What is an ‘Equity’/Share?

Total equity capital of a company is divided into equal units of small denominations, each called
a share. For example, in a company the total equity capital of Rs 2,00,00,000 is divided into
20,00,000 units of Rs 10 each. Each such unit of Rs 10 is called a Share. Thus, the company then
is said to have 20,00,000 equity shares of Rs 10 each. The holders of such shares are members of
the company and have voting rights.

What is a ‘Debt Instrument’?

Debt instrument represents a contract whereby one party lends money to another on pre-
determined terms with regards to rate and periodicity of interest, repayment of principal amount
by the borrower to the lender. In the Indian securities markets, the term ‘bond’ is used for debt
instruments issued by the Central and State governments and public sector organizations and the
term ‘debenture’ is used for instruments issued by private corporate sector.

What is a Derivative?

Derivative is a product whose value is derived from the value of one or more basic variables,
called underlying. The underlying asset can be equity, index, foreign exchange (forex),
commodity or any other asset.

Derivative products initially emerged as hedging devices against fluctuations in commodity

prices and commodity-linked derivatives remained the sole form of such products for almost
three hundred years. The financial derivatives came into spotlight in post-1970 period due to
growing instability in the financial markets. However, since their emergence, these products
have become very popular and by 1990s, they accounted for about two thirds of total transactions
in derivative products.

What is a Mutual Fund?

A Mutual Fund is a body corporate registered with SEBI (Securities Exchange Board of India)
that pools money from individuals/corporate investors and invests the same in a variety of
different financial instruments or securities such as equity shares, Government securities, Bonds,
debentures etc. Mutual funds can thus be considered as financial intermediaries in the investment
business that collect funds from the public and invest on behalf of the investors. Mutual funds
issue units to the investors. The appreciation of the portfolio or securities in which the mutual
fund has invested the money leads to an appreciation in the value of the units held by investors.
The investment objectives outlined by a Mutual Fund in its prospectus are binding on the Mutual
Fund scheme. The investment objectives specify the class of securities a Mutual Fund can invest
in. Mutual Funds invest in various asset classes like equity, bonds, debentures, commercial paper
and government securities. The schemes offered by mutual funds vary from fund to fund. Some
are pure equity schemes; others are a mix of equity and bonds. Investors are also given the option
of getting dividends, which are declared periodically by the mutual fund, or to participate only in
the capital appreciation of the scheme.

What is an Index?

An Index shows how a specified portfolio of share prices is moving in order to give an indication
of market trends. It is a basket of securities and the average price movement of the basket of
securities indicates the index movement, whether upwards or downwards.

What is a Depository?

A depository is like a bank wherein the deposits are securities (viz. shares, debentures, bonds,
government securities, units etc.) in electronic form.

What is Dematerialization?

Dematerialization is the process by which physical certificates of an investor are converted to an

equivalent number of securities in electronic form and credited to the investor’s account with his
Depository Participant (DP).

What is meant by ‘Securities’?

The definition of ‘Securities’ as per the Securities Contracts Regulation Act (SCRA), 1956,
includes instruments such as shares, bonds, scrips, stocks or other marketable securities of
similar nature in or of any incorporate company or body corporate, government securities,
derivatives of securities, units of collective investment scheme, interest and rights in securities,
security receipt or any other instruments so declared by the Central Government.

What is the function of Securities Market?

Securities Markets is a place where buyers and sellers of securities can enter into transactions to
purchase and sell shares, bonds, debentures etc. Further, it performs an important role of
enabling corporate, entrepreneurs to raise resources for their companies and business ventures
through public issues. Transfer of resources from those having idle resources (investors) to
others who have a need for them (corporate) is most efficiently achieved through the securities
market. Stated formally, securities markets provide channels for reallocation of savings to
investments and entrepreneurship. Savings are linked to investments by a variety of
intermediaries, through a range of financial products, called ‘Securities’.. Capital market
instruments are responsible for generating funds for companies, corporations, and sometimes
national governments. These are used by the investors to make a profit out of their respective
markets. There are a number of capital market instruments used for market trade, including

• Stocks • Bonds • Debentures • Treasury-bills • Foreign Exchange •

Fixed deposits, and others
Capital market is also known as securities market because long term funds are raised through
trade on debt and equity securities. These activities may be conducted by both companies and
governments. This market is divided into primary capital market.

What are capital market instruments?

Capital market instruments are instruments used by investors to make a profit out of their
respective markets. (Finance Maps, 2009). These instruments include stocks, bonds, debentures,
treasury bills, foreign exchange, fixed deposits, etc. The market is composed of the primary and
secondary market. Quite simply, the primary market is designed for new issues (IPO’s) and the
secondary market is meant to trade existing issues (i.e. already established companies). Stocks
and bonds are the two basic instruments used in these two markets. Bonds trade in their own
market, a market referred to as the debt, credit or fixed income market. (Finance Maps, 2009).
This market trades debt securities including debentures and t-bills.

