Capital Market Instruments

Ms. Madhu Ruhil

 BASIC CAPITAL
MARKET
INSTRUMENTS

Shares Securities Derivatives

Debt Securities

Option Forward

Equity Preference
Shares Debentures Bonds
Shares

Future Swap
EQUITY SHARES
According to the Companies Act 1956, equity shares are that part of the share capital of the
company, which are not preference shares. They are called as ordinary shares or common
stock or voting share.
◈ issued by companies only
◈ obtained either in the primary market or the secondary market.
◈ ownership of the business
◈ the contract stands in perpetuity unless sold to another investor in the secondary market.
◈ investor possesses certain rights and privileges (such as to vote and hold position) in the
company
◈ the equity holder receives dividends which may or may not be declared.
◈ The risk factor is high and thus yields a higher return (when successful). 
◈ Holders of this instrument rank bottom on the scale of preference in the event of
liquidation of a company
 Preference Shares
◈ Issued by corporate bodies
◈ the investors rank second (after bond holders) on the scale of
preference when a company goes under. 
◈ The instrument possesses the characteristics of equity in the sense
that when the authorised share capital and paid up capital are being
calculated, they are added to equity capital to arrive at the total.
◈ Preference shares can also be treated as a debt instrument as they do
not confer voting rights on its holders and have a dividend payment
that is structured like interest (coupon) paid for bonds issues.
 Preference shares may be:

Cumulative preference shares:

A preference share is said to be cumulative when the arrears of
dividend are cumulative and such arrears are paid before paying any
dividend to equity shareholders. Suppose a company has 10,000 8%
preference shares of Rs. 100 each. The dividends for 1987 and 1988
have not been paid so far. The directors before they can pay the
dividend to equity shareholders for the year 1989, must pay the pref.
dividends for the year 1987, 1988 and 1989 before making any
payment of dividend to equity shareholders for the year 1989.
◈ Non-cumulative preference shares:
In the case of non-cumulative preference shares, the dividend is only payable
out of the net profits of each year. If there are no profits in any year, the arrears
of dividend cannot be claimed in the subsequent years. If the dividend on the
preference shares is not paid by the company during a particular year, it lapses.
Preference shares are presumed to be cumulative unless expressly described as
non-cumulative.
◈ Participating preference shares:
Participating preference shares are those shares which are entitled in addition to
preference dividend at a fixed rate, to participate in the balance of profits with
equity shareholders after they get a fixed rate of dividend on their shares. The
participating preference shares may also have the right to share in the surplus
assets of the company on its winding up. Such a right may be expressly
provided in the memorandum or articles of association of the company.
◈ Non-participating preference shares:
Non- participating preference shares are entitled only to a fixed rate of dividend and do not
share in the surplus profits. The preference shares are presumed to be non-participating, unless
expressly provided in the memorandum or the articles or the terms of issue.
◈ Convertible preference shares:
Convertible preference shares are those shares which can be converted into equity shares
within a certain period.
◈ Non-Convertible preference shares:
These are those shares which do not carry the right of conversion into equity shares.
◈ Redeemable preference shares:
A company limited by shares, may if so authorized by its articles issue preference shares
which are redeemable as per the provisions laid down in Section 80. Shares may be redeemed
either after a fixed period or earlier at the option of the company.
◈ Irredeemable preference shares
◈ Guaranteed preference shares:
These shares carry the right of a fixed dividend even if the company makes no or insufficient
profits.
 Debt Instruments
◈ A debt instrument is used by either companies or governments to generate funds for
capital-intensive projects.
◈ It can obtained either through the primary or secondary market.
◈ The relationship in this form of instrument ownership is that of a borrower – creditor
and thus, does not necessarily imply ownership in the business of the borrower.
◈ The contract is for a specific duration and interest is paid at specified periods as stated
in the trust deed* (contract agreement). 
◈ The principal sum invested, is therefore repaid at the expiration of the contract period
with interest either paid quarterly, semi-annually or annually.
◈ The interest stated in the trust deed may be either fixed or flexible.
◈ The tenure of this category ranges from 3 to 25 years.
◈ Investment in this instrument is, most times, risk-free and therefore yields lower returns
when compared to other instruments traded in the capital market.
◈ Investors in this category get top priority in the event of liquidation of a company.
 DEBENTURES
◈ When a corporation is in need of fund in addition to share capital it borrows
money by issuing debentures. The debenture holder gets interest which is fixed
at the time of issue.
◈ TYPES OF DEBENTURES
🞚 Redeemable or irredeemable ( life time, Such debentures are paid back only
when the company goes to liquidation.)
🞚 Convertible or nonconvertible (can be converted into shares of the company
on the expiry of pre-decided period. )
🞚 Secured or unsecured (mortgage debentures)
🞚 Bearer or registered (transferable)
 Bonds
A bond is a debt investment in which an investor loans money to an entity (typically
corporate or governmental) which borrows the funds for a defined period of time at a
variable or fixed interest rate. Bonds are used by companies, municipalities, states and
sovereign governments to raise money and finance a variety of projects and activities.
Owners of bonds are debtholders, or creditors, of the issuer.
▪ Tenure = 5 to 30 Years
▪ Types of Bonds:
⮚ Term Bond or Serial Bond
⮚ Floating Rate Bond or Fixed Rate Bond
⮚ Bearer or registered (transferable)
⮚ Coupon Based Bond or Zero Coupon Based Bond
⮚ Detachable Warrant Bond or Non - Detachable Warrant Bond
⮚ Convertible Bonds or non - convertible Bonds
 Derivative Contracts
◈ A derivative is a financial instrument whose value is derived from the value of another
asset, which is known as the underlying.
◈ When the price of the underlying changes, the value of the derivative also changes.
◈ A Derivative is not a product. It is a contract that derives its value from changes in the
price of the underlying.
◈ Example :The value of a gold futures contract is derived from the value of the underlying
asset i.e. Gold.
◈ Types of Derivatives contracts are:
◈ Futures
◈ Options
◈ Swaps
◈ Rights
 Basic Purpose of Derivatives
◈ In Derivative Transactions, one party’s loss is always another party’s
gain
◈ The main purpose of derivatives is to transfer risk from one person
or firm to another, that is, to provide insurance
◈ If a farmer before planting can guarantee a certain price he will
receive, he is more likely to plant
◈ Derivatives improve overall performance of the economy
 Traders in Derivatives Market
There are 3 types of traders in the Derivatives Market :
1. HEDGER
◈ A hedger is someone who faces risk associated with price movement of an asset
and who uses derivatives as means of reducing risk.
◈ They provide economic balance to the market.
2. SPECULATOR
◈ A trader who enters the futures market for pursuit of profits, accepting risk in
the endeavour.
◈ They provide liquidity and depth to the market.
3. ARBITRAGEUR
◈ A person who simultaneously enters into transactions in two or more markets to
take advantage of the discrepancies between prices in these markets.
◈ Arbitrage involves making profits from relative mispricing.
◈ Arbitrageurs also help to make markets liquid, ensure accurate and uniform
pricing, and enhance price stability
◈ They help in bringing about price uniformity and discovery.
 Forward Contracts
◈ A forward is a contract in which one party commits to buy and the other party
commits to sell a specified quantity of an agreed upon asset for a pre-
determined price at a specific date in the future.
◈ It is a customised contract, in the sense that the terms of the contract are agreed
upon by the individual parties.
◈ Forwards are also known as Private Contracts
◈ Normally traded outside exchange. Hence, it is traded OTC.

