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Investment avenues

Module 2

Investment avenues
There are two basic investment avenues
Financial assets eg. Equity shares, corporate

debentures, government securities, deposits with banks, mutual funds, insurance policies, derivatives Real assets eg. Residential houses, commercial property, agricultural farm, gold, precious stones, art objects.

Financial assets
Investments in financial assets include 1. Securitised investments 2. Non-securitised investments Securities are those instruments which are

quoted and are transferable.

Eg. Shares, bonds

Non-securitised investments are those which are

not quoted and not freely marketable

Eg. Bank deposits, national savings, insurance


Investment attributes
Risk and return
Risk can be defined as the variability of rates of

returns from an investment. Rate of return is the yield and capital appreciation expected by the investor from his investment
An investment is highly marketable if it can be

bought and sold quickly with a minimum loss.

Investment attributes
Tax advantages
Initial, ongoing or terminal tax shelters.

Convenience is the procedural ease when the

investment is made and also the ease with which the day to day management of the investment can be done

Non-marketable financial assets

Bank deposits

Post office savings account

Post office time deposits Monthly income scheme of post office Kisan Vikas Patra National savings certificate Company deposits Employee provident fund scheme Public provident fund scheme

Money market instruments

These are debt instruments which have a maturity

of less than one year. They are highly liquid and have low risks Eg. Treasury bills, certificates of deposit, commercial papers and repos. The participants of the money market are the government, financial institutions, banks and corporates. The securities traded are in large denominations and hence out of reach of individual investors

Money market instruments

Treasury bills
These represent the obligations of the Government

of India. They are usually issued for 91 days and 364 days. They are sold by auction every week by RBI They are sold at a discount and redeemed at par. They are heavily traded in the secondary market They have no credit risk and have negligible price risk Interest rates are not very attractive.

Money market instruments

Certificates of deposit
Banks and financial institutes are the major issuers

of CDs. Issued for amounts of Rs 1 lakh and above Issued at a discount and redeemed at par. The principal investors are banks, FIs, corporates and mutual funds Short term and easily transferable Have a maturity of 3 months to 1 year Generally risk free Offer a higher rate of interest as compared to treasury bills

Money market instruments

Commercial paper
Short term promissory unsecured notes Sold for large amounts Maturity of 90 to 180 days Sold at a discount and redeemed at par

Attract stamp duty in the primary market

Issued by companies that are financially strong and

highly rated


Money market instruments

Repos and Reverse Repos (repurchase

Involves simultaneous sale and purchase

agreement. Government securities are transferred to an investor with an agreement to buy back those securities after the repo period at a slightly higher price Can be used to finance short term requirements Reverse repo is the mirror image of a repo. Reverse repo involves an initial purchase and a subsequent sale

Call money market

Call money market is a money market where day to

day surplus funds are traded mostly by banks. The loans in this market are of short term nature maturities ranging from 1 day to a 14 days. Loans are highly liquid and are repayable on demand. Banks and primary dealers are allowed to borrow and lend in this market. Other corporates and investment companies are allowed to only lend in these markets. They are encouraged to participate in the repo market RBI wants to convert the call money market into a pure interbank money market


Bonds or debentures
Bonds are long term, fixed income, debt


instruments. The issuer promises to pay its investors a certain rate of interest and to repay the principal amount on the maturity date. Includes government securities, bonds issued by state governments, corporate bonds, public sector bonds, and bonds by financial institutions They are redeemed on the maturity date. An indenture a trust deed is drawn between the bond holders and the company.

Government securities
Government securities are also called as gilt

edged securities or treasury bonds

Issued by central government, state government

and quasi-government bodies Carry a fixed coupon rate, have a fixed maturity period, issued at face value Interest is paid at half-yearly rests and varies from 7% to 10% Maturity ranges from 3 to 20 years Have tax benefits Low interest rates, long maturity periods, somewhat illiquid.

Government securities
Government securities
Banks, FIs, insurance companies, corporates,

FIIs, primary dealers, mutual funds invest in these securities RBI maintains a special account called Subsidiary General Ledger (SGL) for holding and trading the securities in Demat form. Banks and primary dealers open SGL accounts with RBI. PDs can open constituent SGL accounts to other clients to hold securities in demat form.


Bonds or debentures
Corporate bonds or debentures
Debentures are secured by a charge on the

immovable properties of the company by way of mortgage Carry a maturity period of more than 18 months. Must be credit rated. Debentures have a convertible clause wherein the investor can convert it into equity shares after a specified period.


Bonds or debentures
Public sector bonds
Issued by public sector Both taxable and tax free bonds They are transferable by endorsement and

delivery They are traded in exchanges


Types of bonds
Bearer bonds the holder of the bond is paid the interest.


They are unregistered and transferred by simply handing over Deep discount bonds long duration instruments and are issued at a discount to their face value Non-convertible bonds issued by corporates for periods between 5 to 8 years. They are credit rated. They cannot be converted to shares Secured premium notes (SPNs) issued for 3 to 8 years. They offer yield in the form of interest payments or premium Zero coupon bonds are issued at a discount to the face value and are redeemed at par. Floating rate bonds have a variable interest rate Capital indexed bonds interest rates vary as per the WPI

Types of bonds
Puttable bonds provide the investor the

right to seek redemption before the maturity date

Callable bonds gives the right to the issuer

to repurchase the bonds at a lower rate.

