Financial Instruments

Equity Share

An equity share, normally known as ordinary share is a part ownership where each member is a
fractional owner and initiates the maximum entrepreneurial liability related with a trading concern. These
types of shareholders in any organization possess the right to vote.
Features of Equity Shares Capital
● Equity share capital remains with the company. It is given back only when the company is closed
● Equity Shareholders possess voting rights and select the company’s management
● The dividend rate on the equity capital relies upon the obtainability of the surfeit capital. However, there is
no fixed rate of dividend on the equity capital

Types of Equity Share

● Authorized Share Capital- This amount is the highest amount an organization can issue. This amount can
be changed time as per the companies recommendation and with the help of few formalities.
● Issued Share Capital- This is the approved capital which an organization gives to the investors.
● Subscribed Share Capital- This is a portion of the issued capital which an investor accepts and agrees
upon.
● Paid up Capital- this is a section of the subscribed capital that the investors give. Paid-up capital is the
money that an organization really invests in the company’s operation.
● Right Share- These are those type of share that an organization issue to their existing stockholders. This
type of share is issued by the company to preserve the proprietary rights of old investors.
● Bonus Share- When a business split the stock to its stockholders in the dividend form, we call it a bonus
share.
● Sweat Equity Share- This type of share is allocated only to the outstanding workers or executives of an
organization for their excellent work on providing intellectual property rights to an organization.

Merits of Equity Shares Capital

● ES (equity shares) does not create a sense of obligation and accountability to pay a rate of dividend that is
fixed
● ES can be circulated even without establishing any extra charges over the assets of an enterprise
● It is a perpetual source of funding and the enterprise has to pay back; exceptional case – under liquidation
● Equity shareholders are the authentic owners of the enterprise who possess the voting rights

Demerits of Equity Shares Capital

● The enterprise cannot take either the credit or an advantage if trading on equity when only equity shares are
issued
● There is a risk or a liability over capitalization as equity capital cannot be reclaimed
● The management can face hindrances by the equity shareholders by guidance and systematizing themselves
● When the firm earns more profits, then, higher dividends have to be paid which leads to raising in the value
of the shares in the marketplace and its edges to speculation as well

PREFERENCE SHARES
● Preference shares are a kind of equity shares that do not have the same voting rights as ordinary equity
shares.
● Unlike ordinary shares, preference shares pay a pre-defined rate of dividend.
● The dividend is payable after all other payments are made, but before dividend is declared to equity
shareholders.
● Preference shares combine features of equity and debt, they carry equity risk as the principal is not secured
and they give out dividend similar to an interest.
● Preference shares can be convertible into ordinary shares as well as nonconvertible.
● Preference shares are similar to debentures in the sense that the rate of dividend is fixed and preference
shareholders do not generally enjoy voting rights. Therefore, preference shares are a hybrid form of
financing.
Advantages:
1. Appeal to Cautious Investors: Preference shares can be easily sold to investors who prefer reasonable
safety of their capital and want a regular and fixed return on it.
2. No Obligation for Dividends: A company is not bound to pay dividend on preference shares if its profits
in a particular year are insufficient. It can postpone the dividend in case of cumulative preference shares
also. No fixed burden is created on its finances.
3. No Interference: Generally, preference shares do not carry voting rights. Therefore, a company can raise
capital without dilution of control. Equity shareholders retain exclusive control over the company.
4. Trading on Equity: The rate of dividend on preference shares is fixed. Therefore, with the rise in its
earnings, the company can provide the benefits of trading on equity to the equity shareholders.
5. No Charge on Assets: Preference shares do not create any mortgage or charge on the assets of the
company. The company can keep its fixed assets free for raising loans in future.
6. Flexibility: A company can issue redeemable preference shares for a fixed period. The capital can be
repaid when it is no longer required in business. There is no danger of over-capitalisation and the capital
structure remains elastic.
7. Variety: Different types of preference shares can be issued depending on the needs of investors.
Disadvantages:
1. Fixed Obligation:Dividend on preference shares has to be paid at a fixed rate and before any dividend is
paid on equity shares. The burden is greater in case of cumulative preference shares on which accumulated
arrears of dividend have to be paid.
 2. Limited Appeal:
Bold investors do not like preference shares. Cautious and conservative investors prefer debentures and
government securities. In order to attract sufficient investors, a company may have to offer a higher rate of
dividend on preference shares.
3. Low Return:
When the earnings of the company are high, fixed dividend on preference shares becomes unattractive.
Preference shareholders generally do not have the right to participate in the prosperity of the company.
4. No Voting Rights:
Preference shares generally do not carry voting rights. As a result, preference shareholders are helpless and
have no say in the management and control of the company.
5. Fear of Redemption:
The holders of redeemable preference shares might have contributed finance when the company was badly
in need of funds. But the company may refund their money whenever the money market is favourable.
Despite the fact that they stood by the company in its hour of need, they are shown the door
unceremoniously.

