Financial Instruments

Group 4
14P002
14P012
14P046
14P053
14P058
14P060

Abhinav Garg
Ashima Chhabra
Shashank Gupta
Swati Shahani
Vishal Garg
Wazeem Ashraf

What is a Financial Instrument?

A document (such as a check, draft, bond,

share, bill of exchange, futures or options
contract) that has a monetary value or
represents a legally enforceable (binding)
agreement between two or more parties
regarding a right to payment of money.

Financial Instruments
Debentures/Bonds
Debentures/Bonds

Debt
Capital
Capital
Market
Market

Common
Common
Equity
Equity

Financial
Instruments

Zero
Zero Coupon
Coupon

Preference
Preference
Convertible
Convertible Preference
Preference

Money
Money
Market
Market

Treasury
Treasury
CDs
CDs
Futures
Futures

Derivatives
Derivatives

Options
Options
Forwards
Forwards
Swaps
Swaps

Commercial
Commercial Paper
Paper
Call/Notice/Term
Call/Notice/Term Money
Money

Debt Market Instruments

BONDS are fixed income instruments which are issued for

the purpose of raising capital

They are issued by both private and public entities

Government Bonds

Corporate Bonds

Bonds issued by the RBI on

behalf of the Government
They carry the lowest level
of risk
They are characterised by
their maturity period:

Higher Yield, Higher Risk

The company's credit quality is
very important: the higher the
quality, the lower the interest
rate the investor receives
Types:
i. Callable Bond - redeemed
by the issuer prior to its
maturity
ii. Convertible bond that
can be converted into
common stock

i. Bills less than 1 year

ii. Notes 1-10 year
iii. Bonds more than 10
year

Debt Market Instruments

Maturity - predetermined period of time of bond

Par Value Face value of bond

Coupon Premium the borrower has to pay

Zero Coupon Bond: A debt security that

doesn't pay interest (a coupon). At maturity,
investor receives face value
For example, let's say a zero-coupon bond
with a Rs.1,000 par value and 10 years to
maturity is trading at Rs. 600 (at a discount)
then you will be paying Rs. 600 today for a
bond that will be worth Rs.1,000 in 10 years.

Equity Instruments

Two sources of equity funds:

Internal Reserves

Part of the existing equity of the company

Profits earned by the company used for investment needs

Fresh Equity

Raised using specific financial instruments which can be traded.

Equity instruments are of two types

Common Shares

Preference Shares

Equity Instruments
Common Shares

Preference Shares

Represent ownership in a company

Carry a fix rate of dividend

Carry voting rights

Dont carry voting rights

Face value/Par value is set when the

share is first issued

Shares of listed companies are traded

on various stock exchanges

Preferential rights to dividends &

companys assets (upon liquidations)
over common shareholders

Types

Common Shareholders have the last

claim on profit as well as dividends

Cumulative
Redeemable
Convertible

Money Market Instruments

Treasury Bills

Treasury Bills are short term money market instruments with a

maturity of generally 14 / 91 / 182 / 364 days. Currently, RBI
issues T. Bills of maturity of 91 and 364 days.
They are issued at discounted value. The difference between
issueprice and face value (maturity value) is the earning or
return for the investor.
They are issued through the process of auction
Banks, Financial Institutes, Insurance companies, mutual
funds,primary dealers and large corporates who have large
short term funds generally invest in T. Bills
Investments in T. Bills are considered part of SLR securities
forbanks and therefore, they are encouraged to invest in this
instrument in spite of low returns. Also, they are highly liquid
on account of secondary market transactions between banks

Commercial Paper

Commercial papers are issued for the purpose of raising

short term resources for the issuers at very low rates.
CPs are short term, unsecured, with fixed maturity issued
by corporates, financial institutes, primary dealers etc.
Maturity of CPs varies between 15 days to 360 days
CPs are issued at discounted rate and the difference
between issue price and the face value is yield for the
investor
They can be issued in denomination of Rs 5 lacs and in
multiple of Rs 5 lacs.
Individuals (having large net worth), corporates, financial
institutions, insurance companies, banks etc can invest in
this instrument since they have large fund for
investments.

Commercial Paper

Company, to be eligible to issue CPs should have

a tangible net worth (paid-up capital + free
reserves) of at least Rs 4 cr.
Company must obtain a rating for the issue of
commercial papers from a specified rating agency
such as CRISIL, ICRA or CARE. The rating must be
current and not lapsed. Higher the rating of the
company, company would be in a better position
to negotiate favorable rate of interest with the
investor.
Commercial papers are traded in secondary
market and therefore a liquid instrument

Certificate of Deposit (CD)

Acertificate of deposit(CD) is atime depositwith a bank.

Acertificate of deposit(CD) is a fixed-deposit investment option
offered by banks and lending institutions

They bear a specific maturity date (from three months to five

years), a specified interest rate

It offers higher interest rates than conventional savings

accounts because it requires investors to deposit funds for a
specified term ranging from one month to more than five years

However, like savings accounts, CDs are a secure form of

investment, as they are insured by government agencies

Cannot be withdrawn prior to maturity without paying a penalty

Used by individuals/businesses/financial institutions to store

their liquid funds

Relatively safe instruments

Longer the term, better the yield

Call/Notice/Term Money

The money market primarily facilitates lending and borrowing

of funds between banks and entities like Primary Dealers.

Call moneyis short-termfinancerepayable on demand, with a

maturity
periodof one to fifteen days,
used for inter-bank transactions
The money that is lent for one day in this market is known as
call money and, if it is for a period between 2 to 14 days, it
is referred to as notice money
And Term Money refers to borrowing/lending of funds for
period exceeding 14 days
The interest rates on such funds depends on the surplus funds
available with lenders and the demand for the same which
remains volatile

Derivatives

Derivatives , speaking broadly, is a price

guarantee. A Derivative is a contract between
a future buyer and a future seller (for a thing
called underlier ) which can be or must be sold
at a future date.
There are 4 basic kind of derivatives:
Future
Forward
Options
Swap

Derivatives

Forward

Tailored contract between two parties, where payment takes

place at a specific time in the future at today's pre-determined
price.

Future

Future contracts to buy or sell an asset on or before a future

date at a price
specified today.
Future
Forward

Exchange Traded, therefore

standardized

Private contracts, Not as rigid as

Future

Clearing houses guarantee the

transaction, lower chance of default

Higher probability of default

Marked-to-market daily, hence settled Only one settlement date i.e at the
day by day until the end of the
end of the contract
contract
Employed by speculators, who bet on
changes in an asset's price. Actual
trade of commodity unlikely

Mostly used by hedgers who want to

eliminate the volatility of an asset's
price. Actual delivery of commodity is
likely

Derivatives

Swap

Agreement to exchange two streams of cash-flows over a

period of time.
Can be based on interest rates, foreign exchange and
commodity prices.
Allows companies to borrow capital at a fixed rate(or floating)
and then exchange it for floating rate(or fixed) if it desires so.
Also allows companies to switch its loan and interest payments
from one currency into another. This helps companies manage
their foreign currency risks.

Options

Options are contracts that give the owner the right, but not
the obligation, to buy (call option) or sell (put option) an
asset