How are capital market instruments used?

Capital Market instruments like the ones named all exist for one common reason; to generate
funds for companies and corporations. In the case of t-bills, bonds capital market instruments
also benefit many nationalized governments. In any market these instruments hold weighted
value and are designed for different purposes. Typically, stocks are more volatile than bonds. T-
bills are considered secured but yield less of a return than others. Stock instruments are traded
among investors in auction, virtual and physical markets. The NYSE is a physical exchange and
only stocks listed within that exchange could be traded. The NASDAQ is a virtual exchange and
is electronically maintained with buyers and sellers being matched electronically for buying and
selling. The NASDAQ operates in theory similar to the physical exchanges, however buyers and
sellers are considered ”market makers” i.e. making a bid and ask price in order to buy or sell
“their” share(s) of stock.

Which capital market instrument is the most important?.

Every capital market instrument is important in its own way. Firstly, attraction to a
particular instrument is also dependent upon an investors risk tolerance level. An example is that
an investor with more conservative objectives may prefer to get involved with bond trading as
opposed to the more volatile stock market. However I do believe that of all the capital
instruments, the most important instrument tasking into consideration the economic times we are
upon is stock. The stock market has an unlimited cap and truly makes the financial world tic. In
October 2008, the size of the world’s stock market was estimated at $36.6 trillion. (Wiki, 2009).
The stock market is instrumental in obtaining capital for new and existing companies, hence
supporting the economy. Stocks are also liquid instruments (as opposed to bonds) and the stock
market has proven to tie directly to the world economy including the housing market).
What are the main elements in calculating cost of capital? How would an increase in debt affect
the cost of capital?

Essentially, the calculations are done with the cost of debt and equity and preferred stock. This
includes calculating cost of capital by reviewing investor’s required rate of return, floatation
costs and, when applicable, corporate taxes. In order to manage said debt and equity, financial
policies must be adhered to, since they do have an effect on the cost of capital.

An increase cost of debt is an indication of a higher risk, which therefore can increase the
required rate of return. This in turn increases the cost of capital. Additional costs may be
accrued with higher debt, such as higher loans, higher interest payments, and any other costs that
may be associated with the increased debt.

How would you identify the optimal cost of capital for an organization?

To identify the optimal cost of capital for an organization, calculations have to be made of all
included factors. This will vary on the individual company and their required costs, the market,
and the balance between the factors – Cost of debt, equity and preferred stock. The weighted
cost of capital should be reviewed by management. Options that increase the value of
stockholder investment, keeping risk within reason, and factor in reasonable financing options
can help determine an optimal situation.

What is meant by Weighted Average Cost of Capital (WACC)? What are the components
of WACC? Why is WACC a more appropriate discount rate when doing capital
budgeting?

By averaging all of the capital costs acquired by an organization, the Weighted Average Cost of
Capital (WACC) can be determined. The contributing factors in WACC are the various sources
of capital, such as preferred stock, bonds, and common equity. Retained earnings and the sale of
new common stock are both used in regard to common equity.

The WACC is more applicable as a discount rate when doing capital budgeting because it uses
the after-tax costs of the resources used for project financing, and the weights provide a view of
the entire amount of financing on a proportional level. This allows the organization to know what
rate of return it must achieve to satisfy the needs of both stockholders and creditors.

What is the impact on WACC when an organization needs to raise long term capital?

Long term capital requires organizations to review risk-free rates of maturity. Long term leaves
chance for rates to change, so the organization has to make sure they can assume the associated
risk, meet the changing required rate of return, and meet the changing rates which affect
associated costs or fees. Looking at the larger scope of a long term project can weight the
decision due to the potential risks involved in the extended time frame. Since WACC provides a
more appropriate discount rate, it provides a more accurate picture of what financial obligations
must be met, and help determine which long term and short term options make most sense for
that organization.

In the concept of managerial accountability, what legal compliance issues could come up?

The concept of managerial accountability covers the ability of the business houses of managing
their financial aspects and controlling the operations. The concept also includes the
environmental and societal aspects of the business with the financial aspects of the business and
rights of personnel. Managerial accountability is responsible for the success or failure of business
with the improvement in the performance for getting effective results. The legal compliance
issues that can arise due to the improper practices of business are related to financial practices,
human rights, trade unions, environmental organizations, etc.

What is agency theory?

Agency theory is based on the relationship of shareholders and the managers of the company. Its
main emphisis is on the differences in the objectives of the managers and the shareholders. The
managers have to take strategic decisions for providing effective incentives to the shareholders
because shareholders expect to earn benefits from their investment in the company. The theory
has the direct relationship with the decisions based on portfolio investment.

