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  • Investment Basic
  • Equity
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Investment Basic

Q. What is Investment?

A. The money one earns is partly spent and partly saved to meet the future needs. Rather than keeping the savings idle one can use them to earn more returns than he can generate by keeping them with him. This is called as investment.

Q. Why should one invest?

A. One needs to invest to: generate a specified sum of money for a specific goal in life make a provision for an uncertain future The most important reason for a person to invest is to beat inflation. Inflation is the rate at which the cost of living increases. The cost of living is what it costs to buy the goods and services you need to live. Inflation causes money to lose value because it will not buy the same amount of a good or a service in the future as it does now or did in the past. For example, if there was a 7% inflation rate for the next 10 years, a Rs. 100 purchase today would cost Rs. 197 in 10 years. Remember to look at an investment's 'real' rate of return, which is the return after inflation. The aim of investments should be to provide a return above the inflation rate to ensure that the investment does not decrease in value. For example, if the annual inflation rate is 7%, then the investment will need to earn more than 7% to ensure it increases in value.

Q. When to start Investing?

A. The sooner one starts investing the better. By investing early you allow your investments more time to grow, whereby the concept of compounding (as we shall see later) increases your income, by accumulating the principal and the interest or dividend earned on it, year after year. The three rules for all investors should be: Invest early Invest regularly Invest for long term and not short term There are four main things you need to think about before you can decide how to invest your money: Liquidity needs Goals and Objectives Time Horizon Risk Profile.

Q. What care should one take while investing?

A. The sooner one starts investing the better. By investing early you allow your investments more time to grow, whereby the concept of compounding (as we shall see later) increases your income, by accumulating the principal and the interest or dividend earned on it, year after year. The three rules for all investors should be: Invest early Invest regularly Invest for long term and not short term There are four main things you need to think about before you can decide how to invest your money: Liquidity needs Goals and Objectives Time Horizon Risk Profile.

Q. What are various options available for investment?

A. One may invest in: Physical assets like real estate, gold/jewellery, commodities etc. and/or Financial assets such as fixed deposits with banks, small saving instruments with post offices, insurance/provident/pension fund etc. or securities market related instruments like shares, bonds, debentures etc.

Q. What are various Short-term financial options available for investment?

A. Broadly speaking, savings bank account, money market/liquid funds and fixed deposits with banks may be considered as short-term financial investment options: Savings Bank Account is often the first banking product people use, which offers low interest (3%-4% p.a.), making them only marginally better than fixed deposits. Money Market or Liquid Funds are a specialized form of mutual funds that invest in extremely short-term fixed income instruments and thereby provide easy liquidity. Money market funds usually yield better returns than savings accounts, but lower than bank fixed deposits. Fixed Deposits with Banks are also referred to as term deposits and minimum investment period for bank FDs is 30 days. Fixed Deposits with banks are for investors with low risk appetite, and may be considered for 6-12 months investment period as normally interest on less than 6 months bank FDs is likely to be lower than money market fund returns.

Q. What are various Long-term financial options available for investment?

A. Post Office Savings Schemes, Public Provident Fund, Company Fixed Deposits, Bonds and Debentures, Mutual Funds etc. Post Office Savings: Post Office Monthly Income Scheme is a low risk saving instrument, which can be availed through any post office. It provides an interest rate of 8% per annum, which is paid monthly. Minimum amount, which can be invested, is Rs. 1,000/- and additional investment in multiples of 1,000/-Maximum amount is Rs. 3, 00,000/- (if Single) or Rs. 6, 00,000/- (if held jointly) during a year. It has a maturity period of 6 years. A bonus of 10% is paid at the time of maturity. Premature withdrawal is permitted if deposit is more than one year old. A deduction of 5% is levied from the principal amount if withdrawn prematurely; the 10% bonus is also denied. Public Provident Fund: A long term savings instrument with a maturity of 15 years and interest payable at 8% per annum compounded annually. Tax benefits can be availed for the amount invested and interest accrued is tax-free. A withdrawal is permissible every year from the seventh financial year of the date of opening of the account and the amount of withdrawal will be limited to 50% of the balance at credit at the end of the 4th year immediately preceding the year in which the amount is withdrawn or at the end of the preceding year whichever is lower the amount of loan if any. Company Fixed Deposits: These are short-term (six months) to medium-term (three to five years) borrowings by companies at a fixed rate of interest which is payable monthly, quarterly, semi10 annually or annually. They can also be cumulative fixed deposits where the entire principal along with the interest is paid at the end of the loan period. The rate of interest varies between 6-9% per annum for company FDs. The interest received is after deduction of taxes. Bonds: It is a fixed income (debt) instrument issued for a period of more than one year with the purpose of raising capital. The central or state government, corporations and similar institutions sell bonds. A bond is generally a promise to repay the principal along with a fixed rate of interest on a specified date, called the Maturity Date. Mutual Funds: These are funds operated by an investment company which raises money from the public and invests in a group of assets (shares, debentures etc.), in accordance with a stated set of objectives

Q. What is Growth Investing and Value Investing?

A. Growth Investing- The approach to investing which aims to invest in fast-growing companies which are rapidly increasing their turnover and profits, and where the expectation is to make money from a rising share price (rather than income). Value Investing- The strategy of selecting stocks that trade for less than their intrinsic value is called as Value Investing. Value investors actively seek stocks of companies that they believe the market has undervalued. They believe the market overreacts to good and bad news, causing stock price movements that do not correspond with the company's long-term fundamentals. The result is an opportunity for value investors to profit by buying when the price is deflated.

Q. Basic Investment terms Explained ?

A. Bull- An investor who expects the market, sector or security to rise in price. Bear- An investor who is pessimistic about the prospects for a market, a sector or a particular security Bid- The highest price at which a buyer is willing to buy a particular security. The buyer may be a market maker or an ordinary investor Bull Market- A financial market of a certain group of securities in which prices are rising or are expected to rise. The term "bull market" is most often used in respect to the stock market, but really can be applied to anything that is traded, such as bonds, currencies, commodities, etc. Bear Market- A financial market of a certain group of securities in which prices are rising or are expected to rise. The term "bull market" is most often used in respect to the stock market, but really can be applied to anything that is traded, such as bonds, currencies, commodities, etc. Blue Chip- A blue chip is a large and well established company, or its shares. The key criterion is that these are large companies, primarily in terms of market capitalisation. The term also implies financial strength and stability. Broker- A broker is a party that mediates between a buyer and a seller. Spread- The amount by which the ask price exceeds the bid. This is essentially the difference in price between the highest price that a buyer is willing to pay for an asset and the lowest price for which a seller is willing to sell it. Market Capitalization- It is measure of a company's total value. It is estimated by determining the cost of buying an entire business in its current state. Often referred to as "market cap", it is the total value of all outstanding shares. It is calculated by multiplying the number of shares outstanding by the current market price of one share. Dividends- Distribution of a portion of a company's earnings, decided by the board of directors, to a class of its shareholders.

Equity

Q. What is a stock?

A. The money you raise from selling those "pieces" of your business can be used to build new plants and facilities, pay down debt, or acquire another company. A smart owner will keep at least 51% of the stock, which will allow them to retain control of the day to day activities. Any person or institution that owns over a majority of the stock is called the "controlling shareholder". Essentially, this person can do anything they want - right down to firing the CEO. Imagine that you own a business. If you were to divide that business up into small pieces and sell those pieces, you would essentially have issued stock. Quite simply, stock is ownership in a company.

