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Module 2
Investment avenues
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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, commercialproperty, agricultural farm, gold, precious stones, art
objects.
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Financial assets Investments in financial assets include1. Securitised investments
2. Non-securitised investments
Securities are those instruments which arequoted and are transferable. Eg. Shares, bonds
Non-securitised investments are those which arenot quoted and not freely marketable Eg. Bank deposits, national savings, insurance
policies
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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
Liquidity
An investment is highly marketable if it can be
bought and sold quickly with a minimum loss.
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Investment attributes
Tax advantages Initial, ongoing or terminal tax shelters.
Convenience 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
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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
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Money market instruments
These are debt instruments which have a maturityof 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
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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.
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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 bills9
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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
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Money market instruments
Repos and Reverse Repos (repurchaseagreement)
Involves simultaneous sale and purchase
agreement.
Government securities are transferred to aninvestor 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
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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 naturematurities 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 areallowed to only lend in these markets. They are
encouraged to participate in the repo market
RBI wants to convert the call money market into apure interbank money market
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Bonds or debentures
Bonds are long term, fixed income, debtinstruments.
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.
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Government securities
Government securities are also called as giltedged securities or treasury bonds
Issued by central government, state government
and quasi-government bodies
Carry a fixed coupon rate, have a fixed maturityperiod, 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.
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Government securities
Government securities Banks, FIs, insurance companies, corporates,
FIIs, primary dealers, mutual funds invest in these
securities
RBI maintains a special account called SubsidiaryGeneral 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 tohold securities in demat form.
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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.
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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
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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 beconverted 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
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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
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Types of debentures
Secured or unsecured
Fully convertible
Partly convertible
Non-convertible
Registered / Unregistered
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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
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Classification of equity shares
Blue chip
shares of large, well establishedcompanies
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 whoseoperations are of a cyclical nature.
Defensive shares shares of companies
unaffected by ups and downs in the market
Speculative shares
shares tend to fluctuate22
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Types of equity shares Sweat equity are shares issued to employees and
directors at a discount for considerations other thancash for services rendered like providing know-how,making available intellectual property right
Non-voting shares are shares issued with no votingrights or with minimum voting rights. Preferenceshares are a form of non-voting shares. These sharesget a slightly higher dividend to compensate for non-voting rights.
Rights shares are shares offered to existingshareholders at a price by the company in proportionto the shares held by them.
Bonus shares are issued in addition to the cashdividends paid to the existing shareholders. The aim
of bonus shares is to capitalise free reserves. Bonus23
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Advantages of equity shares
Do not create an obligation to pay a fixed rate ofdividend
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
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Preference shares
Preference shares are hybrid in nature i.e. theycarry the features of both debt and equity.
Carry a fixed rate of dividend
Dividend is paid out of distributable profits
Preference shares are cumulative. Dividendskipped in a particular year can be paid in the next
year
Redeemable in 7 to 12 years
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Preference shares
Preference share holders enjoy preferences intwo 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
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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 dividendhas been paid
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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
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Hybrid security
Preference share is a hybrid form of security as ithas 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
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Warrants
Warrant is a document of title to buy specifiednumber 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 aprice called exercise price.
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Bank deposits
Demand deposit Saving deposit
Term deposit
Recurring deposit Current account
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Insurance Insurance is a form ofrisk 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.
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Mutual fund schemes
A mutual fund is a vehicle for collectiveinvestment.
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 ispassed on to the investors after deducting the
deducting the administrative expenses and
investment management fees.
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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 feedback 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.
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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 inderivatives?
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