Type of Securities

• It is the segment of the financial market of an economy where long term capital is raised via security instruments such as Debt, Equity and Derivatives. 
• There are different ways to classify Security Markets.

Classification 1: Type of Security being Traded

Classification 2: By Tenure of Securities

Classification 3: By Freshness of Security

Classification 4: By Settlement of Security

• Consider a hypothetical situation – A businessman has ₹5 Lakh & to start a business, he needs ₹10 Lakh. Now the question arises that, how can he arrange the rest 5 Lakhs? Answer – He can approach Security Market to raise capital via Debt or Equity.

• In general, if anybody wants to start a business, he/she will need 4 factors of production

• And to arrange these factors of production, one needs a truckload of money which can be raised via Debt or Equity. These instruments have their advantages and disadvantages, which we will discuss in detail in the chapter.

• They have a maturity period of less than 1 year.
• The market where they are sold is called Money Market.
• They are highly liquid as they can be sold and resold very easily. 
• These are sold at a discount to face value and bought at face value after a fixed number of days (all Short Term Debt instruments that are mentioned below are sold and purchased in this way)
• E.g., T-Bill issued by the government for a period of up to 14 days.

Short Term Debt Instruments issued by various agencies

1 . Government

1.1 T-Bills or Treasury Bills

• T-Bills have a maturity period of 14, 91, 182 or 364 days.
• Treasury bills are zero-coupon securities as they don’t pay interest. They are issued on a discount to face value and redeemed at face value upon maturity.
• Note: State Governments don’t issue T-Bills (till 2001, they used to issue, but RBI stopped this in 2001).

1.2 Cash Management Bills (CMB)

• They can have a maturity period of up to 90 days.

1.3 Ways & Means Advances

• The mechanism through which RBI lends money to the government for temporary short term needs when there is a mismatch in receipt and expenditure of the government.

2 . Companies

• Commercial Papers
• Promissory Notes

Both work the same as T-Bills but are issued by Companies.

3 . Banks

• Certificate of Deposits: Work same as T-Bills.
• Call Money: Banks inter-borrow among themselves for 1 day for CRR Adjustment.
• Notice Money: Same as Call Money but for a period between 2 to 14 days.
• Repo Agreements: Monetary Policy instrument under which bank lends from RBI for up to 14 days.

4 . Merchant

• Commercial Bill: Merchant sells his unpaid invoice to bank at a discount and again buys the same invoice at face value when recovery date of invoice arrives.

5 . MSMEs

• Factoring: Under Factoring, MSME owner pledges his unpaid invoice made to Corporates to Bank or NBFC at a discount and then again buys invoice at face value when recovery date of invoice arrives. It is conducted through electronic system called Trade Receivables Electronic Discounting System (Treds).

Bond Yields, in essence, shows the financial return the owner of the bond is going to get from the bond at any given time. The simplest version of yield is calculated in the following manner:

If the bond price remains constant (i.e., equal to the face value), then the yield of the bond is the same as the interest rate. But the Bond prices seldom remain constant and are subject to change.

Bond Yield is the profit percentage that an investor is earning from the given bond. It is calculated by dividing interest earned by the investor with the Par Value of Bond for that investor.  

Bond Yield increases in two cases

• During Boom Period: In this period, the investor is interested in investing his money in companies likely to grow faster and sell his existing bonds even at a lesser value to invest his money in growing companies.
• When the country’s economy is about to collapse, investors try to sell it at lower rates before sovereign default and get whatever they can. The implication is that when the government issues new shares, the government has to offer very high interest (greater than the Bond Yield of earlier floating bonds) to attract investors toward new bonds. 

Bond Yield on G-Secs

• The yields on 10-year G-sec, which had reached 8.2 per cent on 26th September 2018, reduced substantially to reach 5.75 per cent in June 2020. It has since then increased to stand at 6.45 per cent as of 31st December 2021.

• Long Term Debt Instruments have a period of maturity greater than 1 year.
• They are sold in called Capital Market.

Types

They are of various types

2.2.1 Redeemable Bonds

• The company will pay regular interest and return the principal on maturity. 

2.2.2 Irredeemable Bonds

• The company will pay only interest, but the principal is not returned.

2.2.3 Partially Convertible Debenture

• The company will pay interest, but at the time of maturity, some portion of the bonds will be converted to shares, and on the rest, the principal will be repaid. 
• Eg : 70% Debenture + 30% Share .

2.2.4 Fully Convertible

• The company will pay interest, but at maturity, bonds will be converted to shares (and the principal is not paid).

2.2.5 Optionally Fully Convertible Debentures

• The company will pay interest, but at the time of maturity, the company can give the investor an option to convert his bonds/ debentures to shares (just an option that the investor can accept or reject). But the ‘rate’, will be decided by the company (i.e., how many shares against how many debentures). 