Q. What is a stock Exchange?

A. The Securities Contract (Regulation) Act, 1956 [SCRA] defines ‘Stock Exchange’ as any body of individuals, whether incorporated or not, constituted for the purpose of assisting, regulating or controlling the business of buying, selling or dealing in securities. Stock exchange could be a regional stock exchange whose area of operation/jurisdiction is specified at the time of its recognition or national exchanges, which are permitted to have nationwide trading since inception. NSE was incorporated as a national stock exchange.

Q. What is the function of Securities Market?

A. Securities Markets is a place where buyers and sellers of securities can enter into transactions to purchase and sell shares, bonds, debentures etc. Further, it performs an important role of enabling corporates, entrepreneurs to raise resources for their companies and business ventures through public issues. Transfer of resources from those having idle resources (investors) to others who have a need for them (corporates) is most efficiently achieved through the securities market. Stated formally, securities markets provide channels for reallocation of savings to investments and entrepreneurship. Savings are linked to investments by a variety of intermediaries, through a range of financial products, called ‘Securities’.

Q. Which are the securities one can invest in?

A. Shares
Government Securities
Derivative products
Units of Mutual Funds etc. are some of the securities investors in the securities market can invest in.

Q. Why does Securities Market need Regulators?

A. OThe absence of conditions of perfect competition in the securities market makes the role of the Regulator extremely important. The regulator ensures that the market participants behave in a desired manner so that securities market continues to be a major source of finance for corporate and government and the interest of investors are protected.

Q. Who regulates the Securities Market?

A. The regulatory responsibility of the securities market is vested in the SEBI, the RBI, and two government departments--Department of Company Affairs and Department of Economic Affairs. Investigative agencies such as Economic Offences Wing of the government and consumer grievance redressal forums also play a role. The SEBI, established under the SEBI Act, is the apex regulatory body for the securities market. Besides regulation, the SEBI's mandate includes responsibilities for ensuring investor protection and promoting orderly growth of the securities market.
The RBI, on the other hand, is responsible for regulation of a certain well-defined segment of the securities market. As the manager of public debt, the RBI is responsible for primary issues of Government Securities. The RBI's mandate also includes the regulation of all contracts in government securities, gold related securities, and money market securities and in securities derived from these securities. To foster consistency of the regulatory processes, the SEBI is mandated to regulate the trading of these securities on recognized stock exchanges in line with the guidelines issued by RBI. Although the SEBI and the RBI are operationally independent, the government can issue directions to both in policy matters.

Q. Who are the participants in the Securities Market?

A. The securities market essentially has three categories of participants, namely, the issuers of securities, investors in securities and the intermediaries, such as merchant bankers, brokers etc. While the corporates and government raise resources from the securities market to meet their obligations, it is households that invest their savings in the securities market.

Q. What is Growth Investing and Value Investing?

A. Growth Investing- The approach to investing which aims to invest in fast-growing companies which are rapidly increasing their turnover and profits, and where the expectation is to make money from a rising share price (rather than income).
Value Investing - The strategy of selecting stocks that trade for less than their intrinsic value is called as Value Investing. Value investors actively seek stocks of companies that they believe the market has undervalued. They believe the market overreacts to good and bad news, causing stock price movements that do not correspond with the company's long-term fundamentals. The result is an opportunity for value investors to profit by buying when the price is deflated

Q. What are Penny stocks?

A. Penny stocks are the companies that generally do not have any business, any track record, loss making and unknown promoters. These are the stocks where manipulation takes place and investors get carried away in the hope of fast profits. Penny Stocks are any stock that trades at a very low price per share. Most financial advisors and long-term investors tend to avoid them completely because of the extremely high risk that comes with owning them. They generally tend to fluctuate wildly in price, and although some report spectacular gains in a matter of a few days [or even hours], those who invest in them are generally surprised when they disappear altogether.

Q. What are the segments of Securities Market?

A. Primary Markets- The primary market is that part of the capital markets that deals with the issuance of new securities. Companies, governments or public sector institutions can obtain funding through the sale of a new stock or bond issue. This is typically done through a syndicate of securities dealers. The process of selling new issues to investors is called underwriting. In the case of a new stock issue, this sale is called an initial public offering (IPO). Dealers earn a commission that is built into the price of the security offering, though it can be found in the prospectus.
Secondary Markets- A market in which an investor purchases a security from another investor rather than the issuer, subsequent to the original issuance in the primary market is called as Secondary Market.

DERIVATIVES

Q. Why Derivatives?

A. There are several risks inherent in financial transactions. Derivatives allow you to manage these risks more efficiently by unbundling the risks and allowing either hedging or taking only one (or more if desired) risk at a time.

Forward contracts

A forward contract is one to one bi-partite contract, to be performed in the future, at the terms decided today
Forward contracts offer tremendous flexibility to the parties to design the contract in terms of the price, quantity, quality (in case of commodities), delivery time and place.
Forward contracts suffer from poor liquidity and default risk.

Future contracts

A forward contract is one to one Future contracts are organized/ standardized contracts, which are traded on the exchanges.
Are of standard quantity; standard quality (in case of commodities). Have standard delivery time and place.
These contracts, being standardized and traded on the exchanges are very liquid in nature.
In futures market, clearing corporation/ house provides the settlement guarantee.

Forward Vs Future Contracts

Features Forward Contract Future Contract
Operational Not traded on exchange Traded on exchange
Mechanism
Contract Differs from trade to trade. Contracts are standardized contracts
Specifications
Counterparty Risk Exists Exists, but assumed by Clearing Corporation/ house
Liquidation Profile Poor Liquidity as contracts are tailor maid contracts Very high Liquidity as contracts are standardized contracts
Price Discovery Poor; as markets are fragmented Better as fragmented markets are brought to the common platform

Options

Options are instruments whereby the right is given by the option seller to the option buyer to buy or sell a specific asset at a specific price on or before a specific date

Option Seller/ Option Writer- In any contract there are two parties. In case of an option there is a buyer to the contract and also a seller. The seller of the contract is called the options writer. He receives premium through the clearing house and is obliged to buy or sell the underlying if the buyer of the contract so desires.
Option Buyer - One who buys the option. He has the right to exercise the option but no obligation.
Call Option - A call option gives the buyer a right to buy the underlying that is the index or stock at the specified price on or before the expiry date
Put Option - A put option on the other hand gives the right to sell at the specified price on or before expiry date.
American Option - An American style option is the one which can be exercised by the buyer on or before the expiration date, i.e. anytime between the day of purchase of the option and the day of its expiry.
The European kind of option is the one which can be exercised by the buyer on the expiration day only & not anytime before that.
Strike Price/ Exercise Price - Price at which the option is to be exercised.
Expiration Date - Date on which the option expires.
Exercise Date - Date on which the option gets exercised by the option holder/buyer.
Option Premium - The price paid by the option buyer to the option seller for granting the option.
Presently we have trading in Index Futures, Index Options, Single Stock Futures and Single Stock Options.

Participants : Participants who trade in the derivatives market can be classified under the following three broad categories.

Hedgers : The farmer's example that we discussed about was a case of hedging. Hedgers face risk associated with the price of an asset. They use the futures or options markets to reduce or eliminate this risk.

Speculators : Speculators are participants who wish to bet on future movements in the price of an asset. Futures and options contracts can give them leverage; that is, by putting in small amounts of money upfront, they can take large positions on the market. As a result of this leveraged speculative position, they increase the potential for large gains as well as large losses.

Arbitragers : Arbitragers work at making profits by taking advantage of discrepancy between prices of the same product across different markets. If, for example, they see the futures price of an asset getting out of line with the cash price, they would take offsetting positions in the two markets to lock in the profit.

