TYPES OF INVESTMENTS

Equity Instruments

Equity securities are financial assets that represent ownership of a corporation. The most prevalent
type of equity security is common stock. And the characteristic that most defines an equity security—
differentiating it from most other types of securities—is ownership.

If you own an equity security, your shares represent part ownership of the issuing company. In other
words, you have a claim on a percentage of the issuing company's earnings and assets. If you own 1%
of the total shares issued by a company, your ownership piece of the controlling company is
equivalent to 1%.

i. Ordinary shares

They typically carry voting rights but do not give shareholders rights to receive or demand for
dividends. Ordinary shareholders also receive less dividends compared to shareholders who hold
preference shares.

ii. Preference shares

Preference shares confer some preferential rights on the holder, superior to ordinary shares. Normally,
the preferential rights are the rights to fixed dividends, priority to dividends over ordinary shares and
to a return of capital when the company goes into liquidation. They do not get voting rights. Notably,
preference shares are usually not issued to the general public, but only to financial institutions.
Companies don’t wish to take loans, so they rather issue preference shares to these financial
institutions.

Differences:

- Rate of dividend – uncertain for ordinary shareholders, but fixed for preferences shareholders
irrespective of the amount of profits received by the company.
- Preference rights – to preference shareholders over ordinary
- Voting rights and right to participate in management – only ordinary shareholders get voting
rights
- Winding up – at the time of liquidation, preference shareholders are paid first.
- Trading on stock market – only ordinary shares are traded on stock market, and are thus their
price is influenced by free forces of demand and supply. Preference shareholders cannot trade
openly on stock market; however, they can, after a fixed time period, sell them back to the
company. Ordinary shareholder cannot sell it back to the company; however, company can
 offer to buy-back these shares (if the company wants to increase earning per share, or to
improve the return on investment).

Types of preference shares:

- Redeemable preference shares

Redeemable preference are those that can be repurchased or bought back by the issuing company at a
fixed rate and a specified date. As per Sec. 55 of the Indian Companies Act 2013, it is not allowed to
issue non-redeemable preference shares.

- Convertible preference shares

Convertible preference shares usually carry rights to a fixed dividend for a particular term. At the end
of the term, the company can choose to convert it into ordinary shares or leave them as they are.
Conversion prices must be specified in the company’s constitution. If the price of an ordinary share
rises, the conversion prices will not follow. It is essentially allowing the shareholder to purchase
ordinary shares at a lower price.

- Participating and non-participating

When still some dividend is left even after paying off all involved parties including equity
shareholders, then if the preference shareholders get a right in the remaining profits, these are called
participating preference shares.

- Cumulative and non-cumulative

In case of cumulative, dividend arrears keep adding up every year.

iii. Treasury shares

Treasury shares or reacquired stock, refers to previously outstanding stock that has been bought back
from stockholders by the issuing company. The result is that the total number of outstanding shares
on the open market decreases. Treasury stock remains issued but is not included in the distribution
of dividends and are neither allowed to exercise any voting rights. Reasons could be – to give these
shares to their employees, or to create a demand for their stock in the market and thereby increase
price.

Debt Instruments
Debt securities are financial assets that define the terms of a loan between an issuer (the borrower)
and an investor (the lender). The terms of a debt security typically include the principal amount to be
returned upon maturity of the loan, interest rate payments, and the maturity date or renewal date.

a. Debentures

Companies issue debentures to raise funds by borrowing money from the public. The company thus
promises to pay fixed interest to the investors. These debt instruments may or may not be backed by
any specific security or collateral (secured or insecure debentures). Hence, the investors have to rely
on the credit ratings of the issuing company as security. While the interest payment and principal
repayment depend on the issuing company’s creditworthiness, the payment of debt instruments is
prioritised over stock dividend payments to shareholders. Minimum amount to be invested in
debentures in Rs. 10,000 and multiples thereof.

Advantages:
- Fixed return, no matter the fluctuations in dividends
- Higher rate of return than a bank FD
- Secure debentures – have a collateral attached. But then there’s always the risk – if the
company goes into insolvency, then it might take really long court battles in order to get your
interest and principal money
- Freely tradable on stock market

b. Bonds

It is a fixed income security which allows a lender to lend a predetermined amount of funds and be
eligible for interest on those funds.
Government Bonds are a popular category of debt instruments issued by the central or state
government. These bonds act as a loan wherein the government borrows money from investors at a
predetermined interest rate for a specific time period. The investors receive the principal and interest
as per the clauses mentioned in the bond. Government bonds fall under the broad category of
government securities (G-secs) and are issued under the supervision of the Reserve Bank of India.
The interest rate offered on the government bond, also known as the coupon rate, can be either fixed
or floating.
- Coupon rate
- Coupon payment date
- Tenure
- Redemption date
- Redemption value
 c. Commercial Papers

CPs are unsecured and negotiable money market instruments issued by highly rated corporate entities
to raise short -term funds for meeting working capital requirements directly from the market instead
of borrowing from banks. Started in 1990.

- Prior approval of RBI is reqd.