• These are offshore ₹ denominated bonds.   
  1. They are known as Masala Bonds because India is famous for Spices (Formosa Bonds for Taiwan, Samba Bonds for Brazil, Samurai Bond for Japan). 
  2. They are called ‘Offshore‘ because they are floated in London and other foreign Exchanges.
  3. ‘₹ denominated’ because they are sold & bought in ₹ (& not $).
• Benefits of Masala Bond
  1. They help in fighting local currency volatility. The investor must bear the currency volatility in Masala Bonds because they buy these bonds in Rupee and later get back their principal and interest in Rupee. 
  2. Interest Rate is also low because they are issued by World Bank (IFC) and not the company itself. Hence, they are very secure (Aaa rated) because in case the company refuses to pay, World Bank will pay on its behalf.
• The move to permit Masala bonds is an attempt to increase the international status of ₹ and is also a step toward full currency convertibility.

Recent activities in Masala Bonds

• Indian Railway Finance Corporation (IRFC) has raised $ 1 billion via Masala Bonds.
• NHAI raised capital via Masala Bonds to fund their highway projects.
• Kerala Government’s Kerala Infrastructure Investment Fund Board raised capital via Masala Bonds, becoming the first state. 

• Rupee Denominated Bond issued in India by World Bank’s IFC.
• Maharaja Bonds are the same as Masala Bond, but these bonds are issued in India.
• They are also ‘Aaa’ rated, so interest rates are very low. 

Side Topic: Formosa Bonds

• Formosa bonds are bonds issued in Taiwan and denominated in currencies other than the Taiwanese Dollar. 
• Formosa bonds are issued by foreign companies in Taiwan. 
• In 2022, SBI has raised $300 million from Taiwan in the form of Formosa Bonds. 

Appendix: Offshore Bonds

• The basic concept behind equity: You borrow money from someone & in return, you offer a partnership. 
• Equity holders are called owners/ proprietors of the company.
• Equity holders are given dividends in case the company earns a profit. But they have the last claim during the liquidation of the company.

There are two types of shares

1. Ordinary shares

• They are the most common type of Shares.
• Ordinary shareholders have voting power in shareholders’ meetings, and they have the last claim during liquidation.

2. Preference shares

• Although retail investors are also eligible, they are generally issued to banks by companies.
• Preference is given to them in the following things.
  1. Holders of Preference Shares are given dividends even if equity shareholders are not.
  2. When a company is to be closed, preference shareholders are given money first from the proceeds of sales of the company’s assets.
  3. They may have enhanced voting rights such as the ability to veto mergers or acquisitions or the right to the first refusal when new shares are issued.

Order of Claim

Bond (Debenture) > Preferential share > Ordinary Share

1. Face Value

• Face Value is the value of the share written on the share itself.
• It can be any integer – 1, 2, 3 ___25, 50, 100 (But can’t be decimal like 1.50) . 
• Condition: When IPO is issued, the company cannot sell Share below its Face Value. 

2. Par Value

• Par Value is the market-determined value of the share.
• When IPO is launched, Par Value can’t be lower than Face Value. After that, the Par value is decided by the market forces. It can be lower or greater than face value.

3. Premium

• If the company is doing well, a person can think that he can get a big dividend when the dividend is announced. So he can buy those shares from the Share Market at a greater price than its Face Value. 
• The value above Face Value is called Premium. For example, if the above share having a face value of ₹50 is selling at ₹ 70, its Premium is ₹ 20.

When a company sell the shares for the first time to the public, it is called IPO.

Red Herring Prospectus

• Before the company launches its IPO to get capital via equity finance, the company has to give Red Herring Prospectus mentioning all the information about their promoters, business plan, address etc. (all details except on which date IPO would be launched & what would be the price of IPO).
• Only when SEBI approves they have the permission to go ahead.

Underwriter

• Underwriters are the companies who do lengthy legal work & accounting before launching IPO that require CA, Corporate Lawyers etc. They charge a commission for providing these services.
• E.g.: Mahindra, ICICI etc.

How price of an IPO would be fixed?

Two methods

Method 1: Fixed Pricing Method

• Suppose the company announces face value and premium in advance. Eg 
  1. Face value = ₹ 10
  2. Premium = ₹15
  3. Final Price = ₹25
  4.  1 lakh such shares will be issued 
• Hence, it would be announced that ₹25 Lakh IPO would be launched in the market.

Method 2: Book Building Method

• Suppose the application for 1 Lakh shares are invited, and investors are asked to send applications at which price they want to get these shares. E.g., 

• In the above example, at ₹125, all 1 Lakh shares have been booked. Hence, the face value of each share will be fixed at ₹125, and all shares will be sold at Rs 125 per share.
• Hence, all the shares are sold at face value in this case.

