum Deposit Amount Rs. 1,000
Interest Rates 5.50% – 6.70%
Interest Payment Annually
Mode of Payment Cash/Cheque
Premature Withdrawal Allowed after 6 months*
Nomination Facility Available
*If account closed between 6 to 12 months from the date of opening, then Post
Office Savings A/c rates will be applicable.

Benefits of Post Office Fixed Deposit

For conservative investors, parking their savings in the post office fixed deposit
is a highly preferred choice. The following are benefits of investing in a Post
Office Time Deposit (POTD) Account:

 Guaranteed by the Government of India, thus investors enjoy the highest

level of security
 Since it is a non-profit-making organization, the main focus is social
welfare and this is the USP of POTD (Post Office Time Deposits)
 An account can be opened offline as well as online via Post Office Net-
banking
 Tax (TDS) is not charged on the interest earned
 Deposit made for 5 years qualify for tax deductions from gross salary
when filing ITR (u/s 80C for up to Rs. 1.5 lakh/FY)
 The deposit can be made individually or jointly (up to 3 members)
 Easy transfer from one post office to another
 Minors can open the time deposit account under valid guardianship
 More than one fixed deposit account can be opened in any post office
 One can add nominee even after opening the account
Who Should Invest in Post Office FD?
Post Office fixed/time deposit scheme is well-suited for those who belong to the
low-middle income group. Housewives should also direct their savings towards
this scheme since TDS (Tax Deducted at Source) is not applicable to the
investments made in Post Office FD.

If you have children above the age of 10 years, you should encourage them
towards investing in this scheme. This would help inculcate the habit of saving
which would prove beneficial in future.

Since the scheme is brought India Post, which is a wholly-owned venture by the
Government of India, the safety of your money is prime.
All being said, you should expect modest returns and retain for good 3-5 years
to reap the maximum benefits.

Post Office Fixed Deposit Calculator

Before finalizing on making a term deposit with Post Office, it is advised to use
the Post Office FD Calculator. One can use the Paisabazaar FD Calculator free
of cost to determine the interest he/she may earn through the entire tenure at the
applicable post office fixed deposit rates.

The tool requires deposit amount, tenure (in months or years) and the current
Post office fixed deposit interest rate for the chosen tenure.

Once the details are entered, hit the calculate button to obtain the estimated
interest earned as well as maturity amount, separately.

Post Office FD Premature Withdrawal

Premature withdrawal is allowed after 6 months from the date of account-
opening
If one withdraws between the period of 6 – 12 months from the date of opening,
interest will be payable as per the Post Office Saving Account interest rates
Post Office FD: TDS Implication/Taxation
One major advantage of investing in Post Office fixed/time deposit is that tax
(TDS*) is not deducted on the interest earned. This is because it is designed to
especially benefit the low-income group and tax liability is taken away from
their shoulders by the government.