Warrants
Definition : Warrants are a derivative that gives the right, but not the obligation, to buy or sell a security
most commonly an equity at a certain price before expiration. The price at which the underlying security
can be bought or sold is referred to as the exercise price or strike price.

Types of warrants :
● a call warrant and a put warrant.
● A call warrant is the right to buy shares at a certain price in the future.
● A put warrant is the right to sell back shares at a specific price in the future.

Stock warrant:
● A stock warrant differs from an option in two key ways: a company issues its own warrants, and the
company issues new shares for the transaction.
● A stock warrant represents the right to purchase a company's stock at a specific price and at a specific date.
A stock warrant is issued directly by a company to an investor.
Stock Option:
● Stock options are purchased when it is believed the price of a stock will go up or down. Stock options are
typically traded between investors.
● When stock options are exchanged, the company itself does not make any money from those transactions.
Stock warrants can last for up to 15 years, whereas stock options typically exist for a month to two to three
years.
● For long-term investments, stock warrants may be a better investment than stock options because of their
longer terms. However, stock options may be a better short-term investment.

DEBENTURES

● Debentures are some of the debt instruments which can be used by the government, companies,
organization for the purpose of issuing the loans.
● It is not secured by collateral and usually has a term greater than 10 years and is given only to the issuer
that has creditworthiness and reputation.
● They have a certificate of debt with the date of redemption (action of seeking) and the amount of repayment
mentioned on it. This certificate is issued under the company sale and is known as a Debenture Deed.
● Debentures have a fixed rate of interest and such interest amount is payable yearly or half yearly.
● Debentures holders do not get any voting right this is because they are not instruments of equity (amount
of money that would be returned to a company shareholder).
● Eg: When companies need to borrow some money to expand themselves they take the help of debenture

Bonds
What is a bond?
❖ A bond is a fixed income instrument that represents a loan made by an investor to a borrower (typically
corporate or governmental).
❖ Bonds are units of corporate debt issued by companies and are securitized as tradable assets.
❖ A bond is referred to as a fixed income instrument since bonds traditionally paid a fixed interest rate
(coupon) to debt holder. Variable/ floating interest rates are also now quite common.
❖ Bond prices are inversely correlated with interest rates - when rates go up, the bond prices fall and vice
versa.
❖ Bonds have maturity dates at which point the principal amount must be paid back in full / risk default.
Governments, at all levels to fund roads, other infrastructure and corporations to grow their business
commonly use bonds in order to borrow money.
❖ When an investor purchases a bond, they are ‘loaning’ that money (called the principal) to the bond issuer,
who is usually raising money for some project. When the bond matures, the issuer repays the principal to
the investor. In most cases, the investor will receive regular interest payments from the issuer until the bond
matures.
Characteristics of Bond
a) Face value - Money amount the bond will be worth at maturity. It is the reference amount the bond issuer
uses when calculating interest.
b) Coupon rate - Rate of interest the bond issuer will pay on the face value.
c) Coupon dates - date on which the bond issued will bank interest payments.
d) Maturity date - It is the date on which the bond will mature, and the bond issuer will pay the bondholder
the face value of the bond.
e) Issue price - It is the price at which the bond issuer originally sells the bonds.

Categories of bonds - corporate, municipal, governmental, agency.

Varieties of bonds - zero-coupon, convertible, callable, puffable, junk bond (credit rating BB and offers
high coupon rate due to higher default value).
Bonds are often viewed as a less risky alternative to stocks.
Advantages:
1) Regularly scheduled payments.
2) Return of invested principal.
Hence, Bonds are a more stable form of investing.
Risk:
1) Default risk - Defaults on paying back the principal. Typically bonds with higher risk have a higher
coupon rate. Risk depends on credit rating.
Example – Government bonds are safe and corporate bonds are risky hence they offer more coupon rate.
2) Interest rate risk - If the interest rate goes up, then the resale value goes down, if sold before the
maturity date.
Real world example: Imagine a bond issued at a coupon rate of 5% having $1000 face value. Hence, the
bondholder will receive $50 annually.
However, if the interest rates begin to decline and similar bonds are now issued with 4% coupon, the original
bond will become more valuable (since it has a 5% coupon rate). Investors who want a higher coupon rate
will have to pay extra for this bond that has now a value above par.
On the other hand, if the interest rates rise, the coupon is no longer attractive. Therefore, the bond's price
will decrease and will be sold at a discount known as below par value bonds.
 Treasury Bills:
When the government is going to the financial market to raise money, it can do it by issuing two types of
debt instruments:-
1. Treasury bills
2. Government bonds.