Q. How does Futures Market help in Price Discovery?

A. Prices in an organized derivatives market reflect the perception of market participants about the future and lead the prices of underlying to the perceived future level. The prices of derivatives converge with the prices of the underlying at the expiration of the derivative contract. Thus derivatives help in discovery of future as well as current prices.

Q. How does one trade in futures and how is it different from the normal market?

A. Securities Markets is a place where buyers and sellers of securities can enter into transactions to purchase and sell shares, bonds, debentures etc. Further, it performs an important role of enabling corporates, entrepreneurs to raise resources for their companies and business ventures through public issues. Transfer of resources from those having idle resources (investors) to others who have a need for them (corporates) is most efficiently achieved through the securities market. Stated formally, securities markets provide channels for reallocation of savings to investments and entrepreneurship. Savings are linked to investments by a variety of intermediaries, through a range of financial products, called ‘Securities’.

Q. Suppose I want to trade in futures, what should I do?

A. To trade in futures, the person will first have to approach a broker who is authorized to trade in derivatives. Then the broker will tell him the different series that are available. In India, both the BSE and NSE offer futures on the Sensex and Nifty respectively, and these are popularly called as index futures.

Q. What are the different series which are available?

A. At any point of time, there are three series which are available in the futures market. For example, if we are in July, we can trade in the July series, August series, or September series.
So, if you choose the July series, say on July 2, you can buy or sell a future contract based on your forecast of the value of the index on the expiry date of the contract, which is the last Thursday of every month. The contract has a minimum size of 50 times the Sensex and 200 times the Nifty. What this means is if the Sensex is considered to be a tangible item, like any commodity, then by entering into a futures contract, you intend to buy or sell 50 units of the Sensex or 200 units of Nifty.
Now, suppose you enter into the contract on July 2 and the prevailing Sensex future is at 3350, but you feel that the Sensex future on the expiry date will be 3500. Technically, your contract is worth Rs 3350x50, but actually you will pay only a certain per cent of the contract value, and this is called initial margin. Now, if the Sensex touches 3500 on the expiry date, you will earn Rs 150x50 (that is the difference between 3350-3500), but if the Sensex value on expiry date is 3200, you will make a loss of Rs 150x50 (that is the difference between 3200-3350).
The stock exchange serves as the clearing house and all claims are made to it. Let's go back to the earlier example. Suppose you are the buyer at 3350 and the series expires at 3500, you are the gainer, and you make a claim for Rs 150x50=Rs 7,500. The seller of the contract at 3350 would have lost Rs 150 per unit or Rs 7,500 in all. So, the exchange will collect Rs 7,500 from the seller and pay it to you.

Q. What is Interest Rate?

A. Bonds pay interest that can be fixed, floating or payable at maturity. Most debt securities carry an interest rate that stays fixed until maturity and is a percentage of the face (principal) amount. Typically, investors receive interest payments semiannually. For example, a Rs.1000 bond with an 8% interest rate will pay investors Rs.80 a year, in payments of Rs.40 every six months. When the bond matures, investors receive the full face amount of the bond—Rs.1, 000.

Q. Can I buy an August contract in June?

A. You can. After the expiry of the June series, you can buy even a September contract, as at any point, an investor can trade in three series.

Q. How does one trade in options?

A. Like in futures, an investor has to register himself with a broker who is a member of the BSE or NSE derivatives Segment. He can trade in three series at any point of time. But the difference here is he has the option not to honor his commitment to buy or sell the index or stock.

Q. What happens if he does not honor the commitment?

A. Nothing as the option buyer has the right but not the obligation to buy or sell. His loss is limited to the amount of premium paid upfront.

Q. What is option premium?

A. At the time of buying an option contract, the buyer has to pay premium. The premium is the price for acquiring the right to buy or sell the index. It is price paid by the option buyer to the option seller for acquiring the added flexibility. Option premiums are always paid upfront.

Q. What is exercise price?

A. In futures what is quoted or negotiated is the exercise price. Exercise price is the price at which the parties are willing to buy and sell. For example, a July future on Nifty can be quoted at 1100, which means a buyer of the contract promises to buy the Nifty at 1100.

Q. What are the different series available?

A. Different series on call options give you a right to buy the Nifty at different prices. For example, you can buy Nifty options at different strike prices of say 1060, 1080, 1100, and 1140.If you buy a Nifty option for July at 1060, it means you are authorised to buy the Nifty at 1060 on the expiry date. If on July 27, the Nifty closes at 1080, just like futures, here also you stand to gain and you make a profit of Rs 20x200. As the contract size is 200, one thus gets 20x200=Rs 4,000 on expiry date.

Q. How does stock-based option differ from the index option?

A. The only difference between index-based and stock-based options is that the underlying asset is individual stock and not the index.

Q. What is meant by Closing out contracts?

A. A long position in futures can be closed by selling futures, while a short position in futures can be closed by buying futures on the exchange. Once position is closed out, only the net difference needs to be settled in cash, without any delivery of underlying. Most contracts are not held to expiry but closed out before that. If held until expiry, some are settled for cash and others for physical delivery.

Q. Is the settlement mechanism different for Cash and Physical Delivery?

A. In case it is impossible, or impractical, to effect physical delivery, open positions (open long positions always being equal to open short positions) are closed out on the last day of trading at a price determined by the spot "cash" market price of the underlying asset. This price is called "Exchange Delivery Settlement Price" or EDSP.
In case of physical settlement short side delivers to the specified location while long side takes delivery from the specified location of the specified quantity / quality of underlying asset. The long side pays the EDSP to clearing house/ corporation which is received by the short side

Q. Is there a theoretical way of pricing Index Future?

A. The theoretical way of pricing any Future is to factor in the current price and holding costs or cost of carry.
The Futures Price = Spot Price + Cost of Carry
Cost of carry is the sum of all costs incurred if a similar position is taken in cash market and carried to maturity of the futures contract less any revenue which may result in this period. The costs typically include interest in case of financial futures (also insurance and storage costs in case of commodity futures). The revenue may be dividends in case of index futures.
In general, the Futures price is greater than the spot price. In special cases, when cost of carry is negative, the Futures price may be lower than Spot prices.
The difference between Spot Price and Futures price is known as basis. Although the spot price and Futures prices generally move in line with each other, the basis is not constant. Generally basis will decrease with time. And on expiry, the basis is zero and Futures price equals spot price.

Q. What is Contango?

A. Under normal market conditions Futures contracts are priced above the spot price. This is known as the Contango Market.

Q. What is Backwardation?

A.It is possible for the Futures price to prevail below the spot price. Such a situation is known as backwardation. This may happen when the cost of carry is negative, or when the underlying asset is in short supply in the cash market but there is an expectation of increased supply in future – example agricultural products.

Q. What is margin money?

A. The aim of margin money is to minimize the risk of default by either counter-party. The payment of margin ensures that the risk is limited to the previous day’s price movement on each outstanding position. However, even this exposure is offset by the initial margin holdings. Margin money is like a security deposit or insurance against a possible Future loss of value.

Q. Are there different types of Margin?

A. Yes, there can be different types of margin like Initial Margin, Variation margin, Maintenance margin and Additional margin.

Q. What is the objective of Initial margin?

A. The basic aim of Initial margin is to cover the largest potential loss in one day. Both buyer and seller have to deposit margins. The initial margin is deposited before the opening of the day of the Futures transaction. Normally this margin is calculated on the basis of variance observed in daily price of the underlying (say the index) over a specified historical period (say immediately preceding 1 year). The margin is kept in a way that it covers price movements more than 99% of the time. This technique is also called value at risk (or VAR).
Based on the volatility of market indices in India, the initial margin is expected to be around 8-10%.