- Minimum net worth requirements to be fulfilled – 4 crore
- Minimum rating of AA
- Maturity tenure ranges from 15 days to 1 year
- Minimum investment value for a single investor – denominations of 5 lac
- CP have to be issued at a discount to face value, which will be determined by market
- Can only be issued by corporations and non-banking financial corporations, primary dealers
- Can be taken by individuals, banks, corporates, NRIs, Foreign Institutional Investors

Benefits:

1. Low expense compared to bank loans

2. Access to short term funding
3. Meeting working capital requirements
4. Can be issued without collateral – so less paperwork and formalities

To investors:

1. Higher returns than bank deposits

2. Portfolio diversification
3. Flexible in liquidity

Drawbacks:

1. Not very popular on secondary market trading

d. Certificate of Deposit

Certificates of Deposit (CDs), introduced in India in 1989, are short-term debt instruments. Banks and
Financial Institutions issue CDs in dematerialised form against the funds that an investor deposits for
a specific term. Banks must maintain the cash reserve ratio (CRR) and statutory liquidity ratio (SLR)
on the price of CDs. Cash Reserve Ratio (CRR) is the minimum deposit amount that a bank has to
hold as reserves with the Reserve Bank of India. On the other hand, SLR is a minimum percentage of
deposits that a commercial bank has to maintain in the form of liquid cash, gold or other securities.
SLR is not reserved with the RBI, but with the bank itself. The interest rate may be fixed or floating
for a CD.

Want higher return than bank saving account but don’t want security market risks? You must find a
bank that offers higher interest rate. The only thing is you need to lock your money in for a
predetermined time period (7 days to 1 year). If you choose to exit early, you will not only lose on the
interest but also you might be asked to pay an additional fee. Minimum value for CD is 1 lac.

e. Fixed Deposits

They score over many other debt instruments in India due to their ease and uncomplicated
nature. Banks offer cumulative and non-cumulative FDs. Cumulative option deposits pay you interest
on maturity. For non-cumulative deposits, you receive the interest monthly, quarterly, or annually and
the principal on maturity. You can also invest in Tax-saving FDs that have a tenure of 5 years, to help
you save tax under Section 80C of the IT Act.

Credit Rating scales by credit rating agencies (e.g. CARE, ICRA, CRISIL) – ranging from AAA, AA,
A, BBB, BB, B, C, D – to rate the credit worthiness of the debt instrument the investor is considering
investing in.

Differences between Equity and Debt Market Instruments

Parameters Equity Markets Debt Markets

Comparatively high risk, as such

Risk Low-risk investments as returns
assets, depend on various micro and
Factor do not depend on market trends.
macroeconomic factors.

Debt markets offer

Equity markets offer high returns on comparatively lower returns,
Returns
stocks as they also hold high risks. usually at a fixed rate throughout
the tenure.
 Volatility Equity markets are highly volatile. Debt markets have low volatility.

Equity market assets do not have a

fixed tenure. The holding period Debt market assets mostly have a
Tenure
generally depends on the investor’s fixed tenure.
objectives.

Mutual Funds

Compare driving your own car from Delhi to Chd. Other option is hiring a driver, where you tell him
the final destination. However, you leave all decisions like which route, what speed etc., to the driver.
The latter situation is similar to mutual funds. Herein, you hire a mutual fund manager to manage your
funds. It takes money from several investors, and then invests this pool of money into several
investment avenues including debt, equity or a combination of both. Mutual fund organization is
going to earn dividend, interest rate etc., which after deducting their management expense fee (1-3%)
will be distributed amongst the investors.

Types:

1. Equity Mutual Fund – when the mutual fund org. invests the fund pool into equity avenues
2. Debt Mutual Fund – investment only in debt avenues
3. Hybrid Fund – combination of both
4. Solution Oriented Fund – e.g. Child education fund, marriage fund – you want money after a
certain period of time for a specific solution
5. Other Fund – e.g. index fund – investment made in Sensex, NIFTY

Precautions:

1. Entry and exit load – entry load is usually zero, but some funds have an exit load if you sell
the units within first n days of investing
2. Lock-in period
3. Risk to reward ratio – ensure that mutual fund should be investing in multiple types of
avenues or instruments, also in different companies

Derivatives
A financial contract that derives its value from an underlying asset (commodities like oil, gold etc.;
stocks, bonds, and currencies). Buyer agrees to purchase the asset on a specific future date at a
specific predetermined price. Derivatives are used for hedging (process of risk management) and
speculation (estimate market positions and make decisions in order to earn profits).

Trading:

1. Over-the-counter (OTC) – direct contract between two people

2. Through stock exchange (Exchange Traded Derivatives – ETD)

Types

1. Futures – An agreement between two parties to buy or sell an asset at a certain time in future
at a certain price. E.g. I say, I will buy stocks from Reliance on 1 st Jan 2025 at Rs. 40 per
share. Used to hedge against risk (e.g. chance is that share price might increase in future) or
speculate on the price movement (price fluctuations bound to happen overtime). Futures are
standardised contracts traded on a stock exchange.

It is a sort of bet between 2 people. Price may increase or decrease, but you’ll get at a predetermined
price. If price increases, seller is at a loss. But if it decreases, buyer is at loss.

2. Forward

Non-standardised contract between two parties to buy or sell an asset at a specified future time at a
price agreed upon today. The only difference with future is that it is non-standardised, i.e., it is OTC,
it is not traded on stock exchange.

3. Swap

Swap is generally a contract between two parties agreeing to trade loan terms. E.g. one might use an
interest rate swap to switch from a variable rate loan to a fixed interest rate loan or vice versa. The
category of the loan should be same, i.e., both home loan, both car loan etc. The loan continues to be
in the name of the same person, it is only the ROI that is swapped. If any person defaults, then they
will have to revert back to their own original loan agreement – so this is an associated risk. Not traded
on stock exchange.

Use – currency rates, commodities

4. Options

Similar to futures, i.e., happens through stock exchange. It is an agreement between two parties
granting one the opportunity to by or sell a security from or to the other party at a predetermined
future date. This is a major difference between option and future – in future, you have to mandatorily
buy or sell as agreed; here however, you get an option to either buy or sell or to retain.
- Call option – gives the holder the right but not the obligation to buy a given quantity of the
underlying asset at a given price on or before a given future date
- Put option – gives the holder the right but not the obligation to sell a given quantity of the
underlying asset at a given price on or before a given future date