1. American Depository Receipts (ADR)

• If Indian Company wants to issue their shares in the USA, they can’t do it directly as they will have to register in the USA and comply with other domestic regulations. 
• Hence, to simplify the matters, the Indian Company can sell its shares to American Intermediary (e.g. Bank of America). The Bank can issue an equivalent amount of American Depository Receipts, which Americans can buy from US Stock Exchanges. 
• When an Indian Company issues a dividend, they will give that to American Intermediary, and American Intermediary will distribute it to ADR Holders.

2. Global Depository Receipts (GDR)

• GDR is same as ADR for European Union countries.

3. Bharat Depository Receipts (BDR)

• BDR is opposite to ADR.
• It is used when foreign companies want to issue shares in India. 

1. Share Buyback

• Share Buyback is the process when corporations repurchase the stock it has issued.
• It reduces the number of shares outstanding, giving each of the remaining shareholders a larger percentage of the company’s ownership.
• Buyback prices are more than market prices.
• According to the legal provisions, companies can buy back with reserves but can’t borrow to buyback.
• Share Buyback has been allowed in India since 1998.
• Reasons for buyback
  1. When companies have significant retained earnings, they don’t issue big dividends because a large amount of money will be wasted in tax. They generally use that money to buy back shares.      
  2. If management is optimistic about the future & believe that the current share price is undervalued.
  3. Putting unused cash into use.
  4. Raising earnings per share.
  5. Reducing the number of shareholders to reduce the cost of servicing them.

2. Employee Stock Option Plan (ESOP)

• The company gives shares to employees at a discounted rate so that employees become more committed to the company’s success (if the company makes more profit, you make more profit).  Employees can sell these shares at a later date depending on the company’s share buyback policy.
• Economic Survey (2020) has suggested that the government give ESOP to public sector banks’ employees to improve their performance.

3. Sweet Equity

• If Company sells its shares to directors, employees etc. at a discount for their value addition like IPR & know-how. 

4. Penny Stocks and Blue Chip Stocks

5. Share Pledging

• When a company raises a loan from the Bank or NBFC by pledging its shares as collateral.

6. Bull and Bear Investors

There are two types of investors

7. Short Selling

Short selling is a way to make money by betting that a company’s stock price will go down instead of up.

How it works?

Step 1

Step 2

The investor will experience a loss if the stock price increases, as he will have to pay more to repurchase their shares. Theoretically, this loss can be unlimited because there is no limit to the price of the stock. Hence, it is advisable to conduct proper research before involving in short selling.

Short selling was in news due to Hindenburg Adani issue.

• These are rich gentlemen who provide financial backing to entrepreneurs for starting their business’. Angel investors are usually found among an entrepreneur’s family and friends, but they may be from outside also. They can give debt or equity, but mostly they play in equity.
• They are focused on helping the business succeed rather than reaping a huge profit from their investment.
• What is the need for Angel Investors?
  • You can take capital from Banks, IPO or venture capitalists if your business project is likely to make success based on previous experience.
  • But if your idea is untested & new, nobody would be interested in financing you. E.g., Steve Jobs was funded by Angel Investor when he started Apple.
• In India, examples of Angel Investors include Ratan Tata, who invested in Urban Ladder, and TVM Pai, who invested in ZoomCar.
• Angel investors can be recognized as Category I Alternate Investment Fund (AIF).

• Crowd Funding is the practice of funding a project or venture by raising money from a large number of people, typically via the internet.  
• Various platforms like Grex, LetsVenture, etc., provide this service in India.
• This funding can be of various types. 
  • Equity-Based 
  • Debt Based 
  • Cause Based
  • Reward-Based 
• A large number of startups, software developers, filmmakers (e.g. Kannada movie Lucia), music festivals (e.g. Control ALT Delete) etc., have raised funds via this platform.

Debt

Equity

There is another type of security as well, known as Derivatives. We will have just an overview of this as it is not that important from an examination point of view.

Question: What is derivative ?

• The financial instrument that derives its price from some underlying asset is known as Derivatives.
• The price of derivatives are directly dependent upon the underlying asset in the present & projected future trends, which can be equity, foreign exchange, commodity or mortgaged Backed securities etc.
• For example, wheat farmers may wish to sell their harvest at a future date to eliminate the risk of a change in prices. Such a transaction is an example of a derivative. The price of this derivative is driven by the spot price of the underlying asset, i.e. wheat.

There are four types of Derivative contracts

1. Forward

• A Forward is a contract between two parties to buy or sell an asset at a specified future time at a price agreed on in the contract.

2. Future

• Future is a legally binding contract that obligates the parties to transact an asset at a predetermined date and price. Here, the buyer must purchase or seller must sell the underlying asset at the set price, regardless of the current market price. 
• Future and forward are almost similar. But forward distinguishes itself from a future as it is traded between two parties directly without using an exchange.

3. Option

• If a person buys an option, it grants him the right but not the obligation to buy or sell an underlying asset at a set price.

4. Swap

• Swap refers to exchanging one financial instrument for another between the transacting parties concerned at a predetermined time.