Treasury bills are issued when the money is needed by government for a shorter period. Treasury bills are
T-bills, have a maximum maturity of 364 days. Hence they are categorized as money market instruments
(i.e money market deals with funds with a maturity of less than a year). T-bills are presently issued in 3
maturities namely, 91 days, 182 days and 364 days. Treasury bills are zero coupon securities and pay no
interest.

Rather, T-bills are issued at a discount and redeemed at the face value at maturity. Example:- A 91 day T-
bill of Rs 100/- (face value) maybe issued at stay Rs 98.20/- ,that's a discount of Rs 1.80/- and would be
redeemed at the face value of Rs 100/-. This means that you can get a hundred-rupee treasury bill at a lower
price and can get rupees hundred at maturity.

The return to the investors is the difference between the maturity value and the issue price. The Reserve
Bank of India conducts auctions usually every Wednesday to issue T-bills. T-bills are free of credit risk
too, but are subject to interest rate risk.
Real world example: - ICICI direct Minimum Investment Rs 10000/-
Cost of security: Cut off Price +Commission / Brokerage (Rs 0.06/- per Rs 100/-).
Risk: Interest rate risk

Commercial Paper

Commercial paper is an unsecured short term debt instrument issued by a corporation typically for
financing of accounts receivable inventories and meeting short term liabilities. Commercial paper is usually
issued at a discount from face value and reflects prevailing market interest rates. Commercial paper is a
short term loan that is less than 270 days .It is relied on heavily by large corporations and financial
institutions as means of fulfilling short term liabilities.

Features of Commercial Paper:

● The maturity period of a commercial paper lies between 15 days to less than 1 year.
● There is no well developed secondary market for commercial paper rather they are placed with existing
inventors who intend to hold it till it gets matured.
● Commercial papers have a variety of benefits to both the issuer as well as the inventor.
● Even though the debt is unsecured it is typically backed by lines of credits at the institutions issuing the
paper.
● Interest on loan is paid up in one lump sum of maturity.

Call Money

● Call money market is the most sensitive segment of the financial system.
● Call money is categorized as a very short term loan typically ranging from 1-14 days.
● Call money deals with day-to-day surplus funds of banks.
● It maintains equilibrium in their short term equity positions.
● It also helps to maintain the Cash reserve ratio CRR.
● Call money rates are usually influential in margin borrowing rates of brokerage accounts. Since call money
serves as a source of funds to cover margin lending.
● Call money loans are avail to auctions and higher bidder gets the loan.
● Negotiated Trading System NTS deals with call money.
● Participants in Indian Call Money market are :-
1. Indian and Foreign Commercial Banks
2. Co-operative Banks
3. Discount and Finance House of India DFHI
These 3 participate as both lenders and borrowers.
● UTI, LIC and NABARD are only lenders.

Short Notice Money

● The money market facilitates lending and borrowing of funds between banks and primary dealers.
● Banks primary dealers borrow and lend for a short period of time to meet their mismatch in fund positions.
● The repayment of the lent funds to discount houses, money brokers, stock exchange,etc within a given
period of quid asset called short notice money.
● The period is usually of 2 to 14 days.
● After cash, short notice money is bank's most liquid asset.
● Liquid asset
 i] Liquid asset is something you own and that can be quickly and simply converted to cash while retaining
its market value.
ii] Liquid assets include accounts, deposit and some precious metals like gold and silver.
● They provide banks with an opportunity to use their surplus funds and to adjust their cash and liquidity
requirements.

Certificate of Deposit

● It is a certificate issued by a bank to a person depositing money for a specified length of time at a specified
rate of interest.
● Certificates of deposits are a secure form of time deposit where money must stay in the bank for a certain
length of time to earn a promised return.

Features:

1. Eligibility: Only scheduled commercial banks/ financial institutions of India (allowed by RBI) can issue
certificate of deposits. Cooperative banks and regional rural banks cannot issue these certificates.
2. Maturity Period: A Certificate of Deposit issued by the commercial banks can have a maturity period.
3. Transferability: Certificates which are available in demat forms must be transferred according to the
guidelines followed by demat securities.
4. Availability of Loan: Since these instruments do not have any lack in period, banks do not grant loans
against them.

Advantages:
1. Your funds are safe.
2. They offer higher interest rates than interest bearing savings accounts.