When filing Income Tax Return (ITR), one can add their investments of fixed
deposit in Post Office to claim deduction u/s 80C of the Income Tax Act, 1961.
The upper limit for deductions under the said section of the IT Act, 1961 is
maxed at Rs. 1.5 lakh, every financial year.
AN OVERVIEW OF PUBLIC PROVIDENT FUNDS
The Public Provident Fund (PPF) is a long-term savings instrument established
by the Central Government. It offers tax benefits on contributions as well as
withdrawals after the lock-in period. This scheme came into force on July 1,
1968, and is backed by the government with the objective of providing old-age
income security to the self-employed and those working in the unorganised
sector. Though the scheme is voluntary, assured returns and income-tax benefits
have fuelled its popularity. The primary objective of saving in the PPF account
is to avail tax deduction on deposits, guaranteed returns on investment and tax-
free withdrawal on maturity. Savings in this product are completely risk-free
because of government backing.
Capital Protection & Inflation Protection
The capital in a PPF account is completely protected as the scheme is backed by
the Government of India, making it fully risk-free with guaranteed returns. The
PPF account is however not inflation protected, which means whenever
inflation is above the latest guaranteed interest rate, the deposit earns no real
returns. However, when the inflation rate is below the guaranteed rate, it does
manage a positive real rate of return.
Guarantees
Interest rates are aligned with G-sec rates of similar maturity, with a spread of
0.25 per cent. The government has decided to review the PPF rates quarterly.
For the second quarter of FY19-20, the rate has been set at 7.9 per cent
compounded annually.
Liquidity
The PPF is liquid, despite the 15-year lock-in stipulated with this account.
Liquidity is offered in the form of loans against the PPF from the third year and
withdrawals subject to conditions from the seventh year.
Tax Implications
The scheme has exempt-exempt-exempt (EEE) status, where the deposits, the
interest earned as well as the maturity amount are tax-free.
The sum invested in the PPF account is eligible for tax deduction under Section
80C subject to a maximum of Rs 1.5 lakh in a financial year. On maturity the
entire amount including the interest is tax free.
Where to Open an Account
You can open the account at various places such as:
  Any head post office or general post office
 State Bank of India
 Branches of nationalised banks such as Bank of Maharashtra
 Private-sector banks such as ICICI Bank
How to Open an Account
Once you have selected the location to open an account, you will need the
following:
 An account-opening form
 Two passport-sized photographs
 Address and identity proof such as the Aadhaar card, passport, PAN
(permanent account number) card or declaration in Form 60 or 61 as per
the Income Tax Act, 1961, driving licence, voter's identity card or ration
card.
 Carry original identity proof for verification at the time of account
opening.
 Choose a nominee.
How to Operate a PPF Deposit
 You need a pay-in slip with the initial account-opening sum to be credited
into your account
 You get a PPF passbook with your photo affixed, stating the nominee's
name.
Exit Option
Earlier, premature closure of a PPF account was not allowed. However, it is
now possible to close your PPF account pre-maturely at a penalty of one per
cent on the interest. But it can be done only after the completion of five
financial years, provided the money is required for the treatment of serious
ailments of the account holder, spouse, dependent children, dependent parents
or for higher education.
Tips and Strategies
 Exhaust the full investment permissible to avail tax deduction on the first
day of each financial year. This will ensure that your yearly investment
 earns interest for the complete year, enjoys the compounding effect and
accumulates a significant sum over the long term.
 Deposit the PPF contribution between the first and fifth of the month to
earn interest for the whole month.
Eligibility: You need to be a resident Indian
Entry age: No age is specified for account opening
Minimum Investment: Rs 500 per annum
Maximum Investment: Rs 1.5 lakh per annum; a maximum of 12 deposits
allowed in a financial year
Interest: 7.9 per cent compounded annually for the period July-September,
2019. Interest rates are subject to revision every quarter.
Tenure: 15 years. On completion of 15 years, the account can be extended by
five years at a time. However it can be extended indefinitely, 5 years at a time.
Account-holding categories: Individual and Minor through the guardian
Nomination Facility: Available

The National Pension System (NPS)

The National Pension System (NPS) is a Government of India initiative to
extend pension benefits to all Indian citizens. It is mandatory for central
government employees and the employees of some state governments to invest
in the NPS. As per a government directive, private-sector employees are now
given a choice between the Employees' Provident Fund Organisation (EPFO)
and the NPS. The employee contribution is generally 10 per cent of the basic
salary and DA, with a matching contribution made by the employer. However,
in the case of government employees, the employer's contribution has been
raised to 14 per cent.
Capital Protection & Inflation Protection
Your capital is not protected as the NPS invests a certain amount in equities.
The returns are therefore market-linked. However, equities are expected to beat
inflation over the long term, thus building a certain level of inflation protection
into the NPS.
Liquidity
After three years of being in the scheme, you can withdraw up to 25 per cent of
the contributions for defined expenses. These defined expenses are children's
higher education or weddings, construction or purchase of the first house, and
treatment of critical illness for self, spouse, children or dependent parents. The
regulations have defined 13 critical illnesses and have extended this facility to
accidents or other ailments of a life-threatening nature.
The point to note is that the 25 per cent limit will be calculated on the
contributed amount, not on the account balance. Suppose you have contributed
Rs 5,000 per month for ten years, you will be eligible to withdraw Rs 1.50 lakh,
i.e. 25 per cent of Rs 6 lakh. You can make up to three withdrawals during the
tenure.
Exit Option
Tier I: On retirement at the age of 60, you have to mandatorily use 40 per cent
of the corpus to buy an annuity. The remaining 60 per cent can be withdrawn
and is now completely tax-free. Earlier, withdrawal of only 40 per cent of the
corpus was tax-free.
If you wish to exit before age 60, you must use 80 per cent of the corpus to buy
an annuity. You can withdraw 20 per cent of your corpus, but it will be taxed as
per your income-tax slab.
Tier II: In this voluntary account, you are free to withdraw your savings
whenever you wish. There are no limits on deposits and withdrawals.
Withdrawals will be taxed as per your slab.
Tax Implications
Tax deduction on investments up to Rs 1.5 lakh (under Section 80CCD) and Rs
50,000 [under Section 80CCD(1B)] can be availed in a financial year. Sixty per
cent of the amount received at the completion of the term is tax-free.
List of Pension Fund Managers (PFMs)
HDFC Pension Management Company
ICICI Prudential Life Insurance Company
Kotak Mahindra Asset Management Company
LIC Pension Fund
SBI Pension Funds
UTI Retirement Solutions
Birla Sun Life Pension Management
Investment Options
The NPS offers different funds with varying exposure to equity (E), corporate
debt (C) and government securities (G). Of these asset classes, equity carries the
maximum risk (and chances of maximum returns) and government securities
carry minimum risk (and least returns). Following are the investment options
available:
Active-choice investment: The investor can mix the E, C and G options as per
their choice. The maximum permitted allocation towards equity is 75 per cent.
Auto-choice investment: Here, investment allocation is done based on the
investor's age. In the default version of this scheme, the equity portion is 50 per
cent till age 35, after which it reduces 2 per cent per year until it becomes 10 per
cent by age 55. The corporate debt portion is 30 per cent till age 35, after which
it reduces 1 per cent per year until it becomes 10 per cent by age 55. The
exposure in government securities is 20 per cent till age 35, after which it
increases gradually every year. Other options within auto-choice are aggressive
and conservative life-cycle funds which begin with an equity allocation of 75
per cent and 25 per cent, respectively. These are reduced as the NPS
subscriber's age advances.
EPF vs PPF
What is an EPF account?
EPF stands for Employee Provident Fund which is a retirement benefit scheme
only designed for the salaried employees. It is a scheme to which both employer
and employee contribute. You and your employer contribute 12% of your basic
salary every month. This scheme is handled by the Employee Provident Fund
Organization which is a government organization. As per EPFO rules, both
employee and employer contribute a total of 24% of your basic salary to the
EPF account. The amount saved in the EPF account can be withdrawn at the
time of retirement or changing jobs. The EPF account can be transferred from
one organization to other, when an employee changes job.
What is PPF account?
A PPF account is an investment instrument which is particularly designed to
provide old age income security. It is a savings as well as investment scheme
offered by the Government of India. A person can start investing with a
minimum amount of Rs. 500 and a maximum of Rs. 1,50,000 in this scheme
and get attractive returns which are tax free. The scheme is only open for the
residents of India.