Foreign currency bonds bonds issued in

foreign currency to raise funds in foreign currency


Types of debentures
Secured or unsecured Fully convertible Partly convertible Non-convertible

Registered / Unregistered


Equity shares
Equity shares represent ownership capital

Equity shareholders bear the risk and enjoy the

rewards of the ownership. They have a residuary claim on the profits and assets of the company. They possess an unlimited potential for share in profits. They control the company through the board of directors. The liability of the equity share holders is limited to the value of the shares they have purchased

Classification of equity shares

Blue chip shares of large, well established


companies Growth shares enjoy above average growth and profitability Income shares have stable operations, limited growth opportunities and high dividend payout ratios Cyclical shares shares of companies whose operations are of a cyclical nature. Defensive shares shares of companies unaffected by ups and downs in the market Speculative shares shares tend to fluctuate

Types of equity shares

Sweat equity are shares issued to employees and


directors at a discount for considerations other than cash for services rendered like providing know-how, making available intellectual property right Non-voting shares are shares issued with no voting rights or with minimum voting rights. Preference shares are a form of non-voting shares. These shares get a slightly higher dividend to compensate for nonvoting rights. Rights shares are shares offered to existing shareholders at a price by the company in proportion to the shares held by them. Bonus shares are issued in addition to the cash dividends paid to the existing shareholders. The aim of bonus shares is to capitalise free reserves. Bonus

Advantages of equity shares

Do not create an obligation to pay a fixed rate of

dividend Can be issued without creating any charge on the assets Permanent source of capital In case of profits, the equity share holders are the real gainers as they get increased dividends and appreciation in the value of the shares

Preference shares
Preference shares are hybrid in nature i.e. they

carry the features of both debt and equity.

Carry a fixed rate of dividend Dividend is paid out of distributable profits Preference shares are cumulative. Dividend

skipped in a particular year can be paid in the next year Redeemable in 7 to 12 years


Preference shares
Preference share holders enjoy preferences in

two situations
Payment of dividend they are paid before the

equity holders Repayment of capital at the time of liquidation they are paid after outside liabilities are repaid and before equity shareholders are repaid
Do not have voting rights

Types of preference shares

Cumulative preference shares
These shares have a right to claim dividends for those

years also for which there have been no profits

Non-Cumulative preference shares
They have no claim on dividend which are in arrears

Redeemable preference shares

These shares can be returned after a certain period

Irredeemable preference shares

Cannot be redeemed till the company is liquidated

Participating preference shares

Have a share in the surplus profits after fixed dividend

has been paid

Types of preference shares

Non-participating preference shares
Earn only fixed dividends

Convertible preference shares

Shares can be converted into equity shares after a

certain period
Non-convertible preference shares
Cannot be converted into equity shares

Hybrid security
Preference share is a hybrid form of security as it

has both features of debt and equity Features of equity

Payment of dividend is not obligatory Preference dividend is paid out of distributable

profits Not deductible as an expense for the purpose of tax calculation

Features of debt
Carries a fixed rate of dividend Entitles the owner a claim prior to the equity holders Does not give voting rights

Warrant is a document of title to buy specified

number of equity shares at a specified price. Warrants are generally issued to make the bonds more attractive. They can be exercised over a number of years. Warrants are detachable instruments and can be traded in stock exchanges. Warrants can be converted into equity shares at a price called exercise price.


Bank deposits
Demand deposit

Saving deposit
Term deposit Recurring deposit Current account


Insurance is a form of risk management primarily used to hedge

against the risk of a contingent, uncertain loss.

Insurance is defined as the equitable transfer of the risk of a loss,

from one entity to another, in exchange for payment.

An insurer, or insurance carrier, is a company selling the

insurance; the insured, or policyholder, is the person or entity buying the insurance policy .
The amount to be charged for a certain amount of insurance

coverage is called the premium.


Mutual fund schemes

A mutual fund is a vehicle for collective

investment. Mutual fund is an investment vehicle that pools together funds from investors to purchase stocks , bonds or other securities. An investor can participate in the mutual fund by buying the units of the fund. The gain or loss made by the mutual fund is passed on to the investors after deducting the deducting the administrative expenses and investment management fees.

The gains are distributed to the unit holder in the

form of dividend or reinvested by the fund to generate further gains. Portfolio manager evaluates his portfolio performance and identifies the sources of strength and weakness. The evaluation of the portfolio provides a feed back about the performance to evolve better management strategy. Even though evaluation of portfolio is considered to be the last stage of investment process, it is continuous process. The managed portfolios are commonly known as mutual funds.

Important questions
What are different types of bonds?

What are the features of shares?

What are the different types of preference

shares? What are the different types of bank deposits? Why is insurance an investment? What are derivatives? How are they classified? What are the advantages of trading in derivatives?