Q. What is Variation or Mark-to-Market Margin?

A. All daily losses must be met by depositing of further collateral - known as variation margin, which is required by the close of business, the following day. Any profits on the contract are credited to the client’s variation margin account.

Q. What is the concept of Cross Margining?

A. This is a method of calculating margin after taking into account combined positions in Futures, options, cash market etc. Hence, the total margin requirement reduces due to cross-Hedges. This type of margining is not allowed in India.

Q. What are long/ short positions?

A. In simple terms, long and short positions indicate whether you have a net over-bought position (long) or over-sold position (short).

Q. Who is a market maker?

A. A dealer is said to make a market when he quotes both bid and offer prices at which he stands ready to buy and sell the security. Thus, he is a person that brings buyers and sellers together. He lends liquidity in the system by making trading feasible.

Q. What is marked-to-market?

A. This is an arrangement whereby the profits or losses on the position are settled each day. This enables the exchange to keep appropriate margin so that it is not so low that it increases chances of defaults to an unacceptable level (by collecting MTM losses) and is not so high that it increases the cost of transactions to an unreasonable level (by giving MTM profits).

Q. What is the role of the clearing house/ Corporation?

A. The Clearing House / Corporation match the transactions, reconcile sales & purchases and do daily settlements. It is also responsible for risk management of its members and does inspection and surveillance, besides collection of margins, capital etc. It also monitors the net-worth requirements of the members. The other role of the Clearing House / Corporation is to ensure performance of every contract.

Q. What is Price Risk?

A. Price Risk is defined as the standard deviation of returns generated by any asset. This indicates how much individual outcomes deviate from the mean. For example, an asset with possible returns of 5%, 10% and 15% is more risky than one with possible returns of –10%, 1% and 25%. It simply means higher the standard deviation more will be the risk.

Q. What are the different types of Price Risk?

A.   RBI: Diversifiable risk or unsystematic risk of a security arises from the security specific factors like strike in factory, legal claims, non availability of raw material, etc. This component of risk can be reduced by diversification.
Non-diversifiable risk or market risk is an outcome of economy related events like diesel price hike, budget announcements, etc that affect all the companies. As the name suggests, this risk cannot be diversified away using diversification or adding stocks in portfolio.

Q. What are the general strategies for Speculating?

A.   RBI: In general, the speculator takes a view on the market and plays accordingly. If one is bullish on the market, one can buy Futures, and vice versa for a bearish outlook.
There is another strategy of playing the spreads, in which case the speculator trades the "basis". When a basis risk is taken, the speculator primarily bets on either the cost of carry (interest rate in case of index futures) going up (in which case he would pay the basis) or going down (receive the basis).
Pay the basis implies going short on a future with near month maturity while at the same time going long on a future with longer term maturity.
Receiving the basis implies going long on a future with near month maturity while at the same time going short on a future with longer term maturity.

Commodity

Q. Knowledge Center - Commodities

A. The institution of formal commodity futures market in India is almost as old as in the USA and UK. The Indian experience, however, is much older as references to such markets in India appear in Kautialya’s Arthasastra. The first organized futures market was established in 1875 under the aegis of the Bombay Cotton Trade Association to trade in cotton contracts which was followed by oilseeds and foodgrains. The Forward Contract (Regulation) Act, 1952, a Central Act, governs commodity derivatives trading in India.

The list of exchanges that has been allowed to trade in commodities are:

  • Bhatinda Om & Oil Exchange Ltd., Bhatinda.
  • The Bombay Commodity Exchange Ltd.Mumbai
  • The Rajkot Seeds oil & Bullion Merchants Association Ltd
  • The Kanpur Commodity Exchange Ltd., Kanpur
  • The Meerut Agro Commodities Exchange Co. Ltd., Meerut
  • The Bombay Commodity Exchange Ltd.Mumbai
  • The Spices and Oilseeds Exchange Ltd.
  • Ahmedabad Commodity Exchange Ltd.
  • India Pepper & Spice Trade Association. Kochi
  • Rajdhani Oils and Oilseeds Exchange Ltd., Delhi
  • National Board of Trade. Indore.
  • The Chamber Of Commerce, Hapur
  • The Central India Commercial Exchange Ltd, Gwalior
  • The East India Jute & Hessian Exchange Ltd.
  • First Commodity Exchange of India Ltd, Kochi
  • Bikaner Commodity Exchange Ltd., Bikaner
  • The Coffee Futures Exchange India Ltd, Bangalore.
  • Esugarindia Ltd.
  • National Multi Commodity Exchange of India Ltd.
  • Surendranagar Cotton oil & Oilseeds Association Ltd.
  • Multi Commodity Exchange of India Ltd.
  • National Commodity & Derivatives Exchange Ltd.
  • Haryana Commodities Ltd., Hissar.
  • e-Commodities Ltd
  • Out of these 25 commodity exchanges the MCX, NCDEX and NMCE are large exchanges and MCX is the biggest among them

Mutual Funds

Q. What are Mutual Funds?

A. A Mutual Fund is a body corporate that pools the savings of a number of investors and invests the same in a variety of different financial instruments, or securities. Mutual funds can thus be considered as financial intermediaries in the investment business who collect funds from the public and invest on behalf of the investors. The Investment objectives outlined by a Mutual Fund in its prospectus are binding on the Mutual Fund scheme. The investment objectives specify the class of securities a Mutual Fund can invest in. Mutual Funds invest in various asset classes like equity, bonds, debentures, commercial paper and government securities.

Q. What is an Asset Management Company?

A. An Asset Management Company (AMC) is a highly regulated organization that pools money from investors and invests the same in a portfolio.

Q. What is NAV?

A. NAV or Net Asset Value of the fund is the cumulative market value of the assets of the fund net of its liabilities. NAV per unit is simply the net value of assets divided by the number of units outstanding. Buying and selling into funds is done on the basis of NAV-related prices. NAV is calculated as follows:
NAV= Market value of the fund's investments + Receivables + Accrued Income - Liabilities - Accrued Expenses
Number of Outstanding units

Q. How to Use Net Asset Values?

A. NAVs are helpful in keeping an eye on your mutual fund's price movement, but NAVs are not the best way to keep track of performance. The reason for this is mutual fund distributions. Mutual funds are forced by law to distribute at least 90% of its' realized capital gains and dividend income each year. When a fund pays out this distribution, the NAV drops by the amount paid. This is important because an investor may become frightened when they see their fund's NAV drop by Rs.3 even though they haven't lost any money (the Rs.3 was paid out to the shareholder).

Q. What is Expense Ratio?

A. The percentage of total fund assets that is used to cover expenses associated with the operation of a mutual fund. This amount is taken out of the fund's assets and lowers the return that fund holders achieve. These expenses include management fees and operating expenses. The management fee is the fee that is charged to the fund by the portfolio manager, and it is often a fixed percentage. The operating expenses are the expenses that the fund incurs through operation and this can include brokerage fees, taxes, investor services and interest expenses.

Q. What are the benefits of investing in Mutual Funds?

A. Professional Management - Qualified and experienced professionals manage Mutual Funds. Generally, investors, by themselves, may have reasonable capability, but to assess a financial instrument a professional analytical approach is required in addition to access to research and information and time and methodology to make sound investment decisions and keep monitoring them.
Diversification - Since Mutual Funds make investments in a number of stocks, the resultant diversification reduces risk. They provide the small investors with an opportunity to invest in a larger basket of securities
Regulated - Mutual Funds are registered with SEBI. SEBI monitors the activities of Mutual Funds.
Liquidity - In case of open-ended funds, the investment is very liquid as it can be redeemed at any time with the fund unlike direct investment in stocks/bonds.