What ethical issues can arise with Agency Theory?

The ethical issues that can arise due to the agency theory are of two types. Firstly, the ethical
issues arise due to the differences in the objectives of the principal and agent conflict. Secondly,
the ethical issues arise due to the plans of the agent, which are not known to the principal. It
arises due to the differences of the principal and agent's perception towards the assessment of
risk. We can consider the example as follows: If the strategy of the manager proves to be
effective, then the shareholders will enjoy higher returns on their investment. If the risk
evaluation of the manager goes wrong, then the shareholders will not face more loss due to the
limited liability, but the manager will have to face losses. Such a situation can be avoided by
utilizing hedging process for the activities of the shareholders.

DERIVATIVES
A derivative is a financial instrument whose characteristics and value depend upon the
characteristics and value of some underlying asset typically commodity, bond, equity, currency,
index, event etc. Advanced investors sometimes purchase or sell derivatives to manage the risk
associated with the underlying security, to protect against fluctuations in value, or to profit from
periods of inactivity or decline. Derivatives are often leveraged, such that a small movement in
the underlying value can cause a large difference in the value of the derivative. Derivatives are
usually broadly categorised by:
· The relationship between the underlying and the derivative (e.g. forward, option, swap)
· The type of underlying (e.g. equity derivatives, foreign exchange derivatives and credit
derivatives)
· The market in which they trade (e.g., exchange traded or over-the-counter)
Futures
A financial contract obligating the buyer to purchase an asset, (or the seller to sell an asset), such
as a physical commodity or a financial instrument, at a predetermined future date and price.
Futures contracts detail the quality and quantity of the underlying asset; they are standardized to
facilitate trading on a futures exchange. Some futures contracts may call for physical delivery of
the asset, while others are settled in cash. The futures markets are characterized by the ability to
use very high leverage relative to stock markets. Some of the most popular assets on which
futures contracts are available are equity stocks, indices, commodities and currency.
Options
A financial derivative that represents a contract sold by one party (option writer) to another party
(option holder). The contract offers the buyer the right, but not the obligation, to buy (call) or sell
(put) a security or other financial asset at an agreed-upon price (the strike price) during a certain
period of time or on a specific date (exercise date).
A call option gives the buyer, the right to buy the asset at a given price. This 'given price' is
called 'strike price'. It should be noted that while the holder of the call option has a right to
demand sale of asset from the seller, the seller has only the obligation and not the right. Forge: if
the buyer wants to buy the asset, the seller has to sell it. He does not have a right.
Similarly a 'put' option gives the buyer a right to sell the asset at the 'strike price' to the buyer.
Here the buyer has the right to sell and the seller has the obligation to buy. So in any options
contract, the right to exercise the option is vested with the buyer of the contract. The seller of the
contract has only the obligation and no right. As the seller of the contract bears the obligation, he
is paid a price called as 'premium'. Therefore the price that is paid for buying an option contract
is called as premium. The primary difference between options and futures is that options give the
holder the right to buy or sell the underlying asset at expiration, while the holder of a futures
contract is obligated to fulfill the terms of his/her contract.

1) Liquidity Measurement Ratios 4) Operating Performance Ratios

- Current Ratio - Fixed-Asset Turnover
- Quick Ratio - Sales/Revenue Per Employee
- Cash Ratio - Operating Cycle
- Cash Conversion Cycle
 2) Profitability Indicator Ratios 5) Cash Flow Indicator Ratios
- Profit Margin Analysis - Operating Cash Flow/Sales Ratio
- Effective Tax Rate - Free Cash Flow/Operating Cash Ratio
- Return On Assets - Cash Flow Coverage Ratio
- Return On Equity - Dividend Payout Ratio
- Return On Capital Employed 6) Investment Valuation Ratios
3) Debt Ratios - Per Share Data
- Overview Of Debt - Price/Book Value Ratio
- Debt Ratio - Price/Cash Flow Ratio
- Debt-Equity Ratio - Price/Earnings Ratio
- Capitalization Ratio - Price/Earnings To Growth Ratio
- Interest Coverage Ratio - Price/Sales Ratio
- Cash Flow To Debt Ratio - Dividend Yield
- Enterprise Value Multiple
1) Liquidity Measurement Ratios
The first ratios we'll take a look at in this tutorial are the liquidity ratios. Liquidity ratios attempt
to measure a company's ability to pay off its short-term debt obligations. This is done by
comparing a company's most liquid assets (or, those that can be easily converted to cash), its
short-term liabilities.

2) Profitability Indicator Ratios

These ratios, much like the operational performance ratios, give users a good understanding of
how well the company utilized its resources in generating profit and shareholder value.