Comparison between EPF & PPF

The following difference are seen between EPF and PPF:
 The interest rate on investments in EPF is 8.5 % while it is 7.1 % for a
PPF account.
 The money in the EPF account can be withdrawn when you resign from
job. But, the deposited amount in PPF cannot be withdrawn until maturity
which is 15 years from the date of depositing the amount.
 An individual can avail loan against PPF accounts whereas a person can
withdraw money from EPF account to meet personal requirements.
 Returns earned from a PPF account are exempted from tax payment while
investments done in EPF qualifies for tax deduction under Section 80C of
the Indian Income Tax Act, 1961.
 The EPF account can be accessed by only salaried individuals while a
PPF account can be opened by all.
Features EPF PPF
Interest Rate 8.5 % 7.1 %
Who can Invest Only Salaried Employee Anybody can invest in PPF
Employer
Yes No
Contribution
Minimum Investment 24% of Basic Salary Rs. 500
15 Years, Extendable in 5 years
Lock-in Period Retirement or Resignation
block
Tax-on Withdrawal If withdrawn before 5 years No
Loan Yes- Only in special cases Yes- From 3rd Year to 6th Year
Tax Exemption Yes Yes
Liquidiy In case of special cases No
Employee Provident Fund Select public sector banks and Post
Scheme offered by
Organisation (EPFO) Office
EPF Vs PPF - Where to invest
Based on the above mentioned discussion we can say that EPF is comparatively
more beneficial than a PPF account as apart from you, your employer also
contributes to your EPF account. It is a kind of joint contribution towards your
future. But, there is no provision for such contribution in a PPF account.
Besides, you can withdraw your EPF amount as and when you need it for
meeting personal requirements. But, you cannot do so when it comes to a PPF
account. Only after maturity, you can withdraw funds from your PPF account.
Also, interest rate offered on an EPF account is higher than what is offered on a
PPF account.
Based on your requirements and eligibility, you can choose between any of the
aforesaid savings schemes.
Different Types of Provident Fund
Listed below are the different types of Provident Funds available in India.
 Employee Provident Fund: In Employee Provident Fund scheme, the
employee makes contribution (a fraction of their salary) to the funds
regularly on a monthly basis. The contributions made by a group of
people is then pooled together and invested in a trust. The fund amount is
 later paid back to the retiree or they can choose to withdraw it after a
certain period of time.
 Unrecognised Provident Fund: This scheme is started between the
employer and employee but is not approved by the Commissioner of
Income Tax department.
 Statutory Provident Fund: This fund is for employees of government
sector, educational institutions and Universities.
 Public Provident Fund: It is a provident fund where in self-employed
individuals and children can make a contribution. Unlike other funds, the
individual need not be salaried.