Q. Are there any risks involved in investing in Mutual Funds?

A. Mutual Funds do not provide assured returns. Their returns are linked to their performance. They invest in shares, debentures and deposits. All these investments involve an element of risk. The unit value may vary depending upon the performance of the company and companies may default in payment of interest/principal on their debentures/bonds/deposits. Besides this, the government may come up with new regulation which may affect a particular industry or class of industries. All these factors influence the performance of Mutual Funds.

Q. What are the different types of Mutual funds?

  • A. (a) On the basis of Objective Equity Funds/ Growth Funds - Funds that invest in equity shares are called equity funds. They carry the principal objective of capital appreciation of the investment over the medium to long-term. The returns in such funds are volatile since they are directly linked to the stock markets. They are best suited for investors who are seeking capital appreciation. There are different types of equity funds such as Diversified funds, Sector specific funds and Index based funds.
  • Diversified funds -These funds invest in companies spread across sectors. These funds are generally meant for risk-taking investors who are not bullish about any particular sector
  • Sector funds - These funds invest primarily in equity shares of companies in a particular business sector or industry. These funds are targeted at investors who are extremely bullish about a particular sector.
  • Index funds - These funds invest in the same pattern as popular market indices like S&P 500 and BSE Index. The value of the index fund varies in proportion to the benchmark index.
  • Tax Saving Funds - These funds offer tax benefits to investors under the Income Tax Act. Opportunities provided under this scheme are in the form of tax rebates U/s 88 as well saving in Capital Gains U/s 54EA and 54EB. They are best suited for investors seeking tax concessions.
  • Debt / Income Funds - These Funds invest predominantly in high-rated fixed-income-bearing instruments like bonds, debentures, government securities, commercial paper and other money market instruments. They are best suited for the medium to long-term investors who are averse to risk and seek capital preservation. They provide regular income and safety to the investor.
  • Liquid Funds / Money Market Funds - These funds invest in highly liquid money market instruments. The period of investment could be as short as a day. They provide easy liquidity. They have emerged as an alternative for savings and short-term fixed deposit accounts with comparatively higher returns. These funds are ideal for Corporate, institutional investors and business houses who invest their funds for very short periods.
  • Gilt Funds - These funds invest in Central and State Government securities. Since they are Government backed bonds they give a secured return and also ensure safety of the principal amount. They are best suited for the medium to long-term investors who are averse to risk.
  • Balanced Funds - These funds invest both in equity shares and fixed-income-bearing instruments (debt) in some proportion. They provide a steady return and reduce the volatility of the fund while providing some upside for capital appreciation. They are ideal for medium- to long-term investors willing to take moderate risks.
  • Hedge Funds - These funds adopt highly speculative trading strategies. They hedge risks in order to increase the value of the portfolio.

  • (b) On the basis of Flexibility
  • Open-ended Funds - These funds do not have a fixed date of redemption. Generally they are open for subscription and redemption throughout the year. Their prices are linked to the daily net asset value (NAV). From the investors' perspective, they are much more liquid than closed-ended funds. Investors are permitted to join or withdraw from the fund after an initial lock-in period.
  • Close-ended Funds - These funds are open initially for entry during the Initial Public Offering (IPO) and thereafter closed for entry as well as exit. These funds have a fixed date of redemption. One of the characteristics of the close-ended schemes is that they are generally traded at a discount to NAV; but the discount narrows as maturity nears. These funds are open for subscription only once and can be redeemed only on the fixed date of redemption. The units of these funds are listed (with certain exceptions), are tradable and the subscribers to the fund would be able to exit from the fund at any time through the secondary market.
  • Interval funds - These funds combine the features of both open-ended and close-ended funds wherein the fund is close-ended for the first couple of years and open-ended thereafter. Some funds allow fresh subscriptions and redemption at fixed times every year (say every six months) in order to reduce the administrative aspects of daily entry or exit, yet providing reasonable liquidity.

  • (c) On the basis of geographic location
  • Domestic funds - These funds mobilize the savings of nationals within the country.
  • Offshore Funds - These funds facilitate cross border fund flow. They invest in securities of foreign companies. They attract foreign capital for investment.

Q. What are the different plans that Mutual Funds offer?

A. Growth Plan and Dividend Plan -A growth plan is a plan under a scheme wherein the returns from investments are reinvested and very few income distributions, if any, are made. The investor thus only realizes capital appreciation on the investment. This plan appeals to investors in the high income bracket. Under the dividend plan, income is distributed from time to time. This plan is ideal to those investors requiring regular income.
Dividend Reinvestment Plan - Dividend plans of schemes carry an additional option for reinvestment of income distribution. This is referred to as the dividend reinvestment plan. Under this plan, dividends declared by a fund are reinvested on behalf of the investor, thus increasing the number of units held by the investors.

Q. What is Entry/Exit Load?

A. A Load is a charge, which the AMC may collect on entry and/or exit from a fund. A load is levied to cover the up-front cost incurred by the AMC for selling the fund. It also covers one time processing costs. Some funds do not charge any entry or exit load. These funds are referred to as 'No Load Fund'. Funds usually charge an entry load ranging between 1.00% and 2.00%. Exit loads vary between 0.25% and 2.00%.
For e.g. Let us assume an investor invests Rs. 10,000/- and the current NAV is Rs.13/-. If the entry load levied is 1.00%, the price at which the investor invests is Rs.13.13 per unit. The investor receives 10000/13.13 = 761.6146 units. (Note that units are allotted to an investor based on the amount invested and not on the basis of no. of units purchased). Let us now assume that the same investor decides to redeem his 761.6146 units. Let us also assume that the NAV is Rs 15/- and the exit load is 0.50%. Therefore the redemption price per unit works out to Rs. 14.925. The investor therefore receives 761.6146 x 14.925 = Rs.11367.10

Q. What is Sales/Purchase price?

A. Sales/Purchase price is the price paid to purchase a unit of the fund. If the fund has no entry load, then the sales price is the same as the NAV. If the fund levies an entry load, then the sales price would be higher than the NAV to the extent of the entry load levied.

Q. What is redemption price?

A. Redemption price is the price received on selling units of open-ended scheme. If the fund does not levy an exit load, the redemption price will be same as the NAV. The redemption price will be lower than the NAV in case the fund levies an exit load.

Q. What is repurchase price?

A. Repurchase price is the price at which a close-ended scheme repurchases its units. Repurchase can either be at NAV or can have an exit load.

Q. What is a Switch?

A. Some Mutual Funds provide the investor with an option to shift his investment from one scheme to another within that fund. For this option the fund may levy a switching fee. Switching allows the Investor to alter the allocation of their investment among the schemes in order to meet their changed investment needs, risk profiles or changing circumstances during their lifetime.

Q. Is there any minimum lock-in period for my units?

A. There is no lock-in period in the case of open-ended funds. However in the case of tax saving funds a minimum lock-in period is applicable. The lock-in period in case of Tax Savings Schemes (ELSS) is 3Yrs.

Q. What are the factors that influence the performance of Mutual Funds?

A. The performances of Mutual funds are influenced by the performance of the stock market as well as the economy as a whole. Equity Funds are influenced to a large extent by the stock market. The stock market in turn is influenced by the performance of the companies as well as the economy as a whole. The performance of the sector funds depends to a large extent on the companies within that sector. Bond-funds are influenced by interest rates and credit quality. As interest rates rise, bond prices fall, and vice versa. Similarly, bond funds with higher credit ratings are less influenced by changes in the economy.