I agree to sell Bread Farmer 500kgs

Farmers wheat at Maker Rs.40/kg after 3 Bread Maker
months

3 Months Later
500 kgs
Farmers Bread Maker

Rs. 20,000
 Future Contracts
◈ 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 exact Future date and price.
◈ A future is a standardised forward contract.
◈ It is traded on an organised exchange.
◈ Standardisations-
- quantity of underlying - quality of underlying (not required in financial futures) -
delivery dates and procedure - price quotes
◈ Some of the most popular assets on which futures Contracts are available are
equity stocks, indices, Commodities and Currency.
 Option Contract
◈ Contracts that give the holder the option to buy/sell specified quantity of
the underlying assets at a particular price on or before a specified time
period.
◈ The word “option” means that the holder has the right but not the
obligation to buy/sell underlying assets.
◈ Types of Options– call and put.
🞚 Call option give the buyer the right but not the obligation to buy a given quantity
of the underlying asset, at a given price on or before a particular date by paying a
premium.
🞚 Puts give the buyer the right, but not obligation to sell a given quantity of the
underlying asset at a given price on or before a particular date by paying a
premium.
 Types of Options (cont.)
◈ The other two types are – European style options and American style options.
◈ European style options can be exercised only on the maturity date of the option,
also known as the expiry date.
◈ American style options can be exercised at any time before and on the expiry
date.
CALL OPTION
Right to buy 100 Reliance shares at Amt to buy call
a price of Rs.300 per share before 3 option= Rs. 2500
Current price= Rs. 250
months Strike price
Expiry Date

Suppose after a month, Market price is Rs.400, then

the option is exercised i.e., the shares are bought. Suppose after a month, market price is
Net gain = 40,000-30,000- 2500 = Rs.7500 Rs.200, then the option is not exercised.
 PUT OPTION

Amt to buy put option=

Rs. 2500 Right to sell 100 Reliance
shares at a price of Rs.300 per Strike price
share before 3 months Expiry Date
Current price= Rs. 250

Suppose after a month, Market price is Rs.200, then

Suppose after a month, market price is
the option is exercised i.e., the shares are sold.
Rs.300, then the option is not exercised.
Net gain = 30,000-20,000- 2500 = Rs.7500
 Swap Contract
◈ Swaps are private agreement between two parties to exchange cash flows in the
future according to a pre-arranged formula.
◈ They can be regarded as portfolio of forward contracts
◈ The two commonly used Swaps are:
(i) Interest Rate Swaps : An interest rate swap entails swapping only the interest
related cash flows between the parties in the same currency.
(ii) Currency Swaps : A currency swap is a foreign exchange Agreement between
two parties to exchange a given amount of one currency for Another and after a
specified period of time, to give back the original Amount swapped.
Thank You