3) Debt Ratios
These ratios give users a general idea of the company's overall debt load as well as its mix of
equity and debt. Debt ratios can be used to determine the overall level of financial risk a
company and its shareholders face. In general, the greater the amount of debt held by a company
the greater the financial risk of bankruptcy.

4) Operating Performance Ratios

Each of these ratios have differing inputs and measure different segments of a company's overall
operational performance, but the ratios do give users insight into the company's
performance and management during the period being measured.

These ratios look at how well a company turns its assets into revenue as well as how efficiently a
company converts its sales into cash. Basically, these ratios look at how efficiently and
effectively a company is using its resources to generate sales and increase shareholder value. In
general, the better these ratios are, the better it is for shareholders.
5) Cash Flow Indicator Ratios
we all know that profits are very important for a company. However, through the magic of
accounting and non-cash-based transactions, companies that appear very profitable can actually
be at a financial risk if they are generating little cash from these profits. For example, if a
company makes a ton of sales on credit, they will look profitable but haven't actually received
cash for the sales, which can hurt their financial health since they have obligations to pay.
The ratios in this section use cash flow compared to other company metrics to determine how
much cash they are generating from their sales, the amount of cash they are generating free and
clear, and the amount of cash they have to cover obligations.

6) Investment Valuation Ratios

This last section of the ratio analysis tutorial looks at a wide array of ratios that can be used by
investors to estimate the attractiveness of a potential or existing investment and get an idea of its
valuation.

However, when looking at the financial statements of a company many users can suffer from
information overload as there are so many different financial values. This includes revenue,
gross margin, operating cash flow, EBITDA, pro forma earnings and the list goes on. Investment
valuation ratios attempt to simplify this evaluation process by comparing relevant data that help
users gain an estimate of valuation.
For example, the most well-known investment valuation ratio is the P/E ratio, which compares
the current price of company's shares to the amount of earnings it generates. The purpose of this
ratio is to give users a quick idea of how much they are paying for each $1 of earnings. And with
one simplified ratio, you can easily compare the P/E ratio of one company to its competition and
to the market.

Price/Earnings Ratio

The price/earnings ratio (P/E) is the best known of the investment valuation indicators. The P/E
ratio has its imperfections, but it is nevertheless the most widely reported and used valuation by
investment professionals and the investing public. The financial reporting of both companies and
investment research services use a basic earnings per share (EPS) figure divided into the current
stock price to calculate the P/E multiple (i.e. how many times a stock is trading (its price) per
each dollar of EPS).
It's not surprising that estimated EPS figures are often very optimistic during bull markets, while
reflecting pessimism during bear markets. Also, as a matter of historical record, it's no secret that
the accuracy of stock analyst earnings estimates should be looked at skeptically by investors.
Nevertheless, analyst estimates and opinions based on forward-looking projections of a
company's earnings do play a role in Wall Street's stock-pricing considerations.

Historically, the average P/E ratio for the broad market has been around 15, although it can
fluctuate significantly depending on economic and market conditions. The ratio will also vary
widely among different companies and industries. Formula:
Arbitrage
The simultaneous purchase and sale of identical or equivalent financial instruments or
commodity futures in order to benefit from a discrepancy in their price relationship.
Warrant
A long-term security, which is similar to an option. A stock warrant usually allows a trader to
purchase one share of stock at a fixed price for a certain period of time.
Write
To write an option is to sell an option. The person who sells the option is considered to be the
writer.
Futures
Contracts that require delivery of a commodity of specified quality and quantity, at a specified
price, on a specified future date. Commodity futures are traded on a commodity exchange and
are used for both speculation and hedging.
Call
An Option contract that gives the holder the right to buy the underlying security at a specified
price for a certain, fixed period of time.
Exercise
To implement the right under which the holder of an option is entitled to buy (in the case of a
call) or sell (in the case of a put) the underlying security.
Futures
A term used to designate all contracts covering the purchase and sale of financial instruments or
physical commodities for future delivery on a commodity futures exchange.
Hedge
A conservative strategy used to limit investment loss by effecting a transaction, which offsets an
existing position.
Intrinsic Value
The amount by which an option is in-the-money.
Mark-To-Market
The daily adjustment of margin accounts to reflect profits and losses.
Offer
The price at which an investor is willing to sell a futures or options contract.
Secondary Market
A market that provides for the purchase or sale of previously sold or bought options through
closing transactions. Stock exchanges and the Over The Counter market are examples of the
secondary market.
Par Value
The face value of a bond, generally $ 1,000.
Sinking Fund
The sale of a futures contract in anticipation of a later cash market sale. Used to eliminate or
lessen the possible decline in value of ownership of an approximately equal amount of the cash
financial instrument or physical commodity.
Yield
A measure of the income generated by a bond. The amount of interest paid on a bond divided by
the price.
Yield to Maturity
The rate of return anticipated on a bond if it is held until the maturity date.