Q. As a new investor how do I select a particular scheme?

A. Choice of any scheme would depend to a large extent on the investor preferences. For an investor willing to undertake risks, equity funds would be the most suitable as they offer the maximum returns. Debt funds are suited for those investors who prefer regular income and safety. Gilt funds are best suited for the medium to long-term investors who are averse to risk. Balanced funds are ideal for medium- to long-term investors willing to take moderate risks. Liquid funds are ideal for Corporates, institutional investors and business houses who invest their funds for very short periods. Tax Saving Funds are ideal for those investors who want to avail tax benefits. An important aspect while selecting a particular scheme is the duration of the investment. Depending on your time horizon you can select a particular scheme. Besides all this, factors like promoter's image, objective of the fund and returns given by the funds on different schemes should also be taken into account while selecting a particular scheme.
Tax Benefit for Mutual Fund Investments: ELSS (Equity Linked Saving Schemes) is eligible for Tax Deduction u/s 80C of Income Tax Act. Up to a maximum of Rs.100000/-
Long Term Capital Gain: If the investment tenure in equity fund is more that 1Yr i.e. at least 366 days then it is treated as Long Term Capital Gain. As per the current Income Tax Laws, it is Tax free in the hands of investors.
Short Term Capital Gain: If the investment tenure in equity fund is less than 365 days, then it is treated as Short Term Capital Gain. As per the current Tax Laws, it is taxed @10%.

INSURANCE

Q. What is insurance?

A. Insurance is a method of risk transfer i.e to protect against the losses due to unforeseen or predictable perils

Q. Why is it important?

A. Insurance is important because it amply compensates a person or entity from financial loss suffered due to accident or unforeseen eventuality

Q. What are the different type of insurance coverage?

A. Insurance is categorized into broadly 3 segments
1). General or Non life insurance
2). Life insurance
3). Health insurance

Q. Is Health insurance same as Life insurance?

A. Life insurance covers insured for untimely death whereas health insurance covers for hospitalization expenses.

Q. What is sum assured ?

A. The amount an insurance company agrees to pay to insured or nominee on occurrence of a loss.

Q. What is the definition of a family ?

A. Family means self, spouse, dependent children upto age of 25 years and parents

Q. How is the premium determined ?

A. Premium depends on factor such as age of the member insured, sum insured, number of family member covered, benefits etc.

Q. What is meant by term “insurer” and “insured” ?

A.Insurer- An entity that enters into contract to indemnify another in the event of loss or damage Insured- A person or entity whose interests is protected by an insurance policy which indemnifies against loss of property or life or health

Q. How to claim within the policy?

A. In order to claim the policy, insured need to fill up claim form and supplement all required documents to insurance company

Q. ATS insurance advisory Advantage

A. We offer customized insurance / risk management solution to individual as well as business houses. Our in-depth knowledge on insurance helps us to negotiate competitive pricing on client’s behalf. ATS safeguards the interest of policyholder while explaining policy terms and conditions that they need to be aware of. We provide professional and technical advice in settling of claim, which can be extremely useful to our clients in the most challenging time.

MONEY MARKET INSTRUMENTS

Q. What are Money Market Instruments?

A. By convention, the term "Money Market" refers to the market for short-term requirement and deployment of funds. Money market instruments are those instruments, which have a maturity period of less than one year. The most active part of the money market is the market for overnight call and term money between banks and institutions and repo transactions. Call Money / Repo are very short-term Money Market products. The below mentioned instruments are normally termed as money market instruments:

  • Certificate of Deposit (CD)
  • Commercial Paper (C.P)
  • Inter Bank Participation Certificates
  • Inter Bank term Money
  • Treasury Bills
  • Bill Rediscounting
  • Call/ Notice/ Term Money

COMMODITIES DEMYSTIFIE

Q. What is a Commodity?

A. Commodities are goods, uniform in quality, where each portion is the same as the other. For example; oil is a commodity because one barrel of oil is the same as the next. Similarly, 1 ounce of gold is the same as the next.

Q. What is Commodity Trading?

A. There are two ways that commodities are traded, in spot markets, or as futures.

Spot market refers to trades that take place literally on the spot. The commodity is traded right then and there, usually for cash. This is spot trading.

Futures is not the actual good that is traded for; rather a contract to buy or sell that particular commodity for a particular price and for a certain date in the future. This is how most of the commodities trading is done. This is futures trading.

Futures trading is organized in commodities permitted by the government. At present, several goods and products of agricultural (including plantation), mineral and fossil origin are allowed for futures trading under the patronage of the commodity exchanges.

Q. Did you know that worldwide trading volumes in commodities are 4-5 times that of trading in shares and stocks?

A. While most of us are familiar with investing in stocks and shares, commodities as a worldwide accepted asset class, can be an interesting way to have your money make money for you.

  • Major Commodities Traded:
  • BULLION: Gold, Silver, Platinum
  • BASE METALS: Nickel, Tin, Copper, Zinc, Aluminum, Lead
  • FERROUS METALS: Steel Long
  • CEREALS: Wheat, Maize, Barley
  • SPICES: Pepper, Red Chilli, Jeera, Turmeric, Cardamom
  • ENERGY & GAS: Crude Oil, Natural Gas, Gasoline, Heating Oil, ATF, Electricity Futures
  • OIL & OIL SEEDS: Castor Seeds, Soy Bean, Refined Soy oil
  • FIBRE: Cotton
  • PULSES: Chana
  • PLANTATIONS: Rubber, Coffee
  • OTHERS: Guar Seed, Gur, Sugar, Guargum, Mentha Oil, Potato

Q. Who regulates the Commodity Market?

A. Just as trading in shares and stocks, the equity market, is regulated by Securities and Exchange Board of India (SEBI), trading in commodity futures and the relevant exchanges viz. MCX (Multi Commodity Exchange of India Ltd.), NCDEX (National Commodity & Derivatives Exchange Ltd.), NMCE (National Multi-Commodity Exchange of India Limited), etc. are regulated by the Forward Markets Commission (FMC).

Advantages of Commodity Trading :Lowest Margins - Equity Futures usually have 10-25% margins, but commodities typically require 5-15% margins. For E.g. one lot of 100gm gold would have an approximate margin of Rs. 6000 only, against the cost of the actual quantity.

Extended Trading Hours - Although trading hours for Equity Market is from 10:00am-3:30pm, you can leverage the extended trading hours in Commodities Market from 10.00am-11.30pm. So you can go trade even after your office hours.

Easy Access - Commodity trading uses a similar trading platform as that of shares and stocks.

Diversified Risk - Other than trading in Stocks & Shares, you can spread your risk by investing in Commodities that offer varied combination of risk-return trading strategies.

Hedge against inflation - Trading in Commodities is a hedge against inflation since the commodity markets typically move opposite to that of stocks & shares.

Global Opportunity - Gold when traded on Commodity Exchanges has international price benchmarking which does not allow anyone to manipulate prices.

Physical delivery of goods- not a compulsion- A commodity demat account is not compulsory unless you intend to take delivery of goods.

International Scenario

Q. New York Mercantile Exchange (NYMEX):

The NYMEX in its current form was created in 1994 by the merger of the former New York Mercantile Exchange and the Commodity Exchange of New York (COMEX). Together they represent one of the world's largest markets in energy and precious metals. It deals in Futures (and Options) in Oil products, such as Crude Oil, Heating Oil, leaded regular Gasoline, Natural Gas, Propane and in rare metals, such as Platinum and Palladium. It also deals in Gold and Silver, Aluminum and Copper, sharing with the London Metal Exchange a dominant role in the world metal trading. The trade of crack spread allows investors to construct their own spread combinations.