Disadvantages:
1. Your money is tied up for the life of the certificate.
2. You pay a penalty if you need to withdraw your money before the end of the term.
3. You could miss on investment opportunities.

COMMERCIAL BILLS

● A commercial bill is a short term negligible and self-liquidating money market instrument which evidences
the liability to make a payment on a fixed date when goods are brought on credit.
● It is an asset with high degree of liquidity and a low degree of risk
● Commercial bills are used to finance the management and storage of agricultural and industrial goods in
domestic and foreign trade.
● The normal maturity period of bills varies for 30 days,60days and 90 days
1. Demand & bills
- Bills which are articulated to be payable on demand are called demand bills.
- Bills which are expressed to be payable at a specified future date.
- 2. Inland & foreign bills
- Inland are drawn between two parties that are located & are made payable
- In the same country
- Two parties from different countries.

● Advantages & Disadvantages

1. Working capital can be raised quickly & cost effective manners.
2. Relatively cheaper in comparison to bank loans.
3. It is very closely regulated by RBI guidelines.
4. It is available to a few selected blue chip & profitable companies.
● Liquidity describes to which an asset or security can be quickly bought or sold in the market at a price
reflecting its intrinsic value.

Mutual fund

• Mutual funds- A mutual fund is a type of financial vehicle made up of a pool of money collected
from many investors to invest in securities like stocks, bonds, money market instruments and other assets.
• Working of mutual funds-mutual funds pool money from the investing public and use that money
to buy other securities usually stocks and bonds. It depends upon the performance of securities. Unlike
stock, mutual fund shares do not give its holder any voting rights.
• Types of mutual funds-equity funds, fixed income funds, index funds, balanced funds, money
market funds, income funds, exchange traded funds.
• Pros of mutual funds-
1. Liquidity
2. Diversification
3. Minimal investment requirements
4. Professional management
5. Variety of offerings.
• Cons of mutual funds
1. High fees, commissions and other expenses.
2. Large cash presence in portfolios.
3. No FDIC coverage.
 4. Difficulty in comparing funds.
5. Lack of transparency in holdings.
• Conclusion with example-A mutual fund is both an investment and an actual company. This dual
nature may seem strange, but it is no different from how a share of AAPL is a representation of Apple Inc.
When an investor buys Apple stock, he is buying partial ownership of the company and its assets. Similarly,
a mutual fund investor is buying partial ownership of the mutual fund company and its assets. The difference
is that Apple is in the business of making smartphones and tablets, while a mutual fund company is in the
business of making investments.

Convertible debentures.
A convertible debenture is a type of long term debt issued by the company that can be converted into stock
after a specified period. These long term debt securities pay interest returns to the bondholder, who is the
lender. Their unique feature is that they can be converted into stock after a specified time. These features
give the bondholder some security that may offset some of the risks involved with investing in unsecured
debt. These are issued by companies which are willing to raise capital. Companies use convertible
debentures as fixed rate loans, paying the bondholder fixed interest payments. These debentures can be
converted into stock with some ratio eg. 10:1 i.e. 10 shares for each debenture purchased.

Lets say a company wants to expand its business internationally for the first time. It offers debentures to
raise capital with an interest rate of say 2% and with a 20:1 conversion ratio.

Case 1: The international expansion is a hit and the company’s stock prices rise. Hence, the bondholders
have the option to convert debentures into stocks.

Case 2: The international expansion fails and the company stock prices plummet. The bondholders are safe
as they will still receive returns at the given rate.

LEASE FINANCING
1. Lease financing is one of the important sources of medium and long term financing where the owner of an
asset gives another person, the right to use that asset against periodical payments.
2. The owner of the asset is known as the lessor and the user is called lesse.
3. The periodical payment made by the less to the lessor is known as lease rental
4. Under lease financing, lesse is given the right to use the asset but ownership lies with lessor and at the end
of the lease contract, the asset is returned to the lessor or an option lesse to either purchase the asset or to
renew the lease agreement.
5. Assets such as vehicles, equipment or software are popular items attracting lease finance.
6. Only tangible assets can be leased.
Different types of lease:
Depending upon the transfer of risk and rewards to the lessee, the period of lease and the number of parties
to the transaction, lease financing can be classified into two categories.
Finance lease and operating lease.
1. Finance lease:
It is the lease where the lessor transfers substantially all the risks and rewards of ownership of assets to the
lessee for lease rentals. In other words, it puts the lessee in the same con-dition as he/she would have been
if he/she had purchased the asset.