Q. International Petroleum Exchange:

A Commodity market that deals in Futures Contracts (Brent and Dubai crude oil, gas oil, leaded and unleaded gasoline, naphtha and heavy fuel oil), as well as in options (Brent crude and gas oil). It offers the facilities for making an exchange of futures for physicals.

Q. London Metal Exchange (LME):

The LME is the London market for trade in metals and the world Futures and Cash market for trades in non-ferrous metals, such as Aluminum, Aluminum alloy, Copper, Lead, Nickel, Tin and Zinc. There are also Exchange-traded options, available on all Futures contracts apart from Aluminum alloy. The market is daily for cash and contracts up to three months, and weekly for contracts up to 15 months. Producers and consumers use the official prices of the LME worldwide for their long-term contracts.

Q. Chicago Board of Trade (CBOT):

The CBOT is a trading center for Commodities and the largest Futures Exchange in the world. The market deals in Futures and Options on agricultural Commodities, such as Maize, Soy Bean, Crude Soy Bean oil, Soy Bean meal, Oats, but also in contracts on Gold and Silver.

Q. Chicago Mercantile Exchange (CME):

The CME - the prime US Futures and Options market - trades a huge range of Futures and Options on Commodities, above all futures contracts in livestock (live cattle, feeder cattle, live hogs, pork bellies). It is also the leader in Exchange-traded Financial Derivatives.

DOMESTIC SCENARIO

Q. Domestic Scenario

Indian markets have opened a new avenue for retail investors and traders to participate in a new financial instrument – “Commodity Derivatives”. Trading in Commodities in India started long ago, but organized trading on the electronic platform has taken its pace with the establishment of three national level exchanges viz. NCDEX, MCX and NMCE. NCDEX commenced operation from December 15, 2003 while MCX was inaugurated in November 2003 by Shri Mukesh Ambani, Chairman & Managing Director, Reliance Industries Ltd.

In India, now there are 25 recognized Futures exchanges of which there are three national level multi-commodity exchanges. With the establishment of the three exchanges, trading volume has increased tremendously with the involvement of different communities like hedgers, arbitragers and speculators. In the agro arena, NCDEX is busy counting its agri products like Pulses, Spices, Soy bean and Refined Soy oil while MCX is busy with the International Commodities like Light Sweet Crude Oil, Gold and Silver. India is a predominantly an agrarian economy and the world’s leading producer of 17 agricultural commodities with the world’s largest consumer of edible oils and gold. As on 31st March, 2009 there are 6507 Indian wholesale markets & 20868 Rural Primary markets.

BOND & DEBENTURES

Q. What are Bonds?

A. A bond is a debt security, by which you are lending money to a government, municipality, corporation, or other entity known as the issuer.

In return for the loan, the issuer promises to pay you a specified rate of interest during the life of the bond and to repay the face value of the bond (the principal) when it matures or becomes due.

Q. Why Invest in Bonds?

A. Because bonds typically have a predictable stream of payments and repayment of principal, many people invest in them to preserve and increase their capital or to receive dependable interest income.

Q. What should be the key Bond Investment Considerations?

A. There are a number of key variables to look at when investing in bonds: the bond’s maturity, redemption features, credit quality, interest rate, price and yield. Together, these factors help determine the value of your bond investment and the degree to which it matches your financial objectives.

Q. What is meant by the term Face Value?

A. Securities are generally issued in denominations of 10, 100 or 1000. This is known as the Face Value or Par Value of the security.

Q. What is the Coupon rate of the Security?

A. The Coupon rate is simply the interest rate that every debenture/Bond carries on its face value and is fixed at the time of issuance. For example, a 10% p.a coupon rate on a bond/debenture of Rs 100 implies that the investor will receive Rs 10 p.a. The coupon can be payable monthly, quarterly, half-yearly, or annually or cumulative on redemption.

Q. What is Interest Rate?

A. Bonds pay interest that can be fixed, floating or payable at maturity. Most debt securities carry an interest rate that stays fixed until maturity and is a percentage of the face (principal) amount. Typically, investors receive interest payments semiannually. For example, a Rs.1000 bond with an 8% interest rate will pay investors Rs.80 a year, in payments of Rs.40 every six months. When the bond matures, investors receive the full face amount of the bond—Rs.1, 000.

Q. What is Floating Interest rate?

A. Some sellers and buyers of debt securities prefer having an interest rate that is adjustable, and more closely tracks prevailing market rates. The interest rate on a floating—rate bond is reset periodically in line with changes in a base interest—rate index, such as the rate on Treasury bills.

Q. What is a zero Coupon Bond?

A. Some bonds have no periodic interest payments. Instead, the investor receives one payment at maturity that is equal to the purchase price (principal) plus the total interest earned, compounded semiannually at the (original) interest rate. Known as zero coupon bonds, they are sold at a substantial discount from their face amount. For example, a bond with a face amount of Rs.10, 000 maturing in 5 years might be purchased for about Rs.7130. At the end of the 5 years, the investor will receive Rs.10, 000. The difference between Rs.10, 000 and Rs.7, 130 represents the interest, based on an interest rate of 7%, which compounds automatically until the bond matures.

Q. What do you mean by the Maturity of the bond?

  • A.Securities are issued for a fixed period of time at the end of which the principal amount borrowed is repaid to the investors. The date on which the term ends and proceeds are paid out is known as the Maturity date. It is specified on the face of the instrument. Maturity ranges are often categorized as follows:
  • Short—term notes: maturities of up to five years
  • Intermediate notes/bonds: maturities of five to 12 years
  • Long—term bonds: maturities of 12 or more years

Q. What is redemption and what are the various Redemption Features?

A. On reaching the date of maturity, the issuer repays the money borrowed from the investors. This is known as Redemption or Repayment of the bond/debenture.

Call Provisions: Some bonds have redemption, or “call” provisions that allow or require the issuer to repay the investors’ principal at a specified date before maturity. Bonds are commonly “called” when prevailing interest rates have dropped significantly since the time the bonds were issued.

Puts: Conversely, some bonds have “puts,” which allow the investor the option of requiring the issuer to repurchase the bonds at specified times prior to maturity. Investors typically exercise this option when they need cash for some purpose or when interest rates have risen since the bonds were issued. They can then reinvest the proceeds at a higher interest rate.

Q. What is redemption and what are the various Redemption Features?

A. The price paid for a bond is based on a whole host of variables, including interest rates, supply and demand, credit quality, maturity and tax status. Newly issued bonds normally sell at or close to their face value. Bonds traded in the secondary market, however, fluctuate in price in response to changing interest rates. When the price of a bond increases above its face value, it is said to be selling at a premium. When a bond sells below face value, it is said to be selling at a discount. When prevailing interest rates rise, prices of outstanding bonds fall to bring the yield of older bonds into line with higher—interest new issues.When prevailing interest rates fall, prices of outstanding bonds rise, until the yield of older bonds is low enough to match the lower interest rate on new issues.

Q. What is the Yield on a Bond?

A. Yield is the return you actually earn on the bond—based on the price you paid and the interest payment you receive. There are basically two types of bond yields you should be aware of: current yield and yield to maturity or yield to call.

Q. What is Current Yield?

A. Current yield is the annual return on the amount paid for the bond and is derived by dividing the bond’s interest payment by its purchase price. If you bought at Rs.1, 000 and the interest rate is 8% (Rs.80), the current yield is 8% (Rs.80 ÷ Rs.1, 000). If you bought at Rs.800 and the interest rate is 8% (Rs.80), the current yield is 10% (Rs.80 ÷ Rs.800).

Q.What is Yield to Maturity/Yield to Call?

A. Current yield is the annual return on the amount paid for the bond and is derived by dividing the bond’s interest payment by its purchase price. If you bought at Rs.1, 000 and the interest rate is 8% (Rs.80), the current yield is 8% (Rs.80 ÷ Rs.1, 000). If you bought at Rs.800 and the interest rate is 8% (Rs.80), the current yield is 10% (Rs.80 ÷ Rs.800).

Q. What is Yield Curve?

A. The relationship between time and yield on a homogenous risk class of securities is called the Yield Curve. The relationship represents the time value of money - showing that people would demand a positive rate of return on the money they are willing to part today for a payback into the future. A yield curve can be positive, neutral or flat. A positive yield curve, which is most natural, is when the slope of the curve is positive, i.e. the yield at the longer end is higher than that at the shorter end of the time axis. This result, as people demand higher compensation for parting heir money for a longer time into the future. A neutral yield curve is that which has a zero slope, i.e. is flat across time. This occurs when people are willing to accept more or less the same returns across maturities. The negative yield curve (also called an inverted yield curve) is one of which the slope is negative, i.e. the long term yield is lower than the short term yield.

Q. How are the Interest Rates and Maturity related?

A. Changes in interest rates don’t affect all bonds equally. The longer it takes for a bond to mature, the greater the risk that prices will fluctuate along the way and that the fluctuations will be greater—and the more the investors will expect to be compensated for taking the extra risk. There is a direct link between maturity and yield.

Q. Who are institutional investors in the Indian Debt Market?

A. Institutional investors operating in the Indian Debt Market are: Banks, Insurance companies, Provident funds, Mutual funds, Trusts, Corporate, treasuries, Foreign investors (FIIs).

Q. What factors determine interest rates?

A. When we talk of interest rates, there are different types of interest rates - rates that banks offer to their depositors, rates that they lend to their borrowers, the rate at which the Government borrows in the bond/G-Sec, market, rates offered to small investors in small savings schemes like NSC rates at which companies issue fixed deposits etc.

The factors which govern the interest rates are mostly economy related and are commonly referred to as macroeconomic. Some of these factors are:

  • Demand for money
  • Government borrowings
  • Supply of money
  • Inflation rate
  • The Reserve Bank of India and the Government policies which some of the variables mentioned above.

Q. What is record date/shut period?

A. G-Sec/Bonds/Debentures keep changing hands in the secondary market. Issuer pays interest to the holders registered in its register on a certain date. Such date is known as record date. Securities are not transferred in the books of issuer during the period in which such records are updated for payment of interest etc. Such period is called as shut period.

Q. What do you mean by "Cum-Interest" and "Ex-Interest"?

A. Cum-interest means the price of security is inclusive of the interest accrued for the interim period between last interest payment date and purchase date. Security with ex-interest means the accrued interest has to be paid separately.

Q. What are G-Secs?

A. G-Secs or Government of India dated Securities are Rupees One hundred face-value units / debt paper issued by Government of India in lieu of their borrowing from the market. These can be referred to as certificates issued by Government of India through the Reserve Bank acknowledging receipt of money in the form of debt, bearing a fixed interest rate (or otherwise) with interests payable semi-annually or otherwise and principal as per schedule, normally on due date on redemption.

Q.What are ‘Gilt edged’ securities?

A. The term government securities encompass all Bonds & T-bills issued by the Central Government, state government. These securities are normally referred to, as "gilt-edged" as repayments of principal as well as interest are totally secured by sovereign guarantee.
'Gilt Securities' are issued by the RBI, the central bank, on behalf of the Government of India. Being sovereign paper, gilt securities carry absolutely no risk of default.

Q. What is Inflation linked bond?

A. These are bonds for which the coupon payment in a particular period is linked to the inflation rate at that time - the base coupon rate is fixed with the inflation rate (consumer price index-CPI) being added to it to arrive at the total coupon rate. The idea behind these bonds is to make them attractive to investors by removing the uncertainty of future inflation rates, thereby maintaining the real value of their invested capital.

Q. What is SDL?

A. State government securities (State Loans): These are issued by the respective state governments but the RBI coordinates the actual process of selling these securities. Each state is allowed to issue securities up to a certain limit each year. The planning commission in consultation with the respective state governments determines this limit. Generally, the coupon rates on state loans are marginally higher than those of GOI-Secs issued at the same time.

Q. What is a PSU Bond?

A. Public Sector Undertaking Bonds (PSU Bonds): These are Medium or long term debt instruments issued by Public Sector Undertakings (PSUs). The term usually denotes bonds issued by the central PSUs (i.e. PSUs funded by and under the administrative control of the Government of India). Most of the PSU Bonds are sold on Private Placement Basis to the targeted investors at Market Determined Interest Rates.

Q. What is a Debenture?

A. A Debenture is a debt security issued by a company (called the Issuer), which offers to pay interest in lieu of the money borrowed for a certain period. In essence it represents a loan taken by the issuer who pays an agreed rate of interest during the lifetime of the instrument and repays the principal normally, unless otherwise agreed, on maturity. These are long-term debt instruments issued by private sector companies. These are issued in denominations as low as Rs 1000 and have maturities ranging between one and ten years.

Q. What is the difference between a bond and a debenture?

A. Long-term debt securities issued by the Government of India or any of the State Government’s or undertakings owned by them or by development financial institutions are called as bonds. Instruments issued by other entities are called debentures. The difference between the two is actually a function of where they are registered and pay stamp duty and how they trade.

Q. What are the different types of debentures?

A. Debentures are divided into different categories on the basis of Convertibility of the instrument and security On the basis of convertibility, debentures are classified into:

Non Convertible Debentures (NCD): These instruments retain the debt character and can not be converted in to equity shares

Partly Convertible Debentures (PCD): A part of these instruments are converted into Equity shares in the future at notice of the issuer. The issuer decides the ratio for conversion. This is normally decided at the time of subscription.

Fully convertible Debentures (FCD): These are fully convertible into Equity shares at the issuer's notice. The ratio of conversion is decided by the issuer. Upon conversion the investors enjoy the same status as ordinary

Optionally Convertible Debentures (OCD): The investor has the option to either convert these debentures into shares at price decided by the issuer/agreed upon at the time of issue.

On the basis of Security, debentures are classified into:
Secured Debentures: These instruments are secured by a charge on the fixed assets of the issuer company. So if the issuer fails on payment of the principal or interest amount, his assets can be sold to repay the liability to the investors Unsecured Debentures: These instrument are unsecured in the sense that if the issuer defaults on payment of the interest or principal amount, the investor has to be along with other unsecured creditors of the company.

Q. What are the different types of debentures?

A. RBI: The Reserve Bank of India is the main regulator for the Money Market. Reserve Bank of India also controls and regulates the G-Secs Market. Another major area under the control of the RBI is the interest rate policy. Earlier, it used to strictly control interest rates through a directed system of interest rates. Each type of lending activity was supposed to be carried out at a pre-specified interest rate. Over the years RBI has moved slowly towards a regime of market determined controls.

SEBI: Regulator for the Indian Corporate Debt Market is the Securities and Exchange Board of India (SEBI).

SEBI controls bond market and corporate debt market in cases where entities raise money from public through public issues.

Apart from the two main regulators, the RBI and SEBI, there are several other regulators specific for different classes of investors, e.g. the Central Provision Fund Commissioner and the Ministry of Labour regulate the Provident Funds.