[Link] lease:
In operating lease , risks and rewards incidental to the ownership of assets are not transferred by the lessor
to the lessee. The term of such lease is much less than the economic life of the asset and thus the total
investment of the lessor is not recovered through lease rental during the primary period of lease.

ADVANTAGES
Lessor Lesse

Assured regular income Use of capital goods

Preservation of ownership Inflation friendly

Recovery of investment

Collateral Value

Collateral Value is the market value of anything used as collateral to support a loan. Collateral value is one
of the key aspects considered by lenders when reviewing applications for secured loans. In a secured loan,
the lender has the right to obtain ownership of a particular asset—called the "collateral" of the loan—in the
event that the borrower defaults on their obligation. In theory, the lender should be able to recover all or
most of their investment by selling the collateral. Therefore, estimating the value of that collateral is a key
step before any secured loan is approved. Secured loans can be made against all types of property. One of
the most common types of secured loan is the home mortgage, in which the house is given as collateral to
secure the mortgage loan. In this situation, if the borrower fails to make their mortgage payments, the
mortgage lender can sell the house in order to recuperate their investment.

The size of a secured loan relative to its collateral value is known as the loan-to-value ratio (LTV). For
example, if a bank provides an $800,000 loan in order to purchase a house with a collateral value of $1
million, then its LTV ratio would be 80%.
 Depending on the type of asset being used as collateral, the methods for assessing collateral value may
differ. For instance, if a loan is being secured by publicly-traded stock, then the current market price of
those securities can be used when estimating its collateral value. If a borrower might pledge collateral in
the form of privately held shares or alternative assets, such as fine art or rare collectors items. In these
situations, an appraiser may need to use specialized valuation methods, such as calculating the value of the
private shares by using discounted cash-flow analysis (DCF). Fine art and other rare items, meanwhile, may
need to be appraised by specialists who are familiar with the private collector and auction markets for those
types of assets.

Forfaiting

Definition: Forfaiting is a means of financing that enables exporters to receive immediate cash by
selling their medium and long-term receivables—the amount an importer owes the exporter—at a
discount through an intermediary.

● Forfaiting is an international supply chain financing method.

● Forfaiting means the discount of future payment obligations on a without recourse basis.
● It helps exporters or international manufacturing companies to reach cash flow by selling their
debts.
● Forfaiting can be applied to a wide range of trade related and purely financial receivables typically
have maturities from 3 months to 10 years.
● Forfaiting can be applied to both international and domestic transactions.
● 100% financing without recourse to the seller of the debt
● The payment obligation is often but not always supported by a bank guarantee
● The debt is usually evidenced as a legally enforceable and transferable payment obligation such as
a bill of exchange, promissory note or letter of credit.
● Debt instruments are typically denominated in one of the world’s major currencies, with Euro and
US Dollars being most common.
● Finance can be arranged on a fixed or floating interest rate basis.

Hire Purchase

Introduction:
Hire purchase is an arrangement for buying expensive consumer goods, where the buyer makes an initial
down payment and pays the balance plus interest in installments over a period of time. This might sound
 similar to payment in installations but there are certain stark differences between the two. There are two
main points that are common among all hire purchases:
● The buyer gains access to but not ownership of the goods/services he is paying for. The ownership is only
transferred after the entire payment due has been given which means that the buyer won’t have ownership
until the stipulated time period of payment is over. In the case of payment by installations, the buyer gains
ownership as well as access to the goods/services.
● The goods/services can be reacquired by the seller at any point of time during the period, if he/she feels
that the due payments aren’t coming in or distrusts the buyer’s ability to be able to complete the transaction.
This differs from the case in payment by installations.
Hire purchase has some clear advantages and disadvantages when it comes to the customer, these are:

Advantage:
Hire purchase is an excellent scheme for customers who have a guaranteed and steady source of income to
acquire expensive commodities that they might need urgent access to. Their steady source of income
guarantees that they’ll be able to finish payment of the whole amount including the interest over time period
they opt for, for the hire purchase. This puts more power in the hands of customers who might not have
huge amounts of money ready at the go.

Disadvantage:
The interest rate in the case of hire purchase is quite substantial in a lot of cases. This means that the total
balance the buyer has to pay when opting for this scheme is usually far higher than the original cost price
of the goods/services. And since the customer does not gain ownership until the entire payment over the
time period has been finished, the threat of having the goods/services seized if the customer cannot produce
payments is always present. The time period in a lot of such cases is also quite long.

The most common examples of hire purchase is one that almost everyone has encountered at some point in
his/her life, vehicle purchases. Hire purchases may even extend to things such as a computer, computer
parts, furniture, all the way